Enghouse Systems Ltd. (EGHSF) CEO Steve Sadler on Q2 2018 Results - Earnings Call Transcript

| About: Enghouse Systems (EGHSF)

Enghouse Systems Ltd. (OTCPK:EGHSF) Q2 2018 Earnings Conference Call June 8, 2018 8:45 AM ET

Executives

Steve Sadler - Chairman and Chief Executive Officer

Vince Mifsud - President

Doug Bryson - Vice President, Finance

Todd May - Vice President, Legal Counsel

Sam Anidjar - Vice President, Corporate Development

Analysts

Daniel Chan - TD Securities

Paul Steep - Scotia Capital

Deepak Kaushal - GMP Securities

Paul Treiber - RBC Capital Markets

Ralph Garcea - Echelon Wealth Partners

Operator

Good day, ladies and gentlemen and welcome to the Enghouse Systems Limited 2018 Q2 Earnings 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.

Steve Sadler

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

Todd May

Certain statements made in this conference call may contain forward-looking statements, which are not historical facts, but are based on certain assumptions and reflect Enghouse’s current expectations. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risk factors are identified in Enghouse’s AIF and other periodic reports filed with applicable regulatory authorities from time-to-time. Enghouse disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Steve Sadler

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

Doug Bryson

Thanks, Steve. Yesterday, Enghouse announced its second quarter unaudited financial results for the period ended April 30, 2018. Second quarter revenue increased to $85.2 million compared to revenue of $79.5 million in the second quarter of the prior year. Income from operating activities was $24.7 million compared to $21.9 million in the prior year second quarter, a 12.8% increase.

Net income for the quarter was $15.3 million or $0.56 per diluted share compared to $9 million or $0.33 per diluted share in the prior year’s second quarter, an increase of 70%. Adjusted EBITDA for the second quarter was $25.4 million or $0.93 per diluted share compared to $22.8 million or $0.84 per diluted share last year, with the increase primarily being attributable to contributions from acquisitions. On a year-to-date basis, revenue was $170.3 million compared to revenue of $158.4 million in the prior year. Income from operating activities was $49.2 million compared to $44 million in the prior year-to-date, an increase of 11.8%.

Operating expenses before special charges related to restructuring of acquired operations were $34.4 million compared to $32.6 million in the prior year’s second quarter and include incremental operating costs related to acquisitions. Non-cash amortization charges in the quarter were $7.4 million compared to $7.5 million in the prior year’s second quarter and includes amortization charges for acquired software and customer relationships from acquired operations. On a year-to-date basis, operating expenses before special charges were $68.2 million or 40% of revenue compared to $63.9 million or 40.3% of revenue last year.

The company generated strong cash flows from operating activities of $21.8 million compared to $18.4 million in the second quarter of 2017. On a year-to-date basis, cash flows from operating activities were $44.9 million compared to $29 million in the prior year, an increase of 54.8%. As a result, Enghouse closed the quarter with a $155.3 million in cash, cash equivalents and short-term investments compared to $130.3 million at year end. Cash balance was achieved after year-to-date payments of $8.6 million in cash dividends, $9.7 million net of cash required for acquisitions concluded in the fiscal year and $5.1 million for acquisitions closed in prior periods.

Yesterday, the Board of Directors approved the company’s quarterly dividend of $0.18 per common share payable on August 31, 2018 to shareholders of record at the close of business on August 17, 2018.

I will now turn the call back to Mr. Sadler.

Steve Sadler

Thanks, Doug. As Doug noted, we continue to grow our cash with cash and short-term investments of approximately $155 million. Cash flow from operating activities was $21.8 million in Q2 and $44.9 million year-to-date compared to $18.4 million in Q2 last year and $29 million year-to-date last year. You will notice that the balance sheet exchange impact was positive $1.4 million compared to a loss over $2.4 million last year in Q2 and a loss in Q1 of 2018.

As discussed last quarter, we separated this accounting item out from our results to provide a better understanding of operating activities. The provision for income taxes was more normal at 21% of income in the quarter after the adjustment of $8.8 million in Q1 one-time accounting charge related to the estimated U.S. repatriation tax imposed in foreign U.S. subsidiaries for deemed repatriation of foreign profits in Q1.

