Enghouse Sys Ltd

Good day and thank you for standing by. Welcome to the EngHouse Q4 2021 conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mr. Steven Sadler, Chairman and CEO. Please go ahead.

Good morning, everybody. I'm here today with Vince Mifsud, Doug Bryson, Todd May, and Sam Manager. Before we begin, I will have Todd read our forward disclaimers.

Certain statements made may be forward-looking by their nature. Such forward-looking statements are subject to various risks and uncertainties, including those in ANCHA's continuous disclosure filing, such as its AIF, which could cause the company's actual results and experience to differ materially from anticipated results or other expectations. Under-reliance should not be placed on forward-looking 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.

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

Thanks, Steve. Yesterday, NHS announced its fourth quarter unaudited and year-end financial results for the period ended October 31st, 2021. Financial and operational highlights for the three and 12 months periods ended October 31st compared to the three and 12 month ended October 31st, 2020 are as follows. Revenue achieved was 113.1 million and 467.2 million, respectively, compared to revenue of 120.9 and 503.8 million last year. Results from operating activities was 39.1 million and 155.2 million, respectively, compared to 42.7 and 162.0 million for last year. Net income was 30.2 million and 92.8 million, respectively, compared to $29.4 and $98.6 million. Adjusted EBITDA was $42.1 and $168.5 million, respectively, compared to $46.6 and $176.8 million, while adjusted EBITDA margins increased from 35.1% to 36.1% for the year. Cash flows from operating activities excluding changes in working capital was $42.4 and $167.8 million, respectively, compared to $48. and $175.5 million. Fiscal 2021 was another year of positive income and operating cash flows, improved adjusted EBITDA margins, and record distributions to shareholders. Although record revenue was not achieved this year, we again demonstrated the benefit of maintaining our financial discipline during times of significant market fluctuations. For the year, Enchaus achieved adjusted EBITDA margins of 36.1%, and cash flows from operations excluding changes in working capital of $167.8 million. Revenue for the quarter was $113.1 million compared to revenue of $120.9 million in the same period in the prior year. The decrease reflects exceptional revenue in the comparative period as a result of COVID-19 related demand in addition to unfavorable foreign exchange. Similar to the second and third quarters of 2021, the comparatively higher revenue last year was driven primarily by the previous year's significant increase in our video business that has returned to levels more consistent with pre-COVID volumes. Revenue for the quarter was negatively impacted by $4.4 million as a result of foreign exchange as the Canadian dollar strengthened against the U.S. dollar and euro. Enchaus closed the year with $198.8 million in cash, cash equivalents, and short-term investments compared to $251.8 million at October 31, 2020. The cash balance was achieved after making payments of $35.6 million for acquisitions and $115.7 million for dividends this year, inclusive of an $83.2 million dividend of special dividends. Changes in the macroeconomic environment caused by COVID or other factors continue to impact our business. We closed three acquisitions during the year that met our return on investment criteria. However, acquisitions in the technology marketplace continue to be priced at prohibitively higher valuations that do not support our return on investment objectives. Going forward, we continue to seek earnings accretive acquisitions to grow our revenue and further expand both our product suite and geographic reach, while maintaining our commitment to profitable growth in accordance with our disciplined business model. We continue to operate our business consistent with our value for money philosophy that we believe provides shareholder value in the long term. Yesterday, the board of directors approved the company's eligible quarterly dividend of 16 cents per common share payable on February 28th, 2022 to shareholders of record at the closest business on February 14th, 2022. I'll now turn the call back to Mr. Sadler.

Thanks, Doug. This will now give some operational highlights of the quarter.

