Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2021-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Enghouse Second Quarter 2021 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Stephen Sadler, Chairman and CEO. Please go ahead.

[Stephen J. Sadler, Chairman & CEO]

Good morning, everybody. I'm here today with Vincent Mifsud, President; Doug Bryson, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before we begin, I will have Todd read our forward disclaimer.

[Todd M. May, VP & General Counsel]

Certain statements may be forward-looking. By the nature of such forward-looking statements are subject to various risks and uncertainties, including those mentioned as continuous disclosure filings such as AIF, which could cause the company's actual results and experience could differ materially from anticipated results or other expectations. Undue reliance should not be placed on forward-looking statements and the 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. Yesterday, Enghouse announced its second quarter unaudited financial results for the period ended April 30, 2021, all financial information is in Canadian dollars, unless otherwise indicated. The financial and operational highlights for the 3 and 6 months ended April 30, 2021, compared to the 3 and 6 months ended April 30, 2020, are as follows: revenue achieved was $117.3 million and $236.4 million, respectively, compared to the record revenue of $140.9 million in the second quarter of last year and $251.6 million year-to-date last year. Results from operating activities were $36.9 million and $77.6 million, respectively, compared to $46.3 million and $77.1 million. Net income was $20.7 million and $41.4 million, respectively, compared to $27.1 million and $43.2 million. Adjusted EBITDA was $40.2 million and $84.7 million, respectively, compared to $49.3 million and $84.6 million. Cash flows from operating activities, excluding changes in working capital was $42.6 million and $84.3 million, respectively, compared to $50 million and $85.2 million. Although revenue for the quarter achieved was $117.3 million compared to a record revenue of $140.9 million in the same period in the prior year and shows continues to generate positive cash flows, operating income and profitability. The decline in revenue was driven primarily by the prior year's significant increase in our video business that has now returned to levels more consistent with pre-COVID volumes. And chose continues to expand its cloud offerings and has implemented new initiatives aimed at increasing sales of cloud-based products while offering choice to its customers by providing multi-tenant cloud, private cloud and on-premise solutions to the market. As previously announced on April 28, Enghouse has signed a $29 million multiyear agreement with the Norwegian government to update its national emergency fire services technology system, the 8-year agreement builds on the success of the Norwegian market with a $55 million, 12-year agreement with the Norwegian Healthcare announced in October 2020. The company closed the quarter with $169.6 million in cash, cash equivalents and short-term investments and no debt after paying $90.5 million in dividends during the quarter. As always, and just prioritized its long-term growth strategy over quarter-to-quarter results, investing in products while ensuring continued profitability and maximizing operating cash flows. As a result, Enghouse has replenished its acquisition capital while returning $83.2 million in special dividends to shareholders. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.16 per common share payable on August 31, 2021, to shareholders of record at the close of business on August 17, 2021. 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 for the quarter.

[Vincent Mifsud, President]

