Vecima Networks Inc

TSX:VCM

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Hello. This is the Chorus Call conference operator. Welcome to Vecima Networks Second Quarter Fiscal 2024 Earnings Conference Call and Webcast. As a reminder, all participants are in a listen-only mode, and the conference is being recorded. [Operator Instructions]

Presenting today on behalf of Vecima Networks are Sumit Kumar, President and CEO; and Dale Booth, Chief Financial Officer.

Today's call will begin with executive commentary on Vecima's financial and operational performance for the second quarter fiscal 2024 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 2024 results, as well as detailed supplemental information are posted on Vecima's Network at www.vecima.com, under the Investor Relations heading.

The highlights provided in this call should be understood in conjunction with the company's unaudited interim condensed consolidated financial statements, and accompanying notes for the 3 and 6 months ended December 31, 2023 and 2022.

Certain statements in this conference call and webcast may constitute forward-looking statements within the meaning of applicable securities laws. All statements other than 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, including the impact of COVID-19 and the distinctive characteristics of Vecima's operations and 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 21, 2023. A copy of which is available at www.sedar.com.

In addition, although the forward-looking statements in this earnings call are based on what management believes are reasonable assumptions, such assumptions may 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, executive]

Thank you. Good morning, and welcome, everyone. Thank you for joining us.

We achieved very strong operating performance again in the second quarter as we continue to successfully navigate the anticipated transition in DAA deliveries while preparing for the next wave of DAA growth.

I'll start today with an overview of our second quarter achievements. Dale will follow with more details on our financial performance, and then I'll return to talk about our outlook going forward.

Following several consecutive quarters of exceptional revenue growth and a tripling of sales over just 3 years, we anticipated that the first half of fiscal 2024 will be a short transition period for our Distributed Access Architecture, or DAA, business.

Our customers were busy catching up and preparing to ramp project rollouts that were previously delayed by various project requirements, as we've talked about in earlier calls. Factors such as building labor capacity, permitting, utility make-ready, and many other project prerequisites that are very typical of large-scale network build-outs, along with supply of materials outside of Vecima's product lines.

As a result, customers temporarily shifted from building up their product pipelines to increasing their rollouts and deployment activity using inventories we secured for them during the previous year supply chain challenges. Now, at the midpoint in our 2024 fiscal year, we believe this transition is approaching its conclusion. And I'm proud to say, we've managed through it very effectively.

Our second quarter results included total sales of $62 million, which were in line with our expectations, and we paired these sales with a strong gross margin percentage of 47.8%, while we also tightly managed our operations. That, in turn, helped us achieve second quarter adjusted EBITDA of $12.5 million, or over 20% of sales, and earnings of $0.15 per share, more than doubling quarter-over-quarter.

In the Video and Broadband Solutions segment, our second quarter sales were up over 10% quarter-over-quarter as sales began to ramp. Specifically, second quarter VBS sales were up 11% compared to Q1. And moreover, Entra DAA sales, which represent the lion's share of VBS segment sales, increased 13% quarter-over-quarter.

This is just an early indication of the continuing momentum we see ahead for Entra DAA, and I want to comment today on some of the growth drivers that are starting to converge.

The first is our new ERM3 Remote PHY device, which we launched with Charter during the second quarter. The ERM3 enables operators to easily upgrade their legacy hybrid fiber coax nodes to DAA, reducing time and cost while dramatically increasing broadband capacity. It's expected to be a key component of Charter's nationwide DAA rollout. Volume launch got underway in December, meaning we haven't yet seen a full quarter's worth of contribution from the program within our Q2 results.

We expect this solution to be used for a substantial portion of Charter's footprint-wide cable access network upgrade to DAA. And as such, it represents a major multiyear revenue opportunity for Vecima, and we expect it will start to provide more meaningful contribution to our results in the second half of the fiscal year.

The second quarter also brought the launch of our new DOCSIS 4.0 already, GAP or Generic Access Platform node. This is the culmination of Vecima's EN9000 GAP platform, which we first demonstrated at a Cable Lab showcase in 2022. It's now ready to provide customers with a future-proof path to 10G, protecting today's network investments by ensuring operators can easily transition to future technologies, including DOCSIS 4.0 cable access and 10 gig Remote OLT fiber-to-the-home applications.

