Enghouse Systems Ltd

TSX:ENGH

Earnings Call Analysis

Revenue Growth and Acquisitions Elevate Firm's Prospects

The company observed an 8.7% quarter-over-quarter revenue increase to $111 million, with key investments in technology offerings and go-to-market strategies boosting revenue growth. The recent acquisition of assets from Lifesize Inc. aligns with the company's existing operations, and they expect at least a five-year payback, although no exact financial projection was disclosed. A commitment to offering choice to customers, such as on-premises and cloud solutions across various providers, underscores an operational principle contributing to the company's success. Two acquisitions earlier in the quarter have been integrated seamlessly, leading to performance surpassing initial expectations and approaching historic EBITDA margins. The firm maintains robust cash reserves and continues to share value with shareholders, evidenced by a regular quarterly dividend of $0.22 per share.

Revenue and Profitability Indicate Strategic Success

The company reported a revenue increase to $111 million and $330.9 million, respectively, which represents a growth compared to their previous figures of $102.1 million and $319.5 million. This upturn signals a profitable trajectory, further underlined by an operating income of $30.9 million and $86.4 million, respectively. However, it is important to note a slight decrease compared to the former $29.8 million and $96.5 million. Net income saw a moderate dip to $17.6 million and $47.1 million from an earlier $18.1 million and $57.5 million, reflecting careful fiscal management in pursuit of growth.

Balancing Growth with Acquisitions

Strategic acquisitions have been central to the company's increased revenue and operational efficiencies. This includes the Q2 purchase of Qumu, which significantly contributed to product innovation enabled by technologies like the Enghouse Source Library. The internal system investments, particularly around AI, have not only streamlined operations but also fostered quicker, profitable integration of acquisitions like Qumu and Navita. In Q3, these absorbed entities were already contributing positively to profits.

Future Prospects with Lifesize Acquisition

The recent acquisition of Lifesize, a company with on-prem and cloud solutions, for approximately $21 million is a move to enhance the company's video and contact center operations. Expectations are set on a five-year payback from Lifesize, which aligns with the company's strategic direction and hints at immediate incremental value.

Cash Flow Resilience Post-Dividends and Acquisitions

A near return to the cash balance held at the start of the year, with cash, cash equivalents, and short-term investments at $249.7 million, is remarkable considering the company disbursed $22.4 million in dividends and made a $29 million strategic acquisition investment. This financial resilience underscores strong cash flow management.

Expectations for Continued EBITDA Margin Improvements

Fiscal 2023 is anticipated to conclude with improved EBITDA margins, fueled by acquisitions outperforming initial expectations and nearing historic company average EBITDA margins.

Embracing Cloud Diversity and Customer Preference

A significant strategy shift is manifest in the company's approach to cloud services. They now offer both private cloud solutions that cater to larger companies and a multi-tenant cloud service for broader markets. This diversification is responsive to customer preferences among cloud providers like Microsoft, Amazon, and Google, and the company ensures its software's compatibility across these platforms. A focus on giving clients choice reflects a philosophy of versatility and customer-centricity that is positive not just for customer satisfaction but also beneficial to the company's cost structure.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to Enghouse Q3 2023 Conference Call. Note that, at this time, all lines are in a listen-only mode. But following the presentation, we will conduct a question-and-answer session. [Operator Instructions] Also, this call is being recorded on Friday, September 8, 2023.

And I would like to turn the conference over to Mr. Stephen Sadler. Please go ahead, sir.

[Stephen Sadler, Chairman and Chief Executive Officer]

Good morning, everybody. I'm here today with Vince Mifsud, Global President; Rob Medved, VP, Finance; and Todd May, VP, Legal Counsel.

Before we begin, I'll have Todd read our forward disclaimer.

[Todd May, Vice President, Legal Counsel]

Certain statements made maybe 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 experience to differ materially from anticipated results or other expectations. Undue reliance should not be placed on forward-looking 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 Sadler, Chairman and Chief Executive Officer]

Thanks, Todd. Rob will now give an overview of the financial results.

[Rob Medved, Vice President, Finance]

Thank you, Steve.