Thank you, Steve. And thank you to those who made the time to join our final call of fiscal 2021. This quarter represents our seventh consecutive quarter of exceeding $40 million of adjusted EBITDA. We achieved $42.1 million of adjusted EBITDA this quarter, 37.2% of sales, which is one of our highest EBITDA percentage quarters. We continue operating our business with significant financial discipline, generating positive cash flows from our operations that can be used for acquisitions and investments in the business without the need for debt financing or shareholder dilution. Gross margins in the quarter were 72.5%, consistent with last year's Q4, and improved over Q3, which was 71.6%. We achieved these gross margins at a time when we are also investing in standing up our own cloud contact center solutions, which tend to have lower gross margins until we ramp up the number of users. Revenue for our interactive group improved slightly this quarter compared to Q3 from 65.6 to 66.8. There are a number of trends we are seeing in the contact center market, communication and video business that are worth noting along with how we have and will continue to respond to these market shifts. COVID has driven a more permanent shift to the cloud contact center technologies away from on-prem solutions. There is growing interest for cloud contact centers, both private cloud and multi-tenant cloud, which depend on the objectives, the size, and the security requirements of the corporations. In response, as we previously have mentioned, we stood up our own multi-tenant cloud contact center offering over a year ago and are offering software as a service to our customers through our direct sales team. We expanded this offering by adding one additional node in Canada and plan to add another node in the Asia-Pac market in the next 60 days to address customers that have data residency needs and also for demands in these markets. We also expanded our private cloud offering, investing engineering resources over the last year to ensure all of our on-prem contact center products are cloud ready and can be offered as a private cloud. Many companies want the option to select various cloud providers depending on their corporate direction, which include Microsoft Azure, Google, AWS, IBM, and others. And Enchouse is agnostic and can work with any cloud provider in the market. Another growing trend we're seeing in the communication space is a move towards cloud unified communication as a service, known as UCaaS, away from on-prem PBX communication platforms. Our strategy is to integrate our contact center with multiple unified communication platforms. And this remains the same. We're agnostic to the platform the customer wants. And due to the growth in UCAS and customers looking for a tight integration of UCAS and contact centers, we decided to develop our own UCAS offering. which we have been working on for over a year, and we just launched it in Q4. And similar to our overall product strategy, we are offering NHELS UCaaS in a private cloud, multi-tenant cloud, and also allowing our partners to stand up their own UCaaS platform, white label it as their own offering. We don't believe that there's other UCaaS vendors with the same approach. The other growing trend is in the area of optimizing and augmenting the contact center agent by using artificial intelligence and natural language processing. EngHouse has a growing suite of products in this area. We have products that are used to manage the quality of the agent, improve their time to productivity, augment and automate interactions, and even coach the agent in real time while they're interacting with the customer. Our video business unit was down this quarter compared to last year, but has now stabilized and shown slight improvement over the last three quarters. Video channels have become another customer interaction point for the contact center, and three of our large telecom partners have recently integrated video into their white-labeled NHELS contact center solution and are now selling video as part of their offering. On the healthcare side, We're seeing more interest from our customers to integrate video into their healthcare communication workflows and patient monitoring systems. And therefore, we continue to partner with healthcare tech companies as part of our go-to-market. And as an example, we signed one large new healthcare partner to our video product in Germany this quarter. Given the nature of our asset management division, revenue can fluctuate from quarter to quarter depending on the timing of large software and hardware orders and deliveries. In general, we are not seeing as significant of a move to the cloud in the telecom and transportation sectors as we are seeing in contact center. However, we invested and continue to invest in preparing our technologies for the cloud in anticipation of this shift occurring in the future. The first two areas we've initially invested in cloud enabling our offering is in our business support systems area and IPTV. IPTV demand continues. We now have 10 customer orders for IPTV. Five just went live and five customers are expected to be live in the next 90 to 120 days. In the transit side, we did see some recent increase in ridership over the last 90 days, which are now at volumes that are approximately 30% lower than pre-COVID levels, but it's up from being 50% lower last quarter. There's also a recent increase in the request for proposals for transit expansions and more opportunities for our automated fare collection product. The EuroPay MasterCard Visa offering, known as EMV, and a certification we received last quarter is starting to get rolled out across our existing customers in Europe, and we started responding to RFPs in the American market. Just to provide a brief update on our large public safety projects, we've recorded a relatively small percentage of the total revenue of these multi-year projects so far, recognizing just under 12% of the project value. So we still are relatively early stages of these projects. On a final note, Although we are always focused on improving profitability, continually looking for ways to operate more efficiently and save costs in areas like facilities and travel, we plan to continually invest in engineering and product development, driving exceptional values through our products to our customers. Let me turn the call over to Mr. Steve Sattler.

