FG Group Holdings Inc.
Q2 2020 Earnings Call Transcript

Published: 13 Aug 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to, Ballantyne Strong, Inc. Second Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to John Nesbett of IMS Investor Relations. Thank you. You may begin.

[John Nesbett:]

Good afternoon, and welcome to Ballantyne Strong's earnings conference call for the second quarter ended June 30, 2020. On the call today from Ballantyne Strong are Mark Roberson, Chief Executive Officer; and Todd Major, Chief Financial Officer. Before we begin, I'd like to remind everyone that some statements made on this call will be forward-looking in nature. These statements are based on management's current view and expectations as of today, and the company is under no obligation and expressly disclaims any obligation to update forward-looking statements, except as required by law. These statements are also subject to risks and uncertainties and may cause actual results to differ materially from those described on today's call. Risks and uncertainties are also described in the company's SEC filings. Today's presentation and discussion also contain references to non-GAAP financial measures. The definition of non-GAAP terms and reconciliations to GAAP measures are available in the earnings release posted on the Investor Relations section of the website. Our non-GAAP measures may not be comparable to those used by other companies, and we encourage you to review and understand all of our financial reporting before making any investment decisions. At this time, I would like to turn the call over to Mark. Okay, go ahead, Mark.

[Mark Roberson:]

Thanks, John. Good afternoon, everyone, and thanks for joining us today. We'll get started on Slide 2 with an agenda for today's call. I'll provide a brief overview, and Todd will review the financial performance. After the financials, we'll take a deeper dive into the current business drivers and discuss how Ballantyne is positioning to be a stronger company going forward. After our prepared remarks, we'll open the call for any questions. So first, let's review the Q2 highlights and where we are today. Turning to Slide 4. I don't think anyone will be surprised that our Q2 revenue was significantly impacted by the COVID pandemic, especially in our entertainment and advertising business lines. Hospitality and entertainment were the most impacted segments of the global economy. And as you might imagine, selling to cinemas has been a bit of a challenge for the last couple of months. However, what was incredibly reassuring is that in spite of the pandemic and its impact on our business, our adjusted EBITDA for the quarter was relatively stable, and we were able to effectively manage cash flow through what we hope was the worst of the storm. This is a testament to the flexibility of our operating model and to the commitment of our entire organization in reacting to the crisis and taking the appropriate actions, and in many cases, personal sacrifices to ensure that the company would come through in a strong position. I can't express how proud we are of our team for all their efforts during this time, and we're excited about the path ahead as our customers begin their reopening initiatives. It also clearly demonstrates the resilience in our Convergent visual signage business. At Convergent, we did see some disruptions related to COVID. But overall, the business levels and collections remained strong and contributed significantly to our second quarter operating results and cash flow. This is a business that has been on a turnaround for the past few years, and those investments are now paying off with high margins, recurring revenue and increasing customer demand. While our entertainment revenues were down substantially for the quarter as expected, cinemas are now in the process of reopening. We believe we've likely seen the trough with respect to entertainment revenue in Q2. And as cinemas reopen, they're increasingly looking to outsource more of their technical support. This plays into our expertise and strengths, and we see opportunities to grow the services business in the near term. Finally, we've also been helping our customers adapt to this challenging environment with innovative solutions such as the temporary drive-in cinemas at Strong Entertainment and our SafeStore touchless technology at Convergent. Overall, while I'm certainly happy to have Q2 in review mirror, I believe the experience has strengthened us in many ways, and we're excited about the opportunities ahead. We'll address those in more detail after Todd runs through the numbers. Todd?

[Todd Major:]

