Quarterhill Inc

TSX:QTRH

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, and welcome to Quarterhill's Q2 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 3 and 6 months ended June 30, 2024 This news release, along with the company's MD&A and financial statements are available on Quarterhill's website and SEDAR+.

Certain matters discussed during today's conference call are 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 Q2 2024 MD&A for full cautionary notes regarding the use of forward-looking statements and non-IFRS measures.

Finally, please note that financial information provided is now 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. After Kyle, we'll open it up for questions. Q2 summary. Overall, we're pleased with the Q2 results, which were in line with our expectations and showed progress on our goals to drive top line growth, increased adjusted EBITDA margin and improved cash flow.

Revenue was $41.5 million, up 7.5% from Q2 last year. Adjusted EBITDA was $1.7 million, down from $2.9 million in Q2 last year, but up from $200,000 in Q1. Cash from operations in Q2 was $802,000 compared to cash used in operations of $6.9 million in Q2 last year. This obviously is a big swing year-over-year and reflects a lot of the work we've done in the past year to strengthen program management, integrate operations and manage expenses. In fact, this was the first quarter of positive cash from operations for Quarterhill in 2 years.

Our substantial revenue backlog at the quarter end was $500 million which gives us good revenue visibility for the remainder of 2024 and into subsequent years. Kyle will take a look at these numbers in more details in his section. Q2 business unit review. In Q2, our 2 business units, tolling enforcement executed on their ongoing projects as well as close new and follow-on businesses and advanced other opportunities through the sales pipeline.

On the tolling side, we made progress on several sections of highway with CTRMA in Texas as our activity under that contract continues to grow. We've also seen progress with E-470 and OCTA in Orange County as those projects move towards acceptance and operations, respectively.

We remain active with our bidding activity, with a focus on both follow-on business and landing new customers. Regarding new customers, we expect to have a couple of bids in by the end of the year, subject to delays in the bidding process that can occur at the customer end. In addition, to the work we've done internally to enhance our bidding process over the year, we think that the addition of Red Fox has strengthened our value proposition.

We announced the acquisition of Red Fox during Q1 and the transaction closed Q2. As a reminder, Red Fox is a profitable and growing provider of automated vehicle detection and classification software to the tolling industry, but we also 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 tolling facility.

In Q2, Red Fox was recognized for its technical prowess, winning 2 Kings awards for enterprise, one for innovation and the other in excellence in international trade. The King's awards are considered very prestigious in the U.K., with King Charles himself involved in the recognition of the winners. The awards recognize outstanding achievement by U.K. businesses in categories such as innovation, international trade, sustainable development. And they've been honoring companies this way since 1965.

We're obviously very pleased with the acquisition and to have them as part of the Quarterhill team. As mentioned, we are already working to integrate their Quantum software into our bids, and we see the potential to integrate it with both of our tolling and enforcement units.

Our enforcement unit delivered solid results in Q2, with this being one of the seasonally strong quarters. The business continues to generate steady and reliable performance, with plenty of follow-on renewal and new customer contracts. These include new agreements in North and South Dakota, New York, California and Idaho. Subsequent to quarter end, we announced 2 international deals, one in South Korea and one in Thailand.

Of note, our contract in North Dakota was for our artificial intelligence vehicle classification system used for traffic monitoring. This involves the use of AI video automatic traffic recorders, or ATRS, the [ common ] classified vehicles, which is essential for highway planning, design, maintenance and management. As you know from our previous calls, AI and machine learning applications in ITS are an area of great interest for us going forward, and I'll touch on that shortly.

Strategy. Our 3-year plan remains focused on leveraging improvements we made in the past year to our project management and contract bidding process to grow our tolling and enforcement units. At the same time, we are looking at 3 areas where we can strengthen those existing operations while expanding our capabilities and market reach. The first is to leverage our existing footprint and our safety and enforcement expertise in Europe to pursue tolling opportunities.

On our last call, I spoke about our participation at the Intertraffic show in Amsterdam, which took place during Q2 and is one of the premier events for the ITS industry. The show gave us an opportunity to advance discussions with customers, prospects and partners in a broad number of tolling enforcement opportunities throughout Europe, with the addition of Red Fox enhancing our potential on this front.

The second area of focus is on software development to support tolling enforcement businesses as well as our penetration into other verticals. The addition of Red Fox and their Quantum solution helps us to advance our goals there. And long term, we will continue with our buy-and-build approach to expanding our suite of applications. AI and machine learning will play an important role in the development of our technology road map, as will our focus on visual technology and data mining and analytics. We're already active on this front, as I just mentioned, with the North Dakota win. And ultimately, these applications will provide a natural lead in to our third area of focus, which is logistics.

