Control4's (CTRL) CEO Martin Plaehn on Q3 2016 Results – Earnings Call Transcript

Control4 Corporation (NASDAQ:CTRL)

Q3 2016 Results Earnings Conference Call

November 03, 2016, 05:00 PM ET

Executives

Martin Plaehn – Chairman and CEO

Mark Novakovich – CFO

Analysts

Saliq Khan – Imperial Capital

Mike Kobin – Raymond James

Operator

Good day ladies and gentlemen, and welcome to the Control4 Third Quarter 2016 Earnings Call. Today’s conference is being recorded.

And at this time, I would like to turn the floor over to Mark Novakovich. Please go ahead, sir.

Mark Novakovich

Thank you, Operator. Good afternoon, everyone. And thank you for joining Control4’s earnings conference call for the third quarter of 2016. My name is Mark Novakovich, and I’m the Chief Financial Officer for Control4. With me on the call today is Martin Plaehn, our Chairman and Chief Executive Officer.

Prior to this call, we distributed our Q3 2016 earnings release over the wire services and we have posted it on our website at investor.control4.com, as well as furnished it to the SEC on Form 8-K. This call is also being webcast and a replay will be available on the Investor Relations section of our website for 14 days.

Before we begin, I would like to remind you that during today’s call we will be making forward-looking statements regarding future events and financial performance including our financial outlook for the fourth quarter of 2016 and our revenue and non-GAAP net income outlook for full year of 2016. We caution you that such statements reflect our best judgment as of today, November 3, based on factors that are currently known to us and that actual future events or results could differ materially due to a number of factors, many of which are beyond our control.

For a more detailed discussion of the risks and uncertainties affecting our future results, we refer you to our filings with the SEC including the 8-K we filed earlier today, which contains our Q2 2016 earnings release. Control4 disclaims any obligation to update or revise these forward-looking statements to reflect future events or circumstances.

During the call, we will also discuss non-GAAP financial measures. We do not provide guidance on GAAP net income because of the variable and unpredictable nature of certain items excluded from non-GAAP net income which is acquisition related expenses, stock-based compensation, litigation settlement expenses and executive severance costs. Unless we specifically state otherwise, the non-GAAP financial measures that we discussed today, were not prepared in accordance with Generally Accepted Accounting Principles and that they exclude expenses related to stock based compensation, acquisition related costs, the amortization of intangible assets, litigation settlement expenses and certain other items that are detailed in the reconciliation of GAAP and non-GAAP results provided in today’s press release and posted on the Investor Relations section of our website.

Now, I will turn the call over to Martin.

Martin Plaehn

Thanks Mark. Welcome everyone. And thank you for joining us on the Control4 earnings call for the third quarter of 2016. I am pleased to report that Control4 experienced another strong quarter, with solid revenue growth and earnings expansion. Here are the high level financial results for Q3.

Revenue for the quarter was a record $55.2 million, $700,000 above the high-end of our guidance range representing year-over-year growth of 27%. During the quarter, we saw a continued strong demand for our new EA Series Controllers with over 24,350 EA Series Controllers shipped this quarter, a sequential quarter increase of 8% above the 22,500 EA Series Controllers we shipped in Q2.

Pakedge networking products delivered $7.1 million in revenue for the quarter. Since January over 1250 Control4 dealers have purchased Pakedge products for the first time since the late January acquisition up from the 830 dealers we reported in August and the 370 dealers we reported in May.

Our strong revenue combined with non-GAAP gross margins of 52.5% enabled us to deliver non-GAAP net income for the quarter of $6.4 million or $0.26 per diluted share also above the high-end of our guidance range. As we noted in prior calls, Control4’s mission is to be both the platform ecosystem and market leader for premium automation and networking solutions for the connected home market.

