Quarterhill Inc

TSX:QTRH

Earnings Call Transcript 2020-Q4

[Operator]

Good morning, and welcome to Quarterhill's Q4 and Fiscal 2020 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- and 12-month periods ended December 31, 2020. 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 today 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 of the company's Q4 and Fiscal 2020 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 in this call today 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]

Thank you. Good morning, everyone, and thanks for joining us on today's call.In terms of agenda, I'll start with a look at business highlights for the year, followed by John, who will take a look at our financial results. I'll provide an update to our M&A strategy, and then we'll open it up for questions.We have slides to accompany our remarks, and they will be available on our website after the call.2020 was a solid year for Quarterhill, both financially and operationally, and even more so against the backdrop of COVID-19. We established new leadership at the company, launched a new M&A strategy, generated significant cash flow and returned funds to shareholders through dividends and share buybacks. Shortly after year-end, we began to put our funds to use as part of our M&A strategy, with the acquisition of Sensor Line, which I'll touch on later.When I joined in June, my list of priorities included hiring a CFO, bringing the leadership team to Toronto, launching our M&A diversification strategy, following through on our commitment to return capital to shareholders and ensuring our portfolio companies were in a position to succeed, especially in this challenging pandemic environment.On the leadership front, John Rim joined as CFO in October, and we moved our head office to Toronto. Having the executive team here in Toronto will help with collaboration and deal execution, and being downtown puts us closer to more sources of deal flow.Consolidated financial results for 2020 saw revenue of $144.5 million, adjusted EBITDA...[Technical Difficulty]

[Operator]

Thank you for holding, ladies and gentlemen. We apologize for the interruption. There was technical difficulty that resulted in the entire conference being halted.We will now continue with Mr. Hill's remarks. Please go ahead, Mr. Hill.

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

Thank you. Sorry for that, everyone. We're not sure what happened; the whole system went down.But I'll just continue on where I left off. So consolidated results for 2020 saw revenue of $144.5 million, adjusted EBITDA of $31.2 million, cash from operations of $35.2 million, and we ended the year with cash and short-term investments of $141.3 million. These strong results were driven by both portfolio companies, and I'll spend a few minutes looking at highlights from each, starting with WiLAN.2020 was a solid year for WiLAN, with licensing activity that led to strong adjusted EBITDA and cash flows. WiLAN has shown an ability to deliver significant cash flows on an annual basis, even though such results sometimes vary quarter-to-quarter, something that is quite common in the Patent Licensing industry.Among WiLAN's achievements in 2020 was a favorable update in its litigation with Apple. Following a jury verdict win in January 2020 of USD 85.23 million, in June the court entered final judgment in favor of WiLAN. The court also awarded WiLAN an additional amount of USD 23.75 million in prejudgment interest, bringing the total to USD 108.98 million.The case has gone to appeal, and both sides have filed their opening briefs. Each party is now preparing to file a response, which should be completed in a month or 2. Following that, an oral hearing before the Court of Appeals for the Federal Circuit is expected to be held sometime in the fall.WiLAN continues to plan for future growth and made several portfolio acquisitions in 2020, including approximately 2,000 patents from MediaTek and 2 portfolios from IBM.COVID-19 has had some impact on WiLAN's business, mainly driven by the postponement of some litigations in the U.S. as well as an inability to hold face-to-face meetings, which is an important part of the deal closing process. As we said before, these postponements may result in delays, including agreements, but we do not consider them lost opportunities.Over all, we're very pleased with the 2020 results at WiLAN and its resilience in light of the pandemic.IRD, which is our business in the intelligent transportation systems, or ITS, industry, had a strong year financially, with stable revenues and expanded margins. COVID had some impact on the business, but mainly in international markets, where some projects were delayed. IRD's North American business remained strong throughout the year, with the company's solutions deemed essential services in many U.S. states.IRD saw multiple new orders in 2020, including Oklahoma, New York state and Indiana, and internationally in the Ukraine and Paraguay. The order backlog remains strong, with bookings reaching historic levels in 2020.Over all, the outlook for IRD remains positive. The company is helping cash-strapped governments drive efficiencies and improve revenue collection, which is a value proposition that resonates at all times, but especially during a pandemic.As discussed throughout the year, we made commitments to return capital to shareholders via a substantial issuer bid and a normal course issuer bid. We completed the SIB in July, and the NCIB remains ongoing. In addition to these 2 initiatives, we continue to pay our quarterly dividend.Finally, in May, we sold VIZIYA, which was our enterprise software holding, for just under $50 million. The transaction further strengthened our balance sheet and enables us to focus additional resources on our M&A strategy.With that, I'll turn it over to John for a look at the 2020 financial highlights.

