Enghouse Systems Limited (ENGH) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Enghouse's Q1 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.

Good morning. I'm here today with Vince Mifsud, Global 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.

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 these forward-looking information pieces, 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.

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

Yesterday, Enghouse announced its first quarter results for the period ended January 31, 2020. Revenue for the first quarter was $110.7 million, a 28.6% increase compared to revenue of $86 million in the first quarter of the prior year primarily as a result of incremental contributions from acquisitions. Results from operating activities were $30.8 million compared to $25.8 million in the prior year's first quarter and reflect the impact of changes in product mix on gross margins. Operating expenses of $47.3 million reflect incremental operating costs related to newly acquired operations and increased noncash amortization charges. Net income for the quarter was $16.1 million or $0.29 per diluted share and includes $1.6 million in special charges and approximately $3 million in incremental amortization charges related to acquisitions. Adjusted EBITDA for the quarter was $35.3 million or $0.64 per diluted share compared to $26.3 million or $0.48 per diluted share last year, with the increase being attributable to incremental revenue contributions from acquisitions as well as the impact of depreciation of right-of-use assets, as now required under the new lease accounting standard under IFRS 16. Cash flows from operating activities, excluding changes in working capital, were $35.2 million compared to $27.1 million last quarter, an increase of 29.7%. As a result, Enghouse closed the quarter with $116.3 million in cash, cash equivalents and short-term investments compared to $150.3 million at October 31. The cash balance was achieved after payments of $6 million for cash dividends and $48.9 million, net of cash acquired, for acquisitions concluded in the current quarter and $500,000 for acquisitions closed in prior years. On December 31, 2019, Enghouse completed the acquisition of Dialogic and commenced integration into its asset management and interactive segments. Dialogic reported revenue consistent with expectations, which is typically lower in January, and was not accretive to earnings in their first month following acquisition. Restructuring initiatives have been implemented that should improve operating results in the coming quarters. Yesterday, the Board of Directors approved a 22.7% increase to the company's eligible quarterly dividend from $0.11 per common share to $0.135 per common share, payable on May 29, 2020, to shareholders of record at the close of business on May 15, 2020. Enghouse has now increased its dividend in each of the past 12 years by over 10% each year. I'll now turn the call back to Mr. Sadler. Steve?

Thank you, Doug. As Doug noted, we continue to have a strong cash balance and minimal bank debt. Our cash flow was strong with revenue growth. Revenue was up 28.6%, with only 1 month of Dialogic included. Compared to the prior year, foreign exchange had a negative impact on revenue of $2 million, while having a positive impact of $1.5 million on costs, resulting in a negative operating impact of $500,000. Doug also mentioned, we adopted IFRS 16, which most companies had to do on years beginning January 1, 2019, so many of you already know that a lot of companies have been doing this for a year. Therefore, Enghouse has adopted it because our year-end was -- our fiscal year is October 31, so this is the first quarter that we adopted IFRS 16. It added about $2 million in EBITDA or $0.04 per share, resulting in an adjusted EBITDA increase of 33%. Using the prior accounting standard, our adjusted EBITDA would have been approximately a 25% increase in -- which is still a significant increase. I want to comment a little bit on COVID-19. Everyone seems to be having questions about it. Enghouse does not have much impact to date on the COVID-19, but there could be a global business develop -- impact. We are a distributed organization in terms of premises and staffing, therefore, limited concentration. A lot of our staff have worked from home, so it's not foreign for us to do so. We have had a high mix -- we have a high mix of recurring revenue with communication products. Possibly, we could deploy capital and acquisitions at lower valuations. Understanding opportunities and risk is key at this time. Maybe demand for video and contact centers will increase as a result of this virus. We do have a small presence in Italy, but not in other high-risk geographies. In summary, we believe our exposure is limited beyond an overall global impact. As to acquisitions, in terms of acquisitions completed, we completed Dialogic on December 31, partway through the quarter. Restructuring was done at the end of January, and therefore, costs remained in the month of January in this business. Also, January is traditionally a lower revenue month for Dialogic. Revenue was approximately $3.5 million in January for Dialogic. And with restructuring costs done late in January, the business had an operating loss of approximately $1 million in the month. We expect improved revenue and performance from Dialogic in Q2. The Dialogic business will be EBITDA positive in Q2, with a further EBITDA increase expected in Q3. We continue to focus our capital deployment -- on our capital deployment activities as well as improving our operations and growth in future years. I will now open the call to questions.

[Operator Instructions] We'll now take our first question from Daniel Chan of TD Securities.