Complementing our strong financial performance this quarter, we continued executing on key operational business and product development programs in advance our mission, as well as strengthen our market position, our competitive differentiation and business velocity. In addition to delivering on our top and bottom line goals, I’d like to provide you with a brief update on several of our accomplishments during the quarter.

First, integration and adoption of Pakedge networking. As we have previously reported, we acquired Pakedge device and software on January 29, 2016. During this last quarter we completed our integration of Pakedge into Control4 including Pakedge sales operations and product development team, fulfillment operation, financial and other internal systems.

Through our rapid integration of sales and support functions across both Pakedge and Control4 channel, we are seeing year-over-year growth in both product line adoption and sales since the acquisition. On a pro forma basis assuming the Pakedge acquisition had closed at the beginning of 2015. Sales of our networking products for the first nine months of 2016 are up 23% year-over-year and we expect additional efficiencies from our completed integration.

Second, international expansion. With the goal of accelerating our international business, we recently opened technical training centers in Melbourne, Australia and Frankfurt, Germany and we have begun more concentrated recruiting and training of Control4 authorized dealers in these regions. We view these investments as essential step in expanding our direct dealer reach and business potential in these regions. We are pleased with the local dealer reception to our increased direct presence, as well as our year-to-date growth in active dealers, revenue contribution and new customer installations in these country.

Third, new product introductions and expanded partnership. During this recent quarter we rolled out new solutions at our industry’s key event Media Expo which took place in Dallas, Texas in mid-September. On the opening evening of the CD Expo to a packed ballroom of over 1000 of our dealers and another 1000 tuning in live from around the globe to our online video broadcast, we launched a wave of new products and services and announced their immediate availability.

In the subsequent three days of the CD Expo we met with more than thousand Control4 and Pakedge dealers, as well as hundreds of perspective dealers at our exhibition booths providing hands-on demonstration of our newest products. The new products and services we announced and began delivering included Amazon Alexa Voice integration to enable voice control for Control4 homeowners with smart home devices and themes throughout the Control4 home or within a single room including lighting, climate control, music, television and much more.

Along with individual device commands such as Alexa turn on the dining chandelier to 50% or Alexa turn the main floor thermostat to 70 degrees. Control4 and Amazon implemented automation scenes to coordinate the actions of multiple devices through a single voice command. For example a homeowner can say Alexa turn on dinnertime to lower the shades in the kitchen and dining room lights and turn on the music or Alexa turn off out to ensure all entertainment devices throughout the home are shut down, the temperature is set to 65 degrees on the upstairs and main floor thermostat, the window shades are all lowered and the interior lights will be turned off in three minutes. It’s very cool and homeowners are finding it rapidly useful.

Within days of our announcement in September we had well over thousand end customers using their Amazon Echo device with their Control4 system. And they’re using this new integration daily.

We also introduced Control4 OS version 2.9 packed with new capabilities to enhance personalization for homeowners and expanded integration tools for our dealers. The enhancements included one, an all new window blinds and shades experience with an intuitive graphical interface to make it easier than ever to control and automate window coverings throughout the home.

Key to this new experience is deep integration and collaboration with the leading window shade manufactured including Lutron, [indiscernible] that can new in-home personalization enabling homeowners to create and modify their own wakeup and sleep scenes and figured individually by room from a Control4 touchscreen interface including lighting, music or television and window shades.

And third, a new Z-Wave of wireless networking support for our EA Series Controllers via new Z-Wave radio module along with device support for specific third-party products to enhance our home safety and security capability.

As with prior major releases of Control4 software, we also updated Composer Express and Composer Pro functionality for our dealers, as well as our end-user Control4 mobile apps for iPhone, iPad and the Apple Watch and for android phones and tablets.

Since releasing Control4 OS 2.9 to our dealers on September 15 as of the end of October approximately 30,000 homes have been upgraded to our new software, and a couple thousand of these are using Alexa Voice interaction daily within their Control4 connected homes.

