SMART Technologies (NASDAQ:SMT)
Q3 2016 Results Earnings Conference Call
February 11, 2016, 4:30 pm ET
Jody Kehler - Manager, IR
Neil Gaydon - CEO
Steve Winkelmann - Interim CFO
Todd Coupland - CIBC
Good day, ladies and gentlemen. And welcome to the SMART Technologies Q3 Fiscal 2016 Earnings Conference Call. At this time all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As reminder, this call is being recorded.
I would now like to turn the call over to Jody Kehler. You may begin.
Thank you, Michelle. Good afternoon, and thank you to everyone on the call for joining us today. Neil Gaydon, our CEO, will begin today's call with some commentaries on key operational highlights and Steve Winkelmann, our Interim CFO will review our financial results. Following his remarks we will open the call for questions.
Please note that some of the information you will hear during our discussion today will include forward-looking statements within the meaning of applicable U.S. and Canadian securities laws. These statements are further discussed in the important cautionary statements found on page 3 of our presentation and include without limitation, statements with respect to our product mix, sales expectations, sales growth and product potential our commitment to kapp and kapp iQ, competition, deferred revenue and the inherent lack of visibility in our business, our financial performance, growth potential for our product, our strategic revenue and our ability to reduce expenses and align our cost structure to our sales outlook.
All of these statements are based on current expectations and assumptions that are subject to known and unknown risks and uncertainties many of which are beyond our control. Actual results or trends could materially differ from our expectations. We do not undertake any duty to update any forward-looking statement. For more information, please refer to the slides accompanying this conference call and to today's earnings press release; as well as the risk factors and assumptions described under risk factors and our annual report on Form 20-F for the fiscal year ended March 31, 2015, risk factors and those assumptions that are in managements discussion and analysis for the three and nine months ended December 31, 2015 referenced under forward-looking statements therein, including without limitations our ability to implement meaningful changes to address the company's business and financial challenges and our ability to identify, execute and consummate any strategic opportunities that may be identified as a part of our strategic review both the annual report and MD&A can be accessed on the SEDAR or SEC websites.
With that, I will turn the call over to Neil.
Thank you, Jody. Good afternoon and welcome everyone. Our focus over the last two years has been launching innovative new solutions that support the ongoing evolution of SMART legacy business. We continue to transition a wave from selling interactive whiteboards to offering state-of-the-art interactive flat-panels, supported by a range of advanced software solutions like Notebook Advantage and SMART amp.
We've expanded our portfolio of IFPs, design specifically for the rigors of both the education and enterprise markets which incorporate key differentiating features. According to the most recent data from Futuresource Consulting, SMART remains the IFP leader with over 20% share globally, excluding China and Turkey and nearly 40% share in North America.
This is been accomplished in just over two years and in addition we offer innovative solutions like SMART Room System, SMART kapp and kapp iQ which further leverage our ability to develop industry leading collaboration solutions for business.
The new hardware and software products we have introduced already comprise approximately 50% of our revenue in the third quarter, compared to approximately 34% in the prior year quarter.
I'll spend a few minutes touching on how we progressed on our strategy. Firstly, I'll discuss our products for the education market. As educators move from legacy interactive whiteboards to interactive flat panels, we are providing them with solutions designed specifically for their needs.
To address this, we recently broadened our award winning 6000 series and further enhanced our portfolio of IFPs with the announcement of 75 and 84-inch models in our 4000 series.
With our expanded portfolio of IFPs, purpose-built for education, SMART now offers a full range of IFP models with class leading features and improved cost of ownership. With regard to our software solutions, we recently announced our offering announcing the new SMART Learning Suite bundle, which combines our education software into a single bundle of one price.
The SMART Learning Suite ships with all SMART interactive displays for the education market and combines our industry leading SMART Notebook software with our recently enhanced SMART Lesson Activity Builder, which includes game based learning and our award winning SMART amp software.
SMART Notebook software sales continue to meet our expectations. Although a modest portion of overall revenue SMART Notebook Advantage, our software maintenance program showed year-over-year revenue growth.
As outlined over the past three years, we continue to experience good times in our legacy interactive whiteboards and while sales of our interactive flat panels and education software products are growing, they are not a level to yet offset the declines.
Quarter-over-quarter growth in IFPs was approximately 40% and IFP revenue more than doubled year-over-year. RFP revenue comprised approximately 35% of education revenues in Q3.
