Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2020-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Enghouse Q3 2020 Conference 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, Chairman & CEO]

Good morning, everybody. In this era of social distancing, I'm here today with Todd May, VP, Legal Counsel; Doug Bryson, VP, Finance; and Vince Mifsud, Global President.Before we begin, I'll have Todd read our forward disclaimer.

[Todd M. May, VP & General Counsel]

Certain statements made may be forward-looking. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those in Enghouse's continuous disclosure filings such as its AIF, which could cause the company's actual results and experiences to differ materially from anticipated results or other expectations. Undue reliance should not be placed on these forward-looking statements and 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 third quarter unaudited financial results for the period ended July 31, 2020. All of the financial information is in Canadian dollars, unless otherwise indicated. Key financial and operational highlights for the 3 months ended July 31 compared to the same period in 2019 are as follows: Revenue grew 29.7% to $131.3 million. Results from operating activities increased 56.2% to $42.2 million.Net income increased 77.3% to $26 million or $0.46 per diluted share. Adjusted EBITDA increased 62.4% to $45.6 million. Cash flows from operating activities, excluding changes in working capital, increased 58.8% to $45.3 million. Cash, cash equivalents and short-term investments were $228.9 million, an increase of -- from $150.3 million at October 31, 2019, which was achieved after making payments of $19.5 million for dividends and $43.9 million for acquisitions this year. The company has no long-term debt other than nominal amount that is noninterest-bearing. In the quarter, the company experienced growth from both internal sources and from acquisitions. Internal growth includes the expansion of the acquired businesses, particularly Vidyo, since acquisition. To date, COVID-19 continues to have an overall positive impact on revenue. Although the initial surge of customers requiring immediate remote work and visual computing solutions upon the initial outbreak of the pandemic was primarily served in the second quarter of 2020, demand for these solutions remains above historic averages.The pandemic has tested Enghouse's ability and capacity to respond to significantly altered circumstances. Enghouse's results continue to demonstrate the resiliency of its business model, which is based on significant recurring revenue streams, positive operating cash flows, large cash reserves with nominal debt and a disciplined cost management and value for money philosophy. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.135 per common share payable on November 30, 2020, to shareholders of record at the close of business on November 16.I'll now turn the call back to Mr. Sadler to provide his comments. Steve?

[Stephen J. Sadler, Chairman & CEO]

Thank you, Doug. As Doug noted, we had another good financial quarter from our operations during these challenging times. Strong cash flow from operations of over $45 million increased our cash and short-term investments to $229 million approximately from $168 million in Q2 despite paying our quarterly dividend of $7.4 million, considering our changes in working capital and income tax installments paid. Net cash provided by our operating activities was $55.7 million.Compared to prior year's Q3, foreign exchange increased revenue by $1.4 million and increased operating costs by $1.1 million with a small positive impact on operating income. Some of our revenue is being delayed by COVID-19, and the business environment remains challenging for new customers, although one of our significant transit customers proceeded to roll out its hardware purchased on a commitment related to a contract completed before the COVID-19 impact. This increased our hardware revenue in the quarter, but at a lower margin. Vidyo revenue once again exceeded our original expectations, but it was reduced from the high Q2 customer demand. As stated last quarter, some of our customers have been significantly impacted by the pandemic and continue to be cautious in committing to new projects, although we have seen some improvement. In terms of acquisitions, in Q3, we completed no new acquisitions, although, our Dialogic acquisition, which we did at the end of December, has been integrated into our operations and is progressing as anticipated. We continue to focus on capital deployment doing most of our acquisition work remotely, but as indicated last quarter, several opportunities continue to focus on their own business issues, delaying acquisition processes. The acquisition pipeline remains consistent with historic levels.I would now like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Stephanie Price with CIBC.

[Stephanie Doris Price]

Just looking at Vidyo, just wondering if you could talk about what you've seen with Vidyo so far in fiscal Q4 in terms of demand? And just curious about whether the Q3 run rate is something you'd expect through kind of the pandemic here?

