Tecsys Inc.

Peter Brereton – President and Chief Executive Officer Berty Ho-Wo-Cheong – Vice-President, Finance & Administration and Chief Financial Officer

Amr Ezzat - Echelon Partners Nick Agostino - Laurentian Bank Hubert Mak - Cormark Securities Gabriel Leung - Beacon Securities

Good morning, everyone. We appreciate you joining us for today’s call.

Yesterday after market closed, we issued our unaudited fiscal 2017 third quarter financial results and a copy of those results is available on our website at tecsys.com. Joining me today is Berty Ho, our Chief Financial Officer.

I’ll start by summarizing the key events for the quarter and reviewing our Q3 financial results. I’ll then close with a few comments on our outlook for the remainder of fiscal ‘17 followed by a Q&A session.

The third quarter of 2017 was a solid quarter with growth in revenue, gross margin and EBITDA, while we continued our disciplined approach to operating expenses. Total contract value bookings were $14.6 million, a 62% increase compared to $9 million booked in Q3 of 2016.

A significant portion of this growth was for new modules with existing customers, amounting to $13.8 million almost double the $7.1 million in contracts from existing customers we signed in Q3 of last year. Included in the contracts are two significant agreements worth $3.3 million with IDN or hospital networks that are WMS customers that is Warehouse Management customers.

One other thing point-of-use [indiscernible] This demonstrates the strong relationships our sales and services teams have built with our hospital customers and puts them in a great position to offer additional solutions. We estimate we’re only about 12% penetrated in our hospital network customers, so there’s significant upside.

In the quarter, the momentum we have been seeing the past fiscal year in signing complex distribution contracts with existing customers continue to grow with three significant contracts added, altogether amounting to $4.7 million. One of the new contracts is a warehouse solution for our contract manufacture.

It is an implementation at just one of their locations and with 20 others in North America there maybe opportunities for expansion. It’s also important to note that this is our first solution sold through a channel partner.

The second new contract we signed in the quarter was a fully global distribution solution that was signed by our UK office. This office was established in September of 2015 and it’s headed by Mark Hawksley, VP of Global Service and Strategic Initiatives for Europe.

Mark has over 30 years of supply chain software experience and worked with us in Montreal for several years. His experience and knowledge of our solutions have generated several opportunities for the pipeline from both the UK and Europe.

Now looking at the financial results in more detail, total revenue in the quarter was $17.4 million, up 11% over $15.6 million achieved in Q3 of 2016. On a trailing 12 month basis, revenue was up 15% to $71.1 million for the 12 months ending January 31, 2017 from $62 million for the same period ending January 31, 2016.

Recurring revenue on an annualized basis was $26.1 million, representing 37% of trailing 12 months revenue. For the quarter, proprietary product revenue increased by 8% to $2.7 million, largely the result of higher hardware technology sales to U.S.

IDN. Third party products, revenue stayed relatively flat quarter-over-quarter at $2.2 million.

Our services revenue which includes support and implementation grew by 12% to $11.8 million. The increase is a result of higher professional and support revenues and is a reflection of our success in growing our relationship with our basic -.

Gross margins for the third quarter of fiscal 2017 was $8.9 million, a 13% increase, compared to $7.9 million in the third quarter of 2016. The improvement is primarily the result of higher margin from services which was 50% in Q3 of 2017 compared to 45% in the same quarter prior year.

For the trailing 12 months ended January 31, 2017, gross margin was $36.5 million, representing 51% of revenue, and up 18% over the $30.9 million or 50% of revenue achieved in the 12 months ended January 31, 2016. Compared to the growth in our top-line, operating expenses grew margin in the quarter by 4% or $7.6 million, or 44% of revenue, from $7.3 million or 47% of revenue in Q3 of 2016.

Sales and marketing expenses were up 2% and G&A expenses were up 5% compared to the same quarter in the prior year. Both increases are from higher salaries and benefits as well as incentives to support our greater sales and support volumes.

