Earnings Call: Q2 2018

Jun 8, 2018

Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2018 Q2 Earnings Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Steve Sadler, Chairman and CEO. Please go ahead, Mr. Sadler. Good morning, everybody. I'm here today with Vince Messud, President Doug Bryson, VP, Finance Todd May, VP, Legal Counsel and Sam Manager, VP, Corporate Development. Before I begin, I'll have Todd read our forward disclaimer. Certain statements made in this conference call may contain forward looking statements, which are not historical facts, but are based on certain assumptions and reflect Enghouse's current expectations. These forward looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risk factors are identified in Enghouse's AIF and other periodic reports filed with applicable regulatory authorities from time to time. And Chaus disclaims any intention or obligation to update or revise any forward looking statements whether as a result of new information, future events or otherwise. Thank you, Todd. Doug will now give an overview of the financial results. Thanks, Steve. Yesterday, Enghouse announced its 2nd quarter unaudited financial results for the period ended April 30, 2018. 2nd quarter revenue increased to $85,200,000 compared to revenue of $79,500,000 in the Q2 of the prior year. Income from operating activities was $24,700,000 compared to $21,900,000 in the prior year Q2, a 12.8% increase. Net income for the quarter was $15,300,000 or $0.56 per diluted share compared to $9,000,000 or $0.33 per diluted share in the prior year Q2, an increase of 70%. Adjusted EBITDA for the 2nd quarter was $25,400,000 or $0.93 per diluted share compared to $22,800,000 or $0.84 per diluted share last year with the increase primarily being attributable to contributions from acquisitions. On a year to date basis, revenue was $170,300,000 compared to revenue of $158,400,000 in the prior year. Income from operating activities was $49,200,000 compared to $44,000,000 in the prior year to date, an increase of 11.8%. Operating expenses before special charges related to restructuring of acquired operations were $34,400,000 compared to 32 point $6,000,000 in the prior year's Q2 and include incremental operating costs related to acquisitions. Non cash amortization charges in the quarter were $7,400,000 compared to $7,500,000 in the prior year's Q2 and include amortization charges for acquired software and customer relationships from acquired operations. On a year to date basis, operating expenses before special charges were $68,200,000 or 40 percent of revenue compared to $63,900,000 or 40.3 percent of revenue last year. The company generated strong cash flows from operating activities $21,800,000 compared to $18,400,000 in the Q2 of 2017. On a year to date basis, cash flows from operating activities were $44,900,000 compared to $29,000,000 in the prior year an increase of 54.8%. As a result, Enghouse closed the quarter with $155,300,000 in cash, cash equivalents and short term investments compared to $130,300,000 at year end. Cash balance was achieved after year to date payments of $8,600,000 in cash dividends, $9,700,000 net of cash acquired for acquisitions concluded in the fiscal year and $5,100,000 for acquisitions closed in prior periods. Yesterday, the Board of Directors approved the company's quarterly dividend of $0.18 per common share payable on August 31, 2018 to shareholders of record at the close of business on August 17, 2018. I'll now turn the call back to Mr. Sadler. Please? Thanks, Doug. As Doug noted, we continue to grow our cash with cash and short term investments of approximately 155,000,000 dollars Cash flow from operating activities was $21,800,000 in Q2 $44,900,000 year to date compared to $18,400,000 in Q2 last year $29,000,000 year to date last year. You'll notice that the balance sheet exchange impact was positive $1,400,000 compared to a loss over $2,400,000 last year in Q2 and a loss in Q1 of 2018. As discussed last quarter, we separated this accounting item out from our results to provide a better understanding of operational activities. The provision for income taxes was more normal at 21% of income in the quarter after the adjustment of $8,800,000 in Q1 one time accounting charge related to the estimated U. S. Repatriation tax imposed on foreign U. S. Subsidiaries for deemed repatriation of foreign profits in Q1. Some items to note in the Q2 results. Deferred revenue increased to over $76,000,000 in Q2 from 68 $800,000 in Q1 $62,400,000 at October 31, 2017, the end of our prior fiscal year. Software license revenue and hosted and maintenance services increased by over 10% compared to Q2 last year and 9.5% year to date. We continue to focus on revenue improving ideas, which would take a couple of quarters to determine their success and reflect in our internal growth results. Our markets remain challenging as revenue shifts to subscription revenue and competition from SaaS providers who emphasize revenue at the expense of cash flow and profitability. We continue to have a strong EBITDA margin of nearly percent. For acquisitions, we completed the acquisition of MobileThink late in the quarter, which added approximately $300,000 in revenue and was immediately profitable. One must remember that this was not even a full month of MobileThink's revenue as we did it early we did it April 5. MobileThink and the 2 acquisitions completed in Q1 are profitable and operating as expected. The economic and market factors remain favorable for acquisition opportunities. I would now like to open the call for questions. Thank you. And we will take an opening question from Daniel Chan of TD Securities. Please go ahead. Hi, good morning guys. Just on the Mobile Think acquisition, this is I believe you made a number of acquisitions in Denmark now. What is the cross sell opportunity with this acquisition? Well, I'm told by my team that there is some good cross sell opportunities. I never depend on them and so