Enghouse Systems Limited (ENGH) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Enghouse's Q2 2022 Conference Call. [Operator Instructions] This call is being recorded on Wednesday, June 8, 2022. I would now like to turn the conference call over to Mr. Stephen Sadler. Please go ahead.

Good morning, everybody. I'm here today with Vince Mifsud, Global President; Rob Medved, VP Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP Corporate Development. Before we will 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 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.

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

Thank you, Steve. Good morning, everyone. I will be discussing the financial and operational highlights for the 3 and 6 months ended April 30, 2022, compared to the 3 and 6 months ended April 30, 2021, as follows. Revenue achieved was CAD 106.3 million and CAD 217.4 million, respectively, compared to revenue of CAD 117.3 million and CAD 236.4 million. Results from operating activities were CAD 31.1 million and CAD 66.8 million, respectively, compared to CAD 36.9 million and CAD 77.6 million. Net income was CAD 17.9 million and CAD 39.5 million, respectively, compared to CAD 20.7 million and CAD 41.4 million. Adjusted EBITDA was CAD 33.8 million and CAD 72.3 million, respectively, compared to CAD 40.2 million and CAD 84.7 million. Cash flows from operating activities excluding changes in working capital was CAD 34.5 million and CAD 73.3 million, respectively, compared to CAD 42.6 million and CAD 84.3 million. Revenue for the second quarter of 2022 was CAD 106.3 million, with results from operating activities of CAD 31.1 million and cash flows from operating activities excluding changes in working capital of CAD 34.5 million. As a result, we closed the quarter with CAD 231.2 million in cash, cash equivalents and short-term investments with no external debt. We remain focused on operating a profitable, cash flow positive business that generates the necessary capital to fund our acquisition strategy without the need for financing. Revenue for the second quarter of 2022 was down from CAD 117.3 million in the same period of the prior year and was negatively impacted by CAD 3.7 million as a result of unfavorable foreign exchange as European currencies have come under pressure with the recent conflict in Ukraine. Excluding the impact of foreign exchange, our Asset Management Group had comparable revenues to the second quarter of 2021. Our Interactive Management Group is experiencing increased competition from cloud solutions providers as the market shifts towards the cloud as more businesses adopt work from home operating models. While we differentiate ourselves from our competitors by providing customers choice between on-premise solutions, private cloud and multi-tenant cloud offerings, we are augmenting our existing channel-partner model, with additional focus on our direct go-to-market approach for our cloud solution that is still in the early stages of its global rollout. Net income for the quarter was CAD 17.9 million, or CAD 0.32 per diluted share, compared to CAD 20.7 million, or CAD 0.37 per diluted share last year. The decrease in net income is a result of higher revenue in the comparative period despite lower operating expenses in the current period. Adjusted EBITDA was CAD 33.8 million or CAD 0.61 per diluted share, compared to CAD 40.2 million, or CAD 0.72 per diluted share in the second quarter of 2021. Enghouse closed the quarter with CAD 231.2 million in cash, cash equivalents and short-term investments, compared to CAD 198.8 million as at October 31, 2021, with no external debt. The cash balance was achieved after making payments of CAD 17.8 million for dividends in the first 6 months of 2022. 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 CAD 0.185 per common share, payable on August 31, 2022 to shareholders of record at the close of business on August 17, 2022. This payment represents an increase of 16% compared to the prior year. I will now hand the call back to Mr. Sadler.

Vince will now give some operational highlights of the quarter.

