Q2 2022 Quarterhill Inc Earnings Call
Q2 and Q3 are seasonally stronger quarters for IRD and accordingly we saw an improvement in IRD from Q1 of this year.
R&D isn't immune to supply chain disruptions and wage and materials inflation and labor scarcity issues, and its results in the quarter reflected some minor project delays along with some higher costs.
IRD's two tuck-in acquisitions from 2021, SensorLine and VDS, are being successfully integrated within IRD Europe . Both acquisitions, when combined, grew revenue as well as EBITDA in the first half of 2022 in comparison to the same period last year.
Overall, the fundamentals at R&D remain strong, with significant backlog, a robust sales pipeline, and the potential for additional tuck-in acquisitions to broaden its system's capabilities and drive its growth.
At ETC, we have signed a significant amount of new business in the past 18 months, and seven of these projects are now in the implementation phase.
As discussed in our Q1 call, the ramp for several of these projects has been slower than expected and this persisted into Q2.
The contributing factors were primarily shifts in customer priorities or preferences that can occur during the early stage of a large infrastructure project, along with some supply chain disruptions.
shifts in customer priorities or preferences that can occur during the early stage of a large infrastructure project along with some supply chain disruptions and labor scarcity.
Fortunately, we saw some of these factors begin to abate during the quarter with resultant progress seen with certain key implementations.
In particular, we did have one implementation where we experienced higher than initially planned cost as well as some impact on revenue.
The net of it is that working closely with the customer, we adjusted certain elements of the project resulting in some one-time costs incurred in Q2. The upside is that the relationship remains strong, the project is now moving along according to the revised plan, and we believe the issue is now behind us.
To provide some context, our ITS business has signed contracts totaling more than $345 million in just the past 18 months. And what we've seen here so far in 2022 are some of the challenges of launching a significant level of activity and to be doing so in an economic environment characterized by tight access to materials and labor.
Again, we believe that the worst of these impacts on our Q2 results are behind us and expect our top line and margin performance to improve. These are long-term infrastructure projects with stable customers and important public policy objectives designed to deliver a valuable set of services and outcomes for decades to come.
Further, these are projects that will continue to move forward should the economy enter a prolonged recession.
As an important aside, that 345 million of new contracts is largely comprised of long-term ETC tolling projects, and that dollar amount does not include change or follow-on orders, which are commonly associated with contracts at ETC and which can have a multiplier effect on the total contract value.
There are several factors that give us confidence and our stronger outlook. First, we'll be moving beyond Q2's one-time items. Plus, we are seeing better ramp-up on our implementations right now, which begin to pick up pace during the quarter and continue to perform well today. We believe the revenue curve on these projects has simply shifted to the right. On the supply chain side, there are still some disruptions in terms of timely access to materials and equipment.
but we have adjusted our purchasing habits to allocate for longer lead times. On the labor side, it's still a competitive and increasingly expensive market for personnel, but we're getting more creative in our hiring to mitigate these costs, and we have made significant hires in Q2, which have helped from both the leadership and horsepower perspective in order to drive these implementations forward.
As mentioned on our last call, to accommodate both supply chain and labor costs, we are aligning our new proposals and pricing to reflect new realities.
I should note that along these lines, our sales pipeline remains robust.
and our win rates remain very high. There are a number of near-term opportunities that we are focused on. Several of these opportunities were expected to have been decided earlier in the year, but the decisions have been pushed out. We still expect these opportunities to materialize, and in fact, in addition to IRD's new contract in New York State, subsequent to quarter end, ETC was selected as vendor of choice for a large electronic toll system integration contract, which is now in the customary protest phase.
Regarding the 2022 financial outlook for the ITS business, previously we had expected that revenue for the year would grow from our annualized Q4 2021 ITS revenue run rate and that adjusted the EVA down margin for the year would also be in line with that generated in Q4.
However, given our results in the first half of the year, we have adjusted our expectations for the year downward from those targets.
We do see improvements in the second half and we believe we will end the year at a run rate approaching our original outlook for the year.
If that look does assume that work on our seven ongoing implementations continues to progress along their current trajectory, then that challenges related to supply chain and labor market developments begin to ease.
