Agilysys' CEO Discusses F4Q2013 Results - Earnings Call Transcript

Jun.12.13 | About: Agilysys, Inc. (AGYS)

Agilysys Inc. (NASDAQ:AGYS)

Q4 2013 Earnings Call

June 12, 2013 8:30 am ET

Executives

James Dennedy – President, Chief Executive Officer

Robert Ellis – Chief Financial Officer, Chief Operating Officer

Analysts

Brian Kintslinger – Sidoti & Co.

Shai Dardashti – DCM

Keith Housum – Northcoast Research

Operator

Good day ladies and gentlemen and welcome to the Agilysys Fiscal 2013 Fourth Quarter conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If you require any assistance during the call, please press star then zero on your touchtone telephone. As a reminder, today’s call is being recorded.

I would now like to turn the conference over to your host, Mr. Jim Dennedy. Sir, you may begin.

James Dennedy

Thank you, Shannon, and good morning everyone. We appreciate you joining us on the call today to review our fiscal 2013 fourth quarter and full year results. Joining me on the call today is our Chief Financial Officer and Chief Operating Officer, Rob Ellis.

Before we get started, just a quick reminder that we’ll be using a slide presentation to accompany this call. You can access it on the Events and Presentations portion of the Investor Relations section of our website at www.agilysys.com.

In addition, I’d like to remind everyone that we will be discussing some non-GAAP metrics on today’s call, primarily adjusted operating income and adjusted net income, which eliminates the effect of restructuring and other items that are either non-cash or non-recurring. Reconciliations to GAAP metrics are provided at the end of the accompanying presentation as well as in the financials of the press release issued earlier today.

We are pleased with our results for the fourth quarter as well as for the full year across both our hospitality and retail segments. Agilysys continues to achieve many of the goals we established since launching our business transition in May 2011 and we are confident that given our steady progress, our personnel, customers and shareholders will further benefit from the improved future results.

Turning to Slide 3 in our presentation, consolidated revenue for the fiscal 2013 fourth quarter increased by 21% or $11 million, driven by 34% growth in product sales. Gross margin for the period compressed due to a greater mix of revenue from the retail solutions group. While Rob will review the segments in more detail, it is important to note that the hospitality solutions group experienced modest revenue growth year over year with substantially higher margins in the current period.

Turning to our operating income, we generated $200,000 of positive operating income in our fourth fiscal quarter versus a $19.9 million loss in the same period a year ago. On an adjusted basis, we achieved a $6.9 million improvement in adjusted operating income year-over-year by generating a positive $3.3 million of adjusted operating income in our fourth fiscal quarter versus a loss of $3.6 million in the same period a year ago. These improvements led to adjusted diluted earnings per share of $0.15 compared with an adjusted net loss of $0.16 in the fiscal 2012 fourth quarter.

Our financial results outperformed our plan as we were able to operate more efficiently while bringing to market products and services that help our customer grow their business, continuing to expand our customer footprint, and generating higher margin recurring revenue. These results provide us with added confidence that we’ll be able to achieve continued recurring revenue growth in fiscal 2014.

Notwithstanding the solid results of our fourth fiscal quarter and full year, most of you are likely eager to learn more about the agreement we announced last week regarding the sale of our retail solutions group to the Clearlake Capital Group. Let me give a few brief highlights of the agreement and then I will come back with some more commentary on the business following Rob’s more detailed review of our operating results.

It is important to me to recognize the work of the talented group of people and leaders in our retail solutions group. The business has been a part of Agilysys for just short of 10 years. During that team, retail has become a market leading systems integrator, providing innovative services-based solutions to the retail industry. From the time I joined the Board of Directors of Agilysys in 2009 and more recently as the CEO, the retail team has continuously developed new offerings, identified new market segments, and improved the overall operating and financial performance of the business. They have delivered substantial and improved value to our larger team, our customers and our shareholders. With the dedicated capita from Clearlake, I am confident that the leadership and personnel in this business will continue to distinguish itself with its customers and partners.

As we outlined in the press release, Agilysys will receive total consideration of $34.55 million in cash, which will bring our cash and cash equivalent position to approximately $108 million or $4.80 per share, including the use of cash to acquire the assets of TimeManagement Corporation announced earlier this week. We will continue to maintain a debt-free balance sheet.

This is an important transaction for Agilysys and marks a strategic point of emphasis for our continuing business and for the retail solutions group under Clearlake. Both businesses now operate focused business strategies with dedicated capital to pursue the growth initiatives each business separately sees in their chosen end markets. For the ongoing Agilysys business, this transaction together with the sale of our technology solutions group in May 2011 reflects management’s commitment and the board support to improve shareholder value by first optimizing the businesses we own, remaining disciplined in our capital allocation, evaluating the portfolio of businesses we owned, and taking action to concentrate our capital and pursue the highest return opportunities available.

In our third fiscal quarter, we indicated the company had reached an important inflection point. We had achieved positive adjusted operating income, and even more importantly achieved positive GAAP operating income for the first time in seven years. When the transaction with Clearlake closes, Agilysys will have completed a two-year transition from a subscale conglomerate operating three subscale, disparate businesses, to a hospitality-focused software-enabled solutions company. During the last two years, we’ve provided detailed guidance on our restructuring plans, estimated savings investors should expect from our restructuring activities, and offered revenue and operating income guidance. The company of incredibly gifted personnel and world-class customers delivered on all the guidance we have provided.

Looking forward, the emphasis of our business strategy will shift quite dramatically. We see an incredible market opportunity available to us in the hospitality industry. We are committed to fully investing the balance sheet and our operating performance in pursuit of market-leading growth. Our investment initiatives will focus on product development, market and customer expansion, business efficiency improvements, and select M&A activity to accelerate product growth advancement, market opportunity expansion, and customer value creation. We will maintain a high integrity process and strict discipline in our use of capital and for that reason, the nature of our forward-looking guidance will change modestly. While Rob will elaborate further, our investors should expect continued market leading growth with profitable operating income.