Thank you, Steve. As Rob has communicated, we continue to generate positive operating income and cash flows. This quarter's EBITDA was CAD 33.8 million, representing 31.8% of sales and we closed the quarter with CAD 231 million in cash with no debt, which leaves us in a very good position to fund future acquisitions. Gross margins in the quarter were 68.4%. We added a number of new staff to our team in Q2 to deliver the next phases of our large public safety projects, which take about 90 days to be fully productive. Our revenue in Q2 was CAD 106.2 million lower than Q2 of 2021 of CAD 117.3 million. This decline comes from our Interactive Division and foreign exchange. Foreign exchange continued to have quite a negative impact on our revenue. Foreign exchange decreased revenue by CAD 3.7 million compared to prior year Q2 2021 and CAD 8.1 million on a year-to-date basis. The overall contact center market is growing and the shift to the cloud is accelerating. The accelerated shift was primarily driven by COVID, resulting in contact center employees working from home, and now many companies adopting some new form of working from home program. However, the overall need for companies to improve their customer experience to retain customers is only increasing and technologies like us that help improve these experiences are growing in significance. Enghouse has made several investments in our go-to-market strategy to address the growing cloud shift over the last 12 months to 18 months. We added some new senior management with cloud go-to-market experience, including a recent hire of a new Global Head of Demand Gen in Q2, a newly created role for us. Our sales teams are more focused on selling direct to augment our channel programs with telcos and we've stood up 4 cloud nodes globally, so we can now provide software-as-a-service directly to our customers in the United States, Canada, Europe and Asia-Pac. These initiatives and efforts have resulted in a 65% growth in our contact center cloud sales pipeline this quarter compared to Q1 2022, and 40% of our total pipeline are now SaaS deals. We are still relatively early in the direct selling of our multi-tenant Enghouse CCaaS product and our private cloud offerings. Our direct selling approach is vertically focused. Rather than take a horizontal approach to the market, which drives up customer acquisition costs and doesn't serve customers well, we focus on what we call micro vertical segments where we have good customer referenceability and unique product advantages compared to generic horizontal offerings. We also sell and service customers with local teams in local languages and time zones across Europe, the US, Americas, Asia, which provides an added level of comfort for customers, which is really important when it comes to mission-critical software. Enghouse CCaaS is a comprehensive cloud contact center product. It has the ability to scale up and down. We have customers with as few as 10 agents on the platform and as high as 2,500 concurrent agents, which allows us to service about 80% plus of the addressable market. Our product handles any customer interaction point, including phone, website chats. We have over 20 social platform plug-ins. We handle e-mail, video. We have embedded AI, including chatbox, quality management, comprehensive CRM integrations, extensive BI reporting, et cetera. We are also very cost-effective, given our rapid speed of deployment and out-of-the-box capabilities. From a product perspective, we have an impressive offering. And at this point, our goal is to get in front of more direct cloud deals, given we're not as well known in the market as a cloud provider because of our historical indirect approach to the market. On the competitive front, what we are seeing, our cloud contact center -- in the cloud contact center market are some competitors operating their businesses at a significant loss, spending on sales and marketing to win market share. However, this is not our business model or approach. We continue to be disciplined about running a sustainable profitable business and we maintain it for all parts of Enghouse, including our cloud business. Our Vidyo business has evolved quite significantly since the start of the COVID pandemic. At the start of the pandemic, we experienced a massive spike in peer-to-peer video calling between a doctor and a patient, which was our primary use case. This was then followed by continued volume declines and more price competitiveness for this initial use case, which continued into this quarter. Now, we are seeing healthcare demands evolve further, beyond just doctor-patient calling towards enhanced workflows and video patient monitoring. We've expanded our video telehealth products. Virtual Sitter is an example of a new product, which is a patient monitoring tool that allows from a single screen a medical professional to monitor multiple patients. Patient Portal, another new product, provides very complex doctor-patient video and communication workflows. These offerings, which we launched over the last year are now being sold into the healthcare market and building momentum, and we see these products and use cases as a potential catalyst to offset the decline in peer-to-peer calling. On a constant currency basis, our Asset Management division has improved again this quarter compared to Q1 2022, which was also up from Q4 2021. This division on a year-to-date basis -- on a constant currency basis was up compared to 2021 also. Overall, the division has delivered very consistent performance and continues to not experience any significant increase in demand for cloud solutions. We are investing ahead of the potential future cloud demand and have implemented a cloud readiness initiative for our key telecom products to ensure they can be deployed in the cloud, should the market move in this direction at some point in the future. IPTV, which is our multi-tenanted SaaS offering, continues to see good demand, signing new logos again this quarter. We now have 12 new IPTV customers, and 9 have recently gone live in the last 6 months. Our large public safety projects are in full execution mode, and we added a number of people to the team in Q2 to deliver the next phases of these projects. The transit automated fare collection payments business is also picking up momentum and we're rolling out our EMV solution across a number of our European customers and started actively selling and building our pipeline into the Americas market, leveraging the signing of a master framework agreement with the California State Department of Transportation. We are pleased with the performance of our Asset Management division and the initiatives we are taking in our Interactive Division to improve organic growth while maintaining our business model of profitability. Let me turn the call over to Mr. Steve Sadler.

Thanks, Vince. In terms of acquisitions, the actionable pipeline continues to improve. As previously noted, with rapidly increasing interest rates, declining public tech values and the possibility of rising taxes, valuations are becoming more realistic in terms of meeting our financial criteria. It is true that we have not completed any acquisitions for about a year, but we have maintained our financial discipline, which seems to have been the right strategy, considering the substantial recent decline in tech valuations. Our growing cash balance, no financial debt put us in a very good position for the future. Sometime it's best to be patient deploy ones cash to get the best long-term return for shareholders. I would now like to open the call for questions.

[Operator Instructions] Your first question comes from Stephanie Price from CIBC.

I wanted to circle back on the direct sales force for the cloud contact center solutions. Can you talk a bit more about whether the team is fully staffed and productive and how we should kind of think about the rollout of the direct sales force team here?

Yes. I would characterize it as, we're never fully staffed, but we're well staffed in our direct. There's been a lot of training as well on selling cloud contact center in SaaS, so that training is largely behind us and we're building pipeline as I mentioned. So the pipeline has grown quite a bit and continues to grow. So that's where we are.

And in the past, you've talked about 70% of your contact center revenue from on-premise. Is that still the number we should be thinking about and how do you think that number evolves over time?

Yes. I -- Stephanie, I think it's about the same. It might be a lower total. But I think the percentage is still about the same today, 70%, although we're moving more into the cloud now that we've set up these platforms in various regions, which we didn't have before.