Next to broadly enable remote configuration and monitoring of Pakedge networking power connected home, we made our backpacks service software freely available to all our Control4 and Pakedge authorized dealers but their use along with Pakedge networking product. Backpack enables our dealers to configure and monitor Pakedge networking product and provides our dealers with near real-time connected home status and alerts for all their backpack monitored customer installation saving dealers direct labor and transportation time and cost and more importantly increasing customer satisfaction through proactive responsiveness and superior system reliability.

Additionally during the CD Expo we also showcased our new Control4 branded Ultra HD 4K video switches with multichannel audio down mixing which we began shipping one week before the CD Expo. As well as our new multi-dwelling unit solution in order to address and serve the growing opportunity of multi dwelling development throughout the world in numerous cities.

We believe Control4 continues to be well positioned and is expanding the home automation landscape. In our positive performance year-to-date reflects that progress and position. For the remainder of 2016 and for 2017, we will continue focusing on the central foundation of our business operation.

Initiatives supporting our business foundation include, one continuing to grow and optimize a professional dealer presence in key the regions where we have direct presence including the United States, Canada, United Kingdom, Germany, Australia and China, as well as deepening our support for our 46 international distributors covering the rest the world.

Two, optimizing new customer acquisition and existing customer service by strengthening our marketing service collaboration with our dealers. We will work to improve both business and technical best practices and work to enhance specific business services that we can perform at scale for our dealers to supplement their imperative local work.

Three, continuing to facilitate and support our growing and industry-leading device interoperability and partner ecosystem. This very strong important differentiator for Control4 now includes approximately 10,000 third-party devices and 200 simple device discovery protocol licensees who are selling and delivering 1690 product models that are Control4 enabled via SDDP and selling through our Control4 dealers and distributors.

And fourth, furthering the development of our connected home solutions and platform services to expand our addressable market within the home owners at the entry level, the mid tier, and the luxury high end, as well as enabling our professional installer channel to become more responsive, more effective, and more efficient.

We believe these initiatives will collectively continue to create shareholder value by strengthening Control4 as the premium and preferred choice for homeowners and their families. For custom home builders, independent connected home integrators, and consumer electronics partners.

With that, I will turn the call over to Mark.

Mark Novakovich

Thank you, Martin. We appreciate everyone’s participation on today’s earnings call. We are also pleased to have exceeded both revenue and non-GAAP EPS guidance for the quarter.

Before opening the call to your questions I’d like to provide some additional details about our recent financial performance, as well as guidance for the fourth quarter. Total revenue for the third quarter was a record $55.2 million, a year-over-year increase of 27%. On a pro forma basis if we were to assume that the Pakedge transaction had closed at the beginning of 2015, our revenue growth for the three and nine months periods ended September 30, 2016 would have been 14% in both periods.

North America core revenue which includes sales in the U.S. and Canada grew 32% and 29% year-over-year for the three and nine month periods ended September 30, 2016 respectively and nearly all of our 25 North American sales regions contributed to that year-over-year growth. International core revenue for the three and nine month periods ended September 30, 2016 declined 1% and grew 8% year-over-year respectively.

International core revenue has been negatively impacted by regions such as Latin America where unfavorable macroeconomic factors resulted in declining business in regions such as the U.K. and Australia when we price in local currencies that have experience significant devaluations year-over-year relative to the U.S. dollar which has impacted growth statistics that are measured in U.S. dollars.

Our international sales model includes both direct to dealer and two-tier distribution via 46 distributors. In countries where we sell direct to dealers we generally invest in some combination of local technical support, training personnel and facilities, warehousing and fulfillment, and sales support personnel. We’ve made these types of investments in the United Kingdom, Germany, Australia, China, and India and these are markets where we see our greatest opportunity for international growth and expansion.

In the markets where we’ve made local presence investments, their combined revenue increased by 10% and 20% respectively for the three and nine month periods ended September 30, 2016. In contrast international revenue from the other countries where we generally have two-tier distribution declined by 28% and 20% respectively during the same three and nine month periods.

