Quarterhill Inc.
Q4 2021 Earnings Call Transcript

Published: 21 Mar 2022

[Operator:]

Good morning and welcome to Quarterhill’s Q4 and Fiscal Year End 2021 Financial Results Conference Call. On this morning’s call, we have Bret Kidd, President and CEO and Steve Thompson, Interim 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 questions. Earlier this morning, Quarterhill issued a news release announcing its financial results for the 3 and 12-month periods ended December 30, 2021. 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. Certain matters discussed during today’s conference call or answers that maybe given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company’s annual information form and other public filings that are available on SEDAR. During this conference call, Quarterhill will refer to adjusted EBITDA. Adjusted EBITDA does not have any standardized meaning prescribed by IFRS. Please refer to Page 3 of the company’s fiscal 2021 management’s discussion and analysis for full cautionary notes regarding the use of forward-looking statements and non-IFRS measures. Finally, please note that all financial information provided is in Canadian dollars unless otherwise specified. I would now turn the meeting over to Mr. Kidd. Please go ahead sir.

[Bret Kidd:]

Thank you and good morning everyone. Thanks for joining us on today’s call. In terms of agenda, I will start with a look at business highlights for Q4 and the year, followed by a discussion on our strategy and priorities for 2022. After which, Steve will take a look at the key financial results. Then we will open it up for questions. Looking at the numbers at a high level, Q4 consolidated revenue was $51.2 million, while revenue for the year was $125.7 million. Adjusted EBITDA was $878,000 in Q4 and $5 million for the year. Q4 results include a full quarterly contribution from ETC, which is reflected in the strong performance of the ITS segment, which generated revenue of $46.5 million compared to $17.6 million in Q4 of last year. Adjusted EBITDA in ITS in Q4 was $4.1 million. For the ITS business, 2021 was characterized as a year of M&A with the completion of three acquisitions

[Steve Thompson:]

Thank you, Brett, and good morning, everyone. I’ll take a look at key consolidated numbers as well as numbers from our ITS and Licensing segments. Starting at the top line. Consolidated revenue in Q4 was $51.2 million and $125.7 million for the year. ITS revenue in Q4 included a full quarter of contribution from ETC and was significantly higher at $46.5 million compared to $17.6 million in Q4 2020. Q4 2021 revenue also included revenue from sensor line and VDS, which were hired earlier in 2021. The Central Texas and Orange County contracts represent two of the three opportunities mentioned on Quarterhill’s last conference call where ETC has been selected as vendor of choice, but had not yet signed a contract. At the time, we were either in the standard protest period post-election or we’re in the final contract negotiating stage. Regarding the third opportunity, we are currently in contract negotiations and expect to announce completion in due course. Licensing revenue was up in Q4 compared to Q4 last year, but down year-over-year due to significant licensing activity in Q3 of 2020. Despite the headwinds related to COVID-19 WiLAN continues to show a complete agreements in a challenging environment, while simultaneously planning for the future and adding to its patent portfolio. Consolidated gross margin was 24% in Q4 and 30% for the year. ITS segment gross margin was 28% in Q4 and 34% for the year. Gross margin in ITS can fluctuate depending primarily on the nature of the projects underway during the period and the related margin profile. In addition, since more than half our ITS revenues are denominated in U.S. dollars, currency volatility between the U.S. and Canadian dollar can impact margins. As we move through the initial implementation phase of projects with Ohio River Bridges, Central Texas and Orange County, margins in 2022 will reflect that in the initial implementation year, usually the first two, revenue tends to have a gross – have a lower gross margin in a range of 10% to 15%, while in the subsequent operational years of those contracts, revenue has a higher gross margin in the range of 30% to 50%, with the higher end largely dependent on the level of change orders involved. Gross margin at WiLAN will fluctuate depending primarily on the level of litigation and contingent legal and partner costs incurred in the respective period relative to revenue generated. For the full year, WiLAN had gross margin of 15%. Total consolidated operating expenses were higher year-over-year in both Q4 and the full year period. The increase in operating expenses was primarily driven by the addition of the cost base of sensor line, VDS and ETC as well as by special charges, which primarily represented acquisition-related costs. During 2022, we will take steps to establish an optimal cost structure for the business as we continue the shift towards more of an operating company structure versus that of a holdco with operating entities beneath it. 2022 will be a bit of a transition year in that respect. Consolidated adjusted EBITDA in Q4 was $878,000 and $5 million for the full year period. On a segmented basis, the ITS business generated adjusted EBITDA of $4.1 million in Q4 and $12.7 million for 2021. Adjusted EBITDA benefits from the addition of ETC, sensor line and VDS via acquisition. However, those increases were offset by a high-margin project in Indiana, which occurred during the second half of 2020. Government expense relief programs that were in place in 2020 due to COVID-19 and foreign exchange fluctuations which negatively impacted revenue and margins in 2021. WiLAN’s adjusted EBITDA for 2021 was $1.2 million, demonstrating its ability to generate positive margin on more modest levels of revenue and which reflects the leaner business model put into place in recent years. Cash generated from operations was $794,000 in Q4 and cash used in operations for the year was $13.3 million. Cash, cash equivalents and short-term investments were $72.6 million at December 31, 2021 compared to $141.3 million at the end of the prior year. During 2021, we used appropriately $88.2 million of cash, including transaction costs, from the balance sheet on the acquisition of ETC, sensor line and VDS. Working capital stood at $105.7 million at year-end. We had several positive developments regarding our capital structure in 2021, which were the addition of a debt facility totaling approximately $82 million, of which $75 million was used for the ETC acquisition. The filing of a preliminary shelf prospectus with capacity to raise up to $200 million over a 25-month period and we also raised $57.5 million of convertible debentures in October. Collectively, these give us further flexibility and resources to pursue M&A. Regarding the return of capital to shareholders, we continue our quarterly dividend payments in Q4 and in our March 10 press release we announced details of our next dividend payment. The Board of Directors has declared an eligible dividend of $0.0125 per share payable on April 8, 2020, for shareholders of record on March 18, 2022. In closing, we remain well positioned to continue to execute our M&A strategy. We have a strong balance sheet today with cash and working capital, and we have three operating companies capable of generating cash to further support the ITS acquisition strategy. ITS revenue comes with a more steady and predictable profile, which we believe should result in Quarterhill elevating its profile in the investment community, receiving a valuation consistent with other public ITS companies at scale and ultimately unlocking growth in shareholder value. This concludes my review of the financial results, and I’ll now turn the call over to the operator for Q&A. Thank you.

