Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2018 Q2 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 I 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 second quarter unaudited financial results for the period ended the April 30, 2018. Second quarter revenue increased to $85.2 million compared to revenue of $79.5 million in the second quarter of the prior year. Income from operating activities was $24.7 million compared to $21.9 million in the prior year's second quarter, a 12.8% increase. Net income for the quarter was $15.3 million or $0.56 per diluted share compared to $9 million or $0.33 per diluted share in the prior year's second quarter, an increase of 70%.Adjusted EBITDA for the second quarter was $25.4 million or $0.93 per diluted share compared to $22.8 million or $0.84 per diluted share last year, with the increase primarily being attributable to contributions from acquisitions.On a year-to-date basis, revenue was $170.3 million compared to revenue of $158.4 million in the prior year. Income from operating activities was $49.2 million compared to $44 million in the prior year-to-date, an increase of 11.8%.Operating expenses before special charges related to the restructuring of acquired operations were $34.4 million compared to $32.6 million in the prior year's second quarter and include incremental operating costs related to acquisitions.Noncash amortization charges in the quarter were $7.4 million compared to $7.5 million in the prior year's second quarter and include amortization charges for acquired software and customer relationships from acquired operations.On a year-to-date basis, operating expenses before special charges were $68.2 million or 40% of revenue compared to $63.9 million or 40.3% of revenue last year.The company generated strong cash flows from operating activities of $21.8 million compared to $18.4 million in the second quarter of 2017. On a year-to-date basis, cash flows from operating activities were $44.9 million compared to $29 million in the prior year, an increase of 54.8%. As a result, Enghouse closed the quarter with $155.3 million in cash, cash equivalents and short-term investments compared to $130.3 million at year-end.Cash balance was achieved after year-to-date payments of $8.6 million in cash dividends, $9.7 million net of cash acquired for acquisitions concluded in the fiscal year and $5.1 million for acquisitions closed in prior periods.Yesterday, the Board of Directors approved the company's quarterly dividend of $0.18 per common share payable on August 31, 2018, to shareholders of record at the close of business on August 17, 2018.I'll now turn the call back to Mr. Sadler. Steve?

[Stephen J. Sadler, Executive Chairman & CEO]

Thanks, Doug. As Doug noted, we continue to grow our cash with cash and short-term investments of approximately $155 million. Cash flow from operating activities was $21.8 million in Q2 and $44.9 million year-to-date compared to 4 -- $18.4 million in Q2 last year and $29 million year-to-date last year. You'll notice that the balance sheet exchange impact was positive $1.4 million compared to a loss of over $2.4 million last year in Q2 and a loss in Q1 of 2018. As discussed last quarter, we separate this accounting item out from our results to provide a better understanding of operational activities.The provision for income taxes was more normal at 21% of income in the quarter after the adjustment of $8.8 million in Q1 onetime accounting charge related to the estimated U.S. repatriation tax imposed on foreign U.S. subsidiaries for deemed repatriation of foreign profits in Q1.Some items to note in the Q2 results. Deferred revenue increased to over $76 million in Q2 from $68.8 million in Q1 and $62.4 million at October 31, 2017, the end of our prior fiscal year.Software license revenue and hosted and maintenance services increased by over 10% compared to Q2 last year and 9.5% year-to-date. We continue to focus on revenue-improving ideas, which would take a couple of quarters to determine their success and reflect in our internal growth results. Our markets remain challenging as revenue shifts to subscription revenue and complete -- and competition from SaaS providers who emphasize revenue at the expense of cash flow and profitability. We continue to have a strong EBITDA margin of nearly 30%.For acquisitions, we completed the acquisition of Mobilethink late in the quarter, which added approximately $300,000 of revenue and was immediately profitable. One must remember that this was not even a full month of Mobilethink's revenue as we did it early -- we did it April 5. Mobilethink and the 2 acquisitions completed in Q1 are profitable and operating as expected. The economic and market factors remain favorable for acquisition opportunities.I would now like to open the call for questions.

