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 Stephen Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.
Good morning, everybody. I'm here today with Vince Mifsud, President, Doug Bryson, VP Finance, Todd May, VP Legal Counsel, and Sam Anidjar, 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. Enghouse 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 second quarter unaudited financial results for the period ended April 30, 2018. Second quarter revenue increased to CAD 85.2 million compared to revenue of CAD 79.5 million in the second quarter of the prior year. Income from operating activities was CAD 24.7 million compared to CAD 21.9 million in the prior year second quarter, a 12.8% increase. Net income for the quarter was CAD 15.3 million, or CAD 0.56 per diluted share compared to CAD 9 million or CAD 0.33 per diluted share in the prior year's second quarter, an increase of 70%. Adjusted EBITDA for the second quarter was CAD 25.4 million or CAD 0.93 per diluted share compared to CAD 22.8 million or CAD 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 CAD 170.3 million compared to revenue of CAD 158.4 million in the prior year.
Income from operating activities was CAD 49.2 million compared to CAD 44 million in the prior year to date, an increase of 11.8%. Operating expenses before special charges related to restructuring of acquired operations were CAD 34.4 million compared to CAD 32.6 million in the prior year's second quarter and include incremental operating costs related to acquisitions. Non-cash amortization charges in the quarter were CAD 7.4 million compared to CAD 7.5 million in the prior year's second quarter 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 CAD 68.2 million or 40% of revenue, compared to CAD 63.9 million or 40.3% of revenue last year. The company generated strong cash flows from operating activities of CAD 21.8 million compared to CAD 18.4 million in the second quarter of 2017.
On a year-to-date basis, cash flows from operating activities were CAD 44.9 million compared to CAD 29 million in the prior year, an increase of 54.8%. As a result, Enghouse closed the quarter with CAD 155.3 million in cash equivalents, and short-term investments compared to CAD 130.3 million at year-end. Cash balance was achieved after year-to-date payments of CAD 8.6 million in cash dividends, CAD 9.7 million net of cash acquired for acquisitions concluded in the fiscal year, and CAD 5.1 million for acquisitions closed in prior periods. Yesterday, the board of directors approved the company's quarterly dividend of CAD 0.18 per common share payable on August 31, 2018, to shareholders of record at the close of business on August 17, 2018. I will now turn the call back to Mr. Sadler. Steve?
Thanks, Doug. As Doug noted, we continue to grow our cash with cash and short-term investments of approximately CAD 155 million. Cash flow from operating activities was CAD 21.8 million in Q2 and CAD 44.9 million year to date compared to CAD 18.4 million in Q2 last year and CAD 29 million year to date last year. You will notice that the balance sheet exchange impact was positive CAD 1.4 million compared to a loss over CAD 2.4 million 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 CAD 8.8 million 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 CAD 76 million in Q2 from CAD 68.8 million in Q1 and CAD 62.4 million at October 31st, 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 will 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 30%. For acquisitions, we completed the acquisition of Mobilethink late in the quarter, which added approximately CAD 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 April 5th. Mobilethink and the two acquisitions completed in Q1 are profitable on 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. If you would like to ask a question at this time, please press the star or asterisk key, followed by the digit one on your telephone. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find your question has already been answered, you may remove yourself from the queue by pressing star two. Once again, that's star one to signal for a question. We will take an opening question from Daniel Chan of TD Securities. Please go ahead.
Hi, good morning, guys. Just on the Mobilethink acquisition, 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, we'll have to wait and see if it happens.
Okay, thanks. 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. There's nothing in the market or results that we see any impact competition or anything like that. 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 a concern for them than us.
Okay. Yeah, that makes sense. Maybe Vince, I wonder if you could 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.
Yeah, sure. Q2 was my first full quarter with the company, as you know. I focused most of the attention in the area of demand gen. We added a couple of demand gen leaders, one on the interactive side and one on the networks to start to get the pipeline of inbound leads started. We added two good leaders there. We've also started to reorganize the sales team, starting in Americas, with having both a channel go to market as well as direct. We did that reorganization in Q2. 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&A kind of coming off from these current levels? Because SG&A was a little bit lower than I expected, and typically we see sequential growth in Q2, but it's actually flat to down this quarter. How should we think about SG&A going forward?
Who is the question for?
Well, either one of you, yeah.
Okay. I think the SG&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. There may be changes that are needed there as we change our strategy. As Vince said, we're going to probably add some people going a little bit more direct, especially on our CCSP side. Yes, we're going to continue with our channel model as well. It should go up a little bit, but I wouldn't model it drastically different. 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.
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? 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 two 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 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. As you know, and I remind the group, that when we do a deal in the first quarter or three months after doing so, you generally don't have any added profitability, depending on the deal, of course. The second quarter, you generally break even, make a little. Third quarter, you get halfway to our normal margins, and by the fourth quarter, we're at normal margins. Some of the ones last year, they're basically in the fourth quarter. We're getting back to normal margins. That's a general trend for smaller ones. You can usually tell by the restructuring, because it always takes a little time. Some, like the Mobilethink, we didn't have to restructure very much.
As you noticed, there wasn't much of a restructuring charge in the quarter. They tend to go faster in that model, i.e., the first quarter, we didn't lose any money. Second quarter, we definitely made a little bit, and hopefully third and fourth, it will progress further. To get to your exact question, yes, Tollgrade from last year is hitting our normal margins. 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. It's not really us, it's because of the market. Those channels generally sell on-premise. It hurts us a little bit as well when the SaaS model clicks in. They don't have a SaaS offering. 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. We'll let them be able to still keep customer control by selling on the platforms that we set up. We're pretty good right now with platforms. We've got pretty good response, we need to do a little bit more.