Steve, the AMG segment grew by about $5 million year-over-year. I thought the -- we were forecasting acquired revenue above that level, suggesting that maybe organic growth was negative in that segment. Can you comment on whether my assumptions are correct and whether the organic growth was negative? And if that's the case, maybe you can give us some color on what's happening there.

I don't think the growth was negative. It's up $5 million. So it looks like it wasn't negative. I think there was a little less hardware in that division in the quarter, so that may be making your numbers a little bit out. But maybe your number was just a little bit too high as well.

Okay. Fair enough. And then you commented on potentially deploying more capital given the market volatility. Just wanted to get an update on you. Are you seeing some of the valuation volatility in public markets, reflecting some of the targets you're looking at and whether your funnel is getting wider as a result of it.

Not really. Again, when the public markets were roaring up until a few weeks ago, we didn't really see in the marketplace that we were at prices increasing that much. And also, today, we don't see prices declining that much. It's pretty steady as it goes in the marketplace that we're in.

We'll now take our next question from Paul Steep of Scotiabank.

Steve, I think you already gave us the answer, but I want just to be clear. For Dialogic, is there anything unusual that would maybe slow us getting to full normal run rate? It sounds like by Q3, you're hoping to have it on plan? Is that the right takeaway from the comment? And then maybe also talk a little bit about Eptica. Even though it's a smaller deal, you'd called it out in the MD&A as well as needing a bit of time to get on plan.

Yes. We've always talked about, in the first quarter, after an acquisition, we generally lose money. Second quarter, we generally are profitable. Third quarter, generally halfway to normal margins. And in the fourth quarter, at the normal margins. In last year, we had 2 acquisitions where they were looking at restructuring and did it before we acquired them, or at least announced it and started that process. So we actually jump-started one quarter last year, which was a benefit, but it does draw a little bit confusion to our normal model. With Dialogic, we closed December 31, December, basically, the month of Christmas, a lot of people away, a lot of people taking holidays. And we divided that company into 2 parts: one, going to the asset management group; the other one going to the IMG group. So the group here, HR, Vince, spent a lot of time in January figuring out the proper actions to take. So we did not take out any costs until the end of January. So all the -- their full costs are in January, which is a slower month for Dialogic. But we did take it out at the end, so we do expect to go to the normal model. Profitability in the next quarter, although the first quarter was only a month, it wasn't actually a quarter. But we do expect to be profitable in the next quarter and further profitability in the third quarter and at full profitability in the fourth quarter.

Okay. And Eptica, anything there? Or just if it's as norm, it was only because you called it out in the document that sort of caught my eye.

It's pretty much the same pattern. There wasn't much restructuring to be done, there’s some. But it was, again, that time of year where you do the product, you go talk to them. It is France, where it could take longer to do some of the changes you want to do. So it's progressing along basically the same way, but it was smaller. So the impact, it is smaller for that was about breakeven in the first quarter, maybe a slight loss, but not anything significant. Certainly, it did not add to the profitability, which sort of says, over the next couple of quarters, we would hope that our EBITDA would improve just by those 2 acquisitions doing what normally we do when we do acquisitions.

Okay. And then maybe for both you and Vince giving -- get your impression, we're still a couple months shy of getting to the 1 year anniversary for Vidyo and Espial. Obviously, they're on plan for margin. Maybe we could talk about what we could think about for, hopefully, upside from the organic initiatives you guys have been working hard on.

Yes. No, we've got a lot of things in place. I'll let Vince talk about it a little bit. But there's quite a challenge there because we had to change the culture. We had to now put in some new techniques for selling. A lot of that's being done. And I'll let Vince give you a little more detail, some of the things he's been working on lately.

Yes. So on the Vidyo stuff, we've got some very interesting use cases there. Some of the ones that are getting good traction are around telehealth in using Vidyo in a telehealth use case. So that's putting a big push there. There's lots of demand, we think, in that area. And we also use Vidyo a lot to enable other tech companies. So we've done a number of partnerships there. And then last quarter, I talked about rolling Vidyo out globally. So we've started to hire sales -- direct sales people in Europe and a little bit in our Australia, New Zealand market to sell Vidyo into these unique use cases in addition to selling Vidyo into a contact center use case. So that's all well underway, and we've got work to do, but we're getting traction there.

So I think as we've also said in the past, we -- it's -- we -- the profitability is not a problem. That's the first thing we do is get acquisitions that we buy profitable, and now we're starting to invest a little bit to improve the revenue growth there. And we're on track to do that.

Great. Last one, I guess, for me is just maybe talking a little bit about how you've seen the progress with teens, where we are in terms of getting product to market. It looks like uptake continues there, and that would be good.

