Enghouse Sys Ltd

Good morning, ladies and gentlemen, and welcome to Inch House Q4 2022 conference call. At this time, all participant lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. And if at any time during this call you require immediate assistance, please press star zero for the operator. Also note that the call is being recorded Friday, December 16, 2022. And I would like to turn the conference over to Stephen Sadler. Please go ahead, sir.

Good morning, everybody. I'm here today with Vince Massoud, Global President, Rob Medved, VP Finance, Todd May, VP Legal Counsel, and Sam Aniger, VP Corporate Development. Before we begin, I'll have Todd read our former disclaimer.

Certain statements made may be forward-looking. By their nature, such forward-looking statements are subject to various risks and uncertainties, including those in HHS'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. Rob will now give an overview of the financial results.

Thanks, Steve. Good morning. I'll be taking you through the financial and operational highlights for the three and 12 months ended October 31st, 2022, compared to the three and 12 months ended October 31st, 2021, as follows. Revenue achieved was $108.1 million and $427.6 million, respectively, compared to revenue of $113.1 million and $467.2 million. Results from operating activities were 33.1 million and 129.7 million respectively compared to 39.1 million and 155.2 million. Net income was 36.9 million and 94.5 million respectively compared to 30.2 million and 92.8 million. Adjusted EBITDA was 35.8 million and 140.6 million compared to 42.1 million and 168.5 million, while adjusted EBITDA margins were 33.1% and 32.9%, respectively, compared to 37.2% and 36.1%. Cash flows from operating activities excluding changes in working capital were 37.1 million and 145.1 million, respectively, compared to 42.4 million and 167.8 million. Cash, cash equivalents, and short-term investments were $228.1 million as at October 31st, 2022, compared to $198.8 million at the end of the prior year. Turbulent global markets, rising interest rates, high inflation, and aggressive competition in the technology sector, particularly from vendors offering software as a service, or SaaS, highlighted the environment in which we operated during fiscal 2022. Despite these factors, consistent with our operating approach and strategy, we continue to manage our business with financial discipline, once again generating positive operating income and cash flows, while increasing quarterly dividends to shareholders for the 14th consecutive year. During fiscal 2022, we invested $72.3 million in research and development activities aimed at ongoing product improvements and innovation. We continue with our strategy of offering customers and partners choice, providing various deployment options of private cloud, multi-tenant cloud, or on-premise solutions. We believe offering choice differentiates us in the vertically focused enterprise software markets in which we operate and addresses the varying needs of our customers. In fiscal 2022, we achieved adjusted EBITDA of $140.6 million, or 32.9% of revenue, and cash flows from operations excluding changes in working capital of $145.1 million, closing the year with $228.1 million in cash, cash equivalents, and short-term investments with no external debt. Our capital allocation focused on deploying $20.2 million for acquisitions, repurchasing $9.3 million of Engel's common stock, and paying dividends to our shareholders of $38.3 million. Revenue for the year was $427.6 million compared to $467.2 million in the prior year. Revenue was negatively impacted by the decline in our video revenue post-COVID, in addition to $15.7 million of unfavorable foreign exchange and the growing shift from on-premise solutions to SaaS. Consistent with our strategy of offering choice, we continue to expand the availability of our SaaS offerings globally. primarily for our customer experience and contact center technologies, where demand for SaaS is rapidly growing. Operating income for the year was $129.7 million compared to $155.2 million in the prior year, resulting from lower revenue levels. Net income for the year increased to $94.5 million compared to $92.8 million in fiscal 2021 as a result of lower non-operating expenses and taxes. During the year, we completed the acquisitions of Compatella, NTW, and VoicePort, broadening our geographic reach and product portfolio, including SaaS offerings. We continue to expand our acquisition pipeline and actively pursue acquisition opportunities. Valuations are generally decreasing in the enterprise software market that we believe are the result of higher debt servicing costs, reduced ability to raise capital, and a broader focus on profitability and cash flow in response to economic uncertainty. We are closely monitoring acquisition opportunities as valuations become more aligned with our financial and operating criteria. We have consistently demonstrated, even during adverse economic conditions, that we can generate positive operating cash flows and augment our cash reserves to be deployed for acquisitions and further investment in our business. We believe that our financial discipline, product approach, and commitment to customers, partners, and employees will continue to drive long-term shareholder value. Yesterday, the Board of Directors approved the company's eligible quarterly dividend of 18.5 cents per common share, payable on February 28, 2023, to shareholders of record at the close of business on February 14, 2023. I will now hand the call back to Mr. Sadler.