we'll have to wait and see if it happens. Okay. Thanks. And then Steve, I wonder if you could comment on the competitive environment, whether you're seeing any impact from Amazon or Twilio in the market yet? No. Okay. I should add a little bit to that. I should add a little bit. There's nothing in the market or results that we see any impact competition or anything like that. But it does help, as I mentioned it, to some of our potential acquisition candidates to give them a little more motivation to sell, I. E, it's more of a risk or concern for them than us. Okay. Yes, that makes sense. And then maybe, Vince, I wonder if you can comment a little bit on some of the progress on some of the initiatives you've been trying to make to get the organic growth up a little bit. Yes, sure. So Q2 was my first full quarter with the company, as you know. I focused most of the attention in the area of demand gen. So we added a couple of demand gen leaders, 1 on the interactive side and 1 on the networks, to start to get the pipeline of inbound leads started. So we added 2 good leaders there. We've also started to reorganize the sales team starting in Americas with having both kind of a channel go to market as well as direct. So we did that reorganization in Q2. And as Steve said, hopefully, we'll start to see some improvements in the next couple of quarters on the organic side. As it relates to some of this reorganization, are you thinking about SG and A coming off from these current levels? SG and A was a little bit lower than I expected. Typically we see sequential growth in Q2, but it's actually flat to down this quarter. So how should we think about SG and A going forward? Who is the question for? Well, either one of you, yes. Okay. I think the SG and A will probably increase a little bit, but not substantially. I don't see it going down, but I do see it probably increasing a little bit. And there may be changes that are needed there, as we change our strategy. As Vin said, we're going a little bit more direct, especially on our CCSP side. And yes, we're going to continue with our channel model as well. So it should go up a little bit, but I wouldn't model it drastically different. But I wouldn't model it down. Okay, great. Thanks. I'll pass the line. Thank you. We will take our next question from Paul Steep of Scotia Capital. Please go ahead. Good morning. Steve, maybe just on that actual topic, how do you think about balancing the margin improvements we saw in the quarter versus some of the investments you're talking about making. We've you had dialed it back and now Vince has laid out that it looks like you're going to sort of shift things a bit. How should we think over the next year or 2 years that sort of plays out? Well, if we are successful with the sales effort, and again, we started on demand generation first, It means our revenue line will go higher and probably our margins will improve. If we're not successful, we have more costs and the revenue will stay the same, the margins will go down a bit. Fair enough. On the asset management side this quarter, we saw a big tick up in margins and we saw some of the holdbacks start to sort of roll out. Is this related to maybe over performance of any of the deals you did a year ago, things like Tollgrade? Or is what else is maybe sort of playing out in the Asset Management segment this quarter? I think the deals that we did a year ago are starting to and have showed some progress. So I think it comes from there. But as you know, and I remind the group that when we do a deal in the Q1 or 3 months after doing so, you generally don't have any added profitability depending on the deal of course. Then the Q2, you generally breakeven, make a little. 3rd quarter, you get halfway to our normal margins. And by the Q4, we're at normal margins. So some of the ones last year, they're basically in the 4th quarter. So we're getting back to normal margins. And that's a general trend for smaller ones. Sometimes you can usually tell by the restructuring because it always takes a little time. But some like the mobile think, we didn't have to restructure very much. As you noticed, there wasn't much of a restructuring charge in the quarter. So they tend to get they tend to go faster in that model, I. E. The Q1, we didn't lose any money. So Q2, we definitely made a little bit and hopefully 3rd 4th it will progress further. So to get to your exact question, yes, toll rate from last year is hitting our normal margins. So yes, it's improved. Okay. The one thing I did want to ask about is, have you noticed any changes in the channel environment on the contact center side? You get a number of sort of key relationships there with large OEMs. How has that played out? Or has there been any change at all in that market environment? There has been a little change there. And it's not really us, it's because of the market. Those channels generally sell on premise. So it hurts us a little bit as well when the SaaS model clicks in. They don't have a SaaS offering. So what we're trying to do now and Vince is getting this organized is we're going to offer them to sell on our SaaS system, which we will have set up in a few platform accounts hopefully in each country. We're progressing with setting up the platforms and then we'll let them be able to still keep customer control by selling on the platforms that we set up. We've just got to get we're pretty good right now with platforms. We've got pretty good response, but we need to do a little bit more. Okay. Last one on my side for Broadridge. So the channel with the SaaS side, it really hurts the channel because when you do SaaS, they don't make their usual money on selling hardware. They don't make their usual money on doing a lot of services. So it's hurt their business, which then hurts our business for that side of what we're doing. So the channel has it's a challenging environment for the channel these days, but we hope we can help them soon. Okay. Thanks. And