We're maintaining our view that we can achieve an adjusted EBITDA margin of 15% in two to three years. This will be achieved through revenue expansion and a greater percentage of higher margin revenue as projects move into the maintenance operations and change order phases, as well as through cost savings at the corporate and segment level.
My top priority today is making sure that the IHS businesses are well positioned to execute on new contract mandates and to continue to build a funnel for future contract winds. Our future contract winds.
On the last call I spoke with several other priorities for the ITS business, with one of them being greater integration of IRD and ETC and the corporate function at Quarter Hill, all as we move towards being a pure-play ITS company.
As part of this plan, I've appointed Bruce Kramer, ETC's Chief Operating Officer, to lead the integration process.
Bruce is a veteran operations executive who joined ETC as COO in 2020. Bruce will work closely with John Carnes on a cost-saving side and across the broader integration.
The goal of the integration between IRD and ETC is to focus on revenue, technological, and operational synergies.
Overall, by the end of 2023, we believe the integration efforts could generate annual run rate cost savings of approximately $3 million as we consolidate the support functions from ETC and IRD into a single corporate entity.
This would provide greater efficiency and effectiveness from those functions while enabling the operating units to focus on sales and delivery.
Savings would occur in a step function during 2023 as initiatives and new processes are implemented.
Another priority I spoke of on the Q1 call is M&A.
We are in the enviable position of having considerable resources to pursue M&A, but will continue to be patient and disciplined buyers looking to pay reasonable valuations for opportunities with both operational and financial profiles.
We are seeing some easing evaluations in our target areas and are looking at opportunities in a range of sizes that can help us accelerate our growth and achieve other strategic objectives.
Looking now at YLAN and our licensing business, YLAN underwent a leadership transition in the quarter and completed several licensing agreements, building on its very strong Q1 results.
On a year-to-date basis, FlyLens results reflect its cash flow generating potential and build on its long-term track record for doing so.
In December last year, we announced a strategic review for the YWAM business, and the process continues to move along in accordance with our expectations.
We will announce material developments related to the process in due course.
As we have said previously, while it was a difficult decision to launch a process for YLAN, it was recognized that there may be better alternatives for that business than as part of a public company structure, especially giving Quarter Hills strategic focus on the ITS business.
In closing, we remain very excited with the opportunity in front of us today and are very well positioned on our organic and imminent growth plan.
ITS industry tailwinds are significant and will remain even in a recessionary environment. We have a significant organic sales pipeline in ETS and also very high wind rates.
We have access to strong M&A gill flow and we have leadership team and board experience in ITS and M&A and Finally, we have a very strong balance sheet giving us great flexibility to grow While we have experienced some growth pains related to the RAM for certain new projects with the significant contract wins We have completed in the past two years the lifts off. We're now seeing in certain of our implementation stage projects
and the new project awards that are on the horizon. We believe that our ITS model for revenue growth and margin expansion remains firmly in place.
With that, at this point, I will hand it over to John to talk through the financials.
Thanks, Brett.
Good morning, everyone.
I will start with revenue and take a look at the key consolidated numbers as well as select numbers from our ITS and licensing segments.
Revenue more than doubled for the quarter driven by the addition of the ETC business, which was acquired last September , as well as revenue growth from the licensing business.
As Brett mentioned, backlog at the end of Q2 stood at a record 573 million, with the potential for enhancements and scope expansions to have a multiplier effect on that number.
ITS revenue at $39.2 million was negatively affected by the pandemic.
by approximately 12 million of customer scheduling complications on newly won implementations.
delays in new contract awards.
supply chain and installation slowdowns, and the one-time implementation project we adjusted during the quarter.
But given that these are long-term contracts...
Slower ramp-ups merely shift revenue to the right and don't otherwise impact the contract value.
The value proposition of Quarter Hill is its raft of newly awarded, long-term contracts with prime governmental agencies, some of which we expect to last for decades.
And of course, the company's new project opportunities remain in the pipeline, where we believe they will ultimately be awarded in due course, like the two Brett mentioned in his remarks.
And while we expect it to be a few quarters further down the timeline by now, which has made 2022 a bit of a transition year, as Brett mentioned, things are finally moving forward, and we are forecasting revenue to now start tracking as we continue to ramp up and deliver our portfolio of implementation projects.
Gross margin for Q2 2022 was 13% for Quarter Hill as a whole, compared to 18% last year.
