Baylin Technologies Inc

TSX:BYL

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Baylin Technologies second quarter investor conference call. [Operator Instructions] Thank you. Randy Dewey, CEO of Baylin Technologies, you may begin your conference.

[Randy L. Dewey, President, CEO & Director]

Thank you, operator. Hello, and welcome everyone. Thank you for joining us this morning for the Second Quarter 2018 Earnings Conference Call for Baylin Technologies. Joining me is our Chief Financial Officer, Mr. Michael Wolfe. He'll provide an overview of our financial results. We will both be available for questions at the end of the presentation. So before we begin our report, let me make it clear that our comments today will include statements and answers to questions that could imply future events, such as our 2018 prospects and financial performance and could include the use of non-GAAP and non-IFRS measures. Though it's obvious these statements are subject to risks, uncertainties and assumptions, accordingly, actual performance could differ materially from statements made today, so do not place undue reliance upon them. We also disclaim any obligation to update forward-looking statements, except as required by law. I ask that you read our legal disclaimer and refer to the risks and assumptions outlined in our public disclosure, in particular, the Risk Factors section of our annual information form, which is dated February 28, 2018, and our prospectus update dated July 3, 2018, to a short form bay shelf prospectus dated November 16, 2017, all of which are available on SEDAR.Q2 results were released after market yesterday. The press release, unaudited interim financial statements as well as the MD&A are available on SEDAR and on our website at baylintech.com. I'd like to provide a brief overview of our financial results, comment on each of our 3 product lines and then discuss our recent acquisition, after which, I will ask Michael to cover the details of our financial results. So revenue grew to $32.6 million in the second quarter of 2018, an increase of $12.2 million over -- which is over 60.1% over the second quarter of 2017. The increase is primarily due to the increase in our sales of Wireless Infrastructure products, which grew 164% compared to the second quarter of 2017, combined with the addition of revenue from Advantech Wireless, which was acquired in January of this year. Revenue from Embedded Antenna products increased by 31% compared to the second quarter of 2017 due largely to a couple of platforms, major platforms that were launched in November of last year. EBITDA before nonrecurring expenses of $365,000 was $2.9 million, an increase of $2.5 million compared to the second quarter of 2017. In January of this year, we acquired the radio frequency, terrestrial microwave and antenna equipment divisions of Advantech Wireless Inc. During the first 6 months of owning the business, sales and margin performance were slightly behind our expectations primarily due to pre-acquisition legacy issues, including inventory shortages and some long supplier lead times. We have started to implement corrective actions, which have already resulted in some positive improvement there. On July 10, we completed a bought deal public offering of subscription receipts and convertible debentures for aggregate gross proceeds of $40.25 million. The offering was underwritten by a syndicate of underwriters led by Raymond James and including Paradigm Capital and National Bank Financial. On July 11, we acquired Alga Microwave, a leading supplier of radio frequency and microwave products. This is very synergistic with our Advantech acquisition, which will help us to further extend our rapidly growing radio frequency and microwave components business. Alga's state-of-the-art facility, which we also acquired, is situated in very close proximity to Advantech, and we will begin moving Advantech's operations into the Alga facility. Alga's modern factory and precision machining capability will allow us to control more of our supply chain and provide for rapid product development. Additionally, Alga brings extensive high-frequency, passive microwave component capability, expanding our addressable market today. Bringing together both Advantech's broad portfolio of sales and marketing channels, along with Alga's manufacturing efficiencies, product and passive components capabilities, this will allow us to address a wider, more diversified market and provide our customers with broader networking solutions. We look forward to working with the team at Alga. The Alga principals, Michael Perelshtein and Frank Panarello, continue to hold executive management positions at Alga following the acquisition and will be instrumental in accelerating our improvement and our efficiencies. I'd like to turn the call over to Michael to provide you with a little bit more commentary and details on our financial results. Michael?

[Michael A. Wolfe, Chief Financial Officer]