In October, we announced full availability of the GAP node. And just a few weeks ago, our lead Tier 1 customer certified it for use on their network. We believe this marks the beginning with long and exciting wrap up for this powerful and future-ready new DAA solution.

Of course, we've also been talking in recent quarters about the huge U.S. federal government push to get broadband access to underserved rural areas. Known as the BEAD program, this $42.5 billion program is the largest injection of federal funding into broadband deployment in U.S. history.

Funding grants from the program are now starting to develop, and we'll be supporting both new and incremental major capital spending projects for many of our customers. We expect our Entra fiber access products will be an integral part of their solution as they bring high-speed connectivity to underserved areas of the U.S.

Already today, our Entra Remote OLTs are heavily utilized by operators to significantly expand their footprints under the Rural Digital Opportunity Fund, or RDOF program, which will carry on in parallel with BEAD. The BEAD program is over double the size of the RDOF program. Keep in mind that these are just 3 of the major near-term growth pathways that are now converging for Vecima.

At the end of Q2, we had 184 unique program engagements for Entra cable and fiber access across 110 operators globally. As more customers of various DAA rollouts commence, they're adding to the wave of demand that's now building for our Entra technologies and solutions.

The overall scope of the opportunity is immense. And as we move into the second half of fiscal '24, we expect it to start translating into strong revenue momentum for our VBS segment.

Turning now to our Content Delivery and Storage segment. Q2 sales of $11.3 million were lower than we anticipated. As you know, CDS quarterly sales are prone to lumpiness due to the typically large size of orders that are tied to IPTV project and capacity increase timings. That means a shift in customer timing can affect segment results, as was the case in Q2.

But some of the noteworthy highlights of the quarter included a new engagement with Blue Ridge Communications to support its video expansion as well as continued expansion with a number of other customers that are growing their footprints with our IPTV platforms.

We also released new versions of our media skill origin and dynamic content products during the quarter. And another key achievement was the continued growth of our CDS services revenues, which are reflective of the growing base of media scale IPTV platforms we now have out in the market. This, in turn, helped the CDS segment achieve a strong Q2 margin of 54.5% despite the lower sales.

Turning to Telematics. The segment turned in another good quarter as we increased sales by 7% year-over-year. That growth reflects the addition of 10 new customers for our NERO asset tracking platform in the quarter, which in turn increased the number of movable assets we now monitor to over 59,000 units.

Telematics also continues to be a highly profitable part of our business, with the segment achieving strong EBITDA margins on a recurring SaaS business.

So overall, it was a very solid quarter for Vecima again, and all across our operations, we continue to focus on the growth ahead while tightly managing the business and operating costs to achieve greater efficiency.

At the same time, we continue to broaden our best-in-class technologies with robust R&D investment, thus further advancing our leadership in preparation for the major opportunities we see ahead.

I'll tell you more about our outlook for the business in just a few minutes. But first, I'll pass the call over to Dale to provide more detail on our Q2 results. Dale?

[Dale Booth, executive]

Thank you, Sumit, and thank you all for joining us today. For the purposes of this call, we assume that everyone has seen our second quarter fiscal 2024 news release, MD&A, and financial statements posted on Vecima's website.

Starting with consolidated sales. We generated second quarter revenue of $62 million, which was within expectations, but down 19% year-over-year.

The Video and Broadband Solutions segment accounted for $49.1 million of these sales, which was 21% lower than in Q2 of last year. This primarily reflects the DAA transition Sumit referenced, with Entra sales also decreasing 21% year-over-year.

As Sumit noted, on a quarter-over-quarter basis, Entra sales were up 13%, providing just a hint of the quarterly revenue momentum we're anticipating.

Commercial video product sales, which are included in VBS results, were stable quarter-over-quarter at $5.3 million, but down about $1.2 million from the same period last year. This reflects the transition to next-generation platforms and the impact of some of our newer DAA-driven commercial video solutions being accounted for as part of the Entra family sales.

In our Content Delivery and Storage segment, we saw significant quarterly fluctuation with sales of $11.3 million, down 9% year-over-year, and 28% quarter-over-quarter. This mostly reflects timing of orders, and we notice always that quarterly sales variances are typical of this segment.

