Avante Corp. (XX) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Avante Logixx's Q2 F '22 Earnings Call. [Operator Instructions] This call is being recorded on November 30, 2021. I would now like to turn the conference call over to Mr. Steve Rotz, CFO. Please go ahead.

Thank you. During today's conference call, management will be making forward-looking statements that constitute future-oriented financial information as such term is defined in securities regulations. Listeners to this call should read the company's forward-looking disclaimers contained with each of the filings related to this fiscal period. We have posted an Investor Relations presentation to our website. We encourage you to review this at avantelogixx.com under the shareholders' tab. I will now turn the call over to Craig Campbell, CEO of Avante Logixx Inc.

Thank you, Steve. Good morning, everyone, and welcome shareholders to the Avante Logixx's Q2 Fiscal '22 Earnings Call. I'm joined today by Steve Rotz, the company's CFO. Today, we'll review Avante's financial results for its second quarter ended September 30, 2021 that we released last evening. We will also provide an update on our strategic priorities and comment briefly on the August 26 announcement of the company's initiation of a strategic review. During our conference call in respect of Q1 during late August, we highlighted the risk of unwinding COVID specials versus the reestablishment of ordinary course contractual revenue streams as COVID reopening was slower than hoped. Consistent with this, revenues during Q2 were $22.6 million, representing a 4.2% year-over-year decline and a 6.3% sequential decline versus Q1. Though we are seeing signs of a return to normal within our results, recurring and contractual revenues grew sequentially by 4.3% during the second quarter and consolidated electronic service revenues grew by 4.7%. This represent positive metrics for our business, indicating an improvement to the quality of revenue. With adjusted EBITDA of $0.6 million during Q2, our trailing 12-month adjusted EBITDA is $6.3 million. I want to thank the entire Avante Logixx team for contributing to our performance during these challenging times. Q2 has been a difficult operating environment driven by inconsistent reopening and return to work policies and implementation, coupled with a tight labor market and supply chain constraints, resulting in significant increases in our labor cost as a percent of revenue. I am proud of the team and our business that despite these challenges, we have demonstrably grown recurring and contractual revenue while reducing our direct operating expenses. It is my belief that these charges are transitory and short term in nature. While navigating these challenges, we continue to drive profitable growth in new markets while onboarding net new customers, increasing wallet share with existing customers all while remaining focused on improving our operating metrics. We own and are managing 2 great businesses with empowered and aligned teams of owners, and we are doing it with a long-term vision. As we have communicated before, our team is focused on positioning well for delivering growth. We continue to operate our business with a continuous improvement approach, driving cost out while enhancing our customer experience. Since achieving national scale in December of '19, we have been delivering top and bottom line growth and remain focused on continuing this effort. Avante Logixx is a leading player in a large and growing residential and commercial security services industry. As the remainder of the year unfolds, we are well positioned to increase market share and further develop the company's excellent growth prospects. Our portfolio of services is backed by exceptional brands with a solid base of reoccurring and contractual revenue from high-quality customers. Lastly, I want to remind you that our named executive officers and directors collectively own 16.6% of all shares outstanding. That is, we have alignment with all of you as shareholders. As noted in our August 25 press release, the Board of Avante Logixx initiated a strategic review to consider a range of possible alternatives intended to increase share value. Our continued focus on maximizing shareholder value led to the Board's decision to explore strategic alternatives. At the same time, following a thorough review of our portfolio of business, and the current strong valuation for businesses like Avante Logixx, we determined that the timing is right to explore strategic alternatives. Avante engaged in [opportunity ] of trial in Imperial Capital of Los Angeles as its financial advisers; and Norton Rose Fulbright Canada LLP as legal adviser in connection with this strategic review. While the process continues, we continue advancing our commitment to building predictable, sustainable growth and profitability at Avante Logixx through continued execution of the operational transformation of the business that is underway. Avante Logixx is a valuable enterprise and our management team is assisting the Board and the company's advisers as we complete this process. No final decisions have been made about any strategic alternative, and there can be no assurances that our Board's review of strategic alternatives will ultimately lead to a particular course of action. We do not intend to provide any further comment on the process until the Board has concluded the review and approved a specific outcome or otherwise determines that further disclosure is appropriate. I'll now turn the presentation over to Steve to further detail our Q2 fiscal '22 financial performance. Steve?