Thank you, Randy. Good morning. Revenue for the second quarter of 2018 was $32.6 million compared to $20.3 million for the prior year period, representing a 60.1% increase. The increase is primarily due to the increase in sales of the Wireless Infrastructure product line, combined with the addition of revenue from Advantech Wireless and offset somewhat by lower revenue generated by Asia Pacific, which decreased by 17% in Q2 compared to the prior year due to lower sales of certain products of a major Asia Pacific customer. Gross profit was $13 million in the second quarter of 2018, an increase of $6.2 million over the second quarter of 2018 -- sorry, 2017 and gross margin was 40.1% in the second quarter of 2018, improved by 7 percentage points compared to the second quarter of 2017. The improvement is a result of higher, small cell antenna sales, which generate a higher gross margin. Operating expenses, which consist of research and development costs, selling and marketing costs, general and administrative costs and acquisition expenses were $11.5 million. Acquisition expenses relating to the Advantech Wireless acquisition were $638,000, consisting primarily of consulting fees paid to the Advantech vendors and additional legal fees. The increase in operating expenses from the prior year was primarily due to the addition of Advantech Wireless expenses, offset by a restructure provision and impairment charge recorded in the second quarter of 2017 related to the closure of Galtronics operations in Israel, amounting to $0.9 million. Adjusted EBITDA for the second quarter of 2018 was $2.9 million, a significant increase compared to $0.4 million in the second quarter of 2017. The improved adjusted EBITDA compared to 2017 was due primarily to higher revenue with higher gross margins. At June 30, 2018, we had a cash balance of $6.2 million. Subsequent to the end of the quarter, we completed a bought deal public offering of 7.4 million subscription receipts and 17.25 million principal amount of 6.5% extendible convertible unsecured debentures for aggregate proceeds of $40.25 million. On July 11, 2018, each subscription receipt was converted into 1 common share. We used $21 million of the net proceeds from the offering for the cash portion of the purchase price of the Alga acquisition. The remainder of the net proceeds, together with our cash balance prior to the offering, will be used for capital expenditures, working capital and general corporate purposes, which may include the additional compensation that will be payable to Alga -- will be payable if Alga meets certain performance targets, refinancing a portion of the debt relating to the premises in which Alga's operations are conducted, moving and other expenses related to the move of Advantech's operations into the Alga facility and the repayment of the remaining outstanding balance of a short-term credit facility with a bank in China. The purchase price for the Alga facility was satisfied in part by the assumption of existing debt with the balance payable to the vendor 1 year after closing, bearing interest at 8% per annum, payable quarterly and repayable at any time without penalty. Noncash working capital increased by $9.4 million from the beginning of the year due primarily to the addition of Advantech Wireless receivables and inventory, offset by Advantech Wireless payables. At June 30, 2018, we had drawn $1.4 million of our available credit lines, which totaled $10.8 million. We expect to repay the outstanding balance over the coming months. In connection with the Advantech acquisition, we entered into a term loan with Crown Capital. The principal amount is $33 million. Subsequent to the end of the quarter, we issued convertible debentures in the amount of $17.25 million, assumed debt secured against the Alga facility in the amount of approximately $3 million and borrowed approximately $3.2 million from the vendor for the Alga facility purchase. In total, we currently have short- and long-term debt in the amount of $57.8 million. At June 30, 2018, our net debt to trailing 12-month EBITDA annualized for the Advantech acquisition was approximately 2.2:1. The ratio has increased to 2.4:1 with the inclusion of the convertible debentures, Alga facility debt and Alga acquisition. We believe this remains a conservative amount of debt given our current cash flow from operations, and we expect the debt ratio to decline as operating cash flows increase going forward. I'll now turn the call back to Randy for his concluding remarks.

[Randy L. Dewey, President, CEO & Director]

Thank you, Michael. So the outlook for 2018 continues to be very positive. We expect that the strategic acquisitions of Advantech Wireless and Alga will accelerate growth by broadening our product offering and providing access to new verticals and markets, and will contribute to the diversification of the company's revenue base. We believe there's significant revenue and cost energy opportunities to be leveraged between the 2 businesses given these synergies with a key focus for us during the remainder of 2018. So we continue to invest in our engineering operations to broaden our product offering in each of our product lines and expect some quarter-over-quarter expense increases to 2018. Manufacturing of initial product units of small cell antennas commenced in our contract manufacturing facility in Guadalajara, Mexico in the second quarter of 2018. We expect production to ramp up over the next several months. That concludes my formal remarks. And with that, can I open up the call for operators -- sorry, for questions, operator?

[Operator]

[Operator Instructions] And the first question comes from the line of Daniel Kim from Paradigm Capital.

[Daniel Kim]

Apologies for this, gents. I missed just some of your earlier commentary. In terms of the year-over-year growth rates for each of your operating divisions, could you give those numbers again, please?

[Michael A. Wolfe, Chief Financial Officer]

Actually, we didn't give those. You didn't miss anything, Daniel. We gave the overall from last year to this year, was with 60.1%. Sorry, let me go back. Sorry, there was -- we did break down one piece here. Where is it?