Some items to note in the Q2 results, deferred revenue increased $76 million in Q2 from $68.8 million in Q1 and $62.4 million at October 31, 2017 the end of our prior fiscal year. Software license revenue and hosted and maintenance services increased by over 10% compared to Q2 last year and 9.5% year-to-date. We continue to focus on revenue improving ideas which will take a couple of quarters to determine their success and reflect in our internal growth results. Our markets remain challenging as revenue shifts to subscription revenue and competition from SaaS providers who emphasized revenue at the expense of cash flow and profitability. We continue to have a strong EBITDA margin of nearly 30%.

For acquisitions, we completed the acquisition of Mobilethink late in the quarter, which added approximately $300,000 in revenue and was immediately profitable. One must remember that this was not even a full month of Mobilethink’s revenue as we did it April 5. Mobilethink and the two acquisitions completed in Q1 are profitable and operating as expected. The economic and market factors remained favorable for acquisition opportunities.

I would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We will take an opening question from Daniel Chan of TD Securities. Please go ahead.

Daniel Chan

Hi, good morning guys. Just on the Mobilethink acquisition, this is I believe you made a number of acquisitions in Denmark, what is the cross-sell opportunity with this acquisition?

Steve Sadler

Well, I am told by my team that there is some good cross-sell opportunities. I never depend on them and so we will have to wait and see if it happens.

Daniel Chan

Great, thanks. And then Steve, why don’t you comment on the competitive environment whether you are seeing impact from Amazon or Twilio in the market yet?

Steve Sadler

No. I should add a little bit. There is nothing in the market or results that we see any impact competition or anything like that, but it does help as I mentioned it to some of our potential acquisition candidates to give them a little more motivation to sell, i.e., it’s more of a risk or a concern for them and us.

Daniel Chan

Yes, that makes sense. And then maybe I wonder if you could comment a little bit on some of the progress on some of the initiatives you have been trying…

Doug Bryson

It’s my first full quarter as you know. I focused most of it in the area of demand. So we added couple of demand gen leaders one on the interactive side and one on the networks to start to get the pipeline of inbound leads started. So we added two good leaders there. We have also started to reorganize the sales teams starting in Americas with having both kind of a channel go-to-market as well as direct, so we did that reorganization in Q2. And Steve said, hopefully, we will start to see some improvements in the next couple of quarters on the organic side.

Daniel Chan

As it relates to some of those reorganizations, are you thinking about SG&A kind of coming off from these current levels, because SG&A was a little bit lower than I expected and typically we see sequential growth in Q2, but it’s actually flat to down this quarter, so how should we think about SG&A going forward?

Doug Bryson

Who is the question for?

Daniel Chan

Well, either one of you, yes.

Doug Bryson

Okay. I think the SG&A will probably increase a little bit, but not substantially. I don’t see it going down, but I do see it probably increasing a little bit and there maybe changes that are needed there as we change our strategy. As Vince said, we are going to probably add some people going a little bit more direct, especially on our CCSP side. And yes, we are going to continue with our channel model as well. So, it should go up a little bit, but I wouldn’t model it drastically different. But I wouldn’t model it down.

Daniel Chan

Okay, great. Thanks. I will pass the line.

Operator

Thank you. We will take our next question from Paul Steep of Scotia Capital. Please go ahead.

Paul Steep

Good morning. Steve, maybe just on an actual topic, how do you think about balancing the margin improvements we saw in the quarter versus some of the investments you are talking about making we have – you have had dialed it back and now Vince has laid out that gee, it looks like you are going to sort of shift things a bit, how should we think over the next year or 2 years that sort of plays out?

Steve Sadler

Well, if we are successful with the sales effort and getting started on demand generation first, it means our revenue line will go higher and probably our margins will improve. If we are not successful, we have more costs then the revenue will stay the same and the margins will do go down a bit.