During the quarter we were also faced with a number challenges that impacted our overall results. Firstly, Q3 education revenue came in lower than anticipated due in part to timing of the award of several large deals that experienced funding and other delays in the quarter.
Secondly, according a new report from The Center on Budget and Policy Priorities, stated the spending in K-12 education in the US has still not recovered to pre-recession levels, with at least 25 states providing less funding per student in the 2015, 2016 school year than in the 2007, 2008. And at least 7 states the decline in funding exceeds 10%.
Local government funding per student has fallen in 18 states since the 2007, 2008 school year. In the EU, Germany and the UK appear to continue to experience similar budget constraints.
And thirdly, we are seeing increasing competition in the IFP market within certain regions, as competitors work to challenge our leadership position through aggressive pricing, coupled with an increase in the number of competitor’s into those market.
Turing to our SMART Enterprise Solutions which include the SMART Room System or SRS, our visual collaboration solutions or the VCS and kapp iQ. SRS is our purpose built solution to bring Skype for business formally called Microsoft Lync into the meeting room. This business contributed approximately 20% of total enterprise revenue in Q3.
Our VCS solutions which consist of our interactive displays, paired with SMART Meeting Pro software contributed approximately half of enterprise revenue in the quarter.
Finally, kapp iQ our Ultra HD display which enables multi-way inking between any combination of devices anywhere anytime, is playing a growing role within our enterprise solutions offering. Although just launched in June, kapp iQ contributed almost 15% of total enterprise revenue in the quarter. While we are seeing growth with our kapp iQ it will take time to build traction with this product.
Lastly I'll speak to SMART kapp, our digital dry-erase whiteboard. Given the warm reception at trade shows and many leading industry awards, positive end user feedback and high initial sales forecast from distributors, we believe that kapp would enjoy strong initial demand and that we could accelerate SMART's turnaround with an increased investment in the development and marketing of kapp.
We ramped up manufacturing based on these forecast from our experienced partners, which store is building stock in July and product entering the channel in August. When it became to clear to us in October, the kapp would take more time to gain the traction that we hoped for in the market and what was originally thought, we immediately adjusted our manufacturing.
Since sales from SMART kapp are growing at a slower rate than originally anticipated, as outlined in our January 18 press release, we re-assessed and revised our future demand assumptions which ultimately resulted in a primarily non-cash, pretax charge against inventory and purchase commitments of $21 million in the third quarter.
During the quarter, we moved quickly to manage our financial position and restructured the company taking decisive action to reduce expenses by approximately $25 million on an annualize basis. Primarily directed towards resources we had allocated to drive kapp sales, but haven’t yet spent a large part of. In other words, we took the necessary steps to align our cost structure given the slower than anticipated kapp outlook.
Through the launch, we've learned the customers are looking to try this product and category before they connect [ph] and buy in volume. We believe that kapp will require more time, greater awareness and the right channel approach.
Despite these challenges, we remain committed to kapp and are analyzing the appropriate channel product pricing of business models to support longer term growth for this brand new product category. Near end of the quarter, we launched a variety of near term sales incentive programs that are showing signs of traction.
In summary, we are encouraged by the continued growth of our IFPs and software solutions for the education market. We remain committed to kapp and kapp iQ knowing its takes time to build new product and they remain a key piece of our longer term plan.
I'll now turn the call over to Steve, who will provide a detailed analysis of our third quarter financial performance.
Thank you, Neil. We reported third quarter GAAP revenue of $78 million compared with a $127 million in the third quarter of the prior year. Given the change in the recognition of deferred revenue in the year ago period, quarterly adjusted revenue provides a better picture of how the business performed there.
Quarterly adjusted revenue decreased 30% year-over-year from $111 million to $78 million, which is slightly below the guidance range of $80 million to $90 million that we provided in our last quarterly press release. This current mix was largely due to timing of the award of certain education deals. The year-over-year decrease was a result of a continued decline of interactive whiteboard sales, partly offset by a modest increase in interactive flat panel sales.
We reported third quarter GAAP gross margin of 5% compared with 45% during the third quarter of the prior year. Gross margin was negatively impacted by the $21 million kapp inventory charge recorded in the third quarter.
Our adjusted gross margin, excluding the kapp inventory charge for the third quarter was 31% compared with 38% during the same quarter last year. The year-over-year decrease in core gross margin was driven primarily by shift in a product mix, interactive flat panels which carry a lower gross margin percentage.
