Enghouse Systems Limited's (EGHSF) CEO Steve Sadler on Q2 2019 Results - Earnings Call Transcript

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About: Enghouse Systems Limited (EGHSF)
by: SA Transcripts
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Earning Call Audio

Enghouse Systems Limited (OTCPK:EGHSF) Q2 2019 Results Earnings Conference Call June 7, 2019 8:30 AM ET

Company Participants

Steve Sadler - Chairman and CEO

Vince Mifsud - President

Doug Bryson - Vice President, Finance

Todd May - Vice President, Legal Counsel

Sam Anidjar - Vice President, Corporate Development

Conference Call Participants

Paul Steep - Scotia Capital

Deepak Kaushal - GMP Securities

Paul Treiber - RBC Capital Markets

David Li - Lizard Investors

Daniel Chan - TD Securities

Operator

Please standby. Good day, ladies and gentlemen. And welcome to the Enghouse Systems Limited 2019 Q2 Earnings Call. Today’s conference is being recorded.

At this time, I would like to turn the call over to Steve Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.

Steve Sadler

Good morning. I am here today with Vince Mifsud, President; Doug Bryson, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development.

Before we begin, I have Todd read our forward disclaimer.

Todd May

Certain statements made may be forward-looking statements. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those discussed in Enghouse’s AIF and other continuous disclosure documents, which could cause the company’s actual results and experience to differ materially from anticipated results or expectations.

You should not place undue reliance on this forward-looking information and the company shall have no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Steve Sadler

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

Doug Bryson

Thanks, Steve. Yesterday, Enghouse announced its unaudited second quarter financial results for the period ended April 30, 2019. Second quarter revenue increased to $89.2 million, compared to revenue of $85.2 million in the second quarter of the prior year. The revenue increase primarily reflects contributions from acquisitions and incremental license revenue in both operating groups.

Results from operating activities were $26.6 million, compared to $24.7 million in the prior year’s second quarter, an increase of 7.9%.

Net income for the quarter was $16.5 million or $0.30 per diluted share, compared to $15.3 million or $0.28 per diluted share in the prior year’s second quarter. Adjusted EBITDA for the second quarter was $27.2 million or $0.49 per diluted share, compared to $25.4 million or $0.46 per diluted share last year, with the increase being attributable to incremental revenue contributions from acquisitions and operating cost synergies.

On a year-to-date basis, revenue was $175.2 million, compared to revenue of $170.3 million in the prior year. Results from operating activities were $52.4 million, compared to $49.2 million in the prior year-to-date, an increase of 6.6%.

On a year-to-date basis, adjusted EBITDA was $53.5 million or $0.97 per diluted share, compared to $50.7 million or $0.93 per diluted share last year.

Operating expenses before special charges related to restructuring of acquired operations were $35.1 million, compared to $34.4 million in the prior year’s second quarter and reflect incremental operating costs related to acquisitions, net of operating cost synergies.

Non-cash amortization charges on amortized -- on acquired software and customer relationships from acquired operations were $6.9 million for the quarter, compared to $7.4 million in the prior year’s second quarter.

The company generated cash flows from operating activities of $21.6 million, compared to $21.8 million in the second quarter of last year. On a year-to-date basis, cash flows from operating activities were $45.8 million, an increase of 1.9% compared to the prior year.

As a result, Enghouse closed the quarter with $205.5 million in cash, cash equivalents and short-term investments, compared to $193.9 million in October 31, 2018. The cash balance was achieved after payments of $9.8 million for cash dividends and $25.6 million net of cash acquired for acquisitions concluded in the current fiscal year and $1.1 million for acquisitions closed in prior years.

Subsequent to quarter end, Enghouse completed the acquisitions of Vidyo, Inc. and Espial Group Inc. The acquisitions extend the company’s product portfolio to include enterprise-class video software solutions to enable customers to more efficiently collaborate and interact, as well as a solution portfolio to help video service providers launch the next-generation video offerings for cable, IPTV and App-based IP video services.

Yesterday, the Board of Directors approved the company’s eligible quarterly dividend of $0.11 per common share payable on August 30, 2019 to shareholders of record at the close of business on August 16, 2019.

