Vecima Networks Inc

TSX:VCM

Earnings Call Transcript 2019-Q2

[Operator]

Hello. This is the Chorus Call conference operator. Welcome to the Vecima Networks Second Quarter Fiscal Year 2019 Results Conference Call and Webcast. [Operator Instructions] And the conference is being recorded. [Operator Instructions] Presenting today on behalf of Vecima Networks, are Sumit Kumar, President and CEO; and John Hanna, CFO. Today's call will begin with executive commentary on Vecima's financial and operational performance for the second quarter fiscal 2019 year results. Lastly, the call will finish with a question-and-answer period for analysts and institutional investors. The press release announcing the company's second quarter fiscal year 2019 results as well as detailed supplemental investor information are posted on Vecima's website at www.vecima.com under the Investors heading. The highlights provided in this call should be understood in conjunction with the company's unaudited condensed interim consolidated financial statements and accompanying notes for the 3 and 6 months ended December 31, 2018. Certain statements in this conference call and webcast may constitute forward-looking statements within the meaning of applicable securities law. All statements other than the statements of historical fact are forward-looking statements. These statements include, but are not limited to, statements regarding management's intentions, belief or current expectations with respect to market and general economic conditions, future sales and revenue expectations, future costs and operating performance. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict and/or are beyond our control. A number of important factors could cause actual outcomes and results to differ materially from those expressed in these forward-looking statements. These factors include, but are not limited to, the current significant general economic uncertainty and credit and financial market volatility and the distinctive characteristics of Vecima's operations in the industry and customer demand that may have a material impact on or constitute risk factors in respect of Vecima's future financial performance, as set forth under the heading Risk Factors in the company's annual information form dated September 27, 2018, a copy of which are available at www.sedar.com. In addition, although the forward-looking statements in these earnings call are based on what management believes are reasonable assumptions, such as assumptions made prove to be incorrect. Consequently, attendees should not place undue reliance on such forward-looking statements. In addition, these forward-looking statements relate to the date on which they are made. Vecima disclaims any intention or obligation to update or revise any forward-looking statements as a result of new information, future events or otherwise, except as required by law. At this time, I would like to turn the conference over to Mr. Kumar to proceed with his remarks. Please go ahead.

[Sumit Kumar, CEO, President & Non Independent Director]

