Executives: Steve Sadler - Chairman and CEO Doug Bryson - VP, Finance Sam Anidjar - VP, Corporate Development Todd May - VP, Legal

Counsel
Analysts: Paul Steep - Scotia Capital Paul Treiber - RBC Capital Markets Michael Urlocker - GMP

Securities
Operator: Good day, ladies and gentlemen, and welcome to the Enghouse Systems Limited 2016 Q4 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 CEO.

Steve 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 I 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.

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

Doug Bryson: Thanks Steve. Yesterday Enghouse announced its fourth quarter and year-end financial results for the period ended October 31, 2016. Revenue increased by 10.3% to $308 million for the fiscal year, compared to revenue of $279.3 million in the previous fiscal year, resulting in another record year for the Company.

Income from operating activities was $81.9 million, compared to $67.3 million last year, an increase of 21.8%. Net income for the fiscal year was 47.3%, or $1.74 per diluted share compared to $31.4 million or $1.17 per diluted share in the prior year. Adjusted EBITDA for the fiscal year was $86.7 million or $3.19 per diluted share, compared to $71.9 million or $2.69 per diluted share last year, an increase of 20.6%. Operating expenses before special charges related to restructuring of acquired operations were $127.8 million for the fiscal year or 41.5% of revenue compared to $121.4 million or 43.4% of revenue in the prior fiscal year as a result of efficiency improvements realized and favorable foreign exchange gains recorded during the fiscal year. Fourth quarter revenue was $78.7 million, an increase of 3.1% over revenue of $76.3 million in the fourth quarter last year.

Revenue in the quarter reflects incremental revenue contributions from acquisitions as well as the unfavorable impact of foreign exchange on revenue, largely on the decline in the pound sterling post-Brexit. Adjusted EBITDA for the quarter was $26.7 million or $0.99 per diluted share compared to $21.1 million or $0.78 per diluted share in last year’s fourth quarter, an increase of 26.5%. Operating expenses before special charges related to restructuring were $28.9 million compared to $32.9 million in the prior year’s fourth quarter and primarily include incremental operating costs related to acquisitions and the favorable impact of foreign exchange gains of $4.2 million booked in the quarter on translation of foreign currency denominated monetary assets and liabilities. Non-cash amortization charges in the quarter were $7.2 million compared to $6.1 million in the prior year’s fourth quarter and include amortization charges for acquired software and customer relationships from acquired operations. Results from operating activities for the quarter were $25.4 million compared to $20 million in the prior year’s fourth quarter, an increase of 27.2%.

Net income for the quarter was $19.9 million or $0.73 per diluted share compared to the prior year’s fourth quarter net income of $13.2 million or $0.49 per diluted share. Enghouse generated cash flows from operations of $15.8 million in the quarter compared to $11.3 million in the prior year’s fourth quarter. Cash flows generated from operations for the fiscal year were $59.7 million compared to $50.5 million in the prior fiscal year. Enghouse closed the year with $85.9 million in cash, cash equivalents and short-term investments compared to $98.4 million at October 31, 2015. The cash balance was achieved after payment of $51.3 million for cash -- for acquisition net of cash acquired $4.5 million to finalize prior year acquisitions and dividends of $13.9 million.

Shortly before year-end, on October 28, 2016, Enghouse acquired Presence Technology for a purchase price of $19 million, net of cash acquired. The Company inherited Presence’s pre-existing long-term debt but does not otherwise have any long-term debt. Only the opening balance sheet on acquisition was included in the results for fiscal 2016 as results between the acquisition date and October 31, 2016 were immaterial. Yesterday, the Board announced -- approved an eligible dividend, quarterly dividend of $0.14 per common share payable on February 28, 2017 to shareholders of record at the close of business on February 14, 2017. I’ll now turn the call back over to Mr.

Sadler.

Steve Sadler: Thank you, Doug. As Doug noted, we continue to have a strong cash position with cash and short-term investments of nearly $86 million, and this is after paying for the Presence acquisition, nearly $15 million net of the cash that we received, a couple of days before the end of the fiscal year. Our cash balance would have been over a $100 million if the Presence acquisition would have been completed four days later. As with the prior quarter, foreign exchange had a significant impact due to the continuing influence of Brexit and the euro.

