Executives: Stephen Sadler - Chairman and Chief Executive Officer Todd May - Vice President & General Counsel Doug Bryson - Vice President, Finance &

Administration
Analysts: Paul Steep - Scotia Capital Deepak Kaushal - GMP Securities L.P. Paul Treiber - RBC Capital Markets Ralph Garcia - Echelon Wealth

Partners
Operator: Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2017 Quarter Two Earnings Call. As a reminder, today’s conference is being recorded. At this time, I’d like to turn the conference over to Steve Sadler, Chairman and Chief Executive Officer. Please go ahead, Mr.

Sadler.

Stephen Sadler: Good morning, everybody. I’m here today with Doug Bryson, VP, Finance; Sam Anidjar, VP, Corporate Development; and Todd May, VP, Legal Counsel. Before we begin, I will have Todd read our forward disclaimer.

Todd May: Certain statements made in this conference call may contain forward-looking statements, which are not historical facts but are based on certain assumptions and reflect Enghouse’s current expectations.

These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risk factors are identified in Enghouse’s AIF and other periodic reports filed with applicable regulatory authorities from time-to-time. Enghouse disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

Stephen Sadler: Thank you, Todd. Doug will now give an overview of the financial results.

Doug Bryson: Thank you, Steve. Yesterday, Enghouse announced its unaudited second quarter financial results for the period ended April 30, 2017. Second quarter revenue was $79.5 million, an increase of 1.3% over revenue of $78.5 million in the second quarter last year. On a year-to-date basis, revenue was $158.4 million compared to $152.9 million last year, an increase of 3.6%. The revenue increase primarily reflects incremental revenue contributions from acquisitions but is mitigated by the unfavorable impact of foreign exchange compared to last year, which negatively impacted revenue by an estimated $3.3 million in the quarter and $8 million year-to-date.

Hosted and maintenance services revenue was $39.9 million in the quarter, an increase of 4.2% over the same period last year and includes the estimated negative impact of foreign exchange of $1.65 million. Adjusted EBITDA for the quarter was $20.5 million, or $0.75 per diluted share, compared to $19.3 million, or $0.71 per diluted share last year – in last year’s second quarter and includes the net negative impact of $2.1 million related to foreign exchange losses compared to last year. Adjusted EBITDA for the year-to-date was $43.6 million, or $1.60 per diluted share, compared to $38.4 million, or $1.41 per diluted share last year, an increase of 13.6%. This includes the net negative impact of $4.4 million related to foreign exchange losses on a year-to-date basis compared to last year, which would have resulted in a 26.7% increase compared to the prior year excluding foreign exchange losses. Net income for the quarter was $9 million, or $0.33 per diluted share, compared to the prior year’s second quarter net income of $8.5 million, or $0.31 per diluted share.

Results from operating activities for the quarter were $19.5 million compared to $18.1 million in the prior year’s second quarter, an increase of 7.5%. Operating expenses before special charges related to restructuring of acquired operations were $35.0 million compared to $35.2 million in the prior year’s second quarter and include incremental operating costs related to acquired operations, net of the favorable impact of foreign exchange. Non-cash amortization charges in the quarter were $7.5 million compared to $7 million in the prior year’s second quarter and include amortization charges for acquired software and customer relationships from acquired operations. On a year-to-date basis, operating expenses before special charges were $65.9 million compared to $67.6 million and include incremental operating costs related to acquired operations, net of the favorable impact of foreign exchange compared to last year. Enghouse generated cash flows from operations of $18.4 million in the quarter and closed the quarter with $87.6 million in cash, cash equivalents and short-term investments, compared to $85.9 million at October 31, 2016.

The cash balance was achieved after year-to-date payments comprised of $16.2 million net of cash acquired and holdbacks for the Tollgrade acquisition, $1.7 million to partially settle loans inherited from Presence Technology, and 400,000 for prior period acquisitions, as well as $7.5 million in dividends paid. Yesterday, the Board of Directors approved an eligible quarterly dividend of $0.16 per common share, payable on August 31, 2017 to shareholders of record at the close of business on August 17, 2017. Enghouse remains committed to its acquisition strategy and continues to seek accretive acquisitions. I’ll now turn the call back over to Sadler.