Thanks, Vince. As Doug noted, our operations remain financially sound today. with good cash flow and a strong balance sheet. Acquisitions completed in the year include Altitude, which was December 2020, Naboo, June 3rd, 2021, and Momindim, July 7th, 2021. And they are operating close to our normal and expected EBITDA margins in Q4. We continue to focus on capital deployment, doing our due diligence remotely. The acquisition pipeline is improving and company values seem to be declining into our financial range with lower impact from the public markets. We believe as interest rates increase, as taxes rise, as cost inflation increases, and as stimulus declines in our business sectors, acquisition activity will improve. We continue to maintain our financial discipline when reviewing acquisition opportunities. In the quarter, there was a report about our M&A potential activity. As a matter of company policy, we do not comment on our M&A activity or market rumors. We remain committed to executing our historic strategic business model, which we believe will add substantial value for shareholders. I would now like to open the call for comments or questions.

Thank you. As a reminder, to ask a question, please press star 1 on your telephone keypad. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Paul Treiber from RBC Capital Markets. Your line is open.

Thanks very much and good morning. Just on your last comment, I know you can't comment on market rumors or media articles out there in regards to M&A, but can you speak at a high level, what you see as a longer-term, either potential exit strategy for shareholders, or how you think about long-term succession planning for the company here?

So long-term planning is basically doing what we're doing. We've got a good team. There's people in the team that can, if people move or leave or retire, they can move up. I think we're just gonna continue with our plan. It's worked pretty well for 10 years. I'm pretty sure it can work pretty well for another 10 years.

And can you elaborate a bit more on the team? I think you added one or two M&A people. How do you think about the division of duties in the process around M&A and due diligence? If you can just elaborate a bit more there, please.

So we've talked about this before, but we have a couple of people who look for opportunities. And that's different than it was two years ago where we didn't really have any of those people employed. We've hired a couple of analysts and put it them under a long-term analyst who did a lot of the initial acquisitions with me. Sam still project manages the whole thing. And as we get opportunities and get agreement to an LOI, we involve the operational staff to be involved in the due diligence. So when the deal closes, they generally take on the responsibility for running under the plan that we had for the acquisition. Pretty simple model, done it for over 10 years, works not too hard.

And just in regards to the M&A environment, you made a comment in the press release about, you know, valuations being expensive, but then also at the end of prepared remarks, you mentioned that valuations have come down. How should we think about, like, is a comment in a press release more encapsulated in the year or and your more recent comment is more relevant? Like, how should we think about valuations where they stand right now?

Valuations, and this is just our view, in the year have been expensive for many reasons. Stimulus, one, you've got a lot of money floating around chasing things. But that seems to be changed lately. Stimulus has dropped. People are talking about... Interest rate increases. They're also looking at, you know, how do we pay this money back, which means taxes, you hear it all the time in the U.S., are going up, but every country is talking that way. You do have to pay for the money that was spent. So we believe that you put all those factors together, it makes the acquisition environment better, and we see that going into 2022 as a reasonable possibility of what will happen.

Okay, thank you.

I'll pass the line.

Our next question comes from Paul Steep from Scotia Capital. Your line is open.

Steve, can maybe we talk a little bit about just capital and use of capital and maybe revisit from a year ago? You talked about, you know, willingness to use debt, and we ended up because you had, you know, larger outsized profits, let's say, and, you know, built cash, you return that to shareholders. But if we look, you're sort of close and almost, you're about $20 million off on a net debt basis from where you would have been, I guess, 16 days before the payment would have been made for the special dividend. Maybe just walk us through, you know, how you're thinking beyond M&A, you know, how you might think about share repurchases or, you know, the regular dividend is special. anything like that in the context of where you're headed today?