With that, I would now like to turn the call over to Rob who will provide greater detail around the results, balance sheet and cash flow. I will then come back and provide some additional insight on the business and open the lines for questions. Rob?

Robert Ellis

Thanks Jim and good morning everyone. I’ll begin with our hospitality segment on Slide 4 of the presentation. Fourth quarter revenue increased 3% or $600,000 to $23.5 million due to increases in both recurring revenue of 6% and professional services of 10%. These increases were partially offset by a $400,000 decrease in product revenue due to timing of hardware shipments that occurred in the prior year. Due to this change in product mix between hardware and software, we saw a 401 basis point improvement in gross margin year-over-year with gross margin increasing to 70% from 66%.

Although our hospitality operating expense structure remained flat, there was a noticeable change in the areas that we were investing in. A reduction in sales, general and administrative expenses of approximately $2.5 million occurred due to the restructuring efforts administered in fiscal year 2012. These savings were reinvested into product development for both our current and future product initiatives.

The continued improvements in margin, while increasing our revenues year-over-year, resulted in an improvement in adjusted operating income of $1.6 million to $4.6 million for the quarter. GAAP operating income also improved by $12.8 million to $4.2 million for the quarter.

Moving to our retail segment on Slide 5, total revenue in this segment grew 36% year-over-year to $39.5 million primarily due to a 51% increase in product sales to $27.1 million, which was driven by a large hardware sale during the quarter. Recurring revenue increased 11% while professional services revenue increased 12%. These improvements are reflective of the increase in hardware maintenance contracts during the year and the continued rollout of several multi-location, multi-year service offerings that have followed the significant hardware sales in our retail division that occurred throughout our fiscal year. Retail’s gross profit margins remained flat at 20%.

The significant increase in revenue and reduction in operating expense year-over-year resulted in the retail segment generating adjusted operating income of $4.1 million, a $3.6 million increase from the last fiscal year. GAAP operating income also improved from $300,000 in fiscal year 2012 to $4 million in fiscal year 2013.

Moving on to our corporate operating expenses on Slide 6, including stock-based compensation we reported consolidated operating expenses of $21.7 million, a $3.2 million improvement over the fourth quarter of fiscal 2012. Adjusted operating expenses also declined to $21 million from $24.4 million in the previous year. As I noted earlier, through our restructuring activities of fiscal year 2012, we were able to reduce our expenditures in sales, general and administrative expenses. A portion of those savings have been redeployed into our product development initiatives, which include further enhancing our existing products and developing future platforms.

Now to summarize our current balance sheet and cash flow for the year, with key points outlined on Slide 7. We are pleased with our ability to maintain a healthy and liquid cash position of approximately $83 million with no debt. In addition, we generated positive adjusted cash flow from operations during the year of approximately $3 million. The decrease in cash from the previous year of approximately $50 million was a result of paying off related employee benefits associated with executive retirement plans, cash expenses related to the restructuring activities accrued for in fiscal year 2012, and the increased investments in software development which was capitalized on the balance sheet. As Jim noted, post the sale of retail and the cash utilized to acquire the assets of TimeManagement Corporation, we expect to have approximately $108 million in cash available for future investments.

As I’ve mentioned on previous calls, we currently have approximately $169 million in federal net operating losses, which have a full valuation allowance against them at this time. Our NOLs will keep our cash tax rate in the low to mid single digits for the foreseeable future and in addition will enable us to realize the full cash benefit of the sale of our retail segment.

Moving to Slide 8, which summarizes our fiscal 2013 results, the execution of our strategy throughout the year has resulted in positive financial and operational results. Total consolidated revenue increased 13% to $236 million compared with $209 million for fiscal 2012. Product revenue grew a healthy 17%. Our recurring revenues grew 6% and professional services revenue grew 15%. As mentioned in our third quarter earnings call, the recurring revenue growth rates we experienced during fiscal year 2013 were compressed by approximately 200 basis points due to a change in a third party provider. Year-over-year, our gross profit remained flat at 38%.

Our top line growth combined with the savings from our fiscal year 2012 restructuring initiatives resulted in adjusted operating income of $7.6 million, an improvement of $15.6 million from fiscal 2012. Adjusted net income improved to $7 million or $0.32 per diluted share, an improvement from a loss of $8.7 million or a loss of $0.39 per diluted share in the prior year, a $0.71 improvement year-over-year. GAAP net loss was $1.3 million or $0.06 per share compared to a net loss of $22.8 million or $1.02 per share in fiscal year 2012.

Moving to our outlook for fiscal 2014, over the past year we’ve provided specific guidance regarding revenue, adjusted operating income, and adjusted earnings per share, and as a business we heavily focused our efforts on improving and maximizing operating income. Over the course of the fiscal year, we exceeded our guidance with double digit growth in revenue and adjusted operating income of $7.6 million. In addition to the top line and bottom line financial results for the fiscal year, we also completed the transition of our corporate services department from Solon, Ohio to Alpharetta, Georgia, significantly reduced spend in sales, general and administrative expenses through our restructuring efforts, and redeployed those savings into improving our current product portfolio and investing in new software platforms. This investment assisted us in increasing customer satisfaction and in turn put us in a position to deliver results above our plan for fiscal 2013. These actions and the successful results obtained from these actions, and the commitment that management has in improving the business has increased the level of confidence and trust that our employees, our customers and our shareholders have in management’s decisions and the strategic direction of the company.

