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Enghouse Systems Ltd
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Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2019 Q2 Earnings Call. Today's conference is being recorded. And at this time, I would like to turn the call over to Steve Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.
Good morning. I'm here today with Vince Mifsud, President; Doug Bryson, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before we begin, I'll have Todd read our forward disclaimer.
Certain statements made 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 or expectations. You should not place undue reliance on these 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.
Thanks, Todd. Doug will now give an overview of the financial results.
Thanks, Steve. Yesterday, Enghouse announced its unaudited second quarter financial results for the period ended April 30, 2019. Second quarter revenue increased to $89.2 million compared to revenue of $85.2 million in the second quarter of the prior year. The revenue increase primarily reflects contributions from acquisitions and incremental license revenue in both operating groups. Results from operating activities were $26.6 million compared to $24.7 million in the prior year's second quarter, an increase of 7.9%.Net income for the quarter was $16.5 million or $0.30 per diluted share compared to $15.3 million or $0.28 per diluted share in the prior year's second quarter. Adjusted EBITDA for the second quarter was $27.2 million or $0.49 per diluted share compared to $25.4 million or $0.46 per diluted share last year, with the increase being attributable to incremental revenue contributions from acquisitions and operating cost synergies.On a year-to-date basis, revenue was $175.2 million compared to revenue of $170.3 million in the prior year. Results from operating activities were $52.4 million compared to $49.2 million in the prior year-to-date, an increase of 6.6%.On a year-to-date basis, adjusted EBITDA was $53.5 million or $0.97 per diluted share compared to $50.7 million or $0.93 per diluted share last year. Operating expenses before special charges related to restructuring of acquired operations were $35.1 million compared to $34.4 million on the prior year second 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 $6.9 million for the quarter compared to $7.4 million in the prior year's second quarter.The company generated cash flows from operating activities of $21.6 million compared to $21.8 million in the second quarter of last year. On a year-to-date basis, cash flows from operating activities were $45.8 million, an increase of 1.9% compared to the prior year. As a result, Enghouse closed the quarter with $205.5 million in cash, cash equivalents and short-term investments compared to $193.9 million on October 31, 2018. The cash balance was achieved after payments of $9.8 million for cash dividends and $25.6 million net of cash acquired for acquisitions concluded in the current fiscal year and $1.1 million for acquisitions closed in prior years.Subsequent to quarter end, Enghouse completed the acquisitions of Vidyo, Inc. and Espial Group Inc. The acquisitions extend the company's product portfolio to include enterprise-class video software solutions to enable customers to more efficiently collaborate and interact as well as a solution portfolio to help video service providers launch the next-generation video offerings for cable, IPTV and app-based IP video services. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.11 per common share payable on August 30, 2019, to shareholders of record at the close of business on August 16, 2019.I'll now turn the call back over to Mr. Sadler to provide an update on the quarter. Steve?
Thank you, Doug. As Doug noted, we continue to have a strong cash position, over $205 million compared to $190 million at the end of Q1 January 31, 2019.Cash flow before changes in working capital was $29 million, an increase of 7.4% over the prior year. We paid $4.9 million in dividends and $3.2 million for the acquisition of ProOpti in the quarter. Excluding the ProOpti acquisition, the quarter revenue increased by over 3% internally from prior quarter Q1. It also increased by 5% over the prior year. We are seeing signs of continued internal growth for the second half of the fiscal year.Adjusted EBITDA remains over 30% in the quarter. Foreign exchange negatively impacted revenue compared to Q1, but not by a significant amount, a few hundred thousand. Deferred revenue increased 17% from the year-end value to $77.5 million. After the end of the quarter, we announced the completion of Vidyo -- the Vidyo acquisition in mid-May and Espial acquisition near the end of May. These acquisitions resulted in deployment of approximately $75 million of our cash after considering the purchase price paid, banker fees, legal fees, sale bonuses and restructuring costs. We expect these acquisitions on an annualized basis to add $70 million to $75 million in revenue, after being negatively adjusted for the purchase price accounting on deferred revenue and other items.Revenue for Q3 will not only reflect the purchase price accounting adjustment, but will only include revenue recognized from the date of acquisition rather than the full quarter. We expect -- although the acquisitions will not achieve our normal EBITDA margins in the first 2 quarters due to the purchase price accounting adjustment and business operational activities, we believe results will be EBITDA positive before restructuring cost in Q3 and improve further in Q4. Both Espial and Vidyo had plans to restructure their business, which were significantly completed before the acquisition by Enghouse, but not fully completed.Economic and market factors in our service industries continue to be favorable to our acquisition strategy and meeting our acquisition financial payback criteria. As stated previously, we have provided more focus to capital deployment in fiscal 2019 as well as positioning to improve internal growth in future years.I would now like to open the call for questions.
