Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2021-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Enghouse Quarter 1 2021 Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker for today Mr. Stephen Sadler, Chairman and CEO. Mr. Sadler, you may begin the call.

[Stephen J. Sadler, 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 former disclaimer.

[Todd M. May, VP & General Counsel]

Certain statements made may be forward-looking. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those in Enghouse's continuous disclosure filings such as its AIF, which could cause the company's actual results and experience to differ materially from anticipated results or other expectations. Undue reliance should not be placed on forward-looking information and the company has no obligation to update or revise any forward-looking information whether as a result of new information, future events or otherwise.

[Stephen J. Sadler, Chairman & CEO]

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

[Douglas C. Bryson]

Thanks, Steve. I'll now review the financial highlights from last night's first quarter release. All the information is in Canadian dollars, unless otherwise indicated. Key financial and operational highlights for the 3 months ended January 31, 2021, are as follows: Revenue grew 7.6% to $119.1 million; results from operating activities increased 32% to $40.7 million; net income increased 27.9% to $20.6 million; adjusted EBITDA increased 26% to $44.5 million; and cash flows from operating activities, excluding changes in working capital, increased 18.6% to $41.7 million, closing the quarter with $230.4 million in cash, cash equivalents and short-term investments. In the first quarter of 2021, hosted revenue increased 17.3% to $19.3 million as a result of ongoing initiatives to transition new and existing customers to cloud-based service agreements, notably in Enghouse's cloud contact-center business. Meanwhile, seasonality that is typically experienced in the first quarter was further exacerbated as a result of the COVID related lockdowns. This delayed some professional services and hardware deployments that require in-person integration and customization. Enghouse continues to realize cost savings from remote work arrangements and reduced expenditure on its physical footprint as the pandemic persists, with most countries experiencing a second wave. The company's adjusted EBITDA margins increased from 31.9% to 37.4%, as Enghouse continues to realize efficiencies related to increased scale after quickly integrating acquisitions and reduced travel costs. On December 30, Enghouse acquired 100% of the issued and outstanding common shares of Altitude Software. Headquartered in Lisbon, Portugal, Altitude, provides omnichannel contact center solutions for small and large organizations with a focus on the business process outsourcing market segment. Its modular software suite supports all media channels and has a strong inbound and outbound capabilities for both on-premise and hosted contact center activities. The acquisition of Altitude extends our presence to Portugal and further expands our operations in Spain, Brazil and Mexico, enabling us to capture additional opportunities within these markets. Efforts to onboard the Altitude team and align their processes with those of Enghouse were almost completed by the end of the first quarter. As previously announced on December 17, the Board of Directors approved a special dividend of $1.50 per common share, which was paid on February 16, 2021, to shareholders of record at the close of business on January 15. Today -- yesterday, actually, the Board of Directors approved the company's eligible quarterly dividend of $0.16 per common share, an increase of 18% over the prior dividend, payable on May 31, 2021, to shareholders of record at the close of business on May 17. This represents the 13th consecutive year in which the company increased its dividend by over 10%. With substantial cash balances, no debt, significant operating cash flow, low interest rates and the ability to access additional capital as needed, we believe that we'll continue to have sufficient funding available for operations and additional acquisitions. I'll now turn the call back to Mr. Sadler. Steve?

[Stephen J. Sadler, Chairman & CEO]

Thanks, Doug. Vince will now give some operational highlights of the quarter.

