Lucas Skoczkowski - CEO David Charron - CFO

Michael Urlocker - GMP Securities Steven Li - Raymond James Robert Young - Canaccord Genuity

Great, thank you. Good morning, everyone and welcome to Redknee's third quarter conference call.

I'd like to draw your attention to Slide 2 of our presentation, where we have outlined company disclaimers and cautions regarding forward-looking statements. I am Lucas Skoczkowski, Redknee's Chief Executive Officer, and joining me on today's call is our Chief Financial Officer, David Charron.

Today, we will be discussing the results for the third quarter of fiscal 2015, which were issued after the close of market yesterday. The press release and accompanying financial tables are available in the Investor Section of our website.

If you haven't done so already, I encourage you to download the presentation, which provides further analysis of our quarterly results. David and I will be referring to this presentation during today's call.

Following my opening remarks, David will review our financial results and then I will return to give an operational update before we open up the call to your questions. During the third quarter of fiscal 2015, we have made solid progress growing bookings, adding new customers, while our revenue was impacted by software license lumpiness that is coming from our telecomm software market.

We have begun to see the benefits of the cost structure realignment program that we have implemented last year and moving focus on the profitability, cash flow generation and growing our current revenues. Revenue in the third quarter came in at $46.7 million declining over prior year quarter as a result of the impact of foreign exchange variations, lumpiness in software license sales, and delays in customer usage making and pending reductions.

More importantly, gross margin was 67% of revenues in the quarter; this resulted in an adjusted EBITDA of $5.3 million, or 11% of revenue. Given the quarterly lump in each of our business, on trailing 12-months is most of the timeframe to view our results.

On interim basis, we had revenues of $224 million with gross margin of 59% and adjusted EBITDA of $32.5 million or 50% of our revenues. This was in line with our objectives to drive improvements in business as we have been discussing over past four quarters.

Our focus remains on revenue quality, and we've made progress and continue to drive towards software model which minimizing low or negative margin items from our top line. Recurring revenue in the quarter was 53% of total revenues, or $24.6 million and we expanded the final former Nokia customers will roll-off of our platform by end of this year, which as mentioned during our last conference call, should not account for more than 5% of our current quarterly rate.

We do expect to increase our recurring revenues with both support revenues and term licenses as we enter fiscal year 2016. Our order backlog at the end of the quarter was at $163 million, reduced year-over-year by impact of foreign currency exchange.

Cash at the end of the quarter was at $103 million, specifically isolating for the fluctuations in foreign exchange rates on a constant currency basis, adjusted Q3 revenue have been $51.7 million and recurring revenues of $27 million. Applying the same principle, our order backlog would otherwise have been at $174 million.

I'll provide a more detailed operational update in a few minutes. However, first, I would like our CFO, David Charron, to walk you through the financial results for the quarter.

David?

Thank you, Lucas and good morning everyone. I would like to spend the next few minutes summarizing our financial performance in the third quarter of 2015.

Please note that 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 in functional currency. Now, on to our results, overall total revenue for the third quarter declined 27% to $46.7 million from the $64 million in the same year ago quarter.

The change in revenue resulted mainly from the impact of foreign exchange variation, as well as a roll off of legacy support contracts we discussed previously. As Lucas mentioned, if we were to isolate the impact of foreign exchange rates, our total revenue would have been $51.7 million.

Recurring revenue which we define as revenue from support maintenance agreements, term based product licenses and long term service agreements was $24.6 million or 53% of total revenue in the quarter as compared to $32.9 million or 51% of revenue in the same year ago quarter. On a constant currency basis, recurring revenues would have been $27 million or 52% of total revenue.

Gross margin was strong at 57% as compared to 44% in the same year ago quarter. Adjusted EBITDA was $5.3 million in the quarter or 11% of revenue compared to an adjusted EBITDA loss of $3.2 million or 5% of revenues in the same year ago quarter.

As presented in the reconciliation of net income to adjusted EBITDA in our press release, the Q3 2015 net loss includes $4.5 million of cost linked directly to the finalization to the open items to the Nokia BSS purchase agreement of $3.7 and $0.8 million of costs incurred in the overall acquisition. It also includes the $0.6 million in costs related to the restructuring plan and $1 million in gain due to the impact of foreign exchange rates in the period.