Thank you, Steve, and welcome, everyone, to our Q2 2021 conference call. As Doug mentioned, Enghouse had another strong earnings quarter with adjusted EBITDA of $40.2 million achieving 34.3% of sales and strong cash flows from operations before working capital of $42.6 million. This represents our 5th consecutive quarters of exceeding $40 million of EBITDA. The strong earnings and cash flow performance was achieved despite lower demand in our video business, which we believe speaks to our company's ability to manage costs and ensure they are in line with revenue. Ultimately, providing long-term sustainability to our business benefiting our shareholders, employees, customers and suppliers. During the quarter, we did experience a spike in demand for our professional services with our highest quarterly revenue achieved of $18.5 million and I'll speak later to what is driving the demand in each of our vertical businesses. One of the advantages we have at our company is the diversity in terms of the verticals and geographic markets we operate in, enabling us to perform well when demand for B2B enterprise software shifts between markets and verticals. Our video business experienced a massive Verizon volume and demand at the start of COVID in Q2 2020 followed by a fall that we've seen over the last few quarters. The NIM for our video platform is a solution that technology companies integrate into their software and hardware products continues to be good and an important part of our business. Video rooms hardware demand and its related hardware support, which is used primarily by enterprise customers has declined significantly since the start of COVID. We believe demand for video rooms hardware will continue to be low until businesses decide on their final mix of employees working from home or in the office. Our overall view on video is that we have now returned to more normal levels of volumes and are through the COVID related fluctuation. For the contact center business, our differentiation continues to be focused around offering choice for our customers, being 1 of the only companies in the market that provides multi-tenant cloud private cloud and on-prem. Currently, we are seeing more interest and demand for our cloud offering, in particular, our multi-tenant cloud that we recently began to offer directly to the market as well as continue to provide through our network of service provider partners is experiencing more demand. We believe this is the result of the overall contact center market accelerating its move to the cloud as agents in many parts of the world continue to work from home. One of the other trends we're seeing in the contact center business is more demand for our professional services as customers request our assistance in migrating to the cloud, and move to MS Teams as their UCaaS platform from Skype and other premise-based communication platforms. Q2 was our first full quarter of post-acquisition of altitude. The acquisition is progressing well, and we are particularly happy with the engineering team that we inherited in Portugal. We were able to leverage the strong talented team, and some of these engineers have been quickly able to contribute positively to our product road map of other in-house cloud products. Turning now to a few highlights in the asset management group. As Doug mentioned, at the end of the quarter, on April 28, we announced the signing of another large public safety deal with the Norwegian government to update to National Emergency fire services technology. This $29 million deal is another great win earned by our public safety team. And this deal was in addition to the October 2020 announcement of the large $55 million deal to deliver medical emergency services. Both of these projects represent a considerable amount of revenue backlog in our public safety business as only a nominal amount of revenue has previously been recognized. Our telecom business is experiencing normal demand for OSS infrastructure solutions and some positive demand for VSS, IPTV and professional services. The growth in VSS is driven by the emergence -- partly by the emergence of mobile virtual network operators that are looking to leverage their large customer bases. As an example, in the quarter, we added a new customer in the insurance industry that are providing mobile offerings to their customers to drive more reading. Added professional services demand is also being driven by our telecom customers transitioning our inches on-prem BSS solutions to the cloud. On the transit market, ridership continues to be down significantly compared to pre-COVID. However, our primary transit product offering is our automated fare collection product, enabling cashless, contactless payments, and we view this as an area in the transit market that will continue to have demand given its public safety benefits. We continue to build out our transit product suite, adding EMV, mobile ticketing and IoT features to expand this business into new geographic markets. Let me turn the call now over to Mr. Steve Sadler.

[Stephen J. Sadler, Chairman & CEO]

Thanks, Vince. As Doug and Vince noted, our operations remain financially strong with good cash flow and a strong balance sheet. We completed the acquisition of Altitude, December 20, and Q2 was the first full quarter that this acquisition was included in our financial results. It operated as anticipated in terms of revenue and profitability. In fact, the operating income was a little better than expected. We expect this business to be operating at our normal EBITDA percentage next quarter than normal earlier than our normal time frame for acquisitions. After the quarter, we announced the completion of a small tuck-in acquisition in the survey and community marketplace, which is being combined with our Survox business. In the U.S. no financial results were included from this operation in the quarter. We continue to focus on capital deployment during our -- doing our due diligence remotely the acquisition pipeline is strong, which is positive, although the company values looking to be acquired have increased with strong public markets, low interest rates and stimulus. It makes it a little tougher to do deals within our financial parameters, but opportunities are not getting done at these higher levels in our marketplace. As a result, opportunities are taking a little longer to be successfully completed. We continue to maintain our financial discipline when reviewing acquisition opportunities. We believe higher global taxes and the possibility of increasing interest rates will provide significant opportunities within our financial parameters. I would now like to open the call for questions.

[Operator]

[Operator Instructions] Your first question is from Daniel Chan with TD Securities.

[Daniel Chan, Research Analyst]

So you're still pushing on the cloud. It sounds like there's still a lot of demand for your cloud solutions. How far along would you say your products are to satisfy in your customers' cloud needs? Just trying to get a sense of whether you're seeing any risk of these customers turning over to a cloud-native competitor?

[Vincent Mifsud, President]

Daniel, this is Vince. Yes. So our product is quite mature. It's been in the market through our service providers for many, many years. We have literally thousands and thousands of agents on our Enghouse cloud product. The only new thing is we stood up our own cloud a few quarters ago. So we're -- when customers -- our existing customers that we deal directly with on a cloud solution, we offer them the choice of going to our cloud offering. So the product is fully functional. It's been in the market for many years and is fully featured, competitive with other cloud, multi-tenant cloud vendors in the market.

[Daniel Chan, Research Analyst]

Okay. That's helpful. And then just on that point where you said for customers that want their own cloud rather than through a service provider. Is there any risk that you're competing with some of these telcos that are offering contact center as a service? And if there is, how do you kind of carve out the market relative to what they're addressing?