[Vincent Mifsud, President]

Thank you, Steve, and welcome, everyone, to our Q1 2021 conference call. As Doug mentioned, Enghouse had a strong earnings quarter with adjusted EBITDA results of $44.5 million, hitting 37.4% of sales, a meaningful improvement over Q1 of 2020. This was driven primarily by our improved gross margins, employee productivity as well as less travel-related costs. Throughout Q1, we continue to operate the business globally in a work from home environment. It's been almost an entire year now that -- where we've been adjusted to selling and servicing our customers virtually as most countries we operate in remain in various stages of lockdown. Our team has adjusted well to this new working environment, and we continue to seek opportunities to reduce our facilities footprint. I would like to turn now to our different business divisions and give some perspective on what we're seeing in each of our vertical markets. On the interactive side of our business, we completed the acquisition of Altitude on December 30, 2020, and welcome the new Altitude team to our organization. Altitude brings us additional scale in LatAm, Spain and Portugal as well as new channel partners, customers and new team members to Enghouse. One added benefit of this acquisition relates to the strength of the Altitude engineering team with strong domain knowledge in the contact center space. We decided to set up a shared services engineering center in Portugal to help drive the development not only of the existing Altitude products, but also to expand our engineering team for other Enghouse global products, specifically our multi-tenant and private cloud contact center product offerings. With regards to our video business, we continue to focus primarily on the B2B mid and large enterprise sector in the general collaboration phase, telehealth and technology verticals. During the quarter, we saw some good expansion in video outside the Americas market, although we are still early in our video business development in these geographies. In the Americas market, since the initial burst we experienced at the beginning of COVID in Q2 and Q3 of 2020, we have seen customers who initially purchase significant capacity continue to right size their capacity as they better determine their needs and volume requirements. The other trend we're seeing is video is a drop in the demand for video rooms and the related support for video rooms as many enterprises continue to have their employees work from home and therefore, have less need for video rooms required in office environments. One of the other common use cases for video is offering our product to technology companies, enabling them to embed video in their software and hardware applications. This continues to be a key market for us. However, these opportunities generally take time to build momentum and have longer sales cycles. For the contact center business, our differentiation continues to be focused around offering choice to our customers, providing a multi-tenant cloud, private cloud or on-prem solutions. And for our multi-tenant cloud solution, which we call Enghouse cloud contact center, we've recently started to offer this directly to our market, standing up our own SaaS solution while continuing to focus on service provider channel partners that have white-labeled Enghouse cloud as their contact center. Our approach to standing up our own cloud solution as the large existing cloud infrastructure providers and ensure we're agnostic to any of these providers in the market. We are seeing more customers request our multi-tenant cloud solutions as well as our private cloud solutions, driven partly by more agents working from home. One of the other focus areas in the contact center market continues to be on enterprise customers that select Microsoft Teams as their unified communication platform. We are seeing more of our existing Skype for Business customers migrating to Teams as well as some new customers that have picked Teams as their UCaaS offering. The migration of existing customers from Skype to Teams generates additional professional services demand and also contributes to customer retention. Turning now to a few highlights in our asset management group. This division continues to focus primarily on enterprise companies in the telecom defense, transit and public safety verticals. As we had previously stated, this business unit can be impacted by large deals that fall into one quarter over another. Last year, in Q1 2020, we won a large contract in the defense market, which impacts this comparative quarter as we didn't see a similar large order in Q1 2021. In late 2020, Enghouse announced the signing of a large $55 million multiyear transaction with the Norwegian government in the public safety vertical, specifically focused on medical related emergency -- emergencies. This project is progressing as we expected. We have previously spoken about our IPTV initiative, which we launched in 2020. Things are progressing as we expected in this area also, as we have signed 6 new customers over the last few quarters. These customers are at various stages of rollout and based on the way we structure our deals, we generate most of our SaaS revenue in future periods when IPTV subscribers are deployed on the platform. The rest of our telecom market is progressing as expected in Q1. With the global rollout of 5G in many markets and the expansion of IoT devices globally, opportunities continue to emerge for VAS, OSS and BSS solutions. The one area of our business that has been negatively impacted by COVID is the transit market, as ridership is down significantly when compared to pre-COVID periods. However, having said that, we still believe there is demand for our automated fare collection solutions in the transit market, driven by the need for less -- more cashless, contactless payments. As such, we plan to expand our automated fare collection offering into new geographies later in calendar 2021. Let me turn the call now over to Mr. Steve Sadler.

