Enghouse Systems Ltd

TSX:ENGH

Earnings Call Analysis

Enghouse Reports Strong Q1 2024 Financial Growth

Enghouse Systems reported a robust first quarter in 2024, with revenues jumping by 13.2% to CAD 120.5 million, buoyed by a 27.2% increase in recurring revenue to CAD 84.6 million, reflecting a shift towards SaaS offerings which now compose 70.2% of total revenue. Operating results rose to CAD 32.6 million, and the company saw a marginal net income hike to CAD 18.1 million. An 18.2% dividend raise points to confident future projections. Despite a competitive software market, Enghouse is leveraging AI advancements to improve efficiency and develop products that enhance customer experiences and agent productivity. Continuous AI integration in various company operations promises a strategic edge in efficiency, with improvements noted in demand generation and software development tasks.

Financial Performance and Revenue Growth

The company reported a significant increase in financial performance for the first quarter ended January 31, 2024, with total revenue growing 13.2% to CAD 120.5 million, compared to CAD 106.4 million in the prior year. A key component of this growth was the expansion of recurring revenue, which includes Software-as-a-Service (SaaS) and maintenance services, by 27.2%, reaching CAD 84.6 million and representing 70.2% of total revenue. This shift indicates a stable and predictable revenue stream that is of particular interest to investors looking for long-term viability.

Operational Efficiency and Profitability

Results from operating activities improved to CAD 32.6 million from CAD 29.9 million. The company successfully maintained a robust EBITDA margin of 28.8% and increased its Adjusted EBITDA to CAD 34.7 million, up from CAD 32.3 million in the previous year. Furthermore, operational expenditure declined as a percentage of revenue, which, alongside an increased net income from CAD 17.0 million to CAD 18.1 million, demonstrates the company's ability to generate operational efficiencies without compromising profitability, even in a challenging high-interest-rate environment.

Dividend Increase and Shareholder Value

Reflecting confidence in the company's financial health and commitment to shareholder return, the Board of Directors approved a significant increase in the company's eligible quarterly dividend to CAD 0.26 per common share, marking an 18.2% increase. This action aligns with the company's history of consecutively raising dividends and emphasizes its strategy to enhance shareholder value.

Deferred Revenue and Market Shifts

The company's focus on modernizing its revenue streams is demonstrated by its highest deferred revenue balance to date, growing by 26% to CAD 135 million. The shift from perpetual software licenses to SaaS is noteworthy and reflects changing consumer preferences, resulting in a slight decline in gross margins from 67.3% in the previous year to 65.5% this quarter. Despite this, the company's agility in managing operating costs continues to support its overall gross profitability.

Innovation with Artificial Intelligence

Enghouse has made significant headway in integrating artificial intelligence (AI) within its suite of products. Notable innovations include a transcription engine catering to more than 50 languages and AI-driven quality assurance tools that provide real-time coaching to contact center agents. These tools not only enhance customer experiences but also focus on boosting the productivity of agents. By eliminating manual tasks, such as the creation of call summaries, the company aids agents in devoting more time to customer interactions, which remains a high demand area for its customers.

Adaptation and Operational Use of AI

Enghouse is leveraging AI within its operations to heighten efficiency, as seen with its inbound lead generation and software development tasks. In particular, they have employed AI tools such as Microsoft Copilot and OpenAI, yielding a productivity enhancement in the range of 10% to 30% for their engineering team. This internal use of AI mirrors the company's objective to utilize cutting-edge technology to improve profitability across all organizational facets.

Market Presence and Customer Engagement

The company's commitment to customer satisfaction and service excellence was evident during its participation at the Mobile World Congress tradeshow in Barcelona, where it engaged with over 180 telecom customers and partners. Feedback highlighted the company's exceptional service and strategic choices, reinforcing its reputation as an easy and reliable business partner. Moreover, the normalization of business and personal travel has favorably impacted mobile revenue for their telecom customers, suggesting potential downstream benefits for Enghouse's mobile-related products.

Earnings Call Transcript 2024-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the Enghouse's Q1 2024 Conference Call. [Operator Instructions] This call is being recorded on Thursday, March 14, 2024. I would now like to turn the conference over to Stephen Sadler, Chairman and CEO. Please go ahead.

[Stephen Sadler, executive]

Good morning, everybody. I'm here today with Vince Mifsud, Global President; Rob Medved, VP Finance; and Todd May, VP, Legal Counsel. Before we begin, I will have Todd read our forward disclaimer.