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

Thank you, Steve, and to those of you that made time to join our final call for fiscal 2022. Today I'm going to take a few minutes to provide some highlights around Q4's financial performance and commentary relating to the aggressive competitive landscape we're operating in, how our strategy around choice and micro verticals is helping our overall performance, and summarize where we are making key product investments. In Q4, total revenue grew sequentially compared to Q3 2022 by 6 million to 108.1 million, up from 102.1 million, a 5.9% revenue improvement. Our recurring revenue generated from our SaaS and support arrangements hit 64.6 million, which was also up 1.6% sequentially. Software license revenue was up $5.8 million, and our video product also slightly increased compared to Q3. Now, comparing to Q4 of 2021, overall revenue was down $5 million. However, foreign exchange represented a negative impact of $4 million. Our asset management division increased revenue on a constant currency basis. However, actual revenue was flat at $46 million. million absorbing the negative impact of FX. Our video revenue was still down compared to last year's Q4. Turning now to what we are seeing in our markets, over the course of fiscal 2022, and especially in the last two quarters, the overall economic and business environment has changed quite significantly with rising interest rates, global inflation, and general economic uncertainty. Our observation is that this environment appears to be creating differences in the way some of our competitors are operating, specifically in the customer experience market. Although the CX market is growing, we are coming up against some of our SaaS vendors becoming more aggressive in terms of product and service pricing, which makes it more difficult for us at times to retain customers or sign new projects, new customers at our target gross profit margins. During Q4, a number of our competitors in the CX market announced the discontinuation of their on-premise products, large personnel layoffs, changes in leaderships, and other restructuring measures. We believe Enghouse has advantages that may serve us well during these economic times. Given we have no debt, rising interest rates doesn't impact our operating profitability. or create a need for us to change the way we manage the business. Having a cash position of $238 million and positive operating cash flow business gives customers the level of comfort they seek from mission-critical technology providers. We also continue to execute our strategy and make investments where needed. One important element of our strategy worth reiterating is around offering customers choice. Although offering choice might sound relatively straightforward, there are a number of engineering product and operational complexities around being able to offer choice and implement on-premise private cloud and multi-tenant cloud products, as well as a number of investments we have and will continue to make to enable us to offer choice. During Q4, we won a number of new customers as a result of providing choice the deployment options they preferred. And we also were successful in converting some of our large on-premise customers to our private cloud and multi-tenant cloud products, thereby mitigating churn and improving recurring revenue. Offering choice this quarter and managing this complexity did translate positively to our revenue results in the quarter. The second important aspect of our strategy is around our go-to-market focus on what we call micro vertical business segments. In order to produce an efficient sales and demand gen organization where the spend relative to the business generate continues to drive a profitable business model, we focus our sales and demand gen team on micro verticals rather than on a horizontal strategy. This is key to sales efficiency efficiency, and ultimately our overall profitability. The acquisition of VoicePort in the quarter is an example of a micro vertically focused company in the CX space, specifically aimed in the print media sector. Product development and ongoing innovation continues to be our single biggest area of investment. In the quarter, we spent $18.2 million on research and development, which was up from $16.9 million a year ago. Considerable engineering investments are being made across all our business units around optimizing our products for the cloud. In the customer experience market, the demand for SaaS is increasing while the demand for on-premise declines. However, in our asset management division, we are not experiencing the same trend. So the demand for on-premise continues to be the same, remains consistent with previous periods. However, we've decided to continue to invest our engineering resources in product cloud readiness as we expect the market may move in that direction in the future. In summary, we finished fiscal 22 with sequential revenue, quarterly growth, EBITDA of 145 million and a healthy cash position. This puts us in a comfortable position to continue to make product investments, cope with the economic conditions, conclude future acquisitions, and keep our strategy focused around choice and micro verticals. Let me turn the call over to Mr. Steve Sadler.

