SoftBrands Inc F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

Executives

Randy Tofteland - President, Chief Executive Officer

Gregg Waldon - Chief Financial Officer

Analysts

Ryan Bergan - Craig-Hallum

David Neuhauser - Livermore Partners

Joe Furst - Furst Associates

SoftBrands Inc. (SBN) F4Q08 Earnings Call December 4, 2008 5:00 PM ET

Operator

Good afternoon ladies and gentlemen and welcome to the SoftBrands fourth quarter fiscal 2008 earnings conference call. Our speakers today are Gregg Waldon, Chief Financial Officer and Randy Tofteland, President and Chief Executive Officer. After the formal remarks, there will be a question-and-answer session.

Now, I’d like to turn the call over the Gregg Waldon. Mr. Waldon.

Gregg Waldon

Thank you, operator. Good afternoon everyone and thank you for joining us today as we discuss our fourth quarter and full year fiscal 2008 financial results which were announced in a press release after the market closed today. I’m Gregg Waldon, Chief Financial Waldon of SoftBrands and with my on the call today is Randy Tofteland, Chief Executive Officer.

Randy and I will make some prepared remarks and then take your questions. The call today is being webcast. We are accompanying our comments with some slides and so if you are listening to the call by phone only you may want to sign on to the webcast to see the slide presentation. Just go to the investor portion of our website and www.softbrands.com to sign on.

All statements other than historical facts included in our remarks regarding future operations are as of today December 4, 2008 and are subject to the risks inherent and predictions and forward-looking statements. These statements are based on the beliefs and assumptions of management at SoftBrands and on information currently available to us.

Nevertheless, these forward-looking statements should not be construed as a guarantee of future performance. They involve risk, uncertainties and assumptions identified in filings by SoftBrands with the SEC. As such, we expressly disclaim any current intention to update this information prior to release to our first quarter fiscal 2009 financial results.

I’d now like to turn the call over to Randy.

Randy Tofteland

Thanks Gregg. We finished our fiscal year with strong fourth quarter results, which reflected good revenue performance for both of our business and excellent profitability. The fourth quarter reflects the benefits of the cost controls we put in place throughout the year. In a moment Gregg will talk about the cost reduction initiatives we have underway given the current uncertain economic environment.

For the full fiscal year, SoftBrands improved its operating income performance significantly and grew revenue almost 6%. Our revenue growth is being driven by our hospitality business, which grew more than 14% for the full year. In addition we generated approximately $11.8 million in EBITDA in fiscal 2008, compare to $9.6 million in the prior fiscal year. Clearly our overall performance is trending in the right direction.

With that let me turn it over to Gregg.

Gregg Waldon

Thanks Randy. Our fourth quarter financial results met our expectations for revenue growth. Total revenues in the fourth quarter were $25.4 million, an increase of almost 9% compared with $23.3 million in the fiscal 2007 fourth quarter.

Revenue in our manufacturing business was $12.6 million, up slightly compared with $12.5 million in last years fourth quarter. Revenues in hospitality were $12.9 million, a 19% increase compared with the prior years fourth quarter. As we noted on our conference call in August, we did expect our revenue decline in hospitality on a sequential basis from the third quarter because of timing of revenues from contracts that use percentage of completion accounting.

Hospitality’s fourth quarter revenues benefited from projects underway for Red Roof Inns. At the end of the fourth quarter, our first three contracts for Red Roof Inns were about 60% complete. The fourth contract, which is for PMS systems and represents approximately $6 million in total revenues, was signed in mid November. The scope of our original contracts including maintenance is now beyond the original $15 million to approximately $17 million.

From our revenue mix perspective, license revenue was 16% to fourth quarter revenue, a decrease from 19% in the prior year period. The prior year quarter included $1.4 million in license revenues from Navy Lodges, which was not recognized on a percentage of completion bases. On a full-year basis, we actually signed much more license revenues in the year than we are able to recognize. So, we are happy to enter fiscal 2009 with a good backlog.

Fourth quarter revenues for professional service increased sharply as a result of large implementations that are underway in our hospitality business and growth in the large enterprise area of our SAP business. In total about 79% of our revenue came from maintenance and professional services in the quarter, which is expected to have a high degree of predictability in the near-term.

Approximately, 56% of total revenue came from maintenance revenue in the quarter compared with 57% in the same period last year. Our maintenance revenues and manufacturing were essentially even with the prior year quarter. For the full-year manufacturing maintenance revenues were down just over 2%.

