Vecima Networks Inc

TSX:VCM

Earnings Call Transcript 2019-Q4

[Operator]

Hello. This is the Chorus Call conference operator. Welcome to the Vecima Networks Fourth Quarter and Year-End Fiscal 2019 Results Conference Call and Webcast. [Operator Instructions] 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 fourth quarter and year-end fiscal 2019 results. Lastly, the call will finish with a question-and-answer period for analysts and institutional investors.The press release announcing the company's fourth quarter and year-end fiscal 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 audited annual consolidated financial statements and accompanying notes for the 3 and 12 months ended June 30, 2019.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 operational performance. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict and/or 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 and industry and customer demand that may have a material impact on or constitute risk factors in respect to Vecima's future financial performance as set forth under the heading Risk Factors in the company's annual information form dated September 26, 2019, a copy of which will be available at www.sedar.com. In addition, although the forward-looking statements in these earnings calls 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 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. Fiscal 2019 was a year of concerted moves and important achievements as we broadly solidified our position in emerging markets for DOCSIS Distributed Access Architecture, or DAA, and IPTV. On the DAA front, I'm delighted to report that we are now on the cusp of initial deployments of our new Entra DAA products. And in our Content Delivery and Storage segment, we are anticipating significant revenue growth in fiscal 2020 as we supply the products that support our customers' transitions to IPTV. We made excellent progress and I'll tell you more about what we have achieved on today's call. But first I want to provide some context for the fiscal 2019 year and for our results.As you know, the industry transition to DAA and gigabit speeds is a seismic shift for our industry. This required significant investment and no small amount of patience as our customers work is demanding technical aspects of operationalizing DAA at scale. Frankly, it's been a slower transition that anyone predicted. And not only has it taken a long time for the industry to get to commercial deployment with this next generation, the demand for legacy products has been tapering off at the same time. This has made for challenging financial realities not just for us but for many of our industry peers as well.At Vecima, we responded by tightening our R&D priorities, streamlining our administrative processes and prudently managing our business and finances. While doing this, we also maintained the agility to respond quickly to our customers' evolving technology needs. This is one of Vecima's core strengths, and we're starting to see the rewards.In our Video and Broadband Solutions segment, we've now secured our first master purchase agreement covering our Entra Remote PHY nodes and Monitor products as one of our Tier 1 operators prepares to enter field trials and deployment. Our new Legacy QAM Adapter, which supports video in DAA environments, has been deployed at multiple customers and is generating revenues today, and we've broadened our Entra engagements, lab trials and field trials with a rapidly widening set of cable operators globally. As of today, we have engagement with 16 cable operators in North America, Central and Latin America, Europe, and the count is growing. These are important milestones on the path to commercialization of our new DAA technologies, and we're anticipating deployments to start in fiscal 2020.We've also made excellent progress with our IPTV initiatives in our Content Delivery and Storage segment. During fiscal 2019, we significantly advanced our next-generation MediaScaleX platform, including further differentiators like hyper-convergence and industry-leading storage efficiency and data throughput speeds. We also continue to expand our relationships with some of the world's largest service providers.By year's end, 17 operators were using our platform to deliver IP video services to their customers. This includes a leading European MSO that's employing our platform as part of an all-encompassing modern IPTV network. We're also working with a top 5 North American MSO that is using MediaScaleX to expand IP-driven video services to over 75% of its customers where Vecima's CDN platforms are powering services for video-on-demand, Start-Over and digital ad insertion. As we move into fiscal 2020, these and other customer engagements are supporting the meaningful growth we see ahead of us in our CDS segment sales.Looking at some of our other product families. In commercial video, the highlight for the year was an expansion of our MPEG4 densification program using the TC600E, which drove strong sales and continues evolution of the product family from all digital conversion towards the next generation of IP migration upcoming at our large Tier 1 customers. And in our Telematics business, we launched our new Nero GPS Asset Tracking product, which targets the fast-growing movable asset tracking market and augments our fleet management business.Financially, our results for fiscal 2019 reflected the technology transition we've been going through. But even in a transition year, we achieved revenues of $85 million, which is up 9% from fiscal 2018. This was largely due to the addition of our new Content Delivery and Storage segment and fitting with our strategic direction in the synergistic IPTV and DAA markets.We also closed the year with a healthy cash balance of $44.4 million in keeping with our continued focus on maintaining financial flexibility and strength. This was a significant achievement when you consider the sizable investments we've made into next-generation platforms, positioning us for the growth to come.We also completed a small but strategic tuck-in acquisition in the fourth quarter by acquiring the assets of Root6. This all-cash deal brought us a software and solutions company based in the U.K. with a product line used by broadcasters and content creators worldwide. ContentAgent is used by world-leading storytellers to author their media assets orchestrating the entire workflow all the way from camera ingest to publishing. This purchase also allows us to expand our end-to-end IPTV solution capability and provides us a new set of blue-chip broadcast customers that are widely addressable with our full CDN and storage portfolio. We also, once again, returned $4.9 million to investors by way of our regular quarterly dividends during the year.Overall, we ended the year in excellent shape, both financially and competitively. And as we move into fiscal 2020, I believe we are one of the vendors best able to take advantage of the near-term opportunities in both DAA and IPTV.I will return to tell you more about what we see ahead for Vecima in just a few minutes. But first, I'll ask John to provide more detail on our financial results. John?

