Baylin Technologies Inc

TSX:BYL

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Baylin Technologies Third Quarter Investor Conference Call. [Operator Instructions] I will now turn the call over to Mr. Daniel Kim, Executive Vice President, Corporate Development, of Baylin Technologies. Mr. Kim, you may begin.

[Daniel Kim]

Good morning, and welcome, everyone. Thank you for joining us this morning for the Third Quarter 2018 Earnings Conference Call for Baylin Technologies. Joining me is our CEO, Mr. Randy Dewey; and our CFO, Mr. Michael Wolfe, who will provide an overview of our financial results. We'll all be available for questions at the end of the presentation. 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 and '19 prospects and financial performance, and could include the use of non-GAAP and non-IFRS measures. Though it is obvious, these statements are subject to risks and 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, that is except as required by law. I ask that you read our legal disclaimers and refer you to the risks and assumptions outlined in our public disclosures, particularly the risk factors section in our AIF dated February 28, 2018 and our prospectus supplement, dated July 3, 2018, to a short form-based shelf prospectus dated November 16, 2017, all of which are available on SEDAR. Q3 results were released after market yesterday. The press release, unaudited interim financial statements as well as the MD&A are available on SEDAR and our website at baylintech.com. Now I'd like to turn over the call to our CEO, Randy Dewey, to provide some comments.

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

Thank you, Daniel. I'd like to provide a brief overview of our financial results, comment on our 4 product lines, after which I will ask Michael to cover the details of our financial results. Revenue increased to $38.2 million in the third quarter of 2018, an increase of $11 million over -- 40.7% over the third quarter of 2017. The increase is primarily related to the increase in our Embedded Antenna as well as Wireless Infrastructure product lines, combined with our addition of revenue from the 2 acquisitions that we closed earlier this year. Wireless Infrastructure revenue grew by 24% compared to the third quarter of 2017, and revenue from Embedded Antenna products increased by 18% compared to the prior year quarter, due largely to 2 major platforms that were launched in November of last year. EBITDA before acquisition costs and other nonrecurring expenses was $7.1 million, an increase of $4 million compared to the third quarter of 2017. In January, we acquired the radio frequency, terrestrial microwave and antenna equipment divisions of Advantech Wireless Inc. As I discussed in our last earnings call, during the first 6 months of owning the business, sales and margin performance were slightly behind our expectation, primarily due to the preacquisition legacy issues, including inventory surges and long supplier lead times. Corrective actions were implemented which have resulted in positive improvement. In addition, as a result of an indemnity claim related to the preacquisition issues, we received a payment of approximately $1.8 million from the portion of the purchase price being held in escrow. This payment compensated us for Advantech's lower profitability in the first 2 quarters of this year caused by preacquisition issues. 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 and will help to further expand our rapidly growing satellite communications product line. Alga's state-of-the-art facility, which also was acquired, is situated in close proximity to Advantech, and we are in the process of moving Advantech's operation into the Alga facility. We've been somewhat delayed in implementing the move due to several permitting issues, but we remain on track to complete the move by the end of this year. Both Advantech and Alga, which manufacture and sell our satellite communications product line, report strong sales and margins in the quarter and significantly contributed to our record third quarter financial results. I'd now like to turn the call over to Mr. Michael Wolfe to provide you more commentary and details on our financial results. Michael?

[Michael A. Wolfe, Chief Financial Officer]