[Operator:]

Your first question comes from Steven Li with Raymond James. Please go ahead.

[Steven Li:]

Thanks, guys. A couple of questions for me. First on licensing. So now that the sales process is underway, are you still out there signing licenses and therefore, 2022 is going to be a normal year for licensing or should we expect licensing activity to be down substantially? Thanks.

[Bret Kidd:]

Hi, Stephen, thanks for joining. What I’ll say is that the – we did announce the strategic review and the process is underway. But WiLAN is being run as the strong business that it is. So we will continue to seek licenses and work the business as we always have historically.

[Steven Li:]

Alright. That’s good to hear. And on ITS, so EBITDA margin in the quarter was with a full quarter of ETC was high single-digit given the number of new contract wins and your prepared remarks about lower margins early on. So is that high single digit? Is that a good margin level for the entire year or you still expect quarterly progression through the year?

[Bret Kidd:]

Yes. We do think that the numbers that you see in Q4 on the margin side are probably indicative for the overall year. There is a couple of things that relate to that. One is that with the new wins, we do have a much higher proportion of implementation revenue in the ITS business, which is we indicated is – tends to be lower in margin. And then there are still some of those headwinds that we’re looking at on the supply chain side and or wage inflation. Over time, as we were talking about, we see 15% EBITDA margins is the right target and expectation in the coming years and as those contracts mature.

[Steven Li:]

Thank you.

[Operator:]

Your next question comes from Gavin Fairweather with Cormark. Please go ahead.

[Gavin Fairweather:]

Hey, good morning. I thought I would start out just on the infrastructure bill. I guess it’s been about 100 days since that was passed. Curious to what extent that’s changing your conversations with customers, whether it’s changing any activity in the pipeline, just curious for how that’s influencing the demand picture there?

[Bret Kidd:]

Yes. Hi, Gavin. It is starting to work its way through, as you might expect, these sorts of bills do take time to reach the ultimate states. Although some of the states that we have talked to already have provisions in place and plans ready to go and ready to move out the door. So, I think especially on the R&D side of the business, we are seeing more activity as a relationship, because the funds are now more available. The ETC pipeline was already very strong prior to the infrastructure bill, and will just be reinforced by the activity that’s underway.