Okay, the special dividend, and I think we've said this before, we had an unusual event, as did the world, with the pandemic. In that process, we had a lot of orders come in and made a lot of money, profit, and cash, so we decided that this was probably not an ongoing event forever, at least we would hope that's the case, and so we actually decided give a special dividend to give that money back to shareholders. That's not normal. We have never done it before. And hopefully there's not another pandemic that we have to do it again. So that's where the special dividend comes in. Share buybacks, I mean, we look at it very easily. We say, is it better to buy our own shares or buy other companies that then can add to our business? And we find buying other companies to add to our business is is a better route to go. So share buybacks, we tend to not do. But if the market crashes down, we have a special acquisition bid that's normal on the Toronto Stock Exchange, and we'd buy back our shares. But they have to be very attractive. And that day may come, but it isn't here yet, and I can't predict it.

The other part of that that I didn't maybe make clear, about a year ago prior to that, you talked about willingness to maybe use what was inexpensive debt, I think is the best way to phrase it, and use that to do more acquisitions. Have we sort of gone back to the historic plan of holding more cash and avoiding debt? You never ultimately tapped the debt, but just that was part of it in there as well that I grabbed in.

The debt is a possibility if the acquisition is large enough that we need to get the debt as well as keep cash for working capital. So that's still possible, but we have a lot of cash and we don't have any significant acquisition that would cause us to go get debt. A lot of the banks are anxious to give money. They're calling all the time, do we need money? And the answer is we don't. We think the environment could be that those who have money might have great opportunities and those who don't might find it more difficult in the future to borrow with higher interest rates and maybe a bit of a change in some of the other parameters we talked about. So it's still a possibility that we could borrow money, every opportunity to do so, but we're not going to borrow money just for the sake of giving banks some more income. We're gonna only borrow money when we have a good need for it, and it always takes some time, but we can get money in 30 to 60 days pretty easily based on our historic profitability, our cash flows, and just how we run the company. So it's still there, Paul, but we've had no need for it yet. Maybe next year, maybe not.

Makes sense. And just maybe on video for a minute, and then the cloud business, can you just remind us, whoever wants to take it, on the rough size of what remains around that hardware business. You called it out in the MD&A that there was sort of some runoff as you'd seen people transition, obviously, from using video rooms, given the changes in our lives at this point. How much more of a runoff would there be in that as you sort of transition over the next year?

I'll let Vince answer that because he's right on top of it, so.

Yeah, I mean, last quarter of Q4 of 2020 was sort of the last peak of the video. And as I mentioned, over the last three quarters, our video business unit has stabilized and started to increase. We don't see any pickup on hardware rooms. So our hardware revenue was down about a million dollars from last year. If you notice, I think last year we were about a million, just over a million more. But I don't see any demand for hardware rooms at this moment.

The only thing I'll add to it is right now we're in a video room. We took our boardroom and we've set it up to be a video room. One day we might use it.

Got it. What's the rough size of the cloud business today in contact center? Just as we start to think about the transition you outlined in the trends, I know we're not yet at a point of you breaking that out into a separate line, but Maybe you could give us a sense of where we are in terms of the journey.

Are you talking the industry or us?

You. I'm meaning specifically to you guys just because we had a large part of on-prem.

We have a pretty good software and have for a long time in the cloud. But as you know, we did it through the telcos. So they hosted it. They either shared revenue or they bought the software from us and paid maintenance on it. We found that wasn't aggressive enough in this environment. So as Vince said, we're starting to set up our own nodes. We've already changed the sales force over the last two years to be a little bit more direct because there's not enough margin to go indirect. And if you looked at us, let's say, five years ago, the channel, they would sell our software. They'd make their money on selling the PBXs and doing all the services. That revenue has decreased. declined a lot. So using the channel, we had to go to direct a lot more. I think it was a good idea. The pandemic came in, it makes it tougher to set that up. If you have it set up, you're okay. But now the direct salespeople almost inside salespeople because they can't travel to go actually do the selling. And therefore the SaaS or in the cloud, actually companies have done better because of the pandemic. because you can't go and install the system on their machines and all that kind of activity that might take place. The market is mostly still on-prem, but it's growing quickly in the cloud. So if I said it was 10% last year, it might be 20% getting the cloud now, and the pandemic has brought that forward a little bit, which certainly has hurt us, because just like it brought some of our video forward, it brought some of the cloud forward, Because you can't get on-prem to do the on-prem installs you need for that in many cases. So, you know, we watch the environment and we try and react to it. And I think that's what Vince went through. He's telling you how we're reacting to it.