Thank you, Randy. Revenue for the third quarter of 2018 was $38.2 million compared to $27.1 million for the prior year period, representing a 40.7% increase. As Randy mentioned, the increase was primarily due to the increase in sales of the Embedded Antenna and Wireless Infrastructure product lines, combined with the addition of revenue from Advantech Wireless and Alga Microwave, and offset somewhat by lower revenue generated by Asia Pacific, which decreased by 15% in Q3 compared to the prior year due to lower sales of certain products of a major Asia Pacific customer. Gross profit was $16.2 million in the third quarter of 2018, an increase of $7.7 million over the third quarter of 2017, and gross margin was 42.3% in the third quarter of 2018, improved by 11 percentage points compared to the third quarter of 2017. The improvement is a result of higher small cell and base station antenna sales, which generate a higher gross margin, combined with revenue from the satellite communication product line, which also generates higher gross margins. Operating expenses, which consist of research and development costs, selling and marketing costs, general and administrative costs and acquisition expenses, were $12.5 million. The increase in operating expenses compared to the third quarter of 2017 was due to expenses relating to the Alga Microwave acquisition of $1.2 million and the addition of Advantech Wireless and Alga Microwave's operating expenses. The increase was offset by the indemnity claim payment of approximately $1.8 million that Randy mentioned. The payment was a receivable at September 30, 2018, and was received subsequent to the end of the quarter. Adjusted EBITDA for the third quarter of 2018 was $7.1 million, a significant increase compared to $3.1 million in the third quarter of 2017. The improved adjusted EBITDA compared to 2017 was due primarily to higher revenue with higher gross margins, combined with lower operating expenses due to the indemnity payment, which we consider to be a recovery of expenses incurred in the first and second quarters of this year that contributed to lower profitability in those quarters. The nonrecurring expenses in the third quarter totaled $2.3 million and were comprised primarily of expenses related to the acquisition of Alga, consulting fees paid to Advantech Wireless Inc. and other onetime costs. For the 9 months ended September 30, 2018, revenue surpassed $100 million and adjusted EBITDA was $11.4 million. Trailing 12-month revenue and adjusted EBITDA at September 30 were $124.6 million and $12.5 million, respectively. At September 30, 2018, we had a cash balance of $19.1 million. During the quarter, we completed a bought deal public offering of 7.4 million subscription receipts and $17.25 million principal amount of 6.5% extendable convertible unsecured debentures, for aggregate gross 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 the cash balance prior to the offering, will be used for capital expenditures, working capital, leasehold improvements and other expenses related to the move of Advantech's operations into the Alga facility, and as well as general corporate purposes, which may include compensation that will be payable if Alga meets certain performance targets. During the quarter, the remaining outstanding balance of a short-term credit facility with a bank in China was repaid, and the vendor of the Alga facility was repaid the loan provided to the company for the acquisition of the facility. At September 30, 2018, we had access to approximately $10.8 million of credit, of which $0.4 million was utilized. In connection with the Advantech acquisition, we entered into a $33 million term loan with Crown Capital. During the quarter, we issued convertible debentures in the amount of $17.25 million, assumed debt secured against the Alga facility in the amount of $3 million and borrowed approximately $3.2 million from the vendor of the Alga facility purchase which, as I mentioned, was repaid during the quarter. In total, we currently have short- and long-term debt in the amount of $53.6 million, with an annual interest expense of approximately $4.2 million. At September 30, 2018, our net debt to trailing 12-month adjusted EBITDA, annualized for the Advantech and Alga acquisitions, was approximately 2:1. We believe this is a conservative amount of debt relative to our current cash flow from operations. We expect the leverage ratio to decline as operating cash flow increases going forward. I'll now turn the call back to Randy for his concluding remarks

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

The outlook for the balance of 2018 continues to be very positive. While Asia Pacific has had downward pressure on sales over the last 2 quarters, revenue at the end of the third quarter started to improve with some new products launched, and the fourth quarter is expected to be strong. The strategic acquisitions of Advantech Wireless and Alga Microwave will continue to accelerate growth and contribute to the diversification of the company's revenue base. We believe that there are significant cost synergies opportunities, including the move of Advantech's operations into the Alga facility, which should be fully realized in 2019. We will continue to invest in our engineering operations to broaden our product offering in each of our product lines. We have been focused on providing our contract manufacturing facility in Guadalajara, Mexico with the required processes and know how to ensure they can manufacture our products to meet or exceed our technical specifications demanded by our customers. We expect that some of our new small cell and base station antennas that will be launched this quarter will be manufactured at that facility. The second half momentum, coupled with new product launches and demand, leaves us comfortable with fourth quarter consensus, which sits at $38 million in revenue. That concludes my formal remarks. And with that, operator, could we please open up the call for questions?

