Enghouse Systems Limited (ENGH) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to Enghouse's First Quarter 2022 Conference Call. [Operator Instructions] Thank you. I would now like to hand the conference over to your speaker today, Mr. Stephen Sadler, Chairman and CEO. Please go ahead.

Good morning, everybody. 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 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.

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

Thanks, Steve. Financial and operational highlights in Canadian dollars for the 3 months ended January 31, 2022, compared to the 3 months ended January 31, 2021 are as follows: Revenue achieved was $111.1 million compared to revenue of $119.1 million. Results from operating activities was $35.7 million compared to $40.7 million. Net income increased to $21.6 million compared to $20.6 million. Adjusted EBITDA was $38.6 million compared to $44.5 million. Cash flows from operating activities, excluding changes in working capital, was $38.7 million compared to $41.7 million. Revenue for the first quarter of 2022 was $111.1 million compared to revenue of $119.1 million in the prior year. While revenue for the first quarter of the comparative year had mostly returned to pre-COVID volumes, it represents the tail end of a period positively impacted by an influx of COVID-related demand for our remote work and visual computing solutions. Revenue for the quarter was also negatively impacted by $4.4 million as a result of foreign exchange compared to the prior year. We also continue to experience a shift toward cloud offerings, particularly in the cloud in the contact center market. Net income for the quarter was $21.6 million or $0.39 per diluted share compared to $20.6 million or $0.37 per diluted share last year. The increase in net income is a result of lower costs and higher other income disposed by lower revenues relative to the comparative period. Adjusted EBITDA was $38.6 million or $0.69 per diluted share compared to $44.5 million or $0.80 per diluted share in the first quarter of 2021. Enghouse closed the quarter with $214.8 million in cash, cash equivalents and short-term investments compared to $198.8 million at October 31, 2021 with no external debt. The cash balance was achieved after making payments of $8.9 million for dividends in the first quarter. Enghouse remains focused on its long-term growth strategy, investing in products while ensuring profitability and maximizing operating cash flows. As a result, Enghouse continues to replenish its acquisition capital, while annually increasing its eligible quarterly dividend. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of $0.185 per common share, an increase of 16% over the prior dividend payable on May 31, 2022, to shareholders of record at the close of business on May 17, 2022. This represents the 14th consecutive year in which the company has increased its dividend by over 10%. I'll now turn the call back to Mr. Sadler. Steve?

Vince will now give some operational highlights of the quarter.

