Enghouse Systems Limited (ENGH) Q3 2020 Earnings Call Transcript

Enghouse Systems Limited  (TSX: ENGH) Q3 2020 earnings call dated Sep. 11, 2020

Corporate Participants:

Steve Sadler — Chairman & Chief Executive Officer

Todd May — Vice President, Legal Counsel

Doug Bryson — Vice President, Finance

Analysts:

Stephanie Price — CIBC — Analyst

Deepak Kaushal — Stifel GMP — Analyst

Tom Treiber — RBC Capital Markets — Analyst

Presentation:

Operator

Good day, ladies and gentlemen and welcome to the Enghouse Q3 2020 Conference Call. As a reminder, today’s conference is being recorded. At this time, I would like to turn the conference over to Steve Sadler, Chairman and CEO. Please go ahead, Mr. Sadler.

Steve Sadler — Chairman & Chief Executive Officer

Good morning, everybody. In this era of social distancing, I am here today with Todd May, VP, Legal Counsel; Doug Bryson, VP, Finance and Vince Mifsud, Global President. Before we begin, I will have Todd read our forward disclaimer.

Todd May — Vice President, Legal Counsel

Certain statements made maybe 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 other expectations. Undue reliance should not be placed on these forward-looking statements and information 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.

Steve Sadler — Chairman & Chief Executive Officer

Thanks, Todd. Doug will now give an overview of the financial results.

Doug Bryson — Vice President, Finance

Thanks, Steve. Yesterday, Enghouse announced its third quarter unaudited financial results for the period ended July 31, 2020. All financial information is in Canadian dollars unless otherwise indicated. Key financial and operating highlights for the 3 months ended July 31 compared to the same period in 2019 are as follows.

Revenue grew 29.7% to $131.3 million. Results from operating activities increased 56.2% to $42.2 million. Net income increased 77.3% to $26 million or $0.46 per diluted share. Adjusted EBITDA increased 62.4% to $45.6 million. Cash flows from operating activities, excluding changes in working capital increased 58.8% to $45.3 million. Cash, cash equivalents and short-term investments were $228.9 million, an increase of — from $150.3 million at October 31, 2019, which was achieved after making payments of $19.5 million for dividends and $43.9 million for acquisitions this year. The company has a long-term debt other than nominal amount that is non-interest bearing.

In the quarter, the company experienced growth from both internal sources and from acquisitions. Internal growth includes the expansion of the acquired businesses, particularly video since acquisition. Today, COVID-19 continues to have an overall positive impact on revenue. Although the initial surge of customers required immediate remote work and visual computing solutions upon the initial outbreak of the pandemic was primarily served in the second quarter of 2020, demand for these solutions remains above historic averages. The pandemic has tested Enghouse’s ability and capacity to respond to significantly altered circumstances. Enghouse’s results continue to demonstrate the resiliency of its business model, which is based on significant recurring revenue streams, positive operating cash flows, large cash reserves with nominal debt and a disciplined cost management and value for money philosophy. Yesterday, the Board of Directors approved the company’s eligible quarterly dividend of $0.135 per common share payable on November 30, 2020 to shareholders of record at the close of business on November 16.

I will now turn the call back to Mr. Sadler to provide his comments. Steve?

Steve Sadler — Chairman & Chief Executive Officer

Thank you, Doug. As Doug noted, we had another good financial quarter from our operations during these challenging times. Strong cash flow from operations of over $45 million increased our cash and short-term investments to $229 million approximately from $168 million in Q2 despite paying our quarterly dividend of $7.4 million, considering our changes in working capital and income tax installments paid.

Net cash provided by our operating activities was $55.7 million. Compared to prior year’s Q3, foreign exchange increased revenue by $1.4 million and increased operating cost by $1.1 million with a small positive impact on operating income. Some of our revenue is being delayed by COVID-19 and the business environment remains challenging for new customers, although one of our significant transit customers proceeded to rollout its hardware purchased on a commitment related to a contract completed before the COVID-19 impact. This increased our hardware revenue in the quarter, but at a lower margin. Video revenue once again exceeded our original expectations, but was reduced from the high Q2 customer demand.

As stated last quarter, some of our customers have been significantly impacted by the pandemic and continue to be cautious in committing to new projects, although we have seen some improvement. In terms of acquisitions in Q3, we completed no new acquisitions, although, our Dialogic acquisition, which we did at the end of December, has been integrated into our operations and is progressing as anticipated. We continue to focus on capital deployment doing most of our acquisition work remotely. But as indicated last quarter, several opportunities continue to focus on their own business issues delaying acquisition processes. The acquisition pipeline remains at it consistent with historic levels.

