Evertz Technologies Limited

Brian Campbell - EVP, Business Development Anthony Gridley - CFO

Thanos Moschopoulos - BMO Capital Markets Steve Arthur - RBC Capital Markets Anshu Deora - Raymond James Robert Young - Canaccord Genuity

Thank you, Lorry. Good afternoon, everyone, and welcome to the Evertz Technologies conference call for fiscal 2019 first quarter ended July 31, 2018, with Anthony Gridley, Evertz Chief Financial Officer and myself Brian Campbell.

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

I’d like to begin by providing a few highlights and then we will go into greater detail. First off, I’m pleased to report sales for the first quarter fiscal 2019 of $103.1 million, up 11% sequentially from the fourth quarter, driven primarily by strength in the U.S., Canada region, which saw an increase of 15%, compared to the prior year.

Our sales base is well-diversified with the top 10 customers accounting for approximately 51% of sales during the quarter and with no single customer over 17%. In fact, we had 114 customer orders of over $200,000.

Gross margins in the quarter were $58.8 million or 57% of sales. Investment in research and development totaled $21.3 million, reinforcing Evertz’s commitment to R&D.

Net earnings for the first quarter were $17.4 million, up 32% from the prior year. And fully diluted earnings per share were $0.23 in the quarter.

Evertz working capital was approximately $268.4 million with $91.7 million in cash as at July 31, 2018. The purchase order backlog was in excessive $81 million at the end of August and shipments during the month were $41 million.

We attribute the strong quarterly performance to the ongoing technical transition in the industry, channel and video services proliferation, increasing global demand for high-quality video anywhere, anytime, and specifically to the growing adoption of Evertz’s IP-based software defined video networking solutions, Evertz’s IT virtualized cloud solutions, and our state-of-the-art DreamCatcher IP replay and production suite. Today Evertz’s Board of Directors has declared a dividend of $0.18 per share.

I will now hand the call over to Anthony Gridley, Evertz’s Chief Financial Officer to cover our results in greater detail.

Thank you, Brian. Good afternoon, everyone.

Sales were $103.1 million in the first quarter of fiscal 2019, compared to $109 million in the first quarter of fiscal 2018, a decrease of 5%. The U.S./Canada region had sales for the quarter of $75.2 million, compared to $65.4 million last year, an increase of 15%.

International region had sales for the quarter of $27.9 million, compared to $43.6 million, last year. Gross margin for the first quarter was approximately 57% compared to 56.1% in the prior year.

Gross margin was within what the Company considers to be in acceptable range. Selling and admin expenses were $15.9 million for the first quarter as compared to $15.8 million in the same period last year.

Selling and admin expenses as a percentage of revenue were 15.4% compared to 14.5% in the same period last year. R&D expenses were $21.3 million for the first quarter, which represents $2 million or 11% increase from the first quarter last year.

Foreign exchange gain was $1.1 million as compared to foreign exchange loss in the prior year of $8.2 million. The gain was predominantly a result of the increase in the value in the U.S.

dollar, July 31, 2018 when compared to April 30th. Turning to the discussion of liquidity.

The Company’s cash at July 31, 2018 was $91.7 million as compared to $94.8 million at April 30, 2018. Working capital was $268.4 million as of July 31, 2018 as compared to $264.5 million at the end of April 2018.

Company generated cash and operations of $24.2 million, which is growth of $3.9 million change in non-cash working capital in current taxes in the first quarter of fiscal 2019. And the effects of the change in non-cash working capital and taxes are excluded.

The Company generated $20.3 million from operations. Company acquired $2.3 million of capital assets and $10.8 million of marketable securities.

The Company used cash from finance activities of $13.5 million, which is predominantly the payment of the dividend of $13.8 million offset by the additions of capital stock pursuant to the stock option program of $0.3 million. Shares outstanding were approximately 76.5 million and options outstanding of approximately 2.2 million at July 31, 2018.

Weighted average shares outstanding were 76.5 million, weighted average fully diluted outstanding were also 76.5 million for the quarter-ended July 31, 2018. This brings to conclusion the review of our financial results and position for the first quarter.

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

Brian, back to you.

Thank you, Anthony. Lorry, we’re now ready to open the call to questions.