[Stephen J. Sadler, Chairman & CEO]

Thanks, Vince. About acquisitions, as Doug and Vince noted, we completed the acquisition of Altitude on December 30, 2020, so there is one month of financial results in the quarter. We did a review staffing at Attitude in the month of February and did some restructuring at the end of January. This resulted in some restructuring costs in Q1, but these costs were minimized as we redeployed some of the Altitude staff to other Enghouse operations, especially their cloud experienced R&D staff. Altitude had an EBITDA loss in the month due to restructuring being done at the end of January, but we expect to be EBITDA positive in Q2 thereby adding to our overall EBITDA performance. It should be at full EBITDA percentage in Q3. We continue to focus on capital deployment doing our due diligence remotely. As noted last quarter, completing acquisition transactions are taking longer than they did historically due to the pandemic. The acquisition pipeline remains consistent with historic levels, although valuations have increased slightly due to public market influences and low interest rates. We continue to maintain our discipline in terms of financial objectives on valuations when reviewing acquisition opportunities. I would now like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Stephanie Price of CIBC.

[Stephanie Doris Price]

Congrats on hosting revenue growth in the quarter. Just curious if you could talk a little bit about what's driving that growth? Is it the direct sales force, increased customer demand or Enghouse implementing new programs to incent people to move?

[Vincent Mifsud, President]

Stephanie, yes. So a little bit of all of the above. We have -- as I mentioned, we stood up our own cloud contact center and are going more direct there. We also have our cloud contact center product being hosted by our channel partners, and they're having more customers on their platform as well. So it's a combination of our direct and our channel partners. And just generally, in the market, we're seeing more demand for both private and public multi-tenant cloud.

[Stephanie Doris Price]

Okay. Great. And then on the hosting and maintenance revenue line, it looks like it's been down sequentially over the past 3 quarters. Should we think about video here and maybe video hosting as the reason for that or maybe you can give us some color on what you're seeing in that line?

[Vincent Mifsud, President]

Yes. So as I mentioned, it's -- a lot of it is related to video, both in the video rooms area, where there's less people needing video rooms and basically, they don't need the hardware support for the rooms. So that's one area. And then there's a bunch of customers sort of adjusting their capacity from their initial sort of surge in Q2 and Q3 of last year. They've essentially rightsized what they need as they figure out where the demand is going to land post the initial surge.

[Stephanie Doris Price]

Okay. That's helpful. And then maybe just finally on Altitude. It seems like you're integrating this one pretty quickly. Just curious if there's anything unique about this acquisition? Or how we should kind of think about the integration abilities here?

[Stephen J. Sadler, Chairman & CEO]

Yes. We're probably integrating it a little bit like we did Dialogic a year ago. The same thing. The only difference here is they had a lot of expertise and a lot of staff in R&D, trying to write a new omnichannel software solution in the cloud, which we already have. So we took some of their staff. And rather than reducing the staff, added them to our R&D development. And they also had other pretty good expertise at a reasonable cost in Portugal. So we added it to some of our other divisions as well. So rather doing a restructuring where the cost would have been much larger, we actually took the opportunity to fill vacancies we had and increase our R&D people in the -- what we call the cloud contact center area. So it's a little different that way. What they had was a system that they were just been working on for 1.5 years with no customers and it wasn't finished. So we discontinued that as we moved these people over. So we integrated the R&D in much faster than usual. Usually, we keep running it. But they had a group just doing a new system that's well supporting their other systems. We kept all that and the people working on the new cloud system, we move to basically our cloud system to move it along faster.

[Operator]

Next question comes from the line of Deepak Kaushal of Stifel GMP.

[Deepak Kaushal, Director and Technology & Communications Analyst]

A couple for me. First, on the follow-up to Stephanie on Altitude. Can you guys talk a little bit about the geographic strategy there? I think you alluded to that in the prepared remarks. I know in the past, you guys had a local presence in places like Brazil and Mexico. Are you now sort of seeing that all through Spain and Portugal? Or do you still have a local presence in Latin America and South America and then what's the strategy there?

