Quarterhill Inc.

Good morning and welcome to Quarter Heels Q1 2025 Financial Results Conference Call. On this morning's call, we have Jack Myers, CEO, and Morgan Demke, Interim Chief Financial Officer. At this time, all participants are in a listen-only mode. Following management's presentation, we will conduct a question and answer session, during which analysts are invited to ask questions. To ask a question, please press star 1 on your touchtone phone to register. Should you require any assistance during the call, please press star zero. Earlier this morning, Quarter Hill issued a news release announcing its financial results for the quarter ended March 31, 2025. This news release, along with the company's MD&A and financial statements, are available on Quarter Hill's website and on TDR+. Certain matters discussed during today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are available on CDER+. During this conference call, Porter Hill will refer to adjusted EBITDA. Adjusted EBITDA does not have any standardized meaning prescribed by IFRS. Please refer to the company's Q1 2025 MD&A for full cautionary notes regarding the use of forward-looking statements and non-IFRS measures. Finally, please note that all financial information provided is in U.S. dollars unless otherwise specified. I will now turn the meeting over to Mr. Myers. Please go ahead, sir.

Thank you. Good morning, everyone, and thanks for joining us on today's call. In terms of agenda, I'd like to discuss highlights for the quarter. after which Morgan will take a look at the key financial results. Following Morgan, we'll open it up for questions. In summary, our Q1 results reflect our ongoing business transformation and turnaround activities for the past 18 months. As we've discussed previously, Q1 is traditionally our seasonally slowest quarter, which had an impact on our results. Our results were also affected by the two legacy contract, tolling contracts that remain in renegotiation which we mentioned during our Q4 call. Despite these challenges, we continue to make progress on our strategic initiatives, such as our new technology architecture, the onboarding of new leadership, and the expansion of our bidding activity and unlocking of new markets. For the quarter, revenue was $33.9 million and adjusted EBITDA was negative $3.4 million. Regarding the two tolling contracts and renegotiation, They represented $3.6 million in revenue in Q1, but they negatively impacted our adjusted EBITDA by $3.2 million. So excluding those contracts, we would have been close to adjusted EBITDA break even for the quarter. The good news is we remain actively engaged in these negotiations and working towards resolutions that we expect will improve our financial performance in the coming quarters. Finally, our contracted revenue backlog stood at $476 million at quarter end. Let me turn now to the performance of our individual business units. Our safety and enforcement unit continues to perform well, delivering solid top-line growth and strong margins in Q1. This consistent performance stems from our long-term customer relationships, product innovation, and our team's dedication to addressing client needs effectively. During the quarter, we signed new contracts in several states, including Indiana, Illinois, Oklahoma, and New Hampshire. At the IBTTA conference in March, we featured Ithea, our AI vehicle counting and classification system, which generated significant interest from attendees. These capabilities, along with ongoing technical enhancements to our traffic data collection systems, deliver improvements in accuracy and reliability creating real value for our customers while strengthening our competitive position. I'll speak more to some of our activity at that conference in a moment. In our tolling unit, we announced a significant new contract in Q1 with ACTC, valued at $40 million, with options to extend an additional four years at $15 million. Implementation on this project has begun, and we expected to contribute more meaningful to our results as we progress through the year. We also want follow-on business with existing clients, which speaks to the strength of our customer relationships and our ability to expand those mandates over time. Just this week, we announced the successful completion and full systems acceptance of the U.S. 290 toll road project for the Central Texas Regional Mobility Authority, CTRMA. The U.S. 290 toll road in Austin is a critical six-mile corridor that has been successfully upgraded to an expressway facility. This enhancement has tripled the roadways capacity and delivered meaningful reductions in travel times for the users of both tolled and non-tolled lanes. We also successfully completed phase three of the 183A toll project for CTRMA. This project provides direct access between key transportation points and significantly improves traffic flow in the region. What's noteworthy about this achievement is that the effective collaboration we fostered between TxDOT, which is the Texas Department of Transportation, and the other stakeholders throughout this project. This approach ensured timely completion and it reinforces our standing as a trusted partner for complex multi-agency initiatives. While we continue to win follow-on business with existing customers, We've also intensified our pursuit of competitive bids and remain optimistic in securing meaningful new contracts this year. That said, we're taking a disciplined approach to pricing. We won't pursue business at any cost, as shareholders have witnessed and are witnessing the consequences of that type of strategy. Switching gears, as most of you know, we have a 10% ownership stake in YLAN, the IP business that we sold in 2023. Our 10% stake entitles us to 10% of any dividends distributed by the LP that owns it. In Q3 2024, we received a $3.8 million dividend. And in April of 25, we received a second dividend in the amount of $3.2 million. This payment will contribute positively to our cash position and will be reflected in our Q2 2025 financial statements. Let me... take a moment to update you on our strategic priorities. Our primary focus remains on growing our core tolling and enforcement business units through improved integration, ongoing technology innovation, increased business development activity, and enhancing