Stephen Sadler: Thank you, Doug.

Our cash and short-term investments remain strong at $87.5 million similar to last quarter and above the balance at October 31, 2016. The balance was achieved after paying $16.2 million for Tollgrade near the end of the quarter and $3.8 million of dividends in the quarter. You’ll notice in our announced results, we mentioned foreign exchange impact to a greater degree. The movement in exchange rates not only impact our operations revenue and cost, but the increase in exchange rates near the end of April had a negative impact of about $2.7 million in additional recorded cost in the quarter compared to Q1 and $4.4 million year-to-date compared to last year. This was a result of balance sheet translations.

There was minimal foreign exchange impact on revenue and operating cost compared to Q1 2017 other than the additional net cost of $2.7 million reflected in selling, general and administration costs. As noted at our Annual General Meeting and last quarter, we are considering the establishment of a bank facility to allow payment of dividends without the need to move our loan funds from foreign subsidiaries to Canada. This will allow us to minimize withholding taxes and reduce intercompany loans, which significantly impact the operating results when there’s foreign exchange movements, which happened late in Q2. Although not a cash item accounting for foreign exchange can distort results. The operating environment remains similar to that over the last five years with new entrants and those existing in the business, which tend to – with large competitors tend – tending to struggle like Avaya.

In terms of acquisitions, we completed the acquisition of Tollgrade near the end of the quarter April 12. It added minimal revenue and profit after adjusting for purchase price accounting changes and restructuring special charges. We expect Tollgrade to add to revenue, EBITDA and cash flow in Q3 its first full quarter as part of Enghouse. In comparing to last year’s results, which some people like to do, prior acquisitions not included in Q2 add approximately $5 million in revenue in the quarter and operated at our expected EBITDA. I would now like to turn the call – the – open the call for questions.

Operator: Thank you. [Operator Instructions] We’ll take our first question from Paul Steep with Scotia Capital.

Paul Steep: Thanks. Good morning, Steve. If we talk – can you talk a little bit about the M&A environments, Steve, just in terms of what you’ve seen if there’s been any geographic shifts, or how the outlook looks towards maybe shifting towards more acquisitions in the asset management area?

Stephen Sadler: Yes, it’s pretty much the same as it has been.

I think, the asset management area we’ve been doing more acquisitions over the last few years, because we have done a lot in the other area previously. So it got consolidated a little bit, and the asset management area is pretty fragmented. But we’re seeing opportunities in both areas still. So it’s sort of business as usual, no big change.

Paul Steep: Great.

You’re now almost like a six months into the – post the acquisition of Presence. Could you talk a little bit about what you’ve seen in those Latin American and the Spanish market if you’ve seen sort of uptick there, or how you’re thinking about sort of investing in those areas?

Stephen Sadler: Yes, whenever you do an acquisition, as you know, the first six months actually up to the first year, you integrate things and it takes a little time just before you see good progress, both in bottom line and top line. But Presence is doing fine. I would say, there’s been a big uptick in revenue. We’ve been consolidating some of it, getting it to our profitable model and it’s operating as we expected.

Operator: And we’ll take our next question from Deepak Kaushal with GMP Securities.

Deepak Kaushal: Hello. Hi, good morning, guys, thanks for taking my questions. I guess, I’ll just start with a quick follow-up on Presence. Maybe, Steve, I was wondering if you could add some more color with the Portuguese speaking markets? I know that in the Spanish speaking markets, Presence is quite strong.

How are you guys progressing in terms of opening up new markets with Presence’s expertise? Any progress on timing?

Stephen Sadler: We’re – Presence, as I said, we’re trying to bring it into our model. It’s in, as you know, Spain, Columbia, Mexico, and Brazil – small in Brazil. We’re trying to get those operations to the model and then grow them from there. We haven’t gone into any new areas with it at this time.

Deepak Kaushal: Okay.