I'll go through the financial highlights for the three and nine months ended July 31, 2022, compared to three and nine months ended July 31, 2022, as follows:

Revenue increased to $111 million and $330.9 million, respectively, compared to revenue of $102.1 million and $319.5 million.

Results from operating activities were $30.9 million and $86.4 million, respectively, compared to $29.8 million and $96.5 million.

Net income was $17.6 million and $47.1 million, respectively, compared to $18.1 million and $57.5 million.

Adjusted EBITDA was $33.4 million and $95.9 million, respectively, compared to $32.5 million and $104.8 million.

Cash flow from operating activities, excluding changes in working capital, was $35.5 million and $97 million, respectively, compared to $34.1 million and $107.3 million.

These achievements are largely attributable to the strategic investments channeled into various facets of the business. These include acquisitions, investing in product enhancements, bolstering our SaaS offering, refining our go-to-market capabilities, optimizing internal systems and growing our acquisition team.

Increased revenue, operating profits and cash flows ultimately culminated in our quarter-end holdings of cash, cash equivalents and short-term investments of $249.7 million, representing a near return to the January 31, 2023 cash balance of $250.7 million even after disbursing $22.4 million in shareholder dividends and $29 million for acquisitions subsequent to January 31.

Subsequent to quarter-end, on August 1, 2023, Enghouse completed the acquisition of substantially all the assets of Lifesize Inc., a cloud communications company. The acquisition was completed for a purchase price of approximately US$20.7 million, bringing our total capital deployed on acquisitions in the year to over $56 million as of August 1, 2023. The macroeconomic environment of increasing interest rates and a more difficult funding environment for technology companies continues to generate more acquisition opportunities for Enghouse that meet our financial and operational criteria.

Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.22 per common share, payable on November 30, 2023 to shareholders of record at the close of business on November 16, 2023.

I will now hand the call over to Mr. Sandler.

[Stephen Sadler, Chairman and Chief Executive Officer]

Thanks, Rob. Vince will now give some operational highlights of the quarter.

[Vince Mifsud, Global President]

Thank you, Steve.

As outlined in our Q3 press release, we are pleased to report three financial achievements during the quarter: revenue growth, improved operating income and increased cash flow from operations. I'm going to delve into the key drivers behind how we achieved these positive financial results.

Regarding our revenue growth, several factors have contributed to the 8.7% quarter-over-quarter growth to $111 million. Approximately 24 months ago, we decided to amplify our distinct advantage over other technology providers in our markets. The advantage centers around a core principle: offering our customers the power and flexibility of choice. While the concept of choice might appear straightforward, it requires significant investment and the ability to cope with operational complexity.

We have made substantial investments in various critical areas, including software engineering, operational capabilities, standing up our own software-as-a-service platform, and significant efforts in our go-to-market strategies. These investments have been crucial in enabling us to fulfill our value proposition around providing choice to our customers.

We believe we are one of the only companies in the world that can provide customers our degree of choice. Our unique proposition involves delivering multi-tenant cloud, private cloud, and on-premise solutions across any cloud provider. This gives our customers the technology option that aligns with their preferences and requirements.

Another big advantage that choice offers to our customers revolves around preserving their technology investments. We can migrate our existing customers' tech stack from on-premise to the cloud, eliminating the need for extensive retraining of their teams. This is really important during times of inflation where businesses are carefully reviewing costs and strive to minimize disruption. Choice isn't a buzzword for us, it's a real tangible advantage, which is key to contributing to our success, enhancing our revenue growth, and positioning us uniquely in our markets.

Another driver contributing the revenue growth relates to our demand generation and go-to-market teams. We have strategically invested in enhancing our digital demand generation capabilities and improving the proficiency of our sales teams, especially around the ability of selling choice. Historically, we weren't widely recognized as a SaaS provider by the market, which required concerted effort to raise awareness, especially around our SaaS offerings, and these investments are now paying dividends, contributing to the 13.8% quarter-over-quarter increase in recurring revenue, which is mostly driven by SaaS, total recurring revenue now increased to $72.3 million in Q3.

