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 Stephen J. Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.
Good morning. I'm here today with Vince Mifsud, President, Doug, VP Finance, Todd May, VP Legal Counsel, and Sam Anidjar, VP Corporate Development. Before we begin, I'll have Todd read our forward disclaimer.
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 experiences 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.
Thanks, Todd. Doug will now give an overview of the financial results.
Thanks, Steve. Yesterday, Enghouse announced its unaudited second quarter financial results for the period ended April 30th, 2019. Second quarter revenue increased to CAD 89.2 million compared to revenue of CAD 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 CAD 26.6 million compared to CAD 24.7 million in the prior year's second quarter, an increase of 7.9%. Net income for the quarter was CAD 16.5 million, or CAD 0.30 per diluted share compared to CAD 15.3 million or CAD 0.28 per diluted share in the prior year's second quarter. Adjusted EBITDA for the second quarter was CAD 27.2 million or CAD 0.49 per diluted share compared to CAD 25.4 million or CAD 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 is CAD 175.2 million compared to revenue of CAD 170.3 million in the prior year. Results from operating activities were CAD 52.4 million compared to CAD 49.2 million in the prior year-to-date, an increase of 6.6%. On a year-to-date basis, adjusted EBITDA was CAD 53.5 million or CAD 0.97 per diluted share compared to CAD 50.7 million or CAD 0.93 per diluted share last year. Operating expenses before special charges related to restructuring of acquired operations were CAD 35.1 million compared to CAD 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 acquired software and customer relationships from acquired operations were CAD 6.9 million for the quarter compared to CAD 7.4 million in the prior year's second quarter.
The company generated cash flows from operating activities of CAD 21.6 million compared to CAD 21.8 million in the second quarter of last year. On a year-to-date basis, cash flows from operating activities were CAD 45.8 million, an increase of 1.9% compared to the prior year. As a result, Enghouse closed the quarter with CAD 205.5 million in cash equivalents, and short-term investments compared to CAD 193.9 million on October 31st, 2019. The cash balance was achieved after payments of CAD 9.8 million for cash dividends and CAD 25.6 million net of cash acquired for acquisitions concluded in the current fiscal year and CAD 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 CAD 0.11 per common share, payable on August 30th, 2019, to shareholders of record at the close of business on August 16, 2019. I'll now turn the call back over to Mr. Sadler to provide an update on the quarter. Steve?
Thank you, Doug. As Doug noted, we continue to have a strong cash position over CAD 205 million compared to CAD 190 million at the end of Q1, January 31st, 2019. Cash flow before changes in working capital was CAD 29 million, an increase of 7.4% over the prior year. We paid CAD 4.9 million in dividends and CAD 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 CAD few hundred thousand. Deferred revenue increased 17% from the year-end value to CAD 77.5 million.
After the end of the quarter, we announced the completion of the Vidyo acquisition in mid-May and Espial acquisition near the end of May. These acquisitions result in deployment of approximately CAD 75 million of our cash after considering the purchase price paid, banker fees, legal fees, sale bonuses, and restructuring costs. We expect these acquisitions on an annualized basis to add CAD 70 million to CAD 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 although the acquisitions will not achieve our normal EBITDA margins in the first two quarters due to the purchase price accounting adjustment and business operational activities, we believe results will be EBITDA positive before restructuring costs in Q3 and improve further in Q4. Both Espial and Vidyo had plans to restructure their businesses, which were significantly completed before the acquisition by Enghouse, but not fully completed. Economic and market factors in our service industries continue 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.
If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you'd like to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal. Our first question will come from Paul Steep with Scotia Capital.
Great. Morning. Thanks, Steve. Steve, can you talk a little bit more about Espial? Just to clarify, obviously, we know they were already doing the restructuring. That operating model I scribbled down, operating positive on EBITDA by Q3 or Q4. Is that the third and fourth quarter of you just owning it, just to be clear?
No, Q3 is the quarter we're in right now.
Right.
Q4 is the next quarter. It's the quarter this year.
Okay. I'm sorry.