Gross margin for the year-to-date period was higher than in the same period of 2021 due to the strong first quarter of 2022 from our licensing business.
Going forward, we expect gross margins to naturally increase as we move through our wave of newly won ITS projects through the implementation phase.
typically at a lower gross margin, and into operations and enhancement phases where the gross margins are structured to be significantly higher.
Operating expenses for Q2 2022 were up on a dollar basis due to the addition of expenses from the acquired ETC business and, to a lesser extent, inflationary pressures related to personnel and sourcing certain equipment and materials.
Operating expenses for Q2 include $15.1 million of other charges, of which $14.6 million is a one-time charge to settle litigation and arbitration disputes with the former owners of Vizia.
The expense was incurred in Q2 and the payment was subsequently made in the third quarter.
Consolidated adjusted EBITDA for Q2 was negative 9 million.
and positive 70.1 million to date. The significant year-to-date number is due to the strong licensing activity last quarter.
The Q2 adjusted EBITDA for the ITS segment was negative 4.5 and was negatively impacted by approximately 2 million of project award timing, 3 million of supply chain installation delays
$3.5 million from the project we adjusted as discussed earlier, and almost a million dollars of out-of-period costs.
Tracking gross margin, we expect adjusted EBITDA in the ITS segment to improve in the future as we get beyond the period's one-time items and our implementations continue to ramp.
and, longer term, as our slew of new ITS projects mature into their higher margin sustaining operation and maintenance phases.
Porter Hill continues to maintain a strong cash and liquidity position.
Dash generated from operations was $77.8 billion in Q2, and cash, cash equivalents, and short-term investments were $122.9 million at quarter end, compared to $72.6 million at the end of 2021.
Working capital was $138 million at quarter end, up from $105 million at year end.
And long-term debt stood at $48.6 million and recall with a debt repayment of $13.7 million being made in Q2.
Regarding the return of capital to shareholders,
We continued our quarterly dividend payments in Q2.
And on August 10th, the board declared the next eligible dividend of 1.25 cents per share, which will be available on October 7th, 2022.
That would be for stockholders of record on September 9, 2022.
So in closing, as Brett mentioned up front, Q2 was a mixed quarter impacted by delays and a one-time item, none of which undermine Quarter Hill's licensing business.
or the long-term value of its ITS project portfolio. We have organic drivers in place, a healthy M&A pipeline, good business fundamentals both in our ITS and licensing segments, and a very strong financial foundation to support our continued growth initiatives.
This continues my review of the financial results and I'll now turn the call over to the operator for question and answers.
Thank you. As a reminder, to ask a question, please press star 1 on your touch-tone phone.
Now the first question comes from the line of Nicolas Cortelucci of mPartners. Please go ahead.
Nicholas, please go ahead, your line is open.
Morning gentlemen, thanks for taking my questions. I just had a question about M&A. With the war chest you guys have kind of accumulated here with collecting the Apple money, what are you guys seeing in terms of private market valuations for ITS firms? Has things pulled back a little bit? Are you seeing a lot of opportunities out there?
Morning, Nicholas.
Yeah, we are seeing some moderating evaluations. I wouldn't say that it's uniform. I think it depends. Certainly the public evaluations have come down, and I think that is putting some pressure on some of the available assets that we're seeing. So it's moderating it, but I wouldn't say that it's in a uniform way.
Okay.
And then is there any timeline to get something done when it comes to a tuck-in or a bolt-on that you guys are working on?
It's probably, as we've talked about before, very difficult to predict timing with any specificity, but what I can say is that we do remain active M&A. We are looking at a range of different companies at various sizes that all help us with our M&A strategy that we've talked about before, those that will increase scale in the core businesses that would bring specific capabilities to our core business to help maintain technological or other leadership.
Thanks, Nicholas.
Our next question comes from the line up Todd Copeland from CIBC. Please go ahead.
Good morning, everyone.
I was wondering, I think I took these numbers down right, the various adjustments to the adjusted EBITDA totaled, I think just under 10 million, nine and a half million.
Is it appropriate to add all of those back?
So you more or less would have been plus five on an adjusted basis
assuming these are non-reoccurring events, is that your message on that?
What I was trying to do is communicate.