Okay. And just finally for me. In terms of the partnerships, you mentioned the telcos and the cloud solutions. Just curious how you are thinking about partnerships and how those relationships are evolving as you look at the market today?

Yes. So we maintain the telco partners because a lot of them have invested heavily and have stood up our platform and are white labeling it. So that continues that program and the standing up of our own SaaS is just augmenting that. On the on-prem side, given that there is less demand for on-prem contact center in general, resellers play a much smaller part in SaaS deals. They're more like a -- consider them more like lead generation rather than delivering hardware and services. So they play a less role in the SaaS world than they do on an on-prem basis and less like our telcos, they stand up their own cloud and go-to-market directly.

Okay.

Stephanie, just to add something to that. We are pretty strong with the telcos, but not in the US. We don't have a big telco. We really have TELUS in Canada, but really don't have full coverage in Canada. We had nothing in Australia. So when Vince mentioned, we set up our own platforms, it's in basically areas where we didn't have telcos to do what we need to be done on the SaaS side. So it's a bit of an expansion as well into areas where we didn't have a telco partner and therefore, we've set up our own platform to go at those markets.

[Operator Instructions] Your next question comes from Paul Treiber from RBC.

In regards to the decline in IMG, on a constant currency basis, can you clarify how much of the decline is related to Vidyo and how much is related to the rest of IMG?

Yes. Good questions. Substantial portion of the decline, I won't give an exact number is Vidyo. Like it's a material portion of the decline and foreign exchange. Those are the 2 factors driving the decline in Interactive.

Okay. That's helpful. And then zooming into Vidyo, the -- when you look at the acquisition in its entirety, you had the sort of the boom out of the gate. What would you say, the IRR on the acquisition overall? Is it above what you anticipated when you initially made the acquisition?

I would think so. We're now back to that volume, but in the -- after the pandemic hit, we made substantial gains. All the revenue went up as people ordered more seats, et cetera. And that's why we paid out the CAD 85 million in special dividend. That dividend was really profit we've made in about the first, let's say 15 months. And rather than go forward, we tried to explain that it was an unusual event. Therefore, we took an unusual action and provided an unusual dividend. We've since gone back to our more normal level. It is profitable, but it has lowered the profit a lot because during that period, we made CAD 85 million, we paid CAD 40 million and we made CAD 85 million probably in 15 months, 16 months. So the return was pretty good.

And looking at the remainder of IMG, I imagined, just given the headwinds over the last couple of years, the cloud, maybe renewal rates have gone down a little bit. When you look at overall like the returns in that segment, what's your enthusiasm to continue to make acquisitions in IMG? Or has the underlying market structure economics changed, where it's less attractive to make acquisitions in that segment?

It's not as attractive to buy SaaS companies in that segment because they tend to grow and lose more money as they grow. So we tend not to buy those. However, it does put pressure on some of the other players who have good customer bases, good software, like when we bought Altitude. And the return on investment is actually quite high for us because others are not interested because the market all wants SaaS, but SaaS actually doesn't give us a good return other than in the stock market than from what we actually get a return on cash from buying those companies. And if you look in the market today, some of those returns, they were pretty frothy at the time. Favorite, of course, is Five9, who has gone from about CAD 200 to under CAD 100. That's not such a good return. So we avoided those types of returns and we bought in Altitude that really does the much growth, shrinking a little bit, but has a very good return compared to what we paid and to what they added in value for us in terms of profitability and cash flow.

And just a last question from me. I mean, just in terms of IMG, just excluding Vidyo for a segment, like the segment continues to trend down. I mean, obviously, the long-term organic growth stability in that business would have a significant impact on the IRR on acquisitions. Where do you see -- do you see ultimately that business stabilizing? I mean I think in the past, you said low-single-digit positive organic growth. Do you think that's still the reasonable long-term outlook for that segment?

Yes. I think that is the reasonable medium-term outlook for that segment versus long-term. And I also think there should be more opportunities for us to do acquisitions, as some of those -- our competitors are feeling the same pressure from a Five9, for example, that is growing okay, but not doing so well in terms of making money. So again from that side, there is pressure in the marketplace from people trying to get market share versus profitability and that impacts a lot of people in the market. So I'm hoping it also will show up in some acquisition opportunities for us as well and we still can invest a lot in our R&D. And again, we are still investing in building that business forward. It is a big market and we feel quite comfortable with our returns in that market even today, even with lower revenue.

Thank you. And there are no further questions at this time. Mr. Sadler, you may proceed your conference.

Okay. Enghouse has a very strong financial position to execute our capital allocation and business strategy. I wanted to inform you we have recently increased our acquisition team in anticipation of more opportunities to deploy capital in the next couple of years. Also, as Vince outlined, we continue to invest in our operations to improve internal growth. We want to thank you for your patience and we look forward to talking to you again next quarter.

Ladies and gentlemen, this concludes your conference call for today. We thank you very much for participating, and ask that you please disconnect your lines. Have a great day.