Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2019-Q1

[Operator]

Good day, ladies and gentlemen. Welcome to the Enghouse Systems Limited 2019 Q1 Earnings Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Stephen 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 I begin, I'll have Todd read the forward disclaimer.

[Todd M. May, VP & General Counsel]

Certain statements may be forward-looking statements. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those discussed in Enghouse's AIF and other continuous disclosure documents, which could cause the company's actual results and experience to differ materially from anticipated results of expectations. Readers should not place undue reliance on this forward-looking information, and the company shall have no 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]

Thanks. Doug will now give an overview of the financial results.

[Douglas C. Bryson]

Yesterday, Enghouse announced its unaudited first quarter financial results for the period ended January 31, 2019.First quarter revenue increased to $86 million compared to revenue of $85.1 million in the first quarter of the prior year. The revenue increase primarily reflects contributions from acquisitions, which were offset by a decline in license revenue in the Interactive Management Group. Income from operating activities was $25.8 million compared to $24.5 million in the prior year's first quarter, an increase of 5.2%.Net income for the quarter was $15 million or $0.27 per diluted share compared to $6.8 million or $0.12 per diluted share in the prior year's first quarter. Last year's first quarter included a one-time charge of USD 6.2 million to reflect the impact of the United States tax reform.Adjusted EBITDA for the first quarter was $26.3 million or $0.48 per diluted share compared to $25.3 million or $0.46 per diluted share last year, with the increase being attributable to contributions from acquisitions and operating cost synergies.Operating expenses before special charges related to restructuring of acquired operations were $33 million compared to $33.9 million in the prior year's first quarter and reflect incremental operating costs related to acquisitions net of operating cost synergies.Noncash amortization charges on amortized -- on acquired software and customer relationships from acquired operations were $7.1 million for the quarter compared to $7.2 million in the prior year's first quarter. The company generated cash flows from operating activities of $24.2 million compared to $23.1 million in the first quarter of fiscal 2018, a 4.5% increase. As a result, Enghouse closed the quarter with $190.5 million in cash, cash equivalents and short-term investments compared to $193.9 million at October 31. The cash balance was achieved after payments of $4.9 million for cash dividends and $22.4 million net of cash acquired for acquisitions concluded in the current fiscal year and $1.1 million for acquisitions closed in prior years.On December 21, the company declared a stock dividend payable on the basis of 1 common share for each common share held as of January 2, 2019, which was paid on January 25, 2019. This dividend doubled the number of shares outstanding to 54,638,000 as of January 31, 2019, and effectively achieved a 2-for-1 stock split. Yesterday, the Board of Directors approved a 22% increase to the company's eligible quarterly dividend from $0.09 per common share to $0.11 per common share, payable on May 31 to shareholders of record at the close of business on May 17. Enghouse has now increased its dividend in each of the past 11 years by over 10% each year. I'll now turn the call back to Mr. Sadler.

[Stephen J. Sadler, Executive Chairman & CEO]

Thanks, Doug. As Doug noted, we continue to have a strong cash position of over $190 million after paying over $4.9 million in dividends and over $23.5 million related to acquisitions in the quarter. Cash flow before changes in working capital and taxes was $27.1 million, an increase of 17% over last year's Q1. IFRS 15 was implemented in the quarter, resulting in a reclassification of software licensed to host of the maintenance to some degree, and as we, in the past, had recurring revenue in our license number. This reflects the new accounting rules.Adjusted EBITDA remained strong at over 30%. In addition, I want to point out a couple of items. Deferred revenue increased to $80.8 million in Q1 '19, an increase of $14.6 million or 22% over Q4 '18 and $12 million or 17.4% over Q1 of '18. This bodes well for our future.The Board of Directors, as Todd -- as Doug mentioned, after reviewing the cash position and projected operating cash flows, increased the quarterly dividend by over 22% from $0.09 to $0.11 per share effective May 17, 2019.In terms of acquisitions, we completed 2 acquisitions in Q1, deploying more capital, $22.4 million, than we did in all fiscal 2018. In addition, we acquired a small tuck-in company in February, which is not reflected in the Q1 results, deploying an additional $3.3 million of capital. Telexis and Capana had minimal restructure in Q1, performed as anticipated and provided approximately just over $4.5 million in revenue in the quarter. These acquisitions are now part of the Asset Management Group. Economic and market factors are favorable for acquisition opportunities, meeting our acquisition criteria. We intend to provide more focus to capital deployment in fiscal 2019. I would now like to open the call for questions.

[Operator]

[Operator Instructions] We will now take our first question from Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

Steve, I just wanted to get some color on the competitive dynamics in the IMG space. This is the second quarter that we've seen significant declines. Last quarter, you highlighted that it was due to some competitive pressure from the cloud providers. Is that still the case?