our customer relationships. We continue to see growing opportunities to expand in Europe, as well as other regions like the Middle East. and we expect to see some progress on this front in 2025. Regarding our new technology architecture, we have deployed significant time and investment in our next generation offering. In doing so, we're making progress in our transition from being primarily an integrator to becoming a more software-focused company. Our new platform is built on a microservices architecture. that enables us to develop, deploy, and scale components independently, enhancing our market responsiveness and improving our ability to maintain solutions over time. This strategic shift is designed to drive higher margins, create defensible proprietary offerings, and enable recurring revenue streams. The platform supports both our tolling and enforcement business while facilitating expansion into new verticals like logistics, Artificial intelligence, AI, is increasingly integral to our operations. Our AI strategy focuses on two key areas, visual technology applications for vehicle ID and classification, and data mining and analytics. Both capabilities have promising applications across all our business units and are aligned with customer demand. Technology development in the ITS industry has been evolutionary in recent decades. But AI now presents revolutionary potential, the most significant innovation opportunity since RFID emerged in 1980s and 90s. We are among the first companies to explore comprehensive AI capabilities from convolutional neural networks, transformation models to large language models and generative AI built directly into our products. The ITS industry generates substantial data, and we're equipping our customers with the tools to transform this data into actionable insights that address critical challenges in operational efficiency, roadway safety, and infrastructure management. This paradigm shift represents the compelling reason I'd return to the industry. As mentioned earlier, The 2025 IBTTA Technology Summit in March was in our backyard in Dallas and was a real success. We had demonstrations of our new software with several customers, and the feedback was excellent. Among other things, we showed off our digital video audio system, DBAS for short, which uses AI to classify in real time without needing any prior training. That would be training of the models, by the way. We also gave people a hands-on look at our quantum vehicle detection system, which is an above-ground tolling solution that's generating a lot of attention. That, by the way, is an offshoot of our acquisition of Red Fox last year. Overall, it was great exposure for our team and our technology and an important milestone event for helping us stand out as innovators in the transportation technology area. On the logistics side, the pilot project we launched in the rail sector is serving as a valuable reference account, providing insights and a foundation for replicating our approach with other businesses in this vertical. Also, as mentioned, this market stands to benefit from the new technology architecture. I'd like to talk about board and leadership. Over the past 12 months, we've added new leadership capabilities to both management and the board. On the executive side, this has helped lead to important changes with our technology development and sales and marketing teams. At the board level, we held our annual AGM earlier this week and now have six board members, four of whom are new within the past six months. The changes to our board reflect the evolution of Quarter Hill over the past 18 months. and they align with our focus on core ITS operations and technology in financial management. I discussed the addition of Pat Dion, Sr. and Robin Saunders on our last call, but it's worth stating again that their combined experience in transportation systems, equity and debt financing, business development enhances our ability to capitalize on our growth opportunities. And now, I'm pleased to welcome Asha Denier and Stephen Smith as our newest members of the board. Following their successful election at our annual meeting earlier this week, Asha and Stephen have complementary skills. Asha brings strong legal and governance experience, while Stephen brings years of financial expertise. This mix will be key as we look to growing our core business and exploring potential acquisitions. They both help guide companies through similar growth phases, and bringing them on board shows our commitment to attracting leadership with the right mix of skills to create long-term value for our shareholders. Our outlook. Looking ahead, we remain laser-focused to drive revenue growth and margin improvement as we move towards the second half of the year. Completing our contract renegotiations, executing on our sales pipeline, and advancing our technology are our primary goals. On the renegotiation front, we have entered a structured settlement process for one of the two contracts to try to resolve the situation positively. Even though these projects generate some revenue, as you can see, it is unprofitable revenue, and it wouldn't be prudent for us to continue with the status quo. Generating consistent cash flow remains our top priority. The dividend received from YLAN will strengthen our position in Q2. And we continue to focus on improving operational cash generation across the business. Our bidding approach for new projects now ensures cash flow neutrality through the implementation phase, which represents a significant improvement over our historical approach. In conclusion, in closing for this, While Q1 presented expected seasonal challenges along with the ongoing impact of contract negotiations, we remain on track with our turnaround and with business transformation. We're building a stronger, more resilient business with enhanced technology capabilities, improved operational efficiency, and a path to top-line growth, margin expansion, and positive cash flows. I want to thank our team. for their continued dedication and hard work during this phase. We're excited about the opportunities they had and remain committed to delivering long-term value to our shareholders, investors, customers, and employees. With that, I'll turn it over to Morgan to discuss our financial results in more detail.

