Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2018 Q3 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, sir.

[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 will have Todd read the 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 or event 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 third quarter unaudited financial results for the period ended July 31, 2018. Third quarter revenue increased to $86.7 million compared to revenue of $82.8 million in the third quarter of the prior year. The revenue increase primarily reflects contributions from acquisitions.Income from operating activities was $26.7 million compared to $22.6 million in the prior year's third quarter, an increase of 18.1%. Net income for the quarter was $16.1 million or $0.58 per diluted share compared to $11.2 million or $0.41 per diluted share in the prior year's third quarter, an increase of 43.6%. Adjusted EBITDA for the third quarter was $27.4 million or $1 per diluted share compared to $23.4 million or $0.86 per diluted share last year, with the increase being attributable to contributions from acquisitions and operating cost synergies.On a year-to-date basis, revenue was $257 million compared to revenue of $241.1 million in the prior year, an increase of 6.6%. Income from operating activities was $75.9 million compared to $66.6 million in the prior year-to-date, an increase of 14%. Adjusted EBITDA for the year-to-date increased 13.1% to $78.1 million or $2.86 per diluted share compared to $69 million or $2.53 per diluted share last year. Net income for the year-to-date was $38.2 million or $1.40 per diluted share compared to $31.9 million or $1.17 per diluted share last year.Operating expenses before special charges related to restructuring of acquired operations were $34.1 million compared to $35 million in the prior year's third quarter and reflect operating cost savings, net of incremental operating costs related to acquisitions.Noncash amortization charges on acquired software and customer relationships from acquired operations were $7.2 million in the quarter compared to $7.4 million in the prior year's third quarter. On a year-to-date basis, operating expenses before special charges were $102.3 million or 39.8% of revenue compared to $98.9 million or 41% of revenue last year.Company generated strong cash flows from operating activities of $29.3 million compared to $25.1 million in the third quarter of fiscal 2017. On a year-to-date basis, cash flows from operating activities were $74.2 million compared to $54.1 million in the prior year, an increase of 37.1%. As a result, Enghouse closed the quarter with a record $178.4 million in cash, cash equivalents and short-term investments compared to $130.3 million at October 31, 2017.The cash balance was achieved after year-to-date payments of $13.5 million in cash dividends, $9.7 million net of cash acquired for acquisitions concluded in the current year and $6.9 million for acquisitions closed in prior periods.Yesterday, the Board of Directors announced -- approved the company's quarterly dividend of $0.18 per common share payable on November 30, 2018 to shareholders of record at the close of business on November 16, 2018.I'll now turn the call back to Mr. Sadler.

[Stephen J. Sadler, Executive Chairman & CEO]

Thanks, Doug. As Doug noted, there is some good news and bad news with our cash position. We continue to grow our cash and short-term investments, which reached approximately $178.4 million. But this means we did not deploy cash on accretive acquisitions as we would have liked in the quarter.Cash flow from operating activities was $29.2 million, a record, and $74.2 million year-to-date, a 37% increase over the prior year. You will note on the balance sheet, the foreign exchange impact was positive $659,000 versus a loss in the prior year of $806,000. Other notable items are: software licenses increased by 7.1% over the prior year, hosted and maintenance revenue increased over the prior year, overall revenue growth was about 5%, including acquisitions; and both single digits, excluding acquisitions. Adjusted EBITDA was 31.6% and 30.4% year-to-date.Forward exchange was a negative headwind of about $1 million in the quarter compared to Q2 '18 on revenue. We continue to focus on improving internal revenue growth, which is showing progress but takes time to improve.In terms of acquisitions, we did not complete any acquisitions in the quarter, but the economic and market factors remain favorable for acquisition opportunities. Sellers tend to want a little more value pulling through the public markets, but we maintain our financial discipline with a 5- to 6-year payback.I would now like to open the call for questions.

[Operator]

[Operator Instructions] We will now take our first question from Paul Steep of Scotia Capital.

[Paul Steep, Analyst]

Steve, maybe you or Sam, could give us a little bit of an update on the M&A environment, and how you've been building up the team and maybe the pipeline on that side of the business.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, the M&A environment hasn't changed that much. A little bit, people are still -- there's a lot of opportunities, some are asking more than we think give us a fair payback. We are finding that most of these opportunities that are not sold, and they tend to come back to us to have further discussions. But it's really not changed that much from the past.