The third catalyst behind revenue growth stems from acquisitions. The broader macro technology environment influenced by rising interest rates and decreased technology funding, followed by us expanding our acquisition team is enhancing our capacity to complete acquisitions. Following the announcement of Lifesize on August 1, we've now deployed $56 million in capital, as Rob mentioned, which is our highest level since fiscal 2020, and we have plenty of runway to do more acquisitions with $250 million of cash and a debt-free balance sheet.

I would like to highlight a few important contributors to how we improved operating income and cash flows, which led to the expansion of EBITDA to 30.1% of sales reaching $33.3 million in Q3 and boosting operating cash flows to $39 million. These results are especially positive when considering the inflationary environment in which we operate in and the turnaround we required to convert the historical operating losses of our Q2 Qumu acquisition.

Born out of the last several years of engineering, we developed a new important technology asset called the Enghouse Source Library. The Enghouse Source Library is a collection of cloud technology components that were developed by Enghouse engineers and they're designed for sharing and deploying across multiple products, which allows us to drive innovation at an accelerated rate. With this best-in-class library of components, our engineering teams can expedite product development, while, at the same time, manage costs and profitability, delivering both product innovation and engineering efficiency.

Our commitment to operational profitability requires significant investments in internal systems, a move we made that improved our operations and our ability to integrate acquisitions. These internal system investments unified our operations across all of Enghouse divisions and departments, including customer experience, sales automation, marketing automation, human resource, and, recently, AI technology to improve demand gen.

These investments in internal systems have proven their value by facilitating the speed and success of acquisition integrations. Both Qumu and Navita acquisitions, which we completed in Q2, were integrated quickly, and, as a result, both businesses were profitable in Q3. Both the Enghouse Source Library and our holistic investments in internal systems have enabled us to achieve profitability and improved cash flows even in times of high rates of inflation.

Just one final point I would like to make about artificial intelligence. Enghouse has been a provider of AI technologies for quite some time. We kick started our AI journey back in 2019 with the acquisition of Eptica. This acquisition brought skilled engineering teams well-versed in natural language processing and AI technologies. And let me highlight an example of one of our AI products with a relatable use case.

Most of us have experienced calling into a contact center and prior to the call, you often hear message, "This call may be recorded for quality assurance purposes." What happens then is contact center's supervisors need to spend hours listening into these recordings to assess agent performance. What our AI product does using our Enghouse's transcription engine is convert these voice recordings into written text. We then ingest the text into our AI engine, which automatically scores and evaluates the agent's performance. This eliminates the need for a supervisor to spend hours listening into these calls and results in huge cost savings and improvements in agent performance by providing an unbiased automated evaluation and recommendations. This is just one example of our AI capabilities here at Enghouse and we continue to invest in this area.

Let me turn the call over to Mr. Steve Sadler.

[Stephen Sadler, Chairman and Chief Executive Officer]

Thanks, Vince.

With respect to acquisitions, the two acquisitions that we completed early in the second quarter are performing better than expected and getting close to our historic EBITDA margins. Further improvement is anticipated in our final Q4 of fiscal 2023.

Subsequent to the end of our fiscal Q3 quarter, we successfully completed the acquisition of Lifesize for approximately $21 million by the U.S. bankruptcy courts. Lifesize is an on-prem and cloud company which fits our current video and contact center operations as part of our Interactive Management Group. Lifesize also provides workforce optimization and management as an addition to our contact center solutions.

The combination of Lifesize with our business is anticipated to be mostly integrated with our operations by the end of our fiscal year. We expect at least a five-year payback, almost -- starting almost immediately from this asset acquisition. No financial results of Lifesize were included in our Q3 results.

I would now like to open the call for questions.

[Operator]

Thank you, sir. [Operator Instructions] And your first question will be from Daniel Chan at TD Cowen. Please go ahead.

[Daniel Chan, TD Cowen]

Hi, good morning, guys. Vince, thanks for all the color on the SaaS progress. It sounds like your organic SaaS efforts are starting to pay dividends. You also highlighted in the MD&A that the SaaS growth was largely driven by contact center solutions growth. Color on how much of the SaaS growth this quarter came from acquisitions, which is one of the factors you highlighted versus progress on that organic -- on your organic SaaS offerings?