[Daniel Kim]

Asia Pacific, I believe was down 17%, I believe, you said in the commentary then I was -- and I think you referenced the other 2 units as well.

[Michael A. Wolfe, Chief Financial Officer]

Yes, yes. The Wireless Infrastructure grew 164% compared to Q2 last year, and Embedded grew 31% compared to Q2 last year, largely in part by the 2 major platforms as we've mentioned, that we had launched in November of last year.

[Daniel Kim]

Right, okay, great. With regards to what's happening on the base station side, can you talk about how that business is ramping up? Because I believe you had some early wins beginning in Q1, if I -- if memory serves, and that was expected to hopefully ramp up for balance of the year. Can you talk about how that is progressing?

[Randy L. Dewey, President, CEO & Director]

Yes, order book is strong. We've got -- certainly as we've been press releasing the launch of some of our newer base station products, most in the form of -- with antennas, those have been launching -- I can't remember the exact number, but there's been quite an expansion of our line. And as we have talked about historically, there's a lot of very unique requirements in the United States in certain cities. So we've had a lot of really good inquiries to sort of change the form factor and increase the size or decrease the size in certain -- so we've launched a lot of sort of children-to-the-parent antenna, and we've got strong backlog against our small cell product line.

[Daniel Kim]

Great, okay. And one metric that you shared with us or, at least, we understood from maybe a quarter or 2 ago is the small cell, the number of designs that were coming out of -- particularly out of -- because -- as a result of your new facility in Ottawa. Can you talk about where that stands today in terms of new designs and/or wins or traction in the end market?

[Randy L. Dewey, President, CEO & Director]

Well, I can't, but maybe I'll share one important metric that we sort of follow internally. The design concept to revenue has increased dramatically since our move from Israel to Ottawa. So in -- historically speaking, we -- designs to revenue in Israel was around 10%, which is not a very good number. Obviously, it's lower than the industry's standard. Today, we're at 90% of the things that are designed in Ottawa converted to revenue. So the -- just being in the stream of information, having our design center in the market in which it serves and being part of the -- as you know, we moved to sales team -- we hired a sales team in the United States and closer to the market with a lot of experience, so we're certainly much better positioned today than we've ever been to be in that market, and we're converting ideas into real revenue at a rate that's been exceptional. It's above industry. It's actually above industry standard. That's typically around 50%, so we're above the standard.

[Daniel Kim]

Right. Well, impressive improvement. So if we look -- so staying on the small cells, if we look at what's happening with your Mexico facility, can you talk about or disclose what the capacity is with your partner there and how that's going to ramp up over time?

[Randy L. Dewey, President, CEO & Director]

Well, not that it's unlimited, but it is kind of close to that because it's a contract manufacturer. As you know, their business is to scale with the customer, and they've got a very significant amount of available capacity and space. Obviously, the biggest hurdle for us to climb this year was to help them learn how to make these types of sophisticated products and have made these types of RF antennas before. So we're still in the throes of that. We're, I would say, on plan. There's no burning need because all of our capabilities can be handled and more out of Wuxi. So the ability to swing over into Mexico is in advance of what we're hoping to be a very bullish few years in front of us and having them to be able to scale with us. So I don't see any capacity constraints if that's your question. Mostly the seeds we're sowing today are just helping the CMs become capable of making these types of products at the degree and quality level that are required to be into the network.

[Daniel Kim]

Okay, great. Moving onto acquired assets, on the Advantech side, Randy. Can you share with us if that asset is performing as you would expect in terms of revenue and EBITDA contribution in the quarter?

[Randy L. Dewey, President, CEO & Director]

So we said -- I said earlier on the call, you may have missed it that -- we were slightly behind in a number of metrics. But everything that we've dealt with in the first 6 months of ownership have been issues, but they're not systemic problems. They're just issues that we're just to going to have to fix and we actually and frankly have fixed most of those and have a few in front of us that we have a clear path to adjusting. So I'm not overly [ fussed ] by the things that we've seen in post ownership. There's always things you learn, but nothing that we're facing today isn't something we can accomplish. And then, particularly with the exceptional group that we hired with Alga and Michael and Frank and their operational prowess, we are really comfortable with our go forward. I think the Alga acquisition was a great step, and we brought some great people and we've got the ability to actually get beyond what we expected with Advantech. It takes some time, of course. We've got a couple of quarters here to get the integration work done and get the move completed and get things moved out but -- and at the same time, deliver on the result that we're striving for. But yes, I'm very happy where we are sitting here today.