Thank you, and good morning, everyone. Second quarter of fiscal 2019 brought important progress for all 3 of Vecima's business segments. Our Content Delivery and Storage segment achieved record results, as we capitalized on the build-up to IPTV. In our Video and Broadband Solutions segment, we significantly increased global activity and customer engagement with Entra and moved closer to field trials. And in our Telematics division, we won an additional municipal fleet management contract, while also achieving initial revenues for our new asset tracking product. I'll provide more detail in each of these achievements on today's call. Financially, I'm pleased to report that our top and bottom line results improved both year-over-year and quarter-over-quarter. Revenue increased to $22.7 million. Adjusted EBITDA climbed to $5.5 million and earnings improved to $2.1 million or $0.09 per share. We also increased our gross profit margin to 57%, and we ended the quarter with a strong cash balance of $44.5 million. Keeping with our plans, our Content Delivery and Storage segment was a key factor in these results, as we benefited from strong order flow during the second quarter. Part of this reflects the timing of orders. Overall though, it highlights the excellent traction we're experiencing across all of our MediaScaleX products. One of our Tier 1 MSO customers is currently expanding its on-demand video network and upgrading associated server hardware across its network at the same time. They're using our MediaScaleX cache technology and taking advantage of software feature enhancements we've provided in recent quarters. This is creating strong demand as our customer modernizes and increases the density of a network that serves millions of subscribers. It's also laying the groundwork for future opportunities. As part of this hardware update, our customer is running all of their on-demand video to the interactive set-top box with a back-end network that is the same as what they'll need if they upgrade to IPTV. And while they have not yet transitioned to primary IPTV, our technology has created the infrastructure to support that logical next move. As a result, Vecima is very well positioned to play a role as its customer ultimately makes the transition to IPTV. In a nutshell, this project is driving revenue now and it could continue to well into the future. On the topic of IPTV, I want to add that we continue to experience growing demand from MSOs that are early movers in the large-scale transition to IPTV that will happen. Our portfolio now encompasses 9 MSOs that are making the transition to IPTV video services using Vecima platforms. IPTV is a compelling investment, because it enables operators to offer services like live linear broadcast, cloud DVR, streaming on-demand and time-shift in look-back TV. These are services consumers want and over time will increasingly demand. As such, IPTV represents a huge emerging opportunity, and I want to emphasize emerging, because the majority of IPTV decisions for the larger group of worldwide potential customers are still in the future. But where IPTV decisions are being made, Vecima is at the forefront and winning. And what positions -- and that positions us to capitalize on the future growth we see in this market. Turning now to our Video and Broadband Solutions segment. The second quarter brought further strides in development of our Entra products, which address the cable industry's evolution to DOCSIS 3.1 Distributed Access Architecture. Our DAA nodes are progressing through lab trials with multiple MSOs including a new European Tier 1 operator that began lab trials in the second quarter. We are also on track to commence field trials in calendar 2019. DAA represents a vast new market for us, and we're creating a powerful, differentiated solution to address it. You'll recall in Q1, we unveiled a new product that enables operators to monitor and manage their Remote PHY access nodes and gain excellent visibility into how the nodes are performing. We recently showcased this product at a major industry event and it attracted significant interest from a wide range of operators. Meanwhile, our success in creating one of the most interoperable nodes is proving critically important as MSOs wrestle with operationalizing DAA at scale. These are 2 of the main issues slowing down the transition, and our focus on making our nodes and their management within the network as optimal and as plug-and-play as possible only enhances our position. We are pleased with our progress and position relative to the overall industry transition. In other products in this segment, we achieved initial revenue from our legacy QAM adapter in Q2, as we began field trials with this significant customer. This is a product that provides video services on our customers' existing Edge QAM infrastructure within a DAA framework and obviates the need to rebuild the video network during the DAA transition. In our Telematics segment, I'm pleased to report that we won a new contract for fleet management deployment for the second major Western Canadian municipality. This win falls on a recent contract award with the city of Victoria, which we announced in Q4. We also achieved initial revenues for our new Nero Equipment Tracking product. This is a GPS tracking beacon designed for smaller, movable assets. We just launched this product in Q1, and we're pleased to be generating some early sales. Overall, it was another busy quarter for Vecima, and we're encouraged by the progress we're making in all 3 of our business segments. At this time, I'll ask John to review our second quarter results with you in more detail. John?

[John Hanna, Chief Financial Officer]

