Redknee Solutions' (RKNEF) CEO Lucas Skoczkowski on Q3 2016 Results - Earnings Call Transcript

| About: Redknee Solutions (RKNEF)

Redknee Solutions Inc. (OTC:RKNEF) Q3 2016 Earnings Conference Call August 4, 2016 8:30 AM ET

Executives

Lucas Skoczkowski - CEO

David Charron - Chief Financial Officer and Corporate Secretary

Analysts

Michael Urlocker - GMP Securities

Lee Edward - Canaccord Genuity

Operator

Good morning, ladies and gentlemen, welcome to the Redknee Solutions Inc., fiscal 2016 third quarter conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at this time for you to queue for any questions.

Before beginning its formal remarks, Redknee would like to remind listeners that today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these forward-looking statements. Redknee does not undertake to update any forward-looking statements except as required.

I would like to remind everyone that this call is being recorded today, Thursday, August 4, 2016.

I will now go ahead and turn the call over to Lucas Skoczkowski, Chief Executive Officer of Redknee Solutions, Inc. Please go ahead, sir.

Lucas Skoczkowski

Great. Thank you. Good morning everyone. Thank you for joining us today. With me is David Charron, our Chief Financial Officer. Before I begin, I would like to draw your attention to Slide 2 of our presentation. We have outlined the company disclaimers and cautions regarding forward-looking statements.

Yesterday, after market closed, we reported our third quarter fiscal 2016 financial results. A press release and the company financial documents are available in Investor section of our Web site as well as on SEDAR.

In addition, if you haven't done already, I encourage you to download the presentation, which provides further analysis of our quarterly results. Dave and I will give you [indiscernible] presentation during today's call.

The agenda for today's call is as follows, I will begin with an overview of the quarter. Then review our financial results in detail and then I will return with some concluding remarks before we open up the call to your questions.

So now, I would like to provide you with a brief high level overview of results for Q3. The third quarter was highlighted by the continued momentum in new orders that we discussed at the time of our last call. In aggregate, since the beginning of Q3, we have one new and the new existing contract with the value in excess of $60 million. In our last call, I walked through a number of those wins, which included 20 plus million dollar free license and services for expansion contract with the leading Tier-1 telecom provider in Asia Pacific and $8 million contract win with a Tier-1 communication service provider in the Americas and addition of a new -- of the multiyear contract with Tim in Brazil.

We can now add to those a multiyear dollar contract was -- that we received as delivered a policy management solution Redknee PCS to a large Tier-1 operator in EMEA that services approximately 55 million subscribers. The renewal of a multimillion dollar service contract with a large Tier-1 operator in Europe and multiyear service agreement with lifecell one of the large operator in Ukraine and part of the Turkcell Group. And earlier this week, we announced a multimillion digital transformation contract with Tbaytel the largest independently owned telecommunication service provider in Canada.

The strong order momentum contributed to continued growth in our order backlog which was up nearly 11% year-over-year to a record $181 million at the third quarter end. It was our fourth consecutive quarter of sequential expansion of our order backlog. Revenue for the quarter came in at $40.5 million which continued to reflect the macro BSS telecom environment and resulting delays in customer decisions that we have discussed on previous calls. The expansion of our backlog throughout fiscal 2016 should contribute to greatly improved visibility around revenue and better feasibility around profit as new software licenses will be recognized as a revenue over the coming quarters. I will discuss this more in detail later.

Gross margin for Q3 was $18.3 million or 45% of revenue. This low gross margin number reflects lower revenue from high margin software licenses dues and higher than normal proportion of third party revenue which has low margins. Adjusted EBITDA loss was $1.9 million. On a trailing 12-month basis which as we had said before we view as a more meaningful reflection of the performance of the business given the quarter-to-quarter lumpiness of our software sales. We generated revenue of $190 million, with gross margin of 55% and adjusted EBITDA of $8 million. Recurring revenue for the last 12 months was $103 million or 54% of revenue.

In summary, we continued to be encouraged by the recent sales order momentum which is pretty evident of the competitive strength of our solution in supporting our customers as they make a critical transition from traditional to real-time digital business models. Looking ahead, our engagement with our customers being very active and we look forward to building on this momentum to convert our robust sales pipeline into order backlog further enhancing our financial visibility.