Net loss for the quarter was $5.6 million or $0.05 per share compared to a net loss of $6.9 million or $0.06 per share in the same year ago quarter. Moving on to the next slide, looking a little more closely at revenues for the quarter, we saw software and services revenue decrease by 23% to $21.5 million or 46% of total revenue from $28 million or 44% of total revenue in the prior year quarter.

This decrease is mainly result of lower software and services revenue on the EMEA region and the impact of foreign exchange rates. Breaking down the software and services revenue further on Slide 5, we see that in the current quarter our estimated split for revenue was $10.8 million for software licenses compared to $16 million in Q3 of fiscal 2014.

In comparison to this quarter's software license revenue of $10.8 million to the previous fourth quarter average of about $17 million illustrates the quarterly lumpiness in the software license revenue that Lucas mentioned earlier. Services revenue decreased about 11% to $10.7 million or 23% of total revenue, and this compares to $12 million or 19% of revenue in Q3 of fiscal '14.

Support and subscription revenue decreased to $21.7 million or 47% of total revenue, and this compares to $32.8 million or 51% of total revenue in the same period last year. This decline was in line with our expectations and primarily caused by lower support revenue on the EMEA region as a result of the non-renewal of certain support contracts.

Sales of third party hardware and software components in the quarter increased slightly to $3.4 million or 7% of total revenue from $3.2 million or about 5% of total revenue one year ago. Now excluding for the impact of foreign exchange rates, on a constant currency basis each of the revenue items would have been as follows; software and services revenue at $24.2 million, support and subscription revenue at $24 million, and third party hardware and software revenue at $3.5 million, recurring revenue would have therefore been at $27 million, and our order backlog would have been $174 million.

The next slide looks at our trends on gross margins which has improved in the quarter to 57% of revenue, primarily as a result of lower compensation cost, a reduction in third party cost the, and the impact of foreign exchange fluctuations. On a trailing 12-month basis our gross margin is now at 59% of revenue which reflects the positive progress we're making on transitioning into a software business model.

During the quarter, total operating expenses adjusted to exclude amortization, stock compensation and acquisition or restructuring cost was $21.3 million or 46% of total revenue compared to $31.1 million or 49% of total revenue a year ago. In general, OpEx reduction are a result of the positive impact of our restructuring efforts we announced one year ago, as well as the impact of foreign exchange rates on costs.

Now I would like to discuss each of the OpEx lines separately. First, sales and marketing costs totaled $8 million, a 12% decrease over the same period last year.

As a percentage of total revenue, sales and marketing expenses were 17%, up slightly from the 13% one year ago. While increasing as a percentage of total revenue, sales and marketing costs decreased in total dollar value as a result of lower compensation costs and foreign exchange impacts.

General and administrative costs decreased 36% to $5.8 million in the quarter from $9 million in Q3 of fiscal 2014. As a percentage of revenue, G&A expenses decreased to 12% from 14% of revenue.

Excluding stock compensation and amortization, G&A cost decreased 46% to $3.6 million or 8% of revenue in the quarter from $6.8 million or 11% of revenue in Q3 of fiscal 2014. The decline in G&A cost is mainly due to the realization of post-acquisition synergies, the impact of FX rates and a onetime allowance for accounts of $1.3 million in the third quarter one year ago.

R&D expenditures decreased to $11.2 million compared to $16.8 million for the same period last year. As a percentage of revenue, R&D expenditures decreased to 24% compared to 26% in the same period last year.

The decline was largely a result of the impact of our restructuring plan, the impact of foreign exchange rates, in addition to the reduced use of external sub-contractors which is a major focus area for us as we have discussed on previous results calls. Total cost related to the acquisition in the quarter was $4.5 million compared to $0.6 million in the same year ago period.

This includes the final settlement agreement of open items signed with Nokia amounting to $3.7 million in addition to the legal professional fees related to the acquisition of Orga Systems, $0.08 million. With this agreement with Nokia, we have finalized on an earn out amount of €13.6 million or $15.7 million versus the potential amounts of €25 million or about $28 million.

