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Edited Transcript of PTG.V earnings conference call or presentation 15-Aug-19 12:30pm GMT

Q2 2019 Pivot Technology Solutions Inc Earnings Call

TORONTO Sep 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Pivot Technology Solutions Inc earnings conference call or presentation Thursday, August 15, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. Toews

Pivot Technology Solutions, Inc. - CFO

* Kevin A. Shank

Pivot Technology Solutions, Inc. - President, CEO & Director

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Conference Call Participants

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* Gianluca Tucci

Echelon Wealth Partners Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Pivot Technology Solutions second quarter results conference call. (Operator Instructions)

This call is being recorded on Thursday, August 15, 2019. Your hosts today are Kevin Shank, President and Chief Executive Officer; and David Toews, our Chief Financial Officer.

Before I begin, I am required to provide the following statement respecting forward-looking information, which is made on behalf of Pivot and all of its representatives on this call.

All statements made on this call will contain forward-looking information. Actual results could differ materially from a conclusion, forecast or projection in the forward-looking information. Certain material factors and assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information. Additional information about the material factors, that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection, as reflected in the forward-looking information, are contained in Pivot's filings with Canadian provincial securities regulators. During today's call, all figures are in US dollars unless otherwise stated. And with that, I'd like to turn the call over to Mr. Shank.

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [2]

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Thank you. Good morning, everyone, and thank you for taking time to participate on today's call. I'll begin with some high-level comments, Dave will provide the financial update, and then I'll conclude with thoughts about our strategies, Smart Edge and our outlook.

Overall, we are pleased with the earnings performance in the quarter. Both gross profit dollars and gross profit margins increased and are strong indications that business is becoming more efficient.

We continue to execute our strategy to build on our core products and services portfolio, while enhancing our services and solutions capabilities. By leveraging our scale, strong customer and vendor relationships and continued investment in services and Edge technologies, we will continue to drive the company forward into the future.

Second quarter adjusted EBITDA improved from $5.1 million last year to $9.7 million this year, an 89.9% improvement year-over-year.

As anticipated, adjusted EBITDA benefited from our cost actions we initiated in the second half of last year as well as very strong growth in our nonmajor segment. Gross margin increased significantly from 10.6% to 13%, primarily driven by the mix and change between the major and nonmajor customers, combined with higher service margins. We are pleased that our financial results are showing the expected benefit from our improved cost management and enhanced flexibility of our overhead cost as part of our transformation plan. The goal of this ongoing approach is to continue to execute our commercial transformation, while investing in areas with high growth potential.

Areas like services, software-defined technology and Edge, including Smart Edge, are internally developed innovations, built on Intel technology that's designed to support enterprise's Multi-Access Edge Computing and customer adoption of 5G. All these areas will continue to be key areas for us, as we move forward.

Looking at top line performance. Total revenues were $345.7 million compared to $381.3 million last year, which reflected lower revenues to major customers, partially offset by a nonrecurring project with a nonmajor customer of over $30 million.

Our product business experienced a 9.8% or $33.2 million reduction in revenue compared to last year, again, primarily due to lower sales to major customers, partially offset with 20% growth in our nonmajor customer volume.

As we've noted previously, product revenues are difficult to predict due to the transactional nature of that part of our business. Moving to the service business. Revenues were $40.1 million, are $2.5 million lower compared to last year.

This reflected a $6.1 million or 21.7% decline in the Pivot Provided Services, offset by a $3.6 million or 25% increase in revenues from third-party maintenance and support contracts.

The decrease in Pivot Provided Services is primarily a result of certain workforce service contracts winding down in 2019 as well as the prior period included a $3.3 million revenue from a large nonrecurring project.

As our strategy indicates, we will continue to focus on growing Pivot Provided Services in the second half of the year. The transformation plan that we initiated last year will prepare Pivot to be more effective and efficient in executing our business plan. Our strategy is to build our core products and services business, while enhancing our service and solution capabilities.

We will continue to invest in the areas of our business where we see the opportunity to accelerate our growth.