[Stephen J. Sadler, Executive Chairman & CEO]

That's been the case for a long time, so I don't think that's anything extra or new. So that's still the case, but we're going through a bit of a transition in our sales performance. We're emphasizing a little bit more and focusing on direct as well as indirect. So that transition takes a little bit of time. That's continuing. The other aspect, again, which has been here for several quarters and it affects generally only the IMG division, is that Microsoft, where we were very strong and tied directly into the Microsoft software, they have now decided that they're going to move from Skype for Business to Teams. They don't have all the APIs ready for Teams, so this has slowed and caused customers to hold back a little bit on implementing, so we can't tie the contact center software in. Of course, the Skype for Business is still continuing on for at least another 3 years, but it does give the market a bit of a hold, especially in the U.S. and Sweden where it was more advanced than in other places. So there's a couple factors that went into it. The SaaS is always a factor. I don't think it was an extra factor. It continues to be a factor.

[Daniel Chan, Research Analyst]

Okay. That's helpful. So do you expect some of these APIs to come out within the next year and that should help you create a product to address some of those issues?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, we're addressing it now. They have some now, but they're not very good. And again, we were sort of a leader in tying directly into their system. Most people did it through, I mean on an API connection. We were directly in. So we've got to change our software around a little bit to do that, which we'd be doing for 6 months now. But on the other side of the equation, Microsoft really hasn't gotten all the API connections done well enough into Teams. So the idea is they -- customers should sell or continue to buy Skype for Business. But yes, I've got -- they've got to be confident. There's a conversion over to Teams because that's the future direction of Microsoft. So will it continue on for a few more quarters? Yes, for sure. The year might be right. Depends how fast Microsoft moves. I don't have any -- I can't influence that actually.

[Daniel Chan, Research Analyst]

Okay. Great. And Vince, just want to get an update from you. It's been a year since you've been here. Just again, an update on any progress that you've had over the last year and maybe what you have planned for the next year.

[Vincent Mifsud, President]

Yes. I mean, just as I discussed previously, we did a lot on the go-to-market team. As Steve mentioned, we've added more direct sales. We added DemandGen. So we've got DemandGen teams globally, and those are starting to generate leads and get the -- our lead flow increased. So those are some of the major things. We're doing more in the cloud. As you know, we can offer on-prem, private cloud and public cloud. So we're seeing more traction on our cloud-hosted offerings. So the building blocks are there. We hope to see some results in 2019 and the future.

[Operator]

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

[Paul Steep, Analyst]

Great. Steve, could you talk a little bit more -- you or Vince, I guess, on the sales transition you alluded to a minute ago, what specifically is going on in terms of maybe comp plan changes or more significant reorganization? Or is it more smaller moves that you've made, as Vince outlined?

[Stephen J. Sadler, Executive Chairman & CEO]

I'm not sure it's smaller moves. We've gone from, what I would call a marketing organization to DemandGen organization. We believe we have some of the best products, but we've got to get in more deals. In doing that, sometimes you have to take a more direct approach because when you go through channels, like we mainly do in the U.S. and in the Nordics, you're really in their hands on how they do it. So that transition takes a bit of time. It means hiring some of the people who sell to channels. They're not the best direct sales people, so we're making that transition. It always takes times to hire people. It takes times -- some people changed over a little bit. We've got to cover the channels. So there's a lot of moving parts there, but it has to be done for the future.

[Paul Steep, Analyst]

Where would we be at, just to close off on that, timing-wise, in terms of when you would have made the majority of the staff or headcount changes, so that way we can think about it? Because obviously, none of this is going to happen overnight or even in a quarter or 2, so.

[Stephen J. Sadler, Executive Chairman & CEO]

We started the process last summer. I think we mentioned there Vince would be in for a quarter. We wanted to take some new approaches, so we started then. So we'd been at it now pretty solidly for 6 to 9 months. But again, it takes time to organize it. There's a lot of changes going on. So it's about 9 months we've been on it now.

[Paul Steep, Analyst]

Got it. And just maybe as well on the license side, not to dwell on that or bring that up too much, but there was a negative impact in the quarter. Was there anything deal related? Obviously, we had the IFRS changes, but it sort of moved quarter-to-quarter on you in a more specific way related to deals we might not have thought about that sort of skewed the number. I know you've called out the deferred growth in your commentary, but is there anything else one-time in nature we should just be thinking about there as well?