Last year we've capped in quarters on a number of open items with respect to that purchase agreement that are now behind us, so we feel this is a lean run from our perspective. Next, I'd like to update you on our Normal Course Issuer Bid, NCIB, under which we were able to purchase up to $9.4 million common shares.

The NCIB commenced on June 3, 2014, and terminated on June 2, 2015. Now at June 30, 2015, we had not purchased any common shares under this NCIB.

Next, I'd like to turn your attention towards some specific balance sheet items that we reported in the quarter where overall growth into the progress we've made on strengthening the balance sheet. Cash and equivalents including restricted cash totaled $103 million at the end of the quarter.

More importantly, cash generated from operations was $5.3 million excluding the cash used separately for the previous announced restructuring. Trailing fourth quarter basis, excluding restructuring, we generated $36 million of cash from operations.

We've made good progress on accounts receivable – or accounts receivables declined 18% from $74.9 million in Q2 to $61.6 million at Q3 fiscal '15. As a result, our day sales outstanding decreased to 100 days compared to 113 days we reported at last quarter end and is in line with our target between 100 to 110 days.

Unbilled revenue increased from $30.7 million in Q2 of 2015 to $35.3 million in the current quarter, by decreasing 17% from the $32.4 million as of September 2014. As well, deferred revenue decreased slightly by 2% at $0.4 million to $20.1 million from $20.5 million.

Overall working capital decreased 13% to $112.2 million from $129.4 million as of Q2. Our order backlog was $162.6 million versus $157.2 million as we look forward in Q2 of this year.

Another $162.6 million backlog, approximately 65%, is expected to be recognized as revenue over the next 12 months with the remaining 35% to be recognized afterwards. Subsequent to the end of the third quarter on August 1, 2015, we've entered into an agreement to expand our existing credit facility increasing the revolving line of credit to $40 million and increasing the term loan to $60 million for our total credit facility of $100 million.

This will provide us with a strength in the balance sheet and the financial flexibility to allow us to continue to pursue our strategic initiatives. This completes my financial summary.

And now let me turn the call back over to Lucas for his operational update.

Thank you, David. We feel it is important to review our financial results within the context of our overall growth strategies.

Here, I will update you on three main areas; our recent acquisition of Orga Systems, I'd like to also discuss our short term management priorities, and standing on our long term growth strategy. With regards to acquisition of Orga Systems; first, we are pleased that we had closed the acquisition at the end of July.

We are encouraged by the feedback from employees, partners and key customers who all have been very supportive and acceptive towards this acquisition. Orga portfolio of real time software product and consultant services have been designed for living in a connected world.

It is utilized in telecom and non-telecom industries including any suppliers, companies and car manufacturers. Long term capitals include America Mobiles, Talent, Avaya, BMW, Telecom Group and Mirare [ph], Philippines.

By positioning for Orga when positioned in its existing market and provides foundation to pursue additional opportunities within the internet of markets. Our combined company had a comprehensive product suite, addition of real time [ph] as intangible, catalog and order management.

We anticipated this transaction will enable Redknee to expand our reach into growing markets of ILT motivation. We see great opportunity to make this transaction accretive in fiscal 2016 by securing recurrent revenues, driving cash flow and EBITDA while integrating within revenue.

We expect that the integration should be completed by the end of second quarter to fiscal 2016. With regards to our short term management priorities, as previously discussed we see a significant opportunity to continue to build value for our shareholders.

Prime [ph] is our number one, continue to drive software business model margins. Number two, contain disciplined costs management.

And number three, continue to drive cash flow generation. During the third quarter, we continue to progress steadily towards achieving these.

Number one, on the software business model we have made progress by improving the trailing 12 months base as the gross margin which is now at 59%. We look to continue to drive gross margin improvement while growing our recurring revenues.

On the disciplined cost management, we continue to execute on the program that we have announced last summer with a recent acquisition; we see that this opportunity will build our cost structure and look to do so once we integrate and stabilize acquired customers. Number three, on cash integration, on a trailing 12-month basis we have generated $36 million of cash from operations.

We look to continue to improve here by focusing on working capital optimization and disciplined corrections. Finally I would like to provide you with an update on our long term growth strategy.