[Stephen J. Sadler, Chairman & CEO]

So it was interesting in this area because they were a pretty big competitor in Spain. Portugal, we weren't in, so it opened up Portugal for us. They have a large operation, I mean, over 30 people in Brazil. We had like 3, so we put our 3 people into their operation in Brazil. Mexico, we combined the two. So actually, we've expanded scale in all areas, expanded it in Spain, set it up in Portugal, sort of, as a new area for us and expanded our Brazil operation, in fact, put our Brazil operation into their operation. Put Mexico together in Colombia, which we also have -- we increased presence there as well. So it's actually a good fit where we increased scale in all the areas we were in and added Portugal to the area. So I guess your question was, did we expand in South America or LatAm? The answer is absolutely. They had -- I think they had about 35, 40 people in Brazil. So we added our 5 to their operation in Brazil, and they're going to be taking our products into that geographical area.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Excellent. And then just stepping back in terms of the cloud contact center. You guys split up your own solution in addition to your channel partners, white label solutions. How do you think about potentials for conflict there with your channel partners? How do your channel partners, how they reacted to you guys standing up to your institution? In other words, how have you kind of segmented those 2 parts in the market?

[Stephen J. Sadler, Chairman & CEO]

Yes. When you talk about channel partners, our channel partners generally sold on-premise. They have not set up their own solution. So we, by setting up our solution, have given our channel partners the opportunity to sell and put it on our solution. So they -- our channel partners never really had their own solution. They were actually looking for when they had customers who are interested in the cloud, they had to -- looking for a place where they could direct them to. So there is no conflict there.

[Vincent Mifsud, President]

And just to add to that -- sorry, just to add to that, we're constantly direct in channels across our business. So we're used to coexisting with our channel partners. The way we do things, we break it up by verticals or by micro segments, et cetera. So it's kind of a common way for us to coexist with partners.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And then my last question. You mentioned COVID impacting implementation second wave across multiple countries. Where -- which kind of geographies are you seeing the most impacted people across the board?

[Stephen J. Sadler, Chairman & CEO]

Without going into detail, I'd say it's pretty even across the board. Again, you've got many factors, seasonality because of professional services as you're coming into the holiday period. You had a lot of people, again, during the year, hoping the pandemic would maybe end earlier, and they could take their holidays at the end of the year, and we encourage them to take their holidays each year. So there's a lot of factors that came into that and it slowed professional services, obviously, and some hardware sales that we could not deploy because our customers, people were on vacation.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So are there no particular geography you want to call out or any geography we should look at for a rebound around that area?

[Stephen J. Sadler, Chairman & CEO]

No. I think it impacted all, maybe the U.S. a little bit more. Because in Europe, they generally take the holidays in the summer, but they also go skiing, a lot of the resorts were shut down. And I think it is -- we didn't assess where it impacted more or less. We think it was pretty even across the board depending on the customers in the region.

[Operator]

Next question comes from the line of Paul Steep of Scotia Capital.

[Paul Steep, Analyst]

Could you maybe just go over what the plan or the strategy sounds like in terms of the new cloud solution on the contact center? Are you actively sort of encouraging clients to migrate? It sounds like they've got the option, but is there sort of a plan put in place now to sort of shift more of that base to the cloud?

[Stephen J. Sadler, Chairman & CEO]

We've always taken the approach. We do what the customers want. If they want to move to the cloud, we have that available to them. I wouldn't call it a new system. It's a system we've had for a while. We're just enhancing it. It's up to them. We will support them in the cloud. We will support them on-premise, and we have software to do both. We aren't encouraging one way or the other, let them make the choice.