Thank you, Sumit. For the purposes of this call, we assume that everyone has seen the news release and financial statements for the fiscal 2019 second quarter that are posted on Vecima's website. I will present the relevant numbers and discussions around overall results, market segments, operational expenses and the balance sheet. I'll start by reminding everyone that our results include the addition of the Concurrent business, which we brought on-board at the end of our second quarter of fiscal 2018. As a result, all comparisons will reflect Content Delivery and Storage numbers in the current quarter and not in the prior year quarter. Now turning to our Q2 results. Starting with consolidated sales for the 3 months ended December 31, 2018, we generated sales of $22.7 million. This was a 54% increase from the same quarter last year due to the contribution from Content Delivery and Storage, and up 6% from $21.3 million in Q1 fiscal 2019. In the Video and Broadband Solutions segment, we generated second quarter sales of $7.0 million, a 38% decrease from the $11.3 million in sales last quarter, and down 48% from $13.4 million in the same period last year. In our Terrace product family, sales were down 51% to $4.2 million from $8.5 million in the same period of last year, reflecting the slower pace of purchasing activity for our Tier 1 MSO customer, as they complete their all-digital conversion. Terrace QAM sales declined to $1.2 million in line with our expectations, as our lead customer's requirement for new systems and upgrade kits nears saturation. Our Content Delivery and Storage business was up 66% sequentially to $14.3 million from $8.6 million in Q1 fiscal '19. This rebound in the second quarter puts us right where we expected to be for the segment at the halfway point in the year. As we've said before, we continue to be confident in the long-term view of this segment, but reiterate that quarterly sales variances can be pronounced. Turning to our Telematics segment. We saw a modest 3% increase to $1.40 million, up from $1.36 million, both last quarter and in Q2 fiscal 2018. This quarter, we achieved a consolidated gross margin at 57%, providing a total gross profit of $12.8 million. This was up from 52% in Q2 of last year, and up from 53% last quarter. The improvement from Q1 to Q2 is mainly a result of the shift in product and customer mix in Content Delivery and Storage. The various components of operating expenses, namely R&D, sales and marketing and G&A, were all higher in the current period compared to the prior year due to our Concurrent acquisition. Excluding Content Delivery and Storage expenses, the notable changes year-over-year in Q2 operating expenses were as follows. R&D decreased to $2.9 million from $3.0 million, reflecting lower subcontracting costs and government assistance in the current quarter, offset by higher staffing and prototype costs. Sales and marketing expenses were flat at $1.1 million, increased staffing costs and marketing expenses, were offset by the reclassification of commissions and support costs to cost of goods sold under IFRS 15 in the fiscal '19 year. G&A decreased to $2.3 million from $2.5 million due primarily to nonrecurring acquisition cost in the prior year. Total OpEx in Q2 at $11.6 million came in lower than the $12.5 million in Q1. Q1 OpEx was elevated due to almost $800,000 in restructuring costs. I note that reported R&D expenses in a period are typically different than the actual expenditure. That's because certain R&D expenditures are deferred until products are in commercial development. Adjusting for deferrals, amortization of deferred development costs and income tax credits, actual R&D investment for the second quarter increased to $7.8 million from $5.7 million a year ago. The difference year-over-year is directly related to the expenditures in Content Delivery and Storage that we didn't have last year. Operating income increased to $1.3 million in Q2, up from $1.1 million in the same period last year, an improvement driven by contributions in both Content Delivery and Telematics segments, offset -- offsetting the year-over-year decrease in the Video and Broadband segment. Net income from continuing operations was $2.1 million or $0.09 per share, compared to net income of $1.3 million or $0.06 per share in Q2 fiscal '18. Net income in the current quarter was favorably impacted by a $1.6 million foreign exchange gain, as compared to a $300,000 gain in the same period last year. Turning to the balance sheet. We ended the quarter with $44.5 million in cash and short-term investments and working capital of $71.2 million. Finally, cash flow from operations excluding noncash working capital was $5.1 million, an improvement from the $3.4 million recorded in the same period last year. Overall, we're very pleased with the continued positive outcomes from our Concurrent acquisition, and the Q2 results were consistent with our expectations. Now back to Sumit.

[Sumit Kumar, CEO, President & Non Independent Director]

Thank you, John. Our outlook for fiscal 2019 remains unchanged from last quarter. In our Video and Broadband Solutions segment, we expect to see a continuation of transition dynamics as the industry prepares for DOCSIS 3.1 Distributed Access Architecture. While the timing of the volume phase still remains difficult to predict, we remain on track for field trials in calendar 2019, and we're continuing to invest in Entra, as we further differentiate and enhance the advantages of our platform. In our Content Delivery and Storage segment, our outlook remains very positive. As I discussed earlier, we're seeing a build-up to a wide IPTV market that can support services like time-shift TV, streaming and cloud DVR. Our MediaScaleX products ideally suit this market, and we see a sizable pipeline of market opportunities in the U.S., Europe, Latin America and Asia-Pacific. Finally, in our Telematics segment, we anticipate continued incremental growth in demand for our fleet tracking products in fiscal 2019. We'll also be pursuing the new opportunities in asset tracking. Across all of our product families, we're creating unique must-have features that are advancing our competitive position. And we remain in an excellent position, as the industry approaches 2 of the most significant market developments driving its future, getting to gigabit internet and moving to IP video with all of its powerful features. Our focus that's going to remain on keeping Vecima's innovative solutions at the forefront, as the lucrative markets mature. We're very excited about our future. That concludes our formal comments for today. We'd now be happy to take questions. Operator?