Okay. Last one on my side for.
Oh, yes. 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. It's hurt their business, which then hurts our business for that side of what we're doing. It's a challenging environment for the channel these days, but we hope we can help them soon.
Okay, thanks. 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 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. Vince has got a little more time than I had on focusing to make sure we do that. 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 has some impact on that deferred revenue, plus and minus. I'd say we're still around the 90%, 92% overall. It's a little bit different between the asset management side and the Interactive side. It's pretty normal.
Yeah. 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. 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 try to do sort of a leader on either side?
On both sides, yeah. On all the different divisions.
Okay.
It's not even one on both sides. We also have, like each country has to do it.
Right.
We've still got a bit more work to do because 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.
Tuning.
Perfect. Thanks, guys. Appreciate it.
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 four times a year when you guys hold your conference calls. I hope you keep holding them. Steve, I just wanted to ask you more about the M&A environment. I think you alluded to earlier competition like Amazon providing more motivation for sellers. What's the dynamic with sellers? Is there a hold-up, or is there a 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. You've got a lot of entrepreneurs in that baby boomer era. I've said it last year and the year before, they're not getting any younger, 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, 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. It's still yet to be seen how long you have to go before you make it profitable, because many have been out there already for years and are not profitable. The market hasn't changed. Its interest rate's going up. I would say, if anything, the opportunities have gotten greater.
Okay. Last year you guys invested in some of your internal systems with the expectation of accelerating M&A activity this year and your ability to integrate. When you look at your CAD 155 million cash balance, how much do you think, or do you target to deploy this year in further M&A activity? At what point do you look at this and say, "Well, hey, the sellers don't have realistic expectations. Maybe we allocate more of that capital back to a dividend increase.
Yeah. Very easy. We don't have a budget on how much we have to do each year. We try and set a target for ourselves. Generally, we work within our operating cash flow that we generate. 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 the deals. There's no budget. We do what we think is right. 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 extra cash flow and dividends, I don't mind.
Right now I think we can better deploy that capital than give it to shareholders as we have in the past.
Okay, excellent. Just one last question on that M&A. You had a flurry of activity over the last five years on the interactive side that's kind of slowed. It was more on the telco side where you found your value, not much on the transportation side. Out of those three buckets, where are you seeing the value and the opportunities? Is it balanced across three portfolios or weighted towards one or the other?
Yeah. We've done a lot of acquisitions already in the IMG sector, of course there's somewhat less to do. As you noted, we did a lot on the network side. Again, the asset management side there at least. That continues because it's a fragmented industry. 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. 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 wondered if you could help set expectations around Mobilethink a little bit. There's been some public disclosures from its prior owners just regarding its annual revenue. I think they disclosed US$13 million, 2016. Is that a reasonable level to expect going forward? In light of your comment on the first quarter or the first month or last month, $300,000. Is there anything unusual in the $300,000 above or below what should be a normal run rate?
I have two comments there. First of all, the $13 million was quite a while ago, and that's not their normal run rate, but we don't forecast run rate, so that's high. Second of all, in the quarter, you've got two factors. It wasn't a full month for us, and as you know in enterprise software, lots of revenue or more revenue tends to happen in the third month of the quarter. April is the first month of their quarter. You also have the impact of being the first month where revenue is generally light in enterprise software companies, and it's no different for Mobilethink or any other ones that I've seen that do enterprise software. You do have that impact in that short period of a few weeks, in the first quarter. The estimates you might have said from the past are just not right.
I can't make any other further comment on that.
Okay. That's fair. Just on M&A. Historically you haven't done this. Maybe perhaps you would. 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 the deals that you're working on in terms of NDAs signed? Anything like that can help us better understand the type of work that you're doing right now and the activity that you're seeing?
No, not really. NDAs come. We have a nice flow. Every week we're signing some. 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. We don't see any different in the activity except there are more opportunities today generally than there have been in the past.
Just the last question, Steve, just with Vince on board for about six months or so, how has your workflow changed over the time in terms of the ability to spend more time on M&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 six months. He hasn't been here for six months. He said it was his first full quarter. He just joined before the start of the quarter. 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. 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. We're just doing the normal transition of those activities.
Okay, great. I'll pass on.
As a reminder, that's star one to signal for an audio question. 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 CAD 500 million 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?
As you know, we don't forecast internal growth or organic growth to The Street. In terms of the market size, if you're sort of asking, is the market big enough in interactive and networks? The addressable market's big. This whole customer experience space is big, focusing on retention of customers and better call center management. They're big markets. My goal is to try to just get the organic growth improved over time. There's no market limitation, so to speak, that I see.
Have you added sales capacity over the last three months other than the two 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 adding sales guys until you get your pipeline moving and your inbound leads flowing. We've just reorganized the existing team in Americas from just a pure channel to have more direct and added more on the demand gen side of the business.
Okay, for Steve, as you look at your pipeline on the M&A side, are you seeing more still in Scandinavia and Europe, or are there opportunities for you in Latin America or Asia even, or Australia, I mean, to sort of grow new geographies from an M&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, yeah, we're still through presence, trying to build that a little bit. We're looking generally in all areas, both in current geographies where we're at and in new geographies.
Okay. Thank you.
As a final reminder, that's star one to signal for an audio question. 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 and 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.