Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited Q3 2019 earnings call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Stephen Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.
Good morning. I'm here today with Vince Mifsud, Global President, Doug Bryson, VP Finance, and Todd May, VP Legal Counsel. Before we begin, I will have Todd read our forward disclaimer.
Certain statements made may be forward-looking. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those in Enghouse's continuous disclosure filings, such as its AIF, which could cause the company's actual results and experience to differ materially from anticipated results or expectations. Undue reliance should not be placed on these forward-looking statements, 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.
Thanks, Steve. Yesterday, Enghouse announced its unaudited third quarter financial results for the period ended July 31st, 2019. Third quarter revenue was CAD 101.3 million, a 16.8% increase compared to revenue of CAD 86.7 million in the third quarter of the prior year. The revenue increase primarily reflects contributions from acquisitions. Results from operating activities were CAD 27 million, compared to CAD 26.7 million in the prior year's third quarter, which reflects the impact of changes in product mix on gross margin and, as expected, lower operating margin contributions from acquisitions in their initial period after acquisition. Net income for the quarter was CAD 14.7 million or CAD 0.27 per diluted share, with increased amortization and a foreign exchange loss.
Adjusted EBITDA for the third quarter was CAD 28.1 million or CAD 0.51 per diluted share compared to CAD 27.4 million or CAD 0.50 per diluted share last year, with the increase being attributable to incremental revenue contributions from acquisitions. On a year-to-date basis, revenue was CAD 276.5 million compared to revenue of CAD 257 million in the prior year. Results from operating activities were CAD 79.4 million compared to CAD 75.9 million in the prior year-to-date, an increase of 4.7%. On a year-to-date basis, adjusted EBITDA was CAD 81.6 million or CAD 1.48 per diluted share compared to CAD 78.1 million or CAD 1.43 per diluted share last year. Operating expenses before special charges related to restructuring of acquired operations were CAD 42 million compared to CAD 34.1 million in the prior year's third quarter and reflect incremental operating costs related to recent acquisitions.
Non-cash amortization charges on acquired software and customer relationships from acquired operations were CAD 8.5 million for the quarter compared to CAD 7.2 million in the prior year's third quarter. The company generated cash flows from operating activities of CAD 13.9 million compared to CAD 29.3 million in the third quarter of fiscal 2018. On a year-to-date basis, cash flows from operating activities were CAD 59.6 million. This relates to unfavorable working capital adjustments from new acquisitions, which when acquired, had severance obligations and significant payable balances that have since been settled. Enghouse closed the quarter with CAD 141.3 million in cash equivalents, and short-term investments, compared to CAD 193.9 million at October 31st, 2018. The cash balance was achieved after payments of CAD 15.8 million for cash dividends and CAD 94.2 million net of cash acquired for acquisitions concluded in the current fiscal year and CAD 1.1 million for acquisitions closed in prior years.
During the quarter, Enghouse completed the acquisitions of Vidyo, Inc. and Espial Group Inc. for an aggregate purchase price of CAD 68.7 million net of cash acquired. These acquisitions reported revenue consistent with expectations and were accretive to earnings in the quarter. Yesterday, the board of directors approved the company's eligible quarterly dividend of CAD 0.11 per common share, payable on November 29, 2019, to shareholders of record at the close of business on November 15th, 2019. I'll now turn the call back to Mr. Sadler.
Thank you, Doug. As Doug noted, we closed the quarter with CAD 141.3 million in cash equivalents, and short-term investments after spending CAD 68.7 million net of cash acquired on acquisitions. Cash flow before changes in working capital was CAD 28.5 million and CAD 13.9 million from operating activities. The difference is mainly working capital, which reflects payment of liabilities and restructuring, as Doug mentioned, which was implemented just prior to our acquisition of Vidyo and Espial. Revenue as expected, other than for our asset management division, which had some revenue delayed to Q4. We expect revenue to increase in Q4 and to improve EBITDA profitability over Q3 as a result of recognizing the delayed AMG revenue and recognition of a full quarter of revenue and EBITDA from recent acquisitions. It's also noted that foreign exchange negatively impacts revenue compared to Q2 by CAD 1.1 million and cost was positively impacted by CAD 500,000.
