Enghouse Systems Limited (ENGH) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to Enghouse Q1 2023 Conference Call. [Operator Instructions] Also know that call is being recorded on Friday, March 10, 2023. And I would like to turn the conference over to Mr. Stephen Sadler. Please go ahead, sir.

Good morning, everybody. Yesterday, we had a nice AGM, and we probably are going to be repetitive to some of the people who were at the AGM. But I think we -- there's more on this call than we're at the things, so we're going to go through it. I'm here with Vince Mifsud, Vice -- General -- Global President; Rob Medved, VP Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before I 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 [Audio Gap] 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.

Thanks, Steve. I'm just going to take us through the financial and operational highlights for the 3 months ended January 31, 2023, compared to the 3 months ended January 31, 2022, as follows. Revenue achieved was $106.4 million compared to revenue of $111.1 million. Results from operating activities were $29.9 million compared to $35.7 million. Net income was $17 million compared to $21.6 million. Adjusted EBITDA was $32.3 million compared to $38.6 million. Cash flows from operating activities, excluding changes in working capital, were $32.6 million compared to $38.7 million. Over the last 4 quarters, revenue in both the Asset and Interactive Management Groups have stabilized significantly, particularly in comparison to the revenue fluctuations that were driven by the changing demands relative to COVID-19 pandemic. Despite the ongoing shift to the cloud, inflation, rising interest rates, economic uncertainty and some competitors experiencing significant financial distress announcing restructuring and employee layoffs, Enghouse continues to operate consistently with positive income and operating cash flows. Enghouse remains well positioned to complete and fund future acquisitions. Subsequent to year-end, we announced the acquisitions of Qumu and Navita with integrations progressing according to plan. Net income for the quarter was $0.31 per diluted share compared to $0.39 per diluted share in the same period last year. The decrease in net income is primarily as a result of a reduction in software licenses alongside lower gross margins from professional services relating to our large public transportation projects. Adjusted EBITDA was $32.3 million or $0.58 per diluted share compared to $38.6 million or $0.69 per diluted share in the first quarter of 2022. Enghouse closed the quarter with $250.7 million in cash, cash equivalents and short-term investments compared to $228.1 million at October 31, 2022, with no external debt financing. The cash balance was achieved after making payments of $10.2 million for dividends in the 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 $0.22 per common share, an increase of 18.9% over the prior dividend payable on May 31, 2023, to shareholders of record at the close of business on May 17, 2023. This represents the 15th consecutive year in which the company increased its dividend by over 10%. I'll now hand the call back to Mr. Sadler.

Thanks, Rob. Vince will now give a brief operational overview of the quarter. Again, we don't want to repeat too much of what we said at the AGM, but he'll give a good summary.

Thank you, Steve. Just a few comments to start on our overall financial performance. Revenue in Q1 of $106.4 million, highlights that over the last 4 quarters, our revenue is improving in terms of consistency, falling between the range of $102 million and $108 million. We are now past the revenue fluctuations that occurred in 2020 and 2021 due to COVID. In terms of revenue mix, we are seeing an improvement in our recurring revenue in the quarter, achieving $66.5 million compared to $64.6 million in Q4, which was up $2 million or 3% sequentially. This is driven by our growing SaaS revenue. Foreign exchange, which negatively impacted our revenue for approximately 2 years, turned favorable in the quarter, creating approximately $1 million improvement in revenue compared to Q1 of last year. We continue to manage our operating expenses, dropping our total operating costs compared to Q4 despite global inflationary pressures. Gross margin on professional services are being impacted due to the short-term use of third-party external contractors for our large public safety projects. Turning now to what we are experiencing in the overall markets we operate in. There are quite different industry dynamics occurring when we compare our Asset Management to our Interactive Group. Asset Management, which is mostly focused on telecom companies, is operating in a growing overall market environment. The sector is characterized by larger enterprise customers, predominantly demanding on-prem or private cloud. And customers prefer technology providers like Enghouse that have a large breadth of integrated products and competitors in the space that are generally large on-prem tech companies that also run profitable businesses. Therefore, we don't experience significant price pressures or any significant SaaS competition. And there are some interesting growth opportunities in the segment, particularly as mobile networks expand, more mobile virtual network operators emerge, IPTV demand grows and fiber optic networks proliferate globally. In the customer experience contact center market, the biggest segment of this market are midsized companies. And competition is coming primarily from mid- to large SaaS providers. We are seeing many competitors facing significant turmoil with one large competitor in the contact center market filing for bankruptcy protection in Q1 and several others announcing significant restructuring. Competitors are mostly horizontal SaaS providers, often competing on price with less emphasis on their profitability. And despite these market dynamics, we maintain our profitable growth business model by continuing our strategy around micro vertical products and go-to-market and offering customers deployment choices. Subsequent to Q1, we announced the completion of the acquisitions of Qumu and Navita. During the due diligence process, we did a lot of post-acquisition planning, enabling us to execute our acquisition integration plans in a timely manner during the month of February. We have a comprehensive M&A integration process, which we implement and onboard new businesses efficiently. Thus far, the integration for Qumu and Navita plans are going well. Qumu products enhance our video solutions for large businesses that utilize their product for large-scale virtual events. The Qumu product and team now form part of our video group within the Interactive division. Our video product suite continues to expand through a variety of internally developed products, Qumu's products and last year's acquisition of [ Momentum ], with a focus on very specific enterprise use cases. And we are seeing -- expanding opportunities for our video suite of products. Navita provides mobile device and expense management, sold into large enterprises directly or through telecom providers in the Brazil market. And this augments our current mobile device management business, which is a growing market segment. As a reminder, the acquisitions happened after the quarter, so there is no revenue from these acquisitions in Q1. Let me turn the call over to Mr. Steve Sadler.