Our long term strategy is comprised of three main elements, which build up on the short term objectives we described earlier; number one, continued evolution of our business critical software product offering. Number two, market share growth and leadership in our served addressable market.

And number three, an increasing proportion of sustainable recurring revenues. So expanding here, on the product offering front, in the quarter we continue to announce secured contracts for our core telecom business, as well as for Redknee connected suite.

Furthermore with Orga acquisition, completed we are spending our product portfolio to just – we suggest product from catalog, order management and system etcetera, as well as expanding our non-product offerings, restricted energy billing, water utility billing, automated connected car etcetera. On expanding our market share and leadership, with our acquisition, we are currently deployed with approximately 250 service providers.

We have added three new customers, organically in the quarter while adding approximately 45 new customers through the acquisition. With a continued consultation with both service providers and vendors, we are emerging as the clear operator for the legacy solution providers for the real time amortization and customer care.

Despite longer customer cycle, we do expect that the current trends would create additional opportunities for us to acquire new customers on a coming 12 to 24 months. Finally on number three, on the sustainable recurring revenue front, our recurring revenues primarily comprised of term licenses, cloud services, and support services that together in a quarter comprise of $24.6 million or 53% of revenue.

As discussed anticipated decline in recurring revenue relates to the specific former not-same customers that have made the decision to move off the platform prior to Redknee's acquisition of Nokia network BSS asset. We expect to start building up downturn revenue organically as we enter fiscal 2016, adding recurring revenues from Orga Systems transactions, as well through future disciplined acquisitions.

In summary, we continue to execute on our plan. We are building strong quality revenue streams, improving gross margins and EBITDA margins.

As well, we had acquired Orga Systems to further strengthen our operating and accelerate our expansion to the growing market for IOT monetization. Before opening up the call for your questions on behalf of the entire management team, I would like to say thank you for the continued support from our employees, our partners, our customer base as well as our shareholders.

Now with that, we are ready to open the call for your questions. Operator, please provide the appropriate instructions.

Good morning. Thanks for taking my question.

Lucas, I wonder – if we look at this, it seems like there is a shortfall in the software license sales, well below the recent average, David described it. Can you help us understand two things, one, has any cancelled or signaled to you that they no longer want to continue with Redknee?

And two, what's the reason for the shortfall?

Okay. So I think, number one, I think Michael the question – number one, we haven't lost any – no customer has signaled that they will not pursue our platform.

So I think that's very good news, I think it's in line with our trend of retaining customers. Number two, hadn't lost any major transaction that we consider to the revenue license decline in the quarter.

The cause has been really that a couple of customers through the corporate decided that they will effectively lower and won't interfere license expansion that they were otherwise planning in the quarter and there was good to there on internal plans, as well as some of the cost reductions that they are pursuing in their business. This approximately became only visible for the later part of the quarter which will give us room to actually react.

I am disappointed, my view has been that we will drive you with – our cadence in average run rate for our software licenses, anything – everything Orga has been vacating in line. And we continue to add new customer as well.

So, is that helpful Michael?

Yes, it's helpful. So, certainly the cost controls are good.

Do you think that you have to change anything in terms of the value proposition or the sales effort to regain a stable software sales?

I didn't mention of our business – our customers are preferring in the software, they will continue to look at driving cost efficiency in their business and perhaps look at upstream when and how they purchase software licenses. Do we have to look at what we do, obviously we continue to innovate, it's always product offering which continues to be both relevant and comparative, and we do need to continue to also broaden our customer base.

I think we added three new customers or three new levels this quarter that's kind of oversized software in the fiscal year, some encourage there. And I think from our perspective is, we need to continue to create more – continue to grow our pipeline as we had been and just to make sure that we are not exposed to any sort of customer and lower the lumpiness in our license business as there is low recurring revenue.

So I think those things are clear to us, we're going to exit on them. We're obviously, I'm concerned to the point in the fact that this has happened but also glad that we head the right cost base and company to have robust order to make sure that we can continue to drive the business forward.

Okay, thank you. I also have a question that's related to a balance sheet item.

So if we look at deferred revenue, it's come down just marginally in each of the past three quarters. I just wonder if David, you can describe what's going on with the deferred revenue account.