Compared to last year, foreign exchange negatively impacted revenue by CAD 1.5 million and CAD 1 million positive for operating costs compared again to Q3 of 2018. In terms of acquisitions, as noted on our last quarterly call, we purchased in May Vidyo and Espial with an objective to be EBITDA positive on these acquisitions, but not achieve our normal EBITDA margins in the first two quarters. We are happy to report, excluding purchase price adjustments, both acquisitions were profitable in Q3. Espial had limited profitability, as we need to continue to invest in IPTV, where although we have interested customers, we do not anticipate revenue until Q2 2020. Vidyo had profitable results in Q3 due to restructuring done just before the acquisition was completed, and some additional restructuring has been done since acquisition.
We expect both revenue and operating income will improve further in Q4 when a full quarter is recognized in our financial results. For Vidyo, we intend to invest in improving revenue on a global basis next fiscal year 2020, and therefore will require some investment from our increased profitability. It is very satisfying that both these businesses were brought to a positive EBITDA position in Q3, since as a business, they had substantial losses for many years prior to their acquisition. We hope to build on this success. Economic and market conditions in our service industries continue to be favorable for our acquisition strategy and meeting our acquisition financial payback criteria with a strong return on invested capital. We continue to focus on our capital deployment activities as well as positioning to improve internal growth in future years. Our integration of both Vidyo and Espial is substantially complete.
I would now like to open the call for questions.
Ladies and gentlemen, if you wish to ask a question at this time, please signal by pressing star one on your telephone keypad. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. Again, please press star one to ask a question. Our first question comes from Stephanie Price of CIBC. Please go ahead.
Good morning.
Hey, Stephanie.
I wonder if you could expand a little bit on the asset management division in the quarter. You mentioned some delayed revenue. Wondering if it has since closed?
Yeah, we expect it to close soon. As I've stated in the past, sometimes the Asset Management Group, which is larger deals, can be a little lumpy from one quarter to another, and we tend to look at it on a yearly basis. It's done pretty good year to date. There was a couple of deals that have moved to Q4. When you look at our Asset Management Group, you'll find its revenue, in my opinion, isn't as good as it should've been. It's not from the acquisitions. It's basically from these delayed revenue being recognized.
Right. Then in terms of Espial, can you talk a little bit about this IPTV opportunity that you see going into next year?
Yeah, IPTV is an up-and-coming item. They're very good on the cable side, but they didn't really have a completed IPTV full software package to provide. We're working on that. No revenue from it yet, but we do expect by early next year that we will have some revenue, and we already have interested customers, i.e., they've committed that they would like to take it. Of course, you can't recognize revenue until you give it to them.
Fair enough. Thank you very much.
Our next question comes from Paul Steep of Scotia Capital. Please go ahead.
Hey, good morning. Steve or Vince, maybe you could talk a little bit about the demand gen initiatives. I guess we've been a year into it. I know we're not looking for forward forecast, but talk about some of the trends you've seen in lead flow. I know you invested more in going to market directly. What have you seen in terms of the conversion there, and maybe what are some of the future opportunities?
I'll let Vince take that one.
Okay. Different divisions are at different stages on the demand gen side. Generally speaking, the interactive group is progressing well on demand gen. We're seeing good bookings and you're seeing it translate into results. Then on the network side, again, that's pretty new on demand gen. We have more opportunity there. I think it's in the area of cross-selling. We've got a lot of products, a great customer base, so we hope to see more progress there in the next few quarters.
Okay. I guess, Steve, on the M&A side, it looks like you're trying to hire some additional resources. Maybe talk about where you're at in terms of team size, as well as what the pipeline looks like in terms of just coverage and growth now that you've had, I guess now two or three quarters of having some extra resources on that file.
Yeah, I'm not sure we're adding a lot of resources. I think we're looking to hire one person to do outbound calling. Otherwise, it's a pretty stable group, a good group that, a lot of the time on acquisition stuff is also integrating them into our current operation. Other than looking for one person, really no change there. It's a pretty solid group.
Great. Then just one last clarification from me. How much revenue was from acquisitions in the quarter, Steve?
About CAD 14 million.
Perfect. Thanks, guys.