In Q3, there will only be a part of a quarter. In Q4, in the purchase price adjustment, we have to take off our revenue, and it goes right to the bottom line. That's just an accounting thing. It's non-cash. It has the greatest impact in the early quarters, like Q3 and Q4.
Correct. The ramp-up, though, for Espial being the biggest of the two, how quickly should we think about that in mid-year? How close is that to your model at that point, or you think there's still a decent amount of drag there?
We think we'll be on the model next year. Espial is the smallest of the two acquisitions.
Okay.
It's about half the size of the Vidyo acquisition. Its impact actually is less than the Vidyo impact.
Okay. The cloud revenue out of Espial, how close and where do you think you're going to report that cloud revenue in terms of the go-forward subscription, since they were transitioning to that model?
Yeah, they had transitioned a lot of it already to the model. We're hoping to increase it as we go forward.
Okay. 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 was some hardware in the business, maybe it's less that and something else.
No hardware.
Okay.
It's really software, mostly software, in the cloud SaaS model, and very little professional services.
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've talked about it. Any updates on where we're at in that transition?
We're 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. Yes, it's stabilized for sure. I think the impact of that will be next year.
Okay.
The positive impact once that conversion's done of next year, because the market's frozen a little bit now, but people are still buying Skype for Business.
Perfect. All right. I'll leave it there. Thanks, guys.
Next we will hear from Deepak Kaushal with GMP Securities.
Hey, good morning, guys. Can you hear me? Hello?
We can hear you.
Oh, good. Sorry, I was on mute for a second there.
Hello.
Got it. I have a question just on Espial. Sorry, I've been calling it Espial for years. I've counted 15 years of this business as EBITDA, and only two of those years have been EBITDA positive. 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 more details on how you get there. Where do the cost savings come from? What's the strategy? Any kind of details you can give us on that path and how you can achieve that versus why they couldn't achieve that in the past would be helpful.
Don't know why they couldn't have achieved it. Like all acquisitions we do, we match costs and revenue. If we have costs that aren't producing enough revenue, we cut those down. The revenue, we try and increase if we're not getting enough money for some of the spending we're doing with customers. There's a lot of factors, but we're pretty confident we'll achieve our objectives there, and it'll be EBITDA positive in the current quarter, Q3, the one we're in right now.
Okay. When I look at the numbers, and even if you just got G&A, you're still not at EBITDA positive. Something's got to come out of sales and marketing and R&D. Are there synergies on the sales and marketing side you can have, or do you guys have a method to get more R&D efficiency out of the business? To give you further, the revenue dropped 20% last year. I understand they're 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?
It isn't a big sales and marketing issue. They probably need to add some sales and marketing in their model. All the factors you discussed, we look at.
Okay.
There's all kinds of other costs in there. You talked a little bit about people, public costs these days are a fairly large expense. They won't have that anymore. We've done some of the restructuring beforehand. We've got a little bit more to do afterwards. We're looking at their revenue to see how we can improve that a little bit. Maybe if there are some negative revenue, often we buy companies that have revenue that loses money, we'll probably eliminate that and not lose money. There's all kinds of factors we go into. It looks like magic, there's not a magic solution. It's just matching cost and revenue.
Okay, got it. Looking forward to the next quarter. Going to Vidyo, the margins for that business are.
Not to interrupt, we believe it will be positive EBITDA this quarter, next quarter will be improved.
Got it. The CAD 70 million-CAD 75 million includes Sorry, the CAD 75 million in cash that you're paying, that includes all the restructuring costs and the fees, all one-time charges that you expect to.
There are restructuring costs in there, and I mention them because people have used, for example, with 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've got to add those costs because in a sense, we're paying it because we bought their shares and they pay it on closing. 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. A lot was done, so you can't expect huge restructuring costs, but there will be some.
Got it. Okay. 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. What kind of revenues, revenue growth has this company been seeing? What does the gross margin profile look like? Is that a similar situation with Espial where you have to take it from an EBITDA loss business to an EBITDA positive business, or is that an easier, more typical Enghouse? I've got one more question, then I'll pass the line.