The SAP business mixed up a small portion of our overall maintenance revenues, but that portion is growing as we add channel deals and retain a good percentage of the maintenance revenue in our channel contracts. However, we are not expecting in fiscal 2009 that the SAP business maintenance will offset our base business maintenance decline.

Our maintenance revenues and hospitality were up more than 19% compared to the fourth quarter of fiscal 2007, due to the contribution of support revenues from large hospitality contracts. For the full fiscal year, our maintenance revenues in hospitality grew by more than 6%. Total company maintenance revenues were up just over 1% year-over-year.

Total gross profit was 60% in the quarter, a decline from 66% in the same quarter of the prior year. Our gross margin for licensed revenue was 80% in the current quarter. You may notice that there is a negative number in license cost of goods sold in the fourth quarter of the prior year. This relates to inter company transactions in our consolidated results.

In the fourth quarter fiscal 2007, as we have previously mentioned in our last conference call of last year, we discovered that we had incorrectly included on a cumulative nine-month basis an immaterial amount of inter company revenues and associated cost of goods sold on a consolidated basis that should have been eliminated when we consolidated our results.

Our gross margin for maintenance was 73%, a decline from 75% in the same quarter of the prior year, while gross margin for professional services was 23%, up from 19% in the fiscal 2007 fourth quarter. Our hospitality group was the largest contributor to this margin increase as it posted a significant boost in the services margins, which were approximately 28%. This is the result of Red Roof Inns significant third-party services work, personnel utilization on some of our larger contracts such as Navy Lodges and outside referral fees.

Let me turn to our operating expenses for the quarter. In a moment I will also summarize the actions we have undertaken company wide to reduce our cost structure. Overall, our operating expenses decline by $0.4 million from the prior year quarter. Sales and marketing expense was $4.2 million in the quarter, a decrease of 13% compared to the period years quarter and down about $0.4 million on a sequential basis. Most of the decrease relates to lower selling expense. Our goal for fiscal 2009 is to hold sales and marketing expense in the 18% to 20% range.

R&D costs of $4.5 million in the quarter were up $1.4 million on an absolute dollar basis, compared to the prior years quarter and represented 18% as a percentage of revenue as a result of much higher research and development expenses in our hospitality business. R&D expense in the fourth quarter was slightly higher than our spending level in the third quarter. For the full-year our R&D spending was almost 17% of revenues. In fiscal 2009, we plan to dial back our R&D spending and hold it in the range of 14% to 16%.

G&A was $3.9 million in the fourth quarter or 15% of revenues, an approximate $1 million decrease from the prior year quarter. G&A benefited from lower personnel costs, lower professional services and overall cost reductions based upon our centralization efforts. Going forward we expect a quarterly run rate for G&A of about $3.8 million to $4.2 million.

Our goal for fiscal 2009 is to have G&A in the range of 17% to 19% of revenues. Our non-cash expenses for the quarter or FAS 123 stock based compensation expenses of $0.5 million, amortization of intangible expense of $0.8 million and depreciation of $0.3 million.

SoftBrands posted operating income of $2.6 million in the fourth quarter compared to operating income of $2.5 million in the fourth quarter of 2007. Looking at our two businesses, manufacturing generated operating income of $3.6 million in the current quarter in hospitality and posted an operating loss of $1.0 million. The operating loss in hospitality in the quarter was primarily the result of higher R&D spending, a higher percentage of lower margin third party business and the impact from our accounting for a large percentage of completion hospitality contracts.

We recorded a tax provision in the September quarter of $1 million. For the full year, our tax provision was $2 million. In fiscal 2009, we expect our effective tax rate to be approximately 15% of pre-tax income. Our effective tax rate on a more normalized basis will be approximately 38% of pre-tax income.

We completed the current quarter with net income available to common shareholders of $0.8 million compared to net income available to common shareholders of $1.8 million for the same period of the prior year. Earnings per diluted common shares were $0.02 compared with $0.04 in the prior year period.

This slide shows EBITDA results for the quarter as calculated per our Wells Fargo Foothill financial covenant. This covenant is calculated on a rolling 12 month basis. SoftBrands credit agreement with Wells Fargo Foothill required us to maintain specified financial ratios and satisfy other financial condition tests. We delivered approximately $4.2 million in EBITDA this quarter and on a rolling 12 month basis we are at $11.8 million. Our go forward EBITDA covenant each quarter for the next five years is $12 million, again calculated on a rolling for quarter basis.

