Tecsys Inc

TSX:TCS

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, everyone. Thank you for standing by. Welcome to the TECSYS Third Quarter Fiscal 2018 Results Conference Call. [Operator Instructions] Please note that the complete third quarter report, including MD&A and financial statements, were filed on SEDAR yesterday evening, March 1, 2018. Some of the statements in this conference call, including the question-and-answer period, may include forward-looking statements that are based on management's beliefs and assumptions. Actual results may differ materially from such statements.I would like to remind everyone that this call is being recorded on Friday, March 2, 2018, at 8:30 a.m. Eastern Time.I would now like to turn the conference over to Mr. Peter Brereton, Chief Executive Officer of TECSYS. Please go ahead, sir.

[Peter Brereton, President, CEO & Director]

Thank you, and good morning. We appreciate you joining us for today's call. Joining me today is Brian Cosgrove, our Chief Financial Officer. I will start by summarizing the key events for the quarter. Brian will then review our Q3 financial results, and I'll close with a few comments on our outlook for the remainder of fiscal '18. We'll then have a Q&A session.Yesterday evening, we issued our unaudited 2018 third quarter financial results.In the third quarter of fiscal '18, we were successful in increasing our penetration into our base accounts on both the health care and complex distribution sides of the business. However, as we've said on previous occasions, the sales cycles for our solutions is long and will result in lumpy results. The wins we did have in the quarter prove the effectiveness of our solutions. One was from a client that is a large health care system, with 93 hospitals in its network. With this hospital network, we were already supplying them with a comprehensive distribution solution. But last quarter, they contracted with us to supply an operating room point-of-use solution inside one of their hospitals. We think this is a good start.Another client, a large university hospital system, continued to invest in our point-of-use pharmacy solution. And on the complex distribution side, one of our largest clients expanded their relationship with us with an additional contract.There is significant potential to grow our presence in each of our base accounts. With our large complex distribution clients like Canon and the Caterpillar dealer network, for example, we've been able to achieve significant expansion throughout their distribution network. There are similar opportunities on the health care side in terms of distribution centers and as well now with the ability to work in hospital with our clients by providing point-of-use solutions like our OR, cath lab or pharmacy products.In the quarter, we signed a contract with a new U.S. health care network system comprising of 11 hospitals. They will be implementing our consolidated service center solutions to manage their internal supply chain.The lower signings of new health care accounts is reflected in our results with flat year-over-year revenue. We are, however, continuing to see strong interest on the health care side and are now seeing this translate into stronger sales in Q4 as I will comment on later.Brian will now provide some details on our financials for the quarter.

[Brian Cosgrove, CFO & Secretary]