Subsequent to the sale of our retail division, the nature of our business plan has changed from a company that is heavily focused on optimizing operating income to a company that is focused heavily on growth and long-term shareholder value. For the foreseeable future, we will focus on increasing the value of the enterprise through expanding our markets, our products, and through business efficiency improvements through disciplined capital deployment of the cash we currently have on our balance sheet and the cash generated from our continuing operations. We will do this through investments in our people, our products and our processes as well as through strategic acquisitions, such as the TimeManagement Corporation acquisition announced earlier this week.

As part of entering this growth phase, we have changed our approach to providing guidance. For fiscal year 2014, we anticipate exceeding the market rate of growth organically and increasing our investments in our people and our products, and we will do so profitably. We will also generate positive adjusted cash flow from operations which we intend to invest back into the business. Profits will vary depending on the investments that we make and whether those investments are classified as assets on our balance sheet or part of our operating expense structure. As such, we will not be providing specific financial metrics on revenue and operating income.

Our visibility in the business, the clarity in our strategic objectives, the opportunity to grow our install base and the ability to improve and expand our product offerings has never been better. I look forward to speaking with you each quarter on the investments that we are making and the long-term shareholder value that we are creating for the company.

With that, I would now like to turn the call back to Jim for a review of some of our most recent announcements, as well as some closing remarks, after which we will open the call for questions. Jim?

James Dennedy

Thanks Rob. Before opening the call to your questions, I’d like to comment further on our forward strategy, capital discipline, and review some highlights from the quarter around new product launches and customer wins.

We see a hospitality market opportunity with nearly $4 billion in annual spend on software services and recurring software maintenance for the solutions we deliver today. This market is served by providers offering disparate solutions focused primarily on transactional efficiency. While this is important, it is not sufficient to drive meaningful return on investment for the operators in the hospitality market. Our market looks to its solution providers – to Agilysys – to help them recruit more guests, maximize wallet share with their guests, and connect with the guests and prospects pre- and post-stay, but more importantly in the moment while on property.

With regard to capital deployment, we see several areas to prudently invest and support the growth opportunity we see in the hospitality industry, both organic investments or through accretive acquisitions. We are investing in our teams to improve our capabilities, in our solutions to add more value, in our markets to create more awareness, on our business through value accretive acquisitions, and in our business to profitably grow revenue and reduce expense. It’s important to keep in mind that every use of capital must meet stringent return on invested capital criteria and advance one of our three strategic elements of helping our customers provide better guest experiences at their property, increase their rate of guest retention, and grow their wallet share of guest spend.

An example of our new strategic direction in action is the acquisition of TimeManagement Corporation – TMx – announced earlier this week. TMx offers an industry leading labor management solution that complements our suite of software and services for the hospitality industry. The hospitality industry increasingly recognizes TMx as a preferred workforce management solution that helps operators meet and exceed their corporate labor initiatives. TMx seamlessly integrates to numerous point of sale, property management, inventory and procurement, and payroll systems including our InfoGenesis point of sale and with our Eatec inventory and procurement solution. This acquisition provides a modest new source of revenue for Agilysys and significant opportunities to expand the use of TMx in our existing install base of InfoGenesis and Eatec customers. With limited customer overlap, we also have the opportunity to sell our suite of solutions to the current TMx install base.

Another example of our forward focus is on mobile solutions, which we believe are a driving force in this market. We plan to explore future investments in this area to ensure that it is an integral part of our offering. We will also look to invest in such as way that we can bring products and services to market more quickly to keep up with the innovation demands of our market and to expand our geographic reach outside the United States.

Evidence of the effectiveness of our organic development activities are the product announcements made during the quarter. Just over the past few weeks, we were pleased to have announced the general availability of both the latest version of our lodging managing system, LMS version 7.2, and our InfoGenesis point of sale solution version 4.4. LMS is recognized as the hospitality industry’s most powerful and highly available property management system, automating every aspect of hotel operations from reservations and credit card processing to accounting and housekeeping. InfoGenesis point of sale is our award-winning comprehensive point of sale solution designed for multi-unit operations common in hospitality environments, combining powerful reporting and configuration capabilities in the back office with an easy to use touch screen terminal application and offline operating capabilities. While we have been highly active in transforming the business, working on a strategic divestiture, and making a select acquisition, we have not lifted our foot off the gas pedal of innovation and business development.

Our success in business development is highlighted by several important customer wins in the quarter. Earlier in the quarter, we announced that Kirkwood Mountain Resort in Kirkwood, California selected the Agilysys InfoGenesis point of sale solution to streamline its dining operations, which consists of several quick serve restaurants, two casual dining locations, and a small grocery store. The property is owned and managed by Vail Resorts Incorporated, a long-time customer.

More recently, we announced that Vanderbilt Campus Dining of Nashville selected the Agilysys Eatec inventory and procurement solution to streamline food service operations at its 19 locations throughout Vanderbilt University.

In the gaming segment, we were pleased to have Indigo Sky Casino and Hotel in Wyandotte, Oklahoma select a suite of software solutions from Agilysys, including our lodging management system, InfoGenesis point of sale solution, and the Stratton Warren inventory and procurement system to help manage its property and deliver exceptional guest service.

Also in the gaming segment, we entered into an agreement with Clearwater River Casino and Hotel in Lewiston, Idaho, who purchased a comprehensive software suite including the Visual One property management system, InfoGenesis point of sale system, and Eatec inventory and procurement solution. The property includes a hotel, casino, convenience store, gas station and RV park, and is currently undergoing a 35,000 square foot expansion to add an event center and 200 gaming machines.

With that summary of our strategy, capital discipline, product announcements and significant customer wins, I will now turn the call over to the operator for questions. Shannon?

Question and Answer Session

Operator

Thank you. [Operator instructions.

Our first question comes from the Brian Kintslinger of Sidoti & Company. You may begin.

Brian Kintslinger – Sidoti & Co.