R&D expenses net of tax credits were $2.5 million, up 5% from $2.3 million in Q3 of 2016. We were still capitalizing a small part of our R&D expenses last year.

So while higher salaries and benefits were part of the reasons for the increase, there was $140,000 of preferred development cost which decreased expenses in Q3 of 2016. With what we feel is sufficient infrastructure to support growth, we are committed to continue to control our operating expenses and we expect them to remain essentially flat going forward.

We recorded profit from operations at $1.3 million in the third quarter of 2017 compared to $604,000 for the same quarter last year. Although net earnings and EPS was reduced by income tax expense of $405,000, it is important to note that 75% of this was non-cash taxes.

The company recorded net earnings of $888,000 or $0.07 per share compared to $543,000 or $0.04 per share in the same quarter of last year. EBITDA in the third quarter of 2017 was $1.9 million, up 45% from $1.3 million in Q3 of 2016.

This represents an EBITDA margin of 11% compared to 9% in the same quarter of the prior year. Increased higher margin service revenue against relatively flat operating expenses drove this growth.

As stated on previous calls, we’re targeting to take EBITDA margins to the high-teens and this quarter demonstrates that progress. Looking at EBITDA on a trailing 12 month basis, we generated $7.5 million for the 12 months ended January 31, 2017, 76% higher than the $4.3 million generated for the 12 months ended January 31, 2016.

We ended the quarter in a strong position with cash and cash equivalents of $10.8 million, compared to $9.7 million at April 30, 2016 the end of our last fiscal year. The company has declared a dividend of $0.045 to be paid on April 11, 2017 to shareholders of record at the close of business on March 31, 2017.

In summary, the third quarter of fiscal 2017 showed strong results particularly at basic health sales and complex distribution. While there is still some uncertainty related to healthcare legislation, we remain confident that our offering is well positioned in the current environment as we help our healthcare customers improve efficiency and productivity driving significant cost savings.

In terms of specific solutions, our OR solution went live late last year at one major hospital network and we’re expecting further implementation on our next quarter. The first phase of a pharmacy point-of-use solution we developed last summer and we continue to work out implementation details with our first client.

TECSYS serves a large addressable IDN market which we estimate at $9.6 billion. Only with our existing customers we estimate the addressable market of more than $450 million which we are about 12% penetrated.

Solutions like our OR solution and pharmacy products will help us to land new customers and expand our relationship with current customers. Looking forward, we’re excited about the opportunity for us.

We have a substantial pipeline that covers projects in the U.S., Canada and Europe, and covers warehouse management, off-site distribution and healthcare point-of-use modules. We believe that our unique solutions and close relationships with our customers combined with careful control of our operating costs will ensure continued success.

With that, I will turn the call over for questions.

Good morning, gents. Congrats on a solid quarter.

Peter, you mentioned in your prepared remarks that you continue to see some impact from the uncertainties surrounding the Affordable Care Act. I’m just wondering are new accounts in a wait and see modes, how have conversations evolved with clients I guess since the last conference call?

It’s interesting that sales process continues in that market and what we continue to see is constant networks actually initiate search for solutions, go through a search, select, asks a vendor, begin to negotiate contracts, get through legal review, get all the way to the end of sales cycle and then it was back to the C-Suite for final approval. And the C-Suite at this point is just so distractive they are ending up saying, we’re not kicking off any major capital projects right now until we get our sort of go-forward playbook sorted out based on the new landscape.

So we’re seeing a number of deals that are sort of hung up right at that final stage, and we believe the lockdown[ph] are about to break. None of them are planning actually wait until sort of the whole Affordable Care Act thing is completely sorted out, they just feel like their landscape’s changed substantially and they need a new plan going forward that sort of takes into account all the different possibility.

So we’re looking at a completely warped pipeline at this point and we would expect the pipeline to be majority healthcare based on our experience over the last few years. But at this point, it’s beyond majority, it’s in the sort of vast majority of the pipeline are these healthcare opportunities and we expect them to begin to start soon.