Progressing well. I think we're pretty much there with all our work on teens, and I see that as a positive catalyst going forward.

[Operator Instructions] We'll now take our next question from Deepak Kaushal of Stifel GMP.

Steve, I want to ask it off with Dialogic. Can you walk us through the seasonality of the business? I used to recall that a lot of telcos had a budget flush in December. What kind of seasonality should we expect there for that business?

So in general, I mean, their year was on a calendar year, ours isn't, so it's a little bit different. But seasonality, their -- our -- their first quarter generally was their lowest, which includes January. It was January, February, March. Their last quarter is generally the better quarter because that's when, again, telco sometimes have extra budget that they spend. So first quarter, I think, will be the -- for us, will still be the lowest quarter, pretty even in the middle, the second and third quarter, and probably the fourth quarter will be a little higher than the other quarters. So there is a bit of a seasonality there, yes.

So for Q4, are we looking for like higher than 30% of the annual revenue in Q4? Or...

I wouldn't say it's 30%. Well, I would say it's about 30%. Maybe go 15%, the middle 2 or pretty even 2020 and 30%, some number like that. That's not the exact -- that's not exactly, but that's sort of what we look at. So if you usually do 25% a quarter, first quarter was probably 15%, between the second and third, maybe third a little better than the second, so 20%, 25%, 30%. It does have that type of seasonality. At least they had it, but then we do things a little differently because sometimes they would discount to get revenue in a quarter, and we generally don't do that. We're happy to take it next quarter rather than take less this quarter.

Okay. That make sense. That's helpful. And then just on the Dialogic, is there any kind of cyclical impact from 5G that we should be thinking about? Or is it just a different side of the telco business?

No, I don't think there is. They've done a lot of work on 5G, so -- which is positive for us. But I don't think it changed the seasonality or anything.

Okay. Okay. And then I had a follow-up for Vince. Some good details last night on the go-to-market strategy. Are you guys able to give us kind of a percentage of revenue today on channel versus direct sales amongst the total business and how that might evolve going forward?

Yes. I mean as I mentioned in the -- yesterday in the meeting in the -- at the AGM, we are putting a little bit more emphasis on direct than we did historically. But we -- it's not that we're ignoring the channel or our OEM partnerships. They're still important. But we're trying to raise the direct mainly because a lot of the verticals, customers want us to go direct. There -- it's a better sales execution sometimes in the mid to larger accounts. So I would say our percentage towards direct is growing over the last several quarters. At the end, hopefully, for me, it'd be nice to have a balance 50-50 between channels and direct. Today, we're a little bit more towards channels.

It also varies by each one of our divisions, so it's kind of hard to answer that question on a global basis because each one of our -- even in each one of our geographies, it's slightly different.

Yes.

Right. Make sense. Is there an appreciable margin difference when you go direct versus channel? And what kind of magnitude?

I think you would say the margin is better direct, but the costs are higher as well. So if you're talking margin, like when you do with the channel, you do have to give the channel partner part of the selling price. So the margin's better direct, but the costs are higher for direct as well. We do think that...

If you just think of cash margin, how would that play out?

I think direct is a little better, but you do have to have a good demand gen and some of the other things, Vince has put in place, so we're better prepared to do that now. But the margin direct is probably a little better. But it's a little riskier, like if there's downturns, recession, you've got the direct salespeople who might have a decline in revenue. When it's in the channel, it's not our problem. So it's a little higher risk on the direct as well. And therefore, the margin should be a little bit better. The net margin, as you call it, should be a little bit better. So it is.

And Deepak, in the direct is -- you typically have the bigger -- you handle the bigger deals in direct in terms of the size of the new customer. So generally, the channels are good in the mid-market. And then the upper mid-market and enterprise, it's better handled direct.

Okay. Okay. That make sense. And then a segue into cash. Cash before working capital grew quite strongly. There's a big working capital hit in the quarter. Can you kind of walk us through what were those moving parts and then the relative impact to that?

The problem when we emphasized before working capital because the way we do acquisitions and the way the accounting works can cause confusion there. Because sometimes what we do, we do a lot of changes or they have done changes or they held payables, then we buy it, reduce the price, but then we do pay it out in the, let's say, 90 days following, we sort out all the liabilities they had. So it can be confusing. And it can be confusing the other way if -- once you've done that, then your cash flow can look better as well because then you pay those out, people think that's the trend when really it was a onetime thing with the acquisition. It will change with acquisitions, but Dialogic was a bigger one, so we cleaned up some of their liabilities. They had debt, we don't have any, et cetera.