[Daniel Kim]

Great, great. So on that, so if we look at now to 2 big asset acquisitions, obviously, your plate is full here, Randy. But in terms of what you see in terms of timing and magnitude, could you give us a sense of what type of synergies we can derive out of these 2 assets with your existing operations?

[Randy L. Dewey, President, CEO & Director]

Yes, sure. So I can, certainly, as you know, I could talk to consensus on this, we certainly don't give guidance, but part of the synergies that were anticipated with the amalgamation of these businesses and with some of the synergies that we are expecting out of Advantech without Alga, it's looking at $5 million of OpEx improvement by 2019, and that's the number that has been the consensus between the analysts, and we're comfortable with that number. So we are, obviously, driving, and I'm not losing sleep over it.

[Daniel Kim]

Very good. Last question. With regards to some of the things we've been seeing in the industry, as of late, it seems like the infrastructure built for 5G is happening at a faster pace than I think people had anticipated or, at least, myself. More recently, we saw an announcement from T-Mobile, as an example, it sounds like one of the biggest deals I've seen, for $3.5 billion to get -- to acquire 5G equipment from Nokia. And we're seeing similar-type ramp up, at least on the infrastructure side for early buildouts for 5G from both AT&T, Verizon. Can you comment at all, Randy, with regards to now your new product portfolio and your new capabilities in millimeter wave, what you're seeing and what potential impact this might have in your business in the near and long term?

[Randy L. Dewey, President, CEO & Director]

Sure. So the one interesting point that you raised about the article is that they're referenced to 28 gigahertz. Obviously, T-Mobile is making a very bold move very early in the genesis year of the 5G evolution, so we're pretty excited about the announcement. We know both companies obviously, Nokia as well as the T-Mobile. So we're -- they're very close partners with us, so we know them quite well. So we're very excited about the announcement because it is, obviously, a precursor. They're accelerating some of their development. But every carrier right now is involved to varying degrees of development of 5G. And as you can well imagine, the amount of work that has to happen in the active component radio side to get ready for the 5G rollouts is significant. We're starting to hear, obviously, an announcement. I would say, you're right, in the sense that there's -- it's a bit more accelerated than maybe, but it is a mammoth, mammoth network to be built. It's not a refresh of LTE. This is a brand-new network. A lot of the previous network generations were augmenting the older -- or the last version. This is a full, brand-new network that has to be built out and the CapEx requirements for all the carriers to build that kind of a network is just enormous. So I'm excited to hear the amount of noise and press releases about it, but it's still a ways away. It's not like coming tomorrow.

[Operator]

[Operator Instructions] Our next question comes from the line of Steven Li from Raymond James.

[Steven Li, Senior Vice President]

Randy, the Advantech tracking a little bit behind. How much are we talking about this quarter, is it like $1 million?

[Randy L. Dewey, President, CEO & Director]

No, it's not $1 million. It is slightly behind. It's single-digit percentages. It's not that significant, but it's more of a large order that didn't quite make it out at the end of the quarter. So it's not like it's a lost opportunity. It was more of a timing issue, and there's a couple of supplier lead times that were a little longer, just some issues with long lead times on certain components. So anyways, it was really just a timing issue, not so much a material problem issue, that's for sure.

[Steven Li, Senior Vice President]

Okay. And can you get back to your original run rate expectation in the second half for Advantech?

[Randy L. Dewey, President, CEO & Director]

Yes, yes. We absolutely believe we are on track. And if I look at the bookings of the business today, it's at a very -- it's at the highest level actually. So we're bullish that we'll be back on our plan for the second half of 2018.

[Steven Li, Senior Vice President]

Okay, great. And Randy, mobile was down 17%. How should we think about for the year? I mean, should we be thinking more like down 5% for the year or maybe even 10%?

[Randy L. Dewey, President, CEO & Director]

Yes. You can certainly see it's very well-publicized that that handset manufacturer's been off of their original forecast. They reported their quarter last week, and they were citing numbers that were higher than the 17%. So yes, I would look at it that way for sure. They're not -- there's going to be some softness in the second half and that would be certainly consistent with their guidance as well.

[Steven Li, Senior Vice President]

Okay, great. The infrastructure, on the other hand, was much stronger than expected. Trying to figure out if this quarter, were there any seasonality or when I think about the second half, you continue to grow from that Q2 base or should we expect seasonality and a dip sometime?

[Randy L. Dewey, President, CEO & Director]

I certainly wouldn't expect that for Q3, maybe slightly in Q4, but the second half of the year, we don't anticipate to be anything -- or certainly not less than the first half of the year.

[Steven Li, Senior Vice President]

Sorry, did you say you expect some seasonality in Q3 or Q4, did you say it, Randy?