[John Rim, Chief Financial Officer]

Thanks, Paul. Good morning, everyone.Just a quick note upfront that with the sale of VIZIYA, our financial statements for the 3- and 12-month periods ending December 31, 2020, as well as for the respective comparison periods of 2019, have been prepared to reflect continuing operations; therefore, excluding the results of VIZIYA during those periods. Operating results from VIZIYA for 2019 and 2020 are reported as net income or loss from discontinued operations.So I'll start off my review with a look at revenue in more detail. 2020 was a strong year for both business units. IRD's revenues for Q4 and Fiscal 2020 of $17.6 million and $66.3 million were both among the highest in its history, despite the impact of the pandemic. IRD's revenues were generally flat in 2020 compared to 2019, as increased revenues in the U.S. market in 2020 were largely offset by a reduction in international sales due to COVID, which delayed or deferred some sales opportunities.WiLAN's revenues were below 2019 levels but still substantial, at $78.3 million for the year. New patent license agreements, such as those with Intel, Kingston Technology Corporation and Konica Minolta, led the way at WiLAN in 2020.While WiLAN's revenue may be variable quarter-to-quarter, on an annual basis the business has shown an ability to consistently generate strong margins and cash flow. The cash flows are a good source of capital to invest in our ITS M&A strategy and also to invest in the WiLAN business itself, as seen by the patent acquisitions we made in 2020.For gross margin, gross margin at IRD in 2020 was 40%, compared to 36% in 2019. This was the result of certain higher-margin projects that we entered into during the year, such as with the state of Indiana. Gross margins at WiLAN were 41% in 2020, compared to 50% in 2019. And again, this is just due to the fact that gross margins on licensing are very specific to each transaction.Operating expenses. So for operating expenses in Q4 2020, on a consolidated basis they were $1.2 million lower than Q4 in 2019. For the full year 2020, our SG&A was lower by $6.6 million compared to 2019, and this was primarily due to lower amortization of intangibles. Throughout the pandemic we've kept a close eye on our expenses at both the corporate level and, of course, our portfolio companies.One note to highlight is that included in our 2020 SG&A are onetime costs related to the implementation of a brand-new ERP system to support our IRD business. This solution will directly support our M&A growth plans by driving back office efficiencies as acquired companies are added to our ITS portfolio.IRD's adjusted EBITDA for Q4 and the full year was $3.6 million and $13.8 million, respectively, compared to $3.1 million and $8.3 million in the respective prior year periods. This was partly due to the higher margin on projects as well as additional subsidies received in 2020.The adjusted EBITDA at WiLAN was $28.8 million, compared to $50.1 million in 2019. As I mentioned before, the revenue and adjusted EBITDA at WiLAN are dependent on specific licensing agreements. However, WiLAN's financial performance remains remarkably consistent on an annual basis, as is evident by the fact that the business has generated significant adjusted EBITDA in 6 of the past 7 years.From a cash perspective, cash from operations was $35.2 million in 2020, which drove an increase in the cash on our balance sheet. I'm pleased to report that cash and cash equivalents and short-term investments at year-end were $141.3 million, up significantly from the $89.4 million we had at the end of 2019.In terms of total working capital, we ended the year with $159.7 million, and that's up also, from $112.2 million at the end of 2019.I'm also pleased to report that Quarterhill currently has no debt, having paid off the small balance that we had as IRD accessed its operating line during 2020. And our strong balance sheet will continue to help support our M&A strategy in 2021 and beyond.Paul mentioned earlier we returned capital to our shareholders through our dividends as well as through share buybacks while the M&A strategy was paused earlier on in the year. In total, we deployed about $15 million in 2020 on the dividend and share buybacks, and our share count at the end of the year was 114.3 million, down from about 118.8 million at the prior year-end.Finally, this morning in our earnings release we announced details of our next dividend payment. Our board has declared an eligible dividend of $0.0125 per share available on April 9, 2021, for shareholders of record on March 19, 2021.So this concludes my review of the financial results, and I'll now turn the call back to Paul.