Thanks, Mark. Slide 5 includes a summary comparison of Q2 2020 and the 6 months ended June 30, 2020, for the same periods of the prior year. As we expected, the slowdown that started during the end of the first quarter persisted throughout the second quarter. Consolidated revenue and gross profit both decreased 54.8% during the second quarter of 2020. The COVID-19 pandemic had a significant impact on operating results of both Strong Entertainment and Strong Outdoor. While revenue was also down in Convergent due to some nonrecurring installation revenue and equipment sales in the prior year, the services revenue continued to grow. Despite the significant declines in revenue, gross margin during the second quarter of 2020 was flat year-over-year. In addition, in response to COVID, we implemented a series of cost-saving measures that, combined with our other cost management initiatives, reduced overall SG&A expenses by 35.3% compared to Q2 of 2019. Slide 6 summarizes our condensed operating results for the previous 5 quarters. Pre COVID, our operating performance improved sequentially during 2019 and dipped a bit in Q1 2020 as we started feeling the impacts of the pandemic. Despite the significant headwinds encountered during the second quarter of 2020, we are pleased that our operating loss and adjusted EBITDA actually improved compared to the prior year. On Slide 7. Strong Entertainment revenues and profitability retracted significantly in Q2 2020 compared to both Q1 2020 and Q2 of the prior year. Our screen manufacturing facility in Québec was closed for approximately 6 weeks during Q2, and once reopened, saw limited demand as cinemas remained closed during the quarter. The closure of cinemas during Q2 also had a significant negative impact on our field services and parts distribution revenue. We were able to see the benefit of our expense rationalization initiatives that commenced in early April as operating loss and adjusted EBITDA during Q2 of 2020 were only slightly below Q1 of 2020. Moving to Slide 8. While we did see an overall decline in Convergent revenue during the second quarter of 2020 compared to the prior year, that decrease was primarily due to the nonrecurring revenue items I previously mentioned. In addition, the impact of COVID-19 on Convergent was somewhat muted as the overwhelming majority of our recurring revenue customer base continued to operate. Convergent's gross margin continues to improve as the mix of higher-margin recurring revenue continues to increase. Moving to Slide 9. As a result of the August 2020 transaction with Firefly, Q2 2020 will be the last full quarter we report for Strong Outdoor. The New York City advertising market was shut down during the second quarter of 2020, and as you would expect, that had a significant impact on Strong Outdoor's operating results. The cost management activities implemented at Strong Outdoor in early April helped to somewhat offset the lost revenue. Slide 10 summarizes our balance sheet as of June compared to the end of 2019. As you can see, we have been able to maintain adequate levels of cash during 2020 while only modestly raising our debt levels. We continue to look at ways to reduce operating costs, while, at the same time, manage working capital and maintain liquidity. We expect the sale of our Strong Outdoor business to have a positive impact on our future operating cash flows and continue to believe our customers will need our services and support more than ever as they reopen their doors. With that, let me turn the call back to Mark.

[Mark Roberson:]

