Evertz Technologies Limited

Anthony Gridley - CFO Brian Campbell - EVP of Business Development

Thanos Moschopoulos - BMO Capital Markets Robert Young - Canaccord Genuity

Thank you, Quinn. Good afternoon, everyone, and welcome to Evertz Technologies conference call for fiscal 2018 second quarter ended October 31, 2017, with Anthony Gridley, Evertz' Chief Financial Officer; and myself.

Please note that our financial press release and MD&A will be available on SEDAR and on the company's Investor website. Anthony and I will comment on the financial results and then open the call to your questions.

First, I would like to begin by providing a few highlights and then Anthony will go into greater detail. I'm pleased to report sales for the second quarter totaled $101.3 million, up 2% from the prior year.

This increase was driven predominately by the adoption of new technologies and products and by strength in the U.S. Canada region, which had sales for the quarter of $66 million, an increase of 6% from the prior year.

Our base is well diversified, the top 10 customers accounting for approximately 57% of sales during the quarter with one customer representing approximately 18%. In fact, we had 91 customer orders of over $200,000 in the quarter.

Gross margin in the quarter was $56.8 million or 56% of sales, which is within our target range. Investments in research and development during the quarter totaled $20.2 million.

Net earnings for the quarter were $17.4 million, while fully diluted earnings per share were $0.23. Evertz working capital was $270.5 million with a cash position of $54 million as at October 31, 2017.

Operational highlights for the second quarter include Evertz's public cloud playout solution winning a prestigious IABM Design and Innovation Award and Evertz's assistance in the completion of Discovery Communication's move of the U.S. network playout to the public cloud.

At the end of November, Evertz's purchase order backlog was in excess of $69 million and shipments during the month were $38 million. We attribute this solid quarterly performance and strong combined shipments and purchase back order or purchase order backlog to ongoing -- the ongoing technical transition channel and video services proliferation, the increasing global demand for high-quality video anywhere anytime and specifically to the growing adoption of the Evertz's IP-based software defined networking solutions or state-of-the-art DreamCatcher IP replay and production suite and Evertz's IT and virtualized cloud solutions.

Today Evertz's Board of Directors declared a quarterly dividend of $0.18 per share payable on December 29. I'll now hand over to Anthony Gridley, Evertz's Chief Financial Officer to cover our results in greater detail.

Thank you, Brian and good afternoon, everyone. Sales were $101.3 million in the second quarter of fiscal 2018 compared to $99.6 million in the second quarter of fiscal 2017.

This represents an increase of $1.7 million or 2% quarter over quarter. Sales were $210.3 million for the six months ended October 31, 2017, compared to $186.6 million in the same period last year.

This represents an increase of approximately 13%. The U.S.-Canada region had sales for the quarter of $66 million compared to $62.3 million last year, which represent an increase of $3.7 million or 6% quarter over quarter.

Sales in the U.S.-Canada region were $131.3 for the six months ended October 31, 2017, compared to $114.4 million in the same period last year, represents an increase of $16.9 million or 15%. The international region had sales for the quarter of $35.3 million compared to $37.3 million last year.

The international segment represents 35% of total sales this quarter as compared to 37% in the same period last year. Sales in international region were $78.9 million for the six months ended October 31, 2017, compared to $72.2 million in the same period last year.

This represents an increase of $6.7 million or 9%. Gross margin for the second quarter was approximately 56.0% and within the company's historical range.

Gross margin for the six months ended October 31 was approximately 56.1%. Selling and admin expenses were $16.0 million for the second quarter, increase of $0.7 million from the same period last year.

Selling and admin expenses as a percentage of revenue were approximately 15.8% this year as compared to $15.3 for the same period last year. Selling and admin expenses were $31.9 million for the six months ended October 31, 2017, an increase of $1.7 million from the same period last year.

For the first two quarters, selling and admin expenses as a percentage of revenue were approximately 15.1% as compared to 16.2% for the same period last year. R&D expenses were $20.2 million for the second quarter, which represents a $2.4 million increase from the second quarter last year.

For the year, R&D expenses were $39.5 million, which represent increase of $4.2 million over the same period last year. Increase in R&D spending were predominantly due to planned growth of R&D personnel, necessary to address new opportunities to acquire technologies.

Foreign exchange for the second quarter was a gain of $2.9 million when compared to a gain of $3.5 million over the same period last year. The gain was predominantly a result of the increase in the value of the U.S.

dollars since July 31, 2017. Foreign exchange for the six months ended October 31, 2017 was a loss of $5.4 million when compared to a gain of $10.1 million over the same period last year.

The loss was predominantly a result of the decrease in the value of the U.S. dollars since April 30, 2017.