[Paul Steep, Analyst]

Got it. And then I guess maybe talk a little bit about how you're thinking about the margins. Obviously, you're still focused on driving deals but theoretically, if we didn't do any more M&A, where do you think you could actually take the margins in the business, in a steady state?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, that's a good point. I mean, the margins are a little higher in this quarter. But it's basically because we haven't done acquisitions. As I mentioned, when we do an acquisition, the first quarter generally either doesn't make money or about breakeven; the next quarter then makes positive contributions; the third quarter, we try and make sure it's half our margins; and by the fourth quarter, it's a full margin. Having not really done very much in acquisitions in the last 2 quarters, you'll see our margins creep up. I think they would creep up even higher, but I do believe we will have acquisitions in the future. So I wouldn't say it's a steady-state, where it's at today, except if we don't do acquisitions, then we should be able to achieve these margins and maybe even a little bit higher. We still expense all our acquisition team in our numbers, like we don't break it out, we don't capitalize anything. So that's unchanged whether we do deals or not.

[Paul Steep, Analyst]

Okay, great. And then the last one on my end would be, I guess just an update on some of the lead gen activities that you're working around. And I know I guess in the past, Steve, you've talked about being excited about some of the opportunities around Skype for Business. If you can give us an update on that, that would be great.

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, we always -- Skype for Business is something that we always had a lot -- great hope for, but Microsoft seems to struggle with how to position it in the marketplace. So it has actually slowed down a little bit. Demand Gen, I know Vince is actually bringing in some more demand Gen talent, and we're changing the focus of the company a little bit, away from what you'd call traditional marketing to more demand gen instead. We believe if we get into more opportunities, our revenue will grow faster. So we're trying to take a different tack really to emphasize marketing on generating more opportunities for us to get involved in. It takes time. You got to get some people in, you got to change it. It's a process, you just got to keep making headway on. And I believe we're doing that.

[Operator]

We will now take our next question from Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

Just a follow-up on the sales team changes. What should we expect in terms of lead time for some of these Demand Gen initiatives? And on the cross-sell opportunities, I mean, what kind of metrics are you guys tracking to, to follow those opportunities?

[Stephen J. Sadler, Executive Chairman & CEO]

I think there's a lot of interest and we've got a lot of potential in the area, but we're hiring some new staff, we're taking a new approach. Some of that staff is in, but we're still looking for some others. If I was looking at it, I see it as a next year benefit. It will show up -- if it's going to show up, because there's always risk that it doesn't, it would be next year. I don't see it really showing up immediately, although we're seeing some signs that there is more -- we're attracting more interest, let's say. But it's not something that will show up immediately like in the next quarter or anything like that.

[Daniel Chan, Research Analyst]

Sounds good. And then any update on the competitive landscape? Are you seeing Amazon or Twilio in any of the engagements you're having with customers?

[Stephen J. Sadler, Executive Chairman & CEO]

None.

[Daniel Chan, Research Analyst]

Got it. Sounds good. And then final one for me, cash. Cash is at an all-time high, I just want to check if there's any changes in your thoughts on capital deployment?

[Stephen J. Sadler, Executive Chairman & CEO]

No. I mean, I still think it's nice to have the cash. Everyone's concerned a little bit about markets, the Democrats in the U.S., Korea, there's all kinds of things out there that might cause the markets to change quite quickly. If it does, we have the cash to take advantage of it. We see that as a positive, and we continue to look for deals. So we have a disciplined acquisition strategy. We're disciplined in how we look at our dividend, paying it as a percentage of cash flow. It seems to work well for us, so we see no reason to change it.

[Operator]

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

[Deepak Kaushal, Director and Technology & Communications Analyst]

So just in Q3, no significant FX impacts, low single-digit overall growth and -- sorry, mid-single-digit overall growth and low single-digit organic growth. Steve, would this suggest that the recent acquisitions aren't bringing in as much revenue as you guys anticipated or expected? Or how do you characterize that?

[Stephen J. Sadler, Executive Chairman & CEO]

Absolutely normal. If you're following the company, it's what everyone would probably expect.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So in terms of Mobilethink, I think in the last quarter you said it contributed 300k, and there was some commentary about it having done $13 million annually in past years. How is that performing? And what is your sense of what that business could contribute to Enghouse over the next year?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, we never mentioned $13 million in past years. I think another analyst put that out, and they were incorrect. It would have added about $1 million in this quarter. And that's what we expected when we did the deal.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, excellent. So that's on -- so Mobilethink, on track?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes. The other thing people should realize in the Mobilethink when the analyst put out that, Mobilethink was a much larger business and we only bought part of it. So that's maybe where the confusion came from. So it was bought by another company and then we bought a part of it out. They kept part of it as well. So you've got to think in terms of $4 million, $5 million in revenue, not $13 million.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, that's an important clarification. And then on the M&A environment, you mentioned higher expectations, companies asking for more. If they don't get sold, they come back. Is this to suggest that the cycle time or the turnaround time on closing some of these deals has lengthened versus a year ago? Is it taking longer to close deals at all?