Thank you, Craig, and good morning to fellow shareholders. A reminder that our fiscal year-end is March 31. So September 30 represents the end of our second quarter of fiscal 2022. Quarterly financial statements and MD&A are filed on SEDAR and are available on our website. Let's begin with a few key financial highlights for Q2. Total RMR and contractual revenues increased during Q2. Electronic service revenues also increased, offset by unwinding COVID specials during Q2 versus Q1 and versus the prior year period. Our Avante Security business generated sequential growth during Q2. Direct OpEx decreased $172,000 during Q2 versus Q1 and adjusted EBITDA was $0.6 million during Q2, down versus last year's -- down versus Q1's $2 million and last year's $1.6 million. Cash flow from operations before working capital was $0.6 million. Turning first to the income statement. Consolidated revenue during Q2 was $22.6 million versus $24.1 million in Q1. The sequential decline is largely explained by a reduction of COVID specials within Logixx Security, offset by improved contractual revenues within Logixx Security and stronger revenues within Avante Security. Compared to last year, Q2's consolidated revenues were lower by 4.2% for the same reasons. Our largest platform, Logixx Security, represents 81% of consolidated Q2 revenue. Logixx Security experienced a 9.4% reduction of sequential revenues during Q2 due to the unwind of COVID specials, offset by improved regular contractual protective service revenues. Logixx Security's year-over-year revenue decline was 5% during Q2 due to the same reasons. Avante Security represented 19% of consolidated revenue. Its revenue was essentially flat on a year-over-year basis but grew by 10.2% sequentially. Within the MD&A, we provide additional disclosure of our revenue layers by summarizing recurring monthly revenues and contract recurring revenues. Total recurring and contractual revenues were $17.3 million during Q2 versus $16.6 million during Q1 and $15.4 million during the comparable period of last year. This improvement reflects stronger return to normal revenues within Logixx Security's protective services. Recurring and contractual revenues represented approximately 76.7% of total revenues in Q2 versus 65.3% during last year's second quarter. This demonstrates that a higher concentration of revenues are from ongoing and stable revenue streams. The remaining revenues were from electronic services, revenues from COVID specials, along with secured transport and other revenues that are most subscription-based. Blended gross margins declined both year-over-year and sequentially. These were 18.8% during Q2 versus 24.4% during Q1 and 24.5% during Q2 of last year. Some of this decline in sequential margins related to the closing out of an installation contract during Q1 within Logixx Security and higher profits than originally anticipated. Over the last 6 quarters, consolidated gross margins have ranged between 18.8% to 24.5% as sales mix drive the actual percentage given our electronic service revenues. The difficult operating environment created by COVID-19 negatively impacted our margins during Q2 as labor shortages and higher wage rates, combined with the renewal of higher-margin COVID-19 specials. Q2 represents a low point in our historical margins. During Q4 of last year and year-to-date this year, regular electronic service revenues were less than we would like within Logixx Security. Electronic service revenues are being impacted by COVID-19 in terms of customers delaying decision-making, and supply chain issues relating to delivery of customer installations or equipment needed for us to record revenue. Currently, our sales teams are focused on winning our share of electronic service installation opportunities as these become available. We are pleased that we are now seeing growth in bookings that will be implemented and become revenues over coming quarters. Such installations are important to our long-term strategy of increasing gross margin dollars during implementation and RMR dollars after installation. In terms of direct operating expenses, we saw a sequential decrease in total expense during Q2 versus Q1 of $172,000. Direct OpEx as a percent of revenue increased sequentially to 16.2% during Q2 versus 15.9% in Q1. However, this year's Q2 improved versus last year's 17.1%. We will continue controlling direct operating expenses and we'll focus on organic growth and revenues during future quarters. Adjusted EBITDA during Q2 was $0.6 million versus $2 million during Q1 and versus last year's $1.7 million. As explained earlier, this is due to the unwinding of COVID specials during Q2 and the delay in return to normal revenues. However, company's continued -- the company continued to generate positive cash flow from operations before working capital of $0.6 million during the second quarter. This represents 6 3 quarters of positive cash flow from operations with LTM at $5 million or 82% of our reported adjusted EBITDA over the last 12 months. Now looking at the balance sheet. Trade accounts receivable net of allowances increased by $0.9 million during Q2 and by $0.4 million on a year-to-date basis. We remain focused on customer collections and are confident in the high-quality nature of our receivables. Collections since quarter end have been strong, so we expect the DSO to decline during Q3. Senior funded debt includes bank debt and vehicle loans. The total was $9.3 million at September 30 versus $9.4 million at June 30 and $6.9 million as of our year-end, March 31, 2021. Net of cash, senior funded debt increased by $1.9 million year-to-date. This year-to-date change is explained by net cash used in operating activities, capital expenditures, costs associated with replacing the credit agreement and strategic activities, including the Board's strategic review project. Senior funded debt of $9.3 million and $7.1 million net of cash is small in context of our trade accounts receivable of $18.5 million inventory of $1.6 million as well as LTM cash flows from operations of $5 million and LTM adjusted EBITDA of $6.3 million. At September 30, drawings under our $8 million revolver were $3.7 million, that is $4.3 million available. Cash balances were $2.1 million, providing further sources of liquidity. The company remains in compliance with financial covenants applicable to new base marines established in June. Two years ago, in November 2019, we issued $8.26 million of subordinated convertible debentures. These notes have an interest rate of 5% to 7%, a maturity date of November 27, 2024, and a conversion right to common shares for the holder at $1.56 per share. On the balance sheet, the total liability reported under IFRS is $11 million. That is the IFRS reported liability now exceeds the actual liability by $2.7 million due to the share price at September 30 being well in excess of the conversion price. Within adjusted EBITDA, we smoothed out the quarterly mark-to-market of the related conversion rate that must be included within IFRS net income or loss. During Q2, we reported net loss on an IFRS basis of $2.9 million. This is largely due to the $2.2 million hypothetical loss on the convertible debentures. The quarterly IFRS loss also reflects $0.2 million of intangible asset amortization. As noted in our press releases for Q1 and Q2, COVID-19 created challenges for our business and we are managing through. COVID-19 continues to impact regular contractual revenue and the pace of return to normal, which has delayed reramping and regular business. The launch of book contracts within new customers for regular services continue to be pushed from July out to increasingly delayed launch dates. In Q2, we experienced removal of Q2 special revenues with strong margin that we benefited from the several quarters prior to Q2. During the second quarter, COVID-19 increased our labor costs as we were impacted by higher hourly labor rates and labor shortages, resulting in elevated unbillable overtime. As mentioned earlier, COVID-19 is impacting supply chains,that caused delays in our implementation of electronic service revenues. However, our entire team understands these risks, we are experienced at dealing with them and are implementing mitigating strategies as needed. In summary, Q2 was a challenging quarter, representing a decline of profitability as compared to prior several quarters. But we have a strong balance sheet, significant liquidity and committed credit facilities to fund organic and strategic growth. The quality of our revenue streams are improving with higher levels of RMR and contractual revenues, and management is continuing to grow in both of these. I'll now turn the call back over to Craig. Craig?

