Earnings Call: Q1 2020

Mar 6, 2020

Good day, ladies and gentlemen, and welcome to the Enghouse's Q1 2020 Conference 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. Good morning. I'm here today with Vince Misfitsood, Global President Doug Bryson, VP, Finance Todd May, VP, Legal Counsel and Sam Anninger, VP, Corporate Development. Before we begin, I'll have Todd read our forward disclaimer. Certain statements may be forward looking. By their nature, our 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 these forward looking information pieces, 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. Doug will now give an overview of the financial results. Yesterday, Enghouse announced its Q1 results for the period ended January 31, 2020. Revenue for the Q1 was $110,700,000 a 28.6% increase compared to revenue of $86,000,000 in the Q1 of the prior year, primarily as a result of incremental contributions from acquisitions. Results from operating activities were $30,800,000 compared to $25,800,000 in the prior year's Q1 and reflect the impact of changes in product mix on gross margins. Operating expenses of $47,300,000 reflect incremental operating costs related to newly acquired operations and increased non cash amortization charges. Net income for the quarter was $16,100,000 or $0.29 per diluted share and includes $1,600,000 in special charges and approximately $3,000,000 in incremental amortization charges related to acquisitions. Adjusted EBITDA for the quarter was $35,300,000 or $0.64 per diluted share compared to $26,300,000 or $0.48 per diluted share last year, with the increase being attributable to incremental revenue contributions from acquisitions as well as the impact of depreciation of right of use assets as now required under the new lease accounting standard under IFRS 16. Cash flows from operating activities, excluding changes in working capital, were $35,200,000 compared to $27,100,000 last quarter, an increase of 29.7 percent. As a result, Enghouse closed the quarter with $116,300,000 in cash, cash equivalents and short term investments compared to $150,300,000 at October 31. The cash balance was achieved after payments of $6,000,000 for cash dividends at $48,900,000 net of cash required for acquisitions concluded in the current quarter and $500,000 for acquisitions closed in prior years. On December 31, 2019, EnTrust completed the acquisition of Dialogic and commenced integration into its Asset Management and Interactive segments. Dialogic reported revenue consistent with exit patients, which is typically lower in January and was not accretive to earnings in the 1st month following acquisition. Restructuring initiatives have been implemented that should improve operating results in the coming quarters. Yesterday, the Board of Directors approved a 22.7% increase to the company's eligible quarterly dividend from $0.11 per common share to 0 point 135 dollars per common share payable on May 29, 2020 to shareholders of record at the close of business on May 15, 2020. Enghouse has now increased its dividend each of the past 12 years by over 10% each year. I'll now turn the call back to Mr. Sadler. Steve? Thank you, Doug. As Doug noted, we continue to have a strong cash balance and minimal bank debt. Our cash flow was strong with revenue growth. Revenue was up 28.6% with only 1 month of Dialogic included. Compared to the prior year, foreign exchange had a negative impact on revenue of $2,000,000 while having a positive impact of 1,500,000 on costs, resulting in a negative operating impact of $500,000 As I also mentioned, we adopted IFRS 16, which most companies had to do on years beginning January 1, 2019. So many of you already know that a lot of companies have been doing this for a year. Therefore, Enghouse has adopted it because our year end was our fiscal year is October 31. So this is the Q1 that we adopted IFRS 16. It added about $2,000,000 in EBITDA or $0.04 per share, resulting in an adjusted EBITDA increase of 33%. Using the prior accounting standard, our adjusted EBITDA would have been approximately a 25% increase, which is still a significant increase. I want to comment a little bit on COVID-nineteen. Everyone seems to be having questions about it. Enghouse does not have much impact to date on the COVID-nineteen, but there could be a global business impact. We are a distributed organization in terms of premises and staffing, therefore, limited concentration. A lot of our staff have worked from home, so it's not foreign for us to do so. We have had a high mix of recurring revenue with communication products. Possibly, we could deploy capital on acquisitions at lower valuations. Understanding opportunities and risks is key at this time. Maybe demand for video and contact centers will increase as a result of this virus. We do have a small presence in Italy, but not in other high risk geographies. In summary, we believe our exposure is limited beyond an overall global impact. As to acquisitions, in terms of acquisitions completed, we completed Dialogic on December 31, partway through the quarter. Restructuring was done at the end of January, and therefore, costs remained in the month of January in this business. Also, January is traditionally a lower revenue month for Dialogic. Revenue was approximately $3,500,000 in January for Dialogic. And with restructuring costs done late in January, the business had an operating loss of approximately $1,000,000 in the month. We expect improved revenue and performance from Dialogic in Q2. The Dialogic business will be EBITDA positive in Q2 with a further EBITDA increase expected in Q3. We continue to focus our capital deployment on our capital deployment activities as well as improving our operations and growth in future years. I will now open the call to questions. Thank We'll now take our first question from Daniel Chen