Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2018 Q1 Earnings Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Steve Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.

[Stephen J. Sadler, Executive Chairman & CEO]

Good morning, everybody. I'm here today with Vince Mifsud, President; Doug Bryson, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before we begin, I'll have Todd read our forward disclaimer.

[Todd M. May, VP & General Counsel]

Certain statements made in this conference call may contain forward-looking statements which are not historical facts but are based on certain assumptions and reflect Enghouse's current expectations. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risk factors are identified in Enghouse's AIF and other periodic reports filed with applicable regulatory authorities from time to time. Enghouse disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

[Stephen J. Sadler, Executive Chairman & CEO]

Thank you, Todd. Doug will now give an overview of the financial results.

[Douglas C. Bryson]

Thanks, Steve. Yesterday, Enghouse announced its first quarter financial results for the period ended January 31, 2018.First quarter revenue increased to $85.1 million compared to revenue of $78.8 million in the first quarter last year. Income from operating activities was $22 million, which includes a foreign exchange balance sheet loss of $2.5 million compared to $22.4 million in the prior year's first quarter, which had a foreign exchange gain of $200,000.Net income for the quarter was $6.8 million or $0.25 per diluted share compared to $11.7 million or $0.43 per diluted share in the prior year's first quarter, with the decrease being attributable, tax charges related to the enactment of the U.S. Tax Cuts and Jobs Act on December 22, 2017, as well as foreign exchange balance sheet loss.Adjusted EBITDA for the quarter was $25.3 million or $0.93 per diluted share compared to $22.8 million or $0.84 per diluted share last year, with the increase being attributable to contributions from acquisitions and stronger license sales in certain regions.To normalize results for the significant volatility in foreign exchange rates over the past couple of years, the definition of adjusted EBITDA has been revised this quarter to exclude foreign exchange balance sheet gains and losses. Both current quarter and prior period comparative figures have been restated accordingly. Operating expenses before special charges related to restructuring of acquired operations were $36.3 million compared to $31 million in the prior year's first quarter and reflect incremental operating cost related to acquisitions and foreign exchange losses on assets and liabilities, including intercompany accounts. Noncash amortizations in the quarter were $7.2 million compared to $7.5 million in the prior year's first quarter. The company generated strong cash flows from operating activities of $23.1 million compared to $10.7 million in the first quarter of 2017, an increase of 116%. As a result, Enghouse closed the quarter with $145 million in cash, cash equivalents and short-term investments compared to $130 million at October 31, 2017. The cash balance was achieved after payment of $4.3 million in cash dividends and $4.9 million for acquisitions. In January, Enghouse named Vince Mifsud as President with responsibility for the company's worldwide sales, operating and finance units. Mr. Mifsud has established an impressive track record in the SaaS and enterprise software industry, helping grow technology companies in Canada. Yesterday, the Board of Directors approved the increase to the company's eligible quarterly dividend to $0.18 per common share payable on May 31, 2018, to shareholders of record at the close of business on May 17, 2018. Enghouse has now increased its dividend in each of the past 10 years by over 10% each year.I'll now turn the call back to Mr. Sadler.

[Stephen J. Sadler, Executive Chairman & CEO]