Thanks, Vince. With respect to acquisitions, the actionable pipeline remains significant. Valuations continue to decline in this challenging environment of increasing global interest rates and the possibility of a recession in 2023. We completed two tuck-in acquisitions late in Q3 and another acquisition in Q4. These businesses had a positive EBITDA in the fourth quarter, including VoicePort, which was for a partial period. VoicePort was included since its acquisition in early September. At the end of Q4, cash on hand remained approximately the same at the end of Q3 at $228 million. We purchased 13,000 shares of Ench House in Q4 at an average price of $28.23 and paid $14.1 million in acquisitions in Q4. With our continued strong positive cash flow and cash on hand, we have the financial resources for further acquisitions and the possible buyback of Ench House stock. I would now like to open the call for questions.

Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touch-tone phone. You will then hear a three-tone prompt acknowledging your request. And if you would like to withdraw from the question queue, please press star followed by two. And if you're using a speakerphone, we do ask that you please lift the handset before pressing any keys. Please go ahead and slowly press star one now if you have a question. And your first question will be from Daniel Chen at TD Securities. Please go ahead.

Hi, good morning. Just wondering if you can give any color around the license wins in the IMG segment, whether that's coming from new customers coming onto the platform or whether it's from like upselling, cross-selling your existing customer base.

Yes, Daniel. So it's a combination of, as I mentioned, there's some customers, existing customers, as well as new customers we want in the quarter. So it's a combination of both.

Great, thanks for that. And then how much of the maintenance revenue associated with these new wins are in the queue for maintenance and SaaS numbers?

Oh, not much because normally the maintenance starts after we implement the project. So when you do a larger project, you win a larger deal, it takes a bit of time to implement and then the maintenance kicks in. So you wouldn't see any maintenance. And similarly, when we do a SaaS uplift project, deal where we take an existing customer from on-prem to private cloud or multi-tenant cloud, the SaaS uplift piece kicks in after the implementation. So not much in the quarter in terms of that recurring revenue uplift.

Okay, so it sounds like we might see some uplift in the future quarters then. Maybe just a final question on that revenue line, SaaS and maintenance. It's declined by about $1.3 million year-over-year. How should we interpret that? Is that a sign that you're losing more customers from your platform than you're gaining?

So a couple of things. One is overall FX did impact our recurring revenue. Video still declined in Q4 2022 compared to Q4 of 2021. So there was still some you know, kind of drop in video volumes. But when we move from a customer from on-prem to SaaS, we normally get more recurring revenue because we've got to handle the whole DevOps and cloud infrastructure. So that normally is an expansion of recurring revenue. Okay, thanks.

Thank you. Next question will be from Deepak Koshal at BMO Capital Markets. Please go ahead.

Hi, good morning, guys. Thanks for taking my questions. I've got a couple. First, on the resilience in AMG, you know, it's a pretty diverse segment. It's got some transportation stuff in there and telecom software in there. Can you kind of parse out where you're seeing that resilience and where you're seeing relative strength between perpetual versus SaaS?

Yep. So across the board in asset management, it's pretty much business as usual. There's not a lot of SaaS competition there. Plus, our products are pretty sticky in that market. They're running telco networks, doing customer billing, so they're quite integrated technologies. And it's in both sides. It's in public safety, in the transit side, as well as in the telecom sector. Some SaaS growth in IPTV. One of our products is internet, you know, television, and we're seeing some SaaS growth in that segment, but that's really the only SaaS piece within that part of our business.

Okay, and just to follow up to that, and then I've got my second question. On the transportation side in particular, you guys had made some wins recently in the U.S. market. Any comments on how that's changed momentum or opportunities in that part of the world for that business?

Yeah, I would say... You know, we were selected by the California Transit Authorities as one of the three preferred vendors for the whole contactless payments area. We've just been building pipeline at this, up to this point. Haven't signed any deals yet, but we've got some positive pipeline growth there. So we're hopeful to get some deals in the upcoming quarters.