[Stephen J. Sadler, Chairman & CEO]

Okay. So you asked for Q4. I think you meant Q3. But we did see an initial demand mostly from current customers, but some new in Q2, that lowered down in Q3 as they bought a lot of the requirements in Q2. We still see more than we anticipated at the beginning of the year for Vidyo. But our international rollout of Vidyo has been slower than we expected. And so we're still pushing to improve in that area.

[Stephanie Doris Price]

Okay. And then the MD&A mentioned the possibility of facilities reduction and other cost savings. Just curious around the margins and how we should kind of think about the impact of those opportunities?

[Stephen J. Sadler, Chairman & CEO]

It's pretty similar to the past. When we don't do acquisitions in a quarter, which we always try and fix over 1 or 2 quarters, our margins tend to increase to about 35%. If we do acquisitions, I still maintain, you've got to think of it, model it at about 30%. 25% to 30% depending how big and how much restructuring has to be done. But it's pretty much the same model that it's been for the last 10 years.

[Stephanie Doris Price]

Okay. And I will ask one more on the M&A environment, since you mentioned it. You mentioned that some of the opportunities are kind of focused on internal operations here. Can you give us a bit more color there and how you kind of think about M&A in the back half of the year here?

[Stephen J. Sadler, Chairman & CEO]

So we're pretty set up to do M&A. But you got to remember, opportunities that we see, they're having their people work from home, and they're a little slower gathering data for us and doing the due diligence process. Also, if an issue or something comes up, they can delay things for a week or 2. Some have delayed it into next year because they just have other things that they're focusing on that are more urgent than doing a transaction with the company at this time. But again, that's also freeing up a little bit, but it's still an issue today. Everything is remote. Everything is remote, except we're kind of lucky because we have people who have done acquisitions virtually in every geographical area. So when we look at acquisitions, we tend to still send somebody in on-premise to have a look at the environment, culture and some other factors.

[Operator]

We will go to our next question coming from Deepak Kaushal with Stifel GMP.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Just a couple of follow-ups on Stephanie's questions to start. Just on Vidyo, Steve, are you able to kind of quantify or even give us a qualitative sense of the pace of acceleration for that business? And how much it's exceeding your expectation?

[Stephen J. Sadler, Chairman & CEO]

Of course, then you'd have to know my expectations, too. It's hard to answer that. But let me say that in Q2, it far exceeded it. There's a lot of the current customers who already were using the product, ordered more license revenue and some hosting revenue. That was mostly in Q2. We saw still some in Q3, but it has slowed down in Q3.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And are...

[Stephen J. Sadler, Chairman & CEO]

And I don't predict -- I don't really predict Q4, but it's still -- the work from home environment, there's a lot of moving parts. It's still an important area for us going forward.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Got it. And for the non-Vidyo part of the interactive business, any color on that, the call center and contact center side?

[Stephen J. Sadler, Chairman & CEO]

Yes. We -- if you remember, at the beginning of the quarter, we talked about how we got certified by Teams, which is the Microsoft product, which we've been working on for about 18 months. And we've had several of our products certified now. So that's positive. But again, new customers buying new contact centers in this environment where it takes work and people coming in to set it up. It's been slower, but the opportunity is still there.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Got it. And then just on the M&A side. I'm just curious. We've heard a couple of companies report in as many days signaling valuation expectations of targets has risen quite substantially. We've seen it in the public markets for tech stocks. What are you seeing in terms of valuation expectations? And is that a hurdle for you guys to get acquisitions done over and above what you're seeing on the work from home side?

[Stephen J. Sadler, Chairman & CEO]

No real change, and our parameters haven't changed. Certainly, if you're going to the public markets and looking at very large deals there, there's a lot of money at virtually, if it's free, no interest rates that private equity has. So I suspect that those valuations are higher, but we are not seeing that in what we're looking at.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And is that because you're seeing more companies with problems or because they're just so smaller and private they haven't really seen that kind of...