Hi. Good afternoon.

Brian, the August shipments number was obviously very strong. Could you give us some spending environment, was that shipments number reflective of stronger environment or perhaps maybe it’s reflective of a large project that’s underway?

I would say, it’s representative of the demand for Evertz’s IP-based and cloud-based products or our next generation of products are helping the industry leaders transition to IP-based solutions, virtualized cloud solutions filed-based solutions.

But only speaking, have you seen any discernable change in the spending environment now versus 3 or 6 months say, or would you say it’s been very consistent?

It’s reasonably consistent. As you know, we have volatility quarter-to-quarter.

But generally, we’ve seen good solid uptake in the Canada/U.S. region, specifically for the last few quarters.

And the European market has been more volatile for us, up and down.

That was going to be my next question. International revenues, obviously weak this quarter.

So, would you just attribute that to volatility, or is there something else going on in that region?

I would say it’s primarily volatility. What we have done recently now, draw your attention to a couple of our press releases.

So, the tail-end of August, we had press release that Russia’s Channel One has deployed first of its kind UHD and IP-based solutions to cover the FIFA World Cup. There’s a very big project involving two hyperscale Evertz IP-based switches and a whole complement of our products right through the mediator, the asset management, workflow solutions in that transcoding.

So, that’s a very big project that was well-received again too in the international market. And then, just today, again, another press release talking about European cloud playout transitioned at massive scale with over 300 European channels.

And again to that end, it’s both the cloud-based playout, so Evertz’s software solutions on a public provider, Amazon Web Services and also our software defined networking solutions deployed in conjunction whether to an on-ramp off-ramp signals.

Regarding that press release, Discovery has previously talked publicly about working with you in the cloud. Could you clarify whether that’s representative of -- is that the customer in question or is that [technical difficulty] customer that you have now deployment with?

The press release does not detail the customer, and that’s by agreement with the customer. So, I don’t want to go any further than what’s in the press release.

But yes, we’ve had a very successful deployment in the U.S. with Discovery where they migrated their entire U.S.

channel playout to Amazon Web Services. The press release here also talks about supporting cloud-based live event management, again to -- this is a massive deployment.

And you have not seen anyone other than Evertz come with the press releases such as this.

Great. Thank you.

Just a couple things to follow up on the last comment. This cloud migration project in Europe sounds obviously very interesting.

Any color you can add just in terms of this sales cycle and then the project implementation there or how long were those things taking, whether anything else competitively that they look at in the sales cycle? And then, just the nature of the products and services that you deliver [technical difficulty]?

So, projects of this scope and magnitude develop over many quarters, if not years. And the deployment cycle is fairly lengthy as well too.

The revenue…

Go ahead, Steve.

Just the revenue model of it, is this mostly upfront revenue, so as you deliver the services and product, it gets booked or is there a meaningful ongoing component as well?

It’s a combination of all of the above, partially because we do have software-defined networking, IP gateways, transcoding, infrastructure solutions provided along with the cloud-based, virtualized solutions which include the workflow media asset management, can include transcoding as well. So, it could be a mixture of both upfront and ongoing.

It’s probably tough to measure pipeline, but just anecdotally, is the pipeline building and is it getting -- is interest building because of these kind of releases and just general industry awareness of these projects going on?

The pipeline and our -- so, what we do disclose is the backlog right into the pipeline. So, the backlog most definitely has significant components of our new products.

So, the IP-based software defined networking solutions, the cloud playout, whether it’s on-premise, hybrid or public cloud and our IP-based DreamCatcher replay and live production. So, those new solutions have been driving our sales very significantly for quite a while and they do represent a significant component of our backlog.

Just one final one, I think, you mentioned earlier the top customer at 17% or not over 17%. That’s still a big number.

Any color on that program or the nature of that project or is it’s been fully recognized now or is that’s flowing into Q2 as well?

Yes. I couldn’t add much traditional color to it other than give you example.

So, it’s 17% in the quarter. We’ve had that happen in the past several times as well.

Oftentimes, there is preceding quarterly revenue as well too and follow-on. But, when it averages out over a 12-month period or a year, we don’t typically see customers quite that high.

In addition, the 51% for the top 10 is still -- that’s a little higher than we would normally average. We would typically range from the 30% to 50% range of top 10.