The volatility and foreign-exchange rates in particular the strengthening of the U.S. dollar versus the British pound has also contributed to a decline in year-over-year international revenue in 2016. We do expect to see continued volatility in the price of the British pound and other currencies relative to the U.S. dollar.

Adjusting for a constant exchange rates between 2015 and 2016, our international core revenue grew 7% and 15% respectively during the three and nine month periods ended September 30, 2016. Our other revenue category consisting primarily of hospitality business and retail store audio/video switching products in Australia contributed $1.7 million to the quarter compared to 445,000 during Q3 of 2015.

Our non-GAAP gross margin percentage for the quarter was 52.5% is up slightly from 52.4% in the second quarter of 2016 and an increase from 51% in Q3 of last year. The increases is non-GAAP gross margin were due to a variety of factors including manufacturing cost reductions, and favorable product mix but we’ve historically seen some volatility in gross margins from quarter to quarter. We anticipate gross margins for the fourth quarter to be similar to those in the second and third quarters of 2016.

As a reminder, our long-term expectations for non-GAAP gross margins are between 52% and 54%. Our non-GAAP operating expenses in the third quarter 2016 were $22.5 million compared to $18.8 million in the third quarter of 2015. On prior calls we communicated our goal of holding our combined Control4 plus Pakedge non-GAAP operating expenses at 2015 exit run rate levels and our increasing leverage is apparent.

For the first nine months of 2016, our non-GAAP operating expenses were 43% of revenue compared to 45% of revenue during the same period in 2015. Non-GAAP research and development expenses during the third quarter of 2016 were $8.2 million or 15% of revenue compared to $8 million or 15% of revenue in Q2 of 2016 and compared to $7.5 million or 17% of revenue during Q3 of 2015.

The Q3 year-over-year increase in absolute dollars is primarily due to the acquisition and integration of Pakedge. Non-GAAP sales and marketing expenses in the third quarter of 2016 were $10 million or 18% of revenue compared to $10 million and 19% of revenue in Q2 of 2016 and compared to $8 million or 18% of revenue in Q3 of 2015.

The Q3 increase relative to the same period in 2015 was impacted by a combination of factors including our participation in the CD Expo which occurred in Q3 this year and in Q4 last year. Sales and marketing expenses associated with Pakedge products and finally increased general marketing expenses to drive lead generation, grow our dealer and distributor networks and deliver tools to the sales channel to support local marketing and sales.

Non-GAAP G&A expenses in Q3 were $4.2 million 8% of revenue compared to $4.2 million or 8% of revenue in Q2 of 2016 and compared to $3.4 million or 8% of revenue in Q3 of 2015. The Q3 year-over-year increase in absolute dollars is primarily due to increases in salaries and wages and other administrative cost associated with running our business including transition costs associated with the Pakedge integration.

Our third quarter non-GAAP net income was $6.4 million or $0.26 per diluted share compared to non-GAAP net income of $3.6 million or $0.14 per diluted share in the third quarter of 2015 representing non-GAAP net income growth of 79% and non-GAAP EPS growth of 86%. For the first nine months of 2016 our non-GAAP net income grew 95% and our non-GAAP EPS grew 104% over the same period of 2015.

As of September 30, 2016 we had $52.1 million in unrestricted cash, cash equivalents and net marketable securities, an increase of $3.5 million from $48.6 million as of June 30, 2016. The increase reflects free cash flow generation of $4.8 million and $2.3 million received from stock options exercised offset by $3.7 million in debt repayments.

As of September 30, 2016 our total debt balance was $1.8 million and subsequent to quarter end we retired that debt leaving us with no bank debt and $30 million of available borrowing capacity under our credit facility. We did not repurchase any shares of our stock during the quarter leaving $7.7 million remaining under our $20 million board authorized share repurchase program. We will continue to monitor market conditions to identify appropriate opportunities to repurchase additional shares during open trading windows.