[Randy L. Dewey, President, CEO & Director]

Four, Q4. Particularly with small cells, the outdoor buildouts can be a little bit -- on the northern states can be a little bit softer in Q4 obviously, for weather reasons, but the second half of the year will certainly -- we expect to be ahead of the first half of the year.

[Steven Li, Senior Vice President]

Okay, makes sense. And your press release, as stated, you started production with small cell antennas with Jabil in Q2. Any color you can share with us on this new contract? I mean, is it -- can it materially move -- increase your run rate infrastructure revenues this year or this is more in 2019?

[Randy L. Dewey, President, CEO & Director]

Certainly, it will have some 2018 benefit, but really the lion's share of the benefit will be in 2019 and beyond, for sure, but it is -- it has benefit for sure in '18.

[Steven Li, Senior Vice President]

Okay. Just a question on cash flow. You're not quite there, I think, in terms of cash generation. All that working capital, I mean what is it for? And does it continue in the second half?

[Randy L. Dewey, President, CEO & Director]

No. As we had mentioned earlier, we had some long supplier lead times and then we had, of course, a very interesting sort of backlog that we had to address when we took over the Advantech. So it required some additional cash, but we actually don't believe that the run rate for the second half of the year. Obviously, if we have a stronger second half than first half, the only working capital needs would be in just general working capital requirements to supply a higher sales run rate, but it won't be addressing some of the shortfalls in inventory that are required to address the inventory that we -- or sorry, the forecast that we took over.

[Steven Li, Senior Vice President]

Okay. And so the way I should think -- I mean, once all these normalize here, how much free cash flow should we think Baylin can generate?

[Randy L. Dewey, President, CEO & Director]

Michael, you had -- would you...

[Michael A. Wolfe, Chief Financial Officer]

It's really not something we're going to -- we have to disclose at the moment. Sorry, Steven.

[Steven Li, Senior Vice President]

Okay. All right, that's fine. And then one last question. So the earn-outs for Advantech, if I remember, I think $0.75 million to $3 million in both '18 and 19. Does it show up on your balance sheet as a liability at some point?

[Randy L. Dewey, President, CEO & Director]

I missed the beginning of that. The beginning...

[Steven Li, Senior Vice President]

The earn-outs for Advantech.

[Michael A. Wolfe, Chief Financial Officer]

Yes, we did a present value calculation and it shows up on -- let me just pull the exact line item on the balance sheet. It's in other long-term liabilities.

[Steven Li, Senior Vice President]

And how much is that amount today?

[Michael A. Wolfe, Chief Financial Officer]

$631,000.

[Steven Li, Senior Vice President]

Okay. So it's in line with the comments that they're tracking behind, what you thought they should be doing?

[Michael A. Wolfe, Chief Financial Officer]

Yes, and the thresholds that are required to meet it. So it's not necessarily because they're tracking behind, but there were aggressive thresholds for the company to achieve to even hit the bottom end of that.

[Operator]

We have no further questions in queue. I'll turn the call back to the presenters for closing remarks.

[Randy L. Dewey, President, CEO & Director]

Good news. So thank you. And in closing, I think that the most important takeaways from this quarter, for us, following the sort of 3 areas. And I think if you take a note of the margin performance, we finally broke back through 40%, which has been a number of years since we hit that threshold, but we're now there and through it. The second one is the adjusted EBITDA is ahead of consensus and it's our tenth straight quarter of positive adjusted EBITDA. Obviously, completing 2 acquisitions in the first 2 quarters of the year was exceptional, but it's also the technology that comes with it and the position of those companies that are -- they have in their own markets as well as what it does as well for the Baylin platform. So we're quite excited about those accomplishments as well. And I think additionally, the trends to watch out for in the coming quarters. One is going to be our cash position and to Steven's earlier question, watching the cash generation of the company is going to be important. Obviously, in Q3, we're going to have a little bit of noise in our financials because of the acquisition costs. So if you can just sort of glean through that performance when we get to the reporting of it, I think that's important for folks to look through. As well watching our net income, and we certainly are excited that we're a positive net income. Moving forward, that's going to be a very important point for us. We're going to be hyper-focused on cash flow and hyper-focused on cash generation over the next 4 quarters as we really smooth out these assets that we bought, get the integration work done and looking forward to solid, consistent financial performance certainly is our goal. So thanks, everybody, for all your support and interest in the company, and we look forward to communicating with you in the future. Thanks.

[Operator]

This concludes today's conference call. You may now disconnect.