[John Hanna, Chief Financial Officer]

Thank you, Sumit. For purposes of this call, we assume that everyone has seen the news release and financial statements for the fiscal 2019 full year and fourth quarter that are posted on Vecima's website. I will present relevant numbers in discussions around overall results, market segments, operational expenses and balance sheet.I'll start by noting that fiscal 2019 results included a full year of contribution from our Content Delivery and Storage segment as compared to only 2 quarters in fiscal 2018. In addition, it includes 1 month of operating results from our acquisition of ContentAgent that is now part of the Content Delivery and Storage segment.Turning to Q4 results, starting with consolidated sales for the 3 months ended June 30, 2019. We generated sales of $20.7 million. This was an uptick of 2% from the $2.3 million in Q3 but a 15% decrease compared to the same quarter last year. The year-over-year drop reflects the expected decline in legacy product sales from our Video and Broadband segment. In that segment, we generated fourth quarter sales of $6.9 million, a decrease of 45% from Q3 and a 38% decline from the same period last year.Within the segment, our fourth quarter Terrace family sales decreased to $4.0 million from $8.5 million in Q3 fiscal 2019 and from $7.9 million in Q4 fiscal 2018. The 52% decrease in sequential quarterly sales reflects the significant deployment of TC600E products in our Q3 fiscal 2019 in support of a Tier 1 MSO's customer's MPEG4 densification program that tapered off in Q4.Terrace QAM sales increased 15% in the fourth quarter to $1.7 million from the $1.5 million in Q3 fiscal '19 but decreased by 23% from $2.2 million during the same period last year as customers' need for the new system neared saturation. We expect to see ongoing quarterly fluctuations for Terrace QAM.The Content Delivery and Storage segment had revenues of $12.5 million in Q4, a 4% increase from the $12.0 million in the same period last year and a 92% improvement from $6.5 million in Q3. As we've mentioned before, the quarter-to-quarter variance in this segment can be pronounced due to the timing of large customer orders impacting sequential quarterly revenue.Turning to the Telematics segment. Sales were flat in Q4 this year as compared to the same period last year at $1.3 million and slightly lower than Q3 fiscal 2019. The drop in revenue between Q3 and Q4 is due to seasonal customers. Gross margin for the fourth quarter was 49.0% compared to 52.6% in Q3 2019.Video and Broadband Solutions gross margin was 45% in the current year quarter, down from 47% in the prior year quarter. Multiple factors accounted for the decrease: lower overall sales, a shift in product mix and lower prices for certain Terrace products.Gross margin was also affected by sales commissions now being classified in cost of sales due to the adoption of IFRS 15. Gross margin in the Content Delivery and Storage segment decreased to 50% in Q4 from 60% last year due to product mix and the impact of commission costs under IFRS 15. In the Telematics segment, gross margin in the quarter decreased to 65% from 70% during Q4 of fiscal '18 due to product mix and sales commissions.Turning to operating expenses, the notable changes year-over-year in Q4 were as follows. R&D expenses increased to $5.0 million in the current quarter from $4.4 million in the prior year as we continue to invest in research and development to support the launch of new products. Until these new products are commercialized, development costs are deferred to future periods.Sales and marketing expenses decreased to $3.6 million from $4.2 million last year due to lower finished goods inventory allowances and sales commissions now being classified to cost of sales. G&A expenses increased slightly to $4.3 million from $4.0 million in Q4 fiscal 2018, reflecting primarily increased staffing costs. Total OpEx in Q4 increased to $14.4 million from $12.6 million during the same period last year due to higher operating expenses in the Video and Broadband segment primarily related to restructuring costs, higher R&D expenses and increased G&A expenses partially offset by the decrease in sales and marketing expenses.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 products are in commercial development. Adjusting for deferrals, amortization of deferred development costs and income tax credits, actual R&D investment for the quarter decreased to $6.2 million from $8.1 million in the same period last year and from $7.5 million in Q3 fiscal 2019. This was primarily a result of lower subcontracting costs and lower staffing costs in the current quarter.We reported an operating loss of $4.3 million in Q4 as compared to operating income of $0.7 million in Q4 fiscal '18 due to lower contributions from both Video and Broadband and Content Delivery and Storage segments this quarter. Net loss from continuing operations for the quarter was $3.0 million or $0.13 per share compared to net income from continuing operations of $3.8 million or $0.17 per share in Q4 fiscal '18.Turning to the balance sheet. We ended the year with $44.4 million in cash and short-term investments, and that is after our acquisition of ContentAgent business assets from Root6. Working capital remained strong at $58.3 million.Finally, cash flow from operations for the fourth quarter, excluding noncash working capital, was $2.9 million, up from $0.7 million during the same period last year. $2.2 million change in the quarter reflects a $4.6 million increase in cash flow from noncash working capital and a $2.4 million decrease in operating cash flow.Now back to Sumit.