of TD Securities. Please go ahead. Hi, good morning. Steve, the AMG segment grew by about $5,000,000 year over year. I thought the we were forecasting acquired revenue above that level, suggesting that maybe organic growth was negative in that segment. Can you comment on whether my assumptions are correct and whether the organic growth was negative? And if that's the growth was negative. It's up $5,000,000,000 So it looks like it wasn't negative. I think there was a little less hardware in that division in the quarter. So that may be making your numbers a little bit out. But maybe your numbers are just a little bit too high as well. Okay. Fair enough. And then you commented on potentially deploying more capital given the market volatility. Just want to get an update on you. Are you seeing some of the valuation volatility in public markets reflecting some of the targets you're looking at and whether your funnel is getting wider as a result of it? Not really. Again, when the public markets were roaring up until a few weeks ago, we didn't really see in the marketplace that we were at prices increasing that much. And also today, we don't see prices declining that much. It's pretty steady as it goes in the marketplace that we're in. Thank you. We'll now take our next question from Paul Steep of Scotiabank. Please go ahead. Great. Good morning. Steve, I think you already gave us the answer, but just to be clear, for dialogic, is there anything unusual that would maybe slow us getting to full normal run rate? It sounds like by Q3, you're hoping to have it on plan. Is that the right takeaway from the comment? And then maybe also talk a little bit about Eptica. Even though it's a smaller deal, you called it out in the MD and A as well as needing a bit of time to get on plan. Yes. We've always talked about in the Q1 after an acquisition, we generally lose money. Q2, we generally are profitable Q3, generally halfway to normal margins and in the Q4, at the normal margins. In last year, we had 2 acquisitions where they were looking at restructuring and did it before we acquired them or at least announced it and started that process. So we actually jump started 1 quarter last year, which was a benefit, but it does draw a little bit confusion to our normal model. With Dialogic, we closed December 31, December basically the month of Christmas, a lot of people away, a lot of people taking holidays, And we divided that company into 2 parts, one going to the asset management group, the other one going to the IMG group. So the group peer, HR, Vince, spent a lot of time in January figuring out the proper actions to take. So we did not take out any costs until the end of January. So all the costs are full costs are in January, which is a slower month for Dialogic. But we did take it out at the end. So we do expect to go to the normal model, profitability in the next quarter, although the Q1 was only a month, it wasn't actually a quarter, but we do expect to be profitable in the next quarter and further profitability in the 3rd quarter and at full profitability in the 4th quarter. Okay. And Eptica, anything there? Or just if it's as norm, it was only because you called it out in the document that sort of caught my eye. It's pretty much the same pattern. There wasn't much restructuring to be done there some, but it was again that time of year where you do the product, you go talk to them. It is France where it could take longer to do some of the changes you want to do. So it's progressing along basically the same way, but it was smaller. So the impact is smaller for it. There was about breakeven in the Q1, maybe a slight loss, but not anything significant. Certainly, it did not add to improve just by those 2 acquisitions doing what normally we do when we do acquisitions. Okay. And then maybe for both you and Vince, giving get your impression we're still a couple of months shy of getting to the 1 year anniversary for Vidyo and eSpiel. Obviously, they're on plan for margin. Maybe the talk about what we could think about for hopefully upside from the organic initiatives you guys have been working hard on? Yes. We've got a lot of things in place. I'll let Vince talk about it a little bit. But there's quite a challenge there because we have to change we had to change the culture. We had to now put in some new techniques for selling. A lot of that's being done. And I'll let Vince give you a little more detail of some of the things he's been working on lately. Yes. So on the video stuff, we've got some very interesting use cases there. Some of the ones that are getting good traction are around telehealth and using video in a telehealth use case. So that's putting a big push there. There's lots of demand, we think, in that area. And we also use video a lot to enable other tech companies. So we've done a number of partnerships there. And then last quarter, I talked about rolling video out globally. So we've started to hire sales, direct sales people in Europe and a little bit in our Australia, New Zealand market to sell video into these unique use cases in addition to selling video into a contact center use case. So that's all well underway, and we've got work to do, but we're getting traction there. So I think as we've also said in the past, the profitability is not a problem. That's the first thing we do is get acquisitions that we buy profitable, and now we're starting to invest a little bit to improve the revenue growth there. And we're on track to do that. Great. Last one, I guess, for me is just maybe talking a little bit about how you've seen the progress with Teams, where we are in terms of getting product to market? It looks like uptake continues there, and that'd be good. Progressing well. I think we're pretty much there with all our work on Teams. And I see that as a positive catalyst going forward. Great. Thanks, guys. Thank