In the basic county as I mentioned in my remarks, where the projects tend to be somewhat a little bit smaller, require a lot less capital because a lot of our new account projects although our deal may only be $1.5 million, it may require $10 million or $15 million or $20 million spend to drive the entire project with the hospital network. Whereas in the basic county, add-on projects the deals maybe the same size for us but for the account there is a lot less sort of ancillary collateral spend.

So they tend to be smaller from that standpoint, and those seem to be moving ahead at a great pace. Hence, our bookings in the base both for the quarter and year-to-date are very strong.

Understood. Then as a follow up I guess, the new account signings the contract value is a little smaller than your typical new accounts, is that a function of what you just described like all this I guess the Affordable Care Act and so on?

I mean the new accounts in the quarter were really in complex distribution. One of them I would say was more of a small to medium size accounts.

The other one is actually a really two phase agreement. We’re only counting in the bookings the first phase of the agreement and the first phase was roughly 25% of the agreement.

So as a second phase, we fully expect the second phase to come through and if the second phase comes through, there is about another well, it will roughly quadruple the deal so. So we’ll see how that plays out.

Understood. Then, would you mind giving us, I’m not sure if I missed that, the revenue splits between healthcare and complex distribution for the quarter?

I think on a year-to-date basis, we’re closed to about mid-40s in terms of healthcare compared to obviously 55 in the complex.

Understood. Then maybe you can give us an update on the traction you’re getting with your channel partners, you did mention that on the distribution sites their contract was done through a channel partner.

Any traction on the healthcare side with the channel partners or…

On the healthcare side, we’re really seeing - we’re not so much actually selling product through channel partners in that case, but we are working with as service partners. And they are now active in our accounts.

We have two one of the hospital network that is active in a number of our accounts, assisting with implementations and other is sort of more of an integration partner, and they’re also active now in a number of our accounts existing with implementation and integration work and so on. So we’re pleased with our progress there.

The particular deal we mentioned in the quarter was actually sold through directly through account partner, they literally brought the opportunity to us. We were obviously –more or same, we actually have another channel partner, it’s actually in ongoing training with which is part of an ongoing on-boarding process.

They are actually in Montreal this week again and we expect to start to see some business through them in the near-term.

Awesome. Then maybe just the last one on the cost side of the equation, great job with the cost execution, but I’m trying to get a sense of utilization levels, if you will.

You mentioned you expect OpEx to remain flat or flattish, how much revenue can you generate at this level of OpEx?

I think from an OpEx standpoint, we don’t see I mean these are sort of almost expansion related decisions. I mean if we held off expansion like for entire another year, I think we could continue a very healthy growth rate for another year.

Could we grow beyond that? Probably not.

At some point, we need to begin to further expand our basic health team, add a couple more people in the basic health team and probably add a couple more people in the complex distribution sales team. Those are areas that we see the need for some expansion.

R&D I think is fine for the time being. I could see us needing to grow R&D a little towards the end of next fiscal year as we’ve got some sort of upcoming projects, we need to put more rustle into.

The upward pressure on cost I would say related to growth is really more on the services cost where we continue to I mean you saw us go up against some this quarter, I mean services expenses will continue to rise. We don’t really expect gross margins and services to rise dramatically from here although with the economy upscale that we get into maintenance and support area, it should continue to sort of drift upwards.

But by and large, we will have to sort of add services, expenses and - up with services revenue growth.

Understood. Thanks and again congratulations.

Great. Thanks, Amr

Good morning. Actually it’s Chris Martino standing in for Nick.

Great, Chris. Good morning.

Good morning. In terms of IDN prospects, are you still targeting six to eight wins for the year?

And the two wins this quarter, I believe both of those will classify?

So the two wins this quarter were not IDNs, they were in complex distribution. So, at this point we actually stand only at one new IDN for the year.

So in answer to your question, yes, we are still targeting five or six IDNs for the year, but a lot is going to depend on when this sort of lockdown really breaks in the hospital market in the U.S. for new accounts.