[Stephen Sadler, Chairman and Chief Executive Officer]

Yeah, we really don't break -- it's hard to break out because we integrate things in. So, how do you do when you bring products in and then grow from there? Certainly, some of our acquisitions were SaaS-oriented because what we're finding is SaaS companies are having difficulty in making money. We make money, they do not, so we buy them and have to fix them to make them work. So, we are building a lot of our SaaS by acquisition because it is the most logical way. People who try and do it internally, a lot in our markets lose money to do it. And unless they get more money, they end up like Lifesize, which is basically in a troubled situation. So, most of it does come from acquisitions. But, yes, we're also building our own cloud SaaS model as well, but the majority is from the acquisitions.

[Daniel Chan, TD Cowen]

Thanks for that, Stephen. And then, you brought up Lifesize and, yes, it does seem to have some challenges before being acquired by you. Can you provide some insight on what some of those challenges were and what your plans are for this asset? Thank you.

[Stephen Sadler, Chairman and Chief Executive Officer]

There's a lot of different things that go wrong, but I would think from Lifesize point of view, they did not spend enough time with their customers and listen to what they need. I believe they tried to force them into the cloud SaaS model. A lot of customers don't want SaaS. That's why, as Vince said, we are flexible when give choice and spend a little more in R&D doing so, but we keep both going. So, I think those are probably the major items. We want to spend more time with the customers to see what they want and we want to give them the choice. They don't have to be forced over to a SaaS or cloud model if they want to keep what they've got.

[Daniel Chan, TD Cowen]

Thanks, Steve. I'll pass the line.

[Operator]

Thank you. Next question will be from Stephanie Price at CIBC. Please go ahead.

[Stephanie Price, CIBC]

Hey, good morning. Steve, I just wanted to follow up on your last comment there around the concept of choice in the Interactive division. So, are you seeing the conversion of existing customers into kind of private cloud or public cloud SaaS offerings? And are you seeing new customers that are looking at on-premise? Just trying to understand exactly what you're seeing there as you roll out the concept of choice.

[Stephen Sadler, Chairman and Chief Executive Officer]

You had such a complex question. I would probably just say, yes. You covered it. We have some customers who don't want to move. We have some customers who want to move into the cloud for various reasons. And we have on-prem new customers as well as in the cloud customers. So, yes, is the answer.

[Vince Mifsud, Global President]

And when it comes to cloud, Stephanie, we have two flavors of that. We have the private cloud, so a lot of the larger companies prefer a private cloud, and we have a multi-tenant cloud offering as well. So again, that also varies in terms of cloud and which cloud provider sits on top of. So, the customers also want flexibility, some have a preference of one cloud provider over another.

[Stephanie Price, CIBC]

Okay. That's...

[Stephen Sadler, Chairman and Chief Executive Officer]

What Vince is detailing there is, we try and set up, so you can move from the platform providers who they are, there's Microsoft, there's Amazon, and Google. We set up, so if someone has a preference of one of those platforms, our software generally can run on any of them. And we spend extra time to make sure we can move and not get, let's say, captured by any one platform.

[Stephanie Price, CIBC]

Okay, perfect. And then just looking at the margins, I know last quarter professional services margins were impacted by a large public safety program that were [required since] (ph) third-party contractors. Is that third-party work now complete? How should we kind of think about those PS margins going forward?

[Stephen Sadler, Chairman and Chief Executive Officer]

Yeah, it's not complete. It's the same this quarter as last quarter. We're hoping to complete it in a few quarters. But there has been no change to that, that's still a little bit of a drag on our results.

[Stephanie Price, CIBC]

Okay. Thank you. I'll pass the line.

[Operator]

Thank you. [Operator Instructions] And your next question will be from Paul Treiber at RBC Capital Markets. Please go ahead.

[Paul Treiber, RBC Capital Markets]

Hello. Thanks so much, and good morning. Just in regards to Lifesize, just to set expectations, because the court documents out there that gives details on the revenue run rate. How should we think about the amount of revenue that you expect to retain from that acquisition going forward? Like how much is that sort of -- do you see as sustainable revenue to get into your five-year payback period?