One notable achievement this quarter was seen in service sales surpassed product sales for the first time, which reflects the strong and growing base of deployed media scale platforms out there in the market. With another strong quarter for the Telematics segment, with sales of $1.6 million, increasing 7% from the $1.5 million in Q2 of last year, gross margin for the company as a whole was 47.8%, which was at the higher end of our target range and up both year-over-year and sequentially.

Turning to second quarter operating expenses. The notable changes year-over-year were as follows: R&D expenses increased by $1.3 million year-over-year to $11.6 million. This primarily reflects increased amortization of deferred development costs, prototyping materials and software and licensing costs, offset by higher capitalized development costs quarter-over-quarter.

Sales and marketing expenses for the second quarter were stable year-over-year at $6.6 million. Second quarter G&A expenses decreased to $6.4 million, an improvement of $1.1 million. This reflects the targeted lower staffing costs we implemented in Q4 fiscal 2023, and lower ERP program implementation costs year-over-year. Other expenses remained flat at $0.1 million.

In total, we reduced second quarter OpEx to $24.9 million, a decrease of 1% year-over-year, and 5% quarter-over-quarter. Costs are expected to increase in the second half of fiscal 2024 to support the sales growth anticipated.

In the Video and Broadband Solutions segment, operating expenses for the quarter were down $0.5 million year-over-year, reflecting a combination of lower G&A expense, partially offset by higher R&D expense.

Content Delivery and Storage operating expenses were $0.1 million lower at $7.4 million. And in our Telematics segment, operating expenses were slightly higher at $1 million, reflecting an increase in R&D expense.

I note that reported R&D expense in a period is typically different than the actual expenditure. That's because certain R&D expenditures are deferred until product commercialization.

Adjusting for deferrals, amortization of deferred development costs and income tax credits, actual R&D investment increased to $15.2 million or 25% of sales in the second quarter, from $13.2 million or 17% of sales in Q2 last year as we continue to invest in our next-generation products.

Looking at our bottom line results, we reported a second quarter operating income of $4.7 million as compared to $10.7 million in the same period last year. This primarily reflects the transition period for our DAA business, partially offset by lower expedite costs as supply chain challenges eased.

We generated second quarter adjusted EBITDA of $12.5 million as compared to $15.8 million last year, reflecting lower sales, partially offset by higher gross margins. On a quarter-over-quarter basis, adjusted EBITDA increased by $4.3 million or 54% from the $8.1 million in Q1.

Foreign exchange gain in the second quarter increased to $1.8 million from a foreign exchange loss of $0.1 million in the prior year period. This reflects the positive impact of a stronger U.S. dollar on our results.

Net income from continuing operations for the quarter was $3.6 million or $0.15 per share as compared to $8.1 million or $0.35 per share for the same period of fiscal 2023.

Turning to the balance sheet. We ended the second quarter with $2.6 million in cash as compared to $2.3 million in the same period last year. Working capital of $80.4 million at the end of Q2 was lower than the $83.7 million recorded in Q4 fiscal 2023, but on par with Q1 of fiscal '24.

We note that working capital balances can also be subject to significant swings from quarter-to-quarter. Our product shipments are lumpy, reflecting the requirements of our major customers. Other timing issues like contracts with greater than 30-day payment terms also affect working capital, particularly if shipments are back-end weighted for a quarter.

Lastly, cash flow used in operations for the second quarter was $13.2 million, as compared to cash flow used in operations of $12.2 million during the same period last year. The $1 million increase reflects a $13 million decrease in operating cash flow, partially offset by a $12 million increase in cash flow from noncash working capital.

On a final note, the Board of Directors approved a quarterly dividend of $0.055 per common share, payable on March 18, 2024 to shareholders of record as at February 23, 2024. It's important to note that this dividend will be designated as an eligible dividend for Canadian income tax purposes.

So just to summarize, another solid quarter as we continue to maintain tight control of our operations. Now back to Sumit.

[Sumit Kumar, executive]

Thank you, Dale. As we look ahead to the balance of fiscal 2024, Vecima is on the cusp of a major new phase of growth and development for the business.

As I mentioned earlier, a number of growth pathways are converging, just as operators worldwide are launching upgrades to their broadband and IPTV networks. We expect this to have a significant and positive impact on our results in the second half.

In our Video and Broadband Solutions segment, we anticipate a major uptick in sales starting in Q3. We expect our quarterly run rate to reach new highs by year-end, with momentum expected to build into fiscal 2025 and beyond.

