Enghouse Systems Ltd

TSX:ENGH

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2018 Q4 Earnings Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Stephen Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.

[Stephen J. Sadler, Executive Chairman & CEO]

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

[Todd M. May, VP & General Counsel]

Certain statements made may be forward-looking statements. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those disclosed in Enghouse's AIF and other continuous disclosure documents. It could cause the company's actual results and experience to differ materially from anticipated results or expectations. Reader should not place undue reliance on this forward-looking information, and the company shall have no 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]

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

[Douglas C. Bryson]

Thank you, Steve. Good morning, everyone. Yesterday, Enghouse announced its unaudited fourth quarter and audited year-end financial results for the period ended October 31, 2018. Revenue increased to $342.8 million for the fiscal year compared to revenue of $325.4 million in the previous fiscal year, resulting in another record year for the company. Revenue includes $176.4 million from hosted and maintenance services, an increase of 6.4%. Operating expenses were $136.2 million for the fiscal year compared to $134.4 million in the prior fiscal year as savings related to operating cost synergies offset incremental costs related to acquired operations. Results from operating activities were $103.2 million compared to $90.6 million last year, an increase of 14%.Net income for the fiscal year was $57.7 million or $2.11 per diluted share compared to $50.8 million or $1.87 per diluted share in the prior year. Adjusted EBITDA for the fiscal year was $106 million or $3.88 per diluted share compared to $94 million or $3.45 per diluted share last year, an increase of 12.8%. Fourth quarter revenue was $85.8 million, an increase of 1.9% over revenue of $84.2 million in the fourth quarter last year. Operating expenses were $33.6 million compared to $34.9 million in the prior year's fourth quarter and include incremental operating costs related to acquisitions. Noncash amortization charges related to acquired software and customer relationships in the quarter were $6.4 million compared to $7 million in the prior year's fourth quarter. Results from operating activities for the quarter were $27.3 million compared to $24 million in the prior year's fourth quarter, an increase of 14%. Net income before tax for the quarter was $22.3 million compared to $19.9 million in the prior year's fourth quarter. Income tax expense was $2.7 million in the current quarter versus an income tax expense of $1 million recorded -- compared to the quarter last year. As a result, net income for the quarter was $19.6 million or $0.71 per diluted share compared to the prior year's fourth quarter net income of $18.9 million or $0.69 per diluted share.Adjusted EBITDA for the quarter was $27.9 million or $1.02 per diluted share compared to $25 million or $0.92 per diluted share in last year's fourth quarter. Enghouse's generated cash flow from operations of $24 million in the quarter compared to $29.1 million in the prior year's fourth quarter. Cash flows generated from operations for the fiscal year were $98.3 million compared to $83.2 million in the prior fiscal year, an increase of 18%. Enghouse closed the year with a record $193.9 million in cash, cash equivalents and short-term investments compared to $130.3 million at October 31, 2017. The cash balance was achieved after payment of $16.8 million for acquisitions, net of cash acquired, and $18.4 million for dividends. Shortly after year-end, Enghouse acquired Telexis Solutions B.V. and Telexis B.V. of the Netherlands and Capana Sweden AB. The acquisitions will expand the suite of solutions and geographic reach of the company's Asset Management Group in the coming year.Finally, yesterday, the Board of Directors approved an eligible quarterly dividend of $0.18 per common share payable on February 28, 2019, to shareholders of record at the close of business on February 14, 2019.I'll now turn the call back to Mr. Sadler

[Stephen J. Sadler, Executive Chairman & CEO]

Thank you, Doug. As Doug noted, we continue to grow our cash and short-term investments and now have over $193 million from $130 million last year. This is after spending $18.4 million on dividends, $16.8 million on acquisitions and over $2 million on capital expenditures. Cash flow from operating activities was $24 million and over $98.2 million for the year, an 18% increase over the prior year. Revenue in Q4 was up modestly from the prior year as we restructure our sales organization and demand generation activities. Adjusted EBITDA was a strong 32.6%, a record up from $29.6 million in the prior year Q4 and 30.9% for the year compared to 28.9% in the prior year. Foreign exchange negatively impacted Q4 revenue compared to Q3 by about $1.3 million, but also reduced our cost by about $800,000, negatively impacting operating income slightly.In terms of acquisitions, we did not complete any acquisitions in the quarter, but we did complete 2 early in November, Telexis and Capana. Both these acquisitions are in the Asset Management Group, a good start to the year. Economic and market factors are favorable for acquisition opportunities that meet our acquisition criteria. I would now like to open the call for questions.

[Operator]

[Operator Instructions] We now move to the first question from Paul Steep from Scotia Capital.