Thank you, Chuck, and good morning, everyone. I'll start with a look at revenue in the quarter. Q1 revenue was $33.9 million, down $1 million from Q1 last year. The decrease was primarily due to the timing of revenue received from certain ongoing projects, which in general leads to some quarterly fluctuation. As you know, Q1 is our seasonally slower quarter due to the impact of winter weather on implementations, which explains the sequentially quarterly variance. As Chuck mentioned, the two contracts that are in renegotiation contributed $3.6 million to revenue in the quarter. This revenue generates a significant negative contribution to operating margins, which is why we are pursuing the renegotiations. touch on their margin impact in a moment. Finally, at quarter end, we continue to have a significant backlog of US $476 million, providing good visibility into revenue for 2025 and the next several years. A large portion of the backlog is higher margin contracted maintenance revenue versus implementation revenue, which we expect will drive better margins in 2025 and beyond. Gross margin percentage in Q1 was 12% compared to 20% in Q1 last year. The decrease was primarily due to the poor margin on the two noted tolling projects, which was partially offset by continued strong margin performance from our enforcement unit. Total operating expenses for Q1 were $11.2 million compared to $10.5 million in Q1 last year. The increase was primarily due to investments in leadership and resources for our project bid development teams, which were offset in part by steps we've taken elsewhere in the organization to optimize the workforce. Q1 adjusted EBITDA was negative 3.4 million compared to positive 0.2 million in Q1 last year. The two tolling contracts that are being renegotiated resulted in a reduction to adjusted EBITDA of 3.2 million in Q1 2025. So excluding those two contracts, Q1 adjusted EBITDA would have been a more modest loss of 0.2 million versus negative 3.4 million. As we've said previously, driven by continued steady results from the enforcement unit, and better expected performance from our tolling unit, we are looking for adjusted EBITDA to grow in 2025 compared to 2024. Completing the two renegotiations will be a big contributing factor for generating that growth. Turning now to the balance sheet. At quarter end, we had adjusted working capital of $59.8 million compared to $66.2 million at the end of 2024. As stated previously, we used adjusted working capital, a non-IFRS measure to highlight the strong working capital position that we have, Adjusted working capital is defined as working capital adjusted for convertible to benches and derivative liability. We ended the quarter with cash and cash equivalents of $26.1 million compared to $31.9 million at the end of 2024. As Chuck mentioned, subsequent to quarter end, we received a $3.2 million dividend for our 10% ownership in YLN. This will be reflected in our Q2 statements. Also on the cash front, one of the main focuses has been the progress, billing, collecting on some of our longer-standing unbilled revenue balances, with work still to be done on a sprint that should help our cash balances in future periods. In 2025, we continue to expect positive cash from operations for the year, assuming completion of the negotiations. Due to the nature of our business, operating cash flows may vary significantly between periods due to changes in timing and working capital balances, namely with collections and payments. This concludes my review of the financial results. I'll turn the call over to the operator for Q&A.