Hi, good morning guys. The first question – obviously I want to touch a little bit on the new guidance and how you guys are approaching it. So from the guidance perspective on adjusted earnings coupled with the comment, Jim I think you made, on investing your balance sheet into growth, should we assume that profits will be modest at best as you reinvest in the business, meaning are you going to be just a little bit better than breakeven, even on an adjusted basis, and continue to generate losses on GAAP? Is that how we should think about it?

James Dennedy

Yes.

Brian Kintslinger – Sidoti & Co.

Good enough. On the revenue side, how fast do you expect the hospitality market to grow in fiscal ’14, and how much share do you think you can gain?

James Dennedy

Brian, that’s a difficult question to answer. We grew at approximately 13% in our fiscal 2013 results. Our business plan has us forecasting above market rated growth, which means we’re taking share. We’re continued focused on growing at an above-market rate so that we know that we’re continuing to take share, and that’s done organically. Through some of the select acquisitions we may make, we could dramatically accelerate that growth rate, although what we’re guiding investors to expect would be the profitable operations on an adjusted basis with an above-market rate of growth.

Brian Kintslinger – Sidoti & Co.

First of all, what do you think the market grew in fiscal ’13?

James Dennedy

For the numbers that we review and for that market opportunity we identified – approximately $4 billion – it’s somewhere between 5 and 7% for hospitality.

Brian Kintslinger – Sidoti & Co.

Right, of course, and do you see the market accelerating, decelerating, being stable compared to where we just were? How do you view, based on talking to customers, how the market is changing?

James Dennedy

Well, we think that growth is going to be stable in that mid-single digits. There are various segments that we address in hospitality, and at any one period of time in an economic cycle one of those segments tends to outperform the others. As you know, gaming has had a difficult period for the last several years, and gaming seems to be improving modestly, particularly tribal gaming which I think we are an above market participant in that particular segment. So we see overall various rates of growth across the segment, but on average we see this mid-single digit as the aggregate for the market opportunity that we can address today.

Brian Kintslinger – Sidoti & Co.

And then what drives market share gains? Is it replacing income in vendors? Is it new software that you have? I mean, outside of the acquisitions, I don’t think you have new software addressing new functions, so what drives those market share gains?

James Dennedy

Well, we do have some new functions. LMS 7.2 introduced some new features as well as the InfoGenesis 4.4. What we really believe will drive market adoption of our solutions is providing solutions that deliver something more than just transactional efficiencies, as we discussed during the prepared remarks. Transactional efficiencies will move the return on investment equation for our customers modestly, though probably not substantially enough to cause them to switch from one provider to another. What we think is more important and the conversations that we’re having with our customers is that if we can deliver them solutions that help them win this guest recruitment battle against all forms of competition, help them maximize wallet share which includes innovations like mobility and extending the reach of what we do, whether it’s in property management or point of sale, those new revenue opportunities or ways to get at increased wallet share will be the reasons why they switch from a competitor to an Agilysys solution. It’s that innovation that we think will drive the switching decision.

The cycle for that is rather continuous. If we could walk into an operator today and say through our InfoGenesis 4.4 platform with our IG mobile solution, we can help you drive a 10% incremental gain in your food and beverage service while increasing the efficiency with which you deliver that service, now we’re activating two components of the return on investment equation, they’re probably going to be pretty interested in that.

Brian Kintslinger – Sidoti & Co.

Great, that’s helpful. As you look at maintenance, as you renew maintenance in this business, what are the pricing ramifications? Are you able to actually increase prices? Are they looking for price decreases, or do you generally keep pricing on maintenance stable after the agreement ends?

Robert Ellis

Hey Brian, it’s Rob. Yes, we have an increase each year on our support and maintenance agreements. Usually it’s right around CPI, so a couple points, and in the new deals as well obviously it’s a percentage of our software or hardware deals, and we don’t see any decreases in the way in which we’re currently pricing that model out.

Brian Kintslinger – Sidoti & Co.

Great. The bookings, I want to focus maybe a little bit on SaaS as the deferred revenue now becomes a little bit more interesting as a standalone business. Maybe talk about how SaaS bookings are growing year-over-year, and since they’re more predictable can you tell us—and you’ve had that change in vendor, can you tell us will the SaaS business over the next four quarters grow slower or faster than the overall company average?

Robert Ellis

Yeah, we have a strategy here, Brian, in which we’re trying to generate more SaaS business. We still see that as a good growth opportunity for us. We anticipate it accelerating a little bit as we move towards newer products into a SaaS line of business. So yeah, we see that as growing.

If you look at our recurring revenue line right now, it grew about 6% year-over-year. I’d anticipate that being into the mid to high single digits for the next fiscal year as well.

Brian Kintslinger – Sidoti & Co.

Okay. And switching gears, I may have missed it – and if not, can you – on the next generation property management software and maybe the timeline investors should expect full release and for meaningful revenue? Just maybe a rough outline for us.

James Dennedy

Sure. We want to be very careful with this. We’ve recruited probably 15 to 18 customers, active Agilysys customers and at least one prospect who is in a segment that we currently don’t address intensively today to be part of a customer advisory board to iterate with us on our development activities. We are participating in an industry trade show in Minneapolis, HITEC, later this month and we will be introducing to them the prototype of this product, which is currently operating live after about 10 months worth of work on a limited basis just to demonstrate basic check-in and checkout functionality.

We expect to be in limited beta with these customers sometime during our fourth quarter of the current fiscal year, and we would expect to be in limited public beta sometime during the first half of our next fiscal year, fiscal 2015. In terms of revenue generating, we don’t expect and we haven’t put in our business plan significant additional revenue on the next gen platform until really the first half of fiscal 2016.

Brian Kintslinger – Sidoti & Co.