[Stephen Sadler, Chairman and Chief Executive Officer]

So, in a bankruptcy-type situation, that's difficult to say. So that's why we didn't announce any revenue. We want to get back to the customers and show them it's different now, that we're going to give them more service, more contact, and give them choice where they don't have to move into a SaaS model if they don't want to. So, we don't have a good number on that yet. So that's why we haven't provided anything, and we need probably this last quarter to see where that all ferrets out.

Are the customers going to trust us to do what we say? We've done it a lot, it's not our first rodeo as they say. But some customers may have started looking before the bankruptcy and enduring it unsure of what's going to happen. So, we don't have a firm number on that. We could guess it, but we don't guess things. So, we're not going to do it.

[Paul Treiber, RBC Capital Markets]

That's fair. I mean maybe looking back at past acquisitions, is there like a rule of thumb that you typically see like if a business is doing whatever certain amount of revenue does it drop by 20%, 30% in order to get to a sustainable level of profitability?

[Stephen Sadler, Chairman and Chief Executive Officer]

It depends how they were running and what they were doing, but you do bring up a good point. To get profitable, sometimes we have to eliminate unprofitable revenue. A lot of companies, to appease their shareholders, take on unprofitable revenue, believing that revenue growth is the key factor. It is certainly an important factor, but we want profitable revenue growth. So, certainly, in many cases, it does decline, but it depends on the particular situation. This is a little unusual because it came through a bankruptcy, which is different than most -- all of our other acquisitions.

[Paul Treiber, RBC Capital Markets]

And just lastly, just on the business and the comments around choice, can you provide a color on renewal rates and upgrade rates, the cloud and how you've seen that track over the last several quarters or years?

[Stephen Sadler, Chairman and Chief Executive Officer]

It's a good question, but a tough one to answer, because sometimes the renewal rate is moving to the cloud. And so, maintenance is not renewed, but it goes to the cloud. And we have a variety of countries doing it differently. So that's a hard one to really project any numbers on. But I would say -- and especially, we used to have about maintenance renewal about 90% to 92%, it has dropped, but some of that goes into the cloud now, which is a different product. So, I really can't answer that very well right now.

[Paul Treiber, RBC Capital Markets]

Maybe another way of asking the same question is, what's the feedback from your customers on starting this new strategy of offering choice? Have you had customers that are -- or could you group customers and characterize them as being firmly positive or are there still some that for whatever reason just want to switch to other vendors?

[Stephen Sadler, Chairman and Chief Executive Officer]

So, the answer comes down to, I think everyone likes choice in their life. I think our customers like choice. It really started with Vidyo initially, because they were -- we've had several acquisitions we've done where the companies were trying to force their customers to a SaaS model, probably because the analysts like it better and will say good things because it's recurring. Even though it doesn't make as much money as on-prem, we give the choice. Some of them don't want to do that. So again, I think they appreciate the choice. I don't see how they can be bad about. We spend a little bit more in R&D to do that, but so be it.

Maybe, Vince, you can add a bit?

[Vince Mifsud, Global President]

Yeah, I can just elaborate. I think it's in every customer call that I have, it's a positive thing offering choice. There is no customer that sees that in negative in any way shape or form. Everybody has preferences, especially around cloud providers and we have that choice as well. It adds operational complexity. It adds engineering complexity for sure for us to do it, but it's very well received by customers.

[Stephen Sadler, Chairman and Chief Executive Officer]

The one thing that is probably obvious, but we should mention, having choice of platforms does improve our cost of revenue. It helps the customer because they may be want one platform or another, but also we can get better rates from the platform providers by saying, we'll just move. If you can't move and get on a platform using all their facilities, they know you can't move, so your costs go up every year. With us, we are a little tighter than that and that's why we think choice also benefits us as well as the customer.

[Paul Treiber, RBC Capital Markets]

Okay. Thanks for taking the questions.

[Operator]

Thank you. And at this time, Mr. Sadler, we have no further questions registered. Please proceed.

[Stephen Sadler, Chairman and Chief Executive Officer]

Okay. Thank you, everyone, for attending the call, and your continued support. Our objective remains to have profitable growth and make sure we service our customers with the highest regard for them and the quality of our solutions. We are looking forward to talking to you again upon completion of our 2023 fiscal year.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines. Have a good weekend.