Thank you, Steve, and I appreciate those of you that are making the time to listen in to our Q1 conference call. As Doug has communicated, we continue to generate good operating income and positive cash flows. This quarter's EBITDA was $38.6 million and 34.7% of sales. And we've been consistently around the 35% EBITDA mark now for more than 2 years. Gross margins were once again above 70%, and our revenue in Q1 was consistent with Q4 with overall revenue being $111.1 million, which was negatively impacted by just over $1.1 million due to foreign exchange compared to Q4, and we were negatively impacted by $4.4 million compared to Q1 of last year. During the previous quarterly conference calls, I already covered the growing shift to the cloud when it comes to the contact center market. This shift is clearly occurring, and we do expect this to continue into the foreseeable future. And although we have responded to this move to the cloud by making several investments in product and engineering, we remain committed to our strategy of growing a highly profitable business by running a lean and nimble sales and demand gen organization, focusing on high-margin business and managing our cost to be in line with revenue. This outcome generates positive cash flows from operations that can be deployed on acquisitions. A key differentiator for us in the market stems around providing our customers choice. Enghouse remains one of the only companies in the contact center market and video market that offers choice between private SaaS, multi-tenant SaaS and on-prem. This offers our existing customers the opportunity to upgrade to the cloud when they're ready and is also attracted to certain segments of enterprise customers. We are seeing growing orders being signed for our SaaS cloud offering for contact center. In Q1, we signed $3.5 million of SaaS contact center orders, which was one of our largest orders in terms of orders signed in the contact center space. Revenue of these deals are recorded over the term of the SaaS agreement, and therefore, all of this revenue is deferred into future periods. Video remains an important part of our business and continues to be focused on the telehealth and enterprise verticals that are looking for security such as defense, courts, legal and finance. Our video engineering group has recently developed 3 new products, including unified communication as a service, our cloud PBX and video patient monitoring. With these new developments and the growing intersection of Contact Center as a Service and unified communication as a service, we believe the outlook for video looks positive. Video product revenue was down from Q1 2021 due to the remaining orders driven by COVID, but was consistent with Q4 2022. This quarter, the Asset Management division improved relative to Q4, increasing revenue from $46 million to $49 million, which was up 6%, and this group continues to focus on telecom, government and transit companies. And these sectors are not experiencing a significant increase in demand for cloud or SaaS. However, we do expect that this cloud shift could occur in the future. So we've made investments in preparing our software for cloud adoption in anticipation of the shift and a number of our SaaS applications have completed their cloud readiness requirements over the last 12 months. IPTV is one example that we've done, we've already done the cloud lift and we've been selling it for several quarters and now have signed over $3.2 million in SaaS IPTV orders, which are -- will be recognized in future quarters. Our Transit business has started its expansion into the Americas market, and during Q1, we signed a master framework agreement with the California State Department of Transportation, which provides us access to 300-plus transit operators, and they now have the ability to purchase our automated fare collection solution under the terms of the framework agreement. We hope this will materialize into revenue for us in the automated fare collection market, and spark further expansions into other states. Just on a final few points. Q1 represents over 100 consecutive quarters of positive operating income and cash flows for Enghouse. We have a track record that demonstrates our ability to adapt to continually changing market trends, product life cycles and economic conditions, while remaining profitable. As we have announced, Doug Bryson has decided to retire from Enghouse. He has been here for 93 of these 100-plus quarters, which is an amazing accomplishment, and I wanted to thank Doug for all that he's done for the company. It's been great working with Doug over the last 4 years since I've been here at Enghouse, and I wish him well in the future. Let me turn the call over to Mr. Steve Sadler.

Thanks, Vince. A little bit on acquisitions. We are actively reviewing opportunities and continue to search the marketplace for opportunities that meet our financial criteria. We continue to focus on capital deployment during our due diligence remotely. The acquisition pipeline continues to improve and with the decline in tech values in the public markets, we are seeing more opportunities that meet our financial payback criteria. As interest rates increase, taxes rise and government stimulus is eliminated, our ability to deploy capital is expected to improve. We remain committed to executing our historic strategic business model and discipline, which we believe will add shareholder value. I would now like to open the call for questions.

[Operator Instructions] Your first question is from the line of Daniel Chan of TD Securities.

I just want to dig into the IMG segment a little bit. Revenue this quarter is now below what it was pre-pandemic in Q1 fiscal '20. And I think you had a number of acquisitions over the last 2 years as well. So can you just provide some color on whether organic growth in IMG is declining relative to your pre-pandemic levels? And if so, what may be causing that?

Okay. I'll start there, Daniel. It's primarily related still to video. Video in Q1 of last year still had some COVID-related orders. So most of the decline is on the video side.

What about when you compare it to 2 years ago before the pandemic started, before you got that bump? It's still below -- like IMG in general, still below that level?

You also have, I guess, on top of that, what Vince has talked about moving to SaaS, which means rather than take your revenue upfront, you're spreading it over 3 years. So we are basically in that second year of that. So that also adds to it. Another major factor is the exchange. U.S. dollar and Canadian dollar has moved a lot and the euro as well. So you got to factor in exchange. I think last year, that was $13 million impact on our revenue line. So there's a lot of factors going into it. I think the IMG side, certainly, we are looking to improve it. But right now, there's a lot of factors that are showing up in the numbers.

Okay, Steve. And then if we dig into the hosted and maintenance revenue, you mentioned in your filings that you're continuing to see some attrition in your existing customer base, particularly around video as they continue to rightsize. As discussions now move towards reopening and moving back into the office, how are your discussions with customers going? Is there a line of sight to where this levels out?