Great. The final piece I wanted to focus on was the corporate overhead. Maybe you can help, Rob, talk about that corporate was adjusted for any one-time events that are in there; and then when you take a look at that, post-divestiture, how much do you think you can knock out of the business assuming obviously that it’s reinvested into growth markets, but how much do you expect to be cutting?

Robert Ellis

Yeah, our corporate overhead on a run rate is just about $20 million, or maybe a little bit over that. In regards to the sale and what we see that expenditure coming down, it’s going to be approximately $3 million that we’ll be able to initially bring the corporate expenses down. Now, we are also going to be looking at other projects, obviously, to get more efficiency namely around the ERP system. Right now we’re using Oracle, and so we are looking at the ERP system now as a $100 million company, not necessary needing a robust system or expensive system such as Oracle, and that should bring down more of the corporate operating expense structure. But you won’t see those until the next fiscal year.

Brian Kintslinger – Sidoti & Co.

And I guess one follow-up on that – when you have divested half your business, why do you think corporate overhead—you know, you’re only cutting about 15% of it. Why the disparity? Why is there not more potentially that you maybe could get rid of?

Robert Ellis

Yeah, I mean, we will continue to look at efficiencies there, but most of the corporate operating expenses associated with hospitality, our retail division had one office located in Greenville while our hospitality division had several offices around the world, so the corporate operating expense structure is a little bit heavier and more associated with the hospitality side.

James Dennedy

And Brian, as it relates to a $100 million software enabled solutions company, operating in the business that we do with 50% of our revenues coming from the gaming segment, there’s a fairly high regulatory compliance overhead we carry to operate both in corporate and tribal gaming enterprises. That includes not only in Las Vegas, in all the states where we service our tribal gaming community, but also overseas in Singapore and Macau. So there are slightly higher regulatory requirements in a hospitality software business like us with 50% or so of our revenue mass coming from the gaming segment that requires us to carry a modestly higher overhead than you might otherwise anticipate for a $100 million business.

Brian Kintslinger – Sidoti & Co.

Right, that’s helpful. It only opens the question – sorry to ask – but maybe of that $20 million, how much is regulatory cost from the gaming? Is it 10% of that, is it 20% of that?

James Dennedy

Yeah – Rob, we estimate it’s somewhere between 10 to 12% of that total overhead.

Brian Kintslinger – Sidoti & Co.

Great, thanks so much for your responses.

James Dennedy

Yes sir.

Operator

Thank you. Our next question comes from Shai Dardashti of DCM. You may begin.

Shai Dardashti – DCM

Hi Jim, hi Rob, good morning. I’d like to please ask six questions, one after the other as a follow-up to what Brian was addressing, because I’m fairly confident that Agilysys right now is very misunderstood and also very well positioned for its coming years.

My first question focuses on the economics of Agilysys. I believe you used the phrase a $100 million business software enabled solution provider. Could you please explain over a three or five-year horizon the typical gross margins of this type of business at a high level?

James Dennedy

Certainly. The gross margins in the business today are in the low to mid 60% range. Over the next several years as we move to more of a software as a service business and a percent of our bookings and then revenue composition increases to be software as a service, you’re going to see somewhat of a shift in that margin to a lower gross margin business, somewhere in the mid 50s, and all that means is some of the expense in the business that’s currently today and what you might consider OPEX nominally shifts more up into the cost of revenue line as you’re delivering the software and a service as part of a total solution offering. But longer term, you should see us operate in the mid 50s, compressing slightly, reflecting the shift in revenue from one-time software with maintenance to more of a longer term three to five-year contract of software as a service.

Shai Dardashti – DCM

Just to clarify, the most recent quarter seems to be a 70% gross margin on your hospitality segment, so am I missing a one-time expense or something that’s going to come up?

James Dennedy

No, what you’re seeing there, Shai, is you look at period over period, we have outsized performance in our products line, particularly software, as well as some outsized performance in our recurring revenue year-over-year that on a comparative basis to last year, we just had some mix shift that was favorable to margin in this period.

Shai Dardashti – DCM

And my second question focused on the install base where I believe there had been disclosure of 3,600 clients with 95% renewal rates, of whom 33% use more than one product. Can you comment on these metrics for Agilysys as a pure play hospitality operation, please?

James Dennedy

Yes, Shai. Those are nominally the metrics for the hospitality business. The retail business in total had just under, let’s say nominally 200 or so customer and in any given year about 30% or so of those customers accounted for the majority of their revenue. It changed year over year as customers’ buying cycle in retail would cycle through. So within hospitality, we’re still in the north of 3,000 customers and we’re still in the range of less than 33% or so using more than one product from our company. So we still see a substantial market opportunity just in cross-selling our install base, without necessarily expanding the markets we serve or the customer count in the markets that we serve.

Shai Dardashti – DCM

My third question focuses on a three to five-year goalpost for revenue, so not guidance but more of appropriate expectations. So as Agilysys does more tuck-in acquisitions and as the revenue per client starts to go higher, what’s a sustainable level of growth? Is 15% a number that’s attainable or is that a reach?

James Dennedy

Well, it’s hard to say what we would estimate the rate of growth might be to include M&A, particularly on a year-over-year basis, because we can’t necessarily predict when we’re going to buy something and the revenue mass associated with it and the price of the acquisition. But what we can focus on is what we target for our organic rate of growth, and what we’ve been guiding folks to expect is that we’re going to outperform the market rate of growth in the segments in which we operate in order to make sure that we’re taking share as we grow. But I think that for us, fiscal 2013 performed above plan. We would like to be able to perform above plan on a recurring basis, but what we’re guiding folks to expect is that we’re just going to be able to at least beat the market rate of growth and take share, and we’re expecting ourselves to do better than that but that’s what we’re suggesting to our investors would be the thing that they should put in their financial plans to assess the value of the business.