Revenue was negatively impacted but profitability was positively impacted by approximately $4 million compared to a similar profit impact last quarter of $2 million. Taxes were negative in the quarter, approximately 1 million, as a result of our annual assessment and our usage of our over $70 million of non-capital losses which are not recognized in our financial statements. From an acquisition point of view, NetBoss which was completed May 27, was included in its first full quarter and contributed to EBITDA, but not yet at its fully expected percentage of revenue. Presence was acquired at the end of the quarter October 27th, and no revenue or results were recorded in the quarter or the year. Presence balance sheet, as Doug has said, was included in our results.

It is expected that Presence will require minimal restructuring. I would now like to open the call for questions.

Operator: [Operator Instruction] We’ll go first to Paul Steep with Scotia Capital.

Paul Steep: Great. Good morning.

Steve, could you talk a little bit about what your thoughts are on the contact center market with all the consolidation that’s been out there; what the opportunities are for Enghouse? And maybe how your take is on renewals as well at this point in the cycle?

Steve Sadler: Okay. The consolidation is quite interesting. It is actually having an impact that we sort of expected, because the consolidation you’re looking at is really the SaaS type companies who are losing money have to do something. I think I’ve mentioned it in several calls. So, either they got to raise money or they’ve got to sell themselves to somebody else.

Some companies like Genesys didn’t really have a SaaS model; they’re in posses of buying interactive intelligence. Another company is buying inContact. So, again, from that changeover of these companies trying to get scale at losses, they look ahead let’s say a year, 18 months, and you got to do that, you can’t wait till the last minute, and they have to find a strategy of either getting money or finding a buyer for themselves. So, I expect when it’s all said and done, you will probably see what I’ll call, SaaS pricing increase because I think some of the companies that are doing the buying are not companies that tend to lose money on their operations.

Paul Steep: Okay.

And how have you seen, have you see any impact out of the cloud on renewals this year or customers still pretty much business as usual, not really looking to change, no massive change in the market?

Steve Sadler: There is some change in the market; it’s more on new revenue. And so, again, in the fourth quarter -- we just avoided saying we want profitable revenue, but in the fourth quarter, we have a strong financial position compared to a lot of the competitors. So, we added another tool to our sales peoples selling tool kit, which we’ve had for a while but we’ve emphasized a little bit more. Some companies do SaaS because they just don’t want to pay the licenses upfront, they want to pay as they go. So, we’ve put a subscription model in place, generally getting the stated revenue but over three years, so we took a little bit of action to get the people who really didn’t want SaaS but wanted -- chose a different payment structure, and we’ve also continued to emphasize our SaaS model through the service providers which is starting to show some promise.

Paul Steep: That was actually where I was going to go next. In the CCSP product, what’s -- maybe you can talk -- just give us a perspective on what you’ve done in terms of service provider onboarding and maybe also end customer uptake or call center seats that you’ve seen them actually sell through into the market at this point?

Steve Sadler: So, there is good news and bad news with service providers. They take a long time to make a decision, so some of the decisions we made last year, they are now implementing in the software which is good. And then you got to get the sales force trained on how to sell it more aggressively in the market. We’re in the process of doing that.

So, again, we are hoping that the revenue will increase going forward but it is a SaaS model, so it goes slower than a license model in doing that. We have what I would say fairly good interest from service providers recently, and we’re expanding our offering globally, which is also good because someone else trying to do this on their own would have to set up standards in each country because they don’t -- privacy rules don’t let data flow across boundaries easily. Since we use service providers in countries, we are expanding globally and have some interest there. My comment would be on which ones and how many, I think you just got to watch the news on that because as they implement and we get approval, we’ll tend to announce new platforms that we get. But we have -- we’re building the platform base, and think about after that’s done, expanding what they do putting more people on those platforms.

So, we’ll end up being, in our view, slow, steady growth on each platform but we also should have growth from the additional platforms that we’re looking at. But something going in today will not impact this year, we see it impacting next year because it also takes about six months to get it all set up on a new service provider that we sold and then they start to ramp up after that. But it is showing an interesting trend. So, we’ll just have to see how it goes.

Paul Steep: Great.

The last one I’ll ask, maybe a little bit down in the weeds, but just curious more about your broader view. Note five of the balance sheet, when we look how you’ve allocated out the cash, one thing that jumped out this year was the fact that you’d allocate it and it’s small, it’s $5 million into equities. But that hasn’t necessarily been there before, Steve. And I guess, the thought is what’s your take or your view on the equities? Is this equities of distressed public software names that you would be looking acquiring or is this just equity like holdings to generate income, Steve?