Thanks, Peter. Revenue in the third quarter declined by less than 1% to $17.2 million compared to $17.4 million in the third quarter of fiscal '17. As Peter mentioned, this is a result of our long sales cycles and the delayed signing of new accounts. In the quarter, about 69% of revenue was generated in the U.S. The lower exchange rate for the U.S. dollar compared to an -- to a year earlier also impacted our results. On a constant-currency basis, revenue would have been $17.8 million in Q3 '18, a 2% increase over Q3 '17.Products represented 17% of total revenue in Q3 '18; cloud maintenance and subscription represented 38%; and professional services represented 45% compared to 18%, 38% and 44%, respectively, in Q3 '17.In terms of our revenue segments, professional services revenue increased by 6% to $7.3 million from $6.9 million in Q3 '17. The increase was a result of higher customization services, offset somewhat by lower implementation service revenue.With our backlog currently at $42 million, we expect that services revenue will remain healthy for the near term and increase as we bring on new business.Proprietary products revenue declined by $616,000 year-over-year in Q3 '18 to $930,000. This largely was a result of a decline in license revenue of $399,000 due to lower new contract signings. Third-party product revenue increased by 17% year-over-year to $1.9 million as a result of increased radio frequency and storage equipment sales.Cloud maintenance and subscription revenue was flat year-over-year at $6.6 million in the quarter. This revenue stream is mostly recurring in nature. And while we achieved higher maintenance revenue, this revenue stream was affected by currency headwind.Gross margin for the third quarter of fiscal 2018 was $8.1 million, or 47% of revenue, compared to $8.9 million, or 51%, in the third quarter of 2017.Operating expenses for Q3 '18 were $7.3 million, 4% lower than $7.6 million in the same quarter last year. As a percentage of revenue, operating expenses declined to 42% of revenue compared to 44% in Q3 fiscal 2017. The decline this past quarter was a result of lower sales and marketing and R&D expenses. This decrease reflects our ongoing strategy to control and lower operating costs.On a trailing 12-month basis, excluding the recognition of $4.6 million of prior year federal nonrefundable R&D tax credits, operating expenses declined by 2% to $30.7 million compared to $31.4 million for 12 months ended January 31, 2017.Looking at expenses in detail. Sales and marketing expenses decreased by 9% to $3.3 million from $3.7 million in Q3 '17, reflecting lower salaries and benefits, incentives and travel expenses. G&A expenses were increased by 9% to $1.6 million in the quarter compared to $1.5 million in Q3 '17. Higher G&A salaries and benefits and consulting expenses were the reason for the increase. Net R&D expenses decreased to $2.4 million in Q3 '18 compared to $2.5 million in the same period last year. We achieved profits from operations of $845,000 in the third quarter of fiscal '18 compared to $1.3 million in the same quarter last year. The decrease is a result of lower sales, a decrease in margin due to the product mix and the impact of foreign exchange, which negatively impacted profits by $400,000. On a per-share basis, we achieved basic and diluted earnings of $0.06 compared to $0.07 for quarter in Q3 '17.EBITDA declined by 32% in Q3 '18 to $1.3 million compared to $1.9 million in Q3 '17. The decrease is a reflection of the lower sales, a decrease in margin due to the product mix and the impact of foreign exchange. Adjusted for currency, the decline was 12%.On a year-to-date basis, EBITDA was $4.2 million, a 13% increase over $3.7 million for the 9 months ended January 31, 2017. Adjusted for currency, the increase was 24%. At the end of the quarter, cash and cash equivalents as well as long-term investments in the form of redeemable GICs totaled $20.7 million compared to $13.5 million at the end of fiscal 2017.I will now hand the call back to Peter.

[Peter Brereton, President, CEO & Director]

Thanks, Brian. To summarize, despite flat revenue in the past quarter, we're confident that fiscal '18 will be a solid year. We continue to have strong interest in our solutions on both the health care and complex distribution side and have a sustainable backlog. So far, the fourth quarter is off to a very strong start with the signing of a new IDN and several base account projects. Historically, our IDN customers would initially start by purchasing our solution to address this specific area and then expand over time. In this case, this new IDN customer recently signed went ahead with an enterprise agreement for all of our modules except for pharmacy.We are pleased with our continued discipline on operating expenses, which, as Brian mentioned, contributed to a 13% increase in EBITDA on a year-to-date basis or 24% of adjusting for currency swing against the backdrop of lower revenue growth.With that, I will turn the call over for questions and back to the operator.

[Operator]

[Operator Instructions] And our first question comes from the line of Amr Ezzat of Echelon Partners.

[Amr Ezzat, Special Situations Analyst]

Peter, on the growth sides, can you provide us with more colors on the dynamics there on a segmented basis? Is it still the same as the last couple of quarters whereby health care continues to suffer and complex distribution is growing? Or were both verticals sort of flattish during the quarter? I'm just trying to get a sense of where we are in the health care segment?

[Peter Brereton, President, CEO & Director]

Yes, I mean, I would say health care has remained pretty much flat to even a slight decline whereas complex distribution has continued to show some growth. I mean, as we -- as I mentioned there towards the end of the call, I think, for us, we are seeing the thought start to happen. So I think that's about to reverse itself and go -- get back to sort of health care being the leading growth side of the business. This -- we did add one new IDN in the third quarter, and now we've added a very large contract with an IDN in the fourth quarter, as I mentioned, because of the fact that they decided to sort of start with a much larger project than most of the IDNs typically start with. So we think that's about to shift gears again. But for Q3, your statement is accurate.

[Amr Ezzat, Special Situations Analyst]

Okay. Then I guess, just on the -- what you mentioned about fiscal Q3 like last quarter, you mentioned, I guess, like some new contracts like the IDN and several base account add-ons. Did we see these numbers like flow into your sales in Q3? Or do we see some of that in Q4? Just wondering on the timing of that.