That's a hard question and to know what's going to happen and what's the reaction after people don't totally work from home, come back to the office. So it's difficult to say where that is. Again, there's a lot of factors that go into it. I think right now, one of the factors is we still do on-prem, as Vince talked about as well in the cloud, and the cloud picked up during the pandemic because people are going into offices. You're not going in to set up the systems. Is on-prem going to come back a little bit because it is, in many ways, more economical? There are several factors there. So I -- we're preparing for whatever happens because we do both. So we'll just have to wait and see. I had no good forecast for you on that.

Okay. That's fair. And then good to see that you're getting traction on the cloud. You mentioned you had the strongest bookings in the most recent quarter. Can you just remind us what is the uplift in revenue per seat we would see as customers migrate from an on-prem maintenance license to a SaaS subscription? I recognize that license revenue will decline, but just wondering what we could see in the hosted and maintenance segment as you make that migration?

Yes, as you mentioned, Daniel, so when we sign an on-prem deal, you get the software recognition upfront and then you get a bunch of services revenue to implement and integrate it. When it comes to SaaS, it's the other way around, we implement, do all the integrations and then the SaaS revenue kicks in on a per user per month basis. So that's the way the rev rec happens. And you end up with more long-term revenue under SaaS. Margins are around the kind of 70% range. So we can keep our margins at that target level. We're at the high 60s at this point. So that's essentially how it works relative to on-prem.

Your next question is from the line of Paul Steep of Scotia Capital.

Vince, maybe just to continue where you were going there. Just remind us on the contact center side, are you typically signing 3-year contracts with the clients? Because I just -- I guess I'm looking at the deferred revenue and you called out a couple of places in contact center and in, I think, in networks signing some cloud -- sorry, IPTV, some cloud-based deals. Just trying to see how that's being recognized maybe into deferred, so we can sort of get a vibe of the transition of the business over time?

Yes. Sure. So we normally do sign 3-year deals for our SaaS, whether it's IPTV SaaS or contact center SaaS, and it's normally billed annually in advance. The billing typically starts when we finish the implementation and integration work. And then we bill for the year annually in advance. And then when it comes on anniversary bill, we bill it again for the next year and the year after. So you don't get 3 years of deferred you get 1-year and then it renews again in the following year. Does that answer that?

Yes. No, that does. I was just looking to sort of get a sense of we know we get RPOs from other people and wanting to see how that was sort of building or how we should start thinking about that over time? It sounds like still early days, but the comments help us sort of figure that out? Maybe the other point there is on content center -- sorry, go ahead.

The other side is you realize it doesn't show up necessarily always in deferred revenue. Sometimes it's quarterly, sometimes in advance, sometimes afterwards, but you really can't tie it to deferred revenue that well.

Perfect. And then maybe on the cloud transition, do we have a sense, and I know you tried to answer it with Daniel, but maybe we try it a different way. If we think about that cloud transition, how have you thought about sort of modeling out your base maybe shifting over, over the next 5 years? In 5 years, should we think that you've made the full move to cloud? Or no, we're going to let -- we're going to be sort of more ceded in that?

Yes. Like I mentioned, so we offer 3 solutions to the customer. So you can purchase from us a private cloud, which is dedicated for one company. We have multi-tenant cloud. We've stood up for cloud nodes around the world and then on-prem. So when it comes to how the whole customer base will transition, we'll see. But we're seeing definitely more opportunities for both multi-tenant and private cloud relative to on-prem. So our opportunity pipeline is now heavier weighted -- getting much heavier weighted towards cloud for the contact center business relative to on-prem. And then we have a fairly big existing customer base, and for them, we have a program where we can migrate them to the cloud. So they can use the same -- if they want the same products they're using today with us, just in the cloud. So we do have a cloud migration program for existing customers or they can move to our multi-tenant cloud products. So we give all this optionality, which is fairly unique. It sounds like it's kind of a trivial differentiation, but it's actually quite important to customers to give them this choice. How it ends up at the end, I guess we'll see, but we're offering all 3 at this point.