[Operator]

[Operator Instructions] Our first question comes from David Kwan of PI Financial.

[David Kwan, Technology Analyst]

It looks just -- looks like the Concurrent business is doing quite nicely. So maybe we'll start there. I know you guys have talked about some of the deals, I guess, that slipped from Q1 into Q2 and that helped boost the Q2 numbers a bit here. Can you quantify that how much actually did slip?

[Sumit Kumar, CEO, President & Non Independent Director]

Can you repeat that, sorry? We just had the volume a bit low here, David.

[David Kwan, Technology Analyst]

Yes. I was just wondering, obviously, a very good quarter on the Content Delivery and Storage side. Some of that you guys referenced was due to some deals that slipped from Q1. Can you quantify how much -- how many -- how much these deals did slip from Q1 that benefited Q2?

[Sumit Kumar, CEO, President & Non Independent Director]

I think that it's going to be on the order of a couple of million, it's not that significant. If you look at the cadence we had in kind of the Q4 versus Q1, Q2, you can get a sense of how that lumpiness moved around between those 3 quarters.

[David Kwan, Technology Analyst]

Yes. Okay, okay. And just looking how you -- Sumit, you've talked about kind of expecting some pretty strong growth driven in part by the migration to IPTV. When I look at what you guys have done, I guess, over the last year, you've grown quite nicely versus kind of what the business was doing pre-acquisition. Can you talk about, in terms of that growth, are we expecting kind of solid double-digit growth?

[Sumit Kumar, CEO, President & Non Independent Director]

So, yes, I think, overall, if we look at -- it's a bit difficult to get a direct prior comparable with the kind of halfway in the fiscal year when they entered -- when Vecima acquired, but kind of on a comparative basis with what fiscal '18 or the 4 quarters would've been on the Content Delivery between -- before Vecima and after Vecima, looking at fiscal '19 overall. And as John said, at the midpoint, we're perfectly on track. We're looking at that low double-digit growth as being a very positive target for us.

[David Kwan, Technology Analyst]

I would like to say over, you've had it for a year now looking out the next 12 months or effectively calendar '19 over calendar '18. You think kind of low double-digit growth rate is something that's achievable?

[Sumit Kumar, CEO, President & Non Independent Director]

Very much so. And they've been on -- that segment has been on a quite consistent trend of about a low double-digit CAGR, and we anticipate that continuing. There's -- this opportunity pipeline around IPTV that's continuing to expand, the broadcast segment remains very promising for us, as a further expansion there, too. So all of that consolidating together, it gives us a good amount of confidence in continuing that growth rate.

[David Kwan, Technology Analyst]

Perfect. Moving on to Entra, it seems like you guys are continuing to add more lab trials. Can you quantify how many you're involved with at this point?

[Sumit Kumar, CEO, President & Non Independent Director]

So what we've been talking about for quite some time is our focus on some very important engagements, as a set of Tier 1s, and we just added in the recent quarter, a new lab trial at yet a fourth major Tier 1 operator in Europe. So those key accounts are very pertinent and important to us, and are -- we're making progress at the set of them widely. I would say the 2 of those are looking at calendar '19 as an important period for moving towards field trials. Two are still, given their size and the importance of what this transition means in the network for the upcoming era, if you will, of broadband access, which is their core service there, they're still moving broadly and looking at the specifications and that's pushing out the time line a bit. But -- so we have those 4 Tier 1s that are very important, overall, to the entire industry and, especially the Vecima. Along with that, another thing I want to highlight is that we've built a new integrated go-to-market team between what we've brought on-board from the Concurrent teams and the Vecima teams. And then -- and that's created a lot of momentum for us in the wider sphere and I view that as highly encouraging. So beyond those 4 Tier 1s, we're looking now at engagements with -- that encompass now over a dozen Tier 2 operators in the Americas alone. So lab trials are underway at these customers in many cases, and we're pleased to be seeing all this progress at these operators beyond those 4 -- those big 4. So that's become another important way of our strategy in terms of going wider compared to those -- with this broadly applicable Tier 1 product ecosystem that we've built. So we're seeing that strategy pay off. And for example, we've had 1 North American customer here that we quickly passed through lab trials, they're moving into the field very soon, and we've done that in a period of about 3 short months with that smaller MSOs. So we're expecting similar results at this wider set, and very positive for us that those that are moving, we're broadening our scope and getting momentum.

