Quarterhill Inc

TSX:QTRH

Earnings Call Transcript 2024-Q1

[Operator]

Good morning, and welcome to Quarterhill's Q1 2024 Financial Results Conference Call. On this morning's call, we have Chuck Myers, CEO; and Kyle Chriest, Chief Financial Officer. [Operator instructions]. Earlier this morning, Quarterhill issued a news release announcing its financial results for the quarter ended March 31, 2024.This news release, along with the company's MD&A and financial statements are available on Quarterhill's website and 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 the company's Q1 2024 MD&A for full cautionary notes regarding the use of forward-looking statements and non-IFRS measures.Finally, please note that all financial information provided is in U.S. dollars unless otherwise specified. I will now turn the meeting over to Mr. Myers. Please go ahead, sir.

[Charles Myers, executive]

Good morning, everyone, and thank you for joining us on today's call. In terms of the agenda today, I'll discuss the results for the quarter, after which Kyle will take a look at the key financial results. And after Kyle, we'll open it up to questions.Q1 summary. Overall, we are pleased with the Q1 results, which were in line with our expectations. Revenue was $34.9 million, up 23% from last year and adjusted EBITDA improved to a positive $0.2 million from negative $3.8 million in Q1 last year.Q1 solid revenue growth and significant year-over-year improvement in adjusted EBITDA reflect the work we've done in the past year to strengthen our project management, integrate operations and manage expenses. Our substantial revenue backlog at quarter end was more than USD 500 million, which gives us good revenue visibility for the remainder of 2024 and into subsequent years. Kyle will look at these numbers in more detail in his section.For our business review, our 2 business units, Tolling and Enforcement made progress in quarter 1 and their ongoing projects as well as closing new business and advancing other opportunities through the sales pipeline.On the tolling side, we signed a 5-year extension with the Illinois Tollway and continue to make progress with our current implementations, moving them closer to the operations phase later this year. Since our last call, we've seen progress on that print with E470-CTRMA and OCTA in Orange County.Since joining, much of my time has been focused on stabilizing and streamlining the business. However, we are currently wrapping up our bidding activity and will be more aggressive during the remainder of the year and pursuing new opportunities. On top of all the work we've done to internally enhance our bidding process over the year, we think that the addition of Red Fox has further strengthened our big potential.We announced the acquisition of Red Fox during Q1 and the transaction closed after the quarter in early April. As a reminder, Red Fox is a profitable and growing provider of automatic vehicle detection and classification or what we commonly call AVDC, software to the tolling industry. But also, we believe, with applications to our enforcement business as well.AVDC is responsible for the detection, classification and tracking of a vehicle as it enters and exits a tolling facility. Red Fox's quantum software platform is unique in its ability to process capture data from both LiDAR and in-payment inductive loops.They are at the forefront of advanced AVDC solutions and have recently been recognized as such. Congratulating the Red Fox team. Last week, we announced Red Fox has been recognized twice by the King's Award for Enterprise in the U.K., winning an award for innovation and another award for excellence in international trade. Perhaps unfamiliar here in North America, the King's Award are considered very prestigious in the U.K.The King's Award recognized outstanding achievement by U.K. businesses in the categories of innovation, international trade, sustainable development and promoting opportunity through social mobility. And they've been honoring companies this way since 1965.We are obviously very pleased with the acquisition and to have them as part of the Quarterhill team. Our tolling unit is a customer of Red Fox as an integrator of their quantum software. So, we have firsthand experience with the quality performance and untapped potential of the product. As mentioned, we're all already working to integrate quantum into our bids, and we see the potential to integrate it with both our tolling and enforcement units.Q1 was a good quarter for the enforcement business. Renewal and customer expansion activity was solid with lots of singles and doubles in terms of contract size, which is typical for that business, especially in the first quarter. These included a $4 million contract in Tennessee, which is our first in that state as well as new safety enforcement contracts in Washington, D.C. and New Jersey, among others.Q1 is traditionally a slower quarter on the enforcement side, primarily due to weather-related delays in lighter scheduling. However, results from that unit came in within target, and we think we remain on plan for the year.In discussing our strategy. On our last call, I outlined the broad strokes of our 3-year plan, which we believe will drive top line growth, margin expansion, positive cash flow. Foremost, we remain focused on leveraging improvements we've made in the past year to our project management and contract