Enghouse Systems Ltd

TSX:ENGH

Earnings Call Analysis

Double-digit Growth and Strategic Acquisitions Drive Enghouse's Strong Performance

Enghouse reported a 17.6% increase in revenue to $130.5 million for Q3 2024, with recurring revenue up 22.8% to $88.8 million. Net income rose to $20.6 million, marking a continued focus on profitability. Significant achievements include the acquisition of SeaChange, contributing positively to IPTV market presence. The strategic direction remains focused on expanding profitability through SaaS and on-premise solutions, increasing annual dividends, and share repurchases. The company ended the quarter with a robust cash balance of $259 million and declared a quarterly dividend of $0.26 per share.

Strong Revenue Growth Signals Company Health

Enghouse reported a remarkable 17.6% increase in revenue for Q3 2024, amounting to $130.5 million, up from $111 million in Q3 2023. For the nine-month period, revenue grew 13.9% to $376.8 million. This consistent growth in revenue reflects the company's strategic focus on operational efficiency and effective acquisition integration.

Recurring Revenue Demonstrates Robust Development

Recurring revenue, driven by SaaS and maintenance services, soared 22.8% to $88.8 million, now comprising 68.1% of total revenue. This highlights Enghouse's successful transition to a SaaS model, which promotes stability and predictability in earnings. Over the nine-month period, recurring revenue rose to $258.4 million, reinforcing the company's commitment to this stream.

Profitability Gains with Strong Operating Cash Flow

Net income for Q3 increased to $20.6 million, compared to $17.6 million in the same period last year, while adjusted EBITDA rose to $37.7 million with a 28.9% margin. This is a 12.9% growth year-over-year, reflecting the company's improved cash flow management and firm commitment to profitability, highlighted by a year-to-date adjusted EBITDA of $108.2 million.

Strategic Acquisition Bolsters Market Position

The acquisition of SeaChange is a significant enhancement to Enghouse's market presence in IPTV. Although SeaChange's profitability is not yet at standard levels, its immediate contribution was positive. The operational integration is expected to strengthen future performance, providing Enghouse with a competitive edge in a growing sector.

Solid Financial Position with Future Growth Potential

With cash and cash equivalents totaling $258.7 million, Enghouse's financial standing is robust, allowing for continued investments in growth opportunities. The company's board has announced a quarterly dividend of $0.26 per share, payable on November 29, 2024, demonstrating a capacity to return capital to shareholders.

Focus on operational efficiency and market adaptation

Enghouse's business is adapting to market changes, leveraging its operational strategies to maintain performance amid industry shifts. The company's choice strategy, allowing customers to adopt SaaS at their own pace, has been crucial in retaining clientele and expanding recurring revenue.

Navigating Changes in Competitive Landscape

Amidst challenges faced by competitors, particularly those burdened with debt, Enghouse's conservative approach to growth has started to pay off. The company has refrained from pursuing unprofitable revenue, which has positioned it favorably in the changing market dynamics, particularly as rivals struggle with their financial positions.

Future Expectations and Continued Caution in M&A

While Enghouse sees significant opportunities in the market, acquisition strategies remain cautious. The company intends to avoid high-debt acquisitions and is waiting for more favorable valuation conditions. Overall, it anticipates improving future margins as it fully integrates acquisitions like SeaChange.

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Enghouse's Q3 2024 Conference Call. [Operator Instructions] This call is being recorded on Friday, September 6, 2024.

I'd now like to turn the conference over to Stephen Sadler, Chairman and CEO. Please go ahead.

[Stephen Sadler, executive]

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, executive]

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 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, executive]

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

[Rob Medved, executive]

Thanks, Steve. I'll take us through the third quarter financial highlights. Revenue increased 17.6% to $130.5 million in the quarter from $111 million in Q3 2023. And for the 9-month period, increased 13.9% to $376.8 million from $330.9 million last year. Recurring revenue, which includes SaaS and maintenance services, grew 22.8% to $88.8 million compared to $72.3 million in Q3 2023, and now represents 68.1% of total revenue.

For the 9-month period, recurring revenue increased to $258.4 million from $210.4 million in the prior period, also an increase of 22.8% as we continue to prioritize this revenue stream. Results from operating activities increased to $34.3 million from $30.9 million in Q3 2023, and has increased for the 9-month period to $100.4 million from $86.4 million in the prior period. Net income was $20.6 million compared to $17.6 million in Q3 2023 and $58.7 million date compared to $47.1 million last year as we grow our business with a focus on profitability.