In our Content Delivery and Storage segment, overall demand for our IPTV and open casting solutions remained strong. However, the Q2 shift in project timing has led to an adjustment in our expectations for the year. We now expect the CDS segment to achieve fiscal '24 sales results similar to the strong performance we achieved in fiscal '23.

Longer term, we continue to see robust future growth potential, as the IPTV and OTT streaming services markets continue to expand.

Finally, in our Telematics business, we expect consistent incremental growth from the fleet tracking market and increasing demand for our NERO movable asset tracking services. The latter has become an important driver of segment differentiation and gains in recent quarters.

On a consolidated basis, we expect our fiscal 2024 revenues will be in line with the all-time record results we achieved in fiscal 2023, despite the slower first half this year.

And in summary, we're now -- we are more than excited about Vecima's prospects, both in the near and the longer term. We're on the cusp again of the next major wave of growth. And as we move into the second half, we're resoundingly executing on multiple multiyear opportunities.

Between a large and growing order backlog, one of the world's most comprehensive portfolios of next-gen DAA and IPTV technologies, covering both fiber and cable access, strong partnerships with some of the world's largest Tier 1 operators and a solid financial position.

We're uniquely positioned to capture this next wave. We look forward to reporting on our achievements in the coming quarters.

And that concludes our formal comments. We'd now be happy to take questions. Operator?

[Operator]

[Operator Instructions] Our first question comes from Jesse Pytlak from Cormark Securities.

[Jesse Pytlak, analyst]

In the release, you mentioned that you're seeing entry order sizes increasing. Can you maybe just give us a sense of the magnitude of the increases?

[Sumit Kumar, executive]

Yes. Jesse, I think that we've seen that, as I mentioned, this first half kind of inventory work down, factors has been underway for our customers while they ramp in the field. We've always had pretty good visibility from our customers. I think I've mentioned that during the supply chain constraints, as you know, over the last several years, our customers have been really great about working with us to give us long-term visibility and that's giving us a good site picture for what we expect in the second half.

In terms of magnitude, I think what I've said is we're going to start to move towards new highs in sales, and in fiscal '23, we had some of our highest growth in Entra, came out with about $222 million in sales.

So as we move into the second half, you've got the first half Entra sales reported, but we're expecting to get by year's end on a run rate that represents a significant ramp for Entra compared to, say, Q4 of '23, setting up to pursue in the range of up to 60% higher quarterly run rate year-over-year, Q4 to Q4.

So we are seeing a significant ramp, and I hope that gives you a sense of the magnitude.

[Jesse Pytlak, analyst]

Yes, that's helpful. Maybe just kind of moving over to BEAD funding. Now, that it's kind of getting closer to being allocated, are -- like is that changing how maybe some of the cable operators are approaching their deployment planning? Are you seeing them in better position to now make decisions? Are you seeing making any changes with maybe some decisions you've already made?

[Sumit Kumar, executive]

I think that with respect to -- if you look at the conjunction of RDOF and BEAD, we've seen that some of the Tier 1 cable operators in the U.S. have been most addressable in terms of their access to those funding programs, and they've been very successful with RDOF to this point when you consider where the BEAD census blocks are targeted for underserved rural areas.

On the Tier 1 cable operators that we work with, have very good addressability to that funding program. So the way that we think about it is they're accelerating their RDOF deployments as we speak. You can see some of the material from -- publicly available from some of the Tier 1s that we work with.

And that are focused on the art out program, and they've ramped in calendar '23. They see a continuing ramp in calendar '24. For RDOF itself, and that carries on through calendar '26. And then BEAD, as we get through calendar '24 and these programs get through their final solidification on granting of the awards to the ISPs from the states. That layers over top, and it's doubled the size of an overall program.

So they're doing really well in terms of IRR on RDOF, so it's very much the picture that's being represented to us, that they get to lean into the success that they've had with RDOF and layer in BEAD.

[Jesse Pytlak, analyst]

That's helpful. And then maybe just one last one for me. There's been some kind of commentary footer on the industry that some cable operators are maybe more seriously considering using extended or enhanced DOCSIS approaches instead of moving ahead with DAA and DOCSIS 4.0 at this time. Just wondering if you're seeing anything like that from where you sit?

