Enghouse Systems Limited (OTCPK:EGHSF) Q4 2022 Earnings Conference Call December 16, 2022 8:45 AM ET
Company Participants
Stephen Sadler – Chairman and Chief Executive Officer
Vince Mifsud – President
Rob Medved – Vice President, Finance and Corporate Secretary
Todd May – Vice President and General Counsel
Sam Anidjar – Vice President, Corporate Development
Conference Call Participants
Daniel Chan – TD Securities
Deepak Kaushal – BMO Capital Markets
Stephanie Price – CIBC
Paul Treiber – RBC Capital Markets
Operator
Good morning, ladies and gentlemen and welcome to Enghouse Q4 2022 Conference Call. [Operator Instructions] Also note that the call is being recorded, Friday, December 16, 2022. I now would like to turn the conference over to Stephen Sadler. Please go ahead, sir.
Stephen Sadler
Good morning, everybody. I am here today with Vince Mifsud, Global President; Rob Medved, VP, Finance; Todd May, VP, Legal Counsel; and Sam Anidjar, VP, Corporate Development. Before we begin, I will have Todd read our forward disclaimer.
Todd May
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 our 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 forward-looking information and the company has no obligation to update or revise any forward-looking information, whether as a result of any new information, future events or otherwise.
Stephen Sadler
Thanks, Todd. Rob will now give an overview of the financial results.
Rob Medved
Thanks, Steve. Good morning. I will be taking you through the financial and operational highlights for the 3 and 12 months ended October 31, 2022 compared to the 3 and 12 months ended October 31, 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 31, 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-tenanted 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 Enghouse 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 Competella, 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 $0.185 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.
Stephen Sadler
Thanks, Rob. Vince will now give some operational highlights of the quarter.
Vince Mifsud
Thank you, Steve and to those of you that made time to join our final call for fiscal 2022. Today, I am going to take a few minutes to provide some highlights around Q4’s financial performance and commentary relating to the aggressive competitive landscape we are 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 absorbing the negative impact of FX. Our video revenue was still down compared to last years 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 assign 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 provider.
We also continue to execute our strategy and make investments where needed. One important element of our strategy worth reiterating is around offering customer’s 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 the 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 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 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 and 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 have 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.
Stephen 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 Enghouse 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 Enghouse stock.
I would now like to open the call for questions.
Question-and-Answer Session
Operator
Thank you, sir. [Operator Instructions] And your first question will be from Daniel Chan at TD Securities. Please go ahead.
Daniel Chan
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 up-selling, cross-selling your existing customer base?
Vince Mifsud
Yes. Daniel, so it’s a combination of, as I mentioned, there are some customers, existing customers, as well as new customers we won in the quarter. So, it’s a combination of both.
Daniel Chan
Great. Thanks for that. And then how much of the maintenance revenue associated with these new wins are in the Q4 maintenance and SaaS numbers?
Vince Mifsud
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 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.
Daniel Chan
Okay. So, it sounds that we might see some uplift in the future quarters, then. Maybe just the 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 are losing more customers from your platform than you are gaining?
Vince Mifsud
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 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 got to handle the whole DevOps and cloud infrastructure. So, that normally is an expansion of recurring revenue.
Daniel Chan
Okay. Thanks.
Operator
Thank you. Next question will be from Deepak Kaushal at BMO Capital Markets. Please go ahead.
Deepak Kaushal
Hi. Good morning, guys. Thanks for taking my questions. I got a couple. First on the resilience in AMG, 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 are seeing that resilience? And where you are seeing relative strength between perpetual versus SaaS?
Vince Mifsud
Yes. So, across the board and asset management, it’s pretty much business as usual. There is not a lot of SaaS competition there. Plus, our products are pretty sticky in that market. They are running telco networks, doing customer billing. So, they are 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 television and we are seeing some SaaS growth in that segment. But that’s really the only SaaS piece within that part of our business.
Deepak Kaushal
Okay. And just a follow-up to that, and then I have 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?
Vince Mifsud
Yes. I would say, we were selected by the California transit authorities as a one of the three preferred vendors for the whole contactless payments area. We have just been building pipeline at this. Up to this point, haven’t signed any deals yet. But we have got some positive pipeline growth there. So, we are hopeful to get some deals in the upcoming quarters.
Deepak Kaushal
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 are targeting micro verticals. Can you kind of give us a sense of, which verticals that you are seeing the most profit opportunity or the most growth opportunity? Maybe a handful that you are targeting or is that something you keep in close to your chest?
Vince Mifsud
Yes. I was going to say, I would like to keep it close to our chest because we don’t really want to let our competitors know because there are segments that we are in that I think are below the radar, so to speak. And so we would like to keep it that way. But I guess that’s all I can really say, and I would rather keep that close to our chest.
Deepak Kaushal
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% or 30% of that, or any kind of context you can give?
Vince Mifsud
Yes. There is probably about 10, ones that we have got good traction and good visibility, customer reference ability, and numerous customers within the same micro vertical. And it’s about 10, I would say.
Deepak Kaushal
Okay. Fantastic. Well, I am sure there will be a lot of questions on M&A for Steve. So, I will pass a line and let those.
Operator
Thank you. Next question will be from Stephanie Price at CIBC. Please go ahead.
Stephanie Price
Hi. Good morning. I will 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?