Adjusted EBITDA increased to $37.7 million from $33.4 million, growing by 12.9% while achieving a 28.9% margin. Year-to-date adjusted EBITDA was $108.2 million compared to $95.9 million in the prior year, an increase of 12.8%. Cash flow from operating activities, excluding changes in working capital, was $37.4 million compared to $35.5 million in the prior quarter, and $111.5 million year-to-date compared to $97 million in the comparable period. Cash, cash equivalents short-term investments reached new record highs at $258.7 million as at July 31, 2024.

Our third quarter operating performance continued its upward trend with revenue, profitability and operating cash flow, all exhibiting positive growth. Our commitment to operational efficiency alongside our capability in executing and integrating acquisitions continues to deliver positive results. This quarter, we completed the acquisition of SeaChange, expanding our IPTV market presence, a growing sector for Enghouse. We have effectively integrated SeaChange into our asset management group, achieving profitability in its first quarter post acquisition, although not yet at our standard levels.

Our strategic direction remains steadfast as we continue to expand our business profitability, offering both SaaS and on-premise solutions positions us uniquely in the marketplace. Operational enhancements across our existing businesses and recent acquisitions are driving positive outcomes, enabling us to maintain robust cash reserves while simultaneously increasing annual dividends, repurchasing shares and pursuing acquisitions. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.26 per common share payable on November 29, 2024 to shareholders of record at the close of business on November 15, 2024.

I will now turn the call back to Mr. Sadler.

[Stephen Sadler, executive]

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

[Vincent Mifsud, executive]

Thank you, Steve. We are pleased to announce another quarter of double-digit growth across all our key financial indicators, including total revenue, recurring revenue and operating profit. This marks our fourth consecutive quarter of double-digit growth in both total and recurring revenue. It's been a particularly good quarter, delivering one of our strongest top line performances in our company's history and achieving our highest revenue quarter since 2020.

Sequential revenue for Q3 2024 in comparison to Q2 2024 is especially positive as historically, this quarter has seen seasonal dip in organic revenue due primarily to our customer summer cycles. However, this year, we effectively mitigated that trend, maintaining total organic revenue in line with Q2 2024.

We attribute our financial performance to 3 factors: our team's execution, acquisitions and our ability to integrate them and our unique market position as one of the few companies offering true customer choice. I would like to highlight several examples of how we have enhanced our business execution. Our business delivered good performance across several key areas, including our go-to-market sales teams, demand generation, product and engineering, operations, cost management and collection efforts. Several of our sales regions achieved sequential improvement against the trend of a historically softer Q3.

This quarter also marked one of our strongest performances in new order bookings, and key successes include expanding our partnership with a leading global telecom provider for our Enghouse cloud contact center product, securing additional deals in the Middle East, growing our transit business in Europe, and increasing the adoption of our video products into the government and pharmaceutical sectors.

Our customer experience and renewals team also performed well, helping to drive recurring revenue and improved customer retention. This team is focused on enhancing customer retention and expanding recurring revenue, and a key achievement this quarter was securing our largest ever 3-year multimillion-dollar SaaS renewal, which will contribute to revenue over the next 36 months.

Our demand generation team also achieved one of their best quarters of inbound leads, optimized with the use of AI tools. They made substantial progress in our organic SCO, securing first page rankings for over 50 industry terms, which is a significant improvement over 12 months ago, and it's leading to cost-effective lead generation. From an operations standpoint, we achieved $18 million in professional services, an increase of 14% from last year, marking one of our highest professional service revenue quarters while at the same time, improving professional services gross margins.

Our product and engineering teams also delivered a strong quarter. This team started to leverage AI tools to accelerate engineering velocity, and we began using these tools in our contact center group and are now expanding them across all the engineering teams. We also completed the cloud uplift for our strategic networks products, and introduced a new transit product for the Americas markets. Another key aspect of execution came from our finance team, which maintained a strong focus on cash collections, an important effort during a high interest rate environment, where customers tend to hold on to their cash more tightly. We ended the quarter with a strong cash balance of $259 million after spending $30.8 million on the acquisition of SeaChange, $14.4 million on dividends and $1.8 million on share buybacks. This reflects our finance team's effectiveness and cash collections and treasury management. Additionally, our 11% operating profit growth highlights our continued focus on cash management.