The other impact you have the people, if you look at competition, et cetera, is a lot of the cloud players are trying to call it a land grab. In other words, they don't actually make much money. So again, that's another thing to factor in why people are moving more to the cloud right now. Will that be the same in 5 years? Or will they -- prices be going up after they got their land grab and then it changes the dynamics a little bit? Right now, it's pretty good for customers in the cloud and the SaaS type model, but over time, it may not be the case because to be good for customers, how long can companies lose money and do that as they try and do that land grab.

Yes, and we don't do that. So our approach is unless our deals are good economically, we don't take them. So we don't do the land grab and lose money model.

Got it. Actually, maybe to take the next one that would be directly for Steve on the M&A side. Steve, where are you standing these days in terms of -- we've seen other folks who might have more traditionally just bought on-prem. Is there a shift or a focus on your side? Is there a bias maybe now to just buy more recurring revenue cloud operations? Or no, open for business as always on both sides?

We tend to look for both sides. The major factor for us is getting a return on investment for our shareholders over time. Right now, you can guess on-prems probably better. And if we can buy on-prem and convert them over, that's a pretty successful model. So again, we look at both. Some of the -- in the cloud and SaaS type opportunities, they have been crazy, i.e., and you see them coming down. You look at companies like Five9, you look at Zoom, they're all in half, and they still aren't making money. So as long as they can get financing for the losses, it makes it tough. But I always find that day of reckoning comes. So we do both. But we're looking for opportunities in both areas, and we always compare what's the value for money we're getting for the price we pay. And then we also -- if we get customers on-prem, as Vince talked about, we can move them over to the cloud when they want to move there. So it's 2 factors when you do acquisitions, price you pay as well as the business you're getting, and we have to always look at both.

Last one. I think I know the answer, but I'll ask it anyway. Steve, is there any thought to maybe lowering the hurdle rates to strategically pick up more SaaS business versus what you'd look at for a hurdle rate on on-prem? Or I think I know what that answer is going to be, but I'll leave it there.

It really doesn't matter. I mean if SaaS is going to make some money, over a period of time, you discount it back, discounted cash flow, you guys do this all the time. And if it makes sense, we do SaaS. If it's prem, we do prem and then we figure out how we can add value on top of that. So we're not going to pay up for SaaS. It doesn't make sense. We are seeing SaaS companies, smaller ones that do meet our financial criteria because it's not quite as hefty as it was, let's say, 6 months ago. So yes, we look at both. Are we going to pay up? It's just a matter of getting our return as long as the profits and our cash flow are up, we'll pay up. If they aren't, we won't. Again, over time.

Your next question is from Scott Fletcher of CIBC.

I want to ask about the pace of M&A. With your comments that the pipeline seems to be expanding and some valuations coming down, is there a desire to sort of really accelerate M&A and to maybe -- or would you prefer to sort of avoid multiple concurrent integrations?

Based on what we've done, I would say we want to accelerate M&A because we haven't done as much as I would like, but we want to do them at the right return to shareholders over time. We're not going to rush to do it. We don't have a mandate to spend a certain amount of M&A due to M&A in a year. What we try and do is do the right deals. And over time, we found that it works out. But we have added some resources to our M&A group. And certainly, we would like to see more M&A or capital allocation done to add value for shareholders which we're working on doing.

Scott, just on your question in terms of doing multiple integrations. If we get 2 deals done, we have the ability to do that. We have invested a lot in systems and integration approaches. So we can handle.

Okay. That helps. And the second question. And...

Just to add, the way to add that -- to answer that is a lot of financial works done on M&A, and we do a financial team separate ones in Europe, North America and APAC. So -- and they've all now done a deal, so they know how to do this. It's not like the first one they're doing. So we've got a bit of experience to do the integration. If we get a bunch in one area, we just have to manage that. And you can spread it out, you can have closing dates that are different, et cetera. I don't see that as the problem. I see getting more good deals done as both an opportunity and a challenge. It has been a challenge, and I think it's going to be quite an opportunity.