Well, I think you did about three or four questions there, but we'll try and go through them. If I miss one, you can ask. We already announced that they did about CAD 60 million in revenue. As you know, Espial does about, it did CAD 6 million in the first quarter, so they're running at about CAD 24 million, maybe CAD 25 million. That's the revenue profile of the two. It seems to be twice the size of Espial. I think that was one of your questions, [Kaushal]. They absolutely were losing money, so it's similar to Espial. Some restructuring certainly was done in advance of the acquisition. Again, like your questions on how do you get it profitable, it's the same answer I had for Espial and most of our acquisitions.
We match cost and revenue, we try and improve the revenue, we try to see where the costs that are being expended are not value in the sense that they generate enough revenue to justify themselves.
Got it.
That's two for one.
Any color on the gross margin? Espial certainly has a strong gross margin. I assume with Vidyo as a software business, similar kind of gross margin?
Yep. There's no real hardware or other costs in there, it's similar to our other businesses. 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. Now, I guess we're going to see if we can improve that.
Okay. My last question, I know I've asked a lot, but it's exciting to be able to ask you something new and get some new answers out of you. 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 of transportation Interactive? I don't really consider transportation a pillar, but could this really be another third pillar? Do you see an opportunity or a runway for more acquisitions related to video that you can get some kind of synergies out of?
The answer is it could be. It does tie 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. That's interesting. Also, service providers, probably is an interesting customer base to take some video to there. Yes, it could be a third pillar. Right now, it's mainly, we're going to put it in the Interactive group because that's where it really ties to. We hope our asset management group also cross-sells it.
Okay, excellent. Well, thanks for taking all my questions and sub-questions and corollary questions, I appreciate it. I'll pass the line.
Our next question will come from Paul Treiber with RBC Capital Markets.
Thanks very much. Good morning. Just want to follow up on Vidyo and the purchase multiple and maybe the background. You're paying CAD 40 million for CAD 60 million in revenue. That's typical for what you'd pay, but it's quite cheap for a VC-backed SaaS company. I was just hoping, could you provide some insight in terms of the background of the acquisition and maybe if there was an auction process and how that went?
We assumed 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 in and look and try and decide how we can get our payback for our shareholders. We make our offer, and I guess it was the best one.
Looking forward on that business, I think there's a two core platforms there. Is the plan to keep all three of them operational, or do you intend to narrow the focus down, like where some of them more legacy or less traction in the market? Are some of them more, just have a higher run rate of business and it's not negative revenue?
I would think we might increase the platform offering. The other advantage we have is they are mostly in the U.S. We do have a global structure, maybe our global structure can use that product in other geographical areas. We're going to investigate that, but we probably have to do a little bit of R&D work before that happens. That takes a little bit of time, but we're not decreasing the platform, no. They have a hybrid model like we do. We can sell in the cloud, we can sell on-premise, we intend to offer both. They did not do much in professional services. We probably can do more in that regard with them. There's a lot of things we're looking at, seeing which one makes sense to do over time.
Just in regards to, like a sales strategy. You mentioned that you're going to put it in the interactive group, 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've been trying to generate there.
Well, just think about it. Our CCSP product, which is the cloud product in contact center, is sold by service providers. We already are doing cross-selling between the two divisions in that regard. This is just another opportunity to do more of it.
Okay, lastly for me, these are two large acquisitions. You mentioned a couple of times there's 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, nine months or so, as you focus on integrating these businesses?
It depends what you're slowing from. I don't expect to do the size of operations every quarter, but we do not think our normal pace of acquisitions will slow.
Okay, great. Thanks a lot.
Again, that is star one if you'd like to ask a question. Next, we will hear from David Lee with Lazard Investors.
Hey, guys. Thanks. I hope you can hear me okay. Thanks for taking my call. Maybe a few questions. Steve, how is the Vidyo and Espial, in terms of the characteristics of these companies, that different from some of the acquisitions you have done in the past? Other than the fact that, there's no professional service, no hardware. It's still very much a pure software business. What are some of the things that's a little bit different from some of the traditional things you've done in the past?
They're a little bit more in the cloud. They've made more of a transition there. We've generally been more on-premise, and we did the cloud through service providers to a large extent. They're a little bit more orientated towards the cloud. Other than that, they're pretty similar.