The pipeline is very full of IDNs that plan to move ahead in the very near term, we’ve already been through contract negotiations with a lot of them. We’re just waiting for income paper.

So we’ll see how that works out. At this point, we have 60 days to go, so there’s no question it is increasingly looking complicated to get another four or five done in the next 60 days, but it’s not impossible.

The opportunities are there in the pipeline and they seem to have every intention of moving ahead. So, we’ll see what the next 60 days brings, but certainly we expect there is going to be a bit of a snapback here as the market sort of catches up after this, certainly what we see and what we’ve heard from others in the marketplaces in elector related slowdown in capital spending.

Alright, okay. Secondly, is the UK an area we’re expecting more growth, following that contract like how does the pipeline look there?

We’ve been trying to sort of build a beachhead in UK and Western Europe and in the sense the challenge always is you need local references and to some extent, local services people in order to be an effective competitor in the market. So the first few deals are always the biggest challenge.

So we’re trying to get, sort of sell a couple a year over there, get them done, get them really successful, happy, referenceable etcetera, before we actually begin to put sort of dedicated feet on the street over there looking for new accounts. So we certainly expect at this point we’ve got other opportunities over there.

We certainly expect to be able to do a couple of deals over there for the next little while, before we start to ramp up more aggressively there.

Okay, thanks. And one more, could you provide any color on the One Sprint solution if possible if you’ve had any implementations there yet…

We actually have two, One Sprint implementation underway right now as we speak. So that’s a good move forward on that, getting out went out of the chute took a little longer than we thought, but some of that I think was even the sales team getting used to a completely different way of selling the solution, but I’m happy to report that I think we’re making some good headway on that.

Great, thank you.

Great. Thank you.

Hey guys. Obviously you guys had a very strong bookings quarter here, could you may be comment on whether there is some [indiscernible] in this quarter, I think last quarter you suggested the – spend for deals so could you sort of quantify that if possible just kind of give some commentary on the bookings where some of the deals came through?

I would say, - in Q3 but I would say there was one particularly that literally missed Q2 like by hours. It had to do with a flight, somebody happened to get onto a flight and couldn’t wait to sign an agreement kind of thing and that was where maybe what 800,000 – well it slipped out of Q2 into Q3 right?

That one was probably somewhere about $1.5 million, Peter, and then Hubert, just remember this, there’s always some of that happening from quarter-to-quarter. This is not unusual, right?

In some quarters yes, there might be more but some typically we would have deal that at the end of a specific quarter, just slipped in and get closed sometime in the following day actually as Peter mentioned.

Yeah, I would say though, to answer your question too, the healthcare deals it was really the IDN deals that we’re talking about at the end of Q2, that were sort of just slipping and they are still slipping, like that group of deals is group that as I mentioned are still really sitting in the pipeline and that we expect to break at some point soon, but sitting here today, I couldn’t honestly predict whether it will be the majority, I’m very confident that a couple of them will come in actually shortly, but the bulk of them will it be in the spring or the summer, it’s kind of – to call it.

Okay, so just to be clear in this quarter’s bookings, the strength really didn’t come from any deals coming through really it was just a record quarter in general across your those verticals?

Yes, that’s a fair statement.

Okay. And the reason I’m asking that is because obviously your quarters were strong and a lot of them will come from existing base here.

So, in light of that, do you expect that bookings strength to continue in the existing pace and on that – if these IDNs will come through which are new customers, are we looking at an elevated level bookings going forward?

That, I mean that’s obviously predicting level of bookings going forward is difficult, but I do think the base is going to continue to invest at quite a reasonable pace. I mean we’re rolling out of a number of modules that the base sees a strong value in.

So that’s driving some of the increased basic health bookings. And yet, the new account as I say, I mean on the new account side, I believe there will be a catch-up at some point, we’ve seen this before in the hospital market, something changes politically, they all go on hold to some extent but then as they regain clarity on the new political environment, they’re in a catch up phase.

