Quarterhill Inc

TSX:QTRH

Earnings Call Transcript 2019-Q3

[Operator]

Good morning, and welcome to Quarterhill's Third Quarter Fiscal 2019 Financial Results Conference Call. On this morning's call we have John Gillberry, Chairman of the Board; Dave Cortens, Interim Chief Financial Officer; and Shaun McEwan, Quarterhill's outgoing CFO. [Operator Instructions] Earlier this morning, Quarterhill issued a news release announcing its financial results for the 3- and 9-month period ended September 30, 2019. This news release, along with the company' MD&A and financial statements will be available on Quarterhill's website and will be filed on SEDAR and EDGAR.Certain matters discussed in 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 made available on SEDAR and EDGAR.During this conference call, Quarterhill will refer to adjusted EBITDA. Adjusted EBITDA does not have any standardized meaning prescribed by U.S. GAAP. Adjusted EBITDA is defined in the company's quarterly and annual filings that are made available on SEDAR and EDGAR. Please note that all financial information in U.S. dollars unless otherwise specified.I would now like to turn the meeting over to Mr. Gillberry. Please go ahead, sir.

[John Kendall Gillberry, Independent Chairman]

Thank you. Good morning, everyone, and thank you for joining us on this call today. It's a pleasure for me to be here today and to be joined by Dave Cortens, our new Interim CFO, and Sean McEwan, who is assisting Dave in his transition into this role.I'll start off with an update on recent developments followed by an overview of business activity in Q3. As Shaun was CFO during the Q3 period, he will then provide a more detailed look at some of the key numbers, after which we will open it up for questions.Recent developments. As you know, on October 1 we announced that Doug Parker had resigned from his executive and board positions at Quarterhill. We are very thankful to Doug for his efforts and his accomplishments during his time at Quarterhill and we wish him all the best in the future. Since that announcement, we have engaged an executive recruitment firm and a search for a CEO candidate is underway.In the interim, it is business as usual for Quarterhill. Each of our 3 portfolio companies has talented and experienced CEOs at the helm and they are interacting directly with the board while we conduct our CEO search. Additionally, our M&A team remains in place and they continue to execute on their mandate to identify and pursue acquisition opportunities that fit with our diversification strategy and/or add incremental value to our platform businesses as tuck-in acquisitions.Recently, we announced that Dave Cortens was appointed as Interim CFO and we are very pleased to have him join us in this role. At the time of his appointment, Dave was the CFO of IRD, a role he has held there since 2012. Dave is a very experienced public company CFO and has been a member of the Quarterhill family since our acquisition in 2017. Our shared history will facilitate a very smooth transition.I'll now take a look at some of the developments during the quarter. Q3 growth was driven primarily by VIZIYA and IRD. Revenue was up 30% year-over-year to $25.4 million and adjusted EBITDA was $2 million, up from negative $2.5 million in Q3 last year. We continue to have a strong balance sheet and we ended the quarter with $72.1 million of cash and cash equivalents and $77.1 million in working capital.Looking now at each of the businesses. I'll start with VIZIYA. In Q3, VIZIYA had its strongest quarter since our acquisition in 2017. This was driven principally by an enterprise software license agreement. You'll recall that on our Q2 conference call we spoke about 2 large software license agreements that VIZIYA had signed in July. Ultimately we recognized one of those contracts in September once certain warranty and customer acceptance conditions were fully satisfied.However, the second contract was not completed in the quarter and the window of opportunity with that customer appears to be closed for the time being. Shaun will address the earnout implications of these developments in his section.The enterprise deal that was completed in the quarter is with a large integrated energy and chemical company with annual revenues of more than $20 billion. The customer contracted VIZIYA for a work-aligned suite of products and the agreement is comprised of the usual perpetual license, maintenance and support elements.As we said on our prior call, we are pleased to see VIZIYA complete a transaction and we believe it reflects the potential that the company has and the potential that attracted us to them in the first place.While we don't expect these types of transactions to occur on a quarterly basis, we would look for this to be a catalyst for further large enterprise sales and partnership opportunities in the future.IRD had a good Q3 with modest growth in revenue and solid expansion of both its gross margin and adjusted EBITDA margin compared to Q3 last year. Revenue and margin improvements were driven in part by several large projects that are underway in 