[Operator]

[Operator Instructions] Your first question comes from the line of Kevin Krishnaratne from Paradigm Capital.

[Kevin Krishnaratne, Analyst of Technology]

Randy, you touched at the end there on the mobile product launches and the stronger Q4. Can you talk about what you're seeing in mobile from customers there? Yesterday or the day before, in Samsung's Q3 call, they spoke of the trend of offering higher-spec parts and features into the more mass-market lineup to remain competitive, so can you remind us how to think about the opportunity there? And I mean, I can appreciate how Baylin's business overall continues to diversify, but any thoughts on how to think about the mobile road map into 2019?

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

Sure. Thank you for the question, Kevin. So obviously, the opportunities in mobile continue to struggle, in a sense, because if you look at the overall macro trends of the market, it is more flatlined. Growth is in small single-digit percentages. So the market, specifically the mobile market, has changed dramatically over the last 3 to 5 years. I think that trend is going to continue over the next period of time. That's 3 years or so. So for us, it's really an opportunity. We have diversified, as we have mentioned previously that we've added more customers in this segment. So that category will continue to grow for us, but not high growth rates, for sure, single-digit kind of growth rate as we continue to add more customers into that segment. So the larger customer that we had historically will be flat, and the additional customers that we gain will certainly be additive to that division.

[Kevin Krishnaratne, Analyst of Technology]

Do you think -- on the Note -- as a company like Samsung might start to move a higher-spec product into the more mass-market, do you think -- how do you think about seeing volume increases offset by ASP? Do you see pressure on ASP? Just how do you think about the different moving pieces as companies shift to make more -- the more mid-tier phones a little bit -- a little closer to higher-tier phones in terms of specs?

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

Yes. Well, certainly, there's been quite a bit of consolidation at the higher-end phones into the mid-market phones. Obviously, the markets do -- continues to change their phones at a significant rate. Certainly, annually is certainly the trend. However, that being said, there is -- what you're saying is true. You're seeing some of the lower-end phones and some of the higher-end phones moving to the mid-market phones because the mid-market phones' performance capabilities, certainly amongst the Chinese OEMs, has leveled the playing field quite substantially. So yes, absolutely, I think there's going to be some of the volume from the edges -- the top and the bottom of that market -- move to the midsection. The midsection will grow. We're positioned across the mid- and upper-end phones anyway, So for us, it would certainly be a good opportunity, should those volumes play out in the manner that they're forecasting.

[Kevin Krishnaratne, Analyst of Technology]

Okay, great. Switching gears. Nice to hear that the Advantech is back on track, and safe to say that Alga is on track with what you were expecting?

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

Yes, absolutely. Right from Day 1 out of the gate with Alga, we've -- the group there has done a fantastic job in operating their company and operating in a lean fashion. The customer base was healthy, and the transition from the previous ownership to us has gone very smoothly, and everything was as advertised, so we're very pleased with the relationship with the Alga owners, who continue to work with us and for us. So that's been a good relationship, and it's been great straight out of the gate.

[Kevin Krishnaratne, Analyst of Technology]

Okay, that's a great to hear. And we look -- if you look in the press releases, there have been a number of positive press releases on product launches at both Alga and Advantech. Is this -- is that the kind of -- that cycle product release, is that in line with the type of cycle that the units have seen in the past? And just wondering what your views -- or how to think about what these products might do for the units into 2019. Just your -- just curious on the pace of product releases versus prior years at those units.

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

Yes. Certainly, we've seen, I would say, particularly in the last 4 months, an increase in the velocity there, for sure. The first half of the year was a little slower out of the gate from Advantech. We had certain operational issues and stuff that -- transition issues that we pointed out in the earlier commentary. So -- and those are behind us. All of those, when I look at them, they're all temporal in nature and required us to sort of work through those things, and we have done so. We're off, obviously, into better moments, and the velocity of the press releases and the velocity of the new business opportunities in the markets that we're moving into with those 2 companies are -- certainly continue to point to the opportunity for growth that we had anticipated for those companies coming in 2019. So we are -- we still remain fairly bullish on the future there.