The acquisitions were okay. I was hoping for a little more revenue, but the asset management side is down a little bit from our network's delayed revenue.
Okay. Thank you.
Our next question comes from Deepak Kaushal of GMP Securities. Please go ahead.
Hey guys. Good morning. Thanks for taking my questions. I have a couple of follow-ups and a couple of minor ones. Steve, just on this AMG delay, have you guys started delivering the product and you just can't bill for revenues? Is this some sort of unbilled revenue here, or is everything kind of on hold?
Generally, you deliver it. With larger accounts, sometimes it takes a little longer than we would expect to get all the sign-offs, and therefore get the PO to record the revenue. It isn't like we're looking for the revenue. We have some interested prospects ready to go, but it takes time to get all the approvals done, and we haven't got them done yet, so there's still some risk in that quarter to get them done. I expect that we will improve the revenue there.
Okay. On the cash drag, I know you said the integration's done on the acquisitions, but on the cash drag from that, is that now complete? Should you get back to normal run rate going forward here?
Yep. Yeah, we should be hopefully better than normal run rate. Again, the two companies had a lot of losses and had some financial issues. We had to pay a lot of fees and straighten some stuff up. That's all being done, so we should be back to a normal run rate in Q4.
Okay. I think I saw mention of a higher hardware mix. Is that a temporary thing? Is there a trend going on, or is this from the acquisitions? Maybe you can shed some light on that and how that should trend. I've got a more-
Yeah
perhaps.
Yeah, I do expect the hardware side to pick up a little bit. Vidyo had some hardware come in with it because to do video, there's hardware involved as well, and they like one-stop shopping. The hardware mix, there will be a little bit more hardware. If you start doing a percentage though, I would think the other parts of our revenue mix will also improve. I don't think the percentage will go up, but as an absolute dollar thing, I do think you'll have a little higher hardware mix.
Okay, great. That's helpful. Thanks. Then just on, I think earlier in your comments, you mentioned investing in global revenue with Vidyo. I was just wondering if you could talk a little bit about the go-to-market strategy for Vidyo globally, and if you might be able to get synergies between Vidyo on the enterprise side with your contact center side of your business, and just a bit more on the strategy on how you grow that business.
There's a couple of questions there. Our objective in the quarter was let's get it to profitability, let's generate cash flow, and once we got it stabilized, then how do we invest some of that cash flow to build a business? If you look in our current contact center, we do service some of our competitors because the products are very secure and good in that area. Again, yes, we hope to build that into our own systems as well. Outside that, remember, one of the great advantages we have is we have a global structure with people in many countries. We want to take the product.
We want to get some of the issues cleaned up first, but we want to take the product, adding a few people in those countries to each of those countries, and therefore expand the product globally, which they did not really have that many people in other countries, where we have 50+ in many countries, you know. We're going to try and use our global structure to see if we can sell more of the Vidyo in those countries. If you look at what's happened today, everyone's putting a bubble over themselves and countries. Best example is the U.S. Once we can show we have people in the country supporting the software in the country, we believe that's an advantage that we should see results from in the future.
That's our intention, but we want the software really solid before we do that expansion, and we're working on that now.
Okay. The investments for both Vidyo and Espial, should they be done by Q2 next year, or will they just be ongoing as part of the normal course of business?
Espial, it's going now.
Yeah, you're investing in both of them, right? As you mentioned.
Yeah, the Espial is going now in R&D to actually get the product ready for market by early next year. For video, we would have to add what I'll say called demand gen, sales, and marketing in our other countries. Probably that will start November to December with results on next calendar year.
Okay.
We're in that whole budget process now to see how to do this, and that'll probably get sorted out, but you do have to hire people, you do have to set up. My guess is it will be done not by the end of October, but by the end of December, and then results starting in next year if it's successful, which we hope it will be.
Okay. Put it in a different way then, the target to get back to corporate average margins for both of these companies. Can we say that's the end of 2020, or does it stretch out beyond that?
I'd say it's going to start 1st quarter of 2020, starting November 1. All these things, remember, if I'm doing the Vidyo, shouldn't cost that much more. Maybe we can use some of our current resources to do it. That's okay, and the IPTV should be bringing in some more revenue, again, in the 2nd quarter of next year. I also have those delayed results. Our margins should have been better this quarter. I expect Q4 will be better, never mind next year.