Thank you. And then a quick question on the interactive side down 3% year-over-year. How much of that was FX? Are you still seeing pricing pressure in that side of the market, or has that stabilized [Multiple Speaker]

Stephen Sadler: First of all, I don’t – I’m not sure we’re – when you get in constant dollars, we’re down 3%. I think, people make some assumptions on our acquisitions versus our ongoing revenue. And it’s hard to do, again, when you look at the profitability and putting some of those numbers together.

So it’s pretty stable. We still have used some – we still have some subscription revenue that we used to get upfront revenue for, but it’s not a lot. But that is impacting the numbers a little bit, but that’s good for us in the future. So the – it’s sort of boring. Things are going as normal as they have in the past.

Deepak Kaushal: Okay. So if I may ask one more boring perhaps type of question. On the cloud solution business that you’re selling with your telco partners, have you seen any changes, or any changes in the market, or any increased interest since you’ve started deploying this with TELUS and starting to see results on that?

Stephen Sadler: So the answer to that is, I haven’t seen really much change in the market in that regard. However, that part of our business is actually growing quite a lot better than the other parts of the business. It still comes up to the overall revenue, which I believe is about even.

But that part of the business is growing probably faster than the competitors in that business, but off a smaller base.

Deepak Kaushal: Okay. Can you give us a sense of what percentage of total that might be or – of interactive?

Stephen Sadler: I can’t, because it could be misread. But it is definitely faster and the number is quite a bit faster, but it’s off a lower base. So when I use percentages, I don’t want to give out anything misleading if I gave you that percentage, it – people might misinterpret it.

Deepak Kaushal: Okay. Okay, that’s fair. Well, thank you for taking my questions, I’ll pass on.

Operator: [Operator Instructions] And we’ll take our next question from Paul Treiber with RBC Capital Markets.

Paul Treiber: Good morning, and thanks for taking my questions.

Just on margins looking at margin expansion quite robust over the last couple of quarters. Can you remind us what’s driving that the margin, and what’s your long-term thoughts on margin, and the sort of the right level of profitability for the company?

Stephen Sadler: Your margins have increased a little bit. I generally use the EBITDA number of 25%, it’s above that. But of course, we have a big negative exchange impact, otherwise, it would be 28%, 29%. That’s probably our normal margin now without the impact of exchange, I’m comfortable with that.

Part of the reason of that – for that, of course, is we did increase salespeople last year. We found, it didn’t add any benefit, i.e., an increased revenue. So we’ve taken out some of those costs and that’s moved up margin up a little bit. So it just means, I have – we’ve taken back similar investment in sales and marketing at this stage and it’s moved the margin up a little bit.

Paul Treiber: Okay.

And then looking at Tollgrade, the cash paid $16 million, is well below the $23 million in the press release. Obviously, I think, that’s the cash acquired as a difference. But the multiple paid is below normally what you historically pay. Can you just provide some back-story on Tollgrade on the asset and how you came about to find it, and also how you’re able to secure it for that price?

Stephen Sadler: Yes, I think you could be misreading a little bit, because that’s what we paid when we try and do the numbers. But we still have the holdback that we owe, so that – which hasn’t been paid, yet.

So I think it’s pretty normal in our pricing. It was about one times revenue. But what is important to us is, we believe in getting a payback in five to six years, and we believe that we’ll achieve that objective.

Paul Treiber: Okay, thank you. I’ll pass on.

Operator: We’ll take our next question from Ralph Garcia with Echelon Wealth Partners.

Ralph Garcia: Good morning and just following-up on Tollgrade. So was there no revenue in the quarter from Tollgrade, or do we – did you get 2.5 weeks or so from the close?

Stephen Sadler: Yes, about two weeks. But you remember, we also have purchase price adjustments that have to be subtracted from that whenever you do an acquisition. So there was some revenue from Tollgrade, it was less than $1 million, but there was some for the two weeks the purchase price adjustment that we had to do, because that – we always do in every acquisition.