[Operator]

[Operator Instructions] And we will take an opening question from Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

Just on the Mobilethink acquisition, this is -- I believe you made a number of acquisitions in Denmark now. What is the cross-sell opportunity with this acquisition?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, I'm told by my team that there is some good cross-sell opportunities. I never depend on them, and so we'll have to wait and see if it happens.

[Daniel Chan, Research Analyst]

Okay. And then, Steve, I wonder if you could comment on the competitive environment, whether you're seeing any impact from Amazon or Twilio in the market yet.

[Stephen J. Sadler, Executive Chairman & CEO]

No.

[Daniel Chan, Research Analyst]

Okay.

[Stephen J. Sadler, Executive Chairman & CEO]

I should add a little bit to that. I should add a little bit. There's nothing in the market or results that we see any impact of competition or anything like that. But it does help, as I mentioned, to some of our potential acquisition candidates to give them a little more motivation to sell, i.e., it's more of a risk or concern for them than us.

[Daniel Chan, Research Analyst]

Okay. Yes. That makes sense. And then maybe, Vince, I wonder if you could comment a little bit on some of the progress on some of the initiatives you've been trying to make to get organic growth up a little bit.

[Vincent Mifsud, President]

Yes. Sure. So Q2 was my first full quarter with the company, as you know. I focused most of the attention in the area of Demand Gen. So we added a couple of Demand Gen leaders: 1 on the interactive side and 1 on the networks to start to get the pipeline of inbound leads started. So we added 2 good leaders there. We've also started to reorganize the sales team, starting in Americas, with having both kind of a channel go-to market as well as direct. So we did that reorganization in Q2. And as Steve said, hopefully, we'll start to see some improvements in the next couple of quarters on the organic side.

[Daniel Chan, Research Analyst]

As it relates to some of those reorganizations, are we -- are you thinking about SG&A kind of coming off from these current levels? Because SG&A was a little bit lower than I expected. And typically, we see sequential growth in Q2, but it's actually flat to down this quarter. So how should we think about SG&A going forward?

[Stephen J. Sadler, Executive Chairman & CEO]

Who was the question for?

[Daniel Chan, Research Analyst]

Well, either one of you. Yes.

[Stephen J. Sadler, Executive Chairman & CEO]

Okay. I think the SG&A will probably increase a little bit but not substantially. I don't see it going down. But I do see it probably increasing a little bit. And there may be changes that are needed there as we change our strategy. As Vince said, we're going to probably add some people going a little bit more direct, especially on our CCSP side. And yes, we're going to continue with our channel model as well. So it should go up a little bit, but I wouldn't model it drastically different. But I wouldn't model it down.

[Operator]

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

[Paul Steep, Analyst]

Steve, maybe just on that actual topic. How do you think about balancing the margin improvements we saw on the quarter versus some of the investments you're talking about making? We've -- you had dialed it back, and now Vince has laid out that it looks like you're going to sort of shift things a bit. How should we think, over the next year or 2 years, that sort of plays out?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, if we are successful with the sales effort -- and again, we started on Demand Generation first, it means our revenue line will go higher and probably, our margins will improve. If we're not successful, we have more costs and the revenue will stay the same, the margins will go down a bit.

[Paul Steep, Analyst]

Fair enough. On the asset management side in the quarter, we saw a big tick up in margins, and we saw some of the holdbacks start to sort of roll out. Is this related to maybe over-performance of any of the deals you did a year ago, things like Tollgrade? Or is -- what else is maybe sort of playing out in the asset management segment this quarter?