I will now turn the call back over to Mr. Sadler to provide an update on the quarter. Steve?

Steve Sadler

Thank you, Doug. As Doug noted, we continue to have a strong cash position of over $205 million, compared to $190 million at the end of Q1 January 31, 2019. Cash flow before changes in working capital was $29 million, an increase of 7.4% over the prior year. We paid $4.9 million in dividends and $3.2 million for the acquisition of ProOpti in the quarter. Excluding the ProOpti acquisition, the quarter revenue increased by over 3% internally from prior quarter Q1. It also increased by 5% over the prior year.

We are seeing signs of continued internal growth for the second half of the fiscal year. Adjusted EBITDA remains over 30% in the quarter. Foreign exchange negatively impacted revenue compared to Q1, but not by a significant amount a few $100,000. Deferred revenue increased 17% from the year end value to $77.5 million.

After the end of the quarter, we announced the completion of Vidyo -- the Vidyo acquisition in mid-May and Espial acquisition near the end of May. These acquisitions resulted in deployment of approximately $75 million of our cash, after considering the purchase price paid, banker fees, legal fees, sale bonuses and some restructuring costs.

We expect these acquisitions on an annualized basis to add $20 -- $70 million to $75 million in revenue, after being negatively adjusted for the purchase price accounting on deferred revenue and other items.

Revenue for Q3 will not only reflect the purchase price accounting adjustment, but will only include revenue recognized from the date of acquisition rather than the full quarter. We expect that although the acquisitions will not achieve our normal EBITDA margins in the first two quarters due to the purchase price accounting adjustments and business operational activities.

We believe results will be EBITDA positive before restructuring costs in Q3 and improved further in Q4. Both Espial and Vidyo had plans to restructure their business, which were significantly completed before the acquisition by Enghouse, but not fully completed.

Economic and market factors in our service industries continued to be favorable to our acquisition strategy and meeting our acquisition financial payback criteria. As stated previously, we have provided more focus to capital deployment in fiscal 2019, as well as positioning to improve internal growth in future years.

I would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question will comes from Paul Steep with Scotia Capital.

Paul Steep

Great. Good morning. Thanks Steve. Steve can you talk a little bit about -- more about Espial and just to clarify, obviously, we know they were already doing the restructuring that operating model I was scribbled down operating cost on EBITDA by Q3 or Q4 is that the third quarter and fourth quarter you have just owning it, just to be clear?

Steve Sadler

No. Q3 is a quarter we are in right now.

Paul Steep

Right.

Steve Sadler

And Q4 is the next quarter. It’s a quarter this year.

Paul Steep

Okay. But I am -- sorry.

Steve Sadler

And in Q3, they all will be a part of a quarter, right? And in Q4 and in the purchase price adjustment we have to take off our revenue and it goes right to the bottomline and that’s just an accounting thing, it’s non-cash. But it’s has the greatest impact in the early quarters like Q3 and Q4.

Paul Steep

Correct. So the ramp-up though for Espial being biggest of the two, how quickly should we think about that sort of mid-year? How close is that to your model at that point or do you think there is still a decent amount to drag there?

Steve Sadler

We think we will be on the model next year. But Espial is the smallest of the two acquisitions.

Paul Steep

Okay.

Steve Sadler

It’s about half the size of the Vidyo acquisitions. So its impact actually is less than the Vidyo impact.

Paul Steep

Okay. And the cloud revenue out of Espial, how close and where do you think you are going to report that cloud revenue in terms of the go-forward subscription, since they were transitioning to that model?

Steve Sadler

Yeah. They had transitioned a lot of it already to the model. We are hoping to increase it as we go forward.

Paul Steep

Got it. And if we move over to Vidyo, could you talk about the split in that business between hardware and software, just to help us sort of reconcile maybe the multiple that was purchased for it, our assumption might have been that there were some hardware in the business, maybe it’s less that and something else?

Steve Sadler

No hardware.

Paul Steep

Got you.