Got it. So should we then expect a swing back to positive and then a normalization or just a normalization, and you have to absorb some of that structural shift?

Hard to say. It depends on what other acquisitions we do. But I think a more normalization is probably the way you should think about it. And hopefully, that will be conservative.

We'll now take our next question from Stephanie Price of CIBC.

Can you talk a bit about the growth that you've seen in Vidyo since acquisition and whether you've seen any changes in the sales pipeline just given COVID-19?

Well, the COVID-19 is pretty or -- still pretty early in the cycle. I mean if you looked at it 3 months ago, no one even mentioned it. So again, we haven't seen -- we've seen interest. We're taking some actions to see if we can improve revenue in that area for us. For example, going to our customers and offering them a free trial because they're our customers anyway, so why not give them an idea of other products that we just got. And also, remember what we said from last year after we bought it, a lot of time was spent rightsizing the company to make it profitable. We weren't worried, and we didn't try to put a lot of things in for growth. That just started in November, so it's still quite early because as -- the way we approach acquisitions, we get them very profitable, and then we can see how much of that profit we should reinvest to grow. So we've done a profit, and now we're doing the reinvesting to see if we can grow. But that just started in this quarter. It hasn't been going on for 6 or 9 months.

Fair enough. Okay. And then with the increase in the dividend, can you talk a bit about your thoughts on capital allocation here?

Yes. I mean it's an interesting market. What happens with COVID-19 to valuations is subject to great debate. Our acquisition pipeline is sort of normal. I don't think it's gone up or down. So we just keep plodding along, and we'll see what happens.

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

I just wanted to hone in on license revenue for a moment. It looked like in the quarter, it's a multiyear high or perhaps a record high. What do you attribute the strength to in the quarter? And then do you see license at the -- in the high $20 million range is sustainable going forward?

Yes, we had some -- a couple good deals in the quarter, which, again, were license revenue deals. It's hard to say because, as you know, we're going more to subscription or recurring revenue. So I don't like making predictions on that because it will be what it will be in the sense that we do the right thing for what the customer wants, and it doesn't matter to us. So again, we don't really emphasize a lot quarter-to-quarter. We've had pretty consistent, but that's not our focus. Our focus is to build a business for the longer term.

Just delving a little bit further, like, are those deals in the pipeline for a while? Or are they created because of some of the new demand gen investments that you've done in the last couple of quarters?

So you've got -- the answer there is both. They've been there for a while, but our demand gen has been there for a while, too, so both are helping. And now you've got the COVID-19 virus. What is that going to do? Is that going to hurt that? Are people going to slow down? There's a lot of moving parts, but both have helped get -- as we said, we -- generally, you should think of the business as low single digits, but we're trying to improve on that.

Okay. And then looking at hardware revenue, it dropped in the quarter. I assume that was related to acquisitions as maybe you exit or run off some of that hardware revenue. Should -- is this the new normal? Or was it a one-off that led to the drop this past quarter?

I would say it's probably a one-off drop in the quarter. That area, which is lower margin, can be lumpy, so the quarter was lower than usual. And I wouldn't project future quarters to continue at that amount. But you may have some quarters in the future that are lower, but you may also see some that are higher by a fair amount, depending when we deliver hardware. Remember, a lot of our software comes in the deals that our customers want us to also be the hardware supplier. We don't make the hardware. We just buy it and sell it to them because they want to buy from one company. There's a saying, they want one throat to choke. So unfortunately, in some cases, that's our throat.

That's helpful. The -- turning to Espial, could you provide an update on the IP product -- IPTV product development and how it's progressing? And if you still expect to launch in the second half of this fiscal year?

Absolutely. You've got it right. It's progressing nicely, and we still expect to launch in the second half of this fiscal year.

And have you seen the orders for that product increase as you get closer to launch? Or is it been pretty stable?

We've had some orders from customers in the past. We had interest, but orders are when you have a product and you sell them. I don't count orders before that too soon because people don't feel they're ready to buy, I don't count it. So I would say there's -- the interest has increased, but the orders have been pretty stable from sort of the initial group who showed interest that started the project off.

Paul, you remember how that works -- sorry, I was just saying it works is -- well, once you launch the IPTV and the customer buys it, as they add subscribers, we get more revenue. So that's how that works. So you plan to feed and then it evolves over time.

Usually, it will grow once it gets in.

[Operator Instructions] There doesn't seem to be any further questions at this time. I would like to turn the conference back over to the speakers. Thank you.

Well, thank you, everyone, for attending the call and your continued support. We hope to build on our positive start to the fiscal 2020 year.

Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.