2019. Additionally, last year we completed a restructuring at IRD which helped to optimize the cost base. While we have benefited from that leaner profile since, we've also continued to invest in the business and its growth potential.As you are aware, we believe that IRD has strong prospects for both organic and acquisition growth. To help drive organic growth, IRD continues to invest in new products such as VectorSense and vehicle information in motion, and is building a good pipeline of opportunities for these new products with its broad global sticky customer base. In fact, IRD's new orders for the year remain ahead of plan and its pipeline has grown nicely year-over-year as well.We continue to like what we see from IRD and its leadership team. We believe they are well-suited for potential tuck-in transactions to enhance its service offering and expand its growth opportunities.With WiLAN, Q3 was a less-active quarter, which is often the case coming on the heels of a stretch of strong performance like we had over the past 3 quarters. Nevertheless, Q3 saw licensing activity as well as continued portfolio expansion.The first portfolio acquired in Q3 was from Vidiator, a pioneer in the delivery of audio and video data. The acquired patents are related to adaptive bit rate streaming, which is the primary way in which video is delivered over the internet today. The second acquisition was from MediaTek, headquartered in Taiwan. MediaTek is a leading fabless chipset provider to the mobile phone, smart TV, voice assistant devices, tablet and optical Blu-Ray markets. The acquired patents relate to error correction and memory control technologies. This is the first licensing partnership transaction between MediaTek and WiLAN.The third acquisition in Q3 was from ROHM Semiconductors, a leading semiconductor provider for industrial, automotive, consumer and PC communication applications. The acquired patents relate to advanced semiconductor packaging technologies. This is the third portfolio acquired from ROHM under the licensing partnership model.On a year-to-date basis, WiLAN has generated strong revenues, adjusted EBITDA and cash flows and is focused on concluding 2019 with a strong overall performance. WiLAN's successful long-term track record suggests by continuing to focus on its licensing and partnership strategies, the business can deliver significant cash flows, even though such results sometimes involve quarter-by-quarter variability, something that is prevalent throughout the patent licensing industry. WiLAN is actively working to stabilize and diversify its revenue-generating initiatives to address this quarterly variability.In terms of upcoming trial activity, we have several scheduled to begin in the next 3 to 6 months relating to our wireless patents. The Apple damages retrial is set to commence in January 2020. The trial with LG is scheduled for late January 2020. And the trial with Canadian service providers Bell, Rogers and Telus is scheduled for later this month.While WiLAN is always open to having reasonable and serious discussions aimed at resolving any ongoing disputes, we are confident in our positions and at the value of our intellectual property. Our teams remain focused on preparing for these trials while at the same time continuing to pursue agreements with other potential licensees in our many licensing programs.Lastly, WiLAN's business development team continues to strengthen relationships with our existing licensing partners and is actively engaging with several other new partners. These potential new partners have deeper folios based on industry-leading technology and a clear interest in working with WiLAN. We believe that these strong and growing partnerships will continue to provide a strong pipeline of licensing opportunities that should drive future revenue and profitability for WiLAN.Regarding our M&A activity, as mentioned, our deal team remains in place and it is business as usual. We have a robust pipeline of standalone and tuck-in opportunities and the team continues their diligent efforts to advance the most promising opportunities towards completion. It is important to note that we are not shifting from our acquisition criteria we established for the company over the past few years.Recurring revenue, positive EBITDA, predictable cash flows, and a committed management team are the characteristics we seek in the business. We will remain patient capital allocators and disciplined on valuations. We recognize for this type of aggregation strategy to work, transactions must be made at reasonable prices and/or multiples.In summary, Quarterhill's fundamentals remain strong. We have a very solid balance sheet with $72 million in cash, with essentially no debt. We are 3 portfolio companies led by strong, capable management teams that are all delivering year-over-year improvements in revenue, adjusted EBITDA, and we have a robust pipeline of M&A opportunities that we will continue to advance, acting only on those transactions that meet our strict deal criteria.With that, I'd like to turn it over to Shaun to take a closer look at the numbers. Shaun.