Steve Sadler

So it’s really software, mostly software in the cloud SaaS model and very little professional services.

Paul Steep

Okay. Final one on my side is the teams and getting an update as to where you see the business going in terms of the interactive side and the impact on contact center with Microsoft shifting over we have talked about it. Any updates on where we are at in that transition?

Steve Sadler

We are continuing to do it. I think I said in the last call, they were going to be ready with their APIs and we would be ready by the fall. That’s still my impression. So, yes, it’s’ stabilized for sure. But I think the impact of that will be next year.

Paul Steep

Yeah.

Steve Sadler

The positive impact once that version is out of next year because the market’s frozen a little bit now. But people are still buying Skype of Business.

Paul Steep

Perfect. All right. I will leave it there. Thanks, guys.

Operator

And next we will hear from Deepak Kaushal with GMP Securities.

Deepak Kaushal

Hey. Good morning, guys. Can you hear me? Hello?

Steve Sadler

We can hear you.

Deepak Kaushal

Oh! Good. Sorry, I was on mute.

Doug Bryson

Yeah.

Steve Sadler

Hello.

Deepak Kaushal

Got it. I have a question, just on Espial. Sorry, I have been calling Espial for years. I have counted 15 years of this business’ EBITDA and only two of those years have been EBITDA positive. So you guys seem pretty confident that you can get it EBITDA positive or breakeven in the first quarter and positive and growing in the second quarter after owning it. Maybe Steve you can give us some details on how you get there? I mean, where did the cost savings come from? What’s the strategy? Any kind of details you can give us on that past and how you can achieve that versus why they couldn’t achieve that in the past, would be helpful?

Steve Sadler

I don’t know why they couldn’t have achieved it. Like all acquisitions we do, we match cost and revenue. So if we have costs that aren’t producing enough revenue, we cut those down. And the revenue we try to increase, if we are not getting enough money for some of the spending we are doing with customers. So there’s a lot of factors, but we are pretty confident we will achieve our objectives there and it will be EBITDA positive in the current quarter, Q3, the one we are in right now.

Deepak Kaushal

Okay. So, I mean, like, when I look at the numbers and even if you just got G&A you are still not at EBITDA positive. Something’s got to come out at sales and marketing and R&D, are there synergies on the sales and marketing side you can have or do you have guys have a method to get more R&D efficiency out of the business or -- and to give you further, I mean, like, the revenue dropped 20% last year. I understand they are transitioning to SaaS and cloud from a licensing model. How do you get more cost out of it and not hamper that transition and potentially even expand markets, because you have a broader customer base you can perhaps dip into?

Steve Sadler

It isn’t the big sales of marketing issue. They probably need to add some sales of marketing in their model and all the factors we discussed we look at.

Deepak Kaushal

Okay. So -- okay.

Steve Sadler

There are all kinds of -- there’s all kinds of other cost in there. You talked a little bit about people, but public cost these days are a fairly large expense, so they won’t have that anymore. We have done some of the restructuring beforehand. We have got a little bit more to do afterwards.

We are looking at the revenue to see how we can improve that a little bit and maybe some of the -- if there are some negative revenue, often we buy companies that have revenue that loses money, we will probably eliminate that and not lose money. There’s all kinds of factors we glint to. There’s not a magic -- it looks like magic, but there’s not a magic solution. It’s just matching cost and revenue.

Deepak Kaushal

Okay. Got it. So looking forward to the next quarter. Going to Vidyo, the margins for that…

Steve Sadler

Not to interrupt, but we believe we will be positive EBITDA this quarter, not -- and next quarter will be improved.

Deepak Kaushal

Got it. And the $70 million to $75 million includes the -- you said, sorry, the $75 million in cash that you are paying, that includes all the restructuring costs and the fees, all one-time charges that you expect to…

Steve Sadler

There are restructuring costs in there and I mentioned them because people have used, for example, Espial’s cash balance. That cash balance did not include some of those costs when we buy a public company. When they pay bankers’ fees and those things, you have got to add those costs, because in a sense, we are paying it because we bought their shares and they pay it on closing.