[Peter Brereton, President, CEO & Director]

No. The ones that I mentioned were -- I'd say, we signed a large new account as well as several base add-ons. That is a reference to beginning of Q4. Like we definitely had some pretty major deal slippage out of Q3 into Q4. But the deals that slipped out of Q3 into Q4, I'm happy to say, did all sign in February, so -- which isn't always the case. Sometimes when you see deal slippage, it turns into a very long slippage. But in this case, it didn't.

[Amr Ezzat, Special Situations Analyst]

Understood. Then on that new large IDN, congrats, but I maybe missed out. Did you guys mention the size of the contract there?

[Peter Brereton, President, CEO & Director]

No, we didn't. And we're not disclosing the size. But it is several times larger than our typical IDN contract because of the fact that they've decided to start with such a large engagement.

[Amr Ezzat, Special Situations Analyst]

Then if I want to perhaps like compare it relative to other IDNs or other existing clients, where does that sort of set? Is it like a top 3?

[Peter Brereton, President, CEO & Director]

In terms of initial start, it would probably be -- well, in fact, it would definitely be our largest ever initial win. And really because of the fact, as I said, that they've decided to start with so much at once. Like many of our IDNs decide to start with the consolidated service center and then later add delivery management to or maybe start with one hospital OR and then spread from there. In this case, they decided to just negotiate a comprehensive agreement to do all of their network point-of-use locations.

[Amr Ezzat, Special Situations Analyst]

Understood. That's great. On the OpEx side, you're now running at $7.3 million. I know some of it is driven by R&D credits. But even when I'm looking at sales and marketing, the headcount there is lower than last year. But I'm just wondering, is that level sustainable? Or at what point do we start to see you guys layer on some investments?

[Peter Brereton, President, CEO & Director]

Yes. You're going to start to see -- I mean, some of this is -- needs to happen in sync here. I mean, you are going to start to see some rising sales and marketing expense. We've brought in the new Chief Marketing Officer, Laurie McGrath. She started at the beginning of January. She is doing a complete analysis of our marketing needs and will be looking to launch some more aggressive marketing programs in coming months. And we also do need to add both sales rep headcount as well as some leadership on the sales side. So you will see that start to ramp back up. Our intention, however, is to continue to control it as a percentage of revenue and continue on our path towards moving that number down over the next several years as a percentage of revenue. But in real dollar terms, it's got to start to move up somewhat. R&D as well -- R&D will need to move up as we go into next fiscal year, but again not substantially relative to the revenue side of things.

[Amr Ezzat, Special Situations Analyst]

Understood. You mentioned your pharmacy solution, it was meant to go live early in the calendar year. Any updates there?

[Peter Brereton, President, CEO & Director]

At this point, they are intending to go live in May, so that has moved somewhat. There is a significant effort there in -- really on the client side in terms of really certifying the data. They need sort of their own pharmacy team to go throughout all their data and make sure all the various drug codes and correlations and substitutions and so on are all accurate before they flip the switch and go live. So they're going through that phase now, and the intention at this point is to go live in May.

[Amr Ezzat, Special Situations Analyst]

Then maybe one last one for me. We've chatted on this before on -- there's been a lot of talk on Amazon entering the hospital supply business. Just wondering what your thoughts are there? And how does it -- or would it impact you guys at all?

[Peter Brereton, President, CEO & Director]

Yes. I mean, the hospital supply business has been dominated for literally decades by sort of the big 4, Cardinal, Amerisource, Owens & Minor and -- what's the other one? I'm forgetting one. McKesson, right?

[Amr Ezzat, Special Situations Analyst]

McKesson.

[Peter Brereton, President, CEO & Director]

Yes. And Amazon is -- those distributors operate, first of all, on actually quite slim margins. And many of them over the years have built up their own brands. And at the clinical level, there is pretty strong loyalty to some of those brands. So I have great respect for Amazon, amazing company. In this case, they've got a -- they definitely have a long, hard fight on their hands. They're up against some very established players that have very strong loyalty in that market. In terms of us, we -- there is really no impact on us. I mean, there is no -- from our standpoint, we don't really care where hospitals buy their supplies or how they buy their supplies. We just -- our focus is on helping them to know what to buy and when to buy it and then managing it and moving it all the way through the hospital supply chain right to point of care and onto a patient bill. So that's our focus. And so we don't see any impact on our business.