Yes, so deferred revenue, Michael, really amounts to support contracts that we invoice. And as I mentioned on previous calls, our plan is over the longer term is to improve how we're invoicing our customers, mostly try to move into an advanced billing, advanced invoicing overtime.

We've inherited a lot of contracts from previous acquisition. And fortunately we had terms that well, I call very customer friendly, we're gradually changing that, but we haven't made as much progress on that as I would have want, look to see that improved over the next 12 months.

Okay, thank you. I do appreciate that collections were strong and there has been a good sustained effort there.

Thank you.

Great, thank you, Michael.

Thank you. Lucas, although it looks like a very good fit for you guys.

So that means we should not see much disruption, so put that other way, Orga revenue should be stable year-over-year?

I think – to me, I'm cautious, our revenue was number one, it's an H1 acquisition, we had very good meetings early this week with our employees, and I do see quite a discussion over the last 12 weeks with customers. So I do feel overall very positive.

On the revenue side, we will provide more color by when we issue the bar report. I do feel confident in recurring revenues, and I just need to see how we – flush out all the different license revenues, what has been done over the last few years by Orga, and then how this flows with our tender [ph].

Having said, they also want – do have a strong pipeline, some of the customers have been with them for over 20 years, and especially the big ones and I feel very, very encouraged that we can do a lot more for them, now that we are in a company. So I think obviously, this quarter will be a sub-period, the fourth quarter, but I do feel good that we have a work to 2016 to be able to both stabilize their customers, since there is a bit of anxiety when they enter into the [indiscernible] earlier this year.

The biggest customers I have specifically spoken to and visit them already, starting next week I'm going to meet more customers just to make sure that they get what we're trying to do, and – throw up in the front of their head within over last 3/4 weeks. So I think I'm encouraged but I want to ensure that I will be cautious until we have this fully enhanced and we will provide more color, early October as we issued a bar report to make sure we give everybody visibility of how we're going to exit Orga.

Okay, that's helpful. And so Nokia market as on-track to close, does the change your relationship with Nokia given Alcatel has its own BSS?

I think from our perspective we continue to work with Nokia and partner with them to go to market. I have positive discussions with Rajeev, the COO of Nokia, and I want to see really how they flatter the strategy.

The given asset in our space, next direction will be, will that asset be claimable [ph] to them or will be the opportunity for us to maybe partner and help them there. I believe right now that partnering is probably higher opportunity for us and maybe helping them to take care from the customer who have the assets from losing side, but really I want to get view of that until the transaction closes next year.

In the meantime we continue to very close cooperation, actually between now and next – this month and next month, probably, both Asia Pacific and as well as in EMEA region, working with Nokia on some of the new customer opportunities where we are working hand-in-hand to be able to support the customer that we both have.

What is percentage of your revenues whether influenced by Nokia today, whether we're selling or cross selling?

I don't know the order bases, we're probably roughly between up to about 20% on annual basis as we work with some of the larger customers. So we work where this is both selling through and selling with.

And majority of it will be selling with right now. So –

Okay, that's great, thanks.

Great, thank you.

Hi, good morning. I was wondering if you could give us an update on the churning customers in Q3, did one of those two drop or are we going to see both of those hit Q4?

And maybe, give us an update on where that recurring revenue or support revenue, which ever it is, where that's going to bottom?

Yes. So I think we have one has robust and we have one more to go, I was worrying when it's going to come up but I think it will be definitely by end of this calendar year and it's really subject to execution of some of the competitors who have been struggling to replace.

Obviously, another example of how sticky this has been for some of these – has been over two – close to three years. We expect that this will be no more than roughly about $500,000 of impact on a quarterly basis, subject to our security, currency exchange rate.

But from our perspective we do see that is – we do see opportunity for us to grow, especially December licenses in cloud services as we are seeing a pick up on those and customers are asking us to do more cloud services for them, the large ones. Is that helpful?

Does that answer your question, Rob?

Yes, that's good. And maybe – it would be very helpful to get a service sense of what you expect the run rate of the core business, are you ignoring Orga, previously you had said somewhere around mid to low 60s, I know that's come down with some of the churn so if I think of the different components of the business, if the support revenue is going to lose $500,000 per quarter then that's going to bottom somewhere around $22 million if I'm thinking of that correctly.