Are there any changes in the duration of deliveries or managed services in your backlog?

Yes, definitely. Since our initial public offering, the backlog was primarily delivered in a 4 to 6-week period.

As we’ve -- the business has evolved and we’ve incorporated workflow, media asset management, other bigger projects, like the software-defined networking, the deployment has lengthened. So, we do have some managed services as well too that are not just big projects deployed over multiple quarters, but those can be contracts that are delivered over one, two, three years, sometimes longer.

So, that has changed some of the nature of our backlog duration.

Makes sense. I guess, what I’m trying to get a sense of is, like I understand that the backlogs are quite significantly and that’s definitely what we like to see.

But, does revenue increase in tandem with that, or is…

It’s information in an indicator. How it’s correlated, I would leave up to you.

However, what I would say is that the shipments in the first month are actual shipments. So, that’s a direct correlation to the next quarter’s revenue.

Yes. And I would also add that going back 6 or 7 -- 5, 6, 7 years ago, the correlation between the backlog and the conversion of the backlog was much, much more linear and easier to predict.

But, we are definitely more-lumpy and we do have a mixture of -- we still have products that are delivered in that 4 to 6-week, but we have, like Brian said, products scalable multiple years, multiple quarters, and the weighting will change quarter-to-quarter of how that backlog gets converted. It’s a little harder to predict.

Yes. I guess, -- and that definitely helps.

I was just trying to get a sense of that correlation, whether -- the increase in backlog versus the increase in duration sort of offsets. So, revenue recognized actually increases year-over-year or whether

It’s still going to be a function of the deliverability and project milestones and like I was saying, in today’s environment, there’s a lot more of that and a lot more variability of revenue than we had five years ago when were -- majority of our revenue just recognized and shipping. So now, it’s much more project-driven than it was five years ago.

But, I think, in terms of -- has it changed drastically in the last 6 or 9 months? No, I mean, it’s got more similarities, but it has changed over the last 4 or 5 years.

Hi. Good evening.

Few questions for me. I guess, maybe I’ll start off with a couple of new contenders suggested that they see a pickup in the second half of the calendar 2018.

Are you seeing the same trend? I guess, you can say that the August shipment -- might be a sign back, but are you seeing a stronger environment in the second half?

Obviously fairly consistent to what Evertz has experienced in the past. So, we’ve seen good uptake and traction for and adoption of our software-defined video networking, our cloud virtualized solutions and our IP-based replay.

I can’t speak for the industry in terms of how our competitors are seeing it. But, we’ve got a very good solid backlog again too.

And when you look at the very strong first-month shipments plus backlog, that would be right up there in what, I guess top three total that we’ve had historically. So, well above our two-year average, so that is good strong indicator.

Okay. And Steve asked this question, I just want to make sure I understand the answer correctly.

But, was there any push and pull of revenue into put forward or delayed into August that made August such a big revenue number?

I guess, there is every quarter and every month. So, a lot of the projects -- actually there are, as you probably know new revenue recognition standards.

So, there is going to be discontinuously pulling in and out of quarters. I think it’s more going back to my answer on how to convert backlog to revenue, it’s a much tougher proposition and the revenue flows are less linear than they were 5 years ago.

Okay. And then, if I go back historically, it seems as though, Q3 is the quarter where you have outsized large shipment number.

And so, this seems bit earlier, and so would there -- that’s where I’m getting. Is this happening earlier in the year or are you seeing a stronger trend, I guess that’s the basic thing I’m trying to get at?

I wouldn’t extrapolate it to trends, it just happens from time-to-time where we have lumpier quarters. And revenue occurs when we have either delivery of products, and that can be dependent upon customers’ readiness for deployments, either their facilities or just timing of others things that they want to cycle in.

So, we’re -- we really do recommend that you look at us on a trailing 12-month basis rather than simply quarter-to-quarter.

Yes. And internally, like we’re even seeing monthly revenues fluctuate quite a bit more than they ever did.

So, even month-to-month, we can have really, really strong months and then more average months, and it really does fluctuate on deliveries.

Right, okay. And the press release that you’re talking about with the shipment migration into the cloud with the European customer.