[Operator Instructions] And our first question will come from Paul Steep with Scotia Capital.
Steve, can you talk a little bit about -- more about Espial? And just to clarify, obviously, we know they were already doing the restructuring. That operating model, I was -- scribbled down operating positive on EBITDA by Q3 or Q4. Is that the third and fourth quarter of you just owning it, just to be clear?
No. Q3 is the quarter we're in right now. And Q4 is the next quarter. It's the quarter this year. And in Q3 -- and Q3, there will only be part of a quarter, right? And then Q4 -- and then the purchase price adjustment, we have to take off our revenue and it goes right to the bottom line. And that's just an accounting thing. It's noncash, but it has the greatest impact in the early quarters like Q3 and Q4.
Correct. So the ramp up though for Espial, being the biggest of the 2, how quickly should we think about that in sort of midyear? How close is that to your model at that point? Or you think there's still a decent amount of drag there?
We think we'll be on the model next year, but Espial is the smallest of the 2 acquisitions. It's about half the size of the Vidyo acquisition. So its impact actually is less than the Vidyo impact.
Okay. And the cloud revenue out of Espial, where -- how close? And where do you think you're going to report that cloud revenue in terms of the go-forward subscription since they were transitioning to that model?
Yes. They had transitioned a lot of it already to the model. We're hoping to increase it as we go forward.
Okay. And if we move over to Vidyo, could you talk about the split in that business between hardware and software, just to help us sort of reconcile maybe the multiple that was purchased for it? Our assumption might have been that there was some hardware in the business. Maybe it's less that and something else?
No hardware. So it's really software, mostly software in the cloud SaaS model and very little professional services.
Okay. Final one on my side is the Teams and getting an update as to where you see the business going in terms of the interactive side and the impact on contact center with Microsoft shifting over. We've talked about it. Any updates on where we're at in that transition?
We're continuing to do it. I think I said in the last call, they were going to be ready with their APIs, and we would be ready by the fall. That's still my impression. So yes, it's stabilized for sure, but I think the impact of that will be next year, a positive impact once that version's out in next year because the market's frozen a little bit now, but people are still buying Skype for Business.
And next, we will hear from Deepak Kaushal with GMP Securities.
Can you hear me?
We can hear you.
Good. Sorry, I was on the other line. Got it. I have a question just on Espial. Sorry, I've been calling you Espial for years. I counted 15 years of this business as EBITDA, and only 2 of those years have been EBITDA positive. So you guys seem pretty confident that you can get it EBITDA positive or breakeven in the first quarter and positive in growing in the second quarter after owning it. Maybe Steve, you can give us some more details on how you get there. I mean where do the cost savings come from, what's the strategy. Any kind of details you can give us on that path. And how you can achieve that versus why they couldn't achieve that in the past would be helpful.
I don't why they couldn't have achieved it. Like all acquisitions we do, we match cost and revenue. So if we have costs that aren't producing enough revenue, we cut those down. And the revenue, we try to increase, if we're not getting enough money for some of the spending we're doing with customers. So there's a lot of factors, but we're pretty confident we'll achieve our objectives there. And it will be EBITDA positive in the current quarter, Q3, the one we're in right now.
Okay. So I mean like when I look at the numbers, and even if you just got G&A, you're still not an EBITDA positive. Something's got to come out of sales and marketing and R&D. Are there synergies on the sales and marketing side you can have? Or do you guys have a method to get more R&D efficiency out of that business? Or -- and to give you further, I mean like the revenue dropped 20% last year. I understand they're transitioning to SaaS and cloud from a licensing model. How do you get more costs out of it and not hamper that transition, and potentially even expand markets because you have a broader customer base you can perhaps dip into?