If the license revenue of there, both $7 million deficit this quarter, I guess that could be a $27 million to $28 million run rate and that gets me to roughly $50 million of quarterly run rate plus whatever the third-party business is. So, I guess you said – should we be thinking of this as sort of $53 million to $55 million quarterly run rate for the next sort of while?

I think – U.S. market – I look at from a business which I did is, we see that – we're not be about all in the green revenue basis around the area of $24 million and then closing from that.

What I see from services businesses is not be somewhere in the area that we have right now which is really close between $10 million to $12 million a quarter. It's basically now – sort of [ph] size and wait for us to charge the rate and occupancy that we have over there.

And I think we've been tracking to – between $16 million to $18 million at quarter in license business. I think I'm cautious, obviously our customers changed this in last minute on some of things that generally happens in last quarter – I'm bit may shy, but my view is at $50 million business, I would be still in the business around to drive the right EBITDA round, and obviously, the lumpiness upwards give us more cash flow, lumpiness is down, we in fact should have – our recurring revenue support the cost base that we continue to have – low double digits EBITDA on that.

That's not how I think about the business, obviously we don't provide guidance but my view is, the hick up in there – in the quarter on license is, I think we will bounce back from that, I cannot tell when those will come back but my view is right now to treat them as deferred comp beyond 12 months, by they come back the early overseas as bill generates additional kudos for the bottom line. Is that helpful?

Yes, that's very helpful, thank you. And then, maybe I'll ask one higher level question.

If you could talk a little bit about the brand awareness that you are seeing around Redknee. There has been and perhaps in context of other changes in the market, for them Docs acquiring and Nokia acquiring in the space, we've talked about how Redknee brand is faring, where they seem unaided lead activity on the back of a better brand, better awareness out there amongst your customers?

And then I'll pass the line, thanks.

Okay. So I think it's a good question I'm not good buyer.

I always believe you know that I'm going to customer expecting that they will know little about us. I have been talking with the suppliers, how customers know more about us and that we obviously have very positive reputation, especially on how dealt with customers over last three years plus Nokia business acquisition.

I think at times the commodities in our investment community that we are not harsh enough with customers, but if we did that – probably other customers have been very pleased that we have acquired them because they feel that we are constructive, we want to keep them for life. We've been invited to – because of that since you mentioned both, end of quarter – the informative and Orga, we have been invited by customers to the UN and we do all sorts of outgoing alternatives in case they feel that existing vendors or products might be in jeopardy and I've been very pleased by the level of load activity if you see we will – in the process we will win over customers, second customers and some of the congress customers who continue to look for evolution, and they do feel that the unified product line that we have continued to invest in has been a great alternative.

I do mention that we have invested – we took steps to invest by different product, and I would say if I had one of the best products in the industry I think Combat was investing about 9% of the revenues into R&D, we've invested slightly higher, over 20% to 24%. And my view is, we have over last two years emerged with probably the best product as in LIBOR but what is the perspective [ph].

Is that helpful?

Yes, just the three new customers you announced, you talked about in the quarter, are any of those related to some of these disruptions that are happening in the market with some of your competitors?

You know, one of them get one against that one of the largest players in our phase, but the two others ones were really – we are winning footprints in some of the Americas customers and one of the most – I can't discuss the name but one of the bigger operators in the U.S. as we are entering into a product range into their business.

So we're very excited about getting the recognition to go with Tier 1 near our backyard.

Okay, thank you very much.

Thank you.

Hi, I didn't fully catch your statement at the start of the call regarding the timing of when final innocent customer is coming off, and I think you said that was going to be less than – represent less than 5% of the sales. Can you just remind me again, what you said there?

Yes, 5% of recurring revenues was about less than what $500,000 a quarter, and it's going to happen by end of this calendar year.

Okay, that's all I had, thanks.

Great, thank you.

Great. Well, thank you for participating in today's call.

We really appreciate your questions and support of Redknee. And further, we look forward to presenting the billed equity report for Orga Systems, and we look to organize the call around that.

Following that we look to report to you in early December on the results of our fourth quarter and the full fiscal year 2015. Thank you, and have a great day.