[Operator]

Our next question comes from the line of Nick Agostino of Laurentian Bank Securities.

[Nick Agostino]

I guess, 2 questions. First, on the IDN side. Can you just maybe speak to, I think, if I recall correctly, in fiscal Q2, you had no wins and now that we're in the second half of the fiscal year, we've seen 2 nice wins. Can you maybe talk a little bit about how your conversations went with the customers? Has the mood changed just given what's happened in the U.S. market? And more specifically, are these wins just basically a case of the sales cycle, as you said, is sometimes long and the wins were due? Or you are seeing a shift in the mindset of your customers?

[Peter Brereton, President, CEO & Director]

No, we feel like we're seeing a shift in the mindset of our customers. I mean, the activity is up. Our pipeline -- I mean, even with this large new one we just signed is sort of now efficiently out of pipeline and into the customer side of things. We still have a very sizable pipeline, and they're very active. So it seems as though the sort of the big fear over the end of Obamacare has subsided, and the focus is back on dealing with the sort of the shifting realities of U.S. health care, which are all about getting costs under control and evidence-based medicine up to provide better results at lower costs. So I mean, we think it's a good shift. We think the mindset is back where we need it to be. And we think these wins are just sort of the early indicators of that shift.

[Nick Agostino]

Okay. And in terms of -- you've said that the pipeline -- can you maybe just give us a sense of how big the pipeline is right now in terms of how many prospects you have? And I think in the past, you were probably north of 20. Can you maybe -- on the number of that nature, can you quantify which ones you see as being early stage versus late stage?

[Peter Brereton, President, CEO & Director]

Sure. We're -- that number would be down at this point. I mean, we're seeing sort of -- I mean, right now we're really actively engaged with about a dozen new account health care players. At the same time, sort of the opportunities that we are discussing with them are averaging sort of 3x to 4x the typical opportunities we've seen in the past. There is -- we are also putting more emphasis on our customer base as with some of these new products we've rolled out in the last few years open up tremendous opportunity in our customer base. The -- one of the agreements we've signed in the third quarter was a very nice contract and yet it was for just one hospital out of a 92-hospital network. So we're sort of looking at that and saying, okay, that -- the base account side is now a very, very large opportunity, so we're putting more focus on that as well. So I would say, total quantity of new accounts less size substantially larger. In terms of phase, there is about probably 4 or 5 of them right now that are right near the end of a sales cycle.

[Nick Agostino]

Okay. That's very helpful. And then just switching gears. Similar conversation around complex distribution. I noticed there was, I think, no mention in the MD&A, specifically. Obviously, it was a big driver of growth momentum leading up to fiscal Q3. I think you said in the quarter it was slightly up. Can you just maybe give us a little bit more color in terms of -- when you say slightly up, how is that momentum looking relative to historical?

[Peter Brereton, President, CEO & Director]

Momentum is looking decent. It definitely took a bit of a breather, I would say, in Q3 though from the standpoint of -- there was no sort of sizable new account wins in complex distribution and so on whereas to our -- typically, Q1 for complex distribution is very dry and yet they knocked it out of the park in Q1. So it definitely took a bit of a breather in Q3. But it doesn't look like there's any real change in momentum there. I mean, we're seeing some quite sizable opportunities. We're seeing a lot of activity around e-fulfillment and companies needing to modernize their supply chains to sort of deal with, for lack of a better word, the collapsing retail landscape. I mean, a lot of companies were dependent for years on retail to get their goods to market, and now sort of retail is not in a great shape, and they're building new channels to market. So that's driving a lot of changes in the supply chain. So we're confident that, that business is in pretty good shape. In terms of year-to-date, they're up -- they're already up about 25% in terms of bookings over the full year last year. So we think that's looking decent.

[Nick Agostino]

Okay. And just last -- just hanging on to that question. How has momentum looked as we start fiscal Q4, specifically on complex distribution?