Paul Steep

Fair enough. On the asset management side, we saw big pickup in margins and we saw some of the holdbacks start to sort of rollout, is this related to maybe over-performance of any of the deals you did a year ago things like total grade or is what else is maybe sort of playing out in the asset management segment this quarter?

Steve Sadler

I think the deals that we did a year ago are starting to and have showed some progress, so I think it comes from there. But as you know and I remind the group that when we do a deal in the first quarter or 3 months after doing so, you generally don’t have any added profitability depending on the deal of course. Then the second quarter you generally break it and make a little third quarter, you get halfway to our normal margins and by the fourth quarter we are at normal margins. So some of the ones last year they are basically in the fourth quarter. So we are getting back to the normal margins. And that’s a general trend for smaller ones, some times, if you can tell by the restructuring, because it always takes a little time, but some like the Mobilethink, we didn’t have to restructure very much. As you noticed, there wasn’t much of a restructuring charge in the quarter. So they tend to get – make they tend to go faster in that model, i.e., the first quarter we didn’t lose any money, so second quarter we definitely made a little bit and hopefully third and fourth it will progress further. So to get to your exact question, yes, total rate from last year is hitting our normal margins. So yes, it’s improved.

Paul Steep

Okay. The one thing I did want to ask about is have you noticed any changes in the channel environment on the contact center side you get a number of sort of key relationships there with large OEMs. How has that played out or has there been any change at all in that market environment?

Steve Sadler

There has been a little change there and it’s not really us, it’s because of the market. Those channels generally sell on-premise. So, it hurts us a little bit as well when the SaaS model clicks in, they don’t have a SaaS offering. So, what we are trying to do now and Vince is getting this organized is we are going to offer them to sell on our SaaS system which we will have setup in a few platform accounts hopefully in each country. We are progressing with setting up the platforms and then we will let them be able to still keep customer control by selling on the platforms that we setup. We have just got to get – we are pretty good right now with platforms, we have got pretty good response, but we need to do a little bit more.

Paul Steep

Okay. Last one on my side…

Steve Sadler

So, the channel with the SaaS side, it really hurts the channel, because when you do SaaS, they don’t make their usual money on selling hardware, they don’t make their usual money on doing a lot of services. So it’s hurt their business at which then hurts our business for that side of what we are doing. So the channel has – it’s a challenging environment for the channel these days, but we hope we can help them soon.

Paul Steep

Okay, thanks. And then the last one on my end, deferred revenue, slightly up year-on-year in terms of the total in line with the business, but a little bit better maybe some comments around what guys have seen on maintenance renewal rates or anything either you or Vince has done to try to help tweak that up or is it just normal course of business?

Steve Sadler

I think we are always trying to do things that make a little bit better. Again, we are looking at we give a pretty good service. We haven’t always in all our territories done annual price increases, which we should do, because if you are paying your people more and you don’t do increases on your maintenance you are just squeezing your margins a bit. So, Vince has got a little more time than I had on focusing to make sure we do that, so we have done that side. The churn – there is always some, because as you are going to a subscription or a different type model, you see that, that has some impact on our deferred revenue plus and minus. I’d say we are still around the 90%, 92% overall and it’s a little bit different between the asset management side and the interactive side, but let’s say it’s pretty normal.

Vince Mifsud

Yes. On the sales execution side, we started to point some people in the area of customer success you know focused on retention and renewing maintenance contracts and subscription agreements and so on. So, we have a few people more focused on it. So hopefully that will also help a bit.

Paul Steep

Just on one side, so did you try to do sort of a leader on either side?

Vince Mifsud

On both sides, yes, on all the different divisions.

Steve Sadler

It was not even in one of both sides. We also have like each country got ready to do it and we still got a bit more work to do, because it’s not – we have got a lot of different geographies to look at, but we are working on it, but it’s not our biggest issue at this stage, it’s just another refinement to improve things a little bit.

Paul Steep

Perfect. Thanks, guys. Appreciate it.

Operator

We will take our next question from Deepak Kaushal of GMP Securities. Please go ahead.