Steve Sadler: So, you’re right, but you’re wrong in the fact, if you go back on our past balance sheets, we’ve done it often. And what we tend to do, if we see a public company where we have some interest, like others, we will take a small position.

And then, if we talk to them, all of a sudden their stock runs up or something happens, we will then to cover some of our acquisition costs by selling it or participate if the value is right. But for public companies, we do take positions, probably be doing it for 25 years and we still continue to do it. You got to be careful though when they come to you because once you’ve signed an NDA you really can’t do that anymore. But we do have some positions we’ve taken in some companies, and we always have. Maybe the number looked a little bigger now, but if you go back, you will see, we’ve had it in the past as well.

Paul Steep: I’d only looked it last year, I knew you did it. Is it just a close off on that opportunistic, Steve, largely, what I conclude is how you’re looking at it and in that opportunistic approach, you think there is more opportunities at the moment or is it sort of a specific situation that may have passed?

Steve Sadler: No, there is always opportunities, and it isn’t one, we do several, and they are really small positions. We sort of do this really -- I look at it as paying from our acquisition costs, like if we don’t do any acquisitions of those by the time, we sell them, we probably made enough money that we’ve sort of paid for the cost of what we do in acquisitions. So, it’s not really a big money maker; it’s more of let’s cover our cost, so our acquisition activity can basically be close to free. So, it’s sort of not -- it’s a core strategy of what we’re trying to do.

We find often, which is interesting that some companies where you buy and then you go talk to them, they all of a sudden jump up double and stuff like that. And when they do that, of course, they are not an acquisition candidate for us, but we might as well make some money on our work to go talk to them.

Operator: [Operator Instructions] We’ll go next to Paul Treiber with RBC Capital Markets.

Paul Treiber: Thanks very much and good morning. Just in regards to the subscription, the shift to subscription revenue.

Could you quantify the impact in terms of either license revenue or total revenue that may have been foregone in the current quarter?

Steve Sadler: It’s hard to do each quarter. Everyone tries to estimate it. So, let me tell you my thinking on this. It’s a tool. There is no shift; it’s we put another tool in our salesmen’s kit that if a customer wants to not pay upfront, and that’s their issue and they should know the customer well enough to know if that’s the issue, then they can do subscription model.

We can direct them to our CCSP platforms and they can do the SaaS model or they can do the Presence model. In the past, we really did emphasize or make it let’s say focus on the subscription model, what we have found is some who go to SaaS really are looking for subscription, which means they just don’t want to pay the licenses upfront. So, in looking at that, we put it in their kit. They may sell none of it, they may sell some of it. But let me give you an example in the fourth quarter, because we just started this; we talked about it a lot but we’ve given a little more emphasis recently.

And it’s interesting numbers. If we were going to sell, and let’s say it was $50,000 of what I call subscription revenue in the fourth quarter, miniscule, if we had sold the license revenue rather than the subscription, because in the fourth quarter, let’s say I sold it in September or August and it started up in October, if I sold the license revenue, that $50,000 would be $1.8 million of license revenue, because now I’m going to get $50,000 for the next generally three years every month. So, it’s a small number when you do that model, you get it over time, you actually will make more in the end, because after three years, they have to buy it again. And most people who buy the license model, generally will run it for six years. So, this way you actually get double the amount over time by the model, that’s why people like it, because if you get there, it’s good.

And why do people do it, customers, they still either have the money, want paid upfront; they want it in their operations budget, not their capital budget. So, there is lots of reasons why a customer would look at it. But let’s -- and it depends on when you do it, but $50,000 let’s say in October, we just started towards the end of the year, would have been $1.8 million in license revenue when you calculate it all out. So, it has quite an impact. Now, what we are hoping with this is not replacing our premise model.

We’re trying to give customers what they want, another alternative. So, we’re hoping by doing this, we will increase our license revenue, i.e. we’ll still do the premise revenue or close to it, but we’ll add on because we might get some deals that we would not with this process. There could be some substitution. And again at the end of the year, if it wasn’t October deal, it would have been 1.8 million for 50,000; 50,000, you’d say not material; 1.8, million you’d look and say hey, I can see how that affects licenses.