[Todd May, executive]

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 these forward-looking statements 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 Sadler, executive]

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

[Rob Medved, executive]

Thanks, Steve. Good morning, everyone. I'll be walking through the highlights for the first quarter ended January 31, 2024, compared to the same period in the prior year. Revenue increased 13.2% to CAD 120.5 million compared to revenue of CAD 106.4 million. Recurring revenue, which includes SaaS and maintenance services, grew 27.2% to CAD 84.6 million and now represents 70.2% of total revenue. Results from operating activities improved to CAD 32.6 million from CAD 29.9 million, while achieving a 28.8% EBITDA margin. Adjusted EBITDA was CAD 34.7 million compared to CAD 32.3 million. Cash flows from operating activities, excluding changes in working capital, were CAD 35.6 million compared to CAD 32.6 million. Net income was CAD 18.1 million compared to CAD 17.0 million.As the software market continues its transition towards SaaS offerings, we are generating an increasing proportion of recurring revenue streams within our overall revenue model, which now represents 70.2% of our total revenue in the first quarter of 2024. Our operational expenditure has declined as a percentage of revenue, consistent with our objective of generating operational efficiencies despite the inflationary pressure on operating costs. This focus on efficiency is part of our broader objective of maintaining a lean operational model that supports our growth ambitions without compromising the bottom line. Despite these challenges, our cash position has increased in the quarter, providing the resources necessary to continue to pursue new acquisition opportunities that we believe will enhance our market position and offer long-term shareholder value.A key advantage Enghouse has in this high-interest-rate operating environment is our debt-free status and a closing cash, cash equivalents, and short-term investments balance of CAD 247.4 million, affording us the flexibility and agility to make investments without the burden of external financial constraints. This positions us uniquely in the market, enabling us to pursue acquisitions and invest in further expanding our product suite.Subsequent to quarter end on February 12, 2024, Enghouse completed the acquisition of Mediasite assets, which offer a suite of SaaS video solutions, as well as expanding Enghouse's presence in the Japanese market. The acquisition was completed for a cash purchase price of USD 15.5 million. Yesterday, the Board of Directors approved an increase in the company's eligible quarterly dividend to CAD 0.26 per common share, an increase of 18.2% over the prior dividend payable on May 31, 2024, to shareholders of record at the close of business on May 17, 2024. This represents the 16th consecutive year in which the company increased its dividend by over 10%.I will now hand the call over to Mr. Sadler.

[Stephen Sadler, executive]

Thanks, Rob. Vince will now give some operational highlights for the quarter.

[Vincent Mifsud, executive]