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

Thank you, John. Moving into fiscal 2020, we are anticipating a year of growth.Starting with the Content Delivery and Storage segment. The combination of enhancements to our MediaScaleX product family, the further buildup of new customers and the expected shift to higher capital spending on IPTV are all underpinning robust demand. We see the potential for over 20% sales growth from this segment in fiscal 2020. This will stem from the increasing pipeline of opportunities for migration to IP video networks, including linear broadcast, cloud DVR and time-shift TV.In our Video and Broadband Solutions segment, our Entra DAA products are in various stages of engagement with 16 MSOs and nearing conversion with several. We anticipate initial sales of our Remote PHY nodes and Remote PHY Monitor products will commence in the first half of fiscal year. While initial sales are typically modest, momentum should start to build as customers move to scale deployment.And in our other product families, we're seeing opportunities for our powerful next-generation Terrace IQ platform progressing with a major MSO customer. And while the timing could still be up to a year away, the all-IP conversion future for our heavily deployed base, there is a major opportunity. There's also the potential for a temporary uptick in demand for Terrace QAM in advance of that migration. Overall, however, we are expecting sales of legacy products will continue to taper off as our customers move to next-generation platforms.Finally, in our Telematics business, we anticipate incremental growth from the fleet tracking market in fiscal 2020 and expect to see growth in demand for our Nero movable asset tracking services.In summary, fiscal 2020 promises to be an exciting year for Vecima. We're well positioned to take advantage of the near-term opportunities in both DAA and IPTV markets. And we're sharply focused on supporting our customers' deployment plans with highly differentiated, world-class technologies.That concludes our formal comments for today. We now would be happy to take questions. Operator?

[Operator]

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

[David Kwan, Technology Analyst]

I guess, starting off on Entra, that's obviously what I think what most investors are focused on at this point. It seems -- it's great that you're providing some more color there, and it sounds like there's been some positive developments. Is there any way that you can help quantify in terms of what you're expecting as it relates to revenues? You talked about, I guess, modest revenues in, I guess, the first half of this year. But is there any way that you can kind of put that into numbers?

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

Sure. So I think we usually cover a lot of detail on Entra, David. As you suggested, it's top of mind for everyone. So before going to your question, I want to make a point on the broad strokes first. So we are now seeing all the right signals on quite a wide set of opportunities as we talked about that the market for us is going to start happening in fiscal '20, and our plan sees that pulling through significant sales from DAA for us. So in terms of product readiness and customer readiness, we're in a really good place. So turning point is coming for Vecima in DAA, and that's going to represent the culmination of all of our work over the last 6 years, an exciting new phase for the company. And I'll be excited when I can report the first win in more detail, and we don't think that's far off.In terms of quantifying things, like you said, modest initial sales first half. Second half is where we see momentum starting to build. We've talked in a little more detail today about a Tier 1 customer that we're very deeply engaged with, they are looking like they will be our lead in fiscal '20, and they have been working through their process and planning for a calendar year '20 scale deployment. And we expect to roughly split that market share with another vendor. And we've said before that a Tier 1 opportunity on the average at scale can drive an annual rate of $40 million to $50 million in node purchases in U.S. for their entire network. So you can think about it in that context of how we see the buildup emerging, starting and scale deployment in the second half and building to that pace.