Regarding our acquisitions, we've deployed $43.4 million on acquisitions so far in fiscal 2024, which includes the most recent acquisition of IPTV provider SeaChange that we completed at the start of Q3. IPTV is an important growth area for Enghouse, and this acquisition has elevated its importance. Since we launched our IPTV product, we have consistently added new customers in North America and grown our business quarterly. The purchase of each -- of SeaChange enhances our IPTV offering. By expanding our presence into Europe and the Lat Am market, as well as entering into a new IPTV market, enabling us to deliver video streaming solutions directly to content creators such as top media and sports organizations.

This introduces a new market segment for us, complementing our existing market through operators. SeaChange contributed positive operating income, as Rob mentioned, started immediately in Q3, although not in line with our normal profit margins yet, given it's the first quarter post acquisition. Our choice offering has proven to be an effective business strategy, significantly aiding in customer retention. Choice allows our customers to migrate to SaaS at their own pace when and if they desire to do so. The expansion of our recurring revenue in the quarter is driven primarily by the growth in SaaS revenue. We view choice as a key competitive advantage, which is helping build loyalty with our customers, ultimately driving recurring revenue growth.

In summary, while we recognize there's always lots of room for improvement, we are pleased with the quarter's results, driven by our team's execution across organic and acquisitions, and we remain confident that our choice strategy is well aligned with the needs of the customers and the markets we are in.

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

[Stephen Sadler, executive]

Thanks, Vince. With respect to acquisitions, as both Rob and Vince have mentioned, we completed the acquisition of the assets of SeaChange in the quarter -- early in the quarter, but not for a full quarter. The acquisition has been integrated into our asset management business group. For the quarter, the business of profitability was not at our historic levels, as Vince has said, it was profitable in the first quarter, which is a little unusual because usually, the first quarter of an acquisition has a negative impact on EBITDA profitability. It was slightly profitable, but we expect to improve profitability in the next quarter and thereafter.

We continue to see substantial opportunities in our industry sectors with some larger organizations having debt problems, staff reductions and interest costs, which are not supported by their slowing growth operations. I would now like to open the call for questions.

[Operator]

[Operator Instructions] And your first question comes from the line of Daniel Chan with TD Cowen.

[Daniel Chan, analyst]

Your MD&A states that the client software licenses revenue is due to a decrease in demand for on-prem software. Can you just provide any details on the major drivers behind that? Just wondering if there's any churn or [Technical Difficulty].

[Vincent Mifsud, executive]

We didn't hear the last part.

[Daniel Chan, analyst]

Yes. Just on the software licenses, what are the major drivers of the decrease in demand there? I know like SaaS might be part of it, but just wondering if there's any churn or prior...

[Vincent Mifsud, executive]

Yes. As I mentioned in my earlier discussion, it's mainly driven by our choice strategy and offering customers the ability to stand up a -- either their own SaaS or use our SaaS platform. So that's basically the delta there.

[Stephen Sadler, executive]

You will notice, Daniel, that -- you'll notice that our amount of SaaS recurring revenue as a percentage of total revenue increased a fair bit in the quarter. So some of the prem are moving there. I will say SaaS is not as profitable for most of our competitors or even us. So we've got to work to make some -- we get more efficiencies there. I believe investors may like it, but it does slow down profitability, cash flow, at least at this stage, is everyone is fighting for basically, new customers.

If you look at our competitors, you'll find they are struggling, i.e., struggling being debt, interest, which is often not covered and their growth is slowing in that area.

[Daniel Chan, analyst]

Okay. Just to be clear, is there any impact from increased churn or any pricing pressure that's impacting that?

[Stephen Sadler, executive]

I would say churn is about as it always has been. We have some churn -- total churn not in some churn goes from maintenance to SaaS or license is going to SaaS as pricing pressure, yes. The other -- for us, it's not too bad because we've always looked for profitable growth and profitable sales. Some of our competitors are starting to suffer. And again, if you analyze that, you'll see what I mean.

[Vincent Mifsud, executive]

And Daniel, just to add to that. If you look at our recurring revenue, you can see it's expanding and growing quite a bit, and that talks to our retentions. This has been positive.