then the last one on my end, deferred revenue, slightly up year on year in terms of the total in line with the business, but a little bit better. Maybe some comments around what you guys have seen on maintenance renewal rates or anything either you or Vince has done to try to help tweak that up or is it just normal course of business? I think we're always trying to do things to make it a little bit better. Again, we're looking at we give a pretty good service. We haven't always in all our territories done annual price increases, which we should do, because if you're paying your people more and you don't do increases on your maintenance, you're just squeezing your margins a bit. So, Vincent has got a little more time and I had him focusing to make sure we do that. So we've done that side. The churn, there's always some because as you're going to a subscription or a different type model, you see that that has some impact on that deferred revenue plus and minus. I'd say we're still around the 90%, 92% overall. And it's a little bit different between the asset management side and the interactive side. But I it's pretty normal. Yes. And on the sales execution side, we started to point some people in the area of customer success focused on retention and renewing maintenance contracts and subscription agreements and so on. So we have a few people more focused on it. So hopefully that will also help a bit. Was it just on one side, Vince? Or did you just try to do sort of a leader on either side? On both sides, yes. On all the different divisions. Okay. Well, it's not even one of both sides. We also have like each country has to do it. And we still got a bit more work to do because it's not we've got a lot of different geographies to look at. But we're working on it, but it's not our biggest issue at this stage. It's just another refinement to improve things a little bit. We will take our next question from Deepak Kaushal of GMP Securities. Please go ahead. Hi, good morning guys. Thanks for taking my questions. I only get to do it once or 4 times a year when you guys hold your conference calls. I hope you keep holding them. Just wanted to Steve, I just wanted to ask you more about the M and A environment. I think you alluded to earlier competition like Amazon providing more motivation for sellers. What's the dynamic with sellers? I mean is there a hold up or is it sticking point on valuation? What can you say about the sellers and how they think about selling their businesses and you as a buyer overcoming those challenges? Where are the sticking points on the negotiations? I think the opportunities are good. Not much has changed. I've discussed several times why people are selling and the people we see. Private equity generally don't want to do smaller deals. That's still the case. People aren't getting younger, they're getting older. So you've got a lot of entrepreneurs in that baby boomer era. And I've said it last year and the year before, but they're not getting any younger. So that's still a motivation for some to get some retirement money. The market's pretty good. Interest rates going up in the U. S, people worry about that. Remember, a lot of people have a good and built a nice little business. They always look forward. And if they have to invest, for example, in SaaS, because that's where they see it's going, they don't want to spend their pension money and their retirement money on the chance that they'll be successful there, because many companies are not. And it usually is not a profitable venture in the beginning and it's still yet to be seen how long you have to go before you make I would say, if anything, the opportunities have gotten greater. I would say if anything the opportunities have gotten greater. Okay. So last year you guys invested in some of your internal systems with the expectation of accelerating M and A activity this year and your ability to integrate. When you look at your $155,000,000 cash balance, how much do you think or do you target to deploy this year in further M and A activity? And at what point do you kind of look at this and say, well, hey, the sellers don't have realistic expectations, maybe we allocate more of that capital back to dividend increase? Yes. Very easy. We don't have a budget, how much we have to do each year. We try and set a target for ourselves. And generally, we work within our operating cash flow that we generate. So it's not it has to meet our financial disciplines. If people don't have realistic expectations, we don't do the deals. If they do have realistic expectations, we do do the deals. So there's no budget. We do what we think is right. We've been pretty good at it for years, and we're comfortable that we should not change that model. I think overall on the acquisition side, as I said, opportunities are pretty good. I don't see needing to pay out a higher dividend, although me getting some cash flow and dividends, I don't mind. But right now, I think we can better deploy that capital, than give it to shareholders as we have in the past. Okay, excellent. And just one last question on that M and A. So you had a flurry of activity a couple of years over the last 5 years on the interactive side that's kind of slowed. Then it was is more on the telco side where you found your value, not much on the transportation side. Out of those three buckets, where are you kind of seeing the value and the opportunities? Is it balanced across 3 portfolios or weighted towards 1 or the other? Yes. A lot of the we've done a lot of acquisitions already in the IMG sector. So of course, there's somewhat less to do. As you noted, we did a lot in the network side. Again, the asset management side there at least. That continues because it's a fragmented industry. And quite frankly, the service providers are getting very tough on their pricing and their bargaining power. In some ways that hurts internal results a little bit, but it also helps our acquisition strategy. So I think that