Turning now to our forward-looking guidance, we expect our revenue in Q4 to be between $53.5 and $55.5 million. We expect our non-GAAP net income for Q4 2016 to be between $5.7 million and $6.7 million or between $0.22 and $0.26 for fully diluted share.

For the nine months ended September 30, 2016 the company has a non-GAAP tax benefit of $0.2 million and anticipates a net non-GAAP tax expense for the full year of approximately $0.6 million or a non-GAAP tax expense of $0.8 million in Q4. Resulting from domestic alternative minimum tax, eight taxes where no operating loss carryforward to exist and tax on foreign income sources.

Taking into account our Q4 2016 guidance, our guidance range for the full year 2016 increases to $205 million to $207 million for revenue and $18.6 million to $19.6 million for non-GAAP net income on non-GAAP EPS of $0.76 to $0.80.

With that we’d like to now open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Saliq Khan with Imperial Capital.

Saliq Khan

Hi Martin, Hi Mark. Guys really good quarter and only a few questions on my end. Martin you talked about the fact that the revenue of Pakedge was roughly $7.1 million and to me this implies a little bit faster growth rate than the 20% year-over-year that I anticipated. What factors are driving this improvement?

Mark Novakovich

There’s a couple of factors, I’ll speak to it numerically and Martin can add some commentary. But as we mentioned in the script, we have over 1250 Control4 dealers that since the acquisition have started buying those products and that’s driving growth and adoption about that 20 percentage as you indicated.

Martin Plaehn

I think that addresses the question.

Saliq Khan

Your question to mine was, you had mentioned [CD] [ph] a couple of times and one of the things that I noticed you spend a good amount of time with these guys, he became Comcast first home automation partner, what is this partnership means for Control4 and how will it help you in the longer-term improved top line growth?

Mark Novakovich

I mean partnership with Comcast is all about device interoperability between their cable and DVR products. We were one of the first companies to embrace their Internet or control over IP protocol so that integration of Comcast broadcast services and cable services through our living room experience are more seamless.

We view it as part of having the richest ecosystem amongst all of the automation platform companies, so we work with Comcast closely and as well as all the other cable and satellite providers and third-party companies. So it’s important and we’ll continue to embrace large service providers as well as large consumer electronics companies.

Saliq Khan

Just one last question on my end. If you take a look at the success that we are seeing now out of the EA Series Controllers, how do I think about this and think about the growth rate particularly given the fact that now you have focus a lot more so on the quality of the overall dealers that are pushing the product for you. Now you have a much bigger suite of other solutions that you can actually put into the house thinking it would be acquisition of Pakedge.

So how do I think about all these parts of solutions and keep in mind the fact that with EA Series you’re really going down the channel and going after a market that it had little bit harder time trying to penetrate previously?

Mark Novakovich

That’s a good question, Saliq. The EA Series is a three model series the EA1, EA3 and EA5 and as we mentioned when we launched that product in the first quarter, it is a market reach expansion line. The EA1 is designed for the one room install family room entertainment, automation at a price point from $500 to a $2,000, that price point was not one where we played in before, our prior price points were between $750 and $1500.

Also the EA Series is an expansion product line at the high-end with the EA5 for very, very large installations with lots of multi-room and simultaneous music streaming. So I think your observation is correct about – that the EA Series is a market expansion vehicle for us. We’re seeing good adoption by our dealers and end customers on more one-room solutions where we didn’t play before and we expect that expansion to continue across all of our dealers and especially internationally.

And we continue to make progress on penetrating more and more of the luxury high end as we continue to expand our capabilities, our software experience. And now with the EA5 we’re probably the best digital to audio conversion quality amongst in-home systems. I think it’s a good step forward for us and we see it continuing. The feedback we’re getting from dealers is very strong.

Saliq Khan

Great. Thank you guys.