If it’s the first month of the next year, of course then, you’re going to get about 600,000 in the year. The impact is not quite as big, but when you just go towards the end of the year, if there is one deal for 50,000, the number would be 1.8 million. So again, small, but it’s something we think we should add and get our sales guys up to speed on, so they at least have another item in their toolkit to present to customers if they feel the customers are looking for that. That’s the issue. The issue is they want OpEx; they don’t want CapEx; and they don’t want to go to their management and get approval for capital expenditure.

This is the way they do it and spread the payment over three years. I mean, generally that’s what we do. It’s really a three-year process for that. We generally, after three years would probably have made the same amount as we would have selling them a license. But then we must buy again if they want to continue to use it.

And again, we don’t have cost on it because it’s not a SaaS model, we still do that through our service providers. It’s just a different way of financing a sale upfront that customers want. It’s more expensive for them. And so, we always said why would they do it, but there is interest, so we put in place our sales people. So, again, 50,000 in Q4 of revenue that we may have gotten, would have been 1.8 if we had sold a license instead.

So, the numbers are...

Paul Treiber: That is helpful to understanding the economics. When you net out all the puts and takes in the quarter or maybe over the year in regards to foreign exchange, this transition, other impacts, how do you -- you previously commented that you see low single-digit organic growth. How did you see this year tracking versus that? And if you look forward, do you see any material shifts in the market that would lead you to deviate from those prior comments?

Steve Sadler: Personally, I think it’s the same but there is a lot of moving parts. One, you’ve got the exchange as you’ve mentioned, a moving part, you’ve also got the subscription part.

If I get 100,000 a month, for example at the end, that could be $3 million and you will be saying hey, it’s an up quarter. So again, we are doing that. If you want to count it, I count it by business and partners I’m getting; I still think it’s low single digits but it depends. If we do more subscription, it could go down. Our hope is that it’s additive for us that we still do the premise but maybe one or two will switch but we’re hoping that we get in some more deals that over time increase our revenue by that offering.

So, again, low single-digits, that’s what we think we can do. But it might not always come out that way in financial statements to you; it might be better; it might be worse. I will tell you for example, in our network side, we had a customer fairly large one who was on the subscription type model. And after three years, they came and said we want to buy it now, we don’t -- this is getting expensive because they figured out it’ more expensive and they were growing, so it was growing each quarter. And we actually sold them software for $1 million; they converted back.

So, you do have some of that opportunity there too. And we do have the option and we’ve got to emphasize it more on moving to our providers, our service providers for the contact center as those platforms get set up, we will point customers there. Where in the past, sales guys probably said well, no, do premise instead and maybe overemphasized that side of it and maybe lost the deal because of it. Now, they’ve got to assess the customer better, they’ve got to find out what their key points are, and if it happens to be a SaaS model, because they want to -- the difference in SaaS is you don’t buy equipment, you don’t have other expenditures. Then, we could also point them to a service provider and say look, they’ll charge you x and we make on the backend because every customer that goes on, they pay off.

So there is a lot of moving parts here on that. And what we’re trying to do is give flexibility, customer choice, and numbers, top and bottom line should prove out over time for our shareholders.

Paul Treiber: Regarding maintenance, have you seen any meaningful changes in renewal rates or customer churn?

Steve Sadler: Not really, it’s generally being the same. The maintenance, just 20% of our revenue is in the UK. They detected -- the exchange affects maintenance like every other line on the revenue line and the cost line.

So, the euro now 1.05, we have a lot of euro of maintenance, that maintenance could go down. But we don’t see it as a business issue; we see it more of a financial issue. We do assumption like everybody else but a lot of our customers generally want on-premise, there is people who want to go in the cloud. To do that, your contact center is not necessarily strategic because you’ve got to have the same center as everybody else. You just want something that can handle a contact center.

There is some companies who see their contact centers more strategic for them as their communication centers, we call it to their customers. But generally, we see the maintenance like it has been in the past. Remember, if we do the subscription model, we carve out maintenance from that or we sell it separately from that. So, it doesn’t really -- it impacts it a little bit, but not very much, so it’s about the same.

Paul Treiber: Okay.

Just in regards to capital allocation, what your thought is? Well, given the stocks year-to-date, would you consider allocating capital to repurchasing shares as opposed to M&A at this point?