Thanks, Vince. Again, with respect to acquisitions, the actionable pipeline remains strong. Valuations continue to decline in this environment of increasing global interest rates and the possibility of a recession. As Vince noted, we did not complete any acquisitions in Q1. And therefore, no acquisitions impacted revenue or profitability. But shortly after the quarter, we completed 2 acquisitions, Qumu and Navita. Vince has already outlined the basics of those 2 acquisitions. And as Vince noted, we are in the process of integrating these acquisitions into our operations and expect them to increase our revenue and EBITDA in future quarters. At the end of Q1, our cash on hand improved to over $250 million after paying our quarterly dividend. With our cash on hand, no debt and our continued strong positive cash flow, we have the financial resources for further acquisitions. We do not need anything from the public markets. I would now like to open the call for questions.

[Operator Instructions] And your first question will be from Daniel Chan at TD Cowen.

Are you able to quantify or share some color with us to what extent you'd attribute the weak licenses revenue to come from customers migrating to the cloud versus video?

I don't think we said anything about that, so no.

Okay. And then you did highlight that video continued to exhibit some weakness. Can you just give some color on where you're seeing that weakness? Some of your competitors are seeing good activity in enterprise. Just wondering if there's anything specific you can point to.

Yes. I could -- Vince could answer some detail, but I disagree that you're -- our competitors are showing great activity. Maybe some of the larger ones you looked at are doing a little better. But if you look at a lot of their stock performance, you can see the real results. And also, there's a lot of medium and small size who get hurt faster first, and that's the market we're in. We're not in the market against Zoom as an example, which is really in the public market, not the enterprise market.

Yes. So in terms of video, we're seeing a bit of improvement in terms of our pipeline on video, on our video side, mainly in the healthcare, as I've mentioned previously, which is our key vertical there. With Qumu, we're getting into larger enterprises. Qumu sold into the bigger enterprise market for virtual events. So we'll see how that goes. But yes, we're seeing a bit of a pickup in that particular use case.

Next question will be from Deepak Kaushal at BMO Capital Markets.

I got 2 if I may. Steve, we haven't seen 30% EBITDA margins for about 4 years, and you guys have yet to absorb Qumu. I know that you mentioned the professional services. How long do you expect that to last? And if you have your typical margin drawdown in the first quarter you make an acquisition, are we expecting you guys to dip below 30% until Qumu becomes profitable? How should we think about the margin dynamics in near term?

I guess it depends how fast we get Qumu profitable, is something you could watch. Remember, they were doing about [ USD 20 million ] in revenue, that's public, and losing $9 million. So our task is to get it onto our profile for EBITDA. It will take a few quarters. But how quick it gets there, it depends how successful we are with our plans this quarter. Remember, we just started a couple of weeks ago. We're pretty good at it. So we'll have to wait and see, but we don't have any expectations that we're putting out there right now other than we will get it consistent with our profitability going forward. The 30%, I've always told everyone, it's 30% with a little bit higher for various reasons, travel, sales, it's come down a bit. Mix has changed a bit. 30% is a pretty normal thing for us. 35% -- for quarters, I would say we are doing better than normal. We're now at normal. Hopefully, we'll do better again. But with acquisitions now picking up, 30% is pretty normal.

Okay. And then in terms of the lower gross margins with the third-party contractors on professional services, is that a 2-quarter thing or a 1-year thing? How long should we think about the tenure of that in those projects?