Thank you, Steve. We are pleased to report growth in the quarter across our key financial metrics with double-digit increase in total revenue of 13.2%, recurring revenue of 27.2%, and operating profitability growth of 9%. Our recurring revenue expansion has been significant and now represents over 70% of our total revenue. We finished the quarter with one of our highest deferred revenue balance reaching CAD 135 million, up from CAD 107 million last year, an increase of 26%. Overall revenue mix is changing in line with shifts in customer demand moving from perpetual software towards software-as-a-service, which is translating into a change in gross margins, achieving 65.5% compared to 67.3% last Q1. Even with these gross margin changes, we continue to grow our overall profitability by carefully managing operating costs.The significant advancement in generative artificial intelligence continues to generate a lot of awareness in the broader technology market and is prompting a lot of discussions with our customers around Enghouse's AI products and our future plans. We understand that some people have a perception that AI may eliminate the need for businesses to have contact center agents. However, what we are seeing in the market and hearing from our customers is not in line with that point of view. Undoubtedly, AI tools like chatbots can handle some customer interactions and are effective in certain types of use cases. However, AI productivity tools that make contact center agents more productive and free up their time to create better customer experiences is where we see AI demand and where most of the interest from our customers lies. This is in line with our AI product strategy and the products we have and are building.Last quarter, we discussed the AI building blocks we put in place that started in 2019. As a reminder, these building blocks include our transcription engine, which translates phone calls and video recordings into text available in over 50 languages; our advanced linguistic search enabling agents to query content knowledge bases and generate relevant answers; and our Enghouse knowledge base technology that provides customers the ability to create their own proprietary datasets from consuming multiple sources of internal content. We have built a suite of AI products and enhancements powered by these building blocks.For example, quality assurance is an important area in contact centers, which is all about improving a contact center's agents and improving their ability to address customer experiences. One of our AI features, which is integrated into our quality management suite, includes real-time coaching which guides the agent while they're speaking to a customer, giving them coaching tips such as "you're speaking too quickly" or "talking over customers." We also have a fully integrated coaching scorecard that provides coaching points to the agents once the call is completed. We are also seeing interest for a conversational summarization feature that creates automated call summaries and action items that eliminate the need to do this manually. This is an example of how we are eliminating tasks that take time away from agents interacting with customers.An example of how we leveraged our transcription engine is our automated translation chat capability, where a customer can go to a website, chat with an agent in their native language, and the agent receives the real-time translation of their chat in their preferred language, responds in their preferred language, and it converts the response back to the customer in their native language, all in real time. We're also using AI within our operations to enhance efficiency. We started using AI in demand generation in '23, driving more inbound leads at a lower cost. And in Q1, we expanded using AI to a pilot group within our engineering team, assisting with several software development tasks, using both Microsoft Copilot and OpenAI. The initial engineering feedback was these tools in their current form can improve engineering productivity in the range of 10% to 30%, depending on the activity. So we're expanding the program to a larger engineering pilot group in Q2, and we continue to plan to use AI across all areas of our company with a goal of improving overall profitability.Turning to our recent participation at the Mobile World Congress tradeshow in Barcelona, where we had very successful event with productive meetings with over 180 of our telecom customers and partners. It was great to hear a consistent theme from our customers commenting on our exceptional customer service, providing several examples of our team's responsiveness, and how our choice strategy is highly valued and makes us a partner they consider easy to do business with. The other common theme from the customers at the event was that business and personal travel have returned to normal levels, resulting in improved mobile revenue for our telecom customers. This is translating into growth in revenue and demand for some of our mobile products such as mobile billing and our mobile device management software. Our mobile device management software product is sold by our telecom customers to their enterprise customers and provides the ability to manage mobile phones, limit the applications on their phones, secure them if they're lost, and manage telecom expenses.Our Asset Management business unit has good pipeline, low customer churn, and generally larger deals that can impact any given quarter. We have completed several acquisitions in the video market over the last 12 months with the acquisition of Qumu, Lifesize, and now Mediasite which closed in early February. Part of our video solution is video meeting and collaboration software that plays in a highly competitive market which has some large players who dominate the market. Our video strategy is about providing technology into unique use cases with less competition from larger providers. For example, using our video product Qumu, one of our customers who's a large global pharmaceutical company, recently powered an 18,000 employee townhall, which they commented went flawlessly. We also sold our video solution this quarter into the government Department of Health in the Middle East that will use our video product to provide virtual healthcare in their country. This customer wanted a secure video product on their government cloud infrastructure in their country. And now with Mediasite, we have a new solution for the education and event market which captures video content from educators and presenters at events, which is then pushed into an integrated learning management system for later consumption. These are just some examples of our unique video use cases and products where we see less competition from large providers. Our strong performance this quarter reflects the hard work and dedication of our team and our ability to operate in a dynamic and always changing market and economic conditions.Let me turn the call over to Mr. Steve Sadler.

[Stephen Sadler, executive]

Thanks, Vince. With respect to recent acquisitions, the Lifesize acquisition that we completed August 1, 2023, at the beginning of Q4 2023 is performing as expected. Revenue and operating income from acquisitions declined slightly in Q1 over Q4 but achieved their financial objective. Acquisitions are operating at our standard financial model in Q1. The assets of Mediasite were acquired in February of Q2 and work continues to integrate this business into our operations in Q2. We expect this acquisition to add to profitability this quarter in Q2. No financial results from Mediasite business was included in the first quarter.I would now like to open the call for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Daniel Chan with TD Cowen.

[Daniel Chan, analyst]

The SaaS and maintenance revenue declined quarter over quarter. Steve, you talked about Lifesize performed to expectations and down slightly quarter over quarter. I think that was expected. Just wonder if there's anything else to call out other than the Lifesize performance that could have accounted for that SaaS and maintenance sequential decline.

[Stephen Sadler, executive]

Well, I think, it's probably because some of it converted over to our more recurring revenue in the SaaS business. Again, we supply both on-prem and in the cloud and in the private cloud. We give customers a choice. Whatever they choose, we do, and we follow their lead. We don't have a strategy of forcing them to one of those areas. So right now, it's more in the cloud, mainly because it's very competitive. If you look at our competition, you'll see most of them don't make any money. So it's a little tougher in that area. Margins are a little lighter, but it's good for customers. So it's just the shift of the marketplace.

[Daniel Chan, analyst]

Maybe I'll ask a different. Steve, the SaaS and maintenance revenue declined sequentially. Was that all from Lifesize, the expected decline in Lifesize, or was there anything else that could have caused the SaaS maintenance revenue to decline sequentially?

[Stephen Sadler, executive]

It was mainly Lifesize. As you know, we bought it out of receivership, or bankruptcy, actually. They were in that process probably for about 3 months, 4 months. Some customers then got worried no one would come in, and so looked for other opportunities to move. It takes a little while to move. So you didn't see it in Q4 last year, but you saw a bit of it in Q1, yes.

[Daniel Chan, analyst]

Okay. And do you expect that to continue into the next quarter, or is that pretty much done?