As previously announced, we are pleased that the United States Patent and Trademark Office approved the patent for our Smart Edge platform. The U.S. patent office cited the embedded multilayered security as a key reason for the patent application approval. The patent is another strong sign of validation of the Smart Edge technology.

Also, you may recall Smart Edge was recognized by Frost & Sullivan for its Technology Innovation Award and was also named Intel's partner of the year for network communications innovation.

We intend to leverage our scale, strong customer and vendor relationships, as we further commercialize this technology in the coming months. I'll now turn the call over to Dave, to provide his update.

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David A. Toews, Pivot Technology Solutions, Inc. - CFO [3]

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Thanks, Kevin, good morning, everyone. Second quarter results continue to show signs of progress that we've been making with the accelerated commercial transformation we initiated in Q3 of 2018.

Since then, we've reduced headcount, lowered facility costs, terminated underperforming relationships and managed discretionary spending. These activities have resulted in an $8 million annualized reduction in cost of sales and SG&A costs, which is higher than our initial target of $5 million.

We continue to manage costs while investing strategically in areas where we see growth opportunities.

While in the second quarter, we did not incur significant restructuring costs, we continue to integrate the businesses to achieve greater synergies. And through that process, we do expect to incur additional restructuring charges as the year progresses.

Overall, while second quarter revenue declined 9.3%, gross profit dollars actually increased by $4.4 million or 10.7% compared to last year.

As Kevin mentioned, the gross margin percentage improved year-over-year from 10.6% to 13%. Margins were assisted by cost reductions and service-related cost of sales and the reduction in sales to major customers. As you know, major customers generate lower gross margin percentages due to their volumes, so this had a positive impact on margin percentage but a negative impact on revenues and gross profit dollars.

Second quarter SG&A expenses were $35.3 million, similar to last year. Net spending on Smart Edge development decreased by $680,000 quarter-over-quarter, as we begun capitalizing certain qualified development costs at the start of 2019.

The total amount capitalized in Q2 was $1 million. Growth spending on Smart Edge increased by $330,000 compared to the prior year before capitalization.

The implementation of IFRS 16 also resulted in a reduction in rent expense of $1.4 million, as under the new accounting rule, certain facility leases are capitalized and depreciated.

This resulted in an increase in depreciation of $1 million and finance expense of $318,000.

SG&A reductions from the company cost reduction efforts were largely offset by increased variable compensation due to the significant growth in gross profit.

As a result of the increased gross profit, adjusted EBITDA was $9.7 million compared to $5.1 million in Q2 of last year. This performance was supported by our cost reduction program and the change in accounting for leases.

Moving down the income statement. Depreciation and amortization increased year-over-year by $860,000, primarily due to the adoption of IFRS 16.

Finance expense decreased by $265,000 or 14.9% to $1.5 million due to reduced average borrowings on our senior facility, which were $102 million in Q2 compared to $115 million a year ago, partially offset by increases in LIBOR and U.S. prime interest rates, which increased 0.5 point. Also impacting finance expense was the adoption of IFRS 16, which imputes an interest element on the capitalized lease liability. The total finance expense for this in Q2 was $318,000.

Other expenses were up year-over-year by $1.2 million to $833,000 for Q2 2019. This increase is primarily due to losses on foreign exchange translations associated with the strengthening of the Canadian dollar in Q2 compared to year-end.

Overall, second quarter income per share improved to $0.04 per share compared to $0.01 per share in the prior year period and the loss of $0.09 in Q1 of this year.

Moving to cash flow. Cash provided by operating activities increased by $70.4 million compared to Q2 of 2018. This performance primarily reflected the timing of noncash working capital items, including accounts receivable, inventory and accounts payable and improved EBITDA.

We finance working capital through our revolver, which we extended for 5 years on favorable terms during the quarter. Fluctuations from cash from operations are normal and are generally offset by changes in the credit line, which were captured in financing activities.

In Q2, cash used in financing activities increased by $60.8 million compared to last year, again, primarily driven by the movements in the borrowing arrangements and bank overdrafts.

As I mentioned, our revolving line tends to fluctuate inversely with the changes in working capital and cash from operations. Q2 cash used in investing activities decreased by $554,000 compared to last year. The decrease was primarily driven by the capitalization of Smart Edge development, offset by reductions in capital expenditures in 2019.