Ralph Garcia: Okay. And it has stabilized…

Stephen Sadler: Just to clarify for people in the call, whenever you do an acquisition, you have deferred revenue, et cetera. You can’t record the deferred revenue or revenue that they have. You really in a sense the theory is, you have to take out of sales and marketing costs that were expended before the acquisition. So you generally write down that revenue somewhere between 30% and 40%.

And over time, it comes back in as you renew, but on the purchase you actually have to reduce revenue and every acquisition has a purchase price adjustment equation that has to be done that comes back later for you.

Ralph Garcia: Okay. And they have sort of stabilized in the $20 million U.S. run rate range. I mean, should we sort of model that going forward over the next 12 months?

Stephen Sadler: Yes, in general, as I always say in acquisitions, it depends on the acquisition.

But usually, initially, revenue drops off a little bit, because you have to get to customers and they’ve got to know where you’re going before they invest some more. But generally, over the longer-term that sort of a 12-month period, it stabilized where it should be. Sometimes it drops, because you’re trying to get more profitable revenue and sometimes it doesn’t. But we do not see that revenue dropping in our model to get our payback, at least, not in the next 12 months.

Ralph Garcia: Okay.

And then just competitively, I guess, with Extreme Networks closing the deal on Avaya, I mean, were you able to capitalize on any of the uncertainty there within that Avaya customer base over the last six months or so?

Stephen Sadler: It’s very interesting, everyone would think that. But what happens, Avaya has done a lot through resellers. We sell with Avaya on Avaya equipment. So as people held back a little bit doing Avaya equipment, they also held back on our software, which goes on the Avaya equipment. So we really did not capitalize very much in the last six months on that.

We do have a lot of interest, because we also operate on platforms other than Avaya. But I would say, it takes time for resellers to get retrained in all those things. So to answer your question, no. In the last six months, we really didn’t, but we do see potential in the future to do so.

Ralph Garcia: And that was my core, I guess, follow-up on that.

Can you leverage the Extreme channel, I guess, going forward now once they sort of integrate the two product lines?

Stephen Sadler: Yes, I don’t know.

Ralph Garcia: Okay. Thank you.

Operator: [Operator Instructions] We’ll take our next question from Deepak Kaushal with GMP Securities.

Deepak Kaushal: Well, hey, guys.

I had a couple of follow-ups, one more on the accounting side. Just on the cash cycle, Steve, it looks like it’s kind of shifted in the last couple of years and the DSO has extended. Is this a result of more acquisitions on the asset management side, or is there anything that we should note on this change?

Stephen Sadler: Yes, the asset management side is generally the service providers of Telcos. It changed the dynamics a little bit usually in two ways. One, it’s all direct, so it usually increased our professional services revenue a little bit.

I’m talking without exchange impact. On the other side, it does – they do take longer to pay for receivables for sure. I don’t think it impacts us as much as others, because we buy the company. It’s not like we’re selling more and more and extending the receivables. So it does have an impact on receivables.

But quite frankly, our receivable balance is too high, and I’m going to work on getting that better next quarter. We can do better than where we are.

Deepak Kaushal: Okay, great. And then just kind of an extension to that. I know that you’re – I believe that you’re still absent a COO.

Just a question about how you’re spending your time these days, Steve? How much is going towards day-to-day operations, or managing the global footprint versus M&A activity?

Stephen Sadler: I haven’t changed much of that, I’m about half and half. I would say depending what you count acquisitions, M&A, then you’ve got investor relations. You’ve got a lot of other things, what I’ll call, administration, that’s in there. I would say, it’s probably 20% in what I’ll call administration and then 40% acquisitions, 40% on day-to-day operations.

Deepak Kaushal:
it:

Operator: [Operator Instructions] And it appears there are no further questions at this time.

Mr. Sadler, I’d like to turn the conference back to you for any additional or closing remarks.

Stephen Sadler: Okay, Enghouse continues to grow and we’ve built this global business to build shareholder value. We appreciate your interest in our business and look forward to talking to you again after the next quarter.

Operator: This concludes today’s call.

Thank you for your participation. You may now disconnect.