And that has happened to us in the past. As I’ve often told investors, it’s one of the advantages I think for us continuing to play in two markets because while healthcare is a strong, long-term market, huge portion of the economy, strong balance sheets, strong ability to invest, great need for supply chain solutions, so all good things.

At the same time, they’re substantially affected by sort of political change and that’s where it’s great to be straddling two markets where we can continue to growth and business in complex distribution while healthcare takes a bit of hiatus here.

And then just to ask more about the delays in the IDNs like, it seems like you have a number of them that are kind of pushed out. Are there any sort of commonality or themes that a lot of these potential customers are waiting for before they move forward with the decision or is this just sort of, everyone’s just trying to figure out how to rearrange the -

The commonality seems to be that they’re sort of relooking at capital allocation based on sort of what they think they can count on going forward and what they aren’t so sure they can count on going forward anymore. There is a couple of exceptions I know one of them for instance is delayed going forward until they finish another major IT project, but we’ve always had those kind of things I mean typically in this kind of market, there’s always one or two of them that have an internal project that takes six months longer than they thought and so on and so that delays are -.

But if I look at the bulk of them, the bulk of them has to do with them relooking at cash flows and capital allocations based on some of the market changes.

Okay. And then on the complex distribution, it sounds like you guys had a - amount of decent quarter in terms of bookings.

Could you kind of give some color on how do you guys think about the trajectory of this business you’re going for?

As I see it, that first year I mean we launched the new complex distribution sales team in fiscal 2016. And sort of simple math, it takes a couple million bucks to launch a new sales team.

The first year they did $4.4 million in bookings. Our average gross margin is about 50%.

So sort of simple math, first year, yeah it was worth launching the team. By the second year, which is the year we’re in now, they’ve already done about $8 million on the new account side.

And I wouldn’t be that surprised if they end the year sort of close to the 10 mark kind of thing. So, and again, sort of same gross margins.

So the math is looking pretty compelling to say, hey this is very much a winning product line, it’s very competitive in the market space. There is a lot of deals going down and I think all the indicators to us are that it’s we need to continue to expand that team, let’s grow that team.

At some point, probably start to break out those teams by geography and look at adding western team and eastern team that kind of thing, but I think we’ve still got a little more maturing to do before we do that. That’s why we’re saying we sort of expect OpEx to remain quite flat for the time being but it certainly looks like the combination of our, the functionality in that offering and the technology stack we’re bringing to market are quite unique and quite appealing to a lot of these prospects.

Okay. And then on the margin profile, I think on the call you talked about targeting the high-teens.

What was the – mind frame are you looking at, I know looking at last few quarters probably fluctuates by on a sustainable level, but [indiscernible] get back sort of the above 15% EBITDA margin?

I mean our goal is to be there by 2020, I mean we’ll see how that goes. I mean we’re about to start fiscal ‘18 and we certainly believe that we can be there by the time we did $100 million in revenue.

So, we’re looking at sort of getting there over the next two to three years kind of thing and we think we’re on track to do that. I mean one of the things to keep in mind, even when you look at EBITDA from last year to this year, we say for instance we went from whatever it is sort of $4 million and changed to $7 million and change if you’re comparing trailing 12 to prior trailing 12.

But remember that the prior trailing 12 was actually boosted by R&D capitalization to the tune of about a million bucks. So really and sort of trailing 12 versus previous trailing 12, we’ve gone from sort of $3 million and changed to $7 million and changed.

So we’ve made some pretty rapid progress on that as we started to focus on it and we think there’s a lot more progress that we made.

Okay. And just a last one, just to kind of go back to healthcare, are you able to quantify sort of how many I guess – pipeline over the last few quarters ago you talked about – or so in the pipeline that must have been up now given the delays but has it increased in terms of pipeline or can you – stakeholder?

I can’t say it’s increased, it’s more just that the stage has continued to move forward. There is only, part of it is we don’t have a large sales team, so there’s only so many sort of opportunities we can remain active in.