In the last two quarters, we have generated cumulative EBITDA of $9.6 million and based in our most recent forecast, we currently believe that we will be in compliance with all of our covenants for the December quarter and for all of fiscal 2009 as well.

Taking a look at our results on a full-year basis; our total revenue was $98.7 million, an increase of almost 6% from fiscal 2007. This was slightly below our guidance that we gave in the last quarter, that full revenue will be approximately $100 million. The slight shortfall was primarily result of some spillage in the fourth quarter in hospitality and we saw some revenues from Red Roof Inns move to future periods.

Within total revenue, manufacturing revenues was $49.5 million in fiscal 2008, a slight decline from $50.3 million in fiscal 2007, while hospitality revenue was $49.2 million an increase more than 14% over the prior year.

From our profitability perspective, SoftBrands posted operating income of $4.4 million in fiscal 2008 compared with operating income of $0.7 million in fiscal 2007. The fiscal 2008 operating income is within the guidance we provided in August of operating income of 4% to 5% of revenues.

In early October we accelerated our efforts to control our cost and given the uncertain economic outlook. The actions we took include a company wide salary freeze, a hiring freeze and a non-revenue generating travel freeze. We expect these three measures alone to add up to almost $5 million in cost reductions compared to our original 2009 budget. We are already seeing the impact of our efforts in our first quarter fiscal 2009 results.

While we have plan for good revenue growth in fiscal 2009; we have identified additional cost levers available to see to us if we see our growth rate slowing. These include further reducing capital expenditures, renewing employee benefits cost sharing and our headcount levels.

We are very committed to improving our profitability in fiscal 2009. In addition the expected negative impact of foreign currency exchange rates on our fiscal 2009 results also makes it essential to aggressively control our cost. The expected negative impact from currency translation to our fiscal 2009 operating income is about $1.3 million. Our manufacturing business is most affected by currency, primarily as a result of its European operations and the strengthening performance of the dollar against the pound in the Europe.

Looking at the balance sheet, we ended the quarter with $11.9 million in cash and cash equivalents, essentially even with our position at the end of the third quarter. Our cash provided by operations for the 12 months ended September 2008 is estimated at $3.9 million compared to cash used by operations of $2.9 million in the same period in the prior year.

Our accounts receivable balance was $21.7 million a decrease from $24.5 million at June 30, 2008. Our collections team continues to make good progress in collecting our accounts receivable balances.

Our deferred revenue was $21.5 million at the end of the fourth quarter, a decrease of more than a $5 million from the end of the prior quarter, which has been typical of our past years performance as a large portion of support revenues renewals that happens in the March quarter. Approximately, $17.7 million, $2 million, $1.3 million and $0.5 million respectively of our $21.5 million in deferred revenue relates to support, license, services and other.

With that, let me turn it back to Randy, to provide additional perspective on our financial performance and outlook.

Randy Tofteland

Thanks Gregg. Let me start with hospitality. Our hospitality business delivered a good quarter on the top-line. License revenues were down primarily due to the timing of large contracts.

The prior year quarter included a $1.4 million in license revenue from Navy Lodges. Unlike our commercial contracts, which most often are on a percentage of completion our project basis, license revenue from most government contracts is often recognized upfront. In addition as Gregg mentioned, some license revenue from Red Roof Inns in the fourth quarter also moved into future quarters.

Our maintenance revenues in hospitality, which increased by 19% compared to the prior year quarter are benefiting from our government businesses we provide support for Navy and Navy Lodges. Professional services revenues increased sharply, primarily as a result of work underway for Red Roof Inns.

Our operating income performance in hospitality was down as a result of our higher R&D spending and revenue mix. The customer relationship management and business intelligence part of the Red Roof Inns solutions is being delivered by our partner [Serenada]. Although, all Red Roof Inns revenues flow through SoftBrands, these third party products have a lower gross margin than our own applications.

Our number one priority for this business in fiscal 2009 is improving profitability and with reduced R&D spending and a more normalized revenue mix outside the Red Roof Inns project, we believe this is very achievable.

Let me update you on the overall hospitality business, the exciting growth we achieved in fiscal 2008 and the momentum we are carrying into fiscal 2009. As witnessed by some of the recent announcements, we have excellent momentum in the government market. We recently increased our sales resources dedicated to the government market. Right now we can call the U.S. Navy, Marine Core and Air Force among our customers for their transient lodging operations.