[Daniel Chan, analyst]

Yes, that's great. Maybe on the R&D again, in the filings, the states it's up because of acquisitions, SaaS and AI. Are you able to quantify how much of that increased R&D as a result of the latitude, the SaaS and the AI part?

[Stephen Sadler, executive]

The increase is probably more than you think of without the SaaS and AI. When I say SaaS, you've got SeaChange in there now, too. I would think that, that ratio would have been lower. So it adds to it. It takes a little bit of time when you do an acquisition, especially in the R&D area to get the cost out because you've got to finish off projects that you're already doing. So that's an area that lags a little bit in any streamlining we might do.

[Vincent Mifsud, executive]

And Daniel, I also touched on -- we did a fairly big initiative to make our networks products cloud-enabled, and we completed all the strategic ones by the end of Q3. So that investment, we got done.

[Stephen Sadler, executive]

Yes. I think the important thing, again, I'm not sure we focus enough on or say enough, we spend a fair bit on R&D. Some would say more than we should. But in spite of that spending, we still have a good EBITDA that we believe will grow as we bring in the SeaChange acquisition, which was profitable in the quarter, but barely. Usually, we have a loss in the first quarter of an acquisition. So we do expect EBITDA profitability will improve in future quarters as some of the things we get in the quarter will impact future quarters.

[Operator]

And your next question comes from the line of Erin Kyle with CIBC.

[Erin Kyle, analyst]

Maybe just starting with a question on M&A integration, and you sort of touched on it there with your last comment. But just on the integration of the assets to SeaChange this quarter, you mentioned in the prepared remarks that it was profitable in Q3 slightly and it's just not quite at standard levels. So when do you think you'll have it operating at standard levels? And what levers do you have to pull to achieve this?

[Stephen Sadler, executive]

It's a complicated question. I'm usually on every call for about 10 years. I've said in the first quarter of acquisition, it's generally negative. The second quarter, you generally are flat. Third quarter is halfway to our normal margins. And by the fourth quarter, you're in normal margins. We've been tending to beat that a little bit, especially when you do an asset deal because you don't take on some of the costs. But we did take on a lot of the R&D.

And in some countries, in this case, Poland, you've got to scale the reductions if you're doing it, for example, in R&D, you can't just do it all once, there's regulations against it. So it does take about, I would say, 2 to 3 quarters to get to the full EBITDA margin level.

[Erin Kyle, analyst]

Okay. That's helpful on fee change. And maybe if I can actually switch gears to Mediasite. Last quarter, you've mentioned some difficulties in integrating that, that business given it went into bankruptcy post acquisition. So my question is have these difficulties mostly been resolved now? And is Mediasite operating at your standard levels?

[Stephen Sadler, executive]

Mediasite is operating close to it, and it's not the fourth quarter, so it's not quite at the full operational level. But it's close to it, and most of the issues there still have been resolved. There's a few left.

[Vincent Mifsud, executive]

The majority of them have been resolved, yes.

[Operator]

[Operator Instructions] Your next question comes from the line of Paul Treiber with RBC Capital Markets.

[Paul Treiber, analyst]

Just in the prepared remarks, the tone on the organic business does sound more positive, probably the least I've heard over the past couple of years. Is that a fair characterization? And then what is driving that? Is that -- like are you seeing an improvement in the external environment? Or is it more that it reflects traction from some of the changes in the investments that you've made over the last couple of years?

[Stephen Sadler, executive]

Well, I'll give a brief and then let Vince speak to it. I think the improvement is just some of the execution we're doing. So yes, I do see some improvement. It's not like spectacular, but it's going in the right direction. And of course, having stopped the video major decline, that looks like improvement in everything else. So a part of it is for that. The other side, I'll say, if you look at the industry, it's not because of the industry. Our competitors are having issues. They're having issues because they took unprofitable revenue and use debt to do it, and now they're struggling with their debt positions.

And I mean it started with Avaya about 1.5 years ago when they went into receivership, but other major competitors are having pretty significant financial difficulties right now. Maybe, Vince, do you want to add.