[Kevin Krishnaratne, Analyst of Technology]

Okay. Sure.

[Daniel Kim]

And -- apologies, Kevin, Dan Kim speaking here. If I may, just to point you to the press release that came out 1 month ago, approximately, with regards to the new 4G antenna with 5G compatibility. That millimeter wave technology came from Advantech, and that has been integrated into our first product here at Galtronics.

[Kevin Krishnaratne, Analyst of Technology]

I was going to -- so the follow-up on that was, I understand that the divisions are essentially being run on their own for now, but it's -- have you seen anything change with regards to -- with the conversation with customers since -- under the Baylin banner? Anything you can share on how those conversations may be progressing or changing? New customers? More engagement since being under Baylin?

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

Yes, absolutely, particularly on the Advantech and Alga side, for sure in that division, because these were privately held smaller corporations in the past, and being part of a larger publicly traded company has helped some of the larger multinational companies and defense companies that we are dealing with, that feel that there's a lot more financial strength behind these 2 companies. So it has helped change the conversation in a great way. And plus, we have assets worldwide, so we have a better coverage of the globe. So there's been a very positive reception. I've attended the satellite show and some of the other show -- trade shows that the companies present in, and it's been very good signs, actually, very good signs.

[Operator]

Your next question comes from the line of Andrew McGee from National Bank.

[Andrew Brice McGee, Associate]

My first question here is on the adjusted EBITDA margins, and it sounds like there was a onetime in the quarter for about $1.8 million related to the Advantech piece. As I think about your G&A into Q4, would it be fair to assume that the growth -- the G&A line will kick up by about $1.8 million and that would be a more normalized margin for the company?

[Michael A. Wolfe, Chief Financial Officer]

Well, there's other onetime expenses in that number as well, so, what I would do is -- you look at acquisition expenses, obviously, those aren't recurring, so those would come off. There's some other nonrecurring as well, and the $1.8 million, as you mentioned. So I think that if you kind of net all those in and around $11 million -- I think you'd have to add a little bit also for Alga because we acquired that in middle of July, so there's 0.5 month there as well, but somewhere in the $11 million range, I think, would be a reasonable assumption going forward.

[Andrew Brice McGee, Associate]

Sorry. $11 million for a quarter?

[Michael A. Wolfe, Chief Financial Officer]

Yes.

[Andrew Brice McGee, Associate]

Okay. And related to the adjusted EBITDA, would you be able to break out how much of the EBITDA was organic versus M&A-driven or from the acquisition?

[Michael A. Wolfe, Chief Financial Officer]

We're not really segment reporting on any of the lines, so I actually don't have that.

[Andrew Brice McGee, Associate]

Okay. And then my next question. In the Q3 results, were there any notable pushes or pulls in the quarter when it came to revenue?

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

So the one area -- obviously, we had some delays from CapEx spending on one of the larger carriers, related to an acquisition that they had completed. So there had been a little bit of CapEx constraint in the quarter that did trickle down, so we did have some revenues shift from Q3 into Q4. So we had a little bit of that in the one division, and -- but the other 2 divisions had pretty strong results. So obviously, we came in just a hair under consensus on the revenue side. Had we not had that one constraint, we would have -- certainly would probably overshot the revenue consensus. So anyways, just the one area, and it was sort of just more timing-related. So we've already seen the orders on that customer already pick up. So anyway, things are moving through, and we should have a pretty strong performance for Q4 from that division.

[Andrew Brice McGee, Associate]

Okay, that's great. And then my last question, just related to the synergy target and how you're progressing. It sounds like Advantech is definitely on track here, but just in terms of your confidence in the $5 million target that you've set out, still feeling strong about that, and the progression to date? Maybe some anecdotal comments to how far through that you are?

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

Sure. So yes, we clearly have our sights set on that number. We've got -- I'd say we're 3/4 of the way through it. We've got a few things left to do before the end of the year, so there's -- and of course, a lot of it is related to the consolidation of facilities, right? So we're moving 2 facilities into 1 facility in Alga. So once we complete that, then we're pretty much 100% to where we wanted to be on that number.