[Paul Steep, Analyst]

Steve, can you talk a little bit on Interactive, just in terms of how you want to think about the targets in the next year for the team? We know -- we've seen declines over the past couple of years. Is there been a specific product -- excuse me, or market segment that's been driving some of those declines? And are we near a point where hopefully some of the lead gen and the other activities start to reverse things in the other direction?

[Stephen J. Sadler, Executive Chairman & CEO]

Well, you've got a market whereby there's a lot in what they call SaaS-type competitors, and we've gone a bit more to that SaaS area as well as subscription. So, of course, that changes the revenue profile. Again, it's a tough market. But I don't see it really changing that much for us. Again, pretty steady, I think, low single digits and we are taking some Demand Gen activities, which take time to show results that hopefully will show some results in the next year.

[Paul Steep, Analyst]

Okay. Fair enough. On the Asset Management side of the business, if we think about what drove growth there, you called out, I guess, CDRator and Locus on a full year -- well, CDRator on a full year basis and then you talked about Locus and Transit on the other side, on the PS side. How is demand? And where are you seeing the most success, I guess, on the licensed side on the Asset Management business?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, if you look at our competitors, they seem to be struggling because, again, it's a tough market. But we're doing pretty well because we generally provide software that makes telcos money. So from our point of view, it's no particular area. It's really the whole business is doing okay.

[Paul Steep, Analyst]

Okay. And then M&A team, you -- how are you progressing on building out that team? You've been putting some efforts there in the last bid. You've obviously closed a couple of deals post-quarter. Where -- how are you feeling about buildup of the team, Steve?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, the team is pretty well built. We're not building it up anymore. We just got to get some more deals done.

[Paul Steep, Analyst]

Okay. Last one, IFRS 15. Any thoughts on how we should think about the impact of that into next year just on the numbers?

[Stephen J. Sadler, Executive Chairman & CEO]

It will have some impact. Some of our revenue, I think, is about $1.8 million or so would -- that we'd normally get it in the next year or 2 that we will take to retained earnings in Q4. But we'll, I think, make that up with the new rules, some of our revenue that we've pushed out years will come into next year. So I wouldn't think it's going to have a major impact.

[Operator]

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

[Deepak Kaushal, Director and Technology & Communications Analyst]

First of all, I just got a quick follow-up on Paul's earlier question. Just in general then, Steve, commentaries on organic growth. So you put a lot of efforts this year into improving Demand Generation. So you're saying that you expect to see some benefit in 2019 from that -- from those strategies?

[Stephen J. Sadler, Executive Chairman & CEO]

That's correct. And again, we put a lot of effort into it and continue to do so. We're not finished.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, great. And then I think in the past, related to organic growth, you embarked on a strategy to sell hosted services via telco partners. I wonder if you could give us an update on that effort and if you're starting to see any traction, or they are starting to see any traction with their own markets compared to you guys.

[Stephen J. Sadler, Executive Chairman & CEO]

I think it's going okay but a little slow mainly because telco partners aren't that aggressive in moving it forward, so we have to help them to move a little bit faster.

[Deepak Kaushal, Director and Technology & Communications Analyst]

And is that something you might see move faster in 2019, in the coming year, calendar year or beyond that?

[Stephen J. Sadler, Executive Chairman & CEO]

We hope so.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, okay, excellent. So, Steve, just stepping back, when I think of the last 10 years and when I first met you, the economy has been on an incredible run here and south of the border. I was just wondering what you think of in terms of -- like, how you think of the business cycles over the longer term? And how you shift or change the way you manage your business through these cycles and where you think we are currently in that?

[Stephen J. Sadler, Executive Chairman & CEO]

Yes, the biggest cycle right now is going through this recurring revenue, call it, SaaS or subscription model. We've been living through that for many years now. Some of those guys have actually been acquired, but that continues to be the thing we have to address. We're a little surprised that people, in doing that model for a long time, continue to lose money. But we've got to be more active in that space because it seems to be still popular and growing with customers and we want to do and offer solutions that the customers want.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And in terms of the telcos, as they look to start investing in things like 5G, how do you see that creating opportunities or challenges for your business units?

[Stephen J. Sadler, Executive Chairman & CEO]

It's pretty steady. We're ready for that. I'm not sure how fast they're going to invest in it. But again, I don't see any positives or negatives from it.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And then last macro question on Brexit. Any kind of outlook or things we should consider for the U.K. business in the coming year?

[Stephen J. Sadler, Executive Chairman & CEO]

The only thing I would watch is the exchange. I don't know what's going to happen. Is it going to be higher or lower? Again, it does a lot compared to the U.S. Not sure what it will do compared to Canada, but the impact in the business, I don't see any major impact for us. But exchange, of course, it impacts the numbers that you -- that we report and you guys see.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And are you looking to put a hedge on for those things? Or do you just naturally hedge through your business?