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

Thanks, John. The M&A strategy at a high level hasn't changed from what I outlined in Q2. However, the market tailwinds have improved significantly since then. Building from our 2 cash-flowing businesses, WiLAN and IRD, we're investing in essential technologies in the ITS industry. This is an industry where IRD is a leader today.ITS improves the way people and goods move through transportation infrastructures. It makes that movement safer, more efficient, cleaner for the environment and less costly. It also creates revenue opportunities for governments. As I've said earlier, ITS is a large, stable and growing market with annual spend in the tens of billions of dollars, and in recent months this market opportunity has only gotten stronger.Slide 8 illustrates the key tailwind in the ITS industry and what's new. What's new is new infrastructure spending. President Biden and his Transportation Secretary, Pete Buttigieg, have pledged USD 2 trillion in infrastructure spending over the next 10 years, with approximately USD 900 billion earmarked for transportation. While not all of the USD 900 billion is allocated to roads, historically about half of federal spending is on roads.This market tailwind gets us very excited about the potential for our ITS business. The combination of massive new infrastructure spending and governments' need for new sources of revenue to pay down ever-increasing debt from the COVID situation means that there is no better time to be in the ITS market.So what types of businesses are we looking for? The next slide is a simplified version of the chart I showed you on the Q2 call, but the overall approach remains the same. The initial phase will focus on acquisitions in the 5 road market segments identified here. We're looking at tuck-in acquisitions, such as Sensor Line, that will help grow the IRD business, but we're also looking at larger businesses that will help us achieve scale more rapidly.Sensor Line was an ideal tuck-in opportunity. Their advanced fiber optic sensors play a role in multiple road subsegments and also gives us an entry into the rail vertical. The business was acquired at a reasonable multiple, and there's potential for additional revenue and cost synergies in the coming years.Longer term, you could see us looking at adjacencies to ITS, which might include investments in smart cities. This is a natural evolution of the business, as these are tech-enabled infrastructure markets and are very similar to ITS. There are many enabling technologies that make connected ITS in smart cities possible, but 5G is the most important. This is a standard where WiLAN has expertise and can play an important role in the future.Based on our existing cash, the annual cash generation of our businesses and access to low-interest financing, our target is to invest up to $400 million over the next 5 years to scale our ITS business. Meeting this target will depend on many factors, including sourcing appropriate market opportunities. However, we are confident, given our significant financial resources and our growing pipeline of M&A opportunities.Successful execution of this strategy will lead to greater consistency of revenue and cash flows for Quarterhill, and we expect that to translate to increased investor interest and higher valuation that is more in line with other public ITS companies.In closing, 2020 was a solid year for the business despite the challenges of COVID-19, and we entered 2021 with a stronger platform to support our M&A strategy. We kicked off the new year on a positive note, with the acquisition of Sensor Line, and we believe the timing could not be better to be an aggregator in the ITS industry. While we can't predict the timing to complete new deals, we do expect 2021 to be an active year on the M&A front.This concludes our formal remarks for the call, and I'll hand it back to the Operator for Q&A.