[Operator]

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

[Steven Li, Senior Vice President]

Randy, on the synergies comment on the last question. So if I'm looking at the Q3 base, so you said I think you're 3/4 of the way. So does that mean you -- there could be maybe $1 million to $2 million of synergies more from where you are in the Q3 cost base?

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

Well, certainly, a lot of the things that were done, you still end up playing out the cost. You have the change implemented, but you don't necessarily net out all the financial benefit quite yet. For example, if you're consolidating 2 facilities into 1, you still have leases to pay, even though you've effected the change that will net out the improvement. So you'll get the fullness of the improvement in 2019, but I wouldn't certainly do the straight math on 1 quarter, because we still are incurring severance costs or whatever types of costs that would sort of neutralize that improvement for a quarter. But the -- our target is to have all of those improvements done and in place and the benefits starting to be fully realized in 2019, if that makes sense.

[Steven Li, Senior Vice President]

No, that makes sense, okay. And now one question I wanted to ask just from your MD&A, the numbers you disclosed. So, Asia Pac was down 15%, but it looks like your largest customer there was flattish year-over-year. Does that make sense?

[Michael A. Wolfe, Chief Financial Officer]

Yes, absolutely. Yes.

[Steven Li, Senior Vice President]

So where was the decline in Asia Pac in that case?

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

So you're talking -- sorry, go ahead, Michael.

[Steven Li, Senior Vice President]

So Asia Pac was down 15%. When I look at your customer concentration, it looks like your largest customer was kind of flattish. So I was wondering where that decline came from.

[Michael A. Wolfe, Chief Financial Officer]

I'd have to pull out the numbers, but there was a decline in the -- from our major customer, for sure.

[Steven Li, Senior Vice President]

From your major customer? Okay, okay, that's fine. Maybe I'll follow up with you after. I joined the call a little bit late, so I'm not sure if you talked about that, but infrastructure, the growth slowed down from the triple digit you've been having. Can you talk a little bit about your outlook going forward on infrastructure?

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

Yes. As I mentioned earlier there, we did have a little bit of CapEx constraint from the one customer during the quarter, and that was temporal in nature as they completed an acquisition. Things going forward have continued to resume. So we don't see any -- that curtailment lasting very long. In fact, it's much -- pretty much over. So we are certainly back on track and are comfortable with the consensus number for Q4.

[Steven Li, Senior Vice President]

And so you -- let's say -- I mean, right now, I mean, you're shipping the last, is it similar to what you saw earlier, let's say, in the summer? Is it back to that level, Randy?

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

Yes, yes.

[Steven Li, Senior Vice President]

Okay, okay. And then on networking levels, it was a really good. Is this -- is there lumpiness there, so maybe we'll see some softer quarters, or you feel pretty good about networking?

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

Well, as we said before, they're quite long sales cycle times, so we have a lot of good visibility on that. Contractions are in single-digit percentages. They certainly don't go above that typically, so we're comfortable with that. But, as we've mentioned on prior calls, that group continues to move towards the Internet of Things and cellular Internet of Things. And there's a lot of embedded devices that we're quoting now and this division continues to grow, and as we shift to -- the business model into more 5G, IoT devices and other types of embedded products that are farther up the chain when it comes to sophisticated engineering and technology.

[Operator]

[Operator Instructions] We have no further questions in the queue at this time. I will turn the call back over to the presenters.

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

Thank you very much. So to summarize the 3 key points: obviously, first of all, the business momentum is clearly evident on the revenue side, EBITDA side and certainly, the gross margin side;second is that our 5 -- the 5G product development contracts that we have won continue to place Baylin in a very solid position as we're doing a lot of development work for 5G applications in multiple divisions of our company, which is certainly strong on the momentum side;and then third, the fundamental cash generation is critical, and please continue to watch our capability in this area as we continue to focus on the bottom line improvement and converting that bottom line EBITDA into cash generation. Thank you much, everybody, for participating on the call. Really appreciate the support that we've received from the market. And with that, we will conclude the call.

[Operator]

This concludes today's conference call. Thank you for your participation, and you may now disconnect.