We've had a big development on the AI/machine learning front with the addition of our newest Board member, which I'll discuss in a moment. On the logistics side, we have a project underway that is going well, and we expect to see the mandate with this customer to expand this year while simultaneously build out our sales pipeline. We are in the early stages of our go-to-market strategy here, but we believe the addressable market is significant and that developing these solutions is complementary to our existing verticals.

Integration and rightsizing. A big part of our positive transformation in the last year has been the integration and streamlining of our ITS business, and this work continues, especially on the technology side. As part of our ongoing efforts to drive efficiencies, we announced restructuring with our Q1 results that was effective in Q2. While we have reduced headcount in certain areas of the business where we believe growth will not be impacted, we also continue to strategically add to the team, in particular, expanding our sales team and adding select senior resources to help drive the execution on our 3-year plan.

Finally, during the quarter, we launched a unified branding campaign throughout the business, and unveiled our new look at the Intertraffic show, as I mentioned earlier. The branding brings together our entire portfolio of subsidiaries under the Quarterhill name with an overhaul of our customer-facing messaging in the new website.

A Board member. In keeping with the themes of AI and organizational change, we also announced today that Vineet Khosla has joined the Quarterhill board effective immediately. Vineet is the Chief Technology Officer at the Washington Post, where he's leading their engineering team and is driving force behind their technology vision and innovation strategy. Vineet is a pioneering researcher and a leading voice in AI, machine learning and cloud computing and has driven significant advancements in these fields. He joined the Post in 2023 and brings an extensive track record as an innovator and executive at some of the world's largest companies.

Prior to the post, Vineet was at Uber for 5 years, where he was responsible for the development of their map routing engine, which optimized routes and timing. Before Uber, he was at Apple for more than 8 years. At Apple, he built the core framework for SIRI's AI engine. He was an AI engineer at SIRI when it was acquired by Apple in 2010. Those of you that have followed the Quarterhill name for some time may recall that our previously owned business, WiLAN acquired the original SIRI patents in 2016. Vineet played a key role in the development of the technology behind those patents.

Finally, he was into Masters in artificial intelligence from the University of Georgia in 2005, so he's not a newcomer to this growing industry. Overall, we're very pleased to have Vineet join the Board and look forward to him playing a role in the development of our product road map and our push to expand the software side of our business, especially with AI and machine learning.

Outlook. Looking forward, our goal is to drive growth for revenue, adjusted EBITDA and capital in 2024 and beyond. We look to achieve this by capitalizing on the progress in our large tolling projects, with steady growth from our enforcement business, the expansion of our technology software footprint and the opportunity to expand into new markets and verticals. Over time, this will result in the company generating reliable cash and building a strong balance sheet capable of supporting both our organic and acquisitive growth strategies.

In closing, we are making progress in improving our financial results, enhancing our software solutions and optimizing our cost structure. We have a great team at Quarterhill, excellent ITS assets, strong customer relationships and a significant revenue backlog. We are very well set to be the #1 and #2 player in the industry, and simply put, that as our goal.

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, please note that discussion pertaining to 2023 financials reflects only the results of our ITS business. WiLAN's financial results for the 3 and 6 months ended June 30, 2023, are reflected in the discontinued operation line items in our P&L and cash flow statements as that business was sold in June 2023.

With that, I'll start with a look at revenue in the quarter. Q2 revenue was $41.5 million, up 7.5% from Q2 last year. Year-to-date, revenue was $76.4 million, up 14%. The increase in the 2 periods was due to strength in our enforcement unit as well as improved performance from our tolling unit, which generated incremental revenues and had experienced cost overruns in the respective 2023 periods that had negatively impacted revenue.

As Chuck touched on in his section, at the end of the quarter, we had significant backlog of $500 million, providing good visibility into revenue for the rest of 2024 and the next several years. Of note, a large portion of the backlog is higher margin contracted maintenance revenue versus implementation revenue. We expect this to result in improved margins as we move through the year. However, as we've 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 then rise over a period of a few quarters before stabilizing.

Gross margin percentage in Q2 was 21% compared to 26% in Q2 last year, but up sequentially from 18% in Q1. In general, we expect gross margin percentage to continue to increase as we move through 2024. The year-over-year decrease in Q2 was primarily due to one [ tolling ] project that is in the maintenance phase, but experiencing a transitory period of lower-than-expected margin, which we expect to resolve in the coming quarters. The gross margin percentage decrease was partially offset by continued strong margin performance from our enforcement unit.