bidding processes to grow a world-class tolling enforcement units.At the same time, we're looking at 3 areas we can strengthen those existing operations while expanding our capabilities in addressable market. The first is to leverage our footprint and expertise in Europe and to pursue tolling opportunities there. We recently had a large contingent from the Quarterhill companies and technical staff to attend the Intertraffic show in Amsterdam, which is one of the premier events for the ITS industry in the world.The show gave us an opportunity to advance discussions with customers, prospects and partners on entering the tolling market in Europe and the addition of Red Fox to enhance our potential on the print.The second area of focus is on software development to support the tolling and enforcement businesses as well as the penetration in other verticals. We've augmented our internal development goals with the acquisition of Red Fox and their quantum solution. And long term, we'll continue with a buy-and-build approach to expanding our transportation software portfolio.AI and machine learning will play a big role in our development as well in the transportation industry itself, and we are focusing on these areas around visual technology, vehicle ID and classification as well as data mining and analytics. These 2 areas could have positive applications for both our business units, and we believe in the best interest in demand from our customers is there.The third element of our strategy is adapting and broadening our solutions to fit within select niches in the logistics market. Our focus here to date is on intermodal terminals, ports, borders and asset management.We have a small project underway that fits within this market for the rail logistics business and our goal here is to see if we can expand the mandate with that customer and replicate it with other businesses.As I said a couple of months ago, we're in the early stages of our go-to-market strategy in logistics, but we believe the addressable market is significant and that the developing these solutions is complementary to our existing verticals.Integration and rightsizing. A big part of our positive transformation this year has been integration and streamlining of our business. And while much heavy lifting has been done, we continue to look for ways to further drive efficiency and effectiveness through this business.In an effort to further streamline operations, improve margins, drive positive cash flow, earlier in May, we made adjustments to our workforce and they are expected to save us approximately $3 million in 2024 and $4 million on an annual basis going forward.Importantly, we don't believe these changes will impact our growth capabilities. As projects have transitioned from implementation to operations on the tolling side, we have excess capacity that we were able to streamline. We have teams in place that can effectively manage new mandates that come in, and we have the need to scale up beyond we can tap into contract and temporary services to do so.We also continue to add strategically to the team, in particular, looking to expand our sales team and add selectively. We're seeking greater efficiency and output in other areas like technology.Finally, my last point on the integration front is, we've launched a unified branding campaign throughout the business and unveiled our new look at the Intertraffic show I mentioned earlier under the Quarterhill brand. The brand brings together our entire portfolio under the Quarterhill name and includes a new look and field website that I encourage you to have you engaged with.In terms of our outlook, little has changed since our year-end call in March. We look to build on the progress we've made by enhancing our large projects and implementation towards the operations space, enhancing our technology footprint, expanding relationships with existing customers, winning strategic opportunities and growing both revenue and adjusted EBITDA.We plan to achieve this by remaining focused on growing our world-class franchisees and tolling enforcement while investing in a higher-margin software applications and seeking expansion opportunities in the European market and logistics vertical.Our goal is to achieve growth while generating reliable cash flows in order to build a healthy and sustainable balance sheet, capable of supporting both organic and acquisitive growth strategies.We expect our cash position to improve as we move through 2024 as we realize milestone payments on several ongoing tolling projects as we benefit from a leaner, more optimized organizational structure.In closing, we are making progress with improving our financial results, enhancing our software solutions and optimizing our cost structure. We're obviously not done and we have more work to do on all fronts, but we are doing it from a position of strength. We have excellent ITS assets, a great team and extensive customer base in both business units and a significant revenue backlog that gives stability and visibility looking forward.We are very focused on improving our cash flow position, which Kyle will touch on and we remain very excited and optimistic with our prospects to become a major player in the industry. Simply put, we want to be #1 or #2 in our markets, and we have the foundation in place to achieve that.With that, I'll turn it over to Kyle. Kyle?

[Kyle Chriest, executive]