That's mainly in our -- with the 2 big projects. Look, it's pretty easy. It happens all the time. When you have a big project, you go along great, and you get towards the end, there's all these little things that -- the last 10% to get cleaned up, takes more effort than 10%. So we're in that mode right now. It's probably expected in the next 2 quarters, we will finish some of those projects and go into our, what we call, support mode, which has huge margins because that's where we tend to make the money. So again, I would think 2 quarters, I think that project could be done. I think it will impact our PS revenue being down a little bit, and it will make our profitability higher.

Got it. And my last question, just on the M&A environment. Thanks for the additional color there. In the past, you guys seem to be capped at about $50 million in terms of transactions to get your target valuation and payback. Is that still the case in this environment? Are you able to -- are you seeing the opportunity to do larger deals and still get your 5-year cash-on-cash payback without competing against private equity firms? How has that dynamic changed?

So we never really had a cap. We just have a discipline of what we've told our shareholders the return we try and get is 5 to 6 years. Valuations have come down, so larger companies are again falling into that range. Private equity is struggling. They used to get their return by borrowing money at low rates and not putting much in. They no longer can borrow at low rates. The rates are going up. I'm not going to try and predict interest rates as well, but I expect it will still go up in spite of everyone think they're going to stop and go down. So I believe that we're looking at a pretty good future for our strategy where we use cash. We don't use debt. We have the cash on hand. And is there larger ones? Potentially. I think there's all sizes we looked at. We never had a cap. We just had what made sense with our financial discipline. And what we've told shareholders, this is the type of return we want to get when we do acquisitions.

Next question will be from Stephanie Price at CIBC.

I was hoping you could talk a little bit about the competitive environment in the cloud CX market. The MD&A and in your prepared remarks as well mentioned significant competitor turmoil. Just curious if cloud competitors are becoming a little more rational here.

So I'll answer it, and I'll pass it to Vince. I'm not sure the cloud competitors are more rational. They're losing money. Some have money, and some don't. The ones that don't are in some difficulty. You saw it with Avaya. There's others. They're hoping that investors will give the money, but they don't make money and really haven't ever made money. So I think it's -- unless they raise their prices and they aren't right now because they're fighting each other, not really us because we don't get into that game. I think you'll see more difficulty in that market in our space. I'm not saying it's in every space, but in the contact center space. The biggest company in that area, Avaya, $2.5 billion, they're now in receivership. They stopped trading. They're trying to -- they'll recapitalize. Investors will get 0. And the guys who have the secured debt will come away owning a lot of the company and then they got to figure out how to make money going forward. There are others in that space. You can look -- just look at our competitors. Anyones that are public, you can see what they're doing. And you can see the news on Google, and people are concerned about it because you can't sell below cost and make it up on volume. It just doesn't work. The more you sell, the more you lose if that's your strategy. Our strategy is to get profitable growth. We don't get as much growth as they do, of course, because we don't want growth at a loss. And we're going to continue that strategy. And if it continues for a long time, the marketplace that it is, a lot of those bigger players, I guess, will have to talk to us about combining or getting financed. We'll just have to wait and see. We've got -- we're patient.

Yes. Just to add to that, Stephanie, in terms of recent behavior changing or improving, I would say it -- there's no -- it's -- I mentioned it last quarter as well, they're still doing the things that they were doing, if not even more aggressive on discounting and giving away free things.

Okay. And then I wanted to discuss the recurring revenue, so it looks like it was up 3% sequentially, which is great to see. Just curious if you could give us any color on the maintenance renewal rate and how you kind of think about the maintenance line and the build of cloud growth to offset some of the shift from on-premise?

Yes. So on the question on renewal rates, in the Asset Management division, it's mostly still on-prem, and the renewal rates are really strong. It's really good customer retention in that side. On the Interactive side, there's more customer churn, but we have a cloud option now that we stood up our own multi-tenant cloud. So we are also getting some success in moving customers from our on-prem to our cloud. So the support revenue would drop, but the SaaS revenue would go up to offset it more than the decline in that particular example. So that's how we're getting the recurring revenue to improve.

The one thing, Stephanie, you also realize and we mentioned the video before. Video had a fair bit of that recurring revenue. And again, it's in decline. It's declined less now. I think we're at a stable rate. So I think you'll see improvement. I think a lot of the analysts predict improvement this quarter. I think they were a quarter early.

[Operator Instructions] And your next question will be from Paul Treiber at RBC Capital Markets.

Just a housekeeping item. Just on the contribution from VoicePort, NTW and Competella in the quarter. What -- how much revenue do they contribute? Or what was the contribution from a sequential point of view?