[Operator]

[Operator Instructions] Your first question today comes from the line of Gavin Fairweather with Cormark.

[Gavin Fairweather, Analyst of Institutional Equity Research]

I wanted to start out on WiLAN. We've talked over the past 6 months about there being a decent amount of kind of activity going on under the hood there. I guess just curious, hit a bit of an air pocket this quarter. Is that just kind of timing? Or was there anything around kind of success rates this quarter? Maybe you could just speak to, give us an update on that general level of kind of activity as we think about 2021.

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

It's the periodic nature of the IP licensing business. It's not an indication of anything more than that. We are very active, as we've talked about, with lots of active licensing discussions and litigations underway. So no, it's nothing more than that.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Okay. Perfect. And then I just wanted to switch over to IRD here. As you've been kind of mapping out what kind of products and solutions you'd like, obviously, M&A is a big piece of that. But I'm curious what role kind of building could take in that. And I'd love for your [ R&D ]. They don't invest a ton as a proportion of their revenue in R&D. So do you see good scope there to build out some additional kind of product offerings in that market? Or do you think that M&A will be kind of the primary way of entering new verticals and bringing new products to market?

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

It's a bit of both, Gavin. Like, the announcement we made in November around our new analytics platform is organic, right? So that's organic R&D. And it's an exciting announcement because we're putting together capabilities from iCOMS, which is our Belgian company that's in the radar and microwave detection market, we're combining that with software capability for analytics and enabling that on a 4G platform. So we're kind of bringing it all together in that way.But as you know, iCOMS was an acquisition, right? So some of the hardware components that came out of that came through an acquisition, and some of the software development was organic. So it's going to be a combination of both, quite frankly.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Okay. But it doesn't sound like we should think about kind of R&D investment moving to 10% or 15% of [indiscernible].

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

No, I don't see material changes in that. I think a lot of it will be M&A, absolutely, especially getting into markets where we don't play today, as you know.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Got it. And then you talked about the favorable kind of tailwinds that are building behind ITS maybe more broadly, and then you also talked about pretty good kind of deal pipeline. So have you noticed that competition is increasing for deals? Or is the environment kind of unchanged to what we've been speaking about?

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

Well, like I said in the remarks, we have a very strong backlog at IRD. I think it was at an historic high ending the year, right?There is a lag effect. So basically, what's going on is there was a change of government in the U.S. and Biden has picked probably the highest profile cabinet minister, Pete Buttigieg, to lead Transportation, right? So they're very vocal about the infrastructure spending. They've passed USD 2 trillion. But it will take time for that funding to work its way through the various layers of government. And so you don't just hit a switch and that money is deployed, right?But the bottom line is a big, a significant portion of that is going to go to roads. And when you build a road, you have to acquire a number of ITS technologies, ranging from digital signage to tolling to weigh-in-motion technology, which we're a leader in; radar; speed cameras. All of that stuff comes along with the infrastructure investment in roads. And the same applies to rail, by the way.So we really like how this is setting up, how the ITS market is setting up and the tailwinds that we think are ahead of us here. So we think the timing is very good for this market.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Got it. And then just lastly before I pass the line, it sounds like the Supreme Court is looking pretty hard at these patent judge appointments, and it sounds like they're leaning towards kind of some change to the process. Is that kind of a -- do you view that as a tweak around the edge? Or do you see that as actually potentially having some favorable kind of tailwinds behind the IP business?

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

I think it's too early to say, to be honest with you. I think we have seen some favorable news lately, but I would say it's early to make that kind of conclusion that it would make a material difference in some of these cases.

[Operator]

Your next question comes from the line of Doug Taylor with Canaccord Genuity.