will continue. And transportation, I think you've noticed we did do a couple of little acquisitions in that in the last little while and we continue to look, but it seems to be an expensive market right now. Okay. Excellent. That's helpful. Thanks so much. I'll pass the line. We will take our next question from Paul Treiber of RBC Capital Markets. Please go ahead. Thanks very much and good morning. Just wanted to if you could help set expectations around MobileThink a little bit. There's been some public disclosures from its prior owners disregarding its annual revenue. I think they disclosed US13 1,000,000 dollars in 2016. Is that a reasonable level to expect going forward? And then in light of your comment on the Q1 or the 1st month or last month, 300,000 or anything unusual in the 300,000 dollars above or below what should be a normal run rate? So I have two comments there. First of all, the $13,000,000 was quite a while ago and that's not their normal run rate, but we don't forecast run rate. So that's high. 2nd of all, in the quarter, you've got 2 factors. It wasn't a full month for us. And it was as you know, in enterprise software, lots of revenue or more revenue tends to happen in the 3rd month of the quarter. April is the 1st month of their quarter. So you also have the impact being the 1st month where revenue is generally light in enterprise software companies and it's no different from Mobile Pink or any other ones that I've seen that do enterprise software. So you do have that impact in that short period of a few weeks in the Q1. But the estimates you might have said from the past are just not right. So I can't make any other further comment on that. Okay. That's fair. Just on M and A, I mean historically you haven't done this, but maybe perhaps you would is, are there any metrics or is there any way that you can quantify the level of activity you're seeing in the market in terms of like the deals that you're working on in terms of like NDAs signed, anything like that, that can help us understand the type of work you're doing right now and the activity that you're seeing? No, not really. NDAs come and we have a nice flow every week. We're signing some, but then some of the people want too much. Some people don't pass through due diligence, some don't meet our financial parameters. All I can tell you, it's the same as it has been in the past generally. That's what you've got to assume. It might come in lumps or it might come steady, but we don't see any difference in the activity, except there are more opportunities today generally than there have been in the past. And then just a last question for me, just with Vince on board for about 6 months or so, has your workflow changed over time in terms of the ability to spend more time on M and A as opposed to operations? Or is it still in a transitionary period? I would say it might seem to Vince that he's been here for 6 months, but he hasn't been here for 6 months. He's actually this is he said it was his 1st full quarter and he just joined before the start of the quarter. So it's actually been a little shorter than that. You know what, we're still transitioning over some of the operations. He's had meetings with the groups. It takes time And we're slowly doing that. And I'm sort of now spending a little bit more time on acquisitions, but that sort of takes a little bit of time too. So we're just doing the normal transition of those activities. Okay, great. I'll pass on. We will take our next question from Ralph Garcia of Echelon Wealth Partners. Please go ahead. Yes. Good morning. Thanks for taking my questions. I guess for Vince first, on the demand gen side, can you get to $500,000,000 in revenue over the next couple of years, just sort of rejigging the sales force and looking for new opportunities? Or do you have to go into adjacent verticals and or new geographies to do that? I mean, we don't as you know, we don't forecast internal growth or organic growth to Street. But in terms of the market size, if you're sort of asking is the market big enough in interactive and networks, the addressable market is big. This whole customer experience space is big, focusing on retention of customers and better call center management. So they're big markets. But my goal is to try to just get the organic growth improved over time. But there's no market limitation, so to speak, that I see. And have you added sales capacity over the last 3 months other than the 2 sort of leads that you mentioned? No, I've mainly added on the demand gen side in order to get sort of the pipe, the inbound lead flow happening. No use to adding sales guys until you get your pipeline moving and your inbound leads flowing. So we've just reorganized the existing team in the Americas from just a pure channel to have more direct and added more on the demand gen side of the business. Okay. And then for Steve, as you look at the your pipeline on the M and A side, are you seeing more still in Scandinavia and Europe or are there more are there opportunities for you in Latin America or Asia even or Australia, I mean, just to sort of grow new geographies from an M and A perspective? Generally, we're seeing good demand globally. I would not count on Asia because we tend not to look there. It's a difficult market to be in actually. If you're in, you're good, but it's hard to get in. And their business approaches are slightly different than we're used to. South America, yes, we're still through presence trying to build that a little bit. But we're looking generally in all areas both in current geographies where we're at and in new geographies. Okay. Thank you. As we appear to have no further questions queued, I would like to turn the call back to the speakers for any additional or closing remarks. Well, thank you for attending the call everybody. We appreciate your interest in our business look forward to providing you another update after our next quarter. Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.