Evertz Technologies Ltd

TSX:ET

Earnings Call Transcript 2020-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Evertz Q4 2020 Conference Call. As a reminder, today's conference is being recorded.It is Tuesday, June 30, 2020.At this time, I would like to turn the conference over to Mr. Brian Campbell, Executive Vice President of Business Development. Please go ahead, Mr. Campbell.

[Brian Scott Campbell, Executive Vice]

Thank you, Brad. Good afternoon, everyone, and. Welcome to the Evertz Technologies conference call for our fourth quarter ended April 30, 2020, with Doug Moore, Evertz' Chief Financial Officer; and myself, Brian Campbell. Please note that our financial press release and MD&A are now available on SEDAR. Doug and I will comment on the financial results and then open the call to your questions.Before delving into our recent business results and outlook, I'd like to briefly address the extraordinary COVID situation. Evertz is a technical innovator delivering operational excellence, a fundamentally sound business committed to protecting our people, our partners and supporting our customers. We're proud of the role we play as an essential service provider and critical supplier, enabling vital telecommunications, broadcast and new media services worldwide. We're appreciative of the continuing strong partnerships with our customers and for the extraordinary efforts made by our employees to continue to support our customers and drive our business forward.Turning now to Evertz' results. I will begin with select annual and fourth quarter highlights, following which Doug will provide more detail. First off, I'm pleased to report sales for the fiscal year totaled $436.6 million driven by the adoption of Evertz' new technologies. Annual net earnings were $69.2 million, resulting in fully diluted earnings per share of $0.90 for fiscal 2020. Liquidity and capital resources remained robust with cash of $75 million at April 30 after the return of $124.3 million by a special and quarterly dividends to shareholders. Investments in research and development totaled $90.8 million for fiscal 2020, further reinforcing Evertz' commitment to R&D.Moving on to the fourth quarter. Operations were impacted by the global COVID-19 pandemic. We moved quickly to implement a number of actions, including workplace best practices from WHO, national and local authorities, implemented the avoidance of essential travel. We scaled work-from-home protocols and work closely with our customers to provide service and support via online tools to the maximum extent possible, all while maintaining our manufacturing capabilities across multiple sites.Turning to the financials. Sales in the fourth quarter were $92.2 million. Gross margin for the fourth quarter was $52.1 million or 56.5% of sales, and foreign exchange for the fourth quarter was a gain of $6.1 million. Net earnings for the fourth quarter were $16 million, while fully diluted earnings per share were $0.21. At April 30, 2020, Evertz' working capital was $223.7 million. We attribute our solid annual and resilient quarterly performance, despite the onset of this unprecedented pandemic, to Evertz' fundamentally sound industry and financial position, the ongoing technical transition in the industry, channel and video services proliferation, the increase in global demand for high-quality video anywhere, anytime, specifically to the growing option of Evertz' IP-based Software Defined Video Networking solutions, Evertz' IT and virtualized cloud solutions, our immersive 4K Ultra HD solutions, and our state-of-the-art DreamCatcher IP replay and live production suite.Our sales base is well diversified with the top 10 customers accounting for approximately 42% of sales during the year with no single customer over 7%. In fact, we had 443 customer orders of over $200,000, a modest increase over the 425 customer orders received last year.In addition, at the end of May, the purchase order backlog was an excess of $94 million, and shipments during the month were $16 million.In response to the current uncertainty, in an environment dominated by COVID-19 and by the desire to maintain the financial flexibility of the company, the Board has declared a dividend of $0.09 per share, which is a reduction in the regular quarterly dividend.I will now hand over the call to Doug Moore, Evertz' Chief Financial Officer, to cover our results in greater detail.

[Doug Moore, Chief Financial Officer]

Thank you, Brian. Good afternoon, everyone.Sales were $92.2 million in the fourth quarter of fiscal 2020 compared to $107.2 million in the fourth quarter of fiscal 2019, which represents a decrease of $15 million or 14%. Sales for the 12 months ended April 30, 2020, were $436.6 million compared to $443.6 million in the same period last year. This represents a decrease of approximately $7 million or 2%. The decrease in sales was largely attributable to projects put on hold or canceled in the fourth quarter as a result of the COVID-19 pandemic.US/Canada region had sales for the fourth quarter of $58.7 million compared to $63.6 million last year, a decrease of 8%. Sales in the US/Canada region were $289 million for the 12 months ended April 30, 2020, compared to $297.8 million in the same period last year. This represents decrease of $8.8 million or 3%.International region had sales for the quarter of $33.5 million compared to $43.7 million last year, a decrease of $10.2 million or 23%. Sales in the International region were $147.6 million for the 12 months ended April 30, 2020, compared to $145.8 million in the same period last year, representing an increase of $1.8 million. International segment represented 36% of total sales in the quarter and 34% of total sales in the year as compared to 41% and 33% in the same respective periods last year.Gross margin for the fourth quarter was approximately 56.5% and gross margin for the 12 months ending April 30, 2020, was 56.9%, both of which were within the company's target range.Selling and administrative expenses were $15.4 million for the fourth quarter, a decrease of $2.6 million from the same period last year. As a percentage of revenue, S&A expenses were approximately 16.7%, consistent with the same period last year. The decrease in selling and administrative expenses was driven by the cancellation of trade shows and the reduced travel and selling costs as a result of the pandemic. Selling and administrative expenses were $67.6 million for the 12 months period ending April 30, 2020, a decrease of $0.2 million from the same period last year. For the year, selling and admin expenses as a percentage of revenue were approximately 15.5% compared to 15.3% last year.Research and development expenses were $21.2 million for the fourth quarter, which represents a $0.6 million decrease from the fourth quarter last year. For the year, research and development expenses were $90.8 million, which represents an increase of $5 million for the same -- over the same period last year. Research and development expenses were up for the year, which is predominantly a result of an increase in R&D salary costs and headcount.During the year, $4.2 million in government assistance related to COVID-19 programs was deducted from expenses, of that $3 million was deducted from the fourth quarter R&D costs.Foreign exchange for the fourth quarter was a gain of $6.1 million compared to a gain of $1.9 million in the same period last year. Gain of $6.1 million was driven by the increase in the value of the U.S. dollar and the Canadian dollar between January 31 and April 30, 2020. Foreign exchange for the 12 months April 30, 2020, was a gain of $3.5 million compared to a gain of $3.4 million in the prior year.Turning to a discussion of the liquidity of the company. Cash as at April 30, 2020, was $75 million as compared to $104.6 million on April 30, 2019. Working capital was $223.7 million at April 30 compare to $282.5 million at the end of April 30, 2019. For the year, the company generated cash from operations of $109.3 million, which includes $21.6 million change in noncash working capital and current taxes. The effects of the change in noncash working capital and current taxes are excluded, right, from the company's operating cash flows to the company would have generated $87.7 million in cash from operations. For the year, the company paid approximately $124.8 million in dividends and acquired $10.1 million in capital assets.Now looking specifically at cash flows for the quarter ended April 30. The company generated cash from operations of $47.1 million, which includes a $25.5 million in noncash working capital in current taxes. The effects of the change in noncash working capital and current taxes are excluded, the company would have generated $21.6 million cash from operations for the quarter. The company used $3.1 million from investing -- for investing activities, which was principally driven by capital asset purchases. The company used cash from financing activities of $17.7 million, which was principally driven by dividends paid of $13.8 million and capital stock repurchased under an NCIB for $2.4 million.Finally, I will review our share capital position as of April 30, 2020. Shares outstanding were approximately 76.4 million and options outstanding were approximately 1.6 million. Weighted average shares outstanding were 76.6 million and weighted average fully diluted shares were also 76.6 million for the year ended.This brings to conclusion the review of our financial results and position for the fourth quarter.Finally, I would like to remind you that some of the statements presented therein are forward-looking, subject to a number of risks and uncertainties, and we refer you to the risk factors described in the annual information form and the official reports filed with the Canadian Securities Commission.Brian, back to you.

[Brian Scott Campbell, Executive Vice]

Thank you, Doug. Brad, we're now ready to open the call to questions.

[Operator]

[Operator Instructions] Our first question comes from Thanos Moschopoulos with BMO Capital Markets.

[Thanos Moschopoulos, VP & Analyst]

Brian, can you give us a little bit more color in terms of the demand environment? Clearly, shipments were weak for May. Can you comment on whether there's been any improvement in June and on what you're hearing from your customers as some economies, globally, are starting to reopen?

[Brian Scott Campbell, Executive Vice]

So the way it looks currently, May was a low point. We are seeing solid quotation activities, order intake. And yes, customers are trying to move back, and you see sports leagues starting to restart that activity does involve, oftentimes, Evertz sales and solutions. And so we are seeing an uptake in activity.

[Thanos Moschopoulos, VP & Analyst]

And generally speaking, can you comment, in terms of the weakness you've been seeing, whether you have had more to do with logistical issues, be it customers having their facilities shut down or not being able to get equipment across borders or supply chain issues or live events not happening versus lower macro activity, I guess a weaker macro spending environment. I guess where I'm going with this is as we think about the recovery, is it more a function of just having some of the logistical things being addressed, or will we also have to see a stronger macro backdrop to see some of the spending coming back?

[Brian Scott Campbell, Executive Vice]

So I'll address the first part of it. So I -- yes, our delivering installations were definitely impacted by border closures, shelter-in-place restrictions in geographies, state of emergencies in various states and countries. So as we said, we've work to the extent possible on -- remotely for both providing service and deployment of new installations, and that involves trying to ensure that solutions can be very efficiently installed. But again, to -- if the customer's facility is closed. That's close to systems integrators and their staff as well, too, who are involved in deployments. You still need to have your systems integrators or others, rack equipment, run fiber and cables and the customer engineering staff available as well, too. So the revenue is against that backdrop.

[Thanos Moschopoulos, VP & Analyst]

Okay. And from an OpEx perspective, should we think about OpEx being similar to Q4 levels in the short term? Have you done any headcount reduction to this point? And are you contemplating any headcount reductions?

[Brian Scott Campbell, Executive Vice]

What I can speak to is, we have applied for multiple different COVID-related government assistance programs. During the quarter, we would have had $4.2 million reduction in costs associated with those programs, including the Canadian Emergency Wage Subsidy as well as others. So I think that I've considered to be month-to-month, it's a conditional application, but that has allowed us to maintain the vast majority of our headcount.

[Thanos Moschopoulos, VP & Analyst]

Okay. And then it might be hard to pin this down, I guess, given where revenue might land. But how should we think about gross margins in the near term? I mean even on the much of this revenue base, should we still expect margins to stay above 50%? Or is that really going to be a function of where revenue lands?

[Brian Scott Campbell, Executive Vice]

So our gross margin stated range is 56% to 60%. In the quarter, we were at 56.5%, which is well within the range. And we haven't announced any changes to that range.

[Operator]

We'll take our next question from Robert Young with Canaccord Genuity.

[Robert Young, Director]

You haven't had any interruption in manufacturing. I don't think -- I might have missed that in the prepared remarks.

[Brian Scott Campbell, Executive Vice]

Robert, that's correct. We are an essential service provider. Our manufacturing operations have remained open, working. We're delivering to customers on a daily basis around the globe.

[Robert Young, Director]

Okay. Okay. Great. And then I don't want to read too much into the wording of the press release, but the dividend reduction, the way you've described it appears to be a temporary measure. You're going to revisit the decision in September. Maybe if you could talk about the process around the decision to reduce it? And then what decision points might be in the future?

[Brian Scott Campbell, Executive Vice]

So the decision process culminates with the Board meeting, and it's a Board decision. And as stated in the press release, it was a dividend reduction to maintain financial flexibility. Clearly, we don't know the duration of the pandemic. We're well positioned to work through it. The financial flexibility also enables us to keep our powder dry and to look at opportunities and to -- for business development. And that, in fact, we're quite active on that front currently.

[Robert Young, Director]

Okay. So do you expect that valuations in the sector will be attractive in the near term? And I guess the inference there might be that there's a lot of businesses that you compete against that are on less stable financial terms than yourself?

[Brian Scott Campbell, Executive Vice]

Correct. Yes, there are. And we remain very disciplined suppliers. We are recipients of numerous phone calls from folks who are considering their strategic options, and our phone is open.

[Robert Young, Director]

Okay. It might be helpful to -- if you haven't done this in the past, but if there was any information you could give us into the composition of the backlog, which was -- remained relatively strong, but is there any way to understand how much of that backlog would convert in the near-term versus longer-term contracts? Or anything around the probability or lack of probability that backlog could be unbooked? The example I might think of there with the Olympics, would there be work related to the Olympics, which might be on book for the backlog. Can you give any information on the backlog competition? That would be very helpful.

[Brian Scott Campbell, Executive Vice]

So the backlog is composed of purchase orders and sign contracts. So there's no pipeline at all in it. The composition does include some longer-term contracts, and not all of it will be delivered in Q1 and Q2, but the majority would be.

[Robert Young, Director]

Okay. To push a little harder on that, is there -- would it be -- I mean 50% of the backlog would convert inside of 12 months? Is there any help you can provide along that line of question?

[Brian Scott Campbell, Executive Vice]

Not this time, Rob.

[Robert Young, Director]

Okay. Okay. And then maybe last question for me will be -- I mean, all of the cultural changes we're seeing, are you seeing any increased demand around IP infrastructure, cloud? Maybe just talk about any changes in the way that your customers are thinking about those new technologies? And I'll pass it on.

[Brian Scott Campbell, Executive Vice]

So Rob, definitely, our customers are thinking about IP and cloud-based solutions. That's been the driving force for Evertz' sales and sales growth in previous years. With respect to IP and our Software Defined Networking solutions, we've had tremendous uptake globally. That continues to progress and similarly with cloud-based virtualized solutions. Again, we continue to have a very strong position in innovative products for public cloud, private cloud and hybrid cloud solutions. So those do continue to deploy. If anything, I think you're going to see the mindset change of customers to be more proactive or continue to push their initiatives in that front into migration to the newer technologies, IP-based infrastructure and cloud-based solutions. That said, we are currently seeing strong uptake of our baseband solutions as well, too, some of which address UHD immersive solutions.

[Operator]

We'll take our next question from Paul Treiber with RBC Capital Markets.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

Just in regards to what you saw in terms of demand in the quarter, was it fairly evenly spread across your customer base? Or was it weighted to any particular group or region a particular group, customer group in terms of like live sports and broadcasters versus others? And also, can you speak to just the regional mix and the demand trends there?

[Brian Scott Campbell, Executive Vice]

So with respect to the regional trends, the U.S. continues to be a very strong base for us, not only in sales, but also in "activity" as well, too. Similarly, you saw the International results were up this quarter. So -- or marginally. So we're having strong international "activity" as well, too, with respect to live sports. We're -- we have a very strong customer base in basketball, baseball, football, soccer, European football. And there, we continue to deploy -- those deployments are slowed down by COVID and the travel restrictions and the on-site customer access availability as well, too. So we are working through that. We actually have deployment teams and service people deployed, continuing to implement infrastructure solutions in North America. So internationally, but that is -- we're continuing to work through and push deployments and help our customers deliver on their business plans.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

Okay. And in the prepared remarks, you mentioned order cancellations. Could you speak to the terms in your contracts, if you typically receive any penalties if there are cancellations? Or what's sort of the business negotiations that you see when the order cancellations come up?

[Brian Scott Campbell, Executive Vice]

It's not a heavily prominent thing, but it's really dependent on the arrangement. So the broader discussion -- I mean we've had cancellations with the understanding that replacements will come in the future. We've had cancellations that are -- have associated returns over restocking fees and things like that. But the postponement, the cancellations today, it's more heavily weighted towards the postponement or the delays as opposed to actually receiving cancellations, which is a rare event. And it's a rare event.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

Okay. And last one from me. The -- is there any typical seasonality heading into Q1? And then do you think at this point, like ultimately, any seasonality will be overshadowed by the macroeconomic environment and then when, like, there's a reopening of the economy and obviously live sporting events and other events?