From a collections perspective, day sales outstanding stood at 50 days for the second quarter, while days payable were 59 days. These figures also tend to fluctuate from quarter-to-quarter based on timing and mix.

Looking forward, from a borrowing perspective, Pivot continues to have the capacity to fund growth under its extended bank facilities and a considerable amount of liquidity.

Our average undrawn availability on existing secured facilities in Q2 was just over $58 million.

At quarter end, our debt position was $99.7 million, down from $101.4 million at December 31.

As always, the timing of noncash working capital items will affect our net debt position going forward.

On June 19, 2019, we received regulatory approval for an NCIB to purchase up to 3,791,395 common shares or approximately 10% of the public float at prevailing market prices in accordance with the rules of the Toronto Stock Exchange.

The company will enter into an automatic share purchase plan with Echelon Wealth Partners in order to facilitate the repurchase of our common shares under the NCIB.

We also announced yesterday that we've declared a common share dividend of CAD 0.04 per share, payable on September 16, 2019, to common shareholders of record on August 31, 2019. We continue to believe that the dividend payments are key part of shareholder value creation.

With that, I'll turn it back to Kevin for his comments.

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [4]

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Thanks, Dave. Our financial results continue to show the benefits of our transformation plan. Gross profit, adjusted EBITDA and net income have all improved dramatically compared to Q2 2018 and have also shown sequential improvement compared to Q1 2019.

Our goal is to create a more integrated organization with a flexible cost structure and allocate capital to areas of our business we feel are growth drivers. We are taking advantage of growth opportunities, which include services as well as software-defined and Smart Edge technologies. As mentioned in my opening remarks, we're very pleased with the recent accolades we have received for our Smart Edge platform for Multi-Access Edge Computing.

We are excited as we set out to commercialize this technology. We are further encouraged that over the last few weeks, we have been awarded our first 2 purchase orders from 2 different customers to deploy Smart Edge.

Although, these initial orders are relatively small deployments, this demonstrates the product has begun commercial deployment.

For the remainder of the year, we will drive hard to make the company more efficient and effective, as we apply our strategies. Strategies include continuing to build on Pivot's core business of selling IT products and services, enhancing Pivot's service and solution portfolio and capabilities, continuing the company's commercial transformation to expand addressable opportunities with existing customers, supporting our customers as they expand internationally, continue to improve our cost management and finally, commercializing and monetizing our Smart Edge technology.

This concludes our prepared remarks. Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Gianluca Tucci with Echelon Wealth.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [2]

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Congrats on a good second quarter. So I'll start on the major side. So your major spending saw a bit of an uptick in the quarter sequentially. Can you add some color here on how you're thinking about Q3 and Q4 on the major spending perspective in your talks with them?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [3]

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We don't give forward-looking statements. But the major customers that we reference, as we've alluded to in the past, are still ongoing customers of ours, and we still have lots and lots of business with those customers. But it's very difficult to try to predict their future spend, as they go through changes in their own business model. So they're still very valid, very viable, very close relationships for us, and we're working hard to get our portion of the captured spend that they are spending at this point.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [4]

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Okay. That's good. Just a follow-up there on margins. I'm impressed at the strength of your gross margins considering that your majors did come back a bit sequentially. I'm just wondering if you could talk about the drivers here in your gross margin and if this is the new norm in terms of your profile on margins?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [5]

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So as we spoke, the margins are a reflection of the change in -- the continued change in mix between majors and nonmajors as well as the performance of our service margins. And we had a real good growth quarter for our nonmajors. I think it was around 20%, which was -- which I think is wonderful when you look at how you diversify as a company, and there's a lot of positiveness in that driving revenue from a broader mix of customers. And we are getting higher margins from those nonmajors. So that's the primary reason for the service margin pickup as well as the mix between majors and nonmajors.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [6]

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Okay. And then just changes gears to services. I know that you've mentioned in the past that your backlog is growing and that the market should see second half expansion on the services side. How do you feel about your services and solutions business today, as we enter 2020?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [7]

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Sure. So I'd like to take things head on. We're not happy, I wasn't happy with the Q2 service performance from the Pivot Provided side. Something that we're focused on and something we're very committed to growing over time. In terms of comparisons, we did have a tough comparison with previous year. We had a large project built completely, all $3.3 million of it built in the second quarter of last year. And we had our largest workforce services contract, which is pretty much annuitized revenue, started winding down as we finished a major initiative for a customer around the data center move.