Now, I would like to turn the call over to our CFO, David Charron to walk through the financial results for the quarter in detail. David?

David Charron

Thank you, Lucas, and good morning everyone.

In the interest of time, I would like to restrict my remarks primarily to our Q3 results. Our complete financial statements, MD&A and earnings release for the quarter and the nine month period are available on SEDAR and our Web site and I encourage everyone to review them.

As a reminder, our financial results are presented under International Financial Reporting Standards and are presented in U.S. dollars. For comparative purposes, our previous year's results are also shown under equivalent accounting standards and functional currency.

Now to our results, total revenue for the third quarter was $40.5 million compared with the $46.7 million for the same quarter last year with the decrease primarily attributable to the continuing purchasing delays by existing and potential customers in the Asia Pacific and EMEA region that we have discussed on recent calls. Recurring revenue which we define as revenue from support maintenance agreements, term base product licenses and long-term service agreements was $25.6 million or 63% of revenue in Q3 which compares to 24.6% or 53% of revenue in the same quarter of last year.

Adjusted EBITDA for the third quarter was a loss of $1.9 million compared with positive adjusted EBITDA of $5.3 million in Q3 of last year. Net loss which includes restructuring cost of $4.1 million was $12.3 million or a loss for share of $0.11 compared with a net loss of $5.5 million or $0.05 loss per share for Q3 of last year and excluding our restructuring charge, net loss for Q3 of this year was $8.2 million.

Now drilling down into the components of revenue, software license and service revenue for Q3 was $12.3 million down from the $21.5 million in Q3 of last year. The estimated split between software licensing and services revenue was $2.7 million and $9.6 million compared to a $10.8 million and $10.7 million for Q3 of last year. The decrease resulting from the delays of purchasing decisions we noted earlier was partially offset by the incremental revenue contribution from the acquisition of Orga at end of July last year.

Support and subscription revenue increased by $1.6 million to $23.4 million or 58% of revenue up from 21.7% or 47% of revenue for the same period last year. The increase is mainly attributable to the higher support revenue in the Americas and EMEA region driven primarily by the Orga acquisition which was partially offset by the non-renewal of certain support contracts in the Asia Pacific region.

Sales to third party hardware and software components increased to $4.8 million or 12% of total revenue from $3.4 million or about 7% of total revenue for Q3 of last year. Gross margin for the third quarter was 45% versus 57% in the same quarter of last year and as Lucas mentioned the larger proportion of low margin third-party revenue contributed to compression in our overall gross margin this quarter as lower revenue from high margin software license deals in the overall mix of revenue. On a trailing 12 month basis our gross margin was 55%.

Total operating expenses for Q3 decreased to $28.2 million down from the $30.1 million in Q3 of last year and excluding restructuring cost, acquisition cost and amortization, operating expenses for Q3 were $20.5 million or about 51% of total revenue comprised at $22.2 million or 48% of total revenue a year ago.

The year-over-year decrease of $1.7 million is primarily the result of lower sales and marketing cost as well as lower R&D expenses. Overall, the impact of the restructuring we announced in March has resulted in savings in Q3 of about $5 million which we expect to be about $25 million on annualized basis.

Now looking at each of the OpEx lines individually, sales and marketing cost totaled $6.7 million a 16% decrease in the same period last year and as a percentage of revenue sales and marketing expenses was 16% down from 17% when compared to the same year ago quarter. General and administrative cost increased 28% to $7.4 million from the $5.8 million for Q3 of last year. The increase is mainly due to the cost associated with the Orga acquisition particularly increased amortization cost.

Excluding stock compensation and amortization G&A increased to $4.7 million or 12% of revenue from $3.6 million or 8% of revenue in Q3 of last year. R&D expenditures decreased 12% to $9.9 million from the $11.2 million in the same period last year. As a percentage of revenue, R&D expenditures were flat year-over-year at 24% of revenue. The decrease in R&D cost was primarily the result of our ongoing cost optimization plan that will see a close of certain offices and we focused our activities in certain regions.

Now turning to key balance sheet items of the quarter, cash and equivalents including restricted cash, at the end of Q3 totaled $43 million down slightly from the $44.3 million at the end of Q2. We generated $4 million of cash from operating activities while adjusted cash generated from operating activities which exclude cash used for our restructuring for the quarter was $7.6 million. The improvement in cash from operating activity is directly attributable to the success of our working capital optimization disciplined collection effort.