[Vincent Mifsud, President]

Yes. So most of the service providers that offer that actually use Enghouse. So we have a lot of the world's leading service providers that white label our product and offer it as a contact center as a service. And the way we segment the market is we work closely with our partners, and we go by vertical. So we'll go directly in some verticals, and they'll go directly in other verticals. So we work closely with them and minimize channel conflict that way.

[Operator]

Your next question is from Stephanie Price with CIBC.

[Stephanie Doris Price]

I was hoping you could talk a little bit about the hosted and maintenance revenue line. From the press release, you mentioned video as an impact, but it also had a comment about customers adjusting their software requirements. Just curious if you could expand on that a bit.

[Stephen J. Sadler, Chairman & CEO]

Yes. Just as a comment, as Vince has said before, the -- our maintenance, for example, in the video part where we had video rooms, it's down quite a bit. So it's it's caused that line to go down in -- on our financial results. We expect, as things open up and we go back to premises, that will come back up. We also had a couple of, let's say, large clients that were hanging on in the transportation area and the retail area. And when the third wave hit, they basically stopped or went out of business and one and the other one, they just stopped using the services -- because it was an airline, and it wasn't really having much business. So the number is down, but our future is still fine.

[Stephanie Doris Price]

Okay. Sounds good. And then can you talk a little bit about the Norrie infrastructure contract that you signed? And just wondering about any other opportunities in that region and in the Transportation division at this point?

[Vincent Mifsud, President]

Okay. Yes. So as we mentioned, these 2 deals are fairly large. So there's a lot of revenue backlog to deliver in the near future. So the focus is currently on delivering those 2 large projects. The other area of transit that we're looking to geographically expand is the automated fare collection market. And that's the product and suite that we are focused on selling in many markets in the world currently.

[Stephen J. Sadler, Chairman & CEO]

The one item that we should mention and clarify, the numbers we provided you is the contracts that we want. We're already getting additional revenue from changes they want made to what was originally proposed. So it's not all in. It's a matter of this is the contract for delivering what they put out originally, but we're already getting additional revenue and services request to do additional work.

[Stephanie Doris Price]

Okay. That's helpful. And just finally for me on the margin in the IMG division. Are these kind of normalized margins here? Or how do you think about the margin profile this quarter and maybe going forward?

[Stephen J. Sadler, Chairman & CEO]

On the IMG, it's pretty steady. So they're probably pretty normal. I would say, it always depends on our revenue mix, the more license or software that we do direct has higher margins, of course. And again, it also depends on maintenance. The SaaS side generally have a little bit lower margins because it's -- right now, it's quite a competitive market. With pricing being still tough in that area. So it just depends on the mix, but you can probably use the margin numbers pretty normal.

[Operator]

Our next question is from Paul Steep with Scotia Capital.

[Paul Steep, Analyst]

Maybe just to key on some of the topics we talked about in the past on cloud. I know you're agnostic and just want to deliver to clients. But could you give us a sense of how much the business has maybe moved to the cloud and IMG and AMG, where you think that maybe goes over the next couple of years?

[Stephen J. Sadler, Chairman & CEO]

I'll give a brief one, and let vital to maybe a little more detail on it. On the AMG, very little goals to the cloud, they're generally direct. It's generally OSS, VSS type systems that we sell. So really not much cloud there. Some competitors are trying to go to the cloud, but they're having difficulty getting a market there. On IMG, it is moving to the cloud. Again, we offer both whatever the customers want. My comment would be that I think we've got to learn how to sell more into the cloud. While in the past, we did a lot through channels and on-premise type systems. We've hired the direct sales. We're going more direct in the cloud, but it takes a little time to ramp that up. Last year, we were basically ready to go in and put some of the pieces in place and then the COVID hit. So that gets tough to do. So we've sort of got the late year, but I still feel pretty confident that we're ready. It's just a matter of getting out there and executing it. It's just we have the software, we have the products, we just got to get more into execution on the sales and marketing side.

[Vincent Mifsud, President]

Yes. And just to add to Steve's comments. So the video product we sell a lot of that in the cloud. We get a lot of requests for our video of multi-tenant cloud. And IPTV, which I touched on last quarter, that's pretty much all cloud-centric. So it is moving the area of contact center as a service, unified communication as a service is moving more aggressively to the cloud.

[Stephen J. Sadler, Chairman & CEO]

Yes. Just another comment, in the pandemic, when you're not going on-site and people are running on their own premises, the cloud is a little easier so you could see that revenue in that area really hasn't been impacted very much. But on-prem has, which we've done more of, and our position is we can sell either. We have products that do both.