[Stephen Sadler, executive]

We hope not, but you never know what customers have planned or what had planned from before. They don't always tell you. So it might be a little bit, but hard to say. We don't see it increasing in Q2 for sure, but the decline, it might have stabilized or may decline a little bit still.

[Daniel Chan, analyst]

Okay. And then on the R&D line as a percentage of revenue, it's been volatile, but generally been ticking higher over the last year. What are your key areas of focus of investment there?

[Stephen Sadler, executive]

We're still focusing in all the areas. We don't tend to make our profitability by cutting back on R&D, which is our future. So we do have a percentage of R&D to revenue a little higher than we would probably I would say like, but that's probably the wrong word, because we like it because we're still integrating things in. Remember, when you buy companies, you do have to integrate their platform into our platform. So as we do that, our R&D will be a little bit higher than we would normally do if we weren't doing any acquisitions. But I'll let Vince comment a bit on that.

[Vincent Mifsud, executive]

Yes. And some of the additional investment areas I touched on with artificial intelligence. And then as more customers move to SaaS, we also had to do some investments to optimize for the cloud. So those are some areas that are incremental investments, I would say.

[Operator]

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

[Paul Treiber, analyst]

First question, just on Mediasite, Sonic Foundry disclosed some financial forecasts for Mediasite, calling for about CAD 20 million, CAD 20.5 million in revenue in their fiscal '24. What's your view on the sustainability or the stickiness of that revenue forecast? And what are you looking for that business to do going forward?

[Stephen Sadler, executive]

Yes, I think as an estimate, and it's always an estimate, we think it will be pretty stable. We may have a slight reduction in revenue, but I say slight because their profitability is not too bad. Paul, as you know, in most of our acquisitions, how we get to profitability is taking out bad revenue or low-quality revenue which doesn't make money. I know the Street sometimes gets concerned because of our revenue change, but that's why our profit grows. A lot of companies who are on their own, especially public companies, they take on all revenue, sometimes revenue that's not very profitable, because they believe the Street just looks at revenue rather than cash flow and profitability. There comes a time when that game ends, and then we show up. Okay? So then that's basically what happened here. They sold off those assets to us, but we think it'll be on our model and be profitable in Q2. So we're getting to profitability there a little faster, as you generally do with asset deals.

[Vincent Mifsud, executive]

So just on your comment of the stickiness of the product, obviously we have to experience the company inside of Enghouse, but generally, based on the data we looked at, it's fairly sticky because it's integrated into a lot of universities where their rooms are outfitted with their software that captures the content that the professors deliver. So it's fairly sticky software. It's not in the video collaboration space that's highly competitive. It's very focused on education and events.

[Paul Treiber, analyst]

That's really helpful to understand that business. Just in terms of the M&A environment, you're quite positive on the environment itself. But then when you look back over the last year, there's only been two deals that have closed. What's the disconnect between getting deals closed and just the healthy environment or the opportunities that are out there? It's hard to say, but there still is some, I'll call it, overhang from a year ago when people saw much higher prices and much higher valuations because of low interest rates. I think some of the companies look at it and are surprised that some we've talked to before that our price goes down, not up with time. So again, I think it's a little bit recovering from that still, but the opportunities and the number of conversations are much higher than they had been in the past. And then just lastly, just on the transition to SaaS or cloud in general, it seems like your emphasis or prioritization of adapting your product for SaaS has actually increased over the last year or so. What's been driving that? I imagine it's feedback from customers, but what specifically are you hearing from them?

[Stephen Sadler, executive]

You answered your own question. It is basically customers that's driving it. And again, the competition are racing to the bottom. Again, if you do a little study on our competition, you realize they don't make money because they're still in the game of -- they want revenue, whether it's profitable or not. So again, that puts a little pressure on that side. I'll also say in our industry right now with that competition, you make less on SaaS than we do on on-premise. So yes, investors like SaaS more, but they're going to have to get used to a little bit lower profitability for the SaaS. We're okay. We just want to make sure that the customer gets what they're looking for. Maybe, Vince, you can speak a bit.

[Vincent Mifsud, executive]

Maybe just to add, Paul. In terms of customer feedback, a lot of the customers are saying, let's just leverage all of the investment that companies like Azure and Amazon and Google are making in the cloud, leveraging that infrastructure versus buying their own hardware and maintaining their own hardware. So they're also moving stuff to the cloud because of less capital required to do that. And there's so much competition with the cloud providers, they can make more money by moving and leveraging their cloud infrastructures.

[Operator]

Gentlemen, there are no further questions at this time. I will now turn the conference back over to Stephen Sadler for closing remarks. Please go ahead.

[Stephen Sadler, executive]

Okay. Thank you, everybody, for attending the call and your continued support. Enghouse continues to build its business with a strong balance sheet, including no bank debt, in a tough economic and challenging business environment.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.