Okay.
I wouldn't think there's any real big difference.
In terms of their channel, do you also feel like you're saying you guys are traditionally more service provider? Do you feel like the channel-wise, they have a more of a direct channel or more of a VAR channel, or the channel mix is also maybe a little bit different from what you had historically?
You've got to remember, our asset management group was basically all direct, and our IMG group was mostly channel. Over the last year, we are changing it to be more direct as well. It fits okay. It will do channel and it will do direct.
Okay.
Whatever makes sense, we do.
Sounds like from your little comment to one of the questions is there's actually a decent amount of synergies across the service providers for Vidyo and SBO. Can, just maybe talk about it again? Something you actually will have some more product to sell to your existing service provider. Is this something that's fairly realistic that you guys can totally synergize?
It'll take time, if you think about it, and you look at other video companies, service providers should be interested in that technology. We see service providers as being interested in adding minutes. Vidyo adds minutes. We'll have to explore it. We don't know yet, but we think there's probably an opportunity for us. It'll take time to get there because you've got to make the product right for that group.
Great. Also, the Microsoft Contact Center transitioning. Other than that, do you feel like for the 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 this is pretty much all Microsoft related?
No, it's not. What we want to do is, we are looking at various options right now of how we could. We have a SaaS product. It only goes through service providers, we don't have enough revenue in North America, especially the U.S. We're looking at ways of maybe enhancing that in the future. The good news is it's not a product issue. We have the product. It's a go-to-market issue, when you go through channels, it's tough. Vince has been, over the last year, trying to get a more direct approach, which you need if you're going to change the strategy a little bit in that area. We're still positioning to do that.
The Microsoft Teams is a good place where we were in the past with Skype for Business, so we're still positive there, and we hope to improve our direct access to market also in the future.
You guys a little bit surprised on Skype, Zoom doing well? Obviously Zoom came out, Zoom's growing 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?
We always try and leverage off our software by putting it together. Certainly, there's a question mark with all 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. Maybe there's some opportunities there, but it depends on what the customers want. Do they want video in their Contact Centers or not? We'll be able to offer it, we'll be able to put it together, and we'll just have to see what happens.
Maybe last question from my end, and thanks for doing this. In terms of your install base, all the products you have in the contact center, do you feel like this is really sticky enough that as these companies transition from on-prem to SaaS, that you guys will definitely be part of it? 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 they would just buy whatever is hot and popular off the shelf in a marketplace? I just want to get a sense a little bit about how much you guys are in control of this whole transition and being able to keep your customers and at least keep the revenue.
As part of the thing we're 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. Remember our CCSP, which is our cloud product and contact center, we're in the biggest telcos in the world. We can scale. Many can't. I don't think we actually went to our base and explained what we actually have as well as we should. 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.
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'd rather do on-premise because they're really a reseller, and they want to make money selling hardware and whatever else they sell with our product. That's why going more to the direct model, we think we'll be able to help that process. It takes some time, and we're still in the process of doing that.
Okay. No, this is about it actually for me. Thank you so much, Steve.
Our next question will come from Daniel Chan with TD Securities.
Hi, good morning. You mentioned CAD 70 million-CAD 75 million in revenue from acquisitions in the next 12 months following purchase price accounting. You also discussed potentially looking at revenue that generates losses and maybe removing some of that. In addition to that CAD 70 million, CAD 75 million, is there potential for that to come in lower as you look at some of those revenues, and do you plan on running off any revenue that's losing money?
That's true. First of all, the CAD 70-CAD 75 is just from those two acquisitions. It's not from other things. It's only from those two. Generally, I take those things into account when I put a number out there. I believe the CAD 70-CAD 75 holds true, including the comment that it might eliminate some revenue.
Okay, that's helpful. Thank you. You mentioned that video may be 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 video?
Since we just did video a couple of weeks ago, the pipeline is not huge, but we've always looked at it a little bit, and 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. 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.
Great. Thank you.
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.
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.
That does conclude our call for today. Thank you for your participation. You may now disconnect.