[Paul Steep, Analyst]

That makes sense. And just to key on the 1 comment you said there, Steve. And I think I know the answer, but it's worth hearing you articulate it. In terms of building up that direct cloud sales force, unlike others, I assume you're going to be pretty measured in going after that. And we shouldn't expect that IMG margins take a big hit if you invest only if you're seeing significant demand. Just to clarify.

[Stephen J. Sadler, Chairman & CEO]

Yes, I like those questions where you ask me the question, and then you give me the answer. So yes or yes, you're right.

[Paul Steep, Analyst]

Just checking. All right. Actually, the last one for Vince here. Vince, on public safety, what's the opportunity -- what's unique in those contracts in the Scandinavian country that you could maybe take to other markets? Or are they unique requirements just to those geographies?

[Vincent Mifsud, President]

Yes. I mean our unique advantage there is we have a lot of credibility in that market. We have a track record. And the way our solution is designed, these systems are quite complex, so they got to integrate with a lot of systems. So think about integrating with your lights so that you can max -- optimize the routes to the emergency situations, you're integrating to databases around people's health, et cetera. So we're really good at having a very open system that has lots of APIs to connect into multiple systems. And so that's kind of part of the reason we won plus our credibility in the market.

[Operator]

[Operator Instructions] Your next question is from Paul Treiber with RBC Capital Markets.

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

I just wanted to focus on video for a couple of questions here. With the hardware versus, I guess, the subscription or the services business of video, can you -- you mentioned that total revenue be is basically back to pre-COVID levels. Can you speak to how those 2 different moving parts that -- what impact that had over last year, hardware versus the services business -- or sorry, the subscription business?

[Vincent Mifsud, President]

Yes. So the hardware business like I mentioned, has gone down dramatically, almost down to nothing. We had hardware, we were selling hardware rooms to enterprises, along with the support that you need for the hardware room. So that just as COVID sort of continued, people just didn't renew those support contracts and stop buying hardware rooms for the enterprise. In the video business, where we're strong on the subscription side is in telehealth. So what happened there is there was a buying surge where a lot of the hospitals that use us bought tons of capacity, not noting where we're going to land. So they sort of bought in anticipation of massive amounts of video calls with doctors. And then as it sort of leveled out, they just renewed according to the volumes they needed. So that's sort of what happened to it. You had this kind of list, massive less than in normalization over 4 quarters.

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

And just to put some numbers or you try to quantify it a bit better, like how large was the hardware business pre-COVID? And then when you look at the telehealth business, has that grown versus pre-COVID levels?

[Vincent Mifsud, President]

Yes. So the telehealth business is up on the subscription side relative to pre-COVID. It is up slightly. The hardware is just down dramatically.

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

Okay. And when -- I mean, you paid 2 years ago for video, you paid $40 million. When you look at the free cash flow that video has generated over the last 2 years, have you gotten to the breakeven point yet on that acquisition? Or looking at it another way, how is the IRR tracking on that acquisition relative to when you bought it -- your expectations when you bought it?

[Stephen J. Sadler, Chairman & CEO]

Yes. We're doing very well on that. I guess that's the good news out of the pandemic for us. We basically got all our money back already. So when we go to a 5- or 6-year payback, that one was probably maybe one more quarter, but it was just over a year for a payback.

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

Okay. That's great to hear. Last one for me. Just on the expense side, looking at SG&A and R&D on a sequential basis, SG&A declined slightly sequentially, but R&D increased. Can you explain some of the moving parts there?

[Stephen J. Sadler, Chairman & CEO]

Yes. Part of the R&D, remember what Vince said, we bought altitude. On December 30. And they had quite a large R&D group. And normally, we would rationalize that. But they had what we thought was talented people, so we actually took a lot of their team and redeployed it into our other groups for now. So that covered any openings or a lot of the openings we had and give us some additional staff to move our products ahead a little bit faster. So it moved out mainly because of the acquisition. It's not like we're adding in a multi places. It's just we feel openings faster. A lot of people are having difficulty finding technical staff. The altitude gave us quite a few additional stack that we deploy not only in helping in the IMG group, what they did, but also in other groups as well. So that's why that went up a little bit more than other items.

[Operator]

We have no further questions at this time. I turn the call back to presenters for closing remarks.

[Stephen J. Sadler, Chairman & CEO]

Well, thank you, everybody. Enghouse continues to have a strong financial position to execute our capital allocation and business strategy even after paying out over $90 million of dividends in the most recent quarter. We continue to build on our journey. Thank you for attending the call and your continued support.

[Operator]

This concludes today's conference. You may now disconnect.