As for cash related to restructuring activities during Q3, we used cash of $3.6 million for the restructuring related cost and as indicated Note 14 of our financial statements we have an additional amount of $21.1 million estimated as payable in the next 12 months and as well there is a further amount of $5.7 million of cash as payable over the next four years. Also I want to mention that we've also paid out the remaining outstanding balance of cash against the earned out to Nokia for the purchase of the BSS business.

Continuing on with balance sheet highlights, accounts receivable at the end of Q3 was $52.6 million down 22% from the $67.4 million at the end of fiscal 2015. Our days sales outstanding increased to 101 days from the 96 days as of 2015 fiscal year end. However, still remains at the low end of our target range of between 100 and 110 days. Unbilled revenue was $32.7 million down $5.6 million or 15% from the $38.3 million at the end of fiscal 2015. Deferred revenue was $19.7 million up $5.5 million or 37% from the $14.2 million as of the end of fiscal 2015. Overall, working capital at the end of Q3 was $40.4 million compared with $87.9 million at the end of our fiscal 2015.

Now turning to an update on our credit facility, for the quarter ended June 30, we have obtained an amendment in waiver under which our lenders have agreed to waiver our financial covenants for the quarter. The temporary restrictions [indiscernible] the use of funds borrowed on the facility and the $20 million temporary limit remain in place for time being.

In yesterday's financial results new release, we provided revenue and EBITDA guidance for the full fiscal 2016 and 2017 years, which Lucas will review in a moment. And in the context of this outlook, we are on the midst of a process of identifying the value of opportunities to refinance our credit facility both with our bankers and third parties and we'll make an announcement when that process is completed. To avoid impairing the refinancing process, we will not be commenting on this process until it is concluded.

I would like to take this opportunity to reiterate that we believe we have sufficient resources to execute on our business plan and the guidance that we have provided. Finally, as Lucas discussed our order backlog at the end of Q3 expanded to $180.7 million from the $162.5 million at the end of Q3 last year. And as it turned out, we expect approximately 60% to be converted to revenue in the next 12 months with the remainder converted in future periods.

This concludes my financial review and now I'd like to turn the call over back to Lucas.

Lucas Skoczkowski

Great, thank you David. There is no doubt that Fiscal 2016 has been a challenging year for our industry and for our customers. Despite those headwinds, we haven't taken our focus off our near term priorities or our long-term goals. On the contrary the tough micro environment has underscored the importance of being relentless and are pursued to further enhance the value proposition of our solutions for our customers and strengthen our competitive position.

We helped deliver customer limitation on time and on budget or providing innovative solutions to their changing requirements implemented extensions to our platforms eliminating expenses CapEx from competing solutions and expanded our service offering to complement and pick other operating -- of our platforms through our cloud [indiscernible] ability.

As we look forward to the end of fiscal year and into fiscal 2013, we remain confident in our ability to continue to win new contracts. And as I discussed earlier, we expect our strong order backlogs to continue to contribute to increase revenue and profitability visibility.

With that additional visibility and given the challenge in the macro BSS industry, we are providing the full length financial guidance for fiscal 2016 and fiscal 2017. For fiscal 2016, we expect revenue of between $170 million to $172 million U.S. and adjusted EBITDA of $1 million to $3 million. For fiscal 2017, we expect revenues of between $170 million and $180 million and adjusted EBITDA of $15 million to $20 million. We remain focused on our near to medium term priorities, one driving expanded business margin by focusing on our software and recurring revenues to improve profitability.

Two, discipline customer management, we've implemented a program this year that would save approximately $25 million of cost in the coming year in comparison to the annualized first quarter 2016 cost basis. We are already benefiting from some of that now and we will see that meaningfully in the fourth quarter of this fiscal year.

Three, cash flow generation, as David discussed during Q3 we generated cash from operating activities of $4 million, $7.6 million before cash that went to our restructuring initiatives as we benefit from our constant focus on cash management. Long-term, we are committed to a three prong growth strategy to drive sustainable stakeholder volume.

One, I spoke earlier, the continued evolution of our business critical solutions as companies look to keep pace with the fast moving changes in technology and new emerging ecosystem namely the Internet of Things or IOT that we continue to provide in the business solutions to enable enterprises to better monetize and manage their subscriber solutions worldwide.