[Peter Brereton, President, CEO & Director]

Again, looking good. The complex distribution sales cycle moves a lot faster than health care, of course. So sometimes you don't know until you're quite near the end of the sales cycle, whether you're in fact the winner or that dreaded second place choice. So it's a little harder to predict. Health care, we typically know sort of months ahead of time that we're the selected winner, and it just goes through a very long contract cycle. But at this point, we're certainly expecting the complex distribution will end the year up substantially, probably 50% or something like that in terms of bookings over last year. So we're -- we think it's in good shape.

[Operator]

[Operator Instructions] And our next question comes from the line of Justin Keywood of GMP Securities.

[Justin Keywood, Analyst]

I was just looking to clarify. So the hospital that expanded within the quarter that was the $1.3 million sale to one hospital? Or am I reading that wrong?

[Peter Brereton, President, CEO & Director]

No, that was -- that particular sale was a -- I think you might be mixing up the new win because we signed a new IDN in the third quarter. And we also signed a contract with an existing account to add a hospital -- to implement point-of-use in that hospital. Now the contract wins, they were not that far apart though in size. I mean, we're not disclosing the amounts, but they weren't that far apart.

[Justin Keywood, Analyst]

Okay. And the hospital that expanded in the quarter though, they have 93 hospitals. Is that correct?

[Peter Brereton, President, CEO & Director]

That's right. That was a hospital network. It's already using us as their sort of supply chain backbone to manage their centralized purchasing and distribution. And they decided to begin to bring us in on the point-of-use side, and they're starting with one hospital.

[Justin Keywood, Analyst]

So obviously, a strong opportunity to expand there.

[Peter Brereton, President, CEO & Director]

We certainly hope so. We're pretty excited about that opportunity.

[Justin Keywood, Analyst]

Okay. And then on the proprietary sales in the quarter, I understand some lumpiness, but it seems to be kind of a multi-year low. Just wondering if there is anything else particularly that contributed to that?

[Peter Brereton, President, CEO & Director]

Sorry, contributed to what?

[Justin Keywood, Analyst]

The proprietary sales decline?

[Peter Brereton, President, CEO & Director]

Yes. I mean, that's just -- I mean, we literally just had -- we had several sizable proprietary sales slip out of the quarter. So it -- unfortunately, it's going to make for some real lumps and bumps in the numbers here. But the accounts that we thought we're going to close in Q3 and would have made for some nice smooth numbers instead signed in the early weeks of Q4, so we ended up with a very low proprietary number because most of our proprietary sales are turned into revenue in the same quarter in which they're signed. So you see the impact almost immediately. And those numbers slipped out of January and into February, and that did it.

[Justin Keywood, Analyst]

Okay. And then just looking into Q4. Should we maybe expect a similar level as in Q4 of last year then?

[Peter Brereton, President, CEO & Director]

I have to look at the comparables in detail. But I mean, from -- let me just look here -- no, I mean, I don't want to give out advanced numbers, Justin, but let me just say that if that's where we ended in Q4 this year, I'd be quite disappointed based on the February we've seen.

[Justin Keywood, Analyst]

Okay. That's helpful. And then just on the tax or R&D adjustments that happened in Q4 last year, there is, obviously, a large benefit. Any idea of -- if we should see that in Q4 this year and what the magnitude might be?

[Brian Cosgrove, CFO & Secretary]

No, that was a onetime adjustment of prior year tax credit. So that was just a onetime adjustment. So you won't see that this year.

[Justin Keywood, Analyst]

But there's still deferred tax credits on the balance sheet to be used in future periods?

[Brian Cosgrove, CFO & Secretary]

Yes, there's still to be used. They already existed. So we had tax credits that were not yet on the balance sheet. And as our prospect of the ability to monetize them in the future, we booked them in our balance sheet. So they existed prior to that, but they just weren't on our balance sheet. And so we did a onetime adjustment in Q4 '17. But that's for prior year, so that's already reflected in the numbers. So you won't see a big adjustment this year.

[Operator]

And there are no further questions at this time.

[Peter Brereton, President, CEO & Director]

Okay. Well, thank you, everyone. Thank you for taking the time to join us. And as always, if you have additional questions, please don't hesitate to give Brian or I a call. And we will look forward to talking to you again when we report our Q4 and year-end results. Thank you.

[Operator]

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