Okay, thanks. That's helpful. And then my second question, I guess my third question. Vince, you mentioned some of the micro verticals you guys are targeting. Well, you mentioned that you're targeting micro verticals. Can you kind of give us a sense of which verticals you're seeing the most profit opportunity or the most growth opportunity, maybe a handful of you targeting, or is that something you're keeping close to your chest?

Yeah, I was going to say, I like to keep it close to our chest because we don't really want to let our competitors know because there's segments that we're in that I think are below the radar, so to speak. And so we like to keep it that way. But I guess that's all I can really say, and I'd rather keep that close to our chest.

Okay, but just are we talking about like 5, 10, 20, 30 micro verticals as a total opportunity, and you guys are focusing on 20, 30% of them, or any kind of context you can give?

Yeah, there's probably about 10 ones that we've got good traction in, good visibility, customer referenceability, and numerous customers within the same micro-vertical. It's about 10, I would say.

Okay. Okay, fantastic. Well, you know, I'm sure there'll be a lot of questions on M&A for Steve, so I'll pass the line and let those fly.

Thank you. Next question will be from Stephanie Price at CIBC. Please go ahead.

Hi, good morning. I'll jump in here with the M&A question. So Steve, hopefully you can talk a little bit about the M&A environment and how you think about the acquisition criteria. Just given the environment, are you shifting more of a focus towards the cloud?

We're sticking to our financial discipline and acquisitions, be it in the cloud or on-prem. The environment today, as you can imagine, there's a lot of companies that are having some difficulty, which is making them, as we call it, motivated sellers. Our backlog is high, higher than it has been in the past, and we think it will last for a couple of years. So we're pretty optimistic on the acquisition front, and we'll just have to wait and see how we do over the next couple of years.

Sounds good. Thanks. And then I just want to touch on R&D as well. Vince, you mentioned it a couple of times in your prepared remarks. Can you talk a bit about where the biggest investments you're expecting are going to be in fiscal 23 and how you think about R&D spending in the year?

Yeah, you know, it's going to be somewhat similar. Like we've done a lot to get our products cloud ready, optimized for the cloud because there's more demand there. In the asset management division, we are making investments in what we call product cloud readiness as well, even though we don't see demand. So we're knocking off our key products and ensuring that they work and are optimized for the cloud. And we continue that into 2023 in asset management ahead of kind of where the market is today. So we're going to continue that. We're doing a lot around UI, UX, modernizing, optimizing for mobile, working in at-home environments, continuing doing that type of investment. In the video side, we're really laser-focused in telehealth and healthcare. We're doing a lot around virtual healthcare monitoring, video healthcare-type features that our customers want. So that's what we're doing on video.

Great. Thanks so much. Thank you. Once again, as a reminder, ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touchtone phone. And your next question will be from Paul Triver at RBC Capital Markets. Please go ahead.

Oh, thanks very much. Good morning. Just a couple of questions here. Just on video, you mentioned it increased sequentially. Now, what's driving the increased uptake at video? And then do you see continued sequential growth in video going forward from here?

Yeah, so, I mean, it increased slightly from Q3 to Q4. And in the area that we're really focused on is in virtual healthcare telehealth. That's the market that we're going after with video. versus being kind of like a general collaboration type platform. We have a couple of other micro verticals we're trying out that we're getting some traction. Again, I'd like to kind of keep them closer to our chest, but you can probably see it if you look at our content that we're out there producing. But yeah, so we're just staying micro vertical focused in video. And we think that's the best approach in order to kind of keep video moving forward positively.

And maybe another way to ask the same question is, I mean, do you see the churn in the general collaboration piece of video pretty much done at this point? And then, you know, assuming that's stable, the growth would come from uptake from these micro verticals?

Yeah, I mean, we did have part of the video business in the general collaboration side, but a lot of it was always at the beginning in healthcare. And when COVID hit, we had a big spike in volumes in the telehealth area. So that's what caused it to kind of spike up and come down. But yeah, the general collaboration market, we're not heavily focused on because it's very competitive. And there's some big players there that drop prices to a point where we don't think it's a good market for us.