I would now like to open the call for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Stephanie Price with CIBC. Please go ahead.

Stephanie Price — CIBC — Analyst

Good morning. Just looking at video…

Steve Sadler — Chairman & Chief Executive Officer

Hi, Stephanie.

Stephanie Price — CIBC — Analyst

Hey, just wondering if you could talk about what you have seen with video so far in fiscal Q4 in terms of demand, I am just curious about whether the Q3 run-rate is something you would expect through kind of the pandemic here?

Steve Sadler — Chairman & Chief Executive Officer

Hey, so, you asked for Q4, I think you meant Q3, but we did see an initial demand, mostly from current customers but some new in Q2 that lowered down in Q3 as it bought a lot of the requirements in Q2. We still see more than we anticipated at the beginning of the year for video, but our international rollout of video has been slower than we expected and so we are still pushing to improve in that area.

Stephanie Price — CIBC — Analyst

Okay, thanks. And then in the MD&A you mentioned the possibility of facilities reduction and other cost savings, just curious around the margins and how we should kind of think about the impact of those opportunities?

Steve Sadler — Chairman & Chief Executive Officer

It’s pretty similar to the past. When we don’t do acquisitions in a quarter, which we always try and fix over one or two quarters, our margins tend to increase to about 35%. If we do acquisitions, I still maintain you got to think of it and model it at about 30%. 25% to 30%, depending how big and how much restructuring has to be done, but it’s pretty much the same model that it’s been for the last 10 years.

Stephanie Price — CIBC — Analyst

Okay. And on the M&A environment, since you mentioned that, you mentioned that some of the opportunities are kind of focused on internal operations here. Can you give us a bit more color there and how you kind of think about M&A in the back half of the year here?

Steve Sadler — Chairman & Chief Executive Officer

So, we are pretty set up to do M&A, but you got to remember opportunities that we see they are having their people work from home and they are a little slower gathering data for us and doing the due diligence process. Also if an issue or something comes up, they can delay things for a week or two, some have delayed it into next year. Because they just have other things that they are focusing on that are more urgent than doing a transaction with their company at this time, but again, that’s also freeing up a little bit, but it’s still an issue today.

Stephanie Price — CIBC — Analyst

Okay, thank you very much.

Steve Sadler — Chairman & Chief Executive Officer

Everything is remote. Everything is remote, except we are kind of lucky, because we have people who have done acquisitions virtually in every geographical area. So, when we look at acquisitions, we tend to still send somebody in on-premise to have a look at the environment culture and some other factors.

Stephanie Price — CIBC — Analyst

Great. Thank you.

Operator

We will go to our next question coming from Deepak Kaushal with Stifel GMP. Please go ahead.

Deepak Kaushal — Stifel GMP — Analyst

Thanks. Thanks for taking my questions. Good morning, everyone. Just couple of follow-ups on Stephanie’s questions to start just on video, Steve, are you able to kind of quantify or even give us qualitative sense of the pace of acceleration for that business and how much it’s exceeding your expectations?

Steve Sadler — Chairman & Chief Executive Officer

Of course, you would have to know my expectations too. It’s hard to answer that. But let me say that in Q2 it far exceeded it. There is a lot of their current customers who already were using the product ordered more — ordered more licensed revenue and some hosting revenue. That was mostly in Q2. We saw still some in Q3, but it is slowed down in Q3.

Deepak Kaushal — Stifel GMP — Analyst

Okay. And I share if I…

Steve Sadler — Chairman & Chief Executive Officer

I don’t really predict Q4, but it’s still the work from home environment, there is a lot of moving parts, it’s still an important area for us going forward.

Deepak Kaushal — Stifel GMP — Analyst

And for the non-video part of the interactive business, any color on that, the call center or contact center side?

Steve Sadler — Chairman & Chief Executive Officer

Yes, if you remember, at the beginning of the quarter, we talked about how we got certified by teams, which is the Microsoft product, which we have been working on for about 18 months and we have had several of our products certified now. So that’s positive, but again, new customers buying new contact centers in this environment, where it takes work and people coming in to set it up, it’s been been slower, but the opportunity is still there.

Deepak Kaushal — Stifel GMP — Analyst

Okay, got it. And then just on the M&A side, I am just curious, we have heard a couple of companies report in as many days signaling valuation expectations if targets has risen quite substantially. We see it in the public markets for tech stocks. What are you seeing in terms of valuation expectations? And is that a hurdle for you guys to get acquisitions done over and above what you are seeing on the work from one side?

Steve Sadler — Chairman & Chief Executive Officer

No real change and our parameters haven’t changed. Certainly, if you are going to the public markets and looking at very large deals there, there is a lot of money at, virtually it’s free, no interest rates the private equity has. So, I suspect that those valuations are higher, but we are not seeing that and what we are looking at.

