Danielle Royston - CEO David Charron - CFO

Todd Coupland - CIBC World Markets Paul Treiber - RBC Capital Markets

Thank you. Good morning and welcome to our 2017 Q3 earnings call.

I am Danielle Royston, CEO of Redknee Solutions and I'm joined by David Charron, our CFO. Today, David will give us a more detailed look at the quarterly numbers for our fiscal Q3.

After that, I'll provide some commentary. And after that, we'll open it up for Q&A.

David and I will be following a presentation today. If you haven't done so already, I encourage you to download it from our website.

So today, I have 3 main points I'd like to communicate on today's call. Number one, we continue to make progress with our transformation of Redknee to refocus on telco and customer success.

We have launched a backstop price offering, recently approved by our shareholders, to raise USD 54 million to fund our strategic plan. And third, we have finished the first reporting period for our Customer Success metrics.

And as expected, it has come in at 20%. So with that, I'm going to turn the call over to David.

David?

Thank you, Danielle and good morning, everyone. Our complete financial statements, MD&A and earnings release for the quarter are available on SEDAR and on our website and I encourage everyone to review them.

Turning to Slide 6. Total revenue for Q3 2017 was $32.6 million compared with $40.5 million for the same quarter last year.

The decline was largely due to lower support and subscription revenue and a decrease in third-party software and hardware revenue. Recurring revenue which we define as revenue from support and maintenance agreements, term-based product licenses and long term service agreements, was $21.8 million or 67% of revenue in Q3 compared to $25.6 million or 63% of revenue in Q3 of 2016.

Looking at the revenue breakdown more closely. Software license and service revenue was $11.6 million or 36% of revenue compared with $12.4 million or 30% of revenue in the same period last year.

Revenue for Q3 2017 decreased primarily as a result of delays in purchasing decisions by customers in the APAC region. For the third quarter of 2017, support and subscription revenue decreased by $3.2 million to $20.2 million or 62% of revenue from $23.4 million or 58% of revenue for Q3 of 2016.

And revenue from sales of third-party hardware and software components declined significantly in Q3 2017 to $0.8 million or 2% of total revenue compared to $4.8 million or about 12% of total revenue for Q3 of last year. We continue to see decreases in sales of third-party software and hardware components due to management decision to reduce these sales as they have a minimal contribution to overall profitability.

Looking at our Redknee geography on Slide 8. We saw smaller changes to our mix with the higher proportion coming from the EMEA region and a lower proportion from the APAC region.

Gross margin for the third quarter was 57% versus 45% in the same quarter of last year. Improvements in gross margin reflect the progress we've made on our cost structure optimization plan.

It's also due to the change in revenue mix, specifically reduced sales from third-party software and hardware which has lower margins and I -- which I just mentioned. Net loss was $26.7 million or a loss per share of $0.25 compared with a net loss of $12.3 million or an $0.11 loss per share for Q3 of last year.

Net loss for the third quarter of 2017 includes restructuring costs of $14.3 million and a $2.4 million foreign exchange loss. Turning to our operating costs on Slide 10.

Total expenses excluding depreciation and amortization for Q3 were $37.1 million, up from $24.8 million for last year. Cost increased primarily due to the $14.3 million in restructuring costs related to our strategic plan compared with $4.1 million in restructuring costs for the comparative period of 2016.

Other costs include additional professional fees incurred on services provided by Crossover and DevFactory and an allowance for doubtful accounts made for certain customers. Excluding depreciation, amortization, restructuring costs and acquisition costs, operating expenses for Q3 were $22.9 million or 70% of total revenue and these compared to $20.5 million or 51% of total revenue in Q3 of 2016.

Turning now to key balance sheet items for the quarter. I'm pleased to report that cash and equivalents, including restricted cash, at the end of Q3 totaled $49 million, up from the $46.8 million at the end of Q2 2017.

Cash provided by operating activities was $1 million after spending about $6 million on restructuring in the quarter. Accounts receivable at the end of Q3 were $25.6 million, down 12% from the $29.2 million for Q2 of 2017.

As a result, our days sales outstanding decreased to 65 days from 70 days as at Q2 of 2017. We've continued to increase our collection efforts and view this downward trend positively.

Unbilled revenue was $22.4 million, a decrease of $3.4 million from the $25.8 million at the end of Q2 of 2017. And conversely, deferred revenue was $19.7 million, up $4.8 million from the $14.9 million at Q2 of 2017.

Now 3 of these accounts were sources of cash for Redknee in the quarter. Working capital at the end of Q3 was $31.9 million compared with $50.6 million in Q2 of 2017.

The improvement is a result of the positive trends in the balance sheet accounts I just mentioned. Our order backlog at the end of Q3 was $151.2 million compared to $161.4 million at the end of Q2 2017.

