Quarterhill Inc.
Q4 2020 Earnings Call Transcript

Published: 11 Mar 2021

[Operator:]

Good morning, and welcome to Quarterhill's Q4 and Fiscal 2020 Financial Results Conference Call. On this morning's call, we have Paul Hill, President and CEO; and John Rim, Chief Financial Officer. At this time, all participants are in a listen-only mode. Following management's presentation, we will conduct a question-and-answer session. During which analysts are invited to ask question. Earlier this morning, Quarterhill issued a news release announcing its financial results for the 3 month and 12 month periods ended December 31, 2020. This news release along with the company's MD&A and financial statements will be available on Quarterhill's website and will be filed on SEDAR.

[Paul Hill:]

Thank you. Good morning, everyone, and thanks for joining us on today's call. In terms of agenda, I'll start with a look at business highlights for the year followed by John, who will take a look at our financial results. I'll provide an update to our M&A strategy, and then we'll open it up for questions. We have slides to accompany our remarks and they will be available on our website after the call. 2020 was a solid year for Quarterhill, both financially and operationally, and even more so against the backdrop of COVID-19. We established new leadership at the company launched a new M&A strategy, generated significant cash flow and returned funds to shareholders through dividends and share buybacks. Shortly after year-end, we began to put our funds to use as part of our M&A strategy with the acquisition of Sensor Line, which I'll touch on later. When I joined in June, my list of priorities, included hiring a CFO, bringing the leadership team to Toronto, launching our M&A diversification strategy, following through on our commitment to return capital to shareholders and ensuring our portfolio companies were in a position to succeed, especially in this challenging pandemic environment. On the leadership front John Rim joined as CFO in October, and we moved our head office to Toronto. Having the executive team here in Toronto will help with collaboration and deal execution, and being downtown puts us closer to more sources of deal flow. Consolidated financial results for 2020 saw revenue of $144.5 million adjusted EBITDA…

[Operator:]

Thank you for holding ladies and gentlemen. We apologize for the interruption. There was technical difficulty that resulted in the entire conference being halted.

[Paul Hill:]

Thank you. Sorry for that everyone. We're not sure what happened; the whole system went down. But I'll just continue on where I left off. So consolidated results for 2020 saw revenue of $144.5 million, adjusted EBITDA of $31.2 million, cash from operations of $35.2 million and we ended the year with cash and short-term investments of $141.3 million. These strong results were driven by both portfolio companies and I'll spend a few minutes looking at highlights from each starting with WiLAN. 2020 was a solid year for WiLAN with licensing activity that led to strong adjusted EBITDA and cash flows. WiLAN has shown an ability to deliver significant cash flows on an annual basis even though such results sometimes vary quarter-to-quarter something that is quite common in the Patent Licensing industry. Among WiLAN's achievements in 2020 was a favorable update in its litigation with Apple. Following a jury verdict win in January 2020 of US $85.23 million, in June the court entered final judgment in favor of WiLAN. The court also awarded WiLAN an additional amount of $23.75 million in prejudgment interest, bringing the total to US $108.98 million. The case has gone to appeal and both sides have filed their opening briefs. Each party is now preparing to file a response, which should be completed in a month or two. Following that an oral hearing before the Court of Appeals for the Federal Circuit is expected to be held sometime in the fall. WiLAN continues to plan for future growth and made several portfolio acquisitions in 2020 including approximately 2000 patents from MediaTek and two portfolios from IBM. COVID-19 has had some impact on WiLAN's business mainly driven by the postponement of some litigations in the US as well as an inability to hold face-to-face meetings, which is an important part of the deal closing process. As we said before, these postponements may result in delays concluding agreements, but we do not consider them lost opportunities. Overall, we're very pleased with the 2020 results at WiLAN and its resilience in light of the pandemic. IRD which is our business in the intelligent transportation systems or ITS industry had a strong year financially with stable revenues and expanded margins. COVID had some impact on the business, but mainly in international markets where some projects were delayed. IRD's North American business remained strong throughout the year with the company's solutions deemed essential services in many US states.