Shai Dardashti – DCM

What I’m really trying to get at is that in fiscal 2017 or fiscal 2018, could Agilysys potentially be a $200 million operation if things go right? So basically, what is the possibility—if there is excellent execution, what’s the range of outcomes that are possible?

James Dennedy

Well, I don’t think that your number is unfair. If you were to evaluate the deployment of capital and the discipline by which we are managing that, apply normal kind of revenue multiples against the capital balance that we have, the fact that we’re able to generate cash flow from operations, looking three years out I don’t think $200 million is an unfair estimate.

Shai Dardashti – DCM

I’d like to actually go back to a conversation we had in February of 2012 where I basically outlined the June 25, 2010 proxy filing with an 18.8% EBITDA bonus target.

James Dennedy

Right.

Shai Dardashti – DCM

Could you explain if this 18.8% EBITDA is still an appropriate number to think about, or if the business in 2013 and 2014 is better or worse?

James Dennedy

Well in that proxy disclosure that you’re referencing and that we discussed, that was on a contribution basis for hospitality. That wasn’t as a standalone business fully absorbing the corporate expense it would require to run the business, so on an EBITDA basis long term, this nominal 2017 fiscal year of which you speak, accounting for the fact that we are intending to fully invest not only the balance sheet but our cash flow from operations, there’s going to be a range of outcomes, Shai.

To the extent that we invest in projects that through our accounting classification we record as OPEX, that’s going to have a compressing effect on EBITDA. To the extent that those projects through our accounting evaluation are judged as CAPEX, that would nominally have a favorable effect on EBITDA. Our plan would include operating organically without any meaningful change in our CAPEX plans today and without any M&A on an adjusted basis, that in 2017 with this growth projection that you’ve highlighted that you would expect us in the high single to low double digit EBITDA percentages.

Shai Dardashti – DCM

And I notice for the first time there’s a sell side analyst on the call, which is phenomenal. I’d like to please clarify two distinct points of fact. Would you say that the appropriate comps to Agilysys would be Micros and Radiant? Is that a fair statement?

Robert Ellis

Yeah, hey Shai, it’s Rob. I think Radiant is a fair assessment. Micros, I would say is also one to look at a little bit but they are a lot bigger – you know, over $1 billion, 50% of their revenue coming internationally. So Radiant obviously is no longer in existence after being acquired by NCR, but if you look at their historical numbers I think it’s a fair assessment.

James Dennedy

The only distinction, and they are sort of the only competitors in the space, if you will, that have meaningful mass that are publicly traded, we are effectively a hospitality pure play software enabled solutions provider. The thing that distinguishes us, and even if you were to look at just our fiscal 2013 results, those companies, both Micros and now NCR, seem to be more acquisition led in their business strategy than R&D and product development led, and in particular if you evaluate the percent of revenue that, let’s say, Micros spends on R&D, it’s a rather small percentage. On a quantum basis when you account for both our organic OPEX and product development and add to that our CAPEX, we’re spending a significant amount of not only our top line but also on a comparative basis pretty darn close to where Micros is spending in order to do what we classify as true product innovation, as opposed to consolidating and integrating that which you acquire. So I think they are two different types of business, while they are competitors in our space.

Shai Dardashti – DCM

And you’ve discussed 50% gross margin economics, and I think you mentioned just now that Micros and Radiant seem to be acquiring when it make sense. Can you comment on what are typical evaluation ranges of transactions in the industry at a high level?

James Dennedy

Well NCR, for whether it’s Ritalix or Radiant, was somewhere in the three times revenue range for the value of those acquisitions on Radiant or Ritalix. I think—and I can’t recollect the exact metrics that Micros paid for Torex, but it was greater than one times revenue. I’m not exactly sure of the exact metrics, Shai.

Shai Dardashti – DCM

My final question – I’m noticing there’s been a lot of job postings on the Agilysys website out of Bellevue, Washington for software development. Can you comment what these people are working on at a high level, please?

James Dennedy

Sure. The principal focus of the folks in Bellevue are working on our VDOT next platform that we think is going to have a meaningful, shape-changing impact on our hospitality industry. Added to that, we’ve centralized product development leadership in Bellevue under our chief technology officer, Larry Steinberg, and our vice president of development for both our property management systems and the next gen platform, Rihan Jadi (ph) as well as our vice president for development for all of our other end market products, who will also assume continued development initiatives over the acquired assets of TimeManagement Corporation, Maris Berzins, and all three of those individuals are located in Bellevue.

Shai Dardashti – DCM

Okay, thank you very much.

James Dennedy

Yes sir.

Operator

Thank you. Once again ladies and gentlemen, if you wish to ask a question at this time, please press the star then the number one key on your touchtone telephone. Our next question comes from Keith Housum of Northcoast Research. You may begin.

Keith Housum – Northcoast Research

Good morning gentlemen. Thanks for taking my phone call. Can you just remind me what this geographical split is of the hospitality group of where the business is conducted?

James Dennedy

Sure. The bulk of the revenue for hospitality is from the United States, and out of the 100 million or approximate $100 million of revenue generated for hospitality, about 5% each is in Europe and Asia.

Keith Housum – Northcoast Research

Got it. Okay, I appreciate that. You guys referenced the vendor and a 2% change in the cost of goods sold. Can you remind me in terms of what that makeup was and what exactly was that switch?

James Dennedy

Sure. We deliver certain InfoGenesis customer solutions in an ASP offering, or a hosted offering. Part of that offering includes a payment gateway with using a third party provider. Working with the customer, they requested a change in that provider of payment services, which changed the margin profile in delivering revenue to that customer, which had a compressing effect on margin in that one particular customer and that one particular solution area.

Keith Housum – Northcoast Research

Got it, appreciate that. You’re suggesting your expectations for FY14, part of that market gain comes from customers making a change from existing vendors over to you guys. Are you guys currently seeing that, do you believe? So it’d be a continuation, I guess, of what you’re sort of experiencing, but would this be new based on the new features you’ve been releasing?