you. We'll now take our next question from Deepak Kaushal of Stifel GMP. Please go ahead. Hi, guys. Good morning. Thanks for taking my questions. Steve, I want to start off with Dialogic. Can you walk us through the seasonality of the business? I used to recall that a lot of telcos had a budget flush in December. What kind of seasonality should we expect there for that business? So in general, I mean, their year was on a calendar year. Ours isn't. So it's a little bit different. But seasonality, their Q1 generally was their lowest, which includes January. It was January, February, March. Their last quarter is generally the better quarter because that's when, again, telcos sometimes have extra budget that they spend. So Q1, I think, will be the for us, will still be the lowest quarter, pretty even in the middle, the second and third quarter, and probably the Q4 will be a little higher than the other quarter. So there is a bit of a seasonality there, yes. So for Q4, are we looking for like higher than 30% of annual revenue in Q4? I wouldn't say it's 30%. I would say it's about 30%. Maybe go 15%, the middle 2% or pretty even 20.20% and 30%, some number like that. That's not the exact doesn't matter exactly, but that's sort of what we look at. So if you usually do 25 a quarter, Q1 was probably 15 between the second and third, maybe 3rd a little better than the second, so 20, 25, 30. It does have that type of seasonality. At least they had it, But then we do things a little differently because sometimes they would discount to get revenue in a quarter, and we generally don't do that. We're happy to take it next quarter rather than take less this quarter. Okay. That makes sense. Thank you for that. It's helpful. And then just on the dialogic, is there any kind of cyclical impact from 5 gs that we should be thinking about? Or is it just a different side of the telco business? No, I don't think there is. They've done a lot of work on 5 gs, so which is positive for us. But I don't think it changed the seasonality or anything. Okay. Okay. And then I had a follow-up for Vince, some good details last night on the go to market strategy. Are you guys able to give us kind of a percentage of revenue today on channel versus direct sales amongst the total business and how that might evolve going forward? Yes. I mean, as I mentioned in the yesterday in the meeting at the AGM, we are putting a little bit more emphasis on direct than we did historically. But it's not that we're ignoring the channel or our OEM partnerships. They're still important. But we're trying to raise the direct mainly because a lot of the verticals customers want us to go direct. It's a better sales execution sometimes in the mid to larger accounts. So I would say our percentage towards direct is growing over the last several quarters. At the end, hopefully, for me, it'd be nice to have a balance fifty-fifty between channels and direct. Today, we're a little bit more towards channels. It also varies by each one of our divisions. So it's kind of hard to answer that question on a global basis because each one of our even in each one of our geographies, it's slightly different. Right. Makes sense. Is there an appreciable margin difference when you go direct versus channel? And what kind of magnitude? I think you would say the margin is better direct, but the costs are higher as well. So if you're talking margin, like when you do the channel, you do have to give the channel partner part of the selling price. So the margin is better direct, but the costs are higher for direct as well. If you just think of cash margin, how would that play out? I think direct is a little better, but you do have to have a good demand gen and some of the other things Vince has put in place. So we're better prepared to do that now. But the margin direct is probably a little better. But it's a little riskier, like if there's downturns, recession, you've got the direct salespeople who might have a decline in revenue. When it's in the channel, it's not our problem. It's a little higher risk on the direct as well. And therefore, the margin should be a little bit better. The net margin, as you call it, should be a little bit better. So it is. And Deepak, in the direct is you typically have the bigger you handle the bigger deals in direct in terms of the sizes and the customers. So generally, the channels are good in the mid market. And then the upper mid market and enterprise is better handled direct. Okay. Okay. That makes sense. And then segue into cash. Cash before working capital grew quite strongly. There's a big working capital hit in the quarter. Can you kind of walk us through what were those leading parts and the relative impact to that? The problem we emphasized before working capital because the way we do acquisitions and the way the accounting works can cause confusion there. Because sometimes what we do, we do a lot of changes or they have done changes or they held payables, then we buy it, reduce the price, but then we do pay it out in the, let's say, 90 days following, we sort out all the liabilities they had. So it can be confusing. And it can be confusing the other way if once you've done that, then your cash flow can look better as well because when you pay those out, people think that's the trend, when really it was a one time thing with the acquisition. It will change with acquisitions, but Dialogic was a bigger one. So we cleaned up some of their liabilities. They had debt. We don't have any, etcetera. Got it. So should we then expect a swing back to positive and then a normalization or just a normalization and you have to absorb some of that structural shift? Hard to say. It depends on what other acquisitions we do, but I think a more normalization is probably the way you should think about it. And hopefully, that will be