Thank you, Doug. First, you'll probably note a new management participant on the call. January 15, 2018, Vince Mifsud was hired as President. He will take on responsibility for worldwide sales operations and finance to give a renewed focus on organic sales growth while allowing us to spend more time on acquisitions. Welcome, Vince. As Doug noted, we continue to grow our cash with cash and short-term investments of approximately $145 million. Cash flow from operating activities was $23.1 million in Q1 compared to $10.7 million in the prior year.You'll notice that due to continued fluctuation of exchange rates, we have separated balance sheet -- the balance sheet impact, generally not cash, of foreign exchange gains and losses that were previously included in sales, general and administration expenses. These are primarily a result of a weaker U.S. dollar just before the end of the quarter when the exchange dropped to approximately 1.23. This since recovered, but converting balance sheet amounts at this lower value resulted in the loss of $2.5 million compared to a gain last year of $200,000. We believe that separating this item gives shareholders a better understanding of our operation activities.Another unusual accounting item is taxes. You'll notice a significant accounting provision of $8.8 million. This is a result of changes to the U.S. tax regulation implemented on December 22, 2017. Federal tax rates declined from 35% to 21% January 1, 2018. This will be a positive to our U.S. business going forward but requires a negative accounting estimate in Q1. It impacts our tax asset, which was set up in accounting at a higher tax rate and causes to true up some of our tax balances, which we usually do in Q4. But the main accounting item impacting the tax provision was an estimate of the U.S. repatriation tax imposed on foreign U.S. subsidiaries for deemed repatriation of foreign profits. An $8.8 million onetime accounting charge was recorded, allowing dividends to be paid tax free to the U.S. from its subsidiaries. This is a tax cost estimate and not a tax cost, as it's to be paid -- not a cash tax cost that is to be paid over 8 years. So it does not impact the current year by that amount.Overall, adjusted for balance sheet foreign exchange, adjusted EBITDA was $25.3 million versus $22.8 million last year. Adjusted EBITDA margin was 29.8% compared to 29% last year and $0.93 per fully diluted share compared to $0.84 last year.We also announced yesterday at our Annual General Meeting that the Board of Directors authorized a dividend increase to $0.18 per quarter per share from $0.16 per quarter per share, effective with the next dividend payment in May 2018.Looking at acquisitions. Two acquisitions were completed in the first quarter, one in Germany for our networks business unit, and the other in our transportation unit in Denmark. Both of these were completed partway through the quarter and added approximately $800,000 in revenue and about $200,000 in EBITDA with minimal restructuring. The economic and market factors remain favorable for acquisition opportunities. I would now like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

My first question is for Vince. I'm just wondering, in your first 60 days, any changes or thoughts in those first 60 days?

[Vincent Mifsud, President]

Thanks, Daniel. Yes. So I mentioned this a little bit yesterday at our AGM. Good thoughts around the product. I looked at a lot of our products. We've got, as you know, a suite of products that helped customer experience and help telcos and the transportation industry. So the products, based on my review, look really strong, and I'm very happy with that part of the business. The area that we want to put some effort in and look to improve going forward is our go-to-market, our sales execution, demand-gen side of the business, is really the area that I want to put some effort and try to get some more organic growth out of this business because the products and the size of the addressable market is there for us to execute on. So that's going to be one of my big focuses in the upcoming quarters.

[Daniel Chan, Research Analyst]

And then, Steve, yesterday, you mentioned that you're going to be focused more on organic growth going forward. Should we expect any increases in OpEx as you do this and some of the changes that Vince is proposing for the sales organization?

[Stephen J. Sadler, Executive Chairman & CEO]

It's hard to say right now if it's some replacement cost or new cost, but I do think we probably have to add in, to improve our demand generation, a bit more expertise and cost. But it's not -- like, you might not notice because it's not a huge amount. But we -- you can expect us to do that. Our margins are pretty good at 29.8%, at the high end of what we talked about, from 25% or 30%. So we can afford to put a little bit of money to see if we can get our sales goals improving.

[Daniel Chan, Research Analyst]

Okay. And then last one for me. I think you've mentioned in the past about the U.S. service providers as an opportunity. Just wondering if there's any progress in winning them over. And what do you think the challenge is there? And what will let you win those carriers over?

[Stephen J. Sadler, Executive Chairman & CEO]

The U.S., we talk about, the carriers in the U.S., of course, are huge. And there, about 3 or 4 that dominate it. They tend to work with lots of people, so it's hard to get our CCSP, our contact center product, in there, but we do business with each of them. But I think the key into the U.S. is to continue the trend and get more business generally not necessarily from the carriers. As you probably heard from many other of the companies in the area, carriers have tightened up their spending in the last year or so. We've done fine by it, but they are more cautious in taking on new products and new activities. So the U.S., it's steady she goes. We hope to get the internal growth slightly better. But again, it won't come right away, it'll be over the year. At least we'll -- well, at least we'll give it a try.