Thank you, Chuck, and good morning, everyone. Before we get into the financials, I want to remind everyone that with our Q1 2024 results, we have switched reporting from Canadian dollars to U.S. dollars. A significant portion of our sales expenses, assets and liability fees are denominated in U.S. dollars.Our internal budgeting and reporting processes are structured around this currency and the move to U.S. dollars one has their internal management efficiency and external stakeholders' ability to assess our financial performance.Secondly, please note that all discussion on Q1 2023 financial reflects only the results of our ITS business. WiLAN's financial results in Q1 2023 are reflected in the discontinued operations line items on our P&L and cash flow statement as that business was sold in June 2023.With that, I'll start with a look at revenue in the quarter. Q1 revenue was $34.9 million, up 23% year-over-year. The increase for the quarter was due to improved performance from our tooling unit, which saw incremental revenues and had experienced cost overruns in the Q1 2023 period that had negatively impacted revenue.Our enforcement unit delivered another quarter with a steady and reliable contribution. This contribution was predictably reduced in Q1, which is a seasonally slow quarter in enforcement and round stack up in the remaining 3 quarters of the year.As Chuck touched on in his section, at the end of the quarter, we had significant backlog of more than $500 million, providing good visibility into revenue for the next several years. Of note, a large portion of the backlog is the higher-margin contracted maintenance revenue versus implementation revenue. We expect this to result in improved margins as we move throughout the year.However, as we have said previously, for those tolling projects that have recently moved into the maintenance phase, margins tend to start out lower at the launch date and rise over a period of a few quarters before stabilizing.Gross margin percentage in Q4 was 18% for the quarter compared to 13% in Q1 last year. The increase in gross margin is primarily due to improved margin profile on tolling implementation projects, which experienced expense overruns in the prior year period. The increase in gross profit margin percentage is also due to improved margins on certain tolling projects that have transitioned from implementation to maintenance.Total operating expenses for Q1 2024 were $10.5 million compared to $11.6 million in Q1 2023. The decrease was primarily due to lower sales, general and administrative or SG&A expenses and R&D expenses.SG&A was $6.4 million compared to $7 million in Q1 2023. As a percentage of revenue, SG&A in Q1 2024 was 18% compared to 24.5% in Q1 2023. We have worked to drive efficiencies in the business through our integration efforts, which are reflected in the year-over-year decrease in SG&A. With the streamlining initiative Chuck mentioned earlier, the majority of the $3 million in 2024 savings will be expected inside cost of goods sold.There are some SG&A savings as well, but also some key SG&A investments we need to make to grow the business. Overall, we expect to cold SG&A cost increases year-over-year to under 10%. Q4 adjusted EBITDA was positive for the fourth quarter in a row at $0.2 million, up from negative $3.8 million in Q1 of last year.Adjusted EBITDA improved year-over-year due to stronger performance from the tolling unit and supported by steady results from the enforcement unit. As a reminder, Q1 has seasonal impact on the enforcement unit with its results expected to strengthen in the Q2 to Q4 period.We expect adjusted EBITDA to grow and for margins to improve as we move throughout the year. This will be driven by the enforcement unit moving into its seasonally stronger quarters and with certain tolling projects generating higher margin revenue having moved into the contract operations phase from the implementation phase.Turning now to the balance sheet. At quarter end, we had adjusted working capital of $75.4 million compared to $78.9 million at the end of 2023. Quarterhill has adopted amendments to IAS 1, which became effective January 1, 2024. These IFRS amendments specify that conditions that exist at the end of a reporting period are those that will be used to determine if the right to defer settlement of a liability exists.The amendments define the settlement of a liability to include settlement through a company's own equity instruments. This means that we must now classify our convertible debentures as a current liability, even if the expected repayments or conversion is more than 1 year away and even if it is not expected to be settled in cash.As a result, we are using adjusted working capital, a non-IFRS measure to highlight the strong working capital position that we have. Adjusted working capital is defined as working capital adjusted for convertible debentures and derivative liability. As a reminder, our convertible debentures matured October 30, 2026.We ended the quarter with cash and cash equivalents of $30.4 million compared to $42.7 million at the end of 2023. Cash used in continuing operations in Q1 was $10.1 million compared to $6.6 million in Q1 last year.Primary uses of cash in Q1 were related to working capital adjustments, which included $5 million in payables, a $2 million increase in unbilled revenues and $1.5 million of cyclical inventory purchases. Other uses of cash included debt repayments and interest expense.As Chuck mentioned, improving our cash flow is a top priority and integral to our strategy. The decline in cash in Q1 is primarily due to the timing of collections on certain contract milestone payments, which is reflected on the balance sheet and unveiled revenue and receivables.As stated on our last call, our outlook for cash in 2024 is that we expect to generate positive cash from operations for the year. Due to the nature of our business, operating cash flows may vary significantly between periods due to changes in timing and working capital balances, namely with collections and payments.Finally, last year, we amended our credit agreement to provide for a covenant release that ran until March 31, 2024. As of March 31, 2024, we were well on side of these covenants and are projecting to remain well on side of them based on our business plan.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] Your first question comes from Gavin Fairweather with Cormark.