[David Kwan, Technology Analyst]

So I guess it sounds like the Tier 1 MSO that you referred to that you got a master purchase agreement, that's the one I assume that's going to be generating revenues kind of starting in the first half of fiscal '20. Is that a fair statement? And the revenue, I'm guessing that you're talking about, would that be more driven by the field trials initially and then, I guess, the eventual rollout?

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

Yes. That's the typical cadence. You're going to get a very modest revenue tick in field trial volume. Field trial, they kind of stage out into -- they're in field trial now, and they're going to expand those field trials and then move towards the first market deployment, et cetera. So we do that, like I said though, the 16 engagements across the entire pipeline that we're working on, and there are other sets of customers that could go to revenue there even in the first half. So it's not necessarily just the Tier 1. That, of course, is going to drive all the significance in the second half.

[David Kwan, Technology Analyst]

How many do you think, of those guys that are in the pipeline, let's say, exiting fiscal '20? Could you give a range in terms of the number that you think could actually be beyond the field trials and actually into the deployment stage?

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

So one thing that I'll add on that group across all the tiers is that beyond the lead Tier 1 that there are 5 other Tier 1s in that list. And amongst those, there are a couple that could start by the end of the fiscal year and make their way through the deployment as well. So that can move things quite significantly one way or another depending on the timing and the pace that happens there. And then when we go on through the list at the 10 other customers that we're engaged with, there are more than a few that look like they can turn over to purchases this fiscal year.

[David Kwan, Technology Analyst]

Has, I guess, the industry got their minds around the full duplex versus the extended spectrum DOCSIS because I know that's been a hindrance in terms of holding things up?

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

Yes. No, most definitely, over the last 2 years, FDX standardization around that and thinking about that planning and whatnot is in some way has become a hindrance. To speak to FDX, I think, I want to start by highlighting that the industry as a whole, like we said, has gone through a lot of churn on that and thinking, standardizing and what role FDX may or may not play in DOCSIS 4.0 versus other flavors like extended spectrum where you're going to 1.8 gigahertz to drive 10G services. So at this point, the good news is that we're starting to see consensus emerged amongst the industry at large that the view seems to be that DOCSIS 4.0 is going to be out in the future and it's going to be primarily driven by extended spectrum. And along with that, the kind of focus on Gen 1 is kind of sharpening. So that all ties with what we want to see here in that operator. The industry as a whole, the bulk of the operators have basically a clear road map what they're going to do down the road, but they are very focused on Gen 1 today.

[David Kwan, Technology Analyst]

And so is there a silicon issue then because I know there was for FDX?

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

Yes. So I've said before that FDX, extended spectrum, 4.0, all of the above are heavily dependent and gated by chips. So the ASIC providers themselves have had to work their way through this industry churn and on the direction that things would go. So in that sense, the silicon has moved, and it's going to crystalize going forward. But some of the earliest anticipated drops of chips for 4.0, FDX, et cetera, have definitely moved. And we expect that's a ways out still until we get the silicon that drives the bulk of the market, and we think that's likely to emerge as extended spectrum first.

[David Kwan, Technology Analyst]

So is it fair to say, I guess, at this point like that the MSOs are pushing ahead with first-gen solutions not waiting around for DOCSIS 4.0 or FDX or extended...

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

Yes, that's absolutely our view. And when we look at our pipeline and what those set of customers are planning to do, it's all focused around Gen 1.

[David Kwan, Technology Analyst]

Fair. As you talk to them, as they eventually move on to whether it's FDX or extended spectrum DOCSIS, et cetera, et cetera, like will you need to requalify at that point? Or are they -- is there an understanding that who they're going with right now, assuming that they're happy with the products you're providing to them, you'll still be in the box for subsequent generations?

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

Yes, and that's a great way to put it as being in the box for the next generation. The bring-up overall is very significant as everyone has observed here in qualifying the software. And when it comes to nodes, physical, environmental, all of the above, RF and having gone through that and got the nod for Gen 1, that's going to give you -- accrue a lot of momentum for any subsequent generation. There will be, of course, elements that have to go through another cycle, no doubt, for such a bold shift as something like extended spectrum, but you're going to get benefit of being where you are on Gen 1.

[David Kwan, Technology Analyst]

And I guess for this kind of lead customer here, you're one of two vendors?