[Operator]

We will now take our next question from Paul Steep of Scotia Capital.

[Paul Steep, Analyst]

Could you maybe talk a little bit about, in the quarter, Steve, SG&A obviously trended down a little bit. Which side did you trim from? And I guess that's sort of tees to the question earlier, the point Vince had made about investing back into the sales force. If it was on the sales side, how should we think about that ramp in terms of you rebuilding extra capacity to go drive growth?

[Stephen J. Sadler, Executive Chairman & CEO]

I think if you remember, and if you look at it, we didn't do as many acquisitions last year as we hoped because we spent a lot of time working with the finance area and centralizing accounting. So when you look at sales G&A, I think we're getting a little bit of the benefit of that centralization coming through now. We didn't trim any sales or marketing area, really, maybe a little bit of marketing because we now are trying to refocus on demand generation versus general marketing, but no real expense reduction there. It was really on the administration side and other areas.

[Paul Steep, Analyst]

So if that's the case, how should we think about, like, the plan and the time line to invest? Obviously, in fairness to Vince, he just got there in the middle of January, this could take you a little time, presumably, to spin this up. How should we think about it? Like, investment through '18 with hopeful results in '19? Or what's the thought, guys?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, we don't take that long to do stuff. Vince hit the ground running and he's already got some ideas and we've already made some moves. So we've started now and we hope -- you won't get the results necessarily that quickly because you got to get the people in place and then you got to -- you have your lead time for making sales. But we've started already.

[Paul Steep, Analyst]

Okay. And then the final one, I guess, for me today. On the M&A side, Steve, has there been any change? I know we've had a relatively static environment, but clearly a lot more focus and discussion today on organic growth. What's your view on the M&A world?

[Stephen J. Sadler, Executive Chairman & CEO]

We've always tried to do a 2-pronged approach. We tried the organic growth 3 years ago in a different method by adding sales resource. That didn't work so well, so 2 years ago, we took it out. The environment wasn't such that maybe we're a little early in thinking the economy would improve. With interest rates going up, what we see in the U.S., the tax cuts in the U.S. and U.S. being a very large market, we're back to believing that it will improve, and we've got to position for internal growth now. But that won't impact the acquisitions. Again, part of the -- with the interest rates also trending up and a lot of people still talking SaaS, the acquisition environment, especially in the area we're looking at, let's say, under $50 million in revenue, is still as it was -- very good, baby boomers are still getting older, people still want to get some cash for their retirements, private equity has gone higher. There's been no real change that we've seen. So we now have a 2-pronged approach with more emphasis on organic growth because we think the environment's changed. It has no impact on our acquisition activity other than we'd like to do more than we did last year. And remember last year, we purposely held back because we're changing the accounting, and it's very tough to bring acquisitions in while you're changing a lot of the finance and accounting backbone. And the interesting part of that, I mentioned it a couple of times, which is quite interesting, companies we're looking at, which we didn't do, they're still there. No one else bought them.

[Operator]