So a lot of -- some of the restructuring costs are in there, but there’s more to come, because not all the restructuring costs were done in the two acquisitions. But a lot was done. So you can’t expect huge restructuring costs, but there will be some.

Deepak Kaushal

Got it. Okay. And then just on the Vidyo side, I think, in response to one of Paul’s questions earlier, you said that, Vidyo was the bigger of the two. Maybe you can give us some more color, because their financial metrics are a bit more opaque. I mean what kind of revenues revenue growth that this company been seeing? What is the gross margin profile look like and is that a similar situation with Espial where you have to take it from a EBITDA lost business to an EBITDA positive business or is that easier, more typical event chest? And I have got one more question and then I will pass the line.

Steve Sadler

Well, I think, you did about three or four questions there. But we will try and go through them, if I missed one you can ask. We already announced that they did about $60 million in revenue and as you know Espial public does about -- it did $4 million in the first quarter -- $6 million in the first quarter, so they are running at about $24 million, maybe $25 million. So that’s the revenue profile of the two.

So it’s seems to be twice the size of Espial. I think that was one of your question you asked. They absolutely were losing money, so it’s similar to Espial. Some restructuring certainly was done in advance of the acquisition.

And again like your question on how do you get it profitable, it’s a same answer I had for profitable and most of our acquisitions. We match cost and revenue, and we try to improve the revenue. We try to see where the costs that are being expended do not or not value in the sense that they generate enough revenue to justify themselves.

Deepak Kaushal

Got it. And so we get to…

Steve Sadler

One…

Deepak Kaushal

And any color on the gross margin, because Espial certainly has strong gross margin. I assume with Vidyo as a software business similar kind of gross margin.

Steve Sadler

Yeah.

Deepak Kaushal

Okay.

Steve Sadler

No real hardware our other costs in there. So there -- it’s similar to our other businesses. So in time we should be able to get the margin up. But we have to do a fair bit of work, because both these companies were not making money and haven’t made money for some time. So, now it’s, I guess, we are going to see if we can improve that.

Deepak Kaushal

Okay. And then my last question and I know I have asked a lot, but it’s exciting to be able to ask you something new and get some new answers out of you. So -- both of these businesses are in the video business, albeit one in video service providers and IPTV and et cetera, and the other one in enterprise video. Can this be a real third pillar to Interactive and the other segments, Transportation, Interactive? I don’t really consider Transportation a pillar, but could this really be another third pillar and you see an opportunity or a runway for more acquisitions related to Vidyo that you can get some kind of synergies out of?

Steve Sadler

So the answer is it could be. It does ties to actually both the other pillars, if you want to call them that, because contact centers do need video and some of their customers are contact center competitors. So that’s interesting.

And also, service providers, probably, use an interesting customer base to do -- take some video to there. So, yes, it could be a third pillar. But right now it’s mainly -- we are going to put it in the Interactive Group, because that’s where it really ties to, but we hope our Asset Management Group also cross sells it.

Deepak Kaushal

Okay. Excellent. Well, thanks for taking all my questions and sub-questions and for all the other questions and I appreciate it. I will pass the line.

Operator

And our next question will come from Paul Treiber with RBC Capital Markets.

Paul Treiber

Thanks so much. Good morning. Just want to follow-up on Vidyo and the purchase multiple and maybe the background, as you are paying $40 million for $60 million in revenue, that’s typical for what you would pay. But it’s quite cheap for a VC backed SaaS company. I was hoping can you provide some insight in terms of the background of the acquisition and maybe if there was an auction process and how that went?

Steve Sadler

Yeah. I mean, we assume there was other bidders, so I guess there -- as you call it an auction process, it’s been on the market for some time. It’s typical for what we do. We go ahead and look and try and decide how we can get our paybacks for our shareholders and we make our offer, and I guess, it was the best one.

Paul Treiber

Okay. And then, looking forward on that business they have, I think, there’s a couple of core platforms there. Do you -- is the plan to keep all three of them operational or do you intend to narrow the focus down, like with some of them little bit more legacy or less traction in the market or some of them more -- they just have a higher run rate of business and it’s not negative revenue?