Turning to a discussion of the liquidity of the company. Cash and cash equivalents as of October 31, 2017 were $54 million compared to $54.3 million at April 30, 2017.

Working capital was $270.5 million at October 31, compared to $264.6 million at the end of April 2017. Looking now specifically at the quarter ended October 31, 2017, the company used cash and operations of $2.8 million which is net of the $22.9 million change in noncash working capital.

The effects of the change in noncash and working capital and current taxes are excluded. The company generated $20.1 million cash from operations for the quarter.

The company acquired capital assets of $2.5 million as well as purchased of the remaining noncontrolling interests of our subsidiary company ATCI for $1.7 million. The company used cash and financing activities of $12.2 million, which was principally driven by the payment of dividends of $13.7 million offset by the issuance of capital stock pursuant to our stock option plan of $1.6 million.

Finally, I will review our share capital position at October 31, 2017. Shares outstanding were approximately 76.2 million and options outstanding were approximately 2.4 million.

Weighted average shares outstanding were 76.0 million and weighted average fully diluted shares were 76 2 million for the quarter ended October 31, 2017. This brings to a conclusion of the review of our financial results and position for the second quarter.

Finally, I'd like to remind you that some of the statements presented today are forward-looking subject to a number of risks and uncertainties, and refer you to the risk factors described in the annual information form and official reports filed with the Canadian Securities Commission. Brian, back to you.

Thank you, Anthony. Quinn, we're now ready to open the call to questions.

Hi. Good afternoon.

The customer concentration was higher than usual this quarter and I realize that can be a very volatile metric depending on specific projects, but maybe as a broader question, are you seeing any change in average deal sizes given the IP upgrades that you're involved in? Or are deals getting larger in some cases or is it quarter sort of just volatility?

To Thanos, it's a little bit of both. Historically we have been at the forefront of some pretty significant projects that have often run the course over several quarters and this quarter as you can tell, we do have some concentration now that it does represent less than 10% on a year-to-date basis or outside of the 18% customer concentration you still have significant orders in the quarter as you can tell with 10% being 57% of the revenue base.

So yes, we are seeing significant interest and big projects attached to the software-defined networking IP and virtualization work that we're doing to help our customers in their technical transitions.

Okay. And on the IP front, can you comment on what you're seeing as far as pipeline, the growing level of adoption there and any developments or changes, the competitive landscape on that front?

So, we continue to see very significant traction, the latest count we had spoken of having over 100 software-defined networking deployments around the world and those include some of the biggest deployments in the broadcast, new media and other segments as well to in fact it's branched into AV as well. So, we're seeing very significant interest and continued interest.

Okay. And I guess finally, you mentioned AV, so any update you can file on that front in terms of the growth and the development of that part of the business?

That part of the business continues to go very well. Our customers have not press released the activity to the same extent that you see the press release and with our new media entertainment broadcast customers.

Okay. Maybe just one final one for Anthony, if we look at the gross margins of last four quarters of your range?

I realized that metric can be volatile as well given revenue mix, given geographic mix. But as we look out going forward, should we presume that it will like to continue to stay towards the bottom end of your range or is there any reason to think that it might start to creep up backup?

Well in the past quite number of quarters it's in the bottom half of that range I guess and I guess we're comfortable with that range being where it is where we're hoping it will shift up a little bit, but you added a bunch of factors. I think another factor would be deal size that can affect margin as well.

So sometimes good, sometimes positively, sometimes negatively, but there's a lot of moving parts with gross margin. A lot of dynamics, some of the software stuff as positive.

Some of the other things are a little bit more negative.

Great. Thanks all.

I'll pass the line.

Hi. Good Evening.

I was hoping to ask about the one large customer that was 18% of the remaining in the quarter. You said last quarter that the $10 million order you received in August was expedited.

So can I assume that that's one and the same and is there anything remaining in that $10 million order? Did that all fall into Q2?

So, Robert, yes. We did announce press release that we received purchase orders in excess of $10 million and did mention the fact that it was expedite.

So that is ongoing again to we have a further press releases, which conceded with the 18% in this quarter and that's a pretty significant shipments of products. And yes, they are primarily with our software-defined networking and our IP-based solutions.

Okay. Is there anything left of that $10 million or would that still be in the backlog?

Our customers very frequently continue to purchase after significant purchases. So, you'll see the same customers over and over again in our top 10 and regularly in our customer list.

So yes, this customer will be an ongoing customer, has been a long-standing customer.

Okay. Another item, the deferred revenue remained above $30 million.

It's up about 70% year-over-year, stay at a pretty high level and so I was wondering if you could talk about what the driver there? You have two consecutive quarters where that's been at a high level.