Thanks, Todd. Now let's review how we're thinking about the business and building for the future. If you turn to Slide 12. As Todd just mentioned, and as many of you are probably already aware anyway, we completed the sale of Strong Outdoor last week. If you recall, we did a transaction with Firefly in May of last year to transition our digital ad business to them in exchange for an equity position. The current transaction completes the sale of all of Strong Outdoor's remaining advertising business in exchange for an increased equity stake in Firefly. In short, this transaction is a win-win. First, it should improve our consolidated financial performance going forward. And second, we're combining this business with a perfect partner, which has the platform to grow and drive value as part of their nationwide network. As one of Firefly's largest shareholders and co-investing with Google Ventures and NFX, we will participate in Firefly's future performance and upside. When combined with our current investments in PIH and Itasca, which are both liquid investments and marketable securities with carrying values totaling approximately $9 million, this strengthens and balances our investment portfolio considerably. So let's take a look now at our 2 go-forward operating businesses. Turning to Slide 13. Convergent has been -- has proven to be a very strong contributor over the past couple of years, generating high-margin recurring revenue. At a macro level, there's been a sustained increase in the use of digital signage in retail, banking and many other areas. Convergent is a cost-effective solution that has proven attractive to larger enterprise retailers, banks and other organizations, especially those with large geographically dispersed signage assets to manage. We have a stable base of large brand name customers in the telecom, home improvement, retail and banking sectors, with over 45,000 end points now in the installed base. Our customers in general have excellent credits, which is also a strong point in uncertain economic times such as these. Turning to Slide 14. Convergent's financial profile has been steadily improving as we reposition the business to focus on recurring services with our DSaaS model. We're continuing to grow the installed base, and as we're growing this installed base, 2 things are happening. We see higher recurring revenues as our DSaaS offering becomes a higher percentage of our overall sales. We're also seeing gross margins and overall profitability improve significantly. So as we think about where we go from here, we've built a solid foundation and we can now add scale and higher incremental margins. New media players that we add on top of the current installed base carry higher incremental margins than the average. New installs benefit from the current infrastructure investments and carry much lower incremental variable costs and much higher margins as a result. This is a highly scalable business. Now if you turn to Slide 15. Our Strong Entertainment business obviously had a tough quarter, as would be expected, but 3 things to point out here. First, exhibitors are in the process of reopening. AMC, for example, announced they expect essentially all theaters in Europe and the Middle East to be opened in the next few weeks. Regal, AMC, Cinemark, Marcus and other large exhibitors have also announced that they plan to be opening in most U.S. cities in the coming months, most by the end of August. So we're in uncharted territory here. And I don't want to get ahead of myself, but we are cautiously encouraged that the second half should look much different from the second quarter. With reopenings underway, we're currently seeing increased demand for our services. Another interesting industry dynamic that we're watching closely is the appetite for exhibitors to outsource versus in-source their technical support. We believe that an increasing amount of the service work in the U.S. will be outsourced post COVID as exhibitors keep -- seek to keep their fixed operating costs low. We can mobilize quickly. We have the expertise and offer an attractive economic option for them. In addition, as the sector begins to return to normal, we expect the trend of upgrading digital projection to laser to continue. These type of upgrade cycles create additional service and other opportunities. Turning over to Slide 16. We just want to take a minute to talk about the international opportunity as well, which is important to understand as we step back from the current quarter and refocus our aperture on the longer-term growth opportunities for the -- particularly for the screen business. We have approximately 65% market share in the U.S. and North America and are obviously firmly established here. In China, we have less than a 5% market share. We have our finishing plant ready to go as soon as travel and other restrictions allow, which will be a beachhead to help us better penetrate the market. In Europe, we also have a relatively small market share and have already started increasing our sales presence there. In the Middle East, Saudi Arabia recently repealed a 35-year commercial cinema ban, and we've already started selling screens into that market. So we have a great entertainment business in North America with both screens and services. We expect to grow our service share in the U.S. and our screen share internationally. If you look at the two operating businesses going forward, you'll see on Slide 17 that they had a combined EBITDA of $12 million in 2019, which was obviously pre COVID. We've done a good job maximizing our financial performance through this difficult period. Cinemas will come back and they'll need support, and this is already starting. And Convergent's business has proven to be resilient and has long-term growth opportunities. So while our company valuation has been impacted, along with most other small public companies over the past several months that operate in impacted industries, we believe we're well positioned as the world reopens. Our focus is squarely on operational execution and driving growth post COVID to create long-term value. On Slide 18. Sitting here today, we have well-established brands, tight expense controls and a solid balance sheet. That provides a solid foundation for difficult times such as these. Our near-term outlook is improving every day as we're seeing signs of recovery in our entertainment business as cinemas reopen, customers are reengaging with our services and screen orders are increasing from their Q2 levels. We expect to open our finishing plant in China soon, and our Convergent DSaaS model should continue to drive recurring revenue and strong margins. We also remain focused on managing operating expenses and cash flow through the turn. Looking out a bit longer term, we're focused on capturing international market share in our screen business and converting the near-term momentum in our services business and to sustain long-term market share growth in the U.S. entertainment sector. We expect to continue to grow Convergent's installed base organically, and we could also consider targeted acquisitions to load the network and achieve greater economies of scale and EBITDA growth faster. Finally, there's a considerable longer-term opportunity in our investment portfolio. We have relatively liquid positions in Itasca and PIH and longer-term upside prospects for Firefly. With that, we'll now open up the call for questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Pam Stanley with Carter Management [ph].

[Unidentified Analyst:]

So Convergent has performed well. How should we think about this business going forward and your ability to continue to drive DSaaS growth? And then after that, I do have one follow-up question, if I may.

[Mark Roberson:]