We recognize that the EBITDA numbers were not as expected. I believe that our team has managed through a difficult operating environment quite well. Heading into future quarters, we continue to focus on the controllable levers while being prepared and responsive to the continued challenges and opportunities presented by the evolving COVID situation. I want to thank and acknowledge the thousands of team members on the front line and those in the back office that continue to work tirelessly in delivering our customers their security and peace of mind. We'll be back to you in late February to provide and to discuss our Q3 fiscal '22 financial results. That concludes our formal remarks. Kelsey, Steve and I would be pleased to address any questions at this time.

[Operator Instructions] Your first question comes from Doug Taylor from Canaccord.

Higher labor costs are pretty common subject right now. Can you speak to your ability to pass through some of those labor costs as part of your regular contracting or renewal processes in the event that these higher costs related to the labor force are not transitory.

Yes. Thanks, Doug. Great question. So definitely have done a review of all customer contracts. For the most part, we have had an action plan that has targeted specific customers where we just are in an environment that we need to make hard decisions about those customers. We've seen a very responsive and probably the best and least resistance we've had the pricing in an industry that you know is highly competitive and price sensitive. So we actively work through that and are seeing great success because it is such a topical issue, not only for us as sort of third-party contractors, but those customers are experiencing in their own business. The other main action plan is just in investments and bolstering our recruiting and recruiting teams as well as using some other workplace tactics that, whether that be employee referral program, signing bonuses, things like that to just get more boots on the street, and we're seeing positive momentum in relation to all those activities.