[Douglas Taylor, Director]

Paul and John, we're pretty well conditioned not to read too much into these quarterly fluctuations in the WiLAN business, but I wonder if you could provide a little more color around -- there were some announcements during the quarter, one at the beginning which I think probably was recognized more in Q3. And you make mention of the fact that there are some deals and licenses slipping due to pandemic. And I'm just wondering if you could help us quantify to what extent or magnitude that might be a factor and whether we should expect at least some uptick here in Q1 with the LG announcement.

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

Well, with LG, specifically, we can't comment. These deals are -- almost all of these settlements are confidential in nature. We believe we got a fair conclusion to that litigation is what I can say.Like we've said before, the WiLAN business we find to be quite reliable when you zoom out and look at it more from an annual basis. But on a quarterly basis, it does have variability. And we can't really say much more than that. That is the nature of the business.I will say that we continue to replenish the portfolios. We made some patent acquisitions last year, as we mentioned in my remarks. We are confident that the activity is going in the right direction.I think the COVID effect is starting to soften, right? In the early days of COVID we saw a lot of delays and we saw that kind of ripple through, but we're starting to see these meetings take place. We're starting to see a bit more activity in that regard. So I think we're at the ending innings of the COVID impact to delays, which I think is positive.

[Douglas Taylor, Director]

Okay. Perhaps I'll switch gears then to IRD. You mentioned the analytics platform that was launched in the quarter. Any comment on perhaps the significance of that announcement in terms of either addressable market or the revenue model predictability, of the revenue model more service versus hardware? Anything like that we should take away from that product announcement?

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

Listen, these are early, ranging from pilots -- we're doing a pilot in Vancouver right now. We are live in Brussels and Paris with some of this capability. But these smart city applications are in the early innings. We want to be one of the first to market in some of these applications.In this case, these applications are mostly around safety. So it has to do with measuring things like speed, volume, direction of bikes and pedestrians and cars to understand some of those flows and to do planning to make cities safer and more efficient.So these types of investments in smart cities, these are the early stages of smart city investments. So they're not super material to results in the short term, but we're excited about the long-term opportunity around these things.

[Douglas Taylor, Director]

Okay. And then with the Sensor Line acquisition tuck-in, any commentary on the integration of that with the IRD product a couple of months in?

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

It's going really well. We're already pursuing deals that are essentially deals brought to us through the IRD sales and marketing distribution. Sensor Line basically is a relatively small company with great technology but was lacking the scale on sales and marketing. So what we're doing is basically putting that product capability onto our sales and marketing platform through the IRD distribution channel. And we're already seeing some early gains from that. So we're very encouraged by it. It's off to a good start.

[Douglas Taylor, Director]

Okay. That's good to hear. Last one from me. Corporate overhead costs, a little bit of an uptick towards the end, in Q4. Anything to take away from that, or onetime in nature, that we should think about when we model that going forward?

[John Rim, Chief Financial Officer]

I can take that one. Doug, I mentioned during my commentary that we had onetime costs associated with the new ERP system implementation at IRD. That's going to help us grow in scale as we add companies, meet all of our continuous reporting requirements as well as bring other back office efficiencies, as well. So definitely, there is that onetime cost in there.

[Operator]

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

[Todd Adair Coupland]

I have a couple of questions. I'll just run through them here. So I just want to, I guess, be clear on that last expense question. So you were, more or less, $14 million OpEx in the fourth quarter. Is that a reasonable run rate as we think about the business through 2021?

[John Rim, Chief Financial Officer]

I would say that's pretty indicative. I would probably take the 4 quarters and take an average of that. Remember, we had our -- I just joined in the fourth quarter of last year. Paul joined halfway through the year. But I think that would be a good proxy.

[Todd Adair Coupland]

Okay. And in terms of IRD seasonality, is there -- we're sort of not out of COVID, but sort of poking our heads out. Is there anything to call out along those lines as you're thinking about the rhythm of the business this year?