No, go ahead John . I was going to throw it to you. I'm sorry. What I was trying to do is communicate the impact of the non-recurring item, which was the project we adjusted. That was 3.5. Then also lay out our contract base and what the company was poised to deliver but for the delays.
So, not to say that it's technically what should be added back in terms of EBITDA, but to make sure everybody understood the value pieces that were out there and what the company was actually poised to do for the quarter, but for delays in contracts that largely are not in the company's control.
Okay, that's helpful. Not surprising given the nature of the business and the current environment.
How much of that, let's say 10 million?
is likely to carry over as an expense or item.
drawdown on EBITDA, however you want to describe it, in the second half of the year.
Yeah, John , I'll let you continue on with that one.
Apologies. Yeah, so again, these are long-term contracts.
with contracted revenue streams that we're ramping up. So what Brett mentioned was, projects are moving forward again, and we are tracking to get back to where the company, are the run rates that was spoken about in Q4 of 2021, moving into 2022, and we expect to see improvement in the future, and...
we forecast that we'll be back moving closer to where we thought we would be at Q4 by the end of the year. So not to say that any of this is going to reverse next quarter or the quarter after. This is a flow of projects that are improving over time. But that is the magnitude of the EBITDA that the contracts were poised to deliver in Q2. But for the fact that they weren't moving forward as forecast.
Yeah, so if I'm in a...
Yeah, and if I understood the question correctly, I think the, excuse me, as John had talked about, it's really just sort of a shifting to the right of the revenue and the resulting EBITDA that comes with it. Some of this we just expected to be ramped a little bit faster this year. So if I understand the question right, that's the way I would.
Yeah, no, that's right. And then my last question is, as you think about the backlog and then these...
various puts and takes, hoping to get back to the Q4 2022, or get back to the run rate by the end of the year of 2021.
What? What?
Should you grow from that in 2023 or do these headwinds?
Drag into next year as well. Is there any comfort on looking out that far at this point?
I guess I'll say that
You're not not speaking to specifics for 23, but what I would say is that you have this massive backlog that we have Again, which is the contracted piece and doesn't include you know the other you know extensions expansions that Historically ETC has gotten throughout its its 20-year history So it doesn't in doesn't include those but when you when you think about that amount Excuse me the additional
awards that we anticipate, I think we would definitely expect to see a continued upward trajectory on both revenue and EBITDA on a consistent basis going forward. So hopefully that helps a little bit.
And then just last question for me, you know, you've added a lot to your backlog, obviously.
But I think you implied that closing in new businesses seems like it's taking a bit longer as well. Could you just sort of give us a bit more detail on current conditions and ability to build on the backlog from here? And that's it for me. Thanks a lot.
Okay, yeah, thanks, Todd. Yeah, first of all, the pipeline remains enormous. We've been talking about that being in the billions, and it continues to be in the billions. There have been a number of delays and awards, and I will say for various reasons, sometimes it's related to some sort of an upstream project that the agency is maybe experiencing some delays with.
Other times it's just the inner workings of some of these government organizations where there's a lot of different stakeholders involved in the decisions. I will say what we really anticipated this year was a bit more of a speed up to pre-COVID level, call it decision making and award timing. Instead what we're seeing is just something that's a bit more like the delays or the longer sales cycles that we saw.
during COVID. Would anticipate again that that would speed up, but perhaps just it's not doing so as quickly as we anticipated.
But the pipeline remains, again, enormous, and I continue to be proud of the team and the win rates that we are achieving on those that we're bidding on. We consistently get the highest technical scores. We have very differentiated technology. The solutions we have in the field, our customers are very happy with. I remain proud of the teams and very confident about those awards. And it's a
again, just to track to the timing of the customer.
Great. Appreciate the answers. Thanks a lot.
Thank you. As a reminder to ask a question please press star 1 on your telephone keypad.
just a moment to allow you to signal.
Ladies and gentlemen, please press star 1 on your touchtone phone to register for questions.
If there are no further questions in the queue, that will conclude today's Q&A session. Now, I'd like to turn the call back over to Mr. Keith for closing comments. Please go ahead.
Okay, well thank you, Sergi. Thank you again for those that attended today. Appreciate the time and the discussion and look forward to speaking with you all again in the near future and staying in touch in the coming months. Thank you very much.
This will conclude today's conference call. Thank you for your participation. You may now disconnect.