[Gavin Fairweather, analyst]

Maybe just to start out on the European tolling opportunities. I know that the business has an existing footprint in that market. But maybe just speak to your efforts to prepare to enter that market in a more fulsome way for tolling? Are you hiring some more experience tolling people in that market? Are you having discussions with some local players around partnerships? Maybe just talk about the efforts there.

[Charles Myers, executive]

Well, you just hit on both of the key points. We do actually have some quite experienced tolling folks in Europe today that have been primarily focused on the safety and enforcement piece. But as we mentioned earlier, we did do our first kick off in Europe. As you know, the company, we've been very careful about the way we've been spending money. But this was our first big conference, which was Intertraffic in Amsterdam, which is a large conference that happens every 2 years, but this was actually a 4-year window, I believe, because of COVID.So, we do have good resources in Europe and good partnerships, and we are actively and aggressively pursuing those now and looking for just the right opportunities. We have a couple of opportunities in the near term that we think we're probably going to be bidding on. And so, we expect to possibly see some small wins by the end of the year, but probably early into the 2025.

[Gavin Fairweather, analyst]

And maybe just in general, you can speak to the cadence of kind of tolling RFPs in the market and kind of how you're feeling about the ability to put up a good win rate in that business as you revised some of your bidding mechanisms?

[Charles Myers, executive]

Yes, I think it's important to understand that the kind of value of this business is the length of the relationships with the customers. We continue to expand our existing customers, and we're in a number of negotiations on expansion in existing relationships as kind of witnessed as we talked about our expansion in Illinois. We have a number of those discussions ongoing.So, you won't necessarily see bid in the kind of the public markets. You'll hear about them after we announce the extensions. And those can be a fairly significant portion of our business, probably in a very large portion of our business. So, we do see a good cadence right now with several RFPs hitting the streets now out or that we have a pretty good line on for the next 12 months.So, the cadence is how you announce it has a lot to do with all of the kind of the political process that goes through these things as they're moving forward. So, I would be probably questionably pressed to give you any exact times on that. But we do see good market action right now and especially in our expansion activities.

[Gavin Fairweather, analyst]

And then maybe just on EBITDA margins. I mean, obviously, moving profitability higher as a big priority. I think that you've talked in the past of a mid-teens target for EBITDA, maybe 20% longer term. I guess I'm just curious, like how much remove we can see as more of these ETC projects slip into maintenance versus kind of how much of the move will require achieving greater scale for the business and some additional wins or M&A? Just curious for your thoughts on that.

[Charles Myers, executive]

I mean, we think a lot of it is going to come from operations. As we've mentioned in the past, there's a hangover in this company probably, and I mean this is speculation on my part, the hangover goes back to all the way and probably before quarters you bought the company, where there were under previous ownership, they had bid jobs very aggressively and probably underbid them with the purposes of maybe promoting revenue that maybe not should have been promoted so hard.So, I think a lot of the margin enhancement just becomes as we spend a lot of time with our customers on these implementations and cleaning them up and cleaning up any of the software changes that need to be done, a lot of that margin improvement just comes with time. and hard work. And so we're moving that forward. And I think that's why you're starting to see some -- while it was small, there was a 3% margin expansion, I think Kyle just reported. And we expect to continue to see that.Current jobs, we're bidding much, let's say, with higher margins, and we're more careful about what we do, how we do it. And the other side of it is we expect to bid jobs in the future, much more along a software license basis with much higher margins as we kind of transition how the company positions itself as a more of a software company rather than just a simple integrator.

[Gavin Fairweather, analyst]

And I apologize, I thought that I'd never ask a willing question on the call. Again, I did see if award announced late last week versus Microsoft. I'm sure that will just kick off kind of more legal wrangling, but does that change your view on the value of your equity stake or not at all? Anything?

[Charles Myers, executive]

The reality is, Gavin, and have a lot of experience personally with patent litigation, don't hold your breath. Microsoft is a big company. They have a reputation of taking things literally all the way to the Supreme Court. I can't remember when I read that, whether it had been through even if that was an appellate rule, I don't even think that's an appellate ruling.So, I think we've got our ways to go before you're going to realize anything on that.

[Gavin Fairweather, analyst]

And then maybe just for Kyle, do you have an estimate on how much excess working capital might be in the business or how much you might be able to pull out between kind of Q2 to Q4 this year as some of these things, some of these milestones are achieved. Any sense or estimate on that?

[Kyle Chriest, executive]

Hi, Gavin. There is an excess. We built up payables as well, which we saw we paid down this quarter, which was kind of the offset to that excess. But we are targeting to improve working capital, somewhere around 10% to 15% overall from where we are today. And that improvement will come in across Q3, Q4 and the year.