Okay. Thanks, Pam. This is Mark. I'll take a stab at that. Thanks for your question. It's a good one. Convergent has been a real successful turnaround story over the past couple of years. I mean we've converted the Convergent model from a lower-margin hardware sale model and project-based installation model to this DSaaS model over the past really 2 to 3 years. And accompanying that change in strategy and that repositioning, we've seen tremendous improvement in both the financial performance of Convergent in terms of its gross margin expansion, its EBITDA contribution and cash flow as well as from our customers, we've seen our anchor customers really coming back to us and asking for more services and expanding their use of our services, which really gives us great confidence in the model and the quality of service that we're offering. It's really a testament to the team at Convergent who had deep experience in the signage business and really led this repositioning to the DSaaS model and is taking good care of our customers. So as we look ahead with that platform in place, we've made lots of investments in Convergent. We've endured the turnaround period. We're now seeing the benefits of that turnaround with the current performance of the business over the past really 7 or 8 quarters now. And a lot -- as we've been growing, we've been digesting a lot of those customer wins and making sure we're taking care of them. And now we have got to continue to grow that business, and we kind of look at that a couple of ways. So when we look Convergent, we look at the investments we've made in the DSaaS model. And we have a really strong group of anchor customers that we're continuing to expand our service offerings within those customers, and they continue to come back and request additional services from us. So that's a very nice way to grow the business. When our customers keep coming back and wanting to do more things with us, it tells us we're probably doing a few things right. Obviously, we're also targeted in terms of adding new customers. We've had a few new wins this year. We expect that to continue. And we may also, as we mentioned, look at very selective, targeted bolt-on acquisitions. There are probably opportunities out there where we could look at adding on, whether it's 1,000, 5,000 or 10,000, additional player end points onto our network and really drive some incremental gross margin by leveraging the fixed costs in our business that we've already got. So in order -- I've kind of put those in order, I'll just mention them. Number one is we're continuing to expand to get more wallet share from our customers, our current customers. We're winning some new accounts. And there may be obviously some M&A opportunity down the road as well.

[Unidentified Analyst:]

My second question is, you had mentioned that we might see increased demand for the services business from the cinema side as the cinemas start to reopen. Could you go a little bit deeper and talk about the dynamics between cinemas keeping their services in-house as opposed to outsourcing to you? And why would they be more inclined to outsource this aspect of their business going forward?

[Mark Roberson:]

Yes. Yes. So when you look at the larger cinema exhibitors in the U.S., they're all names we're all familiar with, AMC, Regal, Cinemark, Marcus, et cetera. They're sizable organizations, and they have technical service capabilities resident in their operations. A lot of times, they also utilize organizations like our service group to supplement those, and in some cases, to do things in areas where they don't have resources. What we're seeing and we've seen this kind of swing over the past 2 to 3 years, where those organizations were doing a little more in-sourcing and a little less outsourcing and adding their own technical staff and building up their own fixed infrastructure in terms of technical services, and we saw that impact our revenues a little bit on the service side as compared to where we were probably 3 years ago. What we're seeing today post COVID, and some of this was occurring already and the trend was already swinging back, I think COVID has accelerated this and will continue to accelerate it, is a lot of those organizations are looking at their infrastructure models and realizing that there's a lot of benefits to being lean and mean. And technical services is an area where we have coverage really in all major cities across all 50 states in the U.S. -- or all states in the -- all 48 states in the contiguous United States. So we can serve all of those customers and all those venues pretty effectively, and we already have the investment in the network to do so. So as movie theaters are reopening, exhibitors are reopening their operations, they're coming out of having been idled for an unprecedented period of time, we're already seeing a lot of those groups come back to us and request additional services, both on a demand basis as well as on a contractual basis, to help them get reopened and help them get ready to welcome patrons back into their venues. We're also seeing signs that as we go forward, there will probably be more of an appetite to utilize outsourced services and to expand the use of that going forward to keep their own fixed costs lower and to utilize groups like STS. So we think that's a trend that's not only occurring right now as things reopen but will continue to be an opportunity for STS, and we're seeing definitive signs of that already coming through.

[Operator:]

[Operator Instructions]. As there are no further questions left in the queue, I would like to turn the call back over to Mr. Roberson for any closing remarks.

[Mark Roberson:]

Great. Thank you again for your time today and for your support of Ballantyne Strong. I'll leave you today with one last thought. We're excited about the future of our operating businesses as well as our investment positions. The past few months have been unprecedented to say the least. We have a great business at Convergent, and the team there really picked up the heavy lifting financially while our entertainment business was weathering the global shutdown. Now our entertainment customers are ramping back up, and we're seeing our business there start to rebound significantly in July and August. Overall, I'm about the second half of the year and look forward to reporting back to you guys in November on our Q3 results. In the meantime, we welcome the opportunity to talk with you personally, answer any questions you might have. My contact information is on our website and it's also on today's press release. So please don't hesitate to reach out. Thank you, and look forward to speaking soon.

[Operator:]

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.