It isn't a big sales and marketing issue. They probably need to add some sales and marketing in their model. And all the factors you discussed, we look at.There all kinds -- there's all kinds of other costs in there. You talked a little bit about people, but public costs these days are a fairly large expense, though they won't have that anymore. We've done some of the restructuring beforehand. We've got a little bit more to do afterwards.We're looking at the revenue to see how we can improve that a little bit. And maybe some of the -- if there are some negative revenue. Often, we buy companies that have revenue that loses money. We'll probably eliminate that and not lose money. But there's all kinds of factors we go into. There's not a magic -- it looks like magic, but there's not a magic solution. It's just matching cost and revenue.
Okay, got it. So I'm looking forward to the next quarter. Going to Vidyo, the margins for that business...
Not to interrupt, but we believe it will be positive EBITDA this quarter, and next quarter will be improved.
Got it. And the $70 million to $75 million includes, that you said -- sorry, the $75 million in cash that you're paying, that includes all the restructuring costs and the fees, all onetime charges that you expect to...
There are restructuring costs in there, and I mention them because people have used, for example, Espial's cash balance. That cash balance did not include some of those costs. When we do -- buy a public company, when they pay banker's fees and those things, you've got to add those costs because, in a sense, we're paying it because we bought their shares and they pay it on closing. So a lot of -- some of the restructuring costs are in there, but there's more to come because not all the restructuring costs were done in the 2 acquisitions. But what was done -- so you can't expect huge restructuring cost, but there will be some.
Got it. Okay. And then just on the Vidyo side, I think, in response to one of Paul's questions earlier, you said that Vidyo was the bigger of the 2. Maybe you can give us some more color because their financial metrics are a bit more opaque. I mean what kind of revenues, revenue growth has this company been seeing? And what does the gross margin profile look like? And is that a similar situation with Espial where you have to take it from an EBITDA-loss business to an EBITDA-positive business? Or is that an easier, more typical event chess? And then I've got one more question, and I'll pass the line.
Well, I think you did about 3 or 4 questions there, but we'll try and go through them. If I miss one, you can ask. We already announced that they did about $60 million in revenue. And as you know, Espial's public does about -- it did $4 million in the first -- or $6 million in the first quarter, so they're running at about $24 million, maybe $25 million. So that's the revenue profile of the 2.So it seems to be twice the size of Espial. I think that was one of your questions you had. They absolutely were losing money, so it's similar to Espial. Some restructuring, certainly, was done in advance of the acquisition. And again, like your questions on how do you get it profitable, it's the same answer I had for Espial and most of our acquisitions. We match cost and revenue. And we try to improve the revenue, and we try to see where the costs that are being expended do not -- are not value in the sense that they generate enough revenue to justify themselves. And so we get 2 of 1.
And any color on the gross margin? Because Espial certainly has a strong gross margin. I assume with Vidyo as a software business, similar kind of gross margin.
Yes. No real hardware or other costs in there. So they're -- it's similar to our other businesses. So in time, we should be able to get the margin up, but we have to do a fair bit of work because both these companies were not making money and haven't made money for some time. So now it's, I guess, we're going to see if we can improve that.
Okay. And then my last question, and I know I've asked a lot, but it's exciting to be able to ask you something new and get some new answers out of you. Both of these businesses are in the video business, albeit one in video service providers and IPTV and et cetera, and the other one in enterprise video. Can this be a real third pillar to interactive and, yes, the other segments, transportation and interactive? I don't really consider transportation a pillar. But could this really be another third pillar? And do you see an opportunity or a runaway for more acquisitions related to Vidyo that you can get some kind of synergies out of?
So the answer is it could be. It does tie to actually both the other pillars, if you want to call them that. Because contact centers do need video, and some of their customers are contact center competitors. So that's interesting. And also, service providers probably is an interesting customer base to do -- take some video to there. So yes, it could be a third pillar, but right now, it's mainly we're going to put it in the interactive group because that's where it really ties to. But we hope our Asset Management Group also cross-sells it.