[Gavin Fairweather:]

Got it. And then maybe on ETC, on the new contracts, obviously, $160 million is a big number. How should we think about number one, the revenue ramp of these new contracts and the timing of revenue starting to flow? And secondly, to what extent is their front end loading on these contracts related to implementation services? I think if I did the math, right, if it was steady across all years, would be $20 million a year. But I suspect that the early years will be a bit higher.

[Bret Kidd:]

Yes, that’s a good question. And there are actually – there is variability amongst the contracts on the revenue profile. Generally speaking, you will see some amount of front loading over the first couple of years around implementation. But there are times that that programs and implementation itself will be spread across several years that we are talking about multiple roadways or different phases of the project. So, it will vary a bit. But I think the average that you are talking about there, where time is probably the right one to think about and given some of the variability in the programs, probably not a bad assumption. We are working through as it relates to timing and ramp up. There already is some things there to manage, but we have got a notice of proceeding on all those contracts and are getting underway with each.

[Gavin Fairweather:]

And then lastly for me, obviously, with the strategic review of WiLAN and becoming an ITS pure play, the plan is to reduce the corporate office and kind of dissolve that hold co structure. Have you quantified the cost reductions that you would be looking to achieve as that plays through there?

[Bret Kidd:]

Excuse me. We haven’t yet, I think what I can say is that we will be looking to reduce the size of actual dollars, but also even more or so the percentage of revenue as the ITS businesses grow organically and as we continue to do M&A there. I think we will see perhaps some modest dollar reduction in 2022. But given that we will – assuming a successful result on the WiLAN process, which we do expect that we will still hold them for a good portion of the year and number of things that still have to take place as a result of that and plus, we are still underway on the implementation or sort of the integration planning side to quantify some of the other areas, which will also some of those will take some time, especially if you are looking at different kinds of support contracts and things like that, that would be renegotiated. So, don’t have numbers to share yet for ‘23, but – and for ‘22, we would expect to see again some modest declines in the overall cost. And then what we will be doing from an integration standpoint is looking across, obviously all the components and trying to optimize and have the right degree of support and overhead across all the units. So, that will include looking beyond the corporate structure and into the units and how they operate as well.

[Gavin Fairweather:]

Great. That’s helpful. I will pass it on. Thank you.

[Operator:]

Thank you. Your next question comes from Doug Taylor with Canaccord. Please go ahead.

[Doug Taylor:]

Yes. Thank you. Good morning. One primary question for me, I am just trying to understand your comments about the margins in the ITS business relative to the original expectations for ETC to contribute was $95 million to $120 million in revenue and $12.5 million to $15 million in adjusted EBITDA. Are you signaling here that with the recent contract wins perhaps revenue is maybe higher than your original expectations, but margin is lower given the mix of new contracts and implementation works? Can you help me with that?

[Bret Kidd:]

Yes, it’s a good question. And I think probably a good way to say it. I think that we feel good about the growth that we are going to see, as we indicated in the upfront comments. We would expect some modest growth off of an annualized version of Q4 in 2021, related to the new contracts that are being signed. And then as it relates to EBITDA, the – yes, that mix combined with some of the other areas that I referred to on supply chain and wages are performing a little bit more of a constraint on the margins side. Does that help?

[Doug Taylor:]

Yes, it does. So, are you saying that, so possibly, ETC will generate $12.5 million to $15 million, but it will be a different margin profile, and might have been laid out would be at the outset?

[Bret Kidd:]

Really don’t want to get into specific guidance along those lines, because of some of the moving parts that we talked about before in terms of the timing of ramp up and then some of the other variables that are that are coming in. But I would just go back to the kind of modest growth off of annualized Q4 and then similar margin profile.

[Doug Taylor:]

So, then taking the Q4 kind of run rate that you have established here, I mean would you still expect seasonally stronger Q3, or Q2, Q3 in terms of the IRD business. And so to use this as a baseline and a little bit stronger through the middle of the year, but arriving at the same margin profile and then expanding in the year and the years to come after that. Is that the right way to think about it?

[Bret Kidd:]

We will have to get back to you on the seasonality piece for IRD. I need to take a closer look at some of the incoming deals and the timeframe associated with it. So, I don’t know if there is necessarily a pattern to interpret there, at least for this year and given the amount of signings that they had as well. So, not sure if I can confirm that, but we can get a better sense to you from a closer look at the deals we have signed in the backlog.

[Doug Taylor:]

Okay. Thank you. I will pass it on.

[Bret Kidd:]

Thank you.

