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Agilysys, Inc. (NASDAQ:AