Quarterhill Inc

TSX:QTRH

Earnings Call Transcript 2021-Q1

[Operator]

Good morning, and welcome to Quarterhill's Q1 Fiscal 2021 Financial Results Conference Call. On this morning's call, we have Paul Hill, President and CEO; and John Rim, Chief Financial Officer. [Operator Instructions] Earlier this morning, Quarterhill issued a news release announcing its financial results for the 3-month period ended March 31, 2021. This news release, along with the company's MD&A and financial statements will be available on Quarterhill's website and will be filed on SEDAR. Certain matters discussed during today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are available on SEDAR. During this conference call, Quarterhill will refer to adjusted EBITDA. Adjusted EBITDA does not have any standardized meaning prescribed by IFRS. Please refer to Page 3 on the company's Q1 2021 management's discussion and analysis for our full cautionary notes regarding the use of forward-looking statements and non-IFRS measures. Finally, please note that all financial information provided is in Canadian dollars, unless otherwise specified. I would now like to turn the meeting over to Mr. Hill. Please go ahead, sir.

[Paul L. Hill, President, CEO & Director]

Good morning, everyone. Thanks for joining us on today's call. In terms of an agenda, I'll start with a look at the business highlights, followed by John, who'll take a look at the key financial highlights. Then we'll open it up for questions. There are slides to accompany our remarks, which can be viewed on the webcast portion of this call. The slides will also be available after the call on our website. In Q1, consolidated revenue was $19.3 million, and consolidated adjusted EBITDA was negative $469,000. We ended the quarter with a strong balance sheet with $132 million of cash and working capital of $155.6 million. Q1 was a good start to the year with both portfolio companies, companies generating positive adjusted EBITDA, despite the weakening of the U.S. dollar and the ongoing pandemic. On the M&A front, we're off to a good start in 2021. We've made 2 acquisitions, and we have a healthy acquisition pipeline. I'll start my review of the quarter with a look at results from each portfolio company. IRD had a good quarter with steady revenue, higher margins and the acquisition and integration of Sensor Line. IRD signed a 5-year $13 million contract with the state of New York in Q1. This is to install, manage and maintain traffic data collection sites around New York City. The data is used to assess transportation needs and highway infrastructure performance as well as for safety purposes, such as evacuation routing. As part of a broader move IRD has seen within its customer base to harvest data for the purposes of improving safety and as a source of revenue or cost savings. IRD also launched a web-based analytics platform that is enabling cities in Belgium and France to collect and analyze vehicle, bike and pedestrian data to enhance safety. The solution comes from IRD's Belgian subsidiary, iCOMS, and will also be deployed in a pilot program in Vancouver. Overall, the pipeline and order book and the outlook for IRD remains solid. WiLAN had a positive adjusted EBITDA in the quarter. And while we expect the business will have its characteristic variability in 2021, on an annual basis, we expect WiLAN to generate positive cash flows consistent with its track record. COVID has added delay to some litigations and license agreements, but we believe these are temporary delays only. Some of the litigations in the pipeline today include Apple, regarding wireless technology, which is currently in the appeals process. In January, WiLAN initiated litigation in Germany against Apple with respect to 3 patents related to memory interface temp -- technology. Motorola regarding wireless technology, Micron regarding semiconductor and membrane technologies and AMD regarding semiconductor memory interface and power management technologies. We continue to support WiLAN's future growth as they replenish their patent portfolio. WiLAN has about 5,000 patents today, and we continue to look to invest in new partnerships as well. In terms of the Apple trial, an oral hearing before a panel of the court of appeals for the federal circuit is expected to be held sometime in the fall of this year. 2021 has been an active year so far on the M&A front. In the first week of January, we acquired Sensor Line, a German-based ITS provider of high-end fiber optic sensors for the road and rail markets. The business was acquired at a reasonable multiple with the potential for additional revenue and cost synergies in the coming years. Sensor Line's products are a strong fit with IRD's global distribution network. Financial results from Sensor Line has so far have met expectations, and we're already exploring and realizing opportunities for sales synergies in North America and other international markets. Our second acquisition announced last week is BDS, which is also a German-based ITS company. BDS develops, manufactures and sells traffic monitoring devices that record driver speed and also red light infractions. BDS' devices are currently the only radar-based product certified under new regulations in Germany that enable direct enforcement for traffic violations. This fits in very well with our goal to expand our offerings in the area of enforcement. These types of products are highly sought after as governments to seek to improve safety, but also identify new revenue sources. BDS has one manufacturing facility and 2 service centers in Germany and will be integrated into Sensor Line, which is actually one of BDS' largest suppliers of sensors. We were introduced to BDS through Sensor Line, and this demonstrates how our presence in the ITS industry can also lead to unique opportunities for acquisitions. We are pleased to have already completed 2 deals in 2021 and look forward to more M&A activity during the remainder of the year. The M&A conditions in ITS are compelling, and were given a substantial boost this year with the Biden administration's plan to spend hundreds of billions on transportation over the next 8 years. We believe that the combination of massive new infrastructure spending and the need for governments to find new sources of revenues to pay down debt, means there is no better time to be in ITS. Our target is to invest up with $400 million over the next 5 years to scale our ITS business. We are confident in our prospects, given our existing balance sheet, access to low-cost capital and a robust pipeline of M&A opportunities. Successful execution of this strategy will lead to greater consistency of revenue and cash flow for Quarterhill, and we would expect that to translate into increased investor interest and a higher valuation multiple on the business in the future. A couple of final items today. We are going live with a new corporate website and an investor presentation that reflects the focus of our business strategy. The presentation can be found on our website in the Investors section. Finally, we are planning several initiatives to proactively get our story head to a broader network of investors, which may include more conference appearances, targeted investor interactions and group events. We think we have a great story to tell, and we look forward to generating greater interest in Quarterhill as an investment opportunity. With that, I'll turn it over to John for a look at the financial highlights for the quarter.

[John Rim, Chief Financial Officer]

Thanks, Paul. And Good morning, everyone. Thank you for joining us on the call, and it's great to speak to you again this quarter. Starting with our top line. Consolidated revenue in the first quarter was $19.3 million. As Paul mentioned, both our operating segments enjoyed solid results in the quarter. With IRD, I just want to remind everyone that the business typically experiences seasonality as less project work is performed during the colder weather months. And also given that a large portion of its revenue is from North American project implementations. IRD's Q1 2021 revenue was $11.5 million compared to $11.4 million in the comparable period last year. IRD's Q1 revenue this year got a boost from Sensor Line, which was acquired in the first week of January, but also experienced some of the effects of the weakened U.S. dollar compared to the same period last year. In terms of WiLAN's performance in Q1, it resulted from the execution of several agreements during the quarter, including a license agreement that settled litigation relating to TV and display technologies with LG. The license patents related to memory interface technologies and digital display and TV technologies. As we've mentioned before, WiLAN's revenue may be variable quarter-to-quarter, but on an annual basis, the business has consistently generated strong margins and cash flow. These cash flows are an important source of capital for our M&A strategy and also to reinvest in the WiLAN business itself, as was shown with the 8 patent acquisitions that we made near the end of last year. In terms of gross margin, consolidated gross margin was consistent year-over-year at 34%. But of note, however, was that IRD's gross margin was 40% compared to 26% in Q1 of last year. This improvement in gross margin was largely the result of strong margins earned on certain select projects worked on during the quarter as well as a higher proportion of product sales that typically have higher gross margins, including a very strong contribution margin of 64% from our newly acquired Sensor Line business. In terms of operating expenses, the total operating expenses remained relatively consistent year-over-year at $12.5 million compared to $12.6 million in Q1 last year. And we continue to keep a close eye on our expenses, both at the corporate level and the operating companies. For adjusted EBITDA, both IRD and WiLAN had positive adjusted EBITDA on a segmented business basis. IRD's adjusted EBITDA was $1.4 million, and WiLAN's adjusted EBITDA was $1.2 million for the quarter. IRD's adjusted EBITDA improved $2.8 million year-over-year on similar revenue, again, due to the higher-margin projects in progress as well as the higher-margin product sales revenue, including from Sensor Line, as I mentioned before. On a consolidated basis, adjusted EBITDA was negative $0.4 million after corporate expenses, which include our public company costs. Corporate costs were approximately $1 million higher in Q1 2020 than in the comparative prior period. As we continue to invest in our ERP system implementation, that will position our company to continue to grow in scale. From a cash flow perspective, cash used in operations was $5.9 million in Q1 or approximately $1 million, excluding changes in noncash working capital balances. But the balance sheet remains very strong at $132 million in cash and about $150 million in working capital with 0 long-term debt. We continued our quarterly dividend payments in Q1 and toward the end of the quarter, we became more active on our previously announced NCIB, which will continue until August of this year. This morning, in our earnings release, we announced details of our next dividend payment. The Board of Directors has declared an eligible dividend of $0.0125 per share payable on July 9, for all shareholders of record on June 18, 2021. So Paul spoke earlier of our intention to deploy $400 million over 5 years to scale our ITS business through M&A. And this morning, I'd like to share a few minutes to go over a slide that we think helps to illustrate the shareholder value creation potential of this strategy. So I'd like to start by reminding everyone that the information presented here is for illustrative purposes only and that this is not to be construed as forecast or guidance. These are targets that we aspire to but we are also confident that we can execute on. You'll see 2 charts on their revenue and adjusted EBITDA. They show the actual business results for 220 or 2020 in light blue. Then in subsequent years, acquired businesses are represented by the dark blue bars on top. While these graphs move in a linear direction to -- up to the right, the actual deployment of capital into our M&A may vary year by year. What's most important, however, is that for our illustration, you can see our target by the end of year 5. There are a couple of assumptions we use to develop our illustration. First, the base business is reported at the end of 2020 is held constant with no growth rate over the 5 years. Also, we are not factoring in any proceeds from our current Apple litigation into our outlook here. Of course, we definitely expect our businesses will continue to grow organically as they've demonstrated. But for purposes of illustration, we're intentionally isolating the potential growth impact from our M&A efforts. The second key assumption is that we assume that Quarterhill's current market capitalization today is based on a sum of parts valuation of 10x IRD's adjusted EBITDA, plus our prevailing working capital in each year. Third, we will continue to deploy capital, which will primarily be from existing and newly generated cash flow but may also include external capital when it optimizes our returns. And this will be deployed to execute our M&A strategy, acquiring smaller ITS companies at between 5 and 9x adjusted EBITDA or possibly higher for higher growth for larger ITS companies already at a certain scale. So based on these assumptions, as we execute our growth plans through M&A, we expect to inorganically grow revenue and adjusted EBITDA over the 5-year period. In this initial example, we include $330 million in ITS revenue and about $50 million of ITS-adjusted EBITDA incrementally to where we are today. This assumes, therefore, that our average acquisition multiple will be 8x EBITDA, and that has been consistent with the 2 transactions we've completed so far. Second, with our ITS business at scale, we believe it would attract a higher multiple -- valuation multiple, consistent with our other public ITS and IoT telematics companies that we -- that have achieved similar scale. So again, this slide is for illustrative purposes only, but we felt it was important to share with investors. A sense of how we are planning to increase shareholder value over the next 5 years. And in closing, we remain focused on growing through M&A, building consistent and profitable revenue streams, maintaining our robust cash flows and controlling expenses throughout all our businesses to increase shareholder value. This concludes my review of the financial results, and I'll now turn the call over to the operator for Q&A.

[Operator]

[Operator Instructions]And your first question comes from the line of Doug Taylor with Canaccord.

[Douglas Taylor, Director]

I appreciate that last slide that you shared with us there. So I guess I wanted to ask one question to start on this slide. And that's can you speak to the reasons and the justification for the expansion in the multiple from the kind of 10x that you're at now, buying things at 8x and yet ending up with a 14x valuation multiple. What are the -- do you think the changes in the business model, the revenue mix or the dynamics that you think are going to justify that multiple expansion?

[Paul L. Hill, President, CEO & Director]

It's -- Doug, it's Paul. So first of all, there's some proof points already. I mean, the last 2 acquisitions we've made are in the mid-single-digit range. There are also public comps that we can provide to you that public ITS companies that trade in the kind of 13 to 15 range and some a little higher than that. So there's a public comp, sort of ITS companies at scale, I would call it. Just looking at the M&A pipeline that we have, the bigger deals could potentially be slightly higher multiples than we paid for the first couple, but not by a wide margin, in my opinion. So it's kind of a combination of looking at the public comps of ITS, the deals that we've already done, the current pipeline, and we can see kind of a healthy gap between what we can pay and what we think we can get valued that at scale as an ITS. But maybe, John, you have other comments on that?

[John Rim, Chief Financial Officer]

Yes, I do, Doug. It's a good question. Obviously, as we're looking at companies that are not at scale that are private, they're owner-managed businesses, they don't have the same type of synergy potentials as a larger organization. We're seeing that now with Sensor Line. They have access to our sales channels, and we're already starting to realize opportunities there. So I think in addition to past practice and what we've seen, what we can buy companies for and what the public is valuing other ITS and adjacent industry companies at scale, that gives us a lot of confidence. In addition to that, I would also say there are cost synergies as well to be realized. Obviously, if we're on common systems, common processes, common sales channels. There are opportunities in that respect as well, too. And I just think as the larger organizations, the things that typically come with being larger in at scale, access to other opportunities, higher barriers to entry, things of that like all contribute to the fact that we're seeing these multiples in the public company markets.

[Douglas Taylor, Director]

And the cost synergies that you talked about is not reflected in this graph or this demonstration you've given us here?

[John Rim, Chief Financial Officer]

This is straight on multiple accretion. We have a more detailed model, obviously. I mean we've tried to be conservative here. As I mentioned before, we want to try to isolate the impact of just our M&A program and a comparison with public company multiples for larger companies at scale in our industry. But absolutely, with our internal models, we model in growth rates. We model in cost synergies. We even model in -- have several "what if" scenarios in terms of sales synergies as well, too. So that's why we're very confident. We're very optimistic in this strategy.

[Douglas Taylor, Director]

Okay. And you point to a relatively stable performance in terms of EBITDA from the WiLAN asset, which is anything but stable in particular, this year, I mean, is there anything standing in the way of you achieving that historic $40 million-plus EBITDA and cash flow in 2021?

[John Rim, Chief Financial Officer]

Well, I think you mentioned it right there, if you look at our last a 4, 5-year average for between $80 million, $90 million of revenue and $35 million -- $30 million to $40 million of EBITDA consistently on an annual basis every year. Nothing's come to our attention that would suggest that it would be other than that at this time. And we have a lot of confidence in our WiLAN business and their ability and their track record of achieving those results.

[Douglas Taylor, Director]

And I wonder -- I mean, the assumed proceeds from the litigation with Apple, a factor in that statement. Could you help us think about that?

[John Rim, Chief Financial Officer]

I mean, I think Paul gave an update on the status. The variability because -- comes in the IP licensing business because of the nature of that business and the sort of the relative lack of predictability in the timing, right? But also, there are other considerations. Our team is expert at the negotiation process to optimize the value of our licensing agreements as well. So that is also something that's strongly considered during that process. So I'm sorry, I can't talk about it more.

[Paul L. Hill, President, CEO & Director]

Yes. I would also just say just a bit more color on that. I mean, first of all, just on the Apple case, where we're at specifically on that is there's going to be an oral argument sometime in the fall, right, to the court of appeals. And normally, there is a decision made somewhere from 3 to 6 months after that hearing. That's kind of the historic norm. So if you play that out, it's kind of early part, sort of, call it, first half of 2022. So just to answer your question, no, unless we settle the case along the way, just if you look at the timing of that process as it unfolds, it's more likely if it goes all the way to bleed into 2022.

[Douglas Taylor, Director]

So put another way, you could get there without it, you feel?