Okay. That's good to know. Just another maybe more minor question. Sales and marketing costs as a percentage of revenue have sort of been around 20% for a few quarters now. Should we be expecting a ramp up as economies open up and you can sort of start doing more in-person selling activity?

So I mean, I'm not sure where you got the 20% from, I think you got SG&A in there, so that's not just the sales engine. So it's all of that. And then on your question, is there more face-to-face meetings happening, there is a bit more happening. It happened. It started in this quarter a bit. So there are more face-to-face meetings. So there is a bit more travel costs, but it's not significant yet.

And just to add to that, as we said on the last call, we expect any increase in costs for travel, et cetera, again, in that line that SG&A, we think a reduction in premise costs will offset it. So I wouldn't expect you'll see costs going up. I think with the change in premise. We're going still a hybrid work from home. I think you'll see savings there offset any extra costs in sales and marketing.

[Operator Instructions] You have a next question from the line of Paul Treiber of RBC Capital Markets.

Just in terms of the product portfolio in contact center, are you now at the point where you basically have 100% parity with the features and offerings in the cloud versus your on-premise offering?

Yes. So there's 2 answers to that one, Paul. So we can take your existing on-prem product that you're using. And we made a lot of investments in the last 12, 18 months to be able to move that to the cloud. So you're at exact feature parity. You're using the exact product. If you were an agent, you wouldn't see any change other than using it through a browser. So that's one model. If you go to our multi-tenant cloud product, depending on what you're using, the features may not be exactly the same. They might be stronger in some areas or others. But we have a whole team getting our multi-tenant cloud product much further ahead. So you can at least keep future parity, but it depends on which products you're currently using, whether you're at parity or not.

Okay. That's helpful. Yes, I think I was referring to the multi-tenant offering. Do you see -- and you mentioned a whole team getting the product ahead. Do you see eventually in time, the multi-tenant version being the one where you lead with new features and becoming the more innovative offering over time?

Yes. So the way we're organized on our engineering group is around building components -- cloud-based components that all the products can use. So you don't end up with a component like an AI component as an example, that's different in the on-prem product versus the multi-tenant product versus the private cloud. So we have these shareable components that we're sharing across all the products and having the engineering teams more kind of in parallel -- working in parallel.

Okay. Makes sense. Just a couple of finance questions around the impact of cloud. And just starting there, the -- you called out the $3.5 million in new cloud orders, is that equivalent to new RPO? And then if you did disclose RPO, what's sort of the cumulative cloud backlog or RPO that you currently have?

So the $3.5 million was signed orders just in the contact center, SaaS piece. So it didn't include SaaS orders in other areas like in our video, for example. In terms of -- that's the value of this -- of the contracts that are typically, like I said, somewhere between 1 and 3 years in duration. So that's the contract value. Does that answer that question?

Yes. And then if you look at cumulatively over -- like since you launched in contact center, how -- what's the cumulative orders that you've seen?

I haven't disclosed that number. But it is...

The $3.5 million is a record high and you expect that trajectory to continue, is that a fair point at this quarter?

Yes, that's a quarterly record high, yes, exactly, for the contact center side.

Okay. And then just lastly, just a question on Ukraine and Russia. I think there was a disclosure, one of the acquisitions that you made that there was -- you might had an office in the region. Can you just provide an update on that region if you have any -- still employees there, any revenue transactions?

Yes. So in the Ukraine, we have 57 engineers that are external contractors. So they don't work -- they're not employees. They're working for a large systems integrator that we partner with, focused primarily on engineering. All of them are safe. Some of them are no longer in the Ukraine, and we wish their families well, obviously. In Russia -- we have a very small amount of business in Russia.

Thank you. Speakers, I'm no longer seeing any other questions on the queue. You may continue.

Okay. Enghouse continues to have a very strong financial position, as Doug has outlined to execute both our capital allocation strategy and our internal growth business strategy. I want to thank you for your patience, and we look forward to talking to you next quarter.

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