And so would you expect that to -- those action plans that you just detailed to have an impact on your margins in the near term? Or is that going to take quarters and years to manifest?

Definitely not years, Doug. But certainly, in the quarters, we're seeing it. It's -- I want to use an analogy of just how fast we can flip it. It's not an overnight fix. That said, if I think of the actions taken over the last 2 months, we've had very little resistance on the customer pricing side. But that said, in our recruiting and development, we managed turnover as just a regular everyday sort of challenge in this business that's been there long before COVID ever happened, where we experienced now a higher turnover not to mention the recruiting anecdotally, I would share with you where we used to count on 80% of all the new hires on the front line to complete their training and report to work, we've seen declines where now we're having to hire 2 people for every 1 expected position that we're getting out there. So it's a challenge and it's a challenge as a result of everything from the government subsidies to employers like Amazon and others that have been upping their wages, and we're out there responding with all the tactics available to us.

Okay. You mentioned that COVID-related special work has kind of -- has begun to roll off. Is that now completely off the books and out of the quarterly results now? Or is there still some other work related to those kinds of activities that may roll off in future periods?

So it's not completely out and sort of the question around our weekly operating meetings with all of our operating divisions. So this quarter that only saw much of what I would call maybe the meat, like the juicy meat on the bone, probably not the right analogy, but we saw a big unwind comment at the beginning of Q2. And then -- which we always knew and expected, like we knew as the world reopened that we would see a rollback. And as we said in Q1 and as we repeat here again in Q2 is we saw it come on -- come off faster but the offsetting return in some of our customers that had peeled back some revenue. It has not returned as fast. Now even as a week ago as we start to draft press releases and things. Here, we have a new variant. And the new variants hitting the news over the last couple of days and that could be very good and sort of throw us right back into an environment where we're responding to the needs of our customers to deal with that new variant. So it really is a challenging environment to forecast and predict, but we are laser focused and our finger is on the pulse of the business.

Okay. So one last question then for me. I mean given everything that we've just talked about related to the costs and also the revenues, I mean, is it -- should we look at Q2's EBITDA performances hopefully bottom or low point you'd expect to build and rebuild from there?

Doug, I reiterate that we're not in the business of giving guidance. But as we pointed out in our remarks, if you look back at our historical performance and on margins, Q2 is absolutely and most certainly the bottom as we've seen in our historical gross margins. And you can, I think, really see it in the way the cost of goods sold has been impacted this quarter as being directly attributable to the reasons mentioned. And so my hope is that this is the low point and that we'll continue to improve from here. But obviously, not in the position to have the crystal ball with certainty on that.

Your last question comes from Nick Corcoran from Acumen.

My first question is to do with the labor market. Were there any revenues you think might have been lost in the quarter from just not being able to staff at contract?

Yes. Yes, in the sense that one of the key metrics on the Logixx side is around the fulfillment of ships. So we have definitely been impacted in not being able to fulfill some of the ships requested. And so as well, I would say to you that the delay of onboarding new revenue has been impacted, not specifically to the labor market, but to the operating environment being customers and said, okay, well, what was originally planned to be started in August, they pushed to September and then they pushed it again. So we've definitely seen a kick the can down the road on some of the new contract, new wins that remained in our pipeline, in our backlog so to speak.

That's good color. And then switching gears to the implementation of electronic services. Can you maybe give a little bit more color on the backlog and what you're seeing subsequent to quarter end?

So I guess, we don't disclose the exact backlog. But what I would say to you is if you run an analysis about our sort of historical run rates on electronic services, you'll see that for a couple of quarters now that they have been tracking under our historical performance. We believe that every sort of one of those projects will monetize and be converted to revenue, and that there will be this eventual catch up. But currently, with both the supply chain issues of just getting things as well as this whole access of getting into the properties and to get work done has been an impact on -- yes.

And there are no further questions at this time. You may please proceed.

Well, thank you very much. And as mentioned, we look forward -- I wish everybody a safe and happy holiday season, and we look forward to being back to you with our Q3 results in the new year.

Ladies and gentlemen, this concludes your conference call for today. We thank you very much for participating and ask that you please disconnect your lines.