Deepak Kaushal

Hi, good morning guys. Thanks for taking my questions. We only get to it once or 4 times a year when you guys hold your conference calls. I hope you keep a little. Just wanted to – Steve, I just wanted to ask you more about the M&A environment, I think you alluded to earlier competition like Amazon providing more motivation for sellers, I mean, what’s the dynamic with sellers, I mean, is there a hold up or is there sticking point on valuation, what can you say about the sellers and how they think about telling their businesses and you as a buyer overcoming those challenges, where are the sticking points on the negotiations?

Steve Sadler

I think the opportunities are good, not much has changed. I discussed several times why people are selling and the people we see. Private equity generally don’t want to do smaller deals, that’s still the case. People aren’t getting younger, they are getting older, so you have got a lot of entrepreneurs in that baby-boomer era. And I have said it last year and the year before, but they are not getting any younger, so that’s still a motivation for some to get some retirement money. The market is pretty good. Interest rates going up in the U.S., people worry about that. Remember, a lot of people have good and built a nice little business, the old look forward and if they have to invest, for example, in SaaS, because that’s where they see it’s going, they don’t want to spend their pension money and their retirement money on the chance that they will be successful there, because many companies are not and that usually is not a profitable venture in the beginning and it’s still yet to be seen how long you have to go before you make it profitable, because many have been out there already for years and are not profitable. So the market hasn’t changed. Its interface going up, I would say, if anything, the opportunities have gotten greater.

Deepak Kaushal

Okay. So last year you guys invested in some of your internal systems with the expectation of accelerating M&A activity this year and you are believe you are great, when I look at your $155 million cash balance, how much do you think or do you target to deploy this year and in further M&A activity? And at what point you kind of look at this and say well, hey, the sellers don’t have realistic expectations, I mean, we allocate more of that capital back to dividend increase?

Steve Sadler

Yes, very easy, we don’t have a budget to how which we have to do each year. We try and set a target for ourselves and generally we work within our operating cash flow that we generate. So it’s not – it has to meet our financial disciplines. If people don’t have realistic expectations, we don’t do the deals. If they do have realistic expectations, we do, do the deals. So there is no budget. We do what we think is right. We have been pretty good at it for years and we are comfortable that we should not change that model. I think overall on the acquisition size, I say the opportunities are pretty good, I don’t see needing to payout a higher dividend, well, me getting some extra cash flow and dividends and I don’t mind, but right now I think we can better deploy that capital, then give it to shareholders as we have in the past.

Deepak Kaushal

Okay, excellent. And just one last question on that M&A, so you had a flurry of activity couple of years over the last 5 years on the interactive site that’s kind of slowed than it was more on the telco side where you found your value, not much on the transportation side, out of those three buckets, where are you kind of seeing the value and the opportunities, is it balanced across the three portfolios or weighted towards one and the other?

Steve Sadler

Yes, a lot of – we have done a lot of acquisitions already in the IMG sector, so of course, there is somewhat less to do. As you noted, we did a lot in the network side, again, the asset management side there at least, that continues, because it’s a fragmented industry. And quite frankly, the service providers are getting very tough on their pricing and their bargaining power in some ways that hurts, in turn it results a little bit, but it also helps our acquisition strategies. So, I think that will continue. And transportation, I think you have noticed we did do a couple of little acquisitions in that, in the last little while. And we continue to look, but it seems to be an expensive market right now.

Deepak Kaushal

Okay, excellent. That’s helpful. Thanks so much. I will pass the line.

Operator

We will take our next question from Paul Treiber of RBC Capital Markets. Please go ahead.

Paul Treiber

Thanks very much and good morning. I just wanted if you could help set expectations around Mobilethink a little bit, there has been some public disclosures from his prior owners disregarding its annual revenue, I think that is close $13 million in ‘16, is that a reasonable level to expect going forward? And then in light of your comment on the first quarter or the first month or last month, $300,000, is there anything unusual in the $300,000 above or below what should be a normal run-rate?