So we had those 2 phenomena hit us in the second quarter and it made our comparable a little tough. Still lots of positiveness in our evolution as -- to our service business and creating more and more -- providing more and more complex solutions to our customers. We won some significant contracts, a very sizable contract here in Canada to provide managed services to it and then adhered to that, we hope to press release more detail on very soon.

We are -- we've begun a very strategic relationship with a large retailer in the U.S. that we are working hard to continue to grow, and we see some positive signs there. Our pipeline is growing on the services side. And it's something that we're getting more diligent and better at tracking and measuring and executing on. And as mentioned, there's -- we believe, there is significant service opportunity for Pivot's core business, as we develop and deploy our more Smart Edge opportunities.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [8]

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That's a great color. So just to continue on Smart Edge. You got 2 small POs in the quarter in the past few weeks. Can you talk about the types of enterprises, they are -- these 2 customers are and the kind of scalability that can be expected into 2020?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [9]

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So you touched on 2 -- a couple really important things there. These are the initial orders from these 2 customers. One is in warehousing and retail distribution. The other is in media and communication. So -- and those 2 relationships are -- will grow. We're already seeing additional opportunities come through those 2. One was with a direct end-user customer, one was with another industry partner, who will drive this solution out to their customers. So we're very pleased with that development. And the media opportunity literally was participating in a live production on TV. So it was a great testimony to the -- how strongly the customer feels that the product is ready for commercialization and use in production. So we're very pleased with that.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [10]

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And Kevin, are these 2 5G opportunities? Or are they on the Wi-Fi side?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [11]

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So they're -- one had a -- primarily on the Wi-Fi and private LTE and the other one was with the same private LTE scenario. So that's going to be the best route to market for us.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [12]

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Excellent. And at the AGM, there was some talk about edge services in becoming the top edge services company in North America. Can you kind of talk about the kind of investment opportunity, thought leadership that this entails -- that this strategy entails?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [13]

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Sure. So we're investing -- as I alluded, we're investing heavily in our -- where we see great opportunities for growth and edge is one of those. So we have -- we've taken our traditional core business, which includes the 5 service channels, integration services, professional services, deployment services, workforce services and managed services. And we have applied that same logic to very specific use case in terms of the edge and managing and deploying the edge. So we've -- we're productizing that capability around Smart Edge and the integration and the deployment of professional services, the technical skills and the ongoing management of that platform, as it's deployed on our customers' locations. We have taken the team and dedicated them to building out all those adjacent services and readying ourselves for the demand that we see coming.

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Gianluca Tucci, Echelon Wealth Partners Inc., Research Division - Research Analyst [14]

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Okay. Great. And just one last one. From here, it seems like you guys have a great control of the internals at the company now evermore so I think that in the company's history. Are you looking to be acquisitive at all in the next, I don't know, 12 months or so?

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [15]

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M&A is always part of our strategy. I talk about that quite a bit. I look at probably a company every -- one every month on average and as the company's performance improves and as we get very specific on some of the areas that we want to focus and go after that are high growth, certainly, acquisitions that fit into that playbook would be very enticing to us. And we've got such a really strong customer base with a great sales team that has reach and touch into those customers. As we create capability and/or acquire capability, driving that back into that customer base, makes a lot of sense for a company like ours.

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Operator [16]

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At this time, I will turn the call back over to Mr. Shank.

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Kevin A. Shank, Pivot Technology Solutions, Inc. - President, CEO & Director [17]

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Thanks, operator. We look forward to providing further updates as we report our Q3 results. I thank everyone for joining today and have a great and happy day.

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Operator [18]

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This concludes today's conference call. You may now disconnect.