[Stephen J. Sadler, Executive Chairman & CEO]

I think the deals that we did 1 year ago are starting to and have shown some progress, so I think it comes from there. But as you know and I remind the group that when we do a deal in the first quarter or 3 months after doing so, you generally don't have any added profitability, depending on the deal, of course. Then, the second quarter, you generally breakeven, make a little. Third quarter, you get halfway to our normal margins. And by the fourth quarter, we're at normal margins. So some of the ones last year, they're basically in the fourth quarter. So we're getting back to normal margins. And that's a general trend. And for smaller ones, sometimes, you can usually tell by the restructuring because it always takes a little time. But some like the Mobilethink, we didn't have to restructure very much. As you noticed, there wasn't much of a restructuring charge in the quarter. So they tend to get -- make -- they tend to go faster in that model, i.e., the first quarter, we didn't lose any money. So second quarter, we definitely made a little bit. And hopefully, third and fourth, it will progress further. So to get to your exact question, yes, Tollgrade from last year is hitting our normal margins. So yes, it's improved.

[Paul Steep, Analyst]

Okay. The one thing I did want to ask about is, have you noticed any changes in the channel environment on the contact center side? You had a number of sort of key relationships there with large OEMs. How has that played out? Or has there been any change at all in that market environment?

[Stephen J. Sadler, Executive Chairman & CEO]

There has been a little change there. And it's not really us. It's because of the market. Those channels generally sell on-premise. So it hurts us a little bit as well when the SaaS model clicks in. They don't have a SaaS offering. So what we're trying to do now, and Vince is getting this organized, is we're going to offer them to sell on our SaaS system, which we will have set up in a few platform accounts hopefully in each country. We're progressing with setting up the platforms, and then we'll let them be able to still keep customer control by selling on the platforms that we set up. We've just got to get it -- we're pretty good right now with platforms. We've got pretty good response, but we need to do a little bit more.

[Paul Steep, Analyst]

Okay. Last one on my side for...

[Stephen J. Sadler, Executive Chairman & CEO]

Oh, yes, the channel. So the channel with the SaaS side, it really hurts the channel because when you do SaaS, they don't make their usual money on selling hardware. They don't make their usual money on doing a lot of services. So it's hurt their business, which that hurts our business from -- for that side of what we're doing. So the channel has -- it's a challenging environment for the channel these days, but we hope we can help them soon.

[Paul Steep, Analyst]

Okay. And then the last one on my end, deferred revenue, slightly up year-on-year in terms of the total in line with the business but a little bit better. Maybe some comments around what you guys have seen on maintenance renewal rates. Or anything either you or Vince has done to try to help tweak that up? Or is it just normal course of business?

[Stephen J. Sadler, Executive Chairman & CEO]

I think we're always trying to do things to make it a little bit better. Again, we're looking at -- we give a pretty good service. We haven't always in all our territories done annual price increases, which we should do, because if you're paying your people more and you don't do increases on your maintenance, you're just squeezing your margins a bit. So Vince has got a little bit more time than I had on focusing to make sure we do that. So we've done that side. The churn, there's always some because as you're going to a subscription or a different type model, you see that, that has some impact on that deferred revenue, plus and minus. I'd say, yes, we're still around the 90%, 92% overall. And it's a little bit different between the asset management side and the interactive side. But I -- it's pretty normal.

[Vincent Mifsud, President]

Yes. And they -- on the sales execution side, we started to point some people in the area of customer success, focused on retention and renewing maintenance contracts and subscription agreements and so on. So we have a few people more focused on it. So hopefully, that will also help a bit.

[Paul Steep, Analyst]

Was it just on one side? Or did you just try to do sort of a leader on either side?

[Vincent Mifsud, President]

On both sides. Yes. On all the different divisions so.

[Stephen J. Sadler, Executive Chairman & CEO]

Well, it's not even one on both sides. We also have -- like each country has to do it. And we still got a bit more work to do because it's -- it's not -- we've got a lot of different geographies to look at. But -- we're working on it, but it's not our biggest issue at this stage. It's just another refinement to improve things a little bit.

[Vincent Mifsud, President]

Tuning.