Total operating expenses for Q2 2024 were $10.8 million compared to $10.6 million in Q2 2023. Year-to-date OpEx was $21.2 million, down from $22.2 million in the same period last year. For the quarter, OpEx grew slightly due to higher SG&A, offset in part by lower R&D. There are some key SG&A investments we are making to grow the business. And as I said on our last call, we expect to hold SG&A cost increases for the year to under 10%. The majority of the savings from the streamlining initiative we announced in May with our Q1 results will be reflected inside cost of goods sold.

Q2 adjusted EBITDA was positive for the fifth quarter in a row at $1.7 million compared to $2.9 million in Q2 last year and $0.2 million in Q1 of 2024. Year-to-date, adjusted EBITDA was $1.8 million compared to negative $0.9 million in the same period last year. Adjusted EBITDA has improved in the year-to-date period due to steady results from the enforcement unit and stronger revenue performance from the tolling unit. We expect adjusted EBITDA to continue to grow and for margins to improve as we move through the year. This will be driven by enforcement unit results in its seasonally stronger quarters from certain tolling projects advancing through the maintenance phase and from others completing the implementation phase.

Turning now to the balance sheet. At quarter end, we had adjusted working capital of $68.4 million compared to $78.9 million at the end of 2023. As we spoke about on our last call, following the IFRS amendment to IAS 1, we are now using adjusted working capital, which is 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 the derivative liability. As a reminder, our convertible debentures don't mature until October 30, 2026.

We ended the quarter with cash and cash equivalents of $24 million compared to $42.7 million at the end of 2023. Of note, payment for the Red Fox acquisition was made in Q2, while other uses of cash included debt repayments and interest expense. So the decline in cash sequentially from Q1 was to be expected. On a positive note, we ended the quarter with a higher cash balance than we had forecasted due to progress filling and collecting on some of our longer-standing unbilled revenue balances.

Improving our cash position is a top priority and a key to our strategy. We saw progress on this front in the quarter, generating positive cash from operations of $0.8 million compared to cash used in operations in Q2 last year of $6.9 million. As Chuck mentioned, this was the first quarter in 2 years that Quarterhill has generated positive cash from operations. Our outlook for cash in 2024 is that we expect to generate positive cash from operations for the year and to grow the cash balance through year-end. 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.

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 from Graham Smith from Cormark Securities.

[Graham Smith, analyst]

My first question is just on the expanding sales team or the choice hires that you're making on the sales team. Can you give a bit more color on where you're hiring specifically? That would be great.

[Charles Myers, executive]

The hiring is -- as you probably -- this is Chuck, by the way. As you may have known, we had kind of significantly cut back on the sales and BD team. So we're starting to strategically hire both in the U.S., and we've actually made a couple of hires in Europe as well.

[Graham Smith, analyst]

That's great. And then just on Europe. So now you guys are hiring in the sales force a little bit. Can you talk a bit more of the progress that you've made in the quarter there?

[Charles Myers, executive]

We continue to streamline the businesses there. As you know, we have basically 4 different subsidiaries over there and primarily in the enforcement space, but we're continuing to aggressively look at tolling opportunities there as well.

[Graham Smith, analyst]

All right. Great. And then switching to just tolling, so can you talk about some of the ramping tolling operations that are going from implementation to operations maybe how those are progressing?

[Charles Myers, executive]

Progressing quite nicely. We're -- it's still a lot of hard work to do, but I think you could see by our numbers, we're making good progress. I think we've significantly improved the relations since I've got here with our customers, and that's been a primary focus of mine to wrap those up. But so far, we're pleased with the way our customer relationships are going, and we're making progress. And we're almost out of the hot water with any problem contracts and most of them are starting to convert to the maintenance phase at this point.

[Graham Smith, analyst]

That's great. And then just a last one for me. Can you maybe just talk about what the sales pipeline looks in the second half? Are you seeing any particular strength in one area? Or is it sort of strong across the business. Any color on that would be really helpful.

[Charles Myers, executive]

Yes. No, we continue to see -- we have a positive pipeline going forward. Even in our businesses, we see a pretty significant pipeline ahead. We don't see a lot of headwinds. We -- typically, the enforcement business is better in the second half of the year, and we suspect that tolling will do quite well in the second half as well.

[Operator]

[Operator Instructions] Your next question comes from Todd Coupland from CIBC.

[Thomas Ingham, analyst]

I wanted to ask about a couple of things on the backlog. Are you able to give us an idea how much backlog -- or how much of a moderate growth plan you have already booked in backlog? So if we think -- if you think about either the second half of the year or 2025, like how much visibility do you have to your plan at this point?