James Dennedy

Well, we really see it from resources. The first and easiest source is from cross-selling our existing customers additional solutions that they aren’t currently buying from Agilysys. We’ve taken some steps to realign the incentive compensation of our sales staff as well as set up a more substantial investment in the account management activity to help promote that. The second thing that we’re doing is expanding our penetration into the markets that we serve by recruiting customers who may be in a growth or a buying phase and examining new systems. Some of that may be switching from competitors; some of that may be upgrading from systems that we sold them several years ago to now modernizing their operations. Third, we are aggressively evaluating how we can drive switching opportunities away from our competitors into our solution. The way we think we’re going to capture the hearts and minds, if you will, of that customer base and that market out there is through innovation and what we are told is our market leading services and support organization. Our customers tell us that the types of services and support they receive from us is substantially better in terms of its overall quality, customer focus than our competitors.

Keith Housum – Northcoast Research

Got it, okay. And I guess last question for you is you guys are defining your FY14 guidance as greater than market growth. How exactly do you define the market? Is there something that we can peg that we can also make that same observation as you report your results?

James Dennedy

Well, we can pull from various research organizations, but if you look at our top segments – global gaming market, the hotel market, managed food service, crews, stadium arena, higher ed, and healthcare are basically the primary six markets that we address globally. You then evaluate what they are buying to enable guest recruitment, so some of the CRM loyalty types of solutions. What they are buying to deliver point of sale, property management, inventory and procurement, document management – those targeted solutions, and now you would include in there workforce management, those specific solutions, the amount of spend that the industry consumes on both the software, services related to implementation, and recurring revenue from software maintenance renewals, that’s how we define the market.

Keith Housum – Northcoast Research

Okay. So as to the analyst, it would be a little bit difficult to recreate that same market growth. It sounds like you’ve got a lot of expensive growth information that was going into that calculation.

James Dennedy

Yeah, it’s really a lot of time that we have spent with various research organizations that focus exclusively on hospitality to assemble the metrics for the market that we think we can address, and we don’t try to target all IT spend. We try to target the spend on technology specifically to the solutions that we think we provide.

Keith Housum – Northcoast Research

Okay, appreciate it. Thanks guys. Good luck.

James Dennedy

Yes sir, thank you.

Operator

Thank. We have a follow-up question from Shai Dardashti of DCM. You may begin.

Shai Dardashti – DCM

Hi Jim. I’d like to please understand, number one, how many sales people Agilysys has right now; and number two, the breakdown of the sales force by inside sales versus new clients please.

James Dennedy

Shai, for some competitive reasons we won’t disclose specific numbers on the number of quota carrying sales folks. I will tell you that it’s greater than 20, less than 30. So far as the breakdown of inside to the quota carrying sales folks, we divide our sales force into, let’s say, five components. We have basically EMEA and APAC as two components, and then the three components domestically are casino or gaming, both corporate and tribal gaming, hotel resorts, and then the third component would be managed food service, crews, stadium arena, and higher ed. Each one of those sales directors and each one of those regions has approximately two to four inside sales folks specific to those markets, and it’s distributed by the revenue mass across each one of those five components.

Shai Dardashti – DCM

And I believe you mentioned there was a change in the incentive structure for the sales force. Could you comment between the prior model and then at a very high level what’s different now?

James Dennedy

Yeah. In the prior model, nominally all acquired revenue from sales was treated somewhat similarly, and there was a small incentive for net new logo business. What we’ve done in this particular sales model is that we’ve created a much bigger incentive for net new logo business. We’ve created a less aggressive incentive for selling new components into the existing base, and a more normal incentive associated for the pickup of recurring or run rate-type renewals and expansion of existing components into the existing install base.

Robert Ellis

Shai, this is Rob. To add to that a little bit, the other thing we’re also doing is investing in an account management structure, which we had an account management team last year but it was nominal, very small. We’re looking to grow that, actually triple the size of our account management team, and that will do a couple things: number one, assist us in customer satisfaction and having a liaison between our customers and our internal departments; and then number two, instead of our direct sales force keeping tabs on the install base and trying to figure out how to sell into the install base, the account management team will be responsible for finding those opportunities for us and then executing on those opportunities in order to give our direct sales force the time to go out and find that new logo business that Jim mentioned.

Shai Dardashti – DCM

Okay. And my very final question – I’m curious, the price point of the TimeManagement offering that you have. I’m curious, of the 3,000 clients you work with, how many do you think might benefit by using this product over time?

James Dennedy

Well, it would be easy to say that all of them could benefit by using the solution. Most of our install base, particularly in gaming and then more broadly the larger enterprises, focus primarily on Kronos. Kronos is a fairly well known workforce management solution. The thing that we think distinguishes TMx is the degree of focus that this particular company has had on the hospitality segments that we serve, and so the TimeManagement solution, the labor force management solution with both the rules, how you manage that workforce, the substantial number of those employees in that workforce who are part-time to make sure that they don’t breach part-time labor requirements, including the Affordable Care Act, et cetera, that kind of solution highly customized to the hospitality segment is the reason why TMx made such great sense for us.

In terms of the near term addressable opportunity for us, Shai, it’s probably somewhere in the 30% range. We think that you look at all of our food service management customers, everybody in the fine dining, table service-type environment would be an opportunity where we could target right away customer acquisition. The second market that we think the segment that we think we could aggressively pursue would be higher ed. We have many new higher ed customers on the Eatec system as we’ve been announcing over this last year, and the tightness of the integration between Eatec, our inventory and procurement solution, and TMx, which are commonly used in higher ed, particularly Eatec, offers us the opportunity to provide those university operations a more complete view of the cost of delivery of food service for the university. It’s going to have both your labor and materials management all in one system, or at least from one provider.