Okay, thank you. I appreciate the color. Thanks very much. I'll pass the line.
Again, please press star one for your question. Our next question comes from Paul Treiber of RBC Capital Markets. Please go ahead.
Thanks very much. Good morning. Just in regards to Vidyo, in terms of their product portfolio, my understanding is that they have several different platforms. Is the strategy to support all of them going forward, or will you prioritize some over the others?
They actually have three main areas that they're in. They do hospitals and financial institutions, which are vertical markets. They have enterprise, which is a more general, and they have a sort of a PlatformIO to let people write programs on and use the basic fundamentals of the platform. They were doing a new system as well, and we've actually curtailed that and decided to improve their current one rather than keep developing the new one. We're trying to put more resource on the current one to build faster versus splitting the platforms up. It's not really a wide variety of platforms right now, the way we've positioned it.
Okay. I assume based on your prior comment about taking it globally, the ones that you're investing in, I assume you believe will be scalable into other geographic markets.
Yeah, I believe that to be true. The one we're investing in, you should also understand, is both in the cloud and on-premise. They were trying to just build in the cloud type system. The one we have with some improvements can do both. We think that's an advantage. We just got to clean it up a bit, put a little more investment in it because they had stopped investment for a couple of years, and we have to catch that back up if we're going to go that route. We're working on that now, and probably I'll have some more resource working on that rather than dividing the resource up into two parts.
Just broadly in terms of the R&D strategy and also the competitive environment. In the past, a couple of years ago, you characterized your R&D spending as industry leading. Since then it's come down a bit. It sounds like you may be going through a little bit more of a cycle here where the R&D spending may be a bit higher. What's the priority for R&D? Do you see that as a competitive differentiator at this point? Related to that, the competitive environment, there's been concerns for the last couple of years about the cloud competitors and whatnot. Could you provide an update on the competitive environment and how you see these new acquisitions fitting in there?
You have a couple of questions there that aren't all related, but let me do the R&D side first. If you look at this quarter and look at the R&D spend to revenue, generally we were running previously around 14%. You'll notice it's jumped up to 16+. That R&D spend is already in the quarter with the two new acquisitions, which I already explained why it's there. Over time, that percentage should come down, hopefully because we have more revenue. If the costs are okay, maybe up a little bit, but hopefully revenue's up more. We've already done that part. From the competitive side, it's pretty much the same. The different divisions have different competitors, but the SaaS side on the contact center is still there, has been for a while.
The part that we hope to bring out soon as well is our Teams integration. Again, we see that coming by, let's say, the end of the calendar year. We're making good progress there. That should improve some of our issues we've had over the last 18 months with our Microsoft Skype for Business operation. Yeah, a lot of things are being positioned and hopefully coming together for a good next year.
Maybe what would tie my couple questions together is, from a competitive perspective, do you see the investments that you're making in the product would either close the competitive gap or extend your lead versus competitors? Do you think more is needed there? Do you think it's sufficient where it is?
We think that they're all pretty much a commodity in some way. Some would do some things better than others, so you can't do everything for everybody. Right now in the two products, the IPTV, it's important to get that done. That would be new. In the video side, they're pretty good with the system that they have, but we have to clean it up. We want to make it more stable, clean up any issues it might have and make it really robust so anyone using it can do it without any issues. That's more of a, I'll call it a bug cleanup, versus trying to do a lot of new things in there, because it's pretty competitive as it is today. It's secure. It does some interesting things compared to competitors who are getting better traction in the market, like Zoom.
We believe our software is more secure than theirs, and we are quite competitive already. We have to catch up a little bit from the getting the software more robust and cleaned up because they've fallen a little bit behind in the last couple of years.
Okay. Thanks for taking my questions.
As a reminder, if you would like to ask a question, please press star one. There are no questions in the telephone queue at this time.
Okay. Thank you everyone for your continued interest in Enghouse. We look forward to completing our October 31st 2019 fiscal year and reporting our Q4 and annual progress.
Ladies and gentlemen, this concludes the Enghouse Q3 2019 conference call. Thank you for your participation. You may now disconnect.