[John Rim:]

Thanks, Paul. Good morning everyone. Just a quick note upfront that with the sale of VIZIYA, our financial statements for the three and 12-month periods ending December 31st, 2020 as well as for the respective comparison periods of 2019 have been prepared to reflect continuing operations; therefore excluding the results of VIZIYA during those periods. Operating results from VIZIYA for 2019 and 2020 are reported as net income or loss from discontinued operations. So I'll start off my review with a look at revenue in more detail. 2020 was a strong year for both business units. IRD's revenues for Q4 and Fiscal 2020 of $17.6 million and $66.3 million were both among the highest in its history despite the impact of the pandemic. IRD's revenues were generally flat in 2020 compared to 2019 as increased revenues in the US market in 2020 were largely offset by a reduction in international sales due to COVID, which delayed or deferred some sales opportunities. WiLAN's revenues were below 2019 levels, but still substantial at $78.3 million for the year. New patent license agreements such as those with Intel, Kingston Technology Corporation and Konica Minolta led the way at WiLAN in 2020. While WiLAN's revenue maybe variable quarter-to-quarter, on an annual basis the business has shown an ability to consistently generate strong margins and cash flow. The cash flows are a good source of capital to invest in our ITS M&A strategy, and also to invest in the WiLAN business itself as seen by the patent acquisitions we made in 2020.

[Paul Hill:]

Thanks John. The M&A strategy at a high level hasn't changed from what I outlined in Q2. However, the market tailwinds have improved significantly since then. Building from our two cash-flowing businesses WiLAN and IRD, we're investing in essential technologies in the ITS industry. This is an industry where IRD is a leader today. ITS improves the way people and goods move through transportation infrastructures. It makes that movement safer, more efficient, cleaner for the environment and less costly. It also creates revenue opportunities for governments. As I've said earlier, ITS is a large stable and growing market with annual spend in the tens of billions of dollars and in recent months this market opportunity has only gotten stronger. Slide 8 illustrates the key tailwind in the ITS industry, and what's new. What's new is new infrastructure spending. President Biden and his Transportation Secretary, Pete Buttigieg have pledged $2 trillion in infrastructure spending over the next 10 years with approximately $900 billion earmarked for transportation. While not all of the $900 billion is allocated to roads, historically, about half of federal spending is on roads. This market tailwind gets us very excited about the potential for our ITS business. The combination of massive new infrastructure spending and governments' need for new sources of revenue to pay down ever-increasing debt from the COVID situation, means that there is no better time to be in the ITS market. So what types of businesses are we looking for? The next slide is a simplified version of the chart I showed you on the Q2 call, but the overall approach remains the same. The initial phase will focus on acquisitions in the five road market segments identified here. We're looking at tuck-in acquisitions such as Sensor Line that will help grow the IRD business, but we're also looking at larger businesses that will help us achieve scale more rapidly. Sensor Line was an ideal tuck-in opportunity. Their advanced fiber optic sensors play a role in multiple road sub-segments and also gives us an entry into the rail vertical. The business was acquired at a reasonable multiple, and there's potential for additional revenue and cost synergies in the coming years. Longer-term you could see us looking at adjacencies to ITS, which might include investments in smart cities. This is a natural evolution of the business, as these are tech-enabled infrastructure markets and are very similar to ITS.

[Operator:]

Your first question today comes from the line of Gavin Fairweather with Cormark. Please proceed with your question.

[Gavin Fairweather:]

Hey, there. Good morning.

[Paul Hill:]

Hi, Gavin.

[Gavin Fairweather:]

I wanted to start out on WiLAN. We've talked over the past six months about there being a decent amount of kind of activity going on under the hood there. I guess, just curious hit a bit of an air pocket this quarter. Is that just kind of timing, or was there anything around, kind of, success rates this quarter? Maybe you could just speak to give us an update on that general level of kind of activity as we think about 2021?

[Paul Hill:]

You know, it's just the – it’s the periodic nature of the IP licensing business. It's not an indication of anything more than that. We are very active as we've talked about with lots of active licensing discussions and litigations underway. So no it's nothing more than that.