[John Rim, Chief Financial Officer]

There's absolutely a normal course of seasonality with IRD. As you can imagine, in North America, with the weather and doing outdoor installations, the weather does have an impact. So typically, Q1 would be impacted by the seasonality in IRD and then ramping up through the spring and summer months.

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

Yes, I agree, although I would say the effects of COVID on project delays is less than it was kind of a year ago.

[Todd Adair Coupland]

Okay. That's good to hear. And I apologize if I missed this, but this seemed like it was news to me, you calling out $400 million over the next few years in terms of your investment plan. Am I right on that? Or did I...?

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

Yes, you are right on that. Yes, you are right on that. That is new information, and we've started modeling that more carefully. And that is our goal, and we think it's very achievable.

[Todd Adair Coupland]

Sorry. Did you give a time frame on that? Was it 4 years, or just a few years? I missed that if there was a time line around that.

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

5 years.

[Todd Adair Coupland]

5 years. Okay. Got it. Got it. Apologies for that. Is there anything to say beyond that in terms of pace, rhythm? You're just going to work through the funnel and make decisions as you come across opportunities? Is there any other color you can [indiscernible] on that?

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

The way to kind of think about it is, first of all, we have cash on the balance sheet, as you know. We've got -- these days there's access to very low-interest capital debt, and we're not allergic to that idea. And as we acquire businesses, those businesses will also generate cash flow that will contribute, as well. So if you model all that out, you can get kind of a cadence. But I have said also in the past that we do want to maintain a certain amount of cash on the balance sheet, right? That's another thing.But the combination of those things if you model it gets you into a comfortable range where we can acquire up to that value over a 4- to 5-year period.

[Todd Adair Coupland]

Okay. And what is the right leverage on the business, I guess, with choppy WiLAN results, although they generate a lot of cash when they happen? How are you thinking about that?

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

Well, I wouldn't necessarily assume you would leverage the entire business. You might, for example, leverage only the acquired asset, right? Or the ITS components of our business as opposed to the entire Quarterhill group. There's different strategies you can take from a debt standpoint.

[John Rim, Chief Financial Officer]

The basic concept, though, would be that as we acquire companies they become the collateral, right? And then the cash they generate, they need to be able to service any financing that we get. So the leverage levels that we pick are going to be incredibly conservative so that we're comfortably within any sort of financial covenants, generally, multiples of EBITDA in terms of debt leverage and very safe fixed cost coverage ratios.It just obviously enhances our capability to accelerate and move on opportunities quicker and optimize our capital allocation.

[Todd Adair Coupland]

Okay. Okay. So $145 million cash, probably $40 million, $50 million cash to keep in the business. So you sort of have $100 million to start and then what you generate, plus the leverage possibilities of what you're going to buy. Is that sort of the right way to think about it?

[John Rim, Chief Financial Officer]

Yes, although I would just caution with the $40 million to $50 million. We've mentioned that before in the past. That is quite a healthy level. The basic concept there in our WiLAN business is with IP patent infringement litigation we want to demonstrate the ability to go long, and that's critical, because we're not going to settle. We're going to optimize those opportunities.But really, the cash that we hold, it's really dependent on the circumstances at the time. So it could be [ less, as well ].

[Todd Adair Coupland]

Okay. That's certainly fair. And is there any, I guess, timing statements you want to make on the funnel right now? Like, do you think you'll do a deal in 2021? Do you think you'll do a couple of deals in 2021? [ How are you thinking about that? ]

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

Listen, the M&A pipeline is very active, and it's a very high priority. So we are very optimistic about doing some deals in 2021.

[Operator]

At this time, there are no further questions in queue. I will turn the call back to Mr. Hill for closing remarks.

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

Well, thanks, everyone, for attending, and we will be back to you on our next quarterly call. Look forward to talking to you then. Goodbye.

[Operator]

And this concludes today's conference call. Thank you for your participation. You may now disconnect.