On November 19, we announced that we signed an agreement with the U.S. Air Force services to provide our enterprise solutions for its 95 on-base transient lodging operations located in the United States and 12 foreign countries. The contract has a total value over its eight term of more than $27 million. We will be providing our Epitome Property Management System, fully integrated central reservations and business intelligence. The implementation begins this month.

We also have signed an extension of our existing contract with the U.S. Navy to continue implementation of our integrated enterprise solution that Navy gateway ends at suits. The value of the extension is approximately $4.5 million. The original contract concluded the deployment of our core central reservation system, reservation portal and management council, along with a global upgrade to be Epitome Property Management System. The extension includes further implementation and support services at Navy basis worldwide.

We’re also a team member on Northrop Grumman’s winning bid for a department of homeland security contract. Under the terms of the task order received by Northrop Grumman, its information technology sector will provide DHS emigration and customs enforcements office of detention and removal operations with an integrated system that will locate and track detainees, reserve detainee bids based among various facilities and manage detainee transportation.

Another recent key win in the U.K. is Corus hotels which has selected our Epitome Property Management System and core central reservation system for five of its hotels across England. The customer wanted to standardize on one solution to reduce costs and maintenance issues.

We continue our implementation for Red Roof Inns, as we provide them with a full suite of products for their 325 hotels. This is the largest deployment of our Epitome and Core products to-date. We have delivered the customized centralized accounts receivable functionality and business intelligence application, which went live in August.

Rollout of our core central reservation system, is expected to occur in the first part of calendar year 2009. The final phase for Red Roof Inn is the implementation of our Epitome Property Management System, which is scheduled to start in 2009. As Gregg mentioned, we signed this fourth and final Red Roof Inns contract in mid-November. In fiscal 2008, we recognized about $6 million of the $11 million in estimated revenue from the first three Phases of the project.

Obviously, it is favorable in today’s environment to have the visibility we do into 2009, as a result the Red Roof Inns projects and our large government implementations. Our commercial customers are affected by the economy’s impact on their business and they are starting to slow their sp ending.

As we mentioned last quarter, we significantly increased research and development spending in our hospitality business in fiscal 2008. We have made major strides in increasing the functionality, scalability and stability of Epitome and core products to meet the needs of complex hotel groups and we believe these investments will payoff in 2009 and future years.

Overall, our R&D spending in hospitality is up approximately 40% year-over-year. In fiscal 2009, our spending will be lower on a percentage basis, as we scale back spending levels in the latter part of the fiscal year. So in summary, our hospitality business continues to drive the revenue growth for SoftBrands overall. Again, our priority for fiscal 2009 is to dramatically improve profitability.

Now, let me turn to our manufacturing business. Our manufacturing business delivered another very profitable quarter. For the full fiscal year, manufacturing more than doubled its operating income. This was the result of the restructuring actions we took in fiscal 2007, increased productivity in consulting and increased SAP revenue.

Revenues and manufacturing for the fourth quarter were essentially even with the prior year. License revenues increased almost 14% compared to fourth quarter of fiscal 2007, as a result of good performance in our SAP business in the channel and large enterprise areas. License revenues were up more than 350,000 compared to the third quarter. Our SAP business is consistently growing quarter-to-quarter, but not at the phase we would have liked.

Let me start by reviewing the channel business. Our channel business performance in the fourth quarter was right on target and somewhat counter intuitively given the current market environment, our pipeline in the channel is the biggest we have had in two years. The food and beverage segment is our strongest vertical market segment and it appears to be less effected by the market downturn.

In addition, some of our customers are taking advantage of a U.S. tax credit they need to use prior to December 31. However, just like other companies, we faced uncertainty in our channel business due to the current economic environment. The good news is that SAP is now pushing larger B1 opportunities our way. For example, if the opportunities bigger than 20 to 25 seats, SAP tends to give it to SoftBrands and we qualify it and then we engage the suitable partner.

As a result, our transaction size is creeping up. Our average sale in 2007 was 15 seats and in 2008 that has jumped to 25 seats. Some of this is a result of a change of mindset in SAP North America about the positioning a B1 in the medium sized market for companies with true-up $20 million to a $150 million in revenue. Previously, SAP targeted B1 from the small company segment.

Last quarter we have mentioned that we have become one of SAPs first extended business network partners. Internally at SAP, we’re called as super bar. This status allows us to recruit our own B1 FSE partners, who get SAP privileges because of their affiliation with us. The transaction will be for full licenses including SAP Business One and give SoftBrands more control of the revenue stream. Since last quarter, we’ve added five of our own partners through this program.

