Avante Logixx Inc

XTSX:XX

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Avante Logixx Q3 Fiscal 2020 Earnings Call. [Operator Instructions] This call is being recorded on Wednesday, February 26, 2020. I'd now like to turn the conference over to Mr. Craig Campbell. Please go ahead.

[Craig Bradley Campbell, CEO & Director]

Thanks, Pam. During today's conference call, management will be making forward-looking statements, as such term is defined in securities regulations. Listeners to this call should read the company's forward-looking disclaimers contained within each of the filings related to this fiscal quarter. And with that said, welcome, fellow shareholders, to Avante Logixx Q3 Fiscal 2020 Earnings Call. I'm pleased today to be joined by Steve Rotz, the company's recently announced Chief Financial Officer. As you would have read recently, Steve joins us with an impressive background for the last 25 years, steeped solidly in corporate development, banking, M&A and senior executive roles with public companies and reporting issuers. It did take some time, but I am so pleased to welcome Steve as a partner in building Avante Logixx with me. Today, we are updating you on our continued journey in building and evolving into a stronger Avante Logixx, our focus on execution and our strategic priorities and we'll review our financial results for the quarter ended December 31, 2019. We are well into the transformation journey at Avante and our XX 2.0 strategy. 24 months ago, I took over at the helm of Avante and told you that we have a clear vision for the future, a detailed plan and are fully aligned with shareholders. Since then, I am proud to highlight the 210% growth, a much more diversified and solid underlying group of companies. In the quarter, we completed our largest acquisition to date, with the purchase of ASAP security, and are well on our way to integrate this acquisition and the realization of acquired synergies. During the quarter, we also completed and are pleased to have announced the up to $18 million convertible debt issue with Fairfax Financial Holdings. An exceptional partner, whose investment endorsed our vision and plan and will be a great long-term partner. We are committed to achieving the results to justify their support in us. We are pleased to bring them to the table and believe it was the best source of capital considering shareholders and dilution. We now have 3 exceptional platforms to grow both organically and acquisitively, a national infrastructure and a widening opportunity. The table is set for organic growth, the right people and the right team is in place, and we continue to integrate, have a solid MIS platform and are confident we'll see the seeds we have planted bear fruit vis-à-vis increased earnings in coming quarters. Our portfolio was strong. It's backed by exceptional brands and an amazing base of reoccurring revenue. In Q4 and future quarters to follow, you can expect continued and focused execution around the strategic priorities of our 2.0 vision. We will acquire, build and generate cash. We will strengthen our competitive advantage with our investments in business systems, and we will drive organic growth in cross-selling opportunities with focus on converting customers to our technology-enabled managed security programs and services. We expect to continue to enhance the portfolio with strategic accretive M&A activity. I'll now turn the presentation over to Steve to discuss the financial performance to Q3. And Steve, welcome to your initial earnings call with shareholders.

[Stephen David Rotz, Chief Financial Officer]