So we haven't really looked at -- published that, but I can give you some general guidelines. I think a lot of the analysts, I don't know which one -- predicted around $5.96 million, and they're about twice the amount of the contribution. So it wasn't near there. I don't know how they got that number, basically, but it's much less than that. And again, people got to remember, when you do an acquisition, the first quarter, a lot of customers hold back. They want to see what you're going to do; how does it combine with other things. So again, it's pretty normal to see that first quarter or 2 afterwards until you get it sorted out where you're going. That revenue doesn't always increase or even stay at the rate that you -- when you bought it. That's why we take that into account when we price the acquisition. And so again, it did add to the quarter. It was profitable in the quarter. It was at our margins in the quarter. All those things are good, but it didn't do the revenue that I think most people estimate it to be in the quarter.

That's helpful. And then if you look out like for the year, do you expect it to get to the run rate that people expect? Or is it like a permanent haircutter or is it temporary?

Hard to say. From a profitability point of view, it's already at the run rate. I expect it will stay there. I think from the revenue side, remember, we got many different products. Do we emphasize the products we just bought or do we emphasize that we bought a customer base that we're going to take our products into that customer base? So just looking at the acquisitions in isolation, it's too difficult a question to answer, but it won't substantially change.

That's helpful. Looking to cash, all-time high in the company's cash. The last time you had cash this high, you did do a special dividend. Is that a consideration now? Or are you looking to hold on to that cash and maybe let that cash grow if you can't find acquisition targets? Because potentially, the environment is going to be quite attractive for the next couple of years.

Well, as we went through at the AGM yesterday, we showed a little chart showing how that -- we're basically on the standard model. And the special dividend was basically the money we earned from the video deal. The video deal, we made 100% profitability in 15 months from the sense of cash flow. We paid that cash out as a special dividend. We weren't doing a special -- we don't do special dividends. But because we had that unusual good or bad, we had a pandemic that caused a lot of that volume to come in. And since then, most of the decline, as you know, came from also that volume going down. But the money we made in the first 15 months, the cash flow is what we paid out as the special dividend. If that happens again in one of our verticals, we will consider a special dividend. Otherwise, we generally use our funds for acquisitions.

Okay. That's helpful. The -- just in terms of like the license revenue -- and this is the last question. On the license revenue, you do about $80 million to $90 million a year. What proportion of that do you see as potentially migrating over to SaaS over time relative to where it is now?

I'll answer in general terms, and I'll pass it to Vince. We can't predict what moves over. We offer both on-prem and license. All the SaaS guys, if you heard what Vince said upfront, they're not doing very well. So they've got to probably increase their prices in time. Customers want deals. SaaS guys are giving it to them and losing money. So how long is that going to last? We'll have to wait and see. But we don't have a prediction. We go to our customers. If they want to go to our cloud offering, we have that offering. If they want to stay on-prem, which many still do, we will do that as well. SaaS is in the news, but it's about 20%, 25% of the volume of the revenue that's out there. But a lot of that revenue on-prem -- is sticky on on-prem and not moving. But we have both offerings. If they want to go to SaaS, we offer them SaaS. If they want to go -- stay on-prem, we stay on-prem. And we don't try and guess how many of them want to go one to the other. It might be interesting to see if some of the SaaS players have financial difficulty and maybe don't make it. There may be some of those -- that marketplace changes a little bit, especially in our contact center business. I don't try and predict that. We just sort of take that hand we're dealt and use it the best we can. And we're very flexible, and we can handle SaaS. We can handle on-prem. We can handle OEM through others. We have a pretty flexible position compared to a lot of them. We don't try and pick the right one. We just make sure whatever the customer wants, we deliver. Maybe I'd throw it to...

Yes. I think you covered most of it. The Asset Management side, very little demand for SaaS other than in our IPTV product, is a SaaS product. But we're not -- we get some requests for private cloud but very little. It's mostly in Interactive that the SaaS demand is there. But like Steve said, choice is -- this whole idea of choice that we provide is quite a differentiator actually in the market because we're one of the only companies that does that. So we're continuing with that strategy.

And it is true. Most of the competitors are going straight SaaS. Well, that's not so bad because it leaves all the premise guys for us, and we can do the SaaS as well. But they're saying they're only going to go one way. I think it was mostly because investors, analysts, et cetera, give higher value to that even though they lose money. I don't know if that will be the case in the future. The markets seem to be changing a little bit, but we can do both. We want to satisfy whatever the customer wants, and that's what we try to do.

And at this time, gentlemen, we have no other questions registered. Please proceed with any closing remarks.

Well, thank you, everyone, for attending the call today and those who attended the AGM meeting yesterday. We continue with our long-term capital allocation strategy and to invest in our operations and improve our internal growth. Thank you again for attending, and we look forward to talking to you again next quarter.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines. Have a good weekend.