[David Kwan, Technology Analyst]

No -- that's good. So you're saying that the 1 that you moved through quickly through the lab trials, was that one of Tier 1s or was that a smaller one?

[Sumit Kumar, CEO, President & Non Independent Director]

That's definitely a smaller one. And that's to be expected that the smaller operators, given the scope of what they're doing, we can move relatively quickly. We have smaller touch points in terms of the org structure that we're engaging with and very, very fast-paced things can happen in that segment of the market.

[David Kwan, Technology Analyst]

Okay, okay. That's good to know. And how does FDX tie into all of this? Does -- for example, does the Tier 1 in Europe, are they kind of waiting for FDX, similar to the guys in North America? And then with -- in terms of your own solution, can you talk about kind of where you guys are? Have you got kind of the first silicon yet? And time lines from -- that you guys expect going forward?

[Sumit Kumar, CEO, President & Non Independent Director]

Yes. We're seeing a little bit of continued, I would say, frothiness in the FDX landscape. What we are seeing is an industry consensus of developing around -- they've started to move towards the 10G moniker and whatnot and that's part and parcel of FDX. So we're seeing a lot of alignment that over the longer term FDX is going to continue to be the future. It's -- and across our set of Tier 1s and Tier 2s, there are a significant quantity of them that are kind of pragmatic about this and look in calendar '19, and what's available with Gen 1 and anticipate forging ahead and looking at FDX as more evolutionary. There are, of course, some leading Tier 1 operators that are heavily invested and moving towards FDX, and we along with that are going to evolve our solution according to the timing, that's our work there -- at those types of customers. So FDX remains a long-term industry consensus view of where distributor access is anticipated to go. But over the inception of the market upcoming here, we believe that the rollouts are going to be pre-FDX in many ways for those that are happening. In terms of Vecima chips, as I've said, this calendar year, it's important for the FDX silicon to emerge, some of that may happen in the short time frame going forward here. And we've been preparing our designs to the extent that we can. Now, again, I've said that a lot of the software in this multiyear effort of development, we've done for our DAA nodes, accrues to the FDX, but added layers, of course, and echo cancellation in some of that. The new IP that the silicon is bringing in that is going to enable these symmetrical gigabit speeds to happen, that's the incremental component. So we've moved our designs along. As the chips emerge, we'll start incorporating them. But we're going to be very customer-focused in terms of our priority on that. And there is features on Gen 1 that relate to opportunities that does carry certain amount of priority for us as well. So it's a bit fluid.

[David Kwan, Technology Analyst]

And can you talk about any -- the kind of the potential requalification process for FDX? Like, are there any of your Tier 1s, in particular, where you hopefully -- and I think you've mentioned it in the past, a couple of them, that you've been kind of shortlisted, in terms of your ability to parlay that into FDX or whether you're going to have to go and recall, if I -- can you provide any update on that front?