Fair enough. One last one for me and I'll pass the line. Is there an opportunity, Steve or Vince, to do some of the same sales changes you've done in the interactive segment to asset management, recognizing obviously that they're distinct businesses and markets, but it sounds like we're sort of through the process and solidly in implementation on interactive. What's the possibility on the other side of the house?

Yeah, on the asset side, the good news there is we're already direct, quite direct. Because the nature of the deals are quite, they're usually big, bigger deals, So we've always been more direct on the asset management side and we're more channel on the interactive side. There is an opportunity in asset management to do some channels, but they're usually large companies like Ericsson, Nokia, Airbus, etc. So we do have some channel business, but it's mostly direct.

And you also got to remember why we did channel on the interactive side. is because the channels sold PBXs and did services, there's no opportunity for that in going on the asset management side. So the channels, unless they're big because they're selling their own equipment with it, they're less interested, as Vince pointed out. Great. Happy holidays, guys.

Talk in the new year. Thank you.

Again, to ask a question, please press star 1 on your telephone keypad. Our next question comes from Stephanie Price from CIBC. Your line is open.

Good morning.

Morning, Stephanie.

Morning. I just wanted to follow up on Paul's question around the cloud contact center business. I mean, how many of these have you set up to date and how many more are you looking at adding and maybe how we should think about those in terms of investment?

Yeah, we've added three nodes to date. So we've got one in the US, one in Europe, and just recently did one in Canada in the last 90 days. And we're adding another one in Asia PAC. We don't necessarily need to put them in every single country. What we... We can leverage a node, for example, the one we have in Germany for other markets outside of Germany. We'll set up a node when we have a large customer that says we'd like to have the data resident and stay in country. That drives us to set up another node.

Stephanie, another point, so we aren't confusing anything, is these nodes are with other suppliers. The capital expenditures and the financials don't change. It's operating costs we have. We're not setting up our own data centers.

That's helpful. Thanks. And then maybe moving over to the networking division, can you talk a little bit about telco spending at this point and what you're seeing there?

I can start. So, I mean, no real change there. Like I said in my presentation, that business has some bigger deal, so it does vary from quarter to quarter depending on when we get an order and when we ship it. So you get a little bit of quarterly variability, but no real change there. The cloud hasn't impacted that business. It's still mostly on-prem. The two areas we see some move to the cloud is for business support systems that help the telco companies run their business and in the IPTV. which we started investing in about a year and a half ago or so. So those two areas are moving to the cloud a bit, but everything else is pretty much the same on-prem.

Great. Thank you.

Our next question comes from Daniel Chen from TD Securities. Your line is open.

Hi, good morning. Vince, you talked about video now being able to be sold through some of your telco partners. Can you talk about how that's structured, whether that's being sold as an add-on package to the contact center software, or whether it's being sold as a standalone, and what's the upsell opportunity there? Thanks.

Yes, yeah, it's being sold as an add-on to a contact center if they want a video channel for their customers, and we get paid by usage. So as they get more usage of the video as they use video, we get paid. Um, so what we had to do first is integrate, integrate it closely with their white label solution and they're out marketing it as an add on.

Great. Thank you.

There's no further question this time. You may continue.

Well, thank you everyone. Ench House continues to have a very strong financial position to execute our capital allocation and business strategy. We continue to build on our journey. Thank you for attending the call and your continued support and have a happy holiday season.

This concludes today's conference call. Thank you all for joining. You may now disconnect.