Steve Sadler

I would think we might increase the platform offering and the other advantage we have is they are mostly in the U.S. We do have a global structure and maybe our global structure can use that product in other geographical areas. So, we are going to investigate that, but we probably have to do a little bit of R&D work before that happens. So that takes a little bit of time.

But we are not decreasing the platform now. They have a hybrid model like we do. We can sell in the cloud and we can sell on-premise and we intend to offer both. They did not do much in professional services. We probably can do more in that regard with them. So there’s a lot of things we are looking at and seeing which will make sense to do over time.

Paul Treiber

And just the -- in regards to like a sales strategy, I mean, you mentioned that you are going to put in the Interactive Group, but then you also spoke about service provider strategy and opportunity. Have you seen the revenue synergies between Interactive and Asset Management? I think there’s some potential crossover that you have been trying to generate there?

Steve Sadler

We will just think about it. Our CCSP product, which is the cloud product in contact center is sold by service providers. So we already are doing cross selling between the two divisions in that regard, so this is just another opportunity to do more of it.

Paul Treiber

Okay. And then lastly for me, these are two large acquisitions, you mentioned a couple times there is a fair amount of work to do. Should we expect the pace of M&A to slow in the next, I don’t know six months to nine months or so, as you focus on integrating these businesses?

Steve Sadler

It depends what you are slowing from. I don’t expect to do this size of operations every quarter. But we do not think our normal pace of acquisitions will slow.

Paul Treiber

Okay. Great. Thanks a lot.

Operator

[Operator Instructions] Next we will hear from David Li with Lizard Investors.

David Li

Hey, guys. Thanks. I hope you guys hear me okay. Thanks for taking my call. Maybe a few questions, Steve, how is Vidyo and Espial in terms of the characteristics of these companies the different from some of the acquisitions you have done in the past, other than the fact that there is no professional service, no hardware, it’s still very much a pure software business. What are some of the things that little bit different from some of the traditional things you have done in the past?

Steve Sadler

They are a little bit more in the cloud. They have made more of a transition there. We have generally been more on-premise and we did the cloud through service providers to a large extent. So they are a little bit more orientated towards the cloud, other than that they are pretty similar. So I wouldn’t think there is a real big difference between the two.

David Li

And in terms of the channels, do you also feel like you saying, you guys are traditionally more service provider, like, do you feel like the channel wise, like, they have a more of a direct channel or more of a bar channel or the channel mix is also maybe a little bit different from what you had historically?

Steve Sadler

You have got to remember our Asset Management Group was basically all direct and our IMG Group was mostly channel, but over the last year we have -- are changing it to be more direct as well. So if it’s okay, there is no -- it will do channel and it will do direct.

David Li

Okay.

Steve Sadler

Whatever makes sense we will do.

David Li

And sounds like from your comment to one of the questions is, there is actually a decent amount of synergies across the service providers for Vidyo and Espial. Can you just maybe talk about organic, if there is something like just on the -- you actually will have some more products to sell to your existing service provider, is this something that’s fairly realistic that you guys can totally synergize?

Steve Sadler

It will take time. But if you think about it and you look at other video companies, you should -- service providers should be interested in that technology. We see service providers as being interested in adding minutes. Vidyo adds minutes. So, we will have to explore it. We don’t know yet, but we think there is probably an opportunity for us, but it will take time to get there, because we -- you have got to make the product right for that group.

David Li

Great. And also the Microsoft contact center transitioning, other than that, do you feel like for Interactive segment, there might be some structural things going on that might prevent you guys from sort of being able to deliver like-for-like growth or flat in the future or you think it’s -- this is pretty much all Microsoft related?

Steve Sadler

No. It’s not. What we want to do is and we are looking at various options right now of how we could -- we have a SaaS product, it only goes through service providers. And we don’t have enough revenue in North America especially in the U.S. So we are looking at ways of maybe enhancing that in the future. It’s -- but it’s -- the good news is it’s not a product issue.

We have the product. It’s a go-to-market issue and when you go through channels it’s tough. So Vince has been over the last year trying to get a more direct approach, which you need, if you are going to change the strategy a little bit in that area.