conservative. Okay. Excellent. Thank you for taking my questions. We'll talk to you, Vincent. Thank you. We'll now take our next question from Stephanie Price of CIBC. Please go ahead. Good morning. Can you talk a bit about the growth that you've seen in Vidyo since acquisition and whether you've seen any changes in the sales pipeline just given COVID-nineteen? Well, the COVID-nineteen is pretty still pretty early in the cycle. I mean, if you had looked at it 3 months ago, no one even mentioned it. So again, we haven't seen we've seen interest. We're taking some actions to see if we can improve revenue in that area for us. For example, going to our customers and offering them a free trial because they're our customers anyway. So why not give them an idea of other products that we just got? And also remember what we said from last year after we bought it, a lot of time was spent rightsizing the company to make it profitable. We weren't worried and we didn't try to put a lot of things in for growth. That just started in November, so it's still quite early because as the way we approach acquisitions, we get them very profitable and then we see how much of that profit we should reinvest to grow. So we've done a profit, and now we're doing the reinvesting to see if we can grow. But that just started in this quarter. It hasn't been going on for 6 or 9 months. Fair enough. Okay. And then with the increase in the dividend, can you talk a bit about your thoughts on capital allocation here? Yes. I mean, it's an interesting market. What happens with COVID-nineteen to valuations is subject to great debates. Our acquisition pipeline is sort of normal. I don't think it's gone up or down. So we just keep plotting along, and we'll see what happens. Fair enough. Thank you very much. Thank you. We'll now take our next question from Paul Treiber of RBC Capital Markets. Please go ahead. Thanks very much and good morning. I just wanted to hone in on license revenue for a moment. It looked like in the quarter, it's a multiyear high or perhaps a record high. What do you attribute the strength to in the quarter? And then do you see license at the in the high $20,000,000 range of sustainable going forward? Yes. We had some a couple of good deals in the quarter, which, again, were license revenue deals. It's hard to say because, as you know, we're going more to subscription or recurring revenue. So I don't like making predictions on that because it will be what it will be in the sense that we do the right thing for what the customer wants, and it doesn't matter to us. So again, we don't really emphasize a lot quarter to quarter. We've had pretty consistent, but that's not our focus. Our focus is to build a business for the longer term. Just delving a little bit further, like, are those deals in the pipeline for a while? Or are they created because of some of the new demand gen investments you've done in the last couple of quarters? So you've got the answer there is both. They've been there for a while, but our demand gen has been there for a while too. So both are helping. And now you've got the COVID-nineteen virus. What is that going to do? Is that going to hurt that? Are people going to slow down? There's a lot of moving parts. But both have helped get, as we said, we generally, you should think of the business as low single digits, but we're trying to improve on that. Okay. And then looking at hardware revenue, it dropped in the quarter. I assume that was related to acquisitions as maybe you exit or run off some of that hardware revenue. I mean, is this the new normal? Or was it a one off that led to the drop this past quarter? I would say it's probably a one off drop in the quarter. That area, which is lower margin, can be lumpy. So the quarter was lower than usual, and I wouldn't project future quarters to continue at that amount, but you may have some quarters in the future that are lower, but you may also see some that are higher by a fair amount depending when we deliver hardware. Remember, a lot of our software comes in the deals and customers want us also to be the hardware supplier. We don't make the hardware. We just buy it and sell it to them because they want to buy from 1 company. There's a saying they want one throat to choke. So unfortunately, in some cases, that's our throat. That's helpful. Turning to Espial, could you provide an update on the IP product, IP TV product development and how it's progressing and if you still expect to launch, I think, in the second half of this fiscal year? Absolutely. You've got it right. It's progressing nicely, and we still expect the launch in the second half of this fiscal year. And have you seen the orders for that product increase as you get closer to launch? Or is it being pretty stable? We've had some orders from customers in the past. We had interest. But orders are when you have a product and you sell them. I don't count orders before that too soon because people don't feel they're ready to buy, I don't count it. So I would say there's the interest has increased, but the orders have been pretty stable from sort of the initial group who showed interest at the start of the project off. I am sorry. Do you remember how that works? Sorry, I was just saying it works as well, once you launch the IPTV and the customer buys it, as they add subscribers, we get more revenue. So that's how that works. So you plant the seed and then it evolves over time. We see a growth once a good fit. Okay. All right. Thanks for taking my questions. Thank you. There doesn't seem to be any further questions at this time. I would like to turn the conference back over to the speakers. Thank you. Well, thank you, everyone, for attending the call and your continued support. We hope to build on our positive start to the fiscal 2020 year. Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.