[Paul Steep, Analyst]

Okay. That helps. Maybe on asset management, is there anything we should think of, guys, just in terms of year-on-year volatility there over the next couple that you want to point out? Obviously, the Norwegian contract will contribute that will help offset, but is there anything else in terms of pressure you're seeing in that part of the business? Just maybe cause things to ebb and flow a little more in the last couple of quarters?

[Stephen J. Sadler, Chairman & CEO]

The only thing is on the transportation side, that large contract is pretty steady each quarter. Professional services, every now and then, we'll get -- they'll have to pay milestones on software. But on the network side, it can be lumpy. As Vince mentioned, in Q1 last year, we had a very large deal midyear last year with one of our customers were nearly $6 million. So it can be a little lumpy. So yes, you do have that, but that's pretty normal. It's been like that for a while. Probably continue like that going forward.

[Paul Steep, Analyst]

Okay. And just maybe on that same topic, Steve, not that we normally want to spend much time on quarters. But last year, obviously, this start of COVID, you had the home run quarter with video there. How should we think about the Q1 to Q2 seasonality? Like in the last few years, it stepped up a little bit, driven in part by acquisitions. And this year, we've got Altitude but should we think that, that's maybe more muted at this point due to lockdowns and where we're all at, I guess, in mid-March at this point?

[Stephen J. Sadler, Chairman & CEO]

Yes. I would say the Altitude is going to mute it more. I mean, as usual, we take on an acquisition. We do eliminate some revenue, which we found to be either not high-quality or not profitable. So it can impact a little bit. But we announced what we thought the revenue would be. We're pretty confident. What I will say is in the first month -- usually the first quarter, but in this case, the first month, just like Dialogic a year ago, customers tend to slow buying because they want to see what we're going to do. Are we going to keep their old system? What's -- what action are we taking? So we went through January. So I would say January as a month was a little lighter in Altitude than what we expect going forward now because we made our changes. We've talked to the customers. It's getting back to more, what I'll call normal rather than wait and see type of approach.

[Paul Steep, Analyst]

Okay. And then the last one for me is a quick clarification and interestingly I was reading the press release last night. You talked about facilities reduction, and we've talked about that for a couple of quarters, but it sounded like maybe you've made more of a substantive decision there. Is there not that subleasing is likely great right now, but is there a move to sort of permanently actually strip out some of that facilities cost? I guess, how I was maybe reading it last night.

[Stephen J. Sadler, Chairman & CEO]

As our facilities come up to be renewed, we either reduce space or eliminate them depending how many people were in there. We found our people now are more -- what can I say, used to working from home. Before it was like, oh, we can't do it. Now it's not so bad. So yes, we will continue to reduce our facilities cost as it makes sense. And we do it in conjunction talking to the people. What would they think the best for them to do? And a good portion of them would like to work -- continue to work from home. So our facilities costs, we look at them every time they come up for renewal. And yes, we're starting to reduce that administrative costs, yes.

[Paul Steep, Analyst]

Okay. Just maybe a clarification on that. Having looked at the annual, is there a big bump in terms of one of the larger facilities coming up in the next year, Steve? Or is it sort of pushed out a couple of years into the future where we'll see maybe the full benefit of the reduction?

[Stephen J. Sadler, Chairman & CEO]

Well, the full benefit probably is a few years, but there's facilities coming up every year, some of them larger. Yes. So it's a continuous process over the next couple of years. We expect our facilities cost to decline.

[Operator]

[Operator Instructions] Next question comes from the line of Paul Treiber of RBC Capital Markets.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

I want to follow-up on the last question. The MDA mentioned the renewed focus on profitability. I would think for Enghouse it wouldn't be a renewed focus, but just ongoing. So beyond facilities, do you see other opportunities to further save cost, perhaps things like just permanently reduced travel or marketing spends, maybe using more of a video conferencing? And do you think this is like a long-term structural improvement in the cost base of the company?