[Charles Myers, executive]

Well, pretty strong. I mean, as you know, it takes a long time to win these contracts, so they tend to be very sticky. The enforcement business is growing nicely and that's obviously more kind of a turn and burn business. You get orders, you book them pretty quick and they go through, but the tolling business, the 2 -- the combined businesses are roughly still $500 million. We've maintained our backlog. So as we add contracts and we get add-on change orders to our contracts, we've maintained that $500 million of backlog, which I've always thought was quite impressive for a company that's doing $150 million a year.

[Thomas Ingham, analyst]

Yes. And this is a little bit of point in terms of your business, but it's a, I guess, macro environment. Sales force, Marc Benioff has talked about longer lead times, smaller deals taking longer to close, et cetera. Can you characterize your pipeline in that context? You're obviously selling to governments, not enterprises, but there are macro questions. Because you just talk about like the size of the deals, time to close deals, versus, let's say, a quarter ago or 6 months ago?

[Charles Myers, executive]

I would say we see little impact from that. These are customers -- well, if you take the tolling side of the business, and most of these are customers on the enforcement side are primarily local agencies, state agencies, they require this equipment to maintain the roads and the traffic. On the tolling side, our tolling agencies continue to perform very well and generate a lot of cash. And when they need the systems, they need the system. So I can't say that we see any economic impact in delaying the systems other than the ordinary normal course of business that state and local governments go through when they try to issue bids or tenders and protests. But I would say unlike sales force, we don't see -- experience that impact and we're fairly recession-proof business on at least at this level.

[Thomas Ingham, analyst]

Yes, Chuck, I was just going to sort of take it to that point. So is it a fair assumption to actually take recessionary fears off the table and this business will roll regardless?

[Charles Myers, executive]

I would think so. I would think it would be minimal impact. You never say never, but I don't -- to the contrary, this business is -- the agencies love this business because they need it. It's how they generate cash so it's fairly recession, at least, resistant, let's put it that way.

[Thomas Ingham, analyst]

Yes. And then just on the technology. You -- in your prepared remarks, you talked about Red Fox quite a bit. How much of a factor is that in your bids now? And maybe just talk a little -- in a little bit more detail on why it's important?

[Charles Myers, executive]

I think it's important -- maybe we talk about it a little too much because it's kind of got a cool name, but it's important because it's really the next generation of tolling and vehicle classification. And our focus there really is to get -- in the future, get as much equipment out of the roadbed as we possibly can because that's where our customers suffer the most problems and they get the most wear and tear on the road. And if you can do all of this transaction -- provide all the transaction capability out -- above the roadbed or on the side of the road, that's what our customers are really looking for. And I think Red Fox does a good job getting us to that point.

[Thomas Ingham, analyst]

Is it unique in the market? Just talk about its competitive position.

[Charles Myers, executive]

Yes, I would say it's unique in the market. Most of -- any of the other ABC systems use a lot of instrumentation embedded in the roadway.

[Operator]

Your next question comes from Steven Li from Raymond James.

[Steven Li, analyst]

I was curious to find out if weather was a factor at all in Q2?

[Charles Myers, executive]

Could you say that again, Steven, sorry?

[Steven Li, analyst]

The weather was a factor in Q2?

[Charles Myers, executive]

No, there's -- we had no impact from weather in Q2.

[Steven Li, analyst]

Okay. All right. And then, Chuck, when you speak of strong visibility in the second half, does that also mean the quarterly revenues in the second half is going to be similar to Q2 or maybe even up from Q2?

[Charles Myers, executive]

I'll let Kyle take that question.

[Kyle Chriest, executive]

Yes. With the strong visibility, we have a lot of our revenues right now that we're looking into the next 2 quarters, finish of the year underneath the backlog. We have some projected revenues on change orders and things that would be a little less predictable due to the timing of customer award. But the majority of our 2024 projects and projected revenue is in our site line. We were giving prior guidance that we expect or hope to achieve close to double-digit growth year-over-year in total revenues. And I think we're still getting close to that and projecting there.

[Operator]

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

[Charles Myers, executive]

Great. Thank you, operator. With that, thank you, everybody for participating in today's call, and we look forward to speaking to you and keep you informed of our progress in the coming months. And as always, I want to thank our -- the employees and all of our partners in this business. We work hard. We want to do well for our investors, we want to grow the company, and I sincerely appreciate the time and effort of our dedicated employees put into this business. And so thank you very much.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. You may now disconnect.