[Shaun McEwan;outgoing CFO]

Thanks, John, and good morning everyone. I'll start off with a look at revenue in a little more detail. Revenue growth in the quarter, as John said, was driven by VIZIYA and IRD. For the year-to-date period, revenue was $107.6 million, up more than 100% from the same period last year. This increase was driven by higher revenue at all 3 portfolio companies and in particular by WiLAN which year-to-date has generated $56.6 million in revenue compared to $10.2 million in the comparable period last year.Of note, on a revenue segment basis, license revenue was $10.5 million, up more than 100% in the quarter. This was led by VIZIYA and the large contract that John just spoke about. WiLAN revenue also forms a key part of this category.Recurring revenue was $4.7 million in Q3 compared to $6.3 million in Q3 last year. A large portion of this revenue line comes from IRD. Higher recurring revenue in Q3 2018 last year is more reflective of significant system upgrades that occurred last year which are a component of service contracts performed on a time and materials basis at IRD. Throughout 2019 IRD has achieved a 100% renewal rate on all term maintenance contracts and continues to see strong levels of service activity to meet customer demands primarily in the U.S. market.Gross margin in Q3 was 41% compared to 26% in Q3 last year. Year-to-date was 47% compared to 18% last year. The Q3 improvement was due primarily to better margin performance at IRD and VIZIYA, while for the year-to-date period increased gross margins were due to better performance from all 3 businesses and in particular, WiLAN, as I said.Q3 operating expenses include a special charge recovery of $11.6 million in contingent liability related to the earnout payment in the VIZIYA acquisition. You will recall that in Q2, we took a $10.6 million non-cash charge related to this VIZIYA earnout. The contingent liability recovery is in part a reversal of that charge and comes as a result of VIZIYA not meeting its requirements for the earnout payment.For VIZIYA to have achieved the earnout, it had to meet certain financial targets for the period April 1, 2017 to July 31, 2019. At the time of our Q2 call it appeared that VIZIYA might meet that target based on these 2 large software license deals signed literally on July 31. However, as John outlined in his comments, those 2 agreements were not delivered within the earnout time front and to date only one of them has actually resulted in some revenue recognition. Consequently, the earnout target was not achieved and the contingent liability associated with the earnout was reversed in Q3.Excluding that $11.6 million special charge recovery, operating expenses for Q3 2019 were $13.7 million compared to $14.4 million in the comparable period last year. And last year, excluding $2.3 million special charge in that period.Operating expenses decreased year-over-year due primarily to the restructurings at IRD and WiLAN that took place in 2018 as well as Quarterhill's overall ongoing focus on cost control.Adjusted EBITDA improved by $4.5 million in Q3 to end at $2.0 million from a negative $2.5 million in the comparable period last year. For the year-to-date period adjusted EBITDA improved by $41.2 million. It ended at $27.3 million up from a negative $13.8 million last year. Stronger adjusted EBITDA performance in 2019 reflects improved operations from all 3 portfolio companies.Cash used in operations was $9.8 million in Q3 due primarily to an increase in accounts receivable, a significant portion of which was collected after the end of the quarter, and ultimately a decrease in accounts payable and accrued liabilities principally in our licensing segment.Year-to-date cash generated from operations was $11.9 million compared to cash used in operations of $17.9 million in the same period last year. Cash from operations in 2019 has benefited from the improved financial performance at all 3 businesses and in particular from WiLAN which has generated $23.8 million of adjusted EBITDA year-to-date.Turning to the balance sheet as John indicated, we ended the quarter with $72.1 million in cash and cash equivalents up from $67.3 million at year-end.And finally, during Q3 we paid dividends of $1.1 million and then this morning in our earnings release we announced details of our next dividend payment. The Board of Directors has declared an eligible dividend of CAD $0.0125 per share payable on January 10, 2020 for shareholders of record on December 13, 2019. This concludes my review of the financial results. And I'll now turn the call back to the operator for questions.

[Operator]

[Operator Instructions] Your first question comes from Doug Taylor with Canaccord Genuity.