And of this amount, we expect approximately 59% to be converted to revenue in the next 12 months with the remainder converted in future periods. Before I turn the call back to Danielle, I'd like to now take a moment to discuss our previously announced Rights Offering.

As part of our restructuring efforts, Redknee has launched a USD 54 million Rights Offering which is fully backstopped by Wave Systems Corp. And under the conditions of the Rights Offering, eligible shareholders as of the close of business on the record date received one right for each subordinate voting share they held as of the record date.

Each right entitles the holder to acquire one subordinate voting share at a subscription price of CAD 0.63. And as I mentioned, the offering is backstopped which means that Wave Systems Corp.

has agreed to acquire at the subscription price any subordinate voting shares available under the Rights Offering that are not otherwise subscribed for by shareholders. And with these measures in place, we have ensured that Redknee will receive no less than approximately $54 million in gross proceeds under the Rights Offering.

The net proceeds will -- that we receive will allow us to ramp up our strategic plan to restructure the company which will help us create a strong platform for long term growth, simplified operations and sustained profitability. With regards to the offering, I'd like to point out a few key dates.

First, August 1, 2017, was the record date. Second, August 18, 2017, is the last day for U.S.

holders and other ineligible holders to submit an exempt purchaser status certificate to the rights agent. And third, August 29, 2017, at 5:00 p.m.

Toronto Time is the expiry date for the exercise of rights. As for the shares outstanding, approximately 108 million rights will be issued under the offering which will result in the same number of subordinate voting shares to be issued in connection with the offering.

The result, of course, is that there will be a minimum of 217 -- of approximately 217 million shares outstanding upon completion of the offering. And I want to stress that for further details on the Rights Offering and the procedures to be followed by shareholders in order to subscribe for rights, please review the Rights Offering circular and the Rights Offering notice which were filed in the qualifying jurisdictions are now available on sedar.com.

And that about covers it for my portion. And with that, I'd like to pass the call back to Danielle.

Thank you, David. I want to take this moment to thank David for his commitment and dedication to Redknee over the years.

As we previously announced, David will be departing Redknee following the close of the Rights Offering and Anin Basu will take over -- take on the role as interim CFO as the board undertakes a formal search for a new CFO. On behalf of Redknee, I want to thank you for your service over the years and wish you the best of luck in your new role.

All right. We continue to make progress on our transition to refocus on telco and Customer Success.

We have visited more customers this quarter and put plans into place for every single customer to get them to Customer Success. As I mentioned, we have finished the first reporting period.

And as expected, our customer results -- Customer Success results are coming in at 20%. And as revenue converges with Customer Success, the single most important thing we can focus on is improving our Customer Success results.

Perhaps the big news of the quarter was our shareholder vote which approved the Rights Offering of USD 54 million. I would expect that many of the people on this call are wondering, "Should I exercise my rights or not?"

And I thought I would give you as clear as picture as I can to help you make that decision. One thing to note is there's potential risk with our customer relationships through this long turnaround process.

And we continue to evaluate the forward $120 million revenue base. We believe the restructuring plan is sufficient in a worst-case scenario of up to a 25% loss from that revenue base.

And we also believe that the funding from the Rights Offering remains sufficient to complete the restructuring and commence the strategic plan. The other good news is that we're engaged with our customers and working to make them successful.

We have not been able to kick off our full restructuring plan because we don't have our funding yet. But come September, we will be full speed ahead.

But even with that, I think you will see a continued revenue shrinkage in 2018 and 2019. On a positive note, I absolutely believe that we can fix these customers and build a profitable business.

When I look at the problems our customers have with Redknee and I look at the talent we have at Redknee plus the new resources I am bringing onboard from Crossover, I know we can deliver Customer Success. I am not worried about our ability to execute.

After profitability, even though revenue is shrinking, we can build a profitable business at this company. I don't know what the margins will be because it depends on our revenue, but I believe it can still be profitable.

Telecom charging is a large market and we can have a good business once we finish the transformation. As for our restructuring plan.

We're excited our shareholders approved the Rights Offering and we expect to close our funding in early September. We're making progress on the restructuring that will kick into high gear come September.

With the cost savings we've received from our restructuring efforts, we plan to reinvest the savings into Customer Success and into our $100 million product revitalization plan. I can't wait to get started.

I'm still very optimistic about Redknee's future. At this point, we're ready to open up the call for Q&A.

Operator?

I wanted to ask you two questions. The first is, could you just lay out the rough time line for the restructuring once the -- rough time line for the restructuring and key milestones once the Rights Offering closes?

Sure. Thanks, Todd.

It's Dave here. What we said in the past and we still continue to believe, is that the restructuring will take 12 to 24 months to work its way through the various projects that we have in our strategic plan.

As Danielle mentioned, we really haven't kick-started this. We haven't really got started until we confirm that we had this funded.