[Paul L. Hill, President, CEO & Director]

Yes. Listen, it's very -- WiLAN has a very active pipeline. I mentioned a bunch of the things, right? There is Motorola. There is Micron. There's AMD. There's Google, Amazon, Microsoft, the applicate in Germany. It is a very active pipeline. It's a similar comment I have on the M&A pipeline. They're both very active. So we're confident that WiLAN is going to perform to kind of a historic performance. But on a quarterly basis, we all know the profile of that business. And that's what you do see -- if you look at the quarterly level. At the annual level, we're very confident.

[Douglas Taylor, Director]

Okay. I mean, you've, again, kind of reiterated this $400 million capital deployment target for the next 5 years. You've obviously got over $100 million in cash right now and the ongoing cash flow. But perhaps you could just refresh us on you mentioned low-cost sources of capital, were you referring just to the cash on hand? Or what would be your ideal capital structure to achieve that exiting 2025, I guess, if you could pick?

[Paul L. Hill, President, CEO & Director]

If we're looking at a larger acquisition or larger acquisitions, we are contemplating leveraging through debt, primary debt. At these interest rates, you can drive greater returns, right? Assuming you have the growth profile. So we are looking at sort of leveraged and unleveraged scenarios as we model these acquisitions. I don't know, John, do you want to add something to that?

[John Rim, Chief Financial Officer]

Yes, absolutely. No, Paul, I think you got the essence of it. Doug, as we acquire companies, obviously, we're acquiring cash-generating companies as well, too. And so with no debt and over 7x current ratio, we're under leveraged, in my opinion. And so with the interest rates being so low, I speak with financial institutions all of the time, who were approached by offering financing. And we -- the acquisitions that we make can easily support the carrying costs. So it just provides incredible flexibility for us to have that available to us. And it also improves our returns, obviously, because we're -- the business that we're buying is basically funding and servicing its own debt. And so it's definitely part of our strategy, but we're going to be selective and thoughtful and have conservative levels of debt where it's the coverage is easily managed.

[Operator]

[Operator Instructions] Your next question comes from the line of Paul Piotrowski with M Partners.

[Paul Piotrowski, Research Analyst]

I had a question with respect to IRD. You guys noted some contract delays. Can you guys go into just a bit more detail and talk about that? And maybe just quantify it a little bit more and then as well, maybe add on what you were seeing in Q2?

[Paul L. Hill, President, CEO & Director]

Yes. It's not -- I wouldn't say I characterize it as very substantial. But the -- if you look at the revenue of IRD, there is a component of revenue around projects and also servicing of equipment that we have in the field, for example. The way the revenue recognition works is you have to perform those services in order to recognize the revenue. So you can imagine with COVID, there are periods of time where the crews just can't get on to the site, and we can't recognize the revenue. I mean, having said that, I have to say Q1 was a very strong quarter for IRD. It's a seasonally softer quarter because you're dealing with winter months, which also limits the ability of the team to service some of their gear. So it's always seasonally softer than other quarters. But having said that, if you add back the FX because they had very big headwinds with the U.S., the softening of the U.S. dollar. If you put that back in and look at it more from a constant currency basis, IRD had a very strong quarter, especially considering the headwinds of FX and COVID. And so that's number one. Number two, is Sensor Line's off to a fast start, too. I mean, we've already done a deal in North America on that product. And we have a pipeline growing all over our distribution network. This is a company with a great product, but it had very little in the way of sales coverage. And so there is a bit of that going on, but I think we're getting near the end of that, hopefully, and it should be a strong future.

[Paul Piotrowski, Research Analyst]

Okay. Great. And I know this is pure speculation, but what do you guys kind of handicap the odds of maybe coming to some kind of settlement with Apple ahead of time? Or do you think this will kind of go the course?

[Paul L. Hill, President, CEO & Director]

I really can't comment on that. And I don't know. I mean, that is always possible. We've seen it in the past with other litigations that at a certain point, that can make sense for both parties. But I can't really comment beyond that.

[Operator]

As we have no further questions at this time, I will turn the call over to Mr. Hill for closing comments.

[Paul L. Hill, President, CEO & Director]

Okay. Well, thank you, operator, and thank you, everyone, for participating in today's call, and we look forward to speaking with you again on the next call. Goodbye.

[Operator]

This does conclude today's conference call. You may now disconnect your lines.