Steve Sadler

So I have two comments there. First of all, the $13 million was quite a while ago and that’s not their normal run-rate but we don’t forecast run-rate so that’s high. Second of all, in the quarter you have got two factors, it wasn’t a full month for us and it was as you know in enterprise software lots of revenue or more revenue tends to happen in the third month of the quarter, April is the first month of their quarter, so you also have the impact of being the first month where revenue was generally light in enterprise software companies and it’s no different for Mobilethink or any other ones that I have seen that do enterprise software. So, you do have that impact in that short period of a few weeks in the first quarter, but the estimates you might have set from the past are just not right. So, I can’t make any other further comment on that.

Paul Treiber

Okay, that’s fair. I guess on M&A, you mean historically, you haven’t done this, but maybe perhaps you would is are there any metrics or is there anyway that you can quantify the level of activity we are seeing in the market in terms of like the deals that you are working on in terms like NDAs signed. Anything like that, that can help us understand the type of work that you are doing right now and the activity that you are seeing?

Steve Sadler

No, not really, NDAs come and we have a nice flow every week, we are signing some, but then some of the people want too much, some people don’t pass through due diligence, some don’t meet our financial parameters. All I can tell you, it’s the same as it has been in the past generally. That’s what you have got to assume. It might come in lumps or it might come steady, but we don’t see any different in the activity, except there are more opportunities today generally then there have been in the past.

Paul Treiber

And just the last question just with Vince on board for about 6 months or so, has your workflow changed over the time in terms of the ability to spend more time on M&A as opposed to operations or is it still in a transitionary period?

Steve Sadler

I would say it might seem to Vince that he has been here for 6 months, but he hasn’t been here for 6 months. He is actually, this is he said, it was his first full quarter he just joined before the start of the quarter. So it’s actually been a little shorter than that. We are still transitioning over some of the operations. He has had meetings with the groups. It takes time. And we are slowly doing that and I am sort of now spending a little bit more time on acquisitions, but that sort of takes a little bit of time. To do so, we are just doing the normal transition of those activities.

Paul Treiber

Okay, great. I will pass on.

Operator

[Operator Instructions] We will take our next question from Ralph Garcea of Echelon Wealth Partners. Please go ahead.

Ralph Garcea

Yes, good morning. Thanks for taking my questions. I guess, for Vince, first on the demand gen inside, can you get to $500 million in revenue over the next couple of years just sort of reaching in the sales force and looking for new opportunities or do you have to go into adjacent verticals and/or new geographies to do that?

Vince Mifsud

I mean, we don’t – as you know we don’t forecast internal growth or organic growth to the Street, but in terms of the market size, if you are sort of asking it is the market big enough in interactive and networks and the addressable market is big. This whole customer experience base is big focusing on retention of customers and better call center management. So they are big market, but my goal is to try to just get the organic growth improved over time, but there is no market limitation so to speak that I see.

Ralph Garcea

And have you added sales capacity over the last 3 months other than the two sort of leads that you mentioned?

Vince Mifsud

No, I have mainly added on the demand gen side in order to get sort of the pipe, the inbound lead flow happening, no use of adding sales guys until you get your pipe – your pipeline moving and your inbound leads flowing. So, we have just reorganized the existing team in America from just a pure channel to have more direct and added more on the demand gen side of the business.

Ralph Garcea

Okay. And then for Steve as you look at your pipeline on the M&A side, are you seeing more still in Scandinavia in Europe or are there more – are there opportunities for you in Latin America or Asia even there or Australia, I mean, just sort of grow new geographies from an M&A perspective?

Steve Sadler

Generally, we are seeing good demand globally. I would not count on Asia, because we tend not to look there, the difficult market to be in actually. If you are in, you are good, but it’s hard to get in and their business approaches are slightly different than we are used to. South America, yes, we are still through presence trying to build that a little bit, but we are looking generally in all areas both in current geographies where we are at and in new geographies.

Ralph Garcea

Okay, thank you.

Operator

[Operator Instructions] As we appear to have no further questions queued, I would like to turn the call back to the speakers for any additional or closing remarks.

Steve Sadler

Well, thank you for attending the call everybody. We appreciate your interest in our business and look forward to providing you another update after our next quarter.

Operator

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

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