We will now take our next question from Deepak Kaushal of GMP Securities.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Steve, I just wanted to dig in more on changes to the corporate team. You've introduced Vince and given us a sense of his role. I was wondering if you could reveal a bit more of the chessboard. You've made a couple of changes, looking over the past year. How do you think of your corporate team overall? And what pieces you need or might change? What's your thinking on that in general?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. We're pretty established now where we need to be. Last year, we added in a Corporate Controller to help with the centralization of the accounting side. So we beefed up that team a little bit. We've also added in with new systems, a new budgeting system, a new analytics system and a rev rec because there's going to be revenue accounting changes coming up that will confuse you guys to no end. But we have to prepare for it at least a year in advance, so we've done that. From the corporate side, about 2 years ago I believe now, time flies, we added in a Chief Accounting Officer, Administration Officer who handles HR. She's done a lot of changes already, that was Lynette Corbett, and she's got some things already positioned for us going forward. So we're better today to integrate in the acquisitions faster. And I think we have the right team going forward. I don't see any further changes.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. That's helpful. And then I just wanted to ask you more of your thoughts on the technology and the opportunity environment. I guess, can you say that we're kind of seeing a resurgence in voice with all these voice assistants coming out? Do you see any opportunities for -- to bring back some growth in that side of the business there? Or do you have any IP that you've accumulated over the past couple of years that might be valuable in this context? And then I've got a follow-up to that.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. We've always been strong in voice. That's where we started. It has gone down. People are using more SMS messaging, they're using more chat, they're using more online email. So you could say voice is picking up a little bit, but it's nothing to write home about, as they say. So we're still continuing to trend. We have a strong development group continuing to upgrade our IVR system and our voice systems. They continue to do that, so we're well positioned there. But again, I still see the marketplace in contact centers, which they now call communication centers because they have outbound and inbound. The outbound part is a little tricky because there's more regulation coming about calling numbers that you shouldn't. But in general, there hasn't been much change.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Any technologies under the hood? Or any thoughts on the e-commerce acceleration and opportunities that, that might bring about for some of your products or services, just from a high level?

[Stephen J. Sadler, Executive Chairman & CEO]

There's always changes that help us and then there's some that hurt us. So I would say, net-net, no change. There's some things, of course, that yes, analyzing voice when people are mad on the phone and things like that, but we're keeping up in that area. But there's other areas with less people using IVR over the years that has caused some declines in some area. And as I said, the outbound communications, there's lots of countries saying you can't keep calling cell phones, et cetera, with ads. And so there's a pretty big worldwide regulation that impacts that slightly negatively. Overall, plus and minuses, we come out at least even.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And then just one final question, if I may. Unfortunately, I wasn't able to attend the AGM. Any updates on Canadian dollar debt? And it should help with the foreign exchange translations and things like that in your dividend. I know you've talked about that in the last couple of quarters as a potential.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. It was an emphasis. We haven't done the debt yet. We're prepared to do that, so you might hear something on that soon. The problem is while we're waiting to get the debt done, we increased our cash by more than the debt we were looking for, which makes it an interesting parameter. So as you know, our cash went up to $145 million. It was about $100 million last year, and we aren't looking for that much debt. But I do think it's important that we have that facility in place, so we don't -- it's taken nearly a year to get something done, so we don't end up that, if we need some extra money to do something with it, like an acquisition, we aren't limited in our ability to do it, we have it already available. So we're still working on it, but we have not done anything on that yet. And we've got to work harder on the intercompany accounts and the foreign exchange on the balance sheet, which we do, but it's really hard when exchanges just fluctuate all over the place. Like someone before last quarter had come out and made some comment about the U.S. dollar, it dropped down to 1.2293. And at our year-end -- and then our quarter happened and like 3 days later, Trump came out and said, "No, that's not the case," and it went back up. That's not real money for us, but it does cost us on our balance sheet foreign exchange numbers. So we decided to separate that out, but we intend to minimize that number.

[Deepak Kaushal, Director and Technology & Communications Analyst]

I guess generating cash is always the best problem to have.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. I made a comment yesterday, and I'd like to emphasize it. Cash is very important to watch as investors. You are going to get some accounting changes, some companies will start it this year. It's IFRS 15. It's going to confuse you and it doesn't target cash that well. Even the provision we made on our taxes, the $8 million is not cash, now it's over 8 years. And yet, we will get cash benefit from the lower tax rate. So I advise all shareholders, you could of course do whatever you want, but watch cash when you're analyzing, especially tech companies.

[Operator]

We will now take our next question from Paul Treiber of RBC Capital Markets.

[Paul Treiber, Associate]

Just, Stephen, you talked -- in the past, you talked about how you allocate time between M&A or operations and investors. Now that you have Vince, how do you see that mix changing?