Cash operating expenses in the third quarter were $25 million compared with $32 million during the same period last year. The decrease reflects the actions that we took towards end of the calendar year to reduce expenses by approximately $25 million on annualized basis, primarily related to resources we had allocated to kapp. These reductions are progressing as planned.
Please note, that our cash operating expenses are comprised of selling, marketing and administration and research and development expenses, excluding stock-based compensation and bad debt expenses.
Third quarter adjusted EBITDA decreased by $9 million year-over-year from a $11 million to $2 million, which is within the guidance range of breakeven to $5 million that we provided in our last quarterly press release.
Positive foreign exchange movements benefited adjusted EBITDA by approximately $1 million in the quarter. The decrease was due to lower gross margin, probably offset by lower cash operating expenses.
Please note, that the kapp inventory charge did not impact adjusted EBITDA or adjusted net income. We reported an adjusted net loss of $23 million for the third quarter compared to adjusted net income $2 million in the comparable quarter last year.
Adjusted net income was negatively impacted by the increase in tax expense due primarily to an increase valuation allowance resulting from de-recognition of previously recognized tax assets.
As a reminder, we adjust GAAP net income for foreign exchange gains and losses, as well as the accelerated deferred revenue recognized and the amortization of intangible assets, stock based compensation, restructuring cost, gain and loss on the sale of long-lived assets and the recent kapp inventory charge.
Looking at our capital structure, we end the quarter with $111 million of debt outstanding, excluding the office premises capital lease which was $49 million. As of December 31, SMART access to capital of approximately $43 million which consisted of $20 million in cash and cash equivalent and $23 million of availability from our ABL facility.
With that, I'll now turn the call back to Neil.
Thanks, Steve. In conclusion, we've decided not to provide forward-looking financial guidance at this time due to the inherent lack of visibility in the business and the difficulty of predicating sales of our still relatively new product lines. The Board will review this policy as appropriate.
We continue to face challenges in the third quarter, including the timing of the award of several large deals that experienced funding and other delays in the quarter, mixed with customer budget constraints in key markets and increasing competition in the IFP market within certain regions.
In the phase of continue transition in the education business, and given the relatively early stage of a number of our newly introduced solutions, we have taken steps in the third quarter to actively manage the business to align our spending with our near term prospects.
That said, we remain focused on assessing and driving the longer term growth potential of the business based on IFPs and our software for education, as well as the potential for both kapp and kapp iQ in enterprise.
As it relates to the strategic review the process is ongoing. As outlined in our last earnings call we do not intend to disclose developments with respect to the strategic review process until the Board has approved a specific course of action or otherwise determined the disclosure is necessary or appropriate.
With that, I'll hand the call over to the operator to begin the Q&A session. Operator?
[Operator Instructions] Our first question comes from Todd Coupland of CIBC. Your line is open.
Hey. Good evening, everyone.
Couple of questions if I could. The cash OpEx of $25 million, does that now – is that roughly reflect of all your actions and should be a representative run rate?
It’s pretty much reflective, keep in mind Todd, Q3 is generally our lowest quarter for cash OpEx. So it’s a bit lower than what the run rate would be.
Okay. And I think in the past you've talked about your breakeven EBITDA, is that changed much this quarter?
It would still be as previously provided.
Okay. And I am not sure if you said this, you gave a lot of percentages within enterprise and education, what was the actually split of the – the $78 million enterprise to education?
We don’t provide that, we don’t provide the segmented splitting you want to talk.
Okay. Fair enough. My last question is on the strategic review. So I guess the options are possible sale of the company, some sort of recap of the company to continue as a public entity, is that essentially it, and are those the two options that you're considering essentially?
Yes, I mean, the Board is reviewing viable options and I think you've categorized pretty much the main ones here.
Okay. And should we rank, order them - preferences the sale of the company, but if there isn’t a buyer then you'll make the adjustments necessary to continue as an ongoing entity, is that the way to think about that?
As it is, we'll not make any specific comments on the strategic review. These things are being discussed and reviewed by the Board.
Okay. And from a timing point of view what's the thinking on that?
These things, it’s a process, and so they go at a certain speed and the process is currently ongoing. And there is no definitive date for this.
Okay. Okay, thanks very much. I appreciate your answers.
Okay. Thank you, Todd.
Thank you, Todd.
At this time I'd like to turn the call back over to Neil Gaydon for any closing remarks.
So, I like to take this opportunity to join the board and thanking our employees and other stakeholders for their continued efforts and support and thank you everyone for joining us on the call today.
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