[Stephen J. Sadler, Chairman & CEO]

The short answer is, yes, we agree with what you've just said. We do see opportunity to reduce costs. We have our own video system, which we can use. Of course, it also depends what customers want. Some customers when travel comes back, want to see salespeople and see people. Right now, they don't. So it will be a bit of a hybrid model, both on the premises. We won't get rid of all the premises, but we'll have less premise cost. I expect we'll have a bit more travel cost, but we probably will not go back to where we were.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

And just to put some numbers around the magnitude. Like in the past, you've called out EBITDA margin targets in the 30% range. I mean, do you want to throw out like where do you think that could perhaps go in time?

[Stephen J. Sadler, Chairman & CEO]

Yes, we really -- a lot depends on acquisitions. But it's very interesting to note that with an acquisition, a fairly reasonable-sized one in Q1, we did 37%. Usually, you would see a drop in that first month. And you can also -- we also told you that Altitude did not make money in that first month. So as we get into our normal margins, that percentage should improve.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

Okay. And shifting to these delayed projects and implementation. What's the time frame for when you think that the revenue of these deals may start to flow to revenue? Like is it just -- is it predominantly vacation? Or is it the travel restrictions related to COVID? And obviously, it's more than just a one quarter delay. It may take until the summer or until the fall.

[Stephen J. Sadler, Chairman & CEO]

Yes. I would say, it's a combination of both those things, but I don't think the delay -- I will call it temporary. I think it will pick up in Q2. So it's picking up now. Because the seasonality from the Christmas period is gone. The travel part is still there, but it wasn't a huge impact to us last summer in the pandemic. So most of it, I would think, relating to customers being off or our staff taking vacation, but it's also customer's staff not available because of that time period. So I think we're seeing it pick up already.

[Operator]

[Operator Instructions] Your next question comes from the line of Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

Just wanted to talk about the cloud contact center. Are you guys hosting that in a public hyperscale cloud and as a result, you should see minimal impact on capital intensity. Maybe related to that, how should we be thinking about the margin impact as more workloads will move to your cost solution?

[Vincent Mifsud, President]

Yes. So exactly right. We are using one of the public cloud offerings, so there's no capital at all. It's pure variable costs. As we get more tenants on the platform, more customers on the platform, the cost scales. And we do video like that already. We do IPTV like that already. So it's common for us to use multi-tenant cloud environments, public cloud offering. And the margins are really healthy.

[Daniel Chan, Research Analyst]

Okay. And then Vince, you commented on the host and maintenance revenue coming off sequentially largely because everyone is rightsizing their video deployments. Can you remind us what the contract structures are for some of these video or the average contract? Is it annual? Is it monthly? And to what extent can they change these agreements relatively quickly?

[Vincent Mifsud, President]

Yes. Yes, we did something during COVID to help our customers, and we let them sign 3, 6, 9 and 12-month agreements. Typically, they're all 12. So we made an exception in COVID because of the scenario we were in. We let them -- because there was so much uncertainty and nobody knew what level of volumes were going to actually happen, we made an exception, but typically, our deals are 12 months.

[Daniel Chan, Research Analyst]

Okay. That makes sense. So are there any renewals, maybe large renewals that are maybe coming up soon that people may want to rightsize as well?

[Vincent Mifsud, President]

We do have a lot of renewals that happen on January 1 every year, a majority, actually. So that's our common renewal period. Having said that, there's renewals that happen every quarter. With video, the only kind of anomaly was what I said, which was we gave some few, some shorter-term flexibility just given the scenario they were in.

[Operator]

[Operator Instructions] There are no further question at this time. Presenters, you may proceed.

[Stephen J. Sadler, Chairman & CEO]

Enghouse continues to have a strong financial position with $230 million in cash, minimal bank debt and good cash flow. I want to thank the engineer -- the Enghouse team who performed well in fiscal 2020 in spite of the pandemic. I -- also I thank you, our shareholders, for your confidence and continued support. Enghouse continues its journey to build into fiscal '19 -- to 2021 and beyond.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a great day.