[Sumit Kumar, CEO, President & Non Independent Director]

Sure. So the way we tend to think about that in terms of the RFP and shortlisting-type processes that go on in some of the bigger Tier 1s, our view is that, on the case, especially on the one of those major Tier 1 engagements where they're highly focused on FDX and where Vecima was shortlisted before, it's true that we'll be entering potentially another re-up on the call process. But our understanding is that the current set of vendors that were previously shortlisted are being viewed by those types of operators as the leads. So it's not as widely open as it once was in the first instance where we did get shortlisted being 1 of 4 amongst the potential set of up to a dozen vendors. So we've gone to that point. These operators have invested to this point and, in truest sense of the word, putting money behind these vendors and resources and qualifying them in labs and that carries some momentum. So there may be RFP emergence for Gen 2 and FDX for their RFPs, with our positioning, we think the shortlist enhances that significantly.

[David Kwan, Technology Analyst]

And I guess in terms of the timing given that there's kind of really no products out there, probably wouldn't see anything, I'm guessing till the middle of second half of this year, when these RFPs might be coming out?

[Sumit Kumar, CEO, President & Non Independent Director]

Yes. It depends on the cadence of planning at a given operator in the sense that they're going to want to run a more formal process some time out from when they intend to deploy. So we could see things sooner than that. But at midyear, I think, is a good view in terms of when we're might see a fresh set of formal RFPs, if you will.

[David Kwan, Technology Analyst]

And would you expect to have something that could get into lab trials in the second half of this year, so have something out available kind of by the middle of this year?

[Sumit Kumar, CEO, President & Non Independent Director]

I think that's a stretch for the entire industry and all of the vendors given where the silicon is at today and the turn in some of the specifications that is going on. I don't believe that anyone is going to be in a position to have FDX product into labs this calendar year.

[David Kwan, Technology Analyst]

So not into even the labs this calendar year? Okay.

[Sumit Kumar, CEO, President & Non Independent Director]

Correct.

[David Kwan, Technology Analyst]

And then you touched on this -- on the interoperability side. Obviously a big issue and concern amongst the vendors -- or sorry, the Tier 1 MSOs. Can you talk about, I guess, where specifically you are vis-à-vis some of the large CCAP vendors in particular and that, obviously, are fairly big in the DAA space?

[Sumit Kumar, CEO, President & Non Independent Director]

Yes, I don't think we have quite perfect visibility into how vendor B may interop with vendor C, node decor, but what I can say, our kind of node in terms of interoperability, has tackled all of the major players on the core side. And as I've said before, that, that's proving to be a key value to the customer set as they look at node selection or they have this desire, of course, to not be close-ended on both the core and the node and also have some selectivity or choice in terms their node vendors. So you can imagine, first out of the gates is a core from the -- and node from a single vendor when they're looking at that second node selection, the widely interoperable and proven node gives us an advantage there.

[David Kwan, Technology Analyst]

Great. Last question. Just on Terrace IQ. Can you give any additional color on where things stand right now? I think, last quarter, you talked about, I think, 2 of your 3 Tier 1 MSOs we're looking at and seem to give indications that they were interested in rolling it out. Has anything changed from that standpoint?

[Sumit Kumar, CEO, President & Non Independent Director]

I think as it normally goes with the timing and something that we're keeping in mind, it remains this evolutionary path that is anticipated by these 2 Tier 1s that once they need to IPTV-ready these commercial platforms, as their back-end network, of course, transitions to IPTVs, so those 2 things go hand-in-hand. I think that we have the current set of products, there are projects in the short term that may associate with the current set of products that will be important for us in terms of channel densification and paid-for upgrades. But it remains the case that Terrace IQ is a long-term anticipated rollout scenario of these 2 Tier 1s.

[David Kwan, Technology Analyst]

Do you expect that you could get stuff into the labs and potentially out commercially sometime this year?

[Sumit Kumar, CEO, President & Non Independent Director]

I think that, that's going to hinge on where the customers anticipate that their needs are. You were seeing, like, I said some short-term project activity that may lend them to move the current set of products that will be, of course, something that we're going to pursue. And there's still a bit of fluctuation in requirement specifications in terms of the road map for Terrace IQ. So, I think, we could -- it's possible that as things crispen here that we could end up with it into labs in this calendar year. But at this point, our view is that, that's moving a bit longer term.

[Operator]

[Operator Instructions] There are no more questions at this time. This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.