[Stephen J. Sadler, Executive Chairman & CEO]

I wouldn't say that because we do value pretty quick. So if the value is not right, we move on to the next one. So I don't think the cycle time to close it is any different than it has been in the past. I do think we have to have more discussions going on to make sure that we are successful in doing accretive acquisitions that meet our financial requirements. So we have -- we've got -- I've added one of my operational people, who used to run one of our divisions, we restructured a little bit, and he's been added to the acquisition team like a week or so ago. So he's transitioning his operational rollout. And as of basically right now, but the transition will be done before the end of the fiscal year. He will be on the team too in helping to look at acquisitions, because we've got enough opportunity just to look at. So I just wanted to add a little more capacity in the looking. And then if we close them, it depends on if they meet our criteria. If they do, great. If they don't, we don't do them.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So in terms of the pipeline, the opportunity set, the geographic and business segment reach, there is no issue. It's a matter of going through the deals and opportunities quickly enough and finding the right price, is that a fair takeaway?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, I wouldn't say the opportunities are better or worse, I see it as very similar to what it's been over the last couple of years. So it isn't like it's improved and it hasn't really gone down. It's pretty steady, would be how I see it. I don't want to make it look like there's a ton more opportunities or anything like that. It's pretty steady like it has been in the past. I just -- we got to do due diligence to make sure that we can achieve our objectives that we've set for doing the acquisitions.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, excellent. And you did mention some of the concern in the markets and all sorts of things -- I think you said all sorts of things that could change things quickly. Have you seen any of these change or impact customer thinking at this stage, changes in Europe or in emerging markets like Latin America on the present side? What's your kind of thought on the [indiscernible] macro environment?

[Stephen J. Sadler, Executive Chairman & CEO]

Not really. I mean -- not really, but the SaaS players are still out there strong. Again, some of them, they don't really make much money and I'm surprised that they still continue to get the investment, but they do. But that's been there for 5 years. So I would say there's no real change that I've seen, to answer your question.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Any kind of goals you're willing to share for the next -- for the balance of this calendar year that you'd be hopeful to achieve or -- either on M&A or organically?

[Stephen J. Sadler, Executive Chairman & CEO]

No, not really. As Doug pointed out, there was about $74 million we made in cash year-to-date, $74 million and a bit. It would be nice to get that to $100 million, but who knows.

[Operator]

[Operator Instructions] We'll now move to our next question from Paul Treiber from RBC Capital Markets.

[Paul Treiber, Associate]

I just wanted to ask about license revenue. Obviously, strong in the quarter. I think you called out in the MD&A that it was in the asset management segment. Can you just speak to what drove the strength this quarter? And then how sustainable do you see that going forward?

[Stephen J. Sadler, Executive Chairman & CEO]

I'd love to give you, a, "Hey, here's a big plan we did." It's a lumpier business. Some quarters are up and some are down. We had a bit better quarter. There's nothing magic about it. So I don't think you should put it in that there's a high-growth aspect there. We're hoping to have growth. And it was a good quarter, but I can't say there is any dynamics that really have changed. I'd like to see better [indiscernible]

[Paul Treiber, Associate]

Was it a large deal, like a multimillion dollar deal? Or was there several smaller ones that came in together this quarter?

[Stephen J. Sadler, Executive Chairman & CEO]

That business tend to have larger deals, over $1 million. So let's say we got one more than we did in the past last quarter. And that generally can make that number turn out like it does. So it isn't -- I would say it's hopeful that it's a trend, but I can't say it's necessarily a trend. But we always -- they're doing a lot of work. We are building up in trying to improve internal growth. But I would say I'm not prepared to say it's a trend at this stage.

[Paul Treiber, Associate]

Okay. That's understandable. Just on your new ERP system or financial system that you put in place I think 6, 9 months ago, could you -- what's been the benefit of that system now that you have it in place operationally in terms of either cost savings or just other sort of operational improvements?

[Stephen J. Sadler, Executive Chairman & CEO]

It's interesting. If you look at our cash flow, part of that, the new system is providing more information, so we can act faster in a lot of areas. Part of our cash flow, if you look at our receivables, they've come down substantially. Again, that was when -- part when the system was going in place. And now that it's in place, we're using the information to do better things there. We're also using the system to improve the foreign exchange impact that's been had. So we're starting to see some benefits, and we hope to see more. The key benefit for that was when we're organized, was as we do acquisitions, that we should be able to integrate them in faster. I can't say that's a benefit yet because we didn't do any acquisitions in the quarter. But certainly, I expect that's still going to be the case as we move forward.

[Operator]

[Operator Instructions] As there are no further questions in the queue, I would like to turn the call back to Steve Sadler for any additional or closing remarks.

[Stephen J. Sadler, Executive Chairman & CEO]

Well, thank you, everyone, for attending the call. I just want to make sure you understand, Enghouse continues to be well positioned for future success.

[Operator]

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