[Gavin Fairweather:]

Okay. Perfect. And then I just wanted to switch over to IRD here. As you've been, kind of, mapping out what kind of products and solutions you'd like obviously M&A is a big piece of that. But I'm curious what role, kind of, building could take in that. And I'd love for your, kind of, IRD. They don't invest a ton as a proportion of their revenue in R&D. So do you see good scope there to build out some additional, kind of, product offerings in that market, or do you think that M&A will be, kind of, the primary way of entering new verticals and bringing new products to market?

[Paul Hill:]

It's a bit of both Gavin. Like the announcement we made in November around our new analytics platform is organic, right? So that's organic R&D. And it's an exciting announcement because we're putting together capabilities from iCOMS, which is our Belgian company that's in the radar and microwave detection market we're combining that with software capability for analytics and enabling that on a 4G platform. So we're kind of bringing it all together in that way. But as, you know, iCOMS was an acquisition, right? So some of the hardware components that came out of that came through an acquisition and some of the software development was organic. So it's going to be a combination of both quite frankly.

[Gavin Fairweather:]

Okay. But it doesn't sound like we should think about kind of R&D investment moving to 10% or 15% of…

[Paul Hill:]

No I don't see material changes in that. I think a lot of it will be M&A absolutely especially getting into markets where we don't play today as you know.

[Gavin Fairweather:]

Got it. And then you talked about the favorable, kind of, tailwinds that are building behind ITS -- maybe more broadly. And then you also talked about pretty good, kind of, deal pipeline. So have you noticed that competition is increasing for deals, or is the environment -- kind of unchanged to what we've been speaking about?

[Paul Hill:]

Well like, I said in the remarks we have a very strong backlog at IRD. I think it was at an historic high ending the year, right? So there is a lag effect. So basically what's going on is there was a change of government in the US and Biden has picked probably the highest profile cabinet minister Pete Buttigieg to lead Transportation, right? So they're very vocal about the infrastructure spending. They've passed $2 trillion. But it will take time for that funding to work its way through the various layers of government. And so you don't just hit a switch and that money is deployed, right? But the bottom line is a big a significant portion of that is going to go to roads. And when you build a road you have to acquire a number of ITS technologies ranging from digital signage to tolling to weigh-in-motion technology which we're a leader in, radar, speed cameras. All of that stuff comes along with the infrastructure investment in roads. And the same applies to rail by the way. So we really like how this is setting up how the ITS market is setting up and the tailwinds that we think are ahead of us here. So we think the timing is very good for this market.

[Gavin Fairweather:]

Got it. And then just lastly before I pass the line it sounds like the Supreme Court is looking pretty hard at these patent judge appointments and it sounds like they're leaning towards, kind of, some change to the process. Is that kind of a -- do you view that as a tweak around the edge, or do you see that as actually potentially having some favorable kind of tailwinds behind the IP business?

[Paul Hill:]

I think it's too early to say to be honest with you. I think we have seen some favorable news lately, but I would say it's early to make that kind of conclusion that it would make a material difference in some of these cases.

[Gavin Fairweather:]

Okay. I will pass the line. Thanks so much.

[Paul Hill:]

Thank you.

[Operator:]

Your next question comes from the line of Doug Taylor with Canaccord Genuity. Please proceed with your question

[Doug Taylor:]

Yeah. Thank you. Good morning, Paul and John, we're pretty well conditioned not to read too much into these quarterly fluctuations in the WiLAN business, but I wonder if you could provide a little more color around -- I mean, there were some announcements during the quarter, one at the beginning which I think probably was recognized more in Q3. And you make the -- mention of the fact that there are some deals and licenses slipping due to pandemic. And I'm just wondering if you could help us quantify to what extent or magnitude that might be a factor and whether we should expect at least some uptick here in Q1 with the LG announcement?