Thank you, Craig. I will now provide highlights from our third quarter financial results, and I will focus on Q3 as opposed to 9-month information. During this call, I will also focus on sequential comparisons of Q3 versus Q2, and where relevant, to the prior year's third quarter. Third quarter financial statements and MD&A are available on our website and are filed with SEDAR. Turning first to the income statement. Note that the third quarter only reflects 1 month of ASAP's earnings and prior year's Q3 only reflected 1 month of the Intelligarde acquisition. Total revenue for Q3 was $14.1 million versus $11.7 million in Q2 and $8.8 million in Q3 of last year. Our Protective Service business now accounts for 63% of revenue, even with only 1 month of ASAP. This compares to 37% in the third quarter of last year. That is, Protective Services is now the dominant segment of our business, and this trend will continue as ASAP's full revenues are reflected next quarter. After normalizing for the acquisition dates of ASAP and Intelligarde, year-over-year and sequential revenues showed declines during this quarter. Part of this is seasonal with respect to sequential comparisons, and some of this is also due to lumpy project business within our Electronic Security Division. In the case of security devices, the year-over-year decline was due to a challenging comparison as the prior year was exceptionally strong at 21% higher than its prior year. Net of these factors, the sequential and year-over-year declines are not significant in context of our $70 million run rate. Additionally, since December, we have seen a solid pickup of new customer wins within our enterprise business, validating our thesis for acquiring ASAP, Intelligarde and Veridin over the last 1.5 years. Our blended gross profit percentage declined during Q3 to 23.6% versus 34.1% during last year's Q3 and 31.4% during Q2. We experienced lower GP percentages in electronic services and in security devices and hardware. Part of the sequential decline was due to an additional staff holiday in Q3 as well as government-mandated payroll increases in Québec that could not be immediately passed on to customers. These items accounted for almost 3% if normalized out. However, our total GP percent came down, in part, by design. That is, we set it to establish a core national platform in Protective Services. By definition, this leads to lower margin initially. Note that Protective Services' GP percentages declined to 16.8% in Q3 versus 29% in last year's quarter. Over the next several quarters, we will see reduced total GP percentages as ASAP's results are fully reflected within reported results. But as of December 1, 2019, we are positioned to build off that newly acquired national base to win new business and implement additional higher-margin services. Note that GP percentages in monitoring and managed services are typically much higher, i.e., in the high 60s to high 70s in percentage terms. As we cross-sell these higher-margin services, we expect to see improved total margins. Based on what we've seen since early December, we anticipate seeing higher revenues and total gross profit dollars within our results over the next several quarters. As the next 18 months unfold, we expect to see the benefit of cross-selling higher-margin services. We also expect to see full integration of back-office activities and technologies, reflecting previously discussed synergies. Adjusted EBITDA was essentially flat during Q3 on a year-over-year basis at $0.3 million. On a sequential basis, it was down by $1 million. These -- the sequential decline was mainly due to gross profit declines, as discussed, new software licenses for our workforce management tool and higher administrative expenses as we continue to invest in process improvements and integration, particularly within Avante Security, our residential security business. These efforts should lead to improved gross profit percentages and OpEx in future quarters. We are not satisfied with, nor complacent about our reported EBITDA earnings. But there are 2 key metrics that I would like you to focus on. Firstly, RMR; and secondly, adjusted OpEx as a percent of revenue. RMR means recurring monthly revenue, and we have 2 sources of RMR: recurring monitoring and response services and recurring contractual protective services. As reported in our MD&A, we grew total RMR to $11 million during Q2 -- during Q3 versus just $4 million during last year's Q3. That is, 78% of our revenue is now RMR. Adjusted OpEx as a percent of revenue is another measure that we look at. We have a well-articulated plan to grow our business, both strategically and organically, and this require upfront spend, negatively impacting reported EBITDA for the time being. We are now starting to see the benefits of scale. Adjusted OpEx as a percent of revenue was 25% during Q3 versus 39% during last year's third quarter. We are glad to see this progress. However, we remain focused on improving that percentage over the next 2 years by growing revenues, improving margins and keeping administrative expenses balanced. Now looking at the balance sheet. Total assets increased to $48.5 million at the end of our third quarter. This represented an increase of 42% or $14.2 million since March 31, 2019's prior fiscal year-end. Closing the ASAP acquisition on December 1 accounted for most of this increase at $10.3 million. Note 12 of the financial statements provides a preliminary summary of the increase in assets and liabilities related to ASAP. Financing the total increase in net assets was mainly from the issuance of $8.3 million of convertible debentures and a net increase in senior debt of -- by $2.2 million. There are 3 additional accounting and finance items I want to cover this morning. Firstly, the acquisition of ASAP requires a purchase price allocation to tangible and intangible assets. We will finalize ASAP's opening balance sheet with the vendors after February 28, so we anticipate changes to the existing PPA as we prepare our Q4 results. Secondly, under IFRS, the issuance of $8.3 million of convertible debentures requires us to split the actual liability into 2 components. One of these is an estimated derivative liability representing a holders' equity conversion rate. That reported liability will move up and down each quarter, depending mainly on our stock price and reduced time value. We provide a detailed summary for the convertible debentures within our MD&A and financial statements so that you can understand this new financing arrangement. We have the right to draw an additional $9.7 million of debentures until August 27, 2020, subject to shareholder and regulatory approvals. My third additional topic deals with senior debt. Our senior debt and lease liabilities were less than $8 million as of quarter end. This is fairly small in context of our RMR of more than $11 million per quarter. This level of debt is also small in context of accounts receivable of $15.7 million and inventory of $1.8 million. We will work over the coming months to increase and amend senior debt arrangements to support our organic and strategic growth plans. In closing, as Craig addressed in the opening of the call, Q3 highlights the journey from what was a single vertical, small boutique residential security business in Toronto 2 years ago with $22 million in revenue and 125 employees to now a business with $70 million in top line across 3 platforms nationally and with 1,525 employees. We are builders and focused on long-term value creation for all shareholders. That concludes our formal remarks. Pam, Craig and I would be pleased to address your questions -- any questions at this time. Thank you.