[Operator]

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

[Deepak Kaushal, Director and Technology & Communications Analyst]

I only get to do it once -- or 4 times a year when you guys hold your conference calls. I hope you keep holding them. I just wanted to -- Steve, I just want to ask you more about the M&A environment. I think you alluded to earlier competition like Amazon providing more motivation for sellers. I mean, what's the dynamic with sellers? I mean, is there a hold up or is there sticking point on valuation? What can you say about the sellers and how they think about selling their businesses and you, as a buyer, overcoming those challenges? What were the sticking points on the negotiations?

[Stephen J. Sadler, Executive Chairman & CEO]

I think the opportunities are good, not much has changed. I've discussed several times why people are selling and the people we see. Private equity generally don't want to do smaller deals. That's still the case. People aren't getting younger, they're getting older, so you've got a lot of entrepreneurs in that baby boomer era. And I've said it last year and the year before, but they're not getting any younger so that's still a motivation for some to get some retirement money. The market is pretty good. Interest rates going up in the U.S., people worry about that. Remember, a lot of people who have a good and built a nice little business, they always look forward. And if they have to invest, for example, in SaaS because that's where they see it's going, they don't want to spend their pension money and their retirement money on the chance that they'll be successful there because many companies are not. And it usually is not a profitable venture in the beginning. And it's still yet to be seen how long you have to go before you make it profitable. Because many have been out there already for years and are not profitable. So the market hasn't changed. If interest rates are going up, I would say if anything, the opportunities have gotten greater.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So last year, you guys invested in some of your internal systems, with the expectation of accelerating M&A activity this year and your ability to integrate. When you look at your $155 million cash balance, how much do you think -- or do you target to deploy this year in further M&A activity? And at what point do you kind of look at this and say, well, hey, the sellers don't have realistic expectations. Maybe we allocate more of that capital back to dividend increase?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. We -- very easy. We don't have a budget to how much we have to do each year. We try and set a target for ourselves. And generally, we work within our operating cash flow that we generate. So it's not a -- it has to meet our financial discipline. If people don't have realistic expectations, we don't do the deals. If they do have realistic expectations, we do, do the deals. So there's no budget. We do what we think is right. We've been pretty good at it for years, and we're comfortable that we should not change that model. I think overall, on the acquisition side as I said, the opportunities are pretty good. I don't see needing to pay out a higher dividend although me getting some extra cash flow in dividends, I don't mind. But right now, I think we can better deploy that capital than give it to shareholders as we have in the past.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Excellent. And just 1 last question on that M&A. So you had a flurry of activity a couple of years -- over the -- in the last 5 years on the interactive side. That's kind of slowed. Then it was -- it's more on the telco side where you found your value, not much on the transportation side. Out of those 3 buckets, where are you kind of seeing the value and the opportunities? Is it balanced across 3 portfolios or weighted towards one or the other?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. A lot of the -- we've done a lot of acquisitions already in the IMG sector, so of course, there's somewhat less to do. As you noted, we did a lot in the network side. Again, the asset management side there, at least. That continues because it's a fragmented industry. And quite frankly, the service providers are getting very tough on their pricing and their bargaining power. In some ways, that hurts internal results a little bit, but it also helps our acquisition strategy. So I think that will continue. And transportation, I think you've noticed, we did do a couple of little acquisitions in that in the last little while. And we've continued to look, but it seems to be an expensive market right now.

[Operator]

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

[Paul Treiber, Associate]

I just wanted to -- if you could help set expectations around Mobilethink a little bit. There has been some public disclosures from its prior owners disregarding its annual revenue. I think they disclosed U.S. $13 million, 2016. Is that a reasonable level to expect going forward? And then in light of your comment on the first quarter or the first month of [ last ] month, $300,000, is there anything unusual in the $300,000 -- above or below, what should be a normal run rate?

[Stephen J. Sadler, Executive Chairman & CEO]

So I have 2 comments there. First of all, the $13 million was quite a while ago, and that's not their normal run rate. But we don't forecast run rate, so that's high. Second of all, in the quarter, you've got 2 factors. It wasn't a full month for us. And it was -- as you know, in enterprise software, lots of revenue or more revenue tends to happen in the third month of the quarter. April is the first month of their quarter, so you also have the impact of being the first month where revenue is generated -- generally light in enterprise software companies. And it's no different for Mobilethink or any other ones that I've seen that do enterprise software. So you do have that impact in that short period of a few weeks in the first quarter. But the estimates you might have said from the past are just not right. So I can't make any other further comment on that.