Steve Sadler: We’ve talked a lot about this in the past. And although the stock is still down a bit, we see any purchaser of own shares being competitive against using that same cash to do M&A. And right now, we can quite frankly find opportunities at better value than our public shares. Part of that is because the public shares. The public markets because of low interest rates tend to be more expensive than the private markets.

So, we allocate capital to where we get the best deal. We don’t really need to see buying back our own shares. People do also say, you don’t have enough flow, that’s why you can’t buy, which I tend to ignore, because they can buy shares, they just have to pay more. But from a public market side, buying back growing shares; the public markets are more expensive than the private right now. So, we allocate funds where we get the best return for our investors.

Operator: We’ll go next to Michael Urlocker with GMP Securities. Please go ahead.

Michael Urlocker: Gee, at this point, most of my questions have been asked. But I did want to observe, Steve, I appreciate your moneymaking approach in terms of reducing the cost of M&A transactions by buying the stock. I think that’s really a good innovation and it represents your general approach to making money.

So, if we look at the business, and maybe to follow up on the last question, we can all understand the stock was probably overpriced a year ago, and that’s why year-to-date performance isn’t good. But for the past six months, the stock has been flat. And I only ask this because I know you are a bit of a stock guy. The financial performance has been strong when we look at cash from ops, especially strong this quarter, why do you think the stock has been flat for the past six months?

Steve Sadler: That’s really more in your court. I should be asking you that.

I mean, my answer, which is it’s a good one and probably a little tongue in cheek is I guess there is more people who sold than are buying right now at this time. I do think they worry a little bit about the top-line, maybe they don’t understand what we’re trying to do or they’re thinking quarter-to-quarter long run type situation. But, I can’t answer that, you’ve got to, I guess talk to all your buddies and find out why that’s happening.

Michael Urlocker: My personal sense is that sometimes stocks move in and out of favor like fashion. But, I don’t think there is anything wrong with the fashion of making money and generating cash from ops.

Steve Sadler: The thing I can tell you because I’ve got some old pie, I can tell you that things in older fashion, sometimes they come back into fashion as well.

Michael Urlocker: So, I should actually ask you an operational question. Part of your business is now exposed to telecom software. What’s your sense of the buying environment from telcos, like are telcos actively buying; are they running slower; what do you observe there?

Steve Sadler: It’s interesting, I hear everyone talking about telcos saying oh, they’re holding, they’re not buying. If you look at our numbers and look at our growth, we’re not finding that.

We think it’s pretty steady, it’s not moving. But, we haven’t seen a decline yet, maybe it’s still coming but we have not seen the same thing that others are talking about, but we do more point software that adds value and money for the service providers. We don’t do things like billing, which just runs what they’ve got. May or may not, it’s something you need, but it’s not something generally that you have a high payback on because you’ve had one for years and you’re just replacing it the other one you have. We tend to sell product that makes the money.

So, maybe at least for now, we haven’t seen any real difference in the trend, which is a steady trend and a little bit stronger growth than our interactive side. But, again, nothing spectacular; pretty steady as she goes, and we aren’t hear saying, oh boy, we got -- they’re not buying that’s why we’re down. We aren’t seeing that and maybe a different market and maybe a different area.

Michael Urlocker: Okay. And then…

Steve Sadler: It’s not what we’re seeing right now.

Michael Urlocker: Thank you. And then, again, if we look at operationally, you’ve -- in the past few years, you’ve added to the team at the executive level. Are you pretty comfortable with everything you got or do you see areas where you want to beef up the team or expand functionality or capabilities?

Steve Sadler: We’re expanding. So, I always want to look to see and add to the team a little bit. The team is a little, always a little stretched because we’re adding more in all the time.

So, I’m always looking to add to the team, but I’m not really looking -- I think the team is pretty good; it’s not replacing the team, it’s more or like as we grow we probably have to add to the team because there is a lot more things to do.

Michael Urlocker: Excellent. Okay.

Steve Sadler: I’m always looking -- good people are hard to find. If we see good person or if you know any great person, we’re happy to look at them, we’re happy to bring them in.

We’re pretty sure we can put them to work.

Operator: And there are no other questions at this time. I’d like to turn the conference back over to management for any additional or closing remarks.

Steve Sadler: Well, thank you everyone. Another fiscal year has been completed.

We want to thank our shareholders for their continued confidence and staff for their ongoing efforts to build Enghouse’s success into the future. Have a merry Christmas and a happy holiday season.

Operator: That does conclude today’s conference. Thank you for your participation.