[Operator]

[Operator Instructions] Your first question comes from Doug Taylor with Canaccord.

[Douglas Taylor, Director]

I'll start with, I think, with the primary question, which I think investors are looking to have answered today, and that's at this -- the EBITDA loss in the quarter caught, I think, us a little off guard. I understand that it's a transitionary quarter and you don't provide guidance, but is there any qualitative commentary or quantitative about the profitability trend into Q4 and beyond that can help us -- provide us comfort with the profitability going forward?

[Craig Bradley Campbell, CEO & Director]

Yes. Certainly, Doug. First and foremost, in past seasons, we've -- or past questions we've been asked about seasonality to the business, of which I've answered the question in saying that, really, we are not affected by seasonality. And I have to say that I think I've realized that there is a slight Q3 seasonality issue in a few areas. First and foremost, one, in our Electronic Security Division, really underestimated the impact of really what essentially becomes a 2-week shutdown of us being able to get in and complete jobs around residential installations that negatively impacted the top line of -- and margin of that business through the quarter. In the Protective Services, as Steve alluded to, we took -- or essentially have a $290,000 impact to gross profit as a result of the extra staff holiday for which was not accrued, and number 2 was you're hit with a near adjustment, that near adjustment being a year-end closing adjustment to the WSIB rates in which we pay on the labor or human capital side of the business. Then certainly, there's some seasonal issues around the expensing of Christmas -- staff Christmas parties, some front-line employee year-end bonuses. So certainly, as we break that down to the -- and approach the $1 million, it was not something that we fully understood or anticipated. But also expect that, that will, both through better accrual processes as well as -- that we will not see the effect of that and better understand that for future quarters. The other piece of it was through some of the growth that we started to see in Q3 in the Protective Services side. Certainly, we spoke about ASAP's very strong franchise in retail as well as some new business that we've acquired from both some financial institutions as well as a national telecom in the tight labor market that we're in. The startup margins on those contracts took a temporary hit that we expect will not continue or will certainly improve in future quarters.

[Douglas Taylor, Director]

So that's helpful. In general, more severe seasonality than you'd originally anticipated. You did mention in the preamble, some impact from payroll increases in certain territories which had not yet been passed through to the customers. What's the typical time frame for you to be able to transition customers on to the new rate?

[Craig Bradley Campbell, CEO & Director]

Yes. So in Québec, they have a Nash, or a provincial thing called the Decree, which essentially is a bargaining or wage and employment standard sort of act that affects security employees. We have 20 customers in Québec. As of today, we have passed on and recovered those increases from 17 of the 20. The 3 remaining are working through contract amendments and procurement departments, and we expect that we will have 100% recoup and catch up on that going forward.