Is it a European customer, like should we expect to see it in the Europe numbers or will that be a U.S. customer expanding in Europe?

It’s a European channel line-up.

Okay. And was that recorded in revenue already or should we expect that in the future, or would this be part of the $41 million of shipments in the August figure?

So, part of it would have been deployed. And because it’s already on air, so, of the year September 11th date, the transition is completed and it’s on air.

So, even when we go to air, that doesn’t mean that the revenue recognition stops roughly, but it’s a good indicator that revenue has been accounted for in prior quarters because something of this scale is a significant undertaking.

Okay. And so, this large single customer, 17%, would that -- would it be the same customer or is that what drove the large…

I’m not going to draw that linkage. So, they’re independent pieces of information.

Yes. I guess, what I’m trying to get at, so you’ve got a large customer in the quarter, you just reported you’ve got a large shipment number in the August month.

And I’m trying to calibrate what drove that. Should we assume that the announcement here with this 300 lineup of channels, is it -- it’s already been -- the bulk of it has already been recognized.

It’s not an either one of those figures.

So, Robert, what we’ve said is it’s deployed. So, it’s on air, and it would have been deployed over multiple quarters.

But that’s not to say that there isn’t ongoing revenue associated with it.

Absolutely, I understand that. Okay.

Then, maybe I’ll shift gears, talk about gross margins. You have to go back to 2016 to see a point where you’re above 57%.

And so, is that a function of the product mix or is it North American mix that drove that or is there an FX component? Can you give a sense of why that might have been higher than in past, even though it’s inside of your guided range?

Yes, I can try. There’s, honestly, we are in the range we want to be so.

So, there hasn’t been certainly a ton of analysis done on why we’re right within our range. And, but yes, I mean, the international was definitely lower, the North American’s higher, and that generally has a somewhat positive impact.

But, again, that can change. There are quarters where we have international business bucks those odds and does even better.

So, it’s really -- it’s geographic mix, product mix, it’s really a bunch of functions. And really, we’re talking about a change of like, half a percent.

So it’s going to change and fluctuate.

Okay. And last question for me…

So, as Anthony was saying to Steve, geographic, mix when you look at it, you’ll see that the U.S./Canada region accounted for 66%. So, that’s higher than normal.

Yes. And that would -- in the past, I would have attributed that to the fact that you go directly to customers in North America more often than you do internationally.

And so, would that be a factor? Or the thing that causes me some pause there is that you’ve also got this piece of growing recurring and software revenue, which might be higher margin.

So, I’m trying to figure those two pieces out.

You are correct. The growing software and recurring streams are higher margin, and that is a component of it.

Yes.

In the press release, you talked about over the top or cloud-based live event broadcast. And so, maybe just sort of backup for a second and talk about whether that’s a positive or a negative overall trend for Evertz because live events broadcast is a big part of, my understanding of your business.

And I’ll pass the line.

It’s positive for us. With the Discovery deployment in the U.S.

as well too, you’ll note that Discovery had noted that it also provided live event playout, which they were quite happy with. So, Evertz’s been very successful deploying the playout, but including cloud-based live events.

So, that is something that we haven’t seen other significant press releases of any scale.

Okay. So, what you’re trying to say is that you’re a leader in that space or see yourself as a leader in that space?

Definitely.

Thank you, Lorry. I’d like to thank the participants for the questions and to add that we are very pleased with the Company’s performance during the first quarter of fiscal 2019, which saw strong sales growth in the U.S./Canada region, resulting in an 11% sequential sales increase, totaling $103.1 million in the quarter.

Solid gross margins of 57%, which together with Evertz’s disciplined expense management, yielded a 32% increase in earnings to $0.23 per share. We’re entering second quarter of fiscal 2019 with significant momentum, fueled by combined August shipments plus purchase backlog totaling in excess of $121 million, up 10% year-over-year.

By the growing adoption and successful large-scale deployments of Evertz’s IP-based software defined video networking and virtualized cloud solutions by some of the largest broadcast, new media service providers, 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 moment in investments in software defined IP, IT virtualized cloud technologies, industry leading deployments and the capabilities of our staff, Evertz is poised to build upon our leadership position. Thank you.

And we look forward to having many of you join us on the 10th of October at our Annual General Meeting. Good night.