Thank you. And ladies and gentlemen, we will now begin the question and answer session. To ask a question, you may press the star followed by the number one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press the star followed by the number two. Once again, please press the star one to ask a question. And with that, our first question comes from the line of Gavin Fairweather with Cormark. Please go ahead.

Oh, hey, good morning, and thanks for taking my questions. Maybe just to start on the tolling business, I think that that was a new point that you brought up, Chuck, in terms of one of the contracts being in a structured settlement. Maybe you can just kind of help us understand what that looks like. Is there a mediator involved? Is there a timeline that we should think about? What does that structured settlement process look like?

Yeah, I have to be somewhat careful because it is considered confidential, which is why I use the structured settlement. There is a structured process that we're following with the customer to come to a resolution of the costs associated with the operating of that system. I'd like to, I can also reemphasize, Both of those contracts are in revenue collection mode, so they're substantially into their implementation phase.

You might not be able to answer, but I'm going to ask it anyway. Are you looking to recoup some of the previous losses, or are you just looking to fix the margin on a go-forward basis?

Both are distinctly possible. My, my, my soul, my, my, you know, primary focus is for this to be cashflow positive as fast as humanly possible.

Understood. And, um, maybe you can, I understand that there's two that have been causing some issues. So what about the one that's kind of not in that structured settlement or are things progressing on that front as well?

Yes, they are. It's just a, it's a much different customer relationship. And, uh, And it's progressing along. It's a positive relationship with that customer.

I understand. And then maybe just on the sales side, on tolling, you've had some decent expansions and new wins recently. Maybe you could discuss, though, the size of the pipeline in terms of how many RFPs are hitting the market, how many... RFPs you've responded to and are waiting for a response on. Maybe just give us a sense of the size of that bit book and pipeline.

I can say I knew you were going to ask that question, Gavin. Our current pipeline that we're going after is about $2 billion right now. Our weighting on the toll side is about $278 million, and on the safety and enforcement side, it's about $250 million. We currently have $131 million in proposals out for review right now. We have quite a good backlog of proposals at the moment. We have been bidding actively.

And as you start to get some decisions on those kind of RFPs, would these be things that would be ramping up in 26, assuming that you

No, some of them will be ramping up this year. We had one that we thought we were going to hear about that got pushed until October. We have another one that we should hear on in the next few days. So they're definitely actively, I mean, we're talking about, we expect some awards very quickly here.

Okay, that's great to hear. And then maybe one quickly for Morgan. Can you remind us of kind of your view of the excess working capital in terms of the, you know, unbilled revenue tied to some of these tolling contracts? Have you sized that up recently?

Kevin, I don't have an exact number for you for those two projects specifically, but throughout the year, we're looking to actively move that unbilled revenue into AR and collect it in the second half of the year.

Assuming, I think it was $37, $38 million in the quarter, can you help us understand the quantum of what might be excess?

For the two projects, we could see a sizable decrease in that in the second half with successful renegotiations. I don't have an exact number, Gavin. I can get back to you on that.

Okay. Sounds good. Thank you. I'll pass on.

And your next question comes from the line of Todd Coupland with CIBC Capital Markets. Please go ahead.

Oh, yeah. Good morning, everyone. I was wondering if the run rate in Q1 is the right number to use for revenue and loss until these contracts are resolved. If you could just give us a sense on seasonality and where the business should be until it you're able to adjust those programs.

Yeah, so typically Q1 is our seasonally softest quarter, so we will start to see an improvement in the quarterly revenue starting in Q2 and wrapping up in Q3 and Q4, as we've seen in previous years. We can still see some impact until those two contracts are renegotiated, but we're actively working to limit the exposure on a weekly basis. I mean, is the right way to think of, oh, sorry. I was just going to say, in the previous year, it was approximately a $7.4 million loss on those projects, on those two projects combined for EBITDA. I see. If that helps give some clarity.

Todd, does that give you some clarity on where we think we will be?