Shai Dardashti – DCM

If I could really nitpick, is TMx being priced on a per-day, on a per-year? Is there a sense of what the price range is at a high level?

James Dennedy

You know, for competitive reasons we’d really like to not disclose that, particularly given the large competitor who is in the space – Kronos. Again, a smaller business like Agilysys combating with some other larger competitors like Micros and NCR, and we’re willing to take on the other large competitor in this space particularly around workforce management. We think our pricing strategy is key to our overall effectiveness in competing.

Shai Dardashti – DCM

Phenomenal. Thank you so much.

James Dennedy

Yes sir.

Operator

Thank you. Our next follow-up is from Brian Kintslinger of Sidoti & Company. You may begin.

Brian Kintslinger – Sidoti & Co.

Great, thanks. Just wanted to touch a little bit on your acquisition strategy. Maybe talk about what you think your business lacks and as a result you’ll need to go acquire, and maybe what kind of valuations are you thinking. Are they what you discussed prior – the one to two times revenue? Is that how we should think about it? Maybe just a sense there would be helpful.

James Dennedy

Well, it would be tough for me in a public setting, Brian, to tell everybody where I think the gaps in our product offering are. I think our focus in M&A is heavily concentrated around kind of three things, and we focus it in this order. It’s the acquisition of talent, technology, and end markets, and that’s the order in which I think about it. If we can acquire fantastic talent who have created competitive and compelling products, we’re going to be able to exploit that opportunity across the 3,000 customer install base that we have, and third most important would be looking at can I just buy a market? I’m not necessarily interested in buying a market by buying something else that we already deliver, because I think we have really competitive products and we even have more competitive services to support the products that we sell.

With regards to your metrics of saying, well, we could buy stuff at 1 to 1.2 times revenue and so therefore you should expect somewhere around 90 to $100 million-some of acquired revenue, that’s one way of looking at it but I’m not sure that that’s the positive way of looking at it. There are going to be some potential deals that if it so substantially accelerates our product roadmap, we’d consider it strategic. It’s going to be one of those things where the revenue we acquire may be outsized for the purchase price, but it’s going to dramatically accelerate the roadmap and we’ll have by that opportunity be able to avoid some other expense, whether it’s capital or operating, that would be in the business.

Brian Kintslinger – Sidoti & Co.

Great. The second question I have follow-up is I think in the September quarter – and I may be confusing your two segments – but I think that you had a very large deal in the hospitality business. Will that make it difficult for the year to compare revenue year-over-year as you compare yourself against the market?

James Dennedy

Well, I believe the quarter you might be mentioning where we had some outsized revenue performance was, I think, the third quarter. The December quarter we had some outsized—

Brian Kintslinger – Sidoti & Co.

The December quarter – right, right.

James Dennedy

We had some hardware deals.

Brian Kintslinger – Sidoti & Co.

Right, exactly.

James Dennedy

What’s important to us is while revenue is interesting, the important component really is the gross profit and gross margin, and the margin contribution from those transactions was not significant but we would expect as we continue to drive growth in our high quality revenue, our high margin revenue, while the revenue may not be a favorable comparison year-over-year, we expect the gross profit to be competitive year-over-year.

Brian Kintslinger – Sidoti & Co.

Right, so I just wanted to make sure I understand as you go through next year’s results, what you’re saying is you’re sort of going to think of backing that out when you’re looking at revenue growth compared to market – is that accurate? And how big, maybe, then was that so we can evaluate how you’re doing on those markets?

Robert Ellis

Yeah, I think Brian, we’ll continue to be able to report on that, and we still believe even though there is some one-time—I wouldn’t even call them one-time. We’re going to always have those kind of deals in the pipeline that are going to occur year-over-year, and so we still anticipate our revenue growth to be above the market. So we’ll be able to report those and give you that as we come through the quarters.

Now, each quarter might be a little bit different – you know, we had a big quarter in Q3 in some of the hardware shipments. We can’t guarantee it’s going to be in that third quarter this year. It could be in a different quarter.

Brian Kintslinger – Sidoti & Co.

Right. Thanks very much.

Operator

Thank you. We have another follow-up from Shai Dardashti of DCM. You may begin.

Shai Dardashti – DCM

Yeah, Rob and Jim, it sounds to me after being on the call for one hour that Agilysys is a very good business and it also might be somewhat cheap. If you happen to agree, I’m curious your thoughts on a buyback program going forward. Thank you.

James Dennedy

A share buyback?

Shai Dardashti – DCM

Yeah, perhaps a tender offer, even.

James Dennedy

We don’t anticipate that happening.

Shai Dardashti – DCM

Okay, thank you.

Operator

Thank you. I’m showing no further questions at this time. I would now like to turn the conference back over to Mr. Dennedy for closing remarks.

James Dennedy

Thank you Shannon. Thank you for your participation on the call today. We are extremely excited about our future and eager to get to work. We wish to thank all our customers for their continued support and the confidence they have in our team. We are pleased to deliver improved quarterly and full-year results with strong underlying business performance. We believe our strong balance sheet, positive operating income and focused strategy presents a compelling and financially strong partner for our customers, a formidable competitor in our chosen end markets, and an exciting organization for the best talent in our industry to practice and develop their craft.

We have an ambitious growth strategy and realize that we have a lot of work to do, but we also know how to get it done and are highly confident of our team of exceptional people that they know how to get it done right for our customers. I would like to take this moment to thank my highly talented and dedicated colleagues at Agilysys who are responsible for our success, and who are always committed to making our company the best it can be.

Thank you and good morning.

Operator

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation and have a wonderful day.

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Agilysys (AGYS): FQ4 EPS of $0.15 beats by $0.09. Revenue of $63M (+21% Y/Y) beats by $11M. (PR)