[Sumit Kumar, executive]

Yes. I think we're still in this phase. We're early in the DOCSIS 3.1 cycle, that itself gets us to gigabit upstream, multi-gigabit downstream and the product availability and readiness of the operators in terms of their qualification is a goal for DOCSIS 3.1 DAA.

DOCSIS 4.0 gives them that next layer in the future, and extended spectrum is a component of DOCSIS 4.0 so they can get to a more symmetrical 10G type service. I think operators are saying, they can leverage this cable access network footprint they have with very, very efficient capital spending to get the gigabit speeds comparable or very competitive with fiber-to-the-home. And then they can, of course, focus their greenfield, new footprint built on fiber-to-the-home itself.

So I think with respect to extended spectrum and 4.0, that's part of the future. It's one and the same thing in large part. And what we're seeing is the DOCSIS 3.1 is what they're going to be focused on for the next period of time, and DOCSIS 4.0 is available to them to continue ramping the speeds and leveraging that CapEx efficiency on the cable access network.

[Operator]

[Operator Instructions]

Our next question comes from Ryan Koontz of Needham & Co.

[Ryan Koontz, analyst]

I saw your announcement on the GAP node at a Tier 1. Can you tell us a little bit about that? And kind of how that's positioned versus traditional DAA platforms and how your customer base, including your key customer there is thinking about that platform?

[Sumit Kumar, executive]

Sure. Thanks, Ryan. Yes, I appreciate the question.

I think we've talked a little bit about the emergence of the GAP node. It's the generic access platform. And what that platform is intended to do, I think as you know, the cable operators have evolved their networks over decades, starting from analog video to the first broadband access, now moving to gigabit broadband and then leveraging the DOCSIS 3.1 DAA followed by DOCSIS 4.0.

But they've also grown through consolidation and acquisitions. So you found yourself with some of the world's leading Tier 1 operators in the space, having accumulated a lot of fragmentation in their hardware in the field, and we have all these older analog nodes, in some cases, up to dozens and dozens of varieties of noding closures from that history, that long history to manage, and that becomes problematic in terms of fragmentation.

So as the industry is moving towards DAA, and generally, us along with a key lead Tier 1 operator, have standardized a future forward platform that is modular in nature, that can move away from that fragmentation of dozens and dozens of legacy analog nodes, and allow us to have a GAP platform that lives for decades to come. It has things like power supplies with multiple voltage levels, a CAN bus, which is an automotive standard for command and control between modules backplanes, lots of thermal efficiency, thermals are very important in terms of a node in closure for cooling. These active electronics that work in.

And it gives them, really, the future-proof platform and more of a single SKU environment in terms of how they train their work first, too, and operate the network, and it's migratable all the way from cable access to even putting fiber-to-the-home modules in that platform, putting edge compute in that platform.

So I think the Tier 1 that we're partnered up with here is planning to leverage it. We're the first to market, and that represents a fantastic opportunity for us.

[Ryan Koontz, analyst]

Yes. It sounds sense. So it's a bit of a premium for the kind of lifetime life cycle flexibility you get from the platform?

[Sumit Kumar, executive]

Very modest premium, but it gives that kind of lifetime usability out of the platform. And I think, when we think about DAA, and generally moving to a bespoke DAA node versus a GAP DAA node is very similar in terms of their CapEx.

[Ryan Koontz, analyst]

Got it. And in terms of -- just a follow-up question on your comments around Charter and your product there. It's primarily the ERM3, that's a retrofit going in for Charter, and that's initially for DOCSIS 3.1, if you could confirm? And also in terms of kind of your outlook for share in this big program, how do you think about that in the big picture over the next couple of years?

[Sumit Kumar, executive]

Yes. So I think it is DOCSIS 3.1 to start, and that makes a lot of sense for what the target is of the program over the initial couple of years. I think there's some detail provided by the customer in that regard over what type of service they plan to unlock.

And in terms of how we think about share, we are one of the awardees, and so it's another vendor. And we both have platforms, in terms of the RPD modules, that are expected to be used for significant portions of the network. And they tend to look at things, perhaps on a market-by-market basis, and we expect it to be a relatively even split, it's how we think of it.

And I don't want to get into perfect detail about where we are versus the other vendor, but I think it's clear that both of us are involved and we expect a very, very nice program and scale rollout across the network.

[Operator]

[Operator Instructions] As there appears to be no further questions, this concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.