So we are still positioning to do that and the Microsoft team seems a good place where we were in the past with Skype for Business. So we are still positive there and we hope to improve our direct access to market also in the future.

David Li

You guys little bit surprised, Skype seem to do well, I mean, obviously, Zoom came out and Zoom is growing like very, very high rate. Is there something opportunity with some of the other platforms or those guys are completely competing, you can’t really leverage off it?

Steve Sadler

We always try and leverage off our software by putting it together. Certainly, there is a question mark with our contact center type operation, which is basically doesn’t have a lot of video, but we actually tie to another video product in a minor way today. So maybe there’s some opportunities there. But it depends on what the customers want. Do they want video in their contact centers or not?

David Li

Yeah.

Steve Sadler

We will be able to offer. We will be able to put it together and we will just have to see what happens.

David Li

And maybe last question from my end and thanks a lot for doing this. In terms of your installed base, all the products you have in the contact centers. Is there, I mean, do you feel like this is really sticky enough that as these companies transition from on-prem to a SaaS that you guys would definitely be part of it or you guys feel like you can see a bunch of churns coming, where the customers really don’t give you guys the option to buy your product, where do we just buy whatever it’s hot and popular off the shelf in the marketplace. I just want to get a sense little bit of how much you guys are in control of this whole transition and being able to keep your customers and at least keep the revenues?

Steve Sadler

As part of thing, we are trying to do, emphasize more customer success going to our current customers. I think in the past we haven’t shown or they didn’t know that we had some of these other products, especially our -- remember our CCSP, which is our cloud product and contact center, we are in the biggest telcos in the world. So we can scale, many can’t.

So I don’t think we actually went to our base and explain what we actually have, as well as we should. So again that’s one of the things that Vince has undertaken, to emphasize more, getting the customers to understand all the options we have and they can pick. They want to be on-premise, we can do that. They want to be in the cloud, we can do that.

So, I think, we have got to be -- and that’s again a little bit of our problem especially in the U.S., the go-to-market through channels. They really don’t want to sell the cloud. They are trying to do on-premise because they are really a reseller and they want to make money selling hardware whatever else they sell with our product. So that’s why going up towards the direct model. We think we will be able to help that process, but it takes some time and we are still in the process of doing that.

David Li

Okay. And -- no that’s about it actually for me. Thank you so much, Steve.

Operator

And our next question will come from Daniel Chan with TD Securities.

Daniel Chan

Hi. Good morning. You mentioned $70 million to $75 million in revenue from acquisitions in the next 12 months following purchase price accounting. But you also discussed potentially looking at revenue that generates losses and maybe removing some of that. So in addition to that $70 million, $75 million, is there potential for that to come in lower as you look at some of those revenues and do you plan to running off any revenues that’s losing money?

Steve Sadler

That’s true. First of all, the $70 million to $75 million is just from those two acquisitions. It’s not from other things. It’s only from those two. And generally I take those things into account when I put a number out there. So I believe the $70 million to $75 million holds true included -- including the comment that it might eliminate some revenue.

Daniel Chan

Okay. That’s helpful. Thank you. And then, you mentioned that Vidyo maybe a third segment that you may be able to acquire into. Can you just give us some color on the deal pipeline, how much of that is related to Vidyo?

Steve Sadler

Since we just did Vidyo a couple weeks ago, the pipeline is not huge, but we have always looked at it little bit. We have opportunities in all of our areas that we continue to look at, comment on the pipeline for acquisitions, look it’s looking pretty good. So in our space for whatever reason we believe our acquisition strategy is healthy, and yes, we will hopefully do some more this year and in the future.

Daniel Chan

Great. Thank you.

Operator

And with no further questions in the queue, I’d like to turn the call back over to Mr. Sadler for any additional or closing remarks.

Steve Sadler

Well, thank you everybody for your interest in Enghouse and for attending this call. We look forward to talking to you again next quarter and appreciate your continued support.

Operator

That does conclude our call for today. Thank you for your participation. You may now disconnect.