[Stephen J. Sadler, Executive Chairman & CEO]

We're pretty naturally hedged. We've got a large group in the U.K., including R&D. So we're naturally hedged, we believe, at least well enough for that.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, great. And then one final housekeeping question and then I'll pass the line. In the past, you've talked to or you've considered adding some debt to facilitate the dividend payments. We've had a rising interest rate environment. Have your thoughts on that changed? And how you might deal with those things going forward?

[Stephen J. Sadler, Executive Chairman & CEO]

Let's just say we're implementing some things that we'll be able to get cash into Canada and probably we've a lot of cash, but it's not all in Canada. And we probably are not looking at doing any debt at this time.

[Operator]

[Operator Instructions] We'll now take the next question from Paul Treiber from RBC Capital Markets.

[Paul Treiber, Associate]

Just hoping you can elaborate on your last comment in prepared remarks on economic and market factors being favorable to M&A.

[Stephen J. Sadler, Executive Chairman & CEO]

Okay. I mean, as we all know, if you just turned on the news, everyday there's issues between countries, with the U.S, in Europe with Brexit. So there's a lot of uncertainty. Again, if anyone running a business that weighs on them a little bit. On the other side, we've got raising interest rates, which also gets people to wonder and people who use debt to do deals makes it a little more difficult if they had to borrow money to do it. So for us, it looks a little bit like 2007, 2008 environment again, and we did very good acquisitions after -- in that environment. I guess the summary would be, the environment has more motivated sellers than it has had in the last couple of years.

[Paul Treiber, Associate]

Okay. And then just elaborate a little bit further on that. Are you seeing sellers begin to drive down their valuation expectations? Or you expect them to do so going forward?

[Stephen J. Sadler, Executive Chairman & CEO]

We are comfortable that the valuations will be their criteria. They -- recently, they've been a little higher, and if we passed on the deal, no one bought them. So maybe that's a wake-up call a little bit. But with rising interest rates and aging population and the news you read every day, I think we'll be fine with the criteria that we've always used and will continue to use.

[Paul Treiber, Associate]

And then with cash building up on the balance sheet, it's a record high, I think, that for last -- for a couple of years now. What are your thoughts on larger acquisitions? And then you potentially adding a new vertical, how do you think about that in terms of the big picture?

[Stephen J. Sadler, Executive Chairman & CEO]

Two questions there. Thoughts on acquisitions and larger ones. If they meet our criteria, we have the cash to do it. Don't really need much help from the markets or anything. So we're in a pretty good position. A new vertical, if it's more opportunistic. We're not searching a new one because we've got plenty of opportunities in the verticals we're in. But if one comes along, and I've been saying that for a long time, we'd be willing to do it. But we haven't seen attracted one that's comes along. It has to be a little bit bigger if it's going to be the first one in a new vertical.

[Paul Treiber, Associate]

And shifting gears to margins. Obviously, the profitability is quite high this quarter. To me, it seems like it's because the -- you've integrated the acquisitions of the last few quarters. There hasn't been any new acquisitions to offset those margins. But is it -- where do you typically see the efficiencies in your business? And then going forward, previously you commented that you expect margins between 25% and 30%. Is that still a reasonable outlook going forward with the normalized mix of acquisitions?

[Stephen J. Sadler, Executive Chairman & CEO]

I think it's probably at the high end of that now. It depends on the acquisitions we do. The ones that we did early November had very little restructuring. And you've got to remember, with restructuring, we only put in severances or premise things we have to get out of. When there's very little special charges or restructuring, it means we get to those higher margins and EBITDA faster. So I expect our margins still to stay pretty good in Q1, unless, of course, we do other acquisitions which might drag it down in the quarter.

[Operator]

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

[Daniel Chan, Research Analyst]

Just a follow-up question on Paul's question on the margins. So we've seen a couple of quarters now where you haven't done the acquisitions and margins continue to move higher. So in a steady-state where you're not doing acquisitions, where do you think your margins would peak out at?

[Stephen J. Sadler, Executive Chairman & CEO]

We don't really forecast that. We're always doing continuous improvement. But I will point out that the exchange in Q4 took down revenue by $1.3 million, took down costs by $800,000. So if it was the same as Q3, we would have been $500,000 higher on the bottom line, and our margins would've also been higher. So it depends a little bit on that exchange rate, but -- and acquisitions, but we continue to look for ways to keep our profitability at a reasonable level while investing to grow our revenue with some new demand generation techniques.

[Operator]

[Operator Instructions] As there are no further questions, I would like to hand the call back over to Mr. Sadler for any additional or closing remarks.

[Stephen J. Sadler, Executive Chairman & CEO]

Well, thank you for your continued support. We continue to take actions to better the company for an improved future. Have a Merry Christmas and a happy holiday season.

[Operator]

Thank you. That would conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.