[Operator:]

Thank you. Your next question comes from Todd Coupland with CIBC. Please go ahead.

[Todd Coupland:]

Hi, good morning. I will just follow-up on that margin question if I could, and then I had a couple of follow-ups. When you say similar margin profile, what is that actually referring to?

[Bret Kidd:]

To what we achieved in Q4.

[Todd Coupland:]

I see. So, you are saying modest growth of the $51 million annualized and a relatively comparable margin given inflation, supply chain, etcetera, that’s essentially the message?

[Bret Kidd:]

Yes, that’s right.

[Todd Coupland:]

Okay. And that includes all these new contracts that you have spoken about as well, whether it’s $20 million a year or spread out or front end load or anything like that, that’s all embedded in that discussion?

[Bret Kidd:]

Yes, that’s right.

[Todd Coupland:]

Okay. Thank you for that. In terms of the balance sheet, for all acquisitions, and capital activities, is it up-to-date as of the end of the year? Are there any pro forma adjustments or cash and debt as presented that’s essentially where it is now?

[Bret Kidd:]

I will let Steve jump in on this. But what I will say just from a balance sheet standpoint and kind of capacity as it relates to M&A, we feel good about the position that we are in. We have got strong balance sheet overall and then we have got cash and debt facility and other things that we can do to act on the pipeline that we have. And then I will let Steve kind of refer to the more detail parts of the question.

[Steve Thompson:]

Yes. Hi, Todd. It’s relatively the same right now the structure you are seeing at 2021. There has been no major material events in that area.

[Todd Coupland:]

Okay, that’s great. Appreciate that color. And then just on WiLAN and strategic review, it sounds like you had some interest in the business. So, our takeaway should be – you feel pretty good about the chances of selling that business at a price you deem to be fair, is that the messaging on strategic review?

[Bret Kidd:]

Yes. I mean we – since we announced in December we have had very nice inbound interest in it. And in the conversations we had in the selection of an advisor, got a lot of good insights from them and especially staff as to the attractiveness of the business. So, we do feel good about a positive outcome there for lots of different reasons. Again, WiLAN has a track record of performance, one of the best licensing companies in the industry and have a history of generating very, very nice financial returns. So, when you look at that the processes they have, of course, the portfolio of patents that they have and the team that’s in place, we just believe that there is a lot to like in that business. And then look at the broader market activity as well, the money that’s looking for attractive assets like that and in this particular IP space, we just think that it lines up well for successful outcome.

[Todd Coupland:]

Okay. This is by no means – this is more of a sort of editorial observation, as opposed to drawing the parallel specifically to WiLAN, but I thought of the BlackBerry patent sale. I wouldn’t have necessarily described that as a pristine outcome, it was fairly slow and dragged out and the price was just okay. So, this seems like you are getting a lot better interest than they ended up getting, or at least that’s my perception of what happened of BlackBerry. So, take that for what it’s worth. But appreciate your answers here. Thanks a lot.

[Bret Kidd:]

Yes. And I will say thank you to appreciate your joining in. And one thing to stress there kind of relative to BlackBerry is WiLAN, a complete business with human and strong portfolio and processes and methodology for optimizing return. So, but yes, certainly appreciate the questions there.

[Todd Coupland:]

Yes. That’s a good point on the business being established. If PE or other types of financial firms are considering it, that’s certainly a very important point. Thanks a lot.

[Operator:]

Thank you. As we have no further questions at this time, I will turn the call over to Mr. Kidd for closing comments.

[Bret Kidd:]

Okay. Thank you very much and thanks, everyone for joining and for the questions today. Again, just want to reiterate, some things that I said before about the attractiveness of the space that we are moving into and as it relates to ITS and this transition to a pure play in that regard. As I mentioned before, I don’t think there has been a better time to be in ITS. And having seen a number of different industry verticals over time, I rarely see anything as attractive as what we are seeing here in terms of the tailwinds on the market side and really undeniable trends that we just don’t see changing. And then we have got some great platforms to build from that have very strong momentum in the market, strong technology and strong teams as well. And then we will expect to see some growth here in ‘22, as we were talking about before related to the new business signings that both R&D and if you see that have had, and then the margins on the ITS business similar to what we are seeing on the Q4 IPS margins as well. So, we see a lot of momentum going into this year in ITS and just even bigger and better things to come down the road. So, appreciate everybody for joining again today and look forward to talking to you again very soon.

[Operator:]

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