[Vincent Mifsud, executive]

Yes. I mean I agree with what Steve said. It's partly due to execution. The whole -- although I always say it sounds trivial, this choice, our choice strategy. It takes time to, first of all, be able to offer choice, get all the products ready for SaaS and private cloud and all of that. And then to train up everybody on the whole choice strategy, and the go-to-market and get the message out there to the market. So all that takes time and that's showing positive outcomes. So...

[Stephen Sadler, executive]

Comment just to add as an example, some of the major competitors that we've talked about in the past, I won't identify in particularly now, you're now hearing great growth in the past are now laying off staff. That's usually an indicator of what they see in their future. And again, they're not making money. So they have to do things like that. That should be good for us. We never took that approach. We actually hurt our revenue a little bit by saying, we're not going to do unprofitable revenue.

So that strategy is now starting to pay dividends for us, and it's starting to show up in our competitors as an issue which they have to address. And they really have a culture of that trying to get growth at a loss. And how do you fix that, especially in a high interest environment and you already have a lot of debt with banks not really willing to lend as easily as they have in the past.

[Vincent Mifsud, executive]

And just one other thing maybe to add is we do also hear our competitors that don't offer choice, upsetting their customers a lot. So we get some of that spillover effect. If somebody doesn't want to necessarily go to a multi-tenant cloud product or have a particular cloud preference because we -- we're cloud agnostic. So we work with all the leading cloud providers. And that choice sometimes helps us win some business from other competitors that are freeing forcing their customers on a time line that they may not want to stick to. So that helps us.

[Paul Treiber, analyst]

And on the choice strategy across all your product lines, like is it fully implemented across all your product lines? Or is it still you have some work to do in some of the product lines?

[Vincent Mifsud, executive]

So sometimes when we buy a company, they didn't have this kind of choice mantra, and they've locked themselves into cloud vendors or offered only one way of taking their product. So we have to do some R&D efforts to enable the choice on acquisitions. So other than that, our products that we've had for, let's say, 12, 18 months, yes, they're choice-enabled.

[Paul Treiber, analyst]

Switching gears to capital allocation. So you have a lot of cash, the stock's trading at a multiyear low in valuation. You bought back a little bit of stock. But why not more aggressively put some of your cash into share buybacks here?

[Stephen Sadler, executive]

That might be a good idea.

[Paul Treiber, analyst]

Can you elaborate a bit more on that just in terms of like how you look at the return?

[Stephen Sadler, executive]

Well, I think it -- we've always looked at it at a certain price. It's better to buy back your stock. Some people buy back their stock even when it's really high. That's not such a bright idea if you have a better allocation for the capital. We do have a lot of opportunities. We've got to, of course, execute, get them done. But as you pointed out, we're at a low price in our stock. And I think there's probably an opportunity to take advantage of that.

Currently, yes. And we always have blackout periods where you're not -- you can't do it by regulation. So I suspect in the next little while, we may -- if the stock stays where it is, we'll be buying back some stock.

[Paul Treiber, analyst]

And then the other half, the question on M&A. You did mention -- and you've mentioned for a while now. There's a lot of opportunities out there. You've closed some, but I think there's still quite a gap versus the cash that you're generating. What are you seeing or why do you think that the deals that are out there aren't closing? Still valuation expectations are high from sellers, is there anything else where maybe they're getting financing from?

[Stephen Sadler, executive]

Yes. I think the valuations are still a little above where we'd like to see them. That's one. But I also think the problem is some of these companies have a lot of debt. We're not really keen to taking on their debt and paying off the problems that they create for themselves. So it takes a little bit longer. There's not a lot of interest -- there's less interest in the space because of AI. AI is supposed to eliminate contact centers, which is not happening. It's actually helping contact center service their customers more, and that's how we see it. But yes, it's always a challenge. You always got to get the right value, and you've got to have 2 people who agree on that value and want to do a deal.

[Operator]

And there are no further questions at this time. I'd like to turn it back to Stephen Sadler for closing remarks.

[Stephen Sadler, executive]

Well, thank you, everyone, for attending the call. Enghouse is in a very strong financial position with growth, no financial debt and substantial opportunities for deployment of capital. We are financially positioned to continue to enhance our products with new features, including AI technologies to improve internal revenue growth attainment and cost efficiencies for ourselves. AI technologies also assist in improving the quality of customer interactions. We look forward to providing our full year update at the end of our next quarter.

[Operator]

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you, all, for participating. You may now disconnect.