[Stephen J. Sadler, Chairman & CEO]

They're basically not public. And although money is cheap, you still have to get money. And some of these companies have difficulties getting money, even though it's cheap. So we aren't seeing really any difference there. In fact, if I was going to make any comment, we probably see a little better valuations in what we're looking at.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. That's interesting. And then my last question...

[Stephen J. Sadler, Chairman & CEO]

Where your comments are coming for -- and I know it's probably in the public markets, that's what you generally look after. We find the public markets are a little expensive based on the criteria that we usually look for.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Yes. No -- I mean, it's also in the private markets. I'm surprised because these companies typically acquire private companies, and they're signaling higher valuation expectations. So I guess you're finding them in certain pockets. All right. Are there any particular segments that are showing better value than others that -- or new segments have come up?

[Stephen J. Sadler, Chairman & CEO]

No. We've always had some companies that -- we've always had some companies that want higher valuations. If it doesn't meet our criteria, we just pass. Many of those companies are still available. So often when people say, yes, the numbers are higher, et cetera, either they're justifying paying more or justifying not doing stuff. We're not finding that in the areas that we're looking at.

[Operator]

[Operator Instructions] We will go to our next caller, Tom (sic) [ Paul ] Treiber with RBC Capital Markets.

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

It's Paul Treiber. Just a follow-up on M&A. The MD&A mentioned other income increased by about $2.5 million because of unrealized gains on investments in equity positions. Are those trading positions? Or are you considering acquisitions of public companies?

[Stephen J. Sadler, Chairman & CEO]

We're always considering acquisitions of both public and private. When I -- you say trading positions. If we see a company that is a potential acquisition, sometimes we take a foothold in it. Often, when they do that for some magic reasons, the stock runs up. And then if we make some money and it's above our valuation expectations, we sell it.

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

Okay. So nothing this quarter...

[Stephen J. Sadler, Chairman & CEO]

So we're not out trading, but they are potential companies we would buy the whole company. And sometimes when you talk to them, magically, all of a sudden, their stock goes higher. And we're not interested in paying up. We're very disciplined. So then we may just sell our positions at that point.

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

Okay. Also, in regards to M&A. I mean, you mentioned that you have people on the ground that can visit targets in all your regions. But from your perspective, though, I mean, you tend to be hands on with M&A. How are you adapting to this -- the challenge of travel restrictions in this environment and also doing M&A from a remote basis? Is it something you're finding comfortable adopting to? Or would you prefer going back to the old world of travel and in-person meetings?

[Stephen J. Sadler, Chairman & CEO]

Okay. So about 80% plus of our M&A work is done remote and always has been. We tend to go to the site to finish off and just have to talk with the people. We now have Vidyo. We do that through Vidyo and online. And we really just have someone remotely go there, just sort of get the layout and get another view. So we never just do it with one view. We always have several people maybe ask the same questions to make sure we get the same answers.

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

Okay. Thanks for that perspective. One more from me. In regards to professional services, it was flat quarter-over-quarter. Are you still seeing challenges in terms of travel restrictions and the inability to travel to customer locations as just restraining the ability to do professional services? And more recently, as you mentioned the fall, are you seeing that beginning to lift? Or is it still a challenging environment?

[Stephen J. Sadler, Chairman & CEO]

It's still pretty challenging there, but a lot of our professional services is not done on a customer site. It's done on our site or done even from people working at home. But there's -- sometimes there's implementation that has to be done on a customer site. So there is some limitations there, but it's not a big factor.

[Operator]

Thank you. There are no additional questions at this time. Mr. Sadler, at this time, I'll turn the call back to you for any additional remarks.

[Stephen J. Sadler, Chairman & CEO]

Okay. Thank you. Enghouse is well positioned both operationally and financially for this unusual business environment. We look forward to finishing our fiscal year 2020 and preparing for whatever business environment develops for next year.

[Operator]

Thank you, and thank you all for your attention. This concludes today's conference. You may now disconnect.