[Stephen J. Sadler, Executive Chairman & CEO]

I'm not sure it's one-time, but the movement of IBM from Skype for Business to Teams, that does have an impact. It will change over time as that transition happens, but that would be the other item. It has been there for a while, probably since last summer as well. But people now are -- it's holding up because Skype for Business is not just for contact centers. It's for communications. So sometimes it's delaying, people making decisions. They've got to decide which way they go in communications. The Teams actually works to do that, but it doesn't work for contact centers and tying in right now, although they're working on it and, of course, Microsoft wants to do that. But I guess, they want to get Teams out the SaaS, they could with not all the IPI -- all the APIs completed.

[Paul Steep, Analyst]

Fair enough. And then the last one for me. Steve, I guess, 6 months ago, you made some changes to increase staffing in the M&A area and some, I don't know if there -- we'd call them big process changes, but maybe talk a little bit about how you've seen the build in the pipeline and how you're feeling. You obviously sounded more bullish about the opportunity set out there, but just in terms of how you're running the process with Sam and the rest of the team.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. The -- well, you saw in Q1, we did more. We deploy more capital in all of last year and all the year before as well, actually. We're emphasizing and putting more focus on that now. Vince is looking after the operations, taking that forward. I'm going to go back and help Sam out a little bit and see if we can get some deals done and deploy more capital this year. And as you know, we have lots of capital to deploy. We don't need to raise money in the markets. So I guess, we'll just have to see how we do.

[Operator]

Our next question comes from Paul Treiber of RBC Capital Markets.

[Paul Treiber, Associate]

Just on IFRS 15, could you -- do you have apples-to-apples numbers in terms of the impact on Q1 revenue and EBITDA?

[Stephen J. Sadler, Executive Chairman & CEO]

You really can't do that easily. I think we disclosed before, $2.2 million of revenue went to retained earnings and is not reflected in our revenue now and future revenue. And we've got some revenue because IFRS 15 brings it forward a little bit. And I think that was about $700,000 or so in the quarter. As time goes on, it will impact revenue positively. But you've got to go through -- you've got the retained earnings part there now that you're going through, and those will roll off and then the new ones will come in and you'll recognize revenue earlier. So there's a lot of moving parts there, but that's okay. It is what it is. It doesn't impact cash flow. And as you know, I like the cash flow. So that's what I keep watching and let the accounts -- no change rules again. I think next year, they're going to want us to capitalize all our leases, which will make EBITDA go up, but it's not cash. So we continue just to run the business like we have in the past.

[Paul Treiber, Associate]

And in terms of the cost impact related to IFRS 15 with the commissions, I think that was -- when you mean -- I think you mentioned that being nominal. There's no real impact on cost in the quarter.

[Douglas C. Bryson]

We still expense it all because we don't think it's material. And again, it ties to my thinking. We do it as we pay it. And so we -- a lot of people capitalize that upfront. Depending with the revenue, we're not doing that right now because we don't think it's material. So that said, though, so from the cost side just to be clear, no impact. We're expensing everything through like we have in the past. Some might say it's a negative. Some might think it's a negative, but for us, it's where the -- how we do the cash.

[Paul Treiber, Associate]

Okay. And then how do you think about margins and profitability here? I mean you mentioned that 2 acquisitions that you did, you didn't need any restructuring. Was that still an initial drag on your margins and a ramp-up as you take cost out of these businesses and bring them into your operating model?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. I don't see them as a significant drag on the margins in the quarter. The last quarter, I think was when it got off to 32% or so, I think was a little higher than normal because we hadn't had acquisitions for a while. Remember, there are still other costs related to acquisitions in the quarter. They're not restructuring costs. But I wouldn't think there's anything there really. We can keep it 30%. That's still pretty good. So I don't see that -- I wouldn't want to say, yes, we're going to back up to higher than that. Although with some of our revenue, once we get it going, yes, that might have, but I wouldn't put it in a model today.

[Operator]

[Operator Instructions] Our next question comes from Edson Lai of GMP Securities.

[Edson Lai, Associate]

So you talked about the larger M&A opportunities last night at the AGM. I was wondering if you could talk about what's driving these opportunities. Are entrepreneurs more willing to sell, there's private equity backing off? Or is it strictly a pullback in valuation?

[Stephen J. Sadler, Executive Chairman & CEO]

I think it's just the general environment out there. I mean everyone watches the news. There's lots of things happening in the U.S. There's lots of things happening in Europe. There's Brexit, and interest rates were going up. So yes, I just see people think it might be a good time to sell the business. I don't think it's anything more than the outside environment. Like I don't have any particular item any more than you would, but I just see an environment in which there's a little more concern, and some people want to take money off the table, I guess. The public markets aren't any better. There's none of these companies trying to go public or that right now. It's about the same, so their only exit is really to sell the business.

[Operator]

[Operator Instructions] It appears there are no further questions at this time.

[Stephen J. Sadler, Executive Chairman & CEO]

Well, thank you, everyone, for attending the call. We appreciate your continued support.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.