And our next question will come from Paul Treiber with RBC Capital Markets.
I just want to follow up on Vidyo and the purchase multiple and maybe the background. So you're paying $40 million for $60 million in revenue. That's typical for what you'd pay, but it's quite cheap for a VC-backed SaaS company. I was hoping, can you provide some insight in terms of the background of the acquisition? And maybe if there's an auction process and how that went?
Yes. I mean we assumed there was other bidders. So I guess there, as you'd call it, an auction process. It's been on the market for some time. It's typical for what we do. We go ahead and look and try and decide how we can get our payback for our shareholders, and we make our offer. And I guess, it was the best one.
Okay. And then looking forward on that business, they have -- I think there's a couple of core platforms there. Do you -- is it planned to keep all 3 of them operational? Or do you intend to narrow the focus down? Like were some of them more legacy or less traction in the market? Or some of them more -- they just have a higher run rate of business that's not negative revenue?
I would think we might increase the platform offering. And the other advantage we have is they're mostly in the U.S. We do have a global structure, and maybe our global structure can use that product in other geographical areas. So we're going to investigate that. Well, we'll probably have to do a little bit of R&D work before that happens. So that takes a little bit of time, but we're not decreasing the platform, no. They have a hybrid model, like we do.We can sell in the cloud, and we can sell on-premise, and we intend to offer both. They did not do much in professional services. We probably can do more in that regard with them. So there's a lot of things we're looking at and seeing which one makes sense to do over time.
And just the -- in regards to like a sales strategy, I mean you mentioned that you're going to put it in the interactive group, but then you also spoke about service provider strategy and opportunity. Have you seen the revenue synergies between interactive and asset management? I think there's some potential crossover that you've been trying to generate there.
Well, just think about it. Our CCSP product, which is the cloud product in contact center, it's sold by service providers. So we already are doing cross-selling between the 2 divisions in that regard. So this is just another opportunity to do more of it.
Okay. And then, lastly for me. These are 2 large acquisitions. There's -- you mentioned a couple of times there's a fair amount of work to do. Should we expect the pace of M&A to slow in the next, I don't know, 6, 9 months or so as you focus on integrating these businesses?
Depends what you're slowing from. I don't expect to do these size of operations every quarter, but we do not think our normal pace of acquisitions will slow.
[Operator Instructions] Next, we will hear from David Li with Lizard Investors.
I hope you can hear me okay. Maybe a few questions. Steve, how is Vidyo and Espial in terms of the characteristics of these companies that's different from some of the acquisitions you have done in the past, other than the fact that there's no professional service, no hardware, still very much a secure software business? Or is some of the things that's a little bit different from some of the traditional things you've done in the past?
They're a little bit more in the cloud. They made more of a transition there. We've generally been more on-premise, and we did the cloud through service providers to a large extent. So they're a little bit more orientated towards the cloud. Other than that, they're pretty similar so I wouldn't think there's any real big differences.
And in terms of the channel, do you also feel like you're saying you guys traditionally are more service provider? Like do you feel like, channel-wise, like they have more of a direct channel? Or more of a bar channel? Or the channel mix is also maybe a little bit different from what you had historically?
You've got to remember our Asset Management Group was basically all direct, and our IMG group was mostly channel. But over the last year, we have -- are changing it to be more direct as well. So if it's okay, there's no -- it will do channel and it will do direct, whatever makes sense, we do.
And sounds like from -- your comment to one of the questions is there's actually a decent amount of synergies across the service providers for Vidyo and Espial. Can you just maybe talk about it again? Like if there's something like -- it sounds like you actually will have some more products to sell to your existing service provider. Is this something that's fairly realistic, that you guys can totally synergize?
It will take time, but if you think about it and you look at other video companies, you should -- service providers should be interested in that technology. We see service providers as being interested in adding minutes, video ads minutes. So we'll have to explore. We don't know yet, but we think there's probably an opportunity for us. But it'll take time to get there because we -- you've got to make the product right for that group.
Great. And also, the Microsoft contact center transitioning, other than that, do you feel like for the interactive segment there might be some structural things going on that might prevent you guys from sort of being able to deliver like-for-like growth or flat in the future? Or you think this is pretty much all Microsoft-related?