So you basically are, sorry, what was the total last year, $7.4 million? Yes. Yeah. And you got hit by 3.2 this quarter, something like that. So, yeah. Okay. And some of that is because... Is the idea that, I mean, just for simplicity, do we just assume until it's cleaned up, spread that out over the rest of the year, the balance? Yes.

Yeah, I think it depends on timing, but I think the reality is that, you know, we expect that we're going to make some positive progress here in the short term on those. We're sure hoping on that. But it gives you an idea. If you were to eliminate those two contracts, where our EBITDA would have been.

That's fair. That's fair.

Yeah, maybe that's fair. So we were trying to give clarity to our shareholders and the market on that. what that was because we've been asked that. So that's why Morgan did the calculation.

Yeah. Okay. That sounds good. Okay. I was wondering, so I see the debenture is, you know, classified as current now. I guess that's October 26. That comes due. What's the thinking and plans for that? How should we, how should we be anticipating an update on that.

Thanks. We're actively in discussions to refinance those where they are just to make sure that we're covered. That kind of thing keeps me up at night. So we're actively in discussions with banks on managing that and or converting it next year.

Yeah. But the conversion price is $380,000, so you're going to need to get that $2 billion of backlog awarded to Quarter Hill. Or the pipeline, sorry.

Yeah, got it.

Thank you. And just on that, sorry, one follow-up on the convert. It's 6%. What's your sense with the turnaround in the business?

if you were to refi do you feel like that's a lower rate um do you have a sense on that don't have a sense on it yet um i obviously the rates have become a little more manageable in that so i'd probably have a more positive feeling about it now than i would have you know three months ago yeah okay yeah fair enough yeah um okay that sounds good and then on the pipeline

Chuck, what do you mean when you say weighting 278 and 250, tolling and enforcement out of the 2 billion? What does that actually mean?

We weighted according to a higher probability of our win. So right now we have actively opened $2 billion of opportunities, but we see about 575 million of that, we have a higher probability of a win. So we wait and we look at it.

Yeah, yeah. I got you. And if you think about, so you see $2 billion and then you wait your high probability. What does that look like over the next, let's say, one, two, three years? Does that $2 billion stay steady in the pipeline? No. What's the opportunity set if we just think about it? looking out a little bit longer?

I think it probably goes up by over a billion dollars a year. Just so you know, so what we do is, as you know, at the beginning of the year, end of last year, I was very careful about making sure we were cleaning up our own house before we focused on opportunities. We brought in a good head of sales that's really driving this project right now. And so we have much more confidence in our bidding and proposal capability today. So we're definitely getting more active, and we're definitely looking at more and bigger opportunities.

Yeah. Okay. And what's the urgency, would you say, in the market right now? I guess you have certainty. I don't know if you're impacted by Doge. I mean, a lot of this is state-driven, I suppose. But what's the urgency, I guess, from a budget point of view and then maybe leveraging the tech that you were talking about before? Give us a sense on what are the factors that are impacting decisions.

Right. The biggest factor is usually the urgency is that these systems are in for a long time So these contract lives are coming to an end or the technology is just kind of evolutionarily phasing out. A lot of these systems that are bid, there's new ones, there's new roads, like some of the stuff we look at CTRMA, the ACTC is a new road or newer road anyway. And then we're bidding on projects right now that have been in existence for a long time. but the technology is basically past its expiration date. So that's usually where the urgency comes. You touched on the right point, and it's also got to do sometimes with these contract renegotiations. I know they're frustrating for you and they're frustrating for all of us, but they're state and local contracts, which makes even the federal government look fast. So they're painful to get through, but when they get through, they tend to be long-term contracts. you know, steady systems. This, again, is all legacy stuff from before I joined, but we're working very hard to get through these things, and hopefully we'll have some good news here in the short term.

And sort of one last question on this. You know, you made the point on trying to have a higher software content in your business. What does the EBITDA margin look like with some of these new wins given that software possibility.

Right. So if you look at in the industry, kind of the gold standard is 20% EBITDA corporate-wide for this business. I think that there's a lot of competition. It's part of the reason we see a good opportunity in this market. because the market's a bit fractured, you're probably looking at companies that are around 10%, 12% EBITDA margin across the corporation. The difference is if you look at the software, when you look at it from an integration perspective and you look at yourself as an integrator, you're looking at kind of 35% gross margins to 40%, whereas if you're looking at the software components, you're more up in the 60% and 70%. And also the maintenance gets significantly better with a modern architecture.