And so the shareholder meeting where we have the Rights Offering funded is a critical start to this process. And so I would look to a good 12 to 24 months as the time line for this.

Okay. And then is there any, I guess, key milestones in terms of the product road map that you want to highlight the reinvestments and any particular areas of focus that we should be watching for?

Yes, this is Danielle. I think in terms of that investment on the product, we're really looking to get the cues from the marketplace as well as our customers that we're on par with competitors and pulling ahead.

And so that's going to be kind of the key metric for us is customer indications they believe our products are the best. And so we will continue to invest in the products until we achieve that mark.

Okay. And you've had all these meetings.

So are you getting a pretty good idea on where you want to go?

Yes. We're getting -- that's one thing that I love about Redknee is these fabulous customer relationships.

They are long term. They are super senior.

We're talking with the top 1, 2, 3 people at our accounts. And they love our message and our focus.

They are excited and want us to succeed. They're still telling us, "No."

But if there's a range that we're getting better, we're trending positively, even though we're still sort of in the no category. And they are happy to share their thoughts and feedback on where we need to take our products.

And we're incorporating that into our road map. We're beginning to share road maps with customers and so it's great.

Just in regards to the initial work that you've done with DevFactory and Crossover, do you have any feedback from them in terms of the progress that they've made to date and their initial sort of thoughts on where they could take it?

Yes. I guess, I'll take that in two parts.

DevFactory first and then Crossover second. So DevFactory is more of a software platform that our resources, both employees and Crossover resources, use to produce source code.

DevFactory is off to a great start, very strong start, pulling in what they can, evaluating our source code and giving feedback on our quality, suggestions for improving our code, all that stuff. And so we began to use it, sort of create a prioritized to-do list of what we can do -- actual items of what we can do to improve our code.

So I'm really excited about that. It's sort of one part of DevFactory.

Second part of DevFactory is the test-writing service to help improve our code coverage. And they're marching ahead of schedule.

So super excited about that. So that's DevFactory.

So I think on track, getting some good insights into our code and making quick progress. Crossover, also, I think the organization is receptive to the recruiting capabilities of Crossover in local markets which were previously challenging for Redknee to recruit in.

And we're beginning to staff in those local markets. The second part of that is really that training component.

And we've tried some new, innovative approaches to training resource really quickly. I think we're currently constrained by the short term interim agreement while we wait for the Rights Offering to conclude.

The long term agreement is linked to that. And so we're operating under a hiring cap of, I think, 250 people.

And so there's demand for a lot more. And so we're just kind of operating within those constraints and waiting for the Rights Offering to close until they're ready to release the kraken.

So that's where we're with those 2.

Okay. And just in regards to the source code.

I mean, I'm under the impression the source code is quite complex, just given the product. And -- how do you plan to manage the transition of knowledge from some of the employees that may have been working on this for perhaps many years to some of the newer employees, just so there's a smooth handoff there?

Yes. I mean, we have a bunch of different tactics to do that.

I mean, we certainly could -- and we're employing all of these. Recorded sessions, tech talks, pair programming which was -- from one of our board members, Farhan, is a big fan of pair programming.

And we've really embarked on that piece, completing thousands of hours of training per week of new employees, new Crossover resources with existing resources. So this is a big part of the ESW playbook, right?

We go into companies, we bring in new resources and always, the question is -- and the statement is, "It's really complex. It takes years to learn this code.

You can't just bring in people and they are productive." and that is true.

They're not productive immediately, but they're productive pretty quickly. And within a year, very productive.

And so it's just a process, I talked about this before on previous calls. It's that one degree of change every day, just making sure we're getting one degree better, 1% better and you just keep pushing that flywheel until you -- until everyone is ramped up.

And so initially, you may start by giving them the easier work. And then as they get better, you give them harder and harder work.

So that's how you do it.

Okay. That's helpful for understanding.

And just one last one for me, just in regards to the comment on revenue shrinkage in 2018 and '19. Does that suggest that revenue may dip below the $120 million run rate comment?

And then which line item, like, do you think is -- where is the most potential downside? Is it on the software and services line as opposed to support?

Or do you think support could drop further?

Yes, I don't -- I mean, I don't know that I have the visibility to these specific categories. But like I said, one of the great things about this company is we have great, deep relationships with our customers.

We're having very honest conversations with them. I think it's a long turnaround.

Customers are going to be evaluating their options. Do they think that we can turn around?

Do they want to wait around for it? And so I think that, like we said in our press release, there's definitely real risks to our revenue.

We're going to fight like crazy to keep it. But again, we're trying to establish a revenue base on which we build our plan and we're still trying to find that floor.

So I guess, what we're messaging there is if we -- I think it's going to continue to shrink and so once we get that data, we'll be able to build from that base. So it's a long turnaround.

Customer Success is at 20%. We have a lot of work to do.