[Stephen J. Sadler, Executive Chairman & CEO]

I'm going to be spending more time on acquisitions and making sure they get integrated properly, and Vince is going to spend time on the operations, especially demand gen and the revenue area, where I really didn't spend much time. So I think the 2 of us have a good 2-pronged approach now. And hopefully, it will benefit the overall results.

[Paul Treiber, Associate]

And with -- it's, obviously -- your cash is building up in the balance sheet. Looking at the flip side of acquisitions, if the pace of acquisitions doesn't pick up, is there any point where you'd consider returning cash to shareholders?

[Stephen J. Sadler, Executive Chairman & CEO]

We always look at all those things, but I am not too worried about the pace of acquisitions not picking up.

[Paul Treiber, Associate]

Okay. That's good to hear. On the interactive side of the business, in the past, you talked about aggressive pricing from some of the SaaS players, that there has been some consolidate -- or some consolidation in the market with Cisco and Broadsoft coming together, and then also Avaya coming out of bankruptcy. Are you seeing just more discipline in regards to pricing than maybe you saw in the past?

[Stephen J. Sadler, Executive Chairman & CEO]

It's hard to tell. I think you're -- I don't think the pressure is there like it was before. I think some of the SaaS players realize that they have to make money, so they're not -- I don't think they're aggressively reducing prices more. So it's still an issue, it's still there, but it isn't -- it's not getting worse. It's maybe improving a little bit. I haven't seen much of that improvement to really make a comment at this stage.

[Paul Treiber, Associate]

And then also related to interactive, but going into the telco service provider channel. Is one of the strategies potentially using the asset management of the networks business to help cross-sell interactive better into the -- into that channel?

[Stephen J. Sadler, Executive Chairman & CEO]

Absolutely. And we're adding some sales resource into the asset management group primarily just to do that. We've already started that process. I'm not sure if we've hired the couple of salespeople yet, but we're certainly looking. And that is absolutely our objective.

[Operator]

[Operator Instructions] We will now take our next question from Ralph Garcea of Echelon Wealth Partners.

[Ralph Garcea]

If I may, a question first for Vince. You've run some pretty good playbooks over your career for $50 million run rate companies and $500 million run rate companies. On the growth side, are you looking more direct, or to do more with channel partners? I mean, where do you see the biggest leverage from the products that you've seen to get the organic growth going again?

[Vincent Mifsud, President]

Yes. Good question, Ralph. It's a little bit different for each division, but the big part of our business, the whole interactive customer experience side of it, we got to do a little bit of both better. So we're definitely launching a direct sales piece to that puzzle, which we currently do all channels. And we're improving our channel enablement as well in parallel to that. And in order to drive both of those, we've added some demand gen resources to help in that area. So I think we got to do a 2-pronged, channel and direct. And in the interactive side of it, we haven't done enough in direct. So that, we're dialing up immediately.

[Ralph Garcea]

Okay. And then, I guess, for Steve. Now that you're free to do more M&A, are you going to stick to your 2 buckets? Or do you see the opportunity to grow the transformation -- transportation side or go start an adjacent vertical if the possibilities are there?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, we do want to grow the transportation side, it's part of our 2 buckets. As I've said, on a new area, that would be an opportunistic type acquisition, where we find a company in a fragmented market that's large enough to be the foundation for starting a new area. We continue to look at that, but opportunistic. We don't have a strategy or plan, but we do see opportunities in other areas that we often look at to see if it's the right company for us to do a third area. A third group, I would say -- we have 3 areas now, but transportation and networks are in one group and Interactive Management, of course, is the other group. But we could do a third group. However, as you know, I've said that for 10 years and haven't done it yet, so.

[Operator]

[Operator Instructions] No further telephone questions at this time.

[Stephen J. Sadler, Executive Chairman & CEO]

Okay. Thank you, everyone, for taking the call. We appreciate your support and look forward to talking to you next quarter.

[Operator]

Thank you. This does conclude the Enghouse Systems Limited 2018 Q1 Earnings Call. Thank you for your participation. You may now disconnect.