[Brian Scott Campbell, Executive Vice]

So Evertz financial results have not shown a great degree of seasonality. So if there were any, it would be dramatically overshadowed by the COVID pandemic. That -- currently we're making very good strides. We're pushing ahead with our business. And the main focus is delivering to our customers in support of their business plans in light of the restrictions and constraints that we're dealing with.

[Operator]

We'll take our next question from Bill Zhang with Raymond James.

[Bill Zhang, Associate]

So I have a question related to operating margin trends. Should we expect pressure during this pandemic period?

[Doug Moore, Chief Financial Officer]

Could you repeat that question for me, please?

[Bill Zhang, Associate]

So it's related to operating margin trends. Should we expect some pressure during this pandemic period?

[Doug Moore, Chief Financial Officer]

Sorry, are you referring to gross margin at a cost -- sales perspective or operating expense?

[Bill Zhang, Associate]

Operating.

[Doug Moore, Chief Financial Officer]

Expenses. So what I would reiterate is 2 components here is, one, that we did have government assistance or assistance programs that we would have recorded as offset to operating expenses in the fourth quarter. I would expect that to continue to occur in the first quarter of the next fiscal year I'm able to quantify as a whole because it's a month-to-month calculation. But -- and then the impact of our inability to travel to certain regions would inherently reduce the associated costs of the travel expenses.

[Brian Scott Campbell, Executive Vice]

So we remain solidly above 20% operating margin. In fact, for the year, it was 21.5%.

[Operator]

And we will now take our final question. Our final question comes from Steven Li with Raymond James.

[Steven Li, Director & Equity Research Analyst]

Brian, I joined a little late, but I did hear you speak of May as a low month with completion activity having picked up. How about actual deployments, access to customer premises? Has that eased up by May to June?

[Brian Scott Campbell, Executive Vice]

Yes. Yes. So with border restrictions opening, Evertz is an essential service provider. So we can cross the border for those customers where we have designation and that activity has been occurring. And you are seeing geographies, states and other locations, right, open up and either resume their seasons or other activities. So that is reflected in our deployment activities as well, too.

[Steven Li, Director & Equity Research Analyst]

But compared to your normal state, I mean, are there still restrictions including deployments at this stage?

[Brian Scott Campbell, Executive Vice]

Yes, absolutely. Yes. So it's better than it was, but there -- we are -- we continue to deal with local jurisdictions where various states have -- in the United States, have different regulations. Some are more open, others have restrictions. And we work within the regulatory environment for those locations. So yes, we are deploying. And yes, we have to plan around those deployments, and we're constrained by on-site access as well too in certain areas.

[Operator]

Thank you. That concludes today's question-and-answer session. I would now like to turn the conference back to Mr. Brian Campbell for any closing or additional remarks.

[Brian Scott Campbell, Executive Vice]

Thank you, Brad. I'd like to thank our participants for their questions. Reiterate that we are encouraged by the company's solid performance in fiscal 2020, achieving sales of $436 million, delivering pretax earnings of 21.1% through disciplined cost control all while investing $90.8 million in R&D to build future growth.While the company believes the COVID pandemic to be temporary, the situation is fluid and the impact of the pandemic on operations and our results, including the impact on overall customer demand, is uncertain at this time. Although the company is an essential service provider, widespread customer shutdowns and travel restrictions and the postponement or cancellation of sporting events as well as other live events and various other related projects, will have an adverse effect on the company's revenue and financial results in the first quarter and potentially the second quarter of 2021.Notwithstanding the uncertainty, the company believes the situation is temporary and we are well positioned to benefit from economic revival and the industry transition to IP and cloud-based solutions. We're cautiously optimistic as we enter the first half of 2021 and with a combined purchase order backlog plus May shipments totaling $110 million and a pristine debt-free balance sheet with over $75 million cash and equivalents, providing the financial flexibility needed to fund working capital and investment opportunities. There are significant investments in software defined IP -- IT virtualizing cloud technologies. Industry-leading deployments and the capabilities of our staff, Evertz is well poised to build upon our position as one of the largest pure players and leading innovators in the broadcast and new media technology sector.We're confident that we will get through this together, emerge stronger, and we wish everyone the best during this difficult time. Thank you, and good night.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's call. We thank you for your participation. You may now disconnect.