Yes, I can try that one. I think it's the nature of how our business is evolving.

A lot of the deferred revenue is driven from project space, projects where there is ongoing work or acceptance targets that have to hit and we expect that it's fluctuating, but it is a growing part of our business. Going back a number of years where we're mostly -- we're shipping products and that type of business has evolved to more of a project-based and not every project goes in and out in the quarter.

So, there's more different elements of revenue and in general, revenue deferrals are -- the standards are a bit stricter than they were five years ago too. So, we have a little bit more deferrals just following accounting principles.

And it's also tracks increasing software.

That's due to software projects.

Right. And would that software would be on a term license or a subscription license or like a recurring revenue?

Could be some of that or it could be like an ongoing project where there is a performance element and we're deferring the revenue until we have the final performance target.

Okay. And then inventory, the same question I guess it's also remained at a very high level.

Can you talk about where -- why that's up, where it isn't -- is that going to come down? What's going on there?

Hopefully overtime it will come down. It's been fairly flat and not increasing after having increased for a while.

So, I'm hoping it's coming down a little bit. It came down a little bit this quarter.

But in general, a lot of products we have are fairly expense to build and it's expensive inventory.

Right and is that a reflection of larger projects that you just are staging in your facility this quarter?

Certainly, the finished goods, we don't break out our finished goods [and what's there] be every quarter. But certainly, when you look at our year-end, you'll notice that the finished goods and the work in process have gone up over the last say four or five years and that is a function of yes, projects building more stuffs, staging more stuff as opposed to going back more than five years ago where we built it and shipped it -- we built and shipped it out.

So now there is more impact for sure. So, the composition of inventory in terms of raw materials hasn’t increased substantially really over the last four or five years.

It's stayed similar.

Okay. Just a couple more for me, since you mentioned Pro AV or the component, you're seeing some software-defined video networking orders there, is there the potential for the Pro AV business to be as large?

Are the -- can the orders be as large there as they are in the broadcast business?

We've deployed hyperscale switching in numerous of the AV installs. So, we're generally targeting significant high-end AV application as this stage.

So, our early entries are with key higher education, enterprise -- global enterprise folks in the financial electronics industry and government as well too. So, they are -- they can be quite significant multimillion dollar deployments.

Okay. Great.

If you could maybe two questions about the -- you said over 100 deployments of software-defined video networking, just maybe a quick definition like how would you compare like IP deployments to software-defined video networking? Would that -- is software-defined video networking a subset of IP deployments or the other way around?

And if you could talk a little bit about…

We're speaking of the over 100 deployments those are IP deployments, software-defined networking IP deployments. So, both that encompasses hyperscale and some of our customers have deployed the equivalent to hyperscale switching with our modular products.

So, our modular switching in the multi-gigabit per second switching capacity, which you can hold in hand.

Okay. That's helpful and last question for me would be about just the pipeline backlog is down a little bit this quarter.

Could you just talk about the pipeline that you see in SVDN and IP over the next year or so? Is it continued to grow or should we think of it positive and I think you've talked or others have talked about some pause for architectural decisions hear?

Can you talk about how you see that pipeline developing, that would be helpful and I'll pass the line?

So, our backlog and actually thanks Rob, it's a very good question. We're at the combined 107, actually that's the average position that we have had.

It's been up and down depending on the timing. Currently were in the throes of quoting numerous large-scale projects.

So, we are very enthused by the opportunities that we see for the software-defined networking and our IP base production replay and our virtualization solutions of taking products to the public and private cloud. So, there's that trends opportunity that we see.

Great. Thank you.

I'll pass the line.

Thank you, Quinn. I'd like to thank you participants for the questions and add that we're very pleased with the company's performance during the second quarter, which saw strong sales of $101.3 million, in particular strength in the important U.S.

Canada region where sales rose 6% from prior year. Solid gross margins of 56% in the quarter, which together with Evertz's disciplined expense management yielded net earnings of $0.23 per share.

We're enthused by the momentum we carry into the second half of fiscal 2018, which is fueled by a combined purchase order backlog plus November shipments totaling in excess of $107 million, by the growing adoption, successful large-scale deployments of Evertz's IP-based software-defined networking and virtualized cloud solutions, by some largest broadcast, new media service provider and enterprise companies in the industry and by the continuing success of DreamCatcher, our state-of-the-art IP-based replay and production suite. With our significant investments in software-defined IP, IT virtualized and cloud technologies, industry-leading deployments and the capabilities of our staff, Evertz is poised to build upon our leadership position as a leader in media and entertainment technology solutions.

Thank you everyone and good night.