Deepak Kaushal — Stifel GMP — Analyst

Okay. And is that because of you are seeing more companies with problems or because they are just so smaller in private, they haven’t really in that kind of…

Steve Sadler — Chairman & Chief Executive Officer

They are basically not public and although money is cheap, you still have to get money. And some of these companies have difficulty getting money even though it’s cheap. So we aren’t seeing really any difference there. In fact, if I was going to make any comment, we probably see a little better valuations and what we are looking at.

Deepak Kaushal — Stifel GMP — Analyst

Okay, that’s interesting. And then my last question…

Steve Sadler — Chairman & Chief Executive Officer

Where your comments are coming from is probably in the public markets. That’s when you generally look after. We find the public markets are a little expensive based on the criteria that we usually look for.

Deepak Kaushal — Stifel GMP — Analyst

Yes, I don’t know. I mean, it’s often in the private markets. I am surprised because these companies typically acquire private companies and they are signaling higher valuation expectations. So, I guess you are finding them in certain pockets. Are there any particular segments that are showing better value than others?

Steve Sadler — Chairman & Chief Executive Officer

We have always had some companies — we have always had some companies that want higher valuations. If it doesn’t meet our financial criteria, we just pack. Many of those companies are still available. So, often when people say, yes, the numbers are higher, etcetera, they are justifying paying more or justifying not doing stuff. We are not finding that in the areas that we are looking at.

Deepak Kaushal — Stifel GMP — Analyst

Okay, okay, that’s very helpful. Thank you for taking the questions and we will talk to you soon.

Operator

Thank you. [Operator Instructions] We will go to our next caller Tom Treiber with RBC Capital Markets. Please go ahead.

Tom Treiber — RBC Capital Markets — Analyst

Hi, good morning. It’s Paul Treiber. Just to follow-up on M&A, the MD&A mentioned other income increase by over $2.5 million because of unrealized gains and investments in equity positions. Are those trading positions or are you considering acquisitions of public companies?

Steve Sadler — Chairman & Chief Executive Officer

We are always considering acquisitions of both public and private. When you say trading positions if we see a company that is a potential acquisition sometimes we take a foothold in it. Often when they do that for some magic reason the stock runs up and then if we make some money and it’s above our valuation expectations, we sell it.

Tom Treiber — RBC Capital Markets — Analyst

Okay, so nothing to disclose…

Steve Sadler — Chairman & Chief Executive Officer

We are not trading, but they are potential companies we would buy the whole company. And sometimes when you talk to them, magically, all of a sudden their stock goes higher and we are not interested in paying up we are very disciplined. So then we may just sell our positions at that point.

Tom Treiber — RBC Capital Markets — Analyst

Okay. Also in regards to M&A, I mean, you mentioned that you have people on the ground that can visit targets in all your regions. But from your perspective though, I mean you tend to be hands on with M&A. How are you adapting to this, the challenge of travel restrictions in this environment and also doing M&A on a remote basis? Is it something you are finding comfortable adapting to or you are going to prefer going back to the old world of travel and in-person meetings?

Steve Sadler — Chairman & Chief Executive Officer

Okay. So about 80% plus of our M&A work is done remote and always has been. We tend to go to the site to finish off and just have talk to the people. We now have video. We do that through video and online and we really just have someone remotely go there just sort of get the layout and get another view, so we never just do it with one view, we always have several people maybe ask the same questions to make sure we get the same answers.

Tom Treiber — RBC Capital Markets — Analyst

Alright. Thanks for that perspective. One more from me. In regard to professional services as flat quarter-over-quarter, are you still seeing challenges in terms of travel restrictions and the inability to travel to customer locations as just restraining the ability to do professional services? And more recently, as we enter the fall, are you seeing that beginning to lift or is it still a challenging environment?

Steve Sadler — Chairman & Chief Executive Officer

It’s still pretty challenging there, but a lot of our professional services is not done on a customer site. It’s done on our site or done even from people working at home, but there is some times there is implementation has to be done on a customer site. So, there is some limitations there, but it’s not a big factor.

Tom Treiber — RBC Capital Markets — Analyst

Okay. Thanks for taking my questions.

Operator

Thank you. There are no additional questions at this time. Mr. Sadler, at this time, I will turn the call back to you for any additional remarks.

Steve Sadler — Chairman & Chief Executive Officer

Okay, thank you. Enghouse is well positioned both operationally and financially for this unusual business environment. We look forward to finishing our fiscal year 2020 and preparing for whatever business environment develops for next year.

Operator

[Operator Closing Remarks]