[Paul Hill:]

Well with LG specifically, we can't comment. I mean, these deals are -- almost all of these settlements are confidential in nature. We believe we got a fair conclusion to that litigation is what I can say. Like we've said before, the WiLAN business we find to be quite reliable, when you zoom out and look at it more from an annual basis. But on a quarterly basis, it does have variability. And we can't really say much more than that. That is the nature of the business. I will say that we continue to replenish the portfolios. We made some patent acquisitions last year, as we mentioned in my remarks. We are confident that the activity is going in the right direction. I think the COVID effect is starting to soften, right? In the early days of COVID, we saw a lot of delays and we saw that kind of ripple through, but we're starting to see these meetings take place. We're starting to see a bit more activity in that regard. So I think we're at the ending innings of the COVID impact to delays which I think is positive.

[Doug Taylor:]

Okay. Perhaps, I'll switch gears then to IRD. You mentioned the analytics platform that was launched in the quarter. Any comment on perhaps the significance of that announcement in terms of either addressable market or the revenue model predictability of the revenue model more service versus hardware? Anything like that we should take away from that product announcement?

[Paul Hill:]

It's a -- listen these are early ranging from pilots -- we're doing a pilot in Vancouver right now. We are live in Brussels and Paris with some of this capability. But these smart city applications are in the early innings. We want to be one of the first to market in some of these applications. In this case these applications are mostly around safety. So it has to do with measuring things like speed volume direction of bikes and pedestrians and cars to understand some of those flows and to do planning to make cities safer and more efficient. So these types of investments in smart cities, these are the early stages of smart city investments. So they're not super material to results in the short term, but we're excited about the long-term opportunity around these things.

[Doug Taylor:]

Okay. And then with the Sensor Line acquisition tuck-in any commentary on the integration of that with the IRD product a couple of months in?

[Paul Hill:]

Yeah. It's going really well. We're already pursuing deals that are essentially deals brought to us through the IRD sales and marketing distribution. And so, Sensor Line basically is a relatively small company with great technology but was lacking the scale on sales and marketing. So what we're doing is basically putting that product capability onto our sales and marketing platform through the IRD distribution channel. And we're already seeing some early gains from that. So we're very encouraged by it. It's off to a good start.

[Doug Taylor:]

Okay. That's good to hear. Last one from me. Corporate overhead costs a little bit of an uptick towards the end in Q4. Anything to take away from that or onetime in nature that we should think about when we model that going forward?

[John Rim:]

I can take that one. Doug I mentioned during my commentary that we had onetime costs associated with the new ERP system implementation at IRD. That's going to help us grow in scale as we add companies meet all of our continuous reporting requirements as well as bring other back office efficiencies as well. So definitely, there is that one-time cost in there.

[Doug Taylor:]

Okay. Just clarifying that, that was in Q4, as opposed to spread out over the year. Okay. Thank you very much. I'll pass it on.

[John Rim:]

Thank you.

[Operator:]

Your next question comes from the line of Todd Coupland with CIBC. Please proceed with your question.

[Todd Coupland:]

Hi. Yeah. Good morning everyone. Thanks for the…

[John Rim:]

Good morning.

[Todd Coupland:]

…Thanks for the color today. I have a couple of questions. I'll just run through them here. So I just want to, I guess, be clear on that, last expense question. So you were more or less, $14 million -- excuse me, OpEx in the fourth quarter. Is that a reasonable run-rate as we think about the business, through 2021?

[John Rim:]

I would say that's pretty indicative. I mean, I would, probably take the four quarters, and take an average of that. Remember, we had our -- I just joined in the fourth quarter of last year. Paul joined, halfway through the year. But I think that would be a good proxy.

[Todd Coupland:]

Yeah. Okay. And in terms of IRD seasonality, is there -- we're sort of not out of COVID, but sort of poking our heads out. Is there anything to call out along those lines as you're thinking about, the rhythm of the business this year?

[John Rim:]

There's absolutely a normal course of seasonality with IRD. As you can imagine in North America with the weather and doing outdoor installations, the weather does have an impact. So typically, Q1 would be impacted by the seasonality in IRD. And then, ramping up through the spring and summer months.

[Paul Hill:]

Yeah. I agree. Although, I would say, the effects of COVID on project delays is less than it was kind of a year ago.