Notably in this regarding during the third quarter we formally partnered with L&T Technology Services, which provide innovative solutions in IOT and machine-to-machine-to-customer including Fortune 500 companies globally across spectrum of industries transportation, industrial product, telecom and high-tech, process industry and medical devices to name a few. L&T was integrated with Redknee's connected suite to provide end-point connectivity advance analytics and amortization in one integrated IOP solution. The meaningful step forward in our strategy to capitalize on the tremendous opportunity in IOP that is ahead of us.

The second component of our strategy is growing our leadership and consequently our market share across addressable market. Redknee has consistently been recognized as heading the leading software solutions for telecommunication providers, with strong reputations in the market we will continue to compete for contract and leverage our spot leadership in the space.

Furthermore, based on customer discussions and evaluation toward continuing to prove ahead of our competition in both our monetization of data, customer engagement management and multiple approach. Here our best product integration had advanced our solution further in multiple context. We have secured new customers this first quarter and remain actively engaged with new prospective customers to replace the legacy systems while existing customers are intriguing -- the breadth of the product in premises the day of getting [indiscernible].

And third, we are focusing on improving our recurring revenues and revenue mix over the medium to long-term to drive profitability and remain committed to achieving our target EBITDA margin of 20% to 25% over the same period. Recurring revenues support in long-term services to build on our support platform are improving and we expect to see additional improvement as we continue to execute on our strategy of growing these recurring revenues.

Before opening the call for questions, I'd like to once again thank the opportunity to -- thank our customers and partners for our continued support and acknowledge the contributions of our employees around the globe. I'd like to now open the call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Michael Urlocker from GMP Securities. Your line is open.

Michael Urlocker

Good morning. Thanks for taking my question. Lucas you've got a record backlog, you've got a lot of contracts that you have signed but the outlook for revenue growth seems quite low still, what do you think is really going on in here for the business?

Lucas Skoczkowski

I think number one, we have the best visibility we had, I would say in recent history of the business. We have four quarters of substantial bookings and if I look at the composition of backlog, we've got strong order licenses and strong view on our services and recurring revenue moving forward. So I think that's number one.

Number two, customer environment globally, our customers are hurting and we need to make sure we continue to deliver value to them. The decisions both in -- this purchasing decisions as well as decision to how quickly they're allowed some of the services and private platforms obviously affect our business directly.

I think number one, we spoke to our investor based here on this call ahead of the -- maybe other companies in our space that have indicated some of the challenges. We have dealt with put in place a strong and lean cost base which I think gives us ability to be responsive to our changing landscape in our marketplace. And more importantly we remain very competitive so we are winning business away from our competitors. We haven't lost a customer to-date. We continue to add customers and I do expect that some of the revenue ability for us to turn the orders into revenue, we'll see more licenses moving forward as we start Q1 fiscal 2017.

We believe that this will be important but also in the process we are seeing growing opportunity to also diversify our customer base both within telecom as we add a bunch of new multiple customers, I expect over coming 12 to 18 months and out of telecom companies that are trying to use their connective environment to diversify their business. So I think we're dealing with the changes in our customer's business and we I think prepare the business from a product and cost basis to make sure that in this environment we are effective and profitable.

Michael Urlocker

Thank you. If we look at the actual software license sales in the quarter was $2.7 million, which really kind of boggles the mind, how low it is, given that basically that telecos aren't buying software licenses, is there any like real reception towards the idea of hosted services in SaaS model with these companies now?

Lucas Skoczkowski

So there is a couple of things, we have converted revenue from the orders to achieve the low number of 2.7, I think is probably a three year low in terms of our ability to do it. But I want to point out that our order intake was very significant and then we have the highest probably in the recent history a highest proportion of software license orders in our order backlog.

I think people are giving up orders for licenses, but with the conditions to turn them into revenue and we look for the opportunity to do that. We see line outside with customers projects being implemented so we can do that starting Q1 fiscal 2017, the quarter beginning in October. On the cloud service capability, I think we see more customers, so we've been I think successfully deployed this in seeing pick up both in North America, in Latin America and in Japan.