No, it's not. What we want to do is -- and we are looking at various options right now of how we could -- we have a SaaS product. It only goes through service providers, and we don't have enough revenue in North America, especially the U.S. So we're looking at ways of maybe enhancing that in the future.It's -- but the good news is, it's not a product issue. We have the product. It's a go-to-market issue. And when you go through channels, it's tough. So Vince has been, over the last year, trying to get a more direct approach, which you need if you're going to change the strategy a little bit in that area. So we're still positioning to do that, and the Microsoft Teams is a good place where we were in the past with Skype for Business. So we're still positive there, and we hope to improve our direct access to market also in the future.
You guys a little bit surprised Skype seem to do well. I mean obviously, Zoom came out, and Zoom is growing like very, very high rate. Is there something, opportunity with some of the other platforms? Or those guys are completely competing, you can't really leverage off it.
We always try and leverage off our software by putting it together. Certainly, there's a question mark with all our contact center-type operation, which is, basically, doesn't have a lot of video, but we actually tie to another video product in a minor way today.So maybe there's some opportunities there. But it depends on what the customers want. Do they want video in their contact centers or not? We'll be able to offer it, we'll be able to put it together, and we'll just have to see what happens.
And maybe last question from my end. In terms of your installed base, all the products you have in the contact center, is there -- I mean do you feel like this is really sticky enough that as these companies transition from on-prem to a SaaS that you guys would definitely be part of it? Or you guys feel like you can see a bunch of churns coming where the customers really don't give you guys the option to buy your product, where they would just buy whatever is hot and popular off the shelf in the marketplace. I just want to get a sense a little bit of how much you guys are in control of this whole transition and being able to keep your customers and, at least, keep the revenue.
That's part of the thing we're trying to do, emphasize more of customer success going to our current customers. I think in the past, we haven't shown or they didn't know that we had some of these other products, especially our -- remember our CCSP, which is our cloud product and contact center, we're in the biggest telcos in the world.So we can scale, many can't. So I don't think we actually went to our base and explained what we actually have as well as we should. So again that's one of the things that Vince has undertaken, to emphasize more, getting the customers to understand all the options we have and they can pick. They want to be on-premise, we can do that. They want to be in the cloud, we can do that.So I think we've got to be -- and that's again a little bit of our problem, especially in the U.S. The go to market through channels, they really don't want to sell the cloud. They'd rather do on-premise because they're really a reseller, and they want to make money selling hardware and whatever else they sell with our product. So that's why going more to the direct model we think will be able to help that process. But it takes some time and we're still in the process of doing that.
And our next question will come from Daniel Chan with TD securities.
You mentioned $70 million, $75 million in revenue from acquisitions in the next 12 months following purchase price accounting. But you also discussed potentially looking at revenue that generates losses and maybe removing some of that. So in addition to that $70 million, $75 million, is there a potential for that to come in lower as you look at some of those revenues? And do you plan on running off any revenue that's losing money?
That's true. First of all, the $70 million to $75 million were just from those 2 acquisitions. It's not from other things. It's only from those 2.And generally, I take those things into account when I put a number out there. So I believe the $70 million to $75 million holds true included -- including the comment that it might eliminate some revenue.
Okay, that's helpful. And then you mentioned that Vidyo may be a third segment that you may be able to acquire into. Can you just give us some color on the deal pipeline? How much of that is related to Vidyo?
Since we just did Vidyo a couple of weeks ago, the pipeline is not huge, but we've always looked at it a little bit. We have opportunities in all of our areas that we continue to look at.Comment on the pipeline for acquisitions. Look, it's looking pretty good. So in our space, for whatever reason, we believe our acquisition strategy is healthy. And yes, we will, hopefully, do some more this year and in the future.
And with no further questions in the queue, I'd like to turn the call back over to Mr. Sadler for any additional or closing remarks.
Well, thank you, everybody, for your interest in Enghouse and for attending this call. We look forward to talking to you again next quarter and appreciate your continued support.
And that does conclude our call for today. Thank you for your participation. You may now disconnect.