[Gavin Fairweather, analyst]

So, 10% to 15% reduction in your working capital level.

[Operator]

Your next question comes from Todd Coupland with CIBC.

[Thomas Ingham, analyst]

I had a balance sheet question as well. Could you just tell us what the likely outcome will be on the current debt and the convert? What does that look like, I guess, post maturity?

[Charles Myers, executive]

Kyle, you want me to take that or you want to take it?

[Kyle Chriest, executive]

No, I can jump in. I guess we're ways away on the converts on the convertible debt, Todd. We're ideally hoping the share price would be up, and we would be converting it in the future and not diluting the stock very heavy, the 380 target prices out there, and that's a good price, and we've got a couple of years to get there.On the debts, we're back on side of our covenants, and we're forecasting to be on side of our covenants I had mentioned in our scripts earlier. And with that debt, it matures around the same time. I think at that point in time, we should be looking to extend or looking to pay down the debt, depending on the position of the business and what's best at that time, but also a couple of years out.

[Thomas Ingham, analyst]

I'm sorry, I've forgotten this number. I thought you said October '24?

[Charles Myers, executive]

No, October '26. Yes, we have 2.5 years. 2.5 years.

[Thomas Ingham, analyst]

My apologies for my ignorance on that date. And so, the takeaway is fine. I mean you have $50 million in cash and no cash calls for a while. And the $21 million debt, how does that compare to your available lines of credit? Do you have a space there if necessary?

[Kyle Chriest, executive]

So, at the end of our covenant release period, we reopened up our $5 million line, and that's to be a little less right now.

[Thomas Ingham, analyst]

So $5 million on top of the $21 million. Second question for me is, what should the margin progression, the EBITDA margin progression be this year? Pretty low in Q1. You have had some high single-digit, low double-digit EBITDA margins over the last year or 2. Talk about the progression this year and the path to get back to double digits. What type of expectation should investors have on that?

[Charles Myers, executive]

You want me to take that, Kyle, or you want to take that?

[Kyle Chriest, executive]

I can jump in and let you add some color. Todd, we weren't giving specific guidance on EBITDA this year, but we do expect it to grow throughout 2024. You have to also keep in mind that in the current quarter, the enforcement revenues, which bring in solid margins are down in Q1 and will ramp back up in Q2, 3 and 4.We want to get to a double-digit EBITDA as quick as we can. And then longer term, we do want to get it up to that 20%, but we're looking at a couple of years to get there. Anything to add there, Chuck?

[Charles Myers, executive]

Look, I think I've mentioned this before. Our goal is to exit as close to double digits as we can at the end of the year. And I think I've been fairly I mean, that's been pretty transparent about my goal there, and that is still our goal, and we still think it's achievable.

[Operator]

[Operator instructions]

[Thomas Ingham, analyst]

Last question for me is on the backlog, just down a little bit sequentially. How should we think about the puts and takes in the backlog quarter-to-quarter versus all the activity you talked about in RFPs and growth in the revenue over the course of the year?

[Kyle Chriest, executive]

Thanks, Todd. On the backlog side, we converted a lot of the items that I think I previously mentioned, we had some high probability pipeline that we know those renewals are coming and a couple of those came in, Chuck mentioned Illinois and converted now to backlog. We had a couple of wins during the quarter, but we, overall, I think we're sitting at above $500 million right now.So, we drained the backlog a little bit, but Q1 wasn't a large planned replenishing quarter. We still bids out there, and we'll look to refill as we continue throughout the year.

[Operator]

There are no further questions at this time. I will now turn the call over to Mr. Myers for closing remarks.

[Charles Myers, executive]

Great. Thank you. Yes, a big thank you to all of our shareholders. I realize you've been through a lot of things with Quarterhill over the years. Rest assured me and my team and Kyle and his team are working extremely hard to really get this thing going in the right direction, and we're pretty pleased with where we are.We know we have a lot of work. We're really focused on moving cash up this year. We want to thank the analysts and the coverage and to be honest, all of our employees. I mean everybody is grinding out. We got great employees. And over the few days, you'll hear about the fact that we brought in a new executive program manager, comes out of the defense and aerospace business to manage overall our programs as well as Kyle's beefed up his team with 3 senior significant financial folks just managing projects.So, we're very happy with our team and we're very happy with the kind of the restructuring process that's going on. So, with that, I'll just say thank you again to all of our shareholders and for taking the time and being supportive.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.