In addition to the Americas channel program, we’re making progress in the EMEA channel. We are consternating on a number of key countries and our actively recruiting sales partners. We have a good pipeline in the U.K., the Netherlands and South Africa. We’ll also be making a push into Latin America in fiscal 2009 and we’re optimistic about our potential there.

Now let me turn to the large enterprise part of the SAP business. Overall, our large enterprise business improved its licenses revenue protection in the fourth quarter, but this is the part of our business where we are seeing the largest impact from current economic conditions. We are witnessing spending decisions by major corporations being delayed or reduced.

In November we announced the release of a new offering called Emerging Markets Platform or EMP, which is an SAP large enterprise, go-to-market initiative and solution stack. It combined software, integration, reporting, deployment components and pre-packet services to support the emerging markets sectors of large SAP-centric enterprises. EMP combines the SAP Business One and Four Shift Edition toolsets from SAP and SoftBrands together with content that has been design for small and midsized subsidiaries of large western-based companies.

In a nutshell, it enables remote sites to implement faster and cheaper. The goal of the EMP is to enable customers to deploy 20 plus sites in emerging markets quickly and cost effectively. We are working with SAP to determine how the SAP Account Executives can take the solutions stack to their clients as a value added offering.

EMP is the first to the bundle of offerings we’ll be introducing to the large enterprise market, which are based on our experience with large enterprises. Our goal is to have the right solution at the right price point, in the right space, which we believe will be well received in the current economic climate.

From a product development standpoint, we have a new release of ForthShift Edition in beta test called ForthShift addition 9.0. The product is expected to enter managed role out in the second quarter of the fiscal year and the release is based on 100% new code at a new simplifying architecture.

The product really broadens out our vertical market approaches as it has enhanced functionality from discreet and mid smaller manufactures. We are starting to do demos of the product this month. ForthShift addition 9.0 also allows us to have a competitive offering in this space as we move up to the 50 to 80 user deals. In addition, the simplifying architecture allows for faster localization in new markets.

Our base business performed well in the quarter with better than expected performance and maintenance. Our base business, we believe is both benefiting and harmed by the current economic environment. On the plus side, our customers that might have considered a move to a new corporate system are delaying those decisions and are more likely to renew their maintenance contracts.

On the minus side, we are seeing some of our smaller manufacturing companies close their doors. Our base business is tightly controlling its costs to continue to deliver strong operating income.

In October, ForthShift released 7.5 became generally available. This is an important release for our customer base and represents ForthShift’s go forward platform. The increase includes a new business intelligence module and customer driven enhancements. We are optimistic about product adoption in 2009.

So, in summary, our fourth quarter results in manufacturing were solid. The business also delivered good performance for the full year. While revues declined slightly as the growth in our SAP business did not quite makeup for the natural attrition in our legacy business; operating income more than doubled which is excellent.

As we outlined in the earnings press release today, Ralf Suerken SoftBrands, Vice President and General Manager of our manufacturing business has resigned his position effective immediately. Given the limited growth, we have experienced in our SAP business and the economic pressures facing the large enterprise segment of our SAP business, we believe the time is right to insure we have the right leadership and strategies for this business going forward.

We’ve appointed Diane Palmquist; currently Vice President SAP Products for SoftBrands, to lead our SAP business and Terry Peterson, who is Vice President of the base manufacturing business, will continue in his current role. Both Palmquist and Peterson will report to me.

Given the current uncertain economic environment, we will not be providing specific revenue or operating income dollar range guidance for fiscal 2009 at this time. We currently have excellent visibility around the December quarter and good visibility around the March quarter, but not enough on the second half to provide credible full-year guidance. With the slowdown, we are seeing in both large enterprise and some of the commercial hospitality opportunities, as well as prospects, 2009 budgets are still being finalized. We just don’t have enough visibility into the second half of our fiscal year.

Our current forecasts are very strong in the first half, but the first two quarters maybe lumpy. We are currently working some business that we had forecast in the March quarter that may close in the December quarter. If that happens, we may have an even lumpier first half, but very strong overall, but again as we mentioned previously, we are planning to improve our profitability no matter what are level of revenue growth and we will continue to closely monitor our cost and take other actions as needed to preserve operating income.

This chart shows percentage ranges of what we’d like to accomplish in fiscal 2009 and as Gregg mentioned, we have identified cost levels we can use to manage our business as appropriate. These slides will be posted on the website as part of this presentation.

Now we would be happy to take your question and Kamisha, you can remind the callers, how to ask a question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ryan Bergan - Craig-Hallum.