Mark Novakovich

Thank you, Saliq for your questions.

Operator

And moving on from Raymond James we have Mike Kobin.

Mike Kobin

Hi, guys. Thanks for taking my question. This is Mike Kobin on for Tavis McCourt. One I just had kind of a housekeeping question, I believe you guys mentioned that gross margin in the fourth quarter is expect to be similar to 2Q and 3Q, I was just – did you mean on a GAAP or non-GAAP basis for that?

Mark Novakovich

On a non-GAAP basis it’s probably the easiest way to look at it. And in our press release we did provide some guidance on our non-GAAP items including amortization of intangibles and stock compensation.

Mike Kobin

Awesome. Thank you. And then about the dealers and their – you just mentioned that they’ve been helping drive some of that Pakedge revenue growth. I was wondering how did you guys think about – you said there’s 1250 so far out of little under 4000 active dealers. So how do you think about, how many of those are you expecting to hop on the bandwagon, how long does this kind of – good boost last?

Martin Plaehn

This is Martin that’s a good question. So in our remarks we mentioned that we reported that they were 830 dealers that had adopted Pakedge in our August report and 370 when we reported in May. So we finished the transaction at the end of January, effectively the beginning of February.

By May 370 adopted, by August 830 adopted, by today 1250 adopted, so you can see a pattern of multi-hundreds joining this adoption curve. These are not just one time purchases. This is – they’re putting it in their showrooms, they’re putting it in their own homes, some have started selling through to their own customers so as we get Control4 dealer adoption of the Pakedge product line, we’re creating a larger and larger channel for our networking product line.

We’ll continue the evangelism across our entire channel base and sell our networking products in those countries where we have the appropriate regulatory credentials. And we can see this expansion running for several quarters and then it’ll be all about the foundation of our core business and producing follow-through and ongoing business much like the way our trip – our core business is.

Mike Kobin

Great, thanks guys. And last question for me just on the currency, just kind of – from back of the envelope calculation looks like the pound was down about, like maybe 5%, 6%, 7% in 3Q. Can you guys give us some sense you know maybe quantify how that affected your revenues in the quarter.

Mark Novakovich

Yes in the script we mentioned that on a constant currency basis our international revenue would have grown 8% compared to the 1% decline during the quarter. So obviously it’s having an impact on revenue internationally. We don’t see necessarily a near-term change in the rates that’s what the information we’re getting from – some of our FX advisors.

So we would expect some softness in the U.K. going into Q4 but on a local currency basis U.K. is performing well and the revenue in local currency was up year-over-year in Q3. So we’re not as concerned about the business this is more of an FX conversion issue that impacts our financials.

Mike Kobin

Okay, great. That’s all for me guys. Good job in the quarter. Thanks a lot.

Operator

[Operator Instructions] Moving on from Wells Fargo Advisors, we have [indiscernible].

Unidentified Analyst

Congratulations on an excellent quarter. You have touched on all the financials but do you have any idea why the 11.3% drop in the stock today prior to the earnings release knowledge of any institution or ETF liquidation?

Martin Plaehn

Hi, this is Martin. We don’t know and we really don’t comment on stock trading, it’s not our expertise, we leave that to the analysts. We focus our energy on building great products, selling a lot of new responsibility and supporting our customers and our channel. We certainly saw it happen when we got on the call but we don’t have any details on it.

Unidentified Analyst

I understand. Thank you very much.

Operator

[Operator Instructions] And it looks like we have no further questions from the audience. I’ll turn the floor back to management for any additional or closing remark.

Martin Plaehn

Hi, this is Martin. Thank you very much for joining us on our report today. We look forward to reporting our full-year results next time. We’re excited about our new products and the channel and the customer enthusiasm that we’re seeing. And we are barreling forward with good momentum. Thank you.

Operator

And ladies and gentlemen that does conclude today’s conference. We appreciate your participation. You may now disconnect.

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