I have to look at the latest pipeline that’s maybe up a little bit it’s more just that we have a lot of deals that are right at the final stage that we expect to sort of clear the pipeline and convert quite shortly.

Okay, great. Thanks for the time.

Good morning and thanks for taking my questions.

Good morning.

Couple of things, on the healthcare side first, would it be safe to say that in terms of the number of networks that you’re talking to that are in that sort of final C-Suite sign off probably in the four to five range, just to get your sort of what your guidance outlook?

Yeah I mean that’s a fairly safe statement I mean that’s really why I’m saying and in answer to the question earlier, are we still targeting five or six IDNs, new account IDN for the year and I said yes, although it’s sort of getting harder to say that with a completely straight face when we only got 60 days up to go on a fiscal year. But yeah, it’s in that range, that we have there right in the final stage.

And just curious, has there been an instance where one of these networks assort in that final signing stage, sort of relooked at their budgets and decide cancel these larger capital projects?

We haven’t seen that, I mean what we have seen and this has been going on for a number of years in this market is right up until you have a signed document, you don’t know if there’s a merger about to happen and I would say there’s a lot of M&A activity in this market and that’s where we’ve sometimes been side swiped right in the final stages of an agreement, get right to the end and suddenly there’s an announcement that they’ve just been bought or they just bought another big idea and suddenly everything’s on a hold for a year while they figure out their new org structure and landscape and leadership team and so on.

Right. And so given that you seem to be getting some very good bookings from the existing network base, are there any thoughts around from TECSYS’s internal perspective to increase investments in that sort of pharma sales force within the networks?

I mean I think it’s probably the next place to invest, it’s something we’re looking at. We think we can sort of run the way we are for another – we do things that we have to make an investment there and we think there’s some really interesting opportunities there.

I mean if you just think point of use and we’re seeing our point of use opportunities sort of following the same progress that our WMS into healthcare followed a number of years back. I mean when we first entered healthcare with WMS, we signed one account I think it was two years before we signed the second one and then another year or so before we did the third one and we finally started getting white papers and testimonials and then the speed really picked up.

But we feel like we’re seeing the same thing on the point of use side, so we’re -- it was literally about five years ago, we signed the first point of use agreement with hospital network and then couple of years later, we signed the second one, the year after that we signed the third one and now within the last 12 months, we’ve signed two of them. So we’re sort of seeing the same thing.

As you get the proof, you start the testimonials, you get the data out and the millions of dollars you can save and then the activity really starts to accelerate. So as we’re seeing that coming to fruition, we’re saying fairly soon activity time to expand that team to sell these solutions in the base.

Got it, great. And maybe one last question just on the complex distribution side, Peter you talked about earlier in your preamble, three contracts sort of $4.7 million in bookings.

Those are all with the existing customers?

That’s right, yes.

Okay. The first one you talked about came from the channel, I guess the contract manufacture you mentioned the deal was basically for one of their locations.

If you think about from a timeline perspective, how long do you think it would take for you to penetrate into the other 19 I guess locations?

Typically I mean this project on a fairly rapid implementation so typically in that case, the first site would be live within by sometime in the spring. And then at that point they would be looking at extending it out to the other ones.

So typically I would say within one year contract signing, looking at sort of can you – are you ready to do a broader roll out.

And then from the second contract the one from the UK, can you provide a little bit more color around that? You mentioned it could be a wider a larger type of distribution.

Yeah that particular one was interesting just because it is a two phase agreement, there’s really sort of a – the agreement was signed as a single document like single contract but it actually has a pilot phase and then a full phase. So we have and the client has the option to opt out after the pilot phase.

So we have only included in our bookings the value of the pilot phase, but at this point, the project’s going well and we have every expectation that it will continue from the pilot phase into the full phase which would as we say roughly quadruple the size of that contract.

All right. That’s great color.

Appreciate it guys. Thank you.

Okay, thanks.

Great. Thank you everyone for your time and as always, if you have additional questions, don’t hesitate to give us a call and we look forward to talking to you after our Q4 results.

Thanks. Have a great day.