[Todd Coupland:]

Okay. That's good to hear. And I apologize, if I missed this, but this seemed like it was news to me, you calling out $400 million over the next few years in terms of your investment plan. Am I right on that, or did I...

[Paul Hill:]

Yeah. You are right on that. Yeah. You are right on that.

[Todd Coupland:]

Okay.

[Paul Hill:]

That is new information. And we've started modeling that more carefully. And that is our goal. And we think it's very achievable.

[Todd Coupland:]

Yeah. Sorry. Did you give a timeframe on that? Was it four years, or just a few years, or what it -- I missed that, if there was a timeline around that.

[Paul Hill:]

Five years.

[Todd Coupland:]

Oh, five years. Okay, got it, got it. I'm apologies for that. And is there anything to say beyond that, in terms of pace rhythm? You're just going to work through the funnel and make decisions, as you come across opportunities? Is there any other color you can provide on that?

[Paul Hill:]

Yeah. I mean I just -- the way to kind of think about it is I mean, first of all, we have cash on the balance sheet as you know. We've got -- I mean these days, there's access to very low-interest capital debt. And we're not allergic to that idea. And as we acquire businesses those businesses will also generate cash flow that will contribute as well. So, if you model all that out, you can get kind of a cadence. But I have said also in the past that we do want to maintain a certain amount of cash on the balance sheet, right? That's another thing. But the combination of those things, if you model it gets you into a comfortable range, where we can acquire up to that value over a four to five-year period.

[Todd Coupland:]

Okay. And what is the right leverage on the business, I guess with choppy WiLAN results, although they generate a lot of cash when they happen? How are you thinking about that?

[Paul Hill:]

Well, I wouldn't necessarily assume, you would leverage the entire business. You might for example leverage only the acquired asset, right?

[Todd Coupland:]

I see.

[Paul Hill:]

So -- or the ITS components of our business as opposed to the entire Quarterhill group.

[Todd Coupland:]

Okay. Okay. Fair enough.

[Paul Hill:]

There's different strategies you can take from a debt standpoint.

[John Rim:]

The basic concept though would be that, as we acquire companies, they become the collateral, right? And then, the cash they generate, they need to be able to service any financing that we get. So the leverage levels that we pick are going to be incredibly conservative, so that we're comfortably within any sort of financial covenants generally multiples of EBITDA in terms of debt leverage and very safe fixed cost coverage ratios. It just obviously enhances our capability to accelerate and move on opportunities quicker and optimize our capital allocation.

[Todd Coupland:]

Okay. Okay. So, $145 million cash probably $40 million $50 million cash to keep in the business. So you sort of have $100 million to start and then, what you generate plus the leverage possibilities of what you're going to buy. Is that sort of the right way to think about it?

[John Rim:]

Yes, although, I would just caution with the $40 million to $50 million. I mean we've mentioned that before in the past. I mean that is quite a healthy level. I mean the basic concept there in our WiLAN business is with IP patent infringement litigation, we want to demonstrate the ability to go long and that's critical because we're not going to settle. We're going to optimize those opportunities. But really, the cash that we hold, it's really dependent on the circumstances at the time. So, it could be less as well.

[Todd Coupland:]

Okay. That's certainly fair. And is there any, I guess timing statements you want to make on the funnel right now? Like, do you think you'll do a deal in 2021? Do you think, you'll do a couple of deals in 2021?

[Paul Hill:]

Listen, the M&A pipeline is very active and it's a very high priority. So we are very optimistic about doing some deals in 2021.

[Todd Coupland:]

Okay. Okay. Great. Appreciate the color and good luck. Nice to see the strategy coming together here.

[Paul Hill:]

Yes, great. Thanks, Todd.

[Operator:]

At this time, there are no further questions in queue. I will turn the call back to Mr. Hill for closing remarks.

[Paul Hill:]

Well, thanks everyone for attending and we will be back to you on our next quarterly call. Look forward to talking to you then. Goodbye.

[Operator:]

And this concludes today's conference call. Thank you for your participation. You may now disconnect.