Stephen Sadler
We are sticking to our financial discipline in acquisitions, be it in the cloud or on-prem. The environment today, as you can imagine, there is 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 are pretty optimistic on the acquisition front. And we will just have to wait and see how we do over the next couple of years.
Stephanie Price
Sounds good. Thanks. And then I just want to touch on R&D as well. Vince, you mentioned a couple of times in your prepared remarks. Can you talk a bit about where the biggest investments you are expecting are going to be in fiscal ‘23? And how you think about R&D spending in the year?
Vince Mifsud
Yes. It’s going to be somewhat similar, like we have done a lot to get our products, cloud-ready optimized through the cloud because there is more demand there. In the Asset Management division, where we are making investments in what we call product cloud readiness as well, even though we don’t see demand. So, we are knocking off our key products, and ensuring that they work and are optimized for the cloud. And we will continue that into 2023 in asset management, ahead of kind of where the market is today. So, we are going to continue that. We are 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 are really laser-focused in telehealth, in healthcare. We are doing a lot around virtual healthcare monitoring, video healthcare type features that our customers want. So, that’s what we are doing on video.
Stephanie Price
Great. Thanks so much.
Operator
[Operator Instructions] And your next question will be from Paul Treiber at RBC Capital Markets. Please go ahead.
Paul Treiber
Hello. Thanks very much and good morning. Just a couple of questions here. Just on video, you mentioned it increased sequentially. What’s driving the increased uptake at video. And then do you see continued sequential growth in video going forward from here?
Vince Mifsud
Yes. So, I mean it increased slightly from Q3 to Q4. And in the area that we are really focused on is in virtual healthcare and telehealth. That’s the market that we are going after with video, versus being kind of like a general collaboration type platform. We have a couple of other micro verticals, we are trying out that we are getting some traction. Again, I would like to kind of keep them closer to our chest. But you can probably see it if you look at our content that we are out there producing. But yes, so we are 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.
Paul Treiber
And maybe another way to ask the question is, I mean do you see the churn in the general collaboration piece of video, pretty much done at this point. And then, assuming that’s stable, the growth would come from uptake from these micro verticals?
Vince Mifsud
Yes. I mean we had a – we did have part of the video business in the general collaboration side, but it was – a lot of it was always at the beginning in healthcare and when we when – 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 yes, the general collaboration market, we are not heavily focused on because it’s very competitive. And there are some big players there that dropped prices to a point where we don’t think it’s a good market for us.
Paul Treiber
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, like, relative to Q4, do you see the competitive environment intensifying? And then, related to that, like, are you seeing any change in your retention rates relative to history? And it looks like, the strengthened licensed revenue, that you did 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?
Vince Mifsud
Yes. I mean I would say that the SaaS vendors, sometimes we are seeing them in deals get pretty aggressive. Relative, especially in the last couple of quarters, I would say I would characterize a little bit of the increase in discounting that we are seeing in the market, primarily in interactive and mainly the SaaS vendors. I don’t know if that answers that question. But yes, the last couple of quarters, a bit of an uptick there.
Paul Treiber
And just sort of the on the retention rates, any material change there?
Vince Mifsud
Yes. So, on the retention rates, our team has gotten a lot better at our whole strategy around choice and moving customers from on-prem to either a private or a multi-tenant cloud. So, I would say we are 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.
Paul Treiber
And then just one last one for me, and I don’t know if you will disclose it, but I will ask is, like, does with the increased pricing competition, have you been more willing to price discount perhaps than what you have done in the past?
Vince Mifsud
I mean we are not really the kind of company that will take a deal that 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 will still make money off of the project. In the multi-tenant world, it’s a little bit easier because you have got one cloud infrastructure, and when you add customers incremental cost is nominal. But we wouldn’t do – we wouldn’t discount much in a private cloud scenario. And so I think overall, our margin discipline is pretty much consistent.
Paul Treiber
Thank you. I will pass it on.
Operator
Thank you.
Stephen Sadler
Paul, just an added comment there, you might looked at our competition, it’s in the cloud, you will see that most of them do not make money. And they are, some might say they are starting to get into financial difficulty, especially if you don’t get more funding, and with rising interest rates, because they tend to base their growth on debt. So, the environment is changing a lot right now. And there is a lot in that area, you can check the competition out, see how they are 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 2 years, we will just have to wait and see.
Operator
Thank you. Next question is a follow-up from Deepak Kaushal. Please go ahead.
Deepak Kaushal
Well. Hi, guys. Yes. 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 are looking to add some more bench strength to the M&A team. I know you have 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? And I have got a follow-up.
Stephen Sadler
We don’t have a really a target, whatever makes sense. And that we are capable of doing we will do. Bench strength, we are still looking for the bench strength. We are going to find the right people and we are 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 resources in to handle the possible extra volume.
Deepak Kaushal
Okay. And then a follow-up. It’s helpful. Thank you. We have 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 has been an anticipation here of when sellers might break and start selling, especially in your snack bucket 3024. Do you have a sense of timing on that? I know you keep saying over the next few 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, as it comes?
Stephen Sadler
Generally, I don’t like to predict the future. So, when I say I expect it the next 2 years, I can tell you it’s already started.
Deepak Kaushal
Okay. Well, I will leave it at that and then pass on. Thanks.
Operator
Thank you. And at this time, Mr. Sadler, we have no other questions registered. Please proceed.
Stephen Sadler
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.
Operator
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 to please disconnect your lines.
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