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

That's the current situation. Yes.

[David Kwan, Technology Analyst]

Is there a plan to expand that? Because I think in the past, the thought was I -- they want to kind of broaden their vendor list to help improve pricing. So I think at least in one of the RFPs, I think there was 4 that got shortlisted. So I don't know on whether that was the eventual plan for these guys going forward after kind of maybe starting with 2.

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

Yes. No, sure. I mean that's the one case and that was a couple of years ago, there's 4 that were shortlisted in Gen 1. That operator itself has just moved everything over to the right. So I think we can maybe think of that one as not entirely relevant. For this type of operator, what we've said is that our view is that the room and the lion's share of the deployment is likely to be driven by 2 vendors. They will always have their stance, and they can pull somebody else in, but the investment is all oriented around 2 vendors, starting from their qualification investments, which are significant. So that's where we see things happening in practice that we see a split amongst 2 for the bulk of a deployment.

[David Kwan, Technology Analyst]

That's great color there, Sumit. So on the Terrace IQ then, so it sounds like stuff is starting to push ahead there, but it sounds like maybe there -- the revenue opportunity there might be fiscal 2021 versus a fiscal '20?

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

Yes, you're on right track there. So of course, Terrace IQ is starting to coalesce, I would say, and particularly with lead MSO, which is most important, where we have several tens of thousands of deployed commercial properties with Terrace and Terrace QAM that's cementing as a next generation. At the same time, development has to come, requirements have to be finalized, et cetera. So it times out, out of fiscal '20 for us at this point, but still remains the overall anticipated transition of commercial video for us, including at the lead, the other 2 Tier 1s and international markets as well.

[David Kwan, Technology Analyst]

So maybe looking at the Terrace family as a whole then, I guess, expected that fiscal '20 is probably going to be another tough year and hopefully start to see a rebound in fiscal '21 then.

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

Yes, I think that's a good distillation of where things are timed out right now. We are going to see ongoing MPEG4 densification, particularly at the one Tier 1 that's most definitely underway there, and we saw a big bite from them in Q3 of '19 that they still have some 30%, 40%, maybe around 40% to do for MPEG4 densification. We've got some -- we have another Tier 1 operator that has kind of design wins on the MPEG4 densification, but they aren't feeling the pressure on their network capacity yet to make the move overall for MPEG4 compression. So that's out in the future. We're not relying on that coming in this fiscal year. And then the lead is kind of moving towards purchasing Terrace QAM and upgrade and finishing all -- wrapping all that up as they start their thinking to move towards Terrace IQ down the road. So summarizing that altogether for fiscal '20, we're thinking in the ballpark 75% of what we did in fiscal '19 for those families.

[David Kwan, Technology Analyst]

And just a couple of more questions. On the M&A side, you made a small tuck-in acquisition in Q4. Can you talk about what your plans are going forward? I assume you're still kind of out there looking for some decent acquisitions to add to the bulk of your business?

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

Yes. So after our Concurrent acquisition in 2018, I guess, at the end of 2018 -- or at the end of 2017, sorry. Time moves fast. So we were saying that our strategy is going to be a little bit digestion oriented now that we've got 2 big market segments that we're running in IPTV and DAA that came about organically. So we've been in that mode, and we're always in that scenario where we're looking for opportunistic stuff that represents potential for enhancing the IP portfolio, the customer reach and whatnot. And the little tuck-in we did in Q4 is representative of that where we've got a great set of IP and technology and 170 new customers that are broadcasters and content creators that we can cross-sell CDN and storage to and at the same time have their technology that is applicable to our service provider traditional markets. So those types of things are always out there and something that we are going to entertain.

[David Kwan, Technology Analyst]

Okay. Perfect. Last one just on the deferred development costs that came down or I think related to some of the restructuring and I guess less subcontracting, I'm guessing there. How should we be looking at that line going forward?

[John Hanna, Chief Financial Officer]

Yes. David, so I would say, on a go-forward at $2.8 million, almost $2.9 million in the quarter, we'd expect it to be maybe between $2.8 million and $3 million in the next quarter or 2.

[David Kwan, Technology Analyst]

And looking out further, John, do you think that, that number goes up again based on the kind of the projects you've got in the pipeline or...

[John Hanna, Chief Financial Officer]

I don't think I have any material expectation, small fluctuation, $100,000 here or there, but not significantly.

[Operator]

[Operator Instructions] We have no more questions at this time. This concludes the question-and-answer session as well as today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.