So Chuck, is your point on this that that just builds a case for your 20% goal where the industry is kind of broken down at 10%? Or is there a possibility above that? What's your point on the 20?

I think, you know, in the next two years, I think the probability is 20% as a corporate EBITDA. But I do think with the new software platform and taking, frankly, a much more modern approach to it, you could see those numbers creep above 20%. above 20% in the next couple of years and more software-oriented margins. Now, some of it is, it's not completely realistic because you're still going to have implementations and you're still going to have subcontractors and things like that. But we still feel pretty good about 20%. And you can see if you add back the loss on those two contracts, we're definitely keeping to our plan. We didn't get them resolved as fast as we wanted to, but you can see when we do, we start to approach those numbers pretty quickly.

Sorry, Chuck, one last question. So on AI, you talk about how it can be used for vehicle counting, etc., Is this just a feature that people are going to want, or does it actually give you revenue upside, i.e., you can actually charge more for that functionality?

The reason you could charge more for that functionality is it eliminates humans. So right now, a lot of the revenue recovery is based around violations and things like that, and A lot of it involves pretty heavily human-involved image review. And when you're putting those violations together, and also when you're just identifying the vehicles, or we kind of use the loose nomenclature of vehicle fingerprinting, you know, identify kind of a blue Toyota with this license number, or if I don't have a license number, find the blue Toyota with these markings that's been through these lanes because it doesn't have a license plate and we want to identify it. So that's one, so you're not requiring human intervention to do that. And the other side of it is when you get on the, just on the tolling side, It allows you to process disputes and things much faster because you start to use kind of active learning with transformer models and large language models. It allows the users and the customer service reps to be able to handle the calls and the chats and everything just with much less human intervention, which really drives your operating costs down for the customers. And the software is more reliable because it shows up at work. On the logistics side, you start to look at what you're using for models like in a scene. So typical vision systems where we're just kind of identifying a license plate or the color of a vehicle centered around convolutional neural networks. As you look at transformer models, And think of those as almost serial models. And transformer models are more active models. So it's almost like the experience of actually monitoring a scene and identifying things that come up in an active and a parallel kind of processing thought process. So there's a lot more crossover between the convolutional neural networks and large language models, given that we're using these transformer models, which only really kind of started to come about in 2017 and 2018. So they've only now just gotten very good.

Appreciate you taking these questions. Thanks very much, Chuck.

Absolutely. Thanks, Todd.

And your next question comes from the line of Stephen Lee with Raymond James. Please go ahead.

Thank you. Hey, guys. So on the program contracts, I appreciate the quantification of the impact, but I also want to clarify, is this a run rate impact? So every quarter it drags on, it's $3 million on the EBITDA? Thanks.

I had to think about that for a second, Steve.

Yeah, so we're taking action to bring that down from $3.2 million in the first quarter this year. As we referenced last year, it was approximately $7.4 million loss on those two projects. So we're actively working to bring that down so that the quarterly run rate is not $3.2 million. Okay. And taking actions within the company. Okay.

Yeah. Okay, that's helpful. Okay, and so leave aside these contracts. So can I ask if IOD grew year over year for Q1?

Yes, it did. Q1 this year over last year was a growth of approximately 28%. Oh, wow. Okay, very good. Thank you. It's a seasonally soft quarter, so we just started the year off very, very strong. But we're looking forward to growing that year.

And we've grown the margins significantly in that business over the last year or two.

Got it. Thanks, guys.

And that concludes our question and answer session. I would like to turn it back to Mr. Myers for closing remarks.

All right. I'd like to thank you, the operator, for hosting the call today. I always want to thank the investors and the and our shareholders for their patience and their support. And we'd like to view ourselves as fairly transparent and provide as much information as we legally can without doing something we're not supposed to. And again, our employees are working hard. I want to thank our new board members. And I think everybody's marching in the same direction. So we look forward to a positive outcome.

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect. Have a good day, everyone.