And in your prepared remarks, you had a couple of comments on the competitive environment just in regards to IMG in general. And I think you mentioned your competitive pricing is making it harder to sign and retain customers. Is that a new comment relative to Q4? Do you see the competitive environment intensifying? And then related to that, are you seeing any change in your retention rates relative to history? And it looks like, you know, with the strength in license revenue, you need to do a good job winning new customers in this quarter. So can you sort of tie that back to that competitive environment comment you had?

Yeah. Yeah, I mean, I would say that the SaaS vendors, sometimes we're seeing them in deals get pretty aggressive. Relative, you know, especially in the last couple of quarters, I would say I'd characterize them a little bit of increase in discounting that we're seeing in the market, primarily in interactive and mainly the SaaS vendors. I don't know if that answers that question, but yeah, the last couple of quarters, a bit of an uptick there.

And just, sorry, on the retention rates, any material change there?

Yeah, so on the retention rates, our team has gotten a lot better at, you know, our whole strategy around choice. and moving customers from on-prem to either a private or multi-tenant cloud. So I would say we're improving our ability to retain there, mainly because of the kind of getting all of our cloud nodes up around the world and getting our team more comfortable selling cloud. So I would characterize that as an improvement.

And then just one last one for me, and I don't know if you'll disclose it, but I'll ask it. Just with the increased pricing competition, have you been more willing to price discount, perhaps, than what you've done in the past?

I mean, we're not really the kind of company that will take a deal at really low margins or negative margins, as you know. Are we... Will we discount? We will, of course, discount if it makes sense and we'll still make money off the project. In the multi-tenant world, it's a little bit easier because you've got one cloud infrastructure and when you add customers, incremental cost is nominal. But we wouldn't discount much in a private cloud scenario. And so I think overall our margin discipline is pretty much consistent.

Thank you. I'll pass the line.

Paul, just an added comment there. You might look at our competition. It's in the cloud. You will see that most of them do not make money. And they're, you know, some might say they're starting to get into financial difficulty, especially if you don't get more funding and with rising interest rates because they tend to have based their growth on debt. So the environment is changing a lot right now. And there's a lot in that area. You can check the competition out, see how they're doing. We tend to want to have profitable growth where they often have gone for any growth. And I think it's coming home to hurt them a little bit now. So just what's going to happen in that market for the next year or two, we'll just have to wait and see.

Thank you. Next question is a follow-up from Deepak Kaushal. Please go ahead.

Oh, hi, guys. Yeah, sorry. I do have a follow-up on the M&A side. I couldn't resist. Two questions, if I may. Thank you. I appreciate it. Steve, I think you mentioned earlier that you're looking to add some more bench strength to the M&A team. I know you've added a lot this year, and you said last quarter that your capacity is the highest it has ever been. Any updates on that and what kind of target you have to deploy over the next 12 months? Then I've got to follow up.

Yeah, we don't have really a target. Whatever makes sense and that we're capable of doing, we will do. Bench strength, we're still looking for the bench strength. We want to find the right people, and we're looking for a couple of people in that regard. But we have a pretty good group already. It's just that I think it's going to pick up in the next year, and so I want to get some extra resource in to handle the possible extra volumes.

Okay. And then the follow-up, and that was helpful. Thank you. You know, we've seen a couple of large private equity transactions on the large side at pretty healthy valuations. I assume this isn't hurting valuation expectations on the low side, but there's been an anticipation here of when sellers might break and start selling it, especially in your snack bracket. Do you have a sense of timing on that? I know you keep saying over the next two years, but like, Could something change in the near term that could accelerate things or slow things down? Or how do you look at that timing? Or is it just, you know, as it comes?

Generally, I don't like to predict the future. So when I say I expect it in the next two years, I can tell you it's already started.

Okay. Well, I'll leave it at that and then pass the line again. Thanks.

Thank you. And at this time, Mr. Sadler, we have no other questions registered. Please proceed.

Well, thank you, everybody. We continue with our long-term capital allocation strategy and to invest in our operations to improve our internal growth. Thank you for attending the call and your continued support. Have a Merry Christmas and a happy holiday season.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.