[Douglas Taylor, Director]

And there's been a lot of acquisitions. So could you help us understand how large a proportion of your revenue base Québec or that impact would have applied to?

[Craig Bradley Campbell, CEO & Director]

So the business with -- so the first exposure to Québec comes vis-à-vis the ASAP acquisition. Doug, I don't have the exact percentage for you, but let's go with less than 20% of the overall revenues out of Québec. I can certainly follow up with you with a more prescribed percentage. And as I mentioned, there's a total of 20 customers there, 17 of which we have successfully completed the catch-up and reprice of the contract. So...

[Douglas Taylor, Director]

That's helpful. So that's, I think, good enough for my purposes anyways. The -- so taking all of these different issues and impacts into account, and as you look ahead at Q4 with, hopefully, a better performance from some of the lumpier hardware-centric areas, would you say it's fair that you expect that you'd recapture that $1 million shortfall versus the Q2 expectations by Q4? And also, can you talk about the -- I mean, I think you mentioned an integration timetable of about 18 months for all things you'd like to do with ASAP and the rest of your acquisitions. But can you talk through when we should -- be more specific on when we should expect benefits with respect to revenues and costs for those acquisitions as well?

[Craig Bradley Campbell, CEO & Director]

Yes. I can certainly tell you that we're working hard on integration. I do -- I don't want to make it an excuse in any way, but I do want to highlight that the 200% growth comes with some learnings, some speed bumps, and it's not all smooth. We are certainly transformed as far as internal controls, systems and insights into the business. We are well on our way with the integration. We have identified a number of opportunities. In past calls, I've suggested to you that we should see synergies within 6 months, 2 quarters post synergies, with full effect 12 to 18 months down the road. As you know, certainly, we are and have now for a number of quarters been slightly overbuilt for the size of the business, but in support of the pursuit of the opportunity. And we will look forward to reporting improved financial positions and earnings, both margin and bottom line as quarters move forward. And a great bulk of the spend, which I do want to highlight, is people-based spend. We have not been overly aggressive in our reorganization or onetime -- we don't want to be in the one-time-all-the-time category. But certainly, when it comes to driving costs out of the business, the costs are people cost, and it's not -- so we don't have a huge amount of fixed cost, hard to get out of big real estate commitments or capital commitments. We simply need to get the target operating model, set the processes working, and then we expect to be able to take those costs out of the business with some speed.

[Douglas Taylor, Director]

Okay. I realize I'm hogging the line here. So perhaps I'll just sneak one more in. You still got a significant amount of capital available for deployment. Can you talk a little bit about your updated view on your M&A outlook and the prospects of deploying the second tranche of the capital from Fairfax and other resources in the near term?

[Craig Bradley Campbell, CEO & Director]

Well, so I would say that in 2 parts. One, as alluded to in our press release, our funnel remains -- our pipeline of liquids of opportunities remains full. We have a number of interesting opportunities ahead of us. Certainly, we want to make sure that the infrastructure and the back-office is capable of consuming, so we certainly, with Steve's arrival, we're doing some work to make sure we're buttoned down and positioned with a strong foundation. But we do hope that we will deploy capital into accretive, complementary tuck-in opportunities in the coming quarters. And certainly, we recognize that the company will benefit from the scale of those opportunities, and so we look forward to reporting positive news on that front as we move forward. And as far as -- certainly, more directly to your question about accessing the Fairfax capital, that is an option that remains open. It is at our option and discretion, so we certainly are pleased to have that tool in the toolbox. But ultimately in being focused on shareholder value, we will continue to assess market conditions for our opportunity to look for many sources of capital and are not solely relying on that Fairfax option.

[Operator]

[Operator Instructions] You have no further questions at this time. Please proceed.

[Craig Bradley Campbell, CEO & Director]

Great. Pam, thank you. To the fellow shareholders, thank you for dialing in on this -- what will become a snowy morning in Toronto, and I look forward to communicating with you shortly on all the great things happening here at Avante. I wish you a great day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your line. Have a great day.