[Paul Treiber, Associate]

Okay. That's fair. Just on M&A, I mean, historically, you haven't done this, but -- and maybe perhaps you would is -- are there any metrics? Or is there any way that you can quantify the level of activity we're seeing in the market in terms of like the deals that you're working on in terms of like NDA signed? Anything like that, that can help us better understand the type of work that you're doing right now and the activity that you're seeing?

[Stephen J. Sadler, Executive Chairman & CEO]

No, not really. NDAs come and we have a nice flow. Every week, we're signing some. But then some other people want too much. Some people don't pass through due diligence. Some don't meet our financial parameters. All I can tell you, it's the same as it has been in the past generally. That's what you've got to assume. It might come in lumps or it might come steady, but we don't see any difference in the activity, except there are more opportunities today generally than there have been in the past.

[Paul Treiber, Associate]

And then just a last question. Just with Vince onboard for about 6 months or so, how has your workflow changed over the time in terms of the ability to spend more time on M&A as opposed to operations? Or is it still in a transitionary period?

[Stephen J. Sadler, Executive Chairman & CEO]

I would say it might seem to Vince that he's been here for 6 months, but he hasn't been here for 6 months. He's actually, just as he said, it was his first full quarter. He just joined before the start of the quarter, so it's actually been a little shorter than that. We're still transitioning over some of the operations. He's had meetings with the group. It takes time. And we're slowly doing that, and I'm sort of now spending a little bit more time on acquisitions, but that sort of takes a little bit of time, too. So we're just doing the normal transition of those activities.

[Operator]

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

[Ralph Garcea]

I guess for Vince first. On the Demand Gen side, can you get to $500 million in revenue over the next couple of years, just sort of re-jigging the sales force and looking for new opportunities? Or do you have to go into adjacent verticals and/or new geographies to do that?

[Vincent Mifsud, President]

I mean, we don't -- as you know, we don't forecast internal growth or organic growth to The Street. But in terms of the market size, if you're sort of asking is the market big enough in interactive and networks, the addressable market's big. This whole customer experience base is big, focusing on retention of customers and better call center management. So they're a big market, but my goal is to try to just get the organic growth improved over time. But there's no market limitation so to speak, that I see.

[Ralph Garcea]

And have you added sales capacity over the last 3 months, other than the 2 sort of leads that you mentioned?

[Vincent Mifsud, President]

No. I have mainly added on the Demand Gen side in order to get sort of the pipe, the inbound lead flow happening. No use adding sales guys until you get your pipeline moving and your inbound leads flowing. So we've just reorganized the existing team in Americas from just a pure channel to have more direct and added more on the Demand Gen side of the business.

[Ralph Garcea]

Okay. And then for Steve, as you look at the year pipeline on the M&A side, are using more still in Scandinavia and Europe? Or are there more -- are there opportunities for you in Latin America or Asia, even there, or Australia, I mean, just to sort of grow new geographies from an M&A perspective?

[Stephen J. Sadler, Executive Chairman & CEO]

Generally, we're seeing good demand globally. I would not count on Asia because we tend not to look there. It's a difficult market to be in actually. If you're in, you're good, but it's hard to get in. And their business approaches are slightly different than we're used to. South America, yes, we're still through presence trying to build that a little bit. But we're looking generally in all areas, both in current geographies where we're at and in new geographies.

[Operator]

[Operator Instructions] As we appear to have no further questions queued, I would like to hand the call back to the speakers for any additional or closing remarks.

[Stephen J. Sadler, Executive Chairman & CEO]

Well, thank you for attending the call, everybody. We appreciate your interest in our business and look forward to providing you another update after our next quarter.

[Operator]

Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.