We offer a cloud service to our global customer base and I think as customers are dealing with their own challenges of CapEx and OpEx constraints, we see the opportunity to do more of it. I also feel that our offering around multi-play, but we offer more now not only to wireless operators, who are probably under quite a bit of the rest right now globally. We see opportunity to address fixed cable and video providers, which I think will change positively some of the competitive dimensions from a customer perspective and should lead to additional offerings and pick up on our cloud service.

Michael Urlocker

Okay. Thank you. And then my last question is regarding the debt position, if I understand correctly the current lenders waives covenants, I think they're still imposing some spending restrictions and you said you're going to look to refinance, why the refinance?

David Charron

So Michael, as I mentioned given the outlook that we've provided the forecast, the covenants we had in place over a year ago certainly are relevant to the business that we're seeing going forward and so we are in the process of refinancing our debt facility and again until that process is completed we're not really going to make anymore comments on that.

Michael Urlocker

Okay. Thank you.

David Charron

Thank you, Michael.

Operator

[Operator Instructions] We do have a question from the line of Lee Edward from Canaccord Genuity. Your line is open.

Lee Edward

Hi guys, just a quick question, are you seeing some of your larger peers in the BSS that are starting to become more competitive and how is that affecting your ability to win new deals?

Lucas Skoczkowski

Great. Good question. I think couple of things we are -- if I look at over there the past quarter, I guess, on every quarter, we haven't loss any deals to competitors in the deals that we've been pursuing. The biggest challenge I think for us has been the customer decisions continue to slip and they keep pushing them out.

So, I would say a variety of reasons that is coming out between some of the geographies. Our competitors are being more competitive. I think we're seeing comments from some of the larger players in the space that there is a lot more focus on profitability. So, I think some of them maybe historically move that has made which might not have been financially sound. I think those behaviors will eventually work themselves out and that's happening faster than probably otherwise, there have been changes in management in some of those companies.

We feel that compared perspective, we're in kind of top, three top five real-time platform providers. We can go head to heads down on any of the competitors as long as the business is sound. We don't provide financing to our customers obviously and that's the requirement that probably know the customer for us, if they require three or five year financing.

Even those I think are becoming less, we see less in our engagement. So I feel that comparably we're probably ahead. I think what I want to underscore is that with addition of capabilities to go after the non-wireless operators that is really enhancing the opportunity for us to drive a better mix in our revenues and we have a very good line of side to continue to drive and scale up the profitability.

Lee Edward

Okay. Thank you. And sorry, one last question, I apologize if you've already said this. In regards to customer spending delays, what are you seeing as the commonality in the main headwinds? Are customers allocating spend to other areas or is it just macro factors?

Lucas Skoczkowski

I think we have seen our customers having fairly low headwind on their top line, so low revenue pressure and lot of the CEOs that I talk to focus on reduction of cost. So we see a lot of restructuring in our customer's business on employees. There is fairly significant CapEx pressure and we see obviously a lot of discipline around their OpEx aspects.

So some projects have been pushed out, some projects have been -- maybe slower, a lot of scrutiny goes in on how to affect -- how the business being affected. And I think if you look at any of the larger groups I think they do see a low revenue pressure, so the way we see it is we do see opportunity for us to -- and we have demonstrated replacement of other solutions to drive a lower OpEx, they require less people to run it. They can have more leverage from our system and from our solutions which means that we are broadening our capability in those businesses.

For new customers that we are engaged with they have those pains, but they also have pain from legacy systems that are making them very ineffective and being able to respond to changing oppositions in the marketplace. And in those decisions are taking longer, but we see a clear view and as we demonstrated this first quarter, we're able to capture those businesses in terms of contracts and commitments. And we see our ability to implement both over coming 16 and 18 months to be able to drive significant improvement in both mix in our revenue. But it is our customers, I think overall globally the mobile industry has had increase in usage, but decline in revenues which you can draw probably the conclusions from that as data revenues aren't going as fast to be able to maybe absorb some of the cost to service them so. Is that helpful?

Lee Edward

That's great. Thank you.

Lucas Skoczkowski

Great.

Operator

There are no further questions at this time.

Lucas Skoczkowski

Excellent. Well, thank you for joining us on today's call. We look forward to speaking to our stakeholders over coming weeks as we meet on one-on-one basis. But, I do look forward to speaking with you all again next quarter to report on our full fiscal year 2016 and Q4 results. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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