[Douglas Taylor, Director]

I understand that the M&A team, business development team, remains in place and it continues to be business as usual. But is it reasonable to assume that Quarterhill is unlikely to deliver a material deployment of capital until the C-suite chair has been filled and potentially we should expect if any transactions, it would be more tuck-in in nature in at least the near term?

[John Kendall Gillberry, Independent Chairman]

I do think that any acquisitions that we make in the near term are to be more likely tuck-in acquisitions, and that's because we already have CEOs in place who understand the value, the merits and the ability to manage those particular acquisitions. It would be, I think, very difficult at this point in time to launch a brand-new platform without a new CEO in place.

[Douglas Taylor, Director]

As expected, I think. What can you tell us about what you're seeing or what your team is seeing in terms of the valuations of those types of tuck-in assets, given that the public markets for smaller tech assets appears to have been a bit more choppy of late?

[John Kendall Gillberry, Independent Chairman]

We still continue to see assets that are for sale that look kind of reasonable in terms of pricing. And then you have to get a layer down on them to understand why and what the nature of them are. And there is going to be, as I just mentioned, the opportunity for strategic acquisitions in which the price is not the only driving factor in the ability to maybe secure those assets. So it really becomes a deep due diligence exercise to try to A, find the right assets, and then B, understand why we can get those assets at a valuation that hits our criteria and our filter. And I have to say, we've been very diligent in looking at those assets and we do have like I said earlier, a pipeline of opportunities that is moving through that process.

[Douglas Taylor, Director]

But in terms of the valuations, expectations that are out there, would you say then there's been no change? I understand that it's only one of a number of factors you're considering, but would be interested in the perspective.

[John Kendall Gillberry, Independent Chairman]

Yes. I think it's only one of a number of factors, and I think, Doug, it's also a factor of who you may be bidding against, right. There are, as you all know, some PE companies that just need assets. And we're not going to get into a pure bidding war on any asset that we might just know that from the get-go is just going to get sold at a valuation that just doesn't hit our criteria. And that probably means it wasn't overly strategically important for us at the same time. So I do see a bit of the, what we call the frothiness coming off a little bit in terms of pricing. That might be -- it might be seasonal. It might just be some market dynamics. But I still am very optimistic in terms of what I see in our pipeline in terms of good assets at right valuations.

[Douglas Taylor, Director]

Understood. A question for Shaun or perhaps Dave, and welcome to this forum, Dave. Regarding the -- so the VIZIYA earnout, is that now closed and there's not expected to be any flip-flop going forward? The time -- just to remind us the time line that's completely finished now with respect to when they can deliver the revenue to achieve their earnouts?

[Shaun McEwan;outgoing CFO]

Yes. The earnout period covers from April 1, 2017 until July 31, 2019. The opportunity to add to that is gone now, and it's complete.

[John Kendall Gillberry, Independent Chairman]

The window is closed.

[Douglas Taylor, Director]

So even if this deal that has slipped was signed, or came to fruition, and we'll get into the nuance there, it wouldn't go back and retroactively trigger anything?

[Shaun McEwan;outgoing CFO]

Correct. Correct.

[Douglas Taylor, Director]

Okay. And you mentioned in your prepared remarks that that second transaction, the probability of closing or the window is closing. I guess how should we handicap whether -- like, are you signaling that it's unlikely to happen, or less likely than it is to go forward? Or how should we read that in terms of our expectations going forward?

[Shaun McEwan;outgoing CFO]

Yes. Without actually providing guidance on this, Doug, the reality -- the customer ultimately reached out and started to change the terms of the deal dramatically, right. They started demanding things like prototyping and acceptance criteria and things of that nature. So while the VIZIYA team believes that that's still a doable contract in the early part of next year, perhaps, the reality is it still has to be delivered on and probably renegotiated and reconfigured.

[Douglas Taylor, Director]

Okay. Working capital swung negatively this quarter. Is it fair to assume that part of this was the receivables on the other large VIZIYA deal you mentioned with the chemical company? And has that since been captured and is sitting on your balance sheet in cash now?

[Shaun McEwan;outgoing CFO]

That is correct. It's also, we're also a bit of a victim, if you want to call it that, of a highly-successful Q2 with WiLAN in which all the receivables were collected and the payables were still sitting on the books at the end of the quarter. And those payables are now gone too. So a little bit of positive on both sides, frankly.

[Operator]

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

[Todd Adair Coupland]

I apologize if this was answered in the early part of the call. I got on a little bit late. So if I look at the revenue segmentation, $8.7 million for enterprise, is that essentially all VIZIYA?

[Shaun McEwan;outgoing CFO]

Yes.

[Todd Adair Coupland]

Okay. And is that elevated this quarter, and this quarter only, because of that single contract and it'll drop back down to the $3 million, $4 million-a-quarter range? Or is this a new level for that business?

[Shaun McEwan;outgoing CFO]

I would say the one big contract had a dramatic impact on this particular quarter.

[Todd Adair Coupland]

Okay. And is that a one-time impact or is there recurring revenue from that large contract?

[Shaun McEwan;outgoing CFO]

Like I think John said at the very beginning of his comments, in all these big enterprise deals, there's a piece of it that's the software license, which is an up-front, that's kind of like one time. There's some systems and services-related implementation and that's more or less time and materials in the services line. And then there is a very significant recurring revenue that comes from the maintenance function. The majority of VIZIYA is maintenance, like most software or enterprise software companies, they serve in the 22% to 28% of the license price. So when you do a multi-million-dollar license, you get a multi-million-dollar revenue stream for the next number of years related to the maintenance contract. And VIZIYA has been very successful at maintaining its maintenance sort of well north of 90% renewal rate on an annual basis. So it's got the potential to be a dramatic long-term impact on the recurring revenue piece.

[Todd Adair Coupland]

I mean, is there any color you can provide in terms of the last few quarters? You've been at sort of a $2.5 million, $3 million with the new business. Is it now on a recurring basis, stepping up above that level? Is there any color you can provide on that?

[Shaun McEwan;outgoing CFO]

I'll try and get this right in terms of not giving long-term forecasts out. But the reality is the recurring revenue is a result of in particular this one big contract as well as the ongoing work that VIZIYA is doing out on the street. We should see a reasonably significant improvement in the recurring revenues for the foreseeable future.

[Todd Adair Coupland]

Okay. That's helpful. And then the only other question I had was on OpEx. So just a little bit below $14 million in the quarter. Is all the restructuring done now, so barring any outsize WiLAN quarters, that's about the run -- the right run rate OpEx level?

[Shaun McEwan;outgoing CFO]

We continue to try to sort of streamline operations at the Quarterhill level, looking at ways to cut our expenses at that level. But again, it -- any changes there, not a restructuring kind of percentage. It's just sort of streamlining the operations. It'll have a small impact on that, like taking it down a little bit from there. But for the most part in the operational businesses, that kind of expense base is pretty well status quo.

[Operator]

Your next question comes from Gavin Fairweather with Cormark.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Just maybe for John, is there any color you can provide just on kind of the executive search efforts ongoing in terms of how advanced those processes are and kind of the candidate flow that you're seeing?

[John Kendall Gillberry, Independent Chairman]

Well, it's early days as you can well imagine, but I can tell you this was an activity that the board did not sit on and wait until we could convene. We formed a committee immediately after Doug's resignation and we did go out to the market and interviewed and talked with many executive search firms. We have engaged one. I think that we will start to see sort of indicative profiles within I'm going to say, the next 30 days. Now that doesn't mean that those are hard candidates and so forth but we will start to see profiles of the type of individuals that may be in the market within the next 30 days or so. It's impossible to predict how long this search may take. I mean, we may see somebody that we like very, very quickly and we may just have to cast the net a little wider and a little farther in order to catch the right CEO candidate. So I can't really predict for you when that -- what that time line looks like, except to say that it is a major focus of the Board to stay on top of this and push this as hard as we can, as fast as we can, to get the right outcome.

[Gavin Fairweather, Analyst of Institutional Equity Research]

And then just lastly for me, maybe for Shaun, so the jump in SG&A at VIZIYA, that's just kind of sales commission related?

[Shaun McEwan;outgoing CFO]

Pretty much.

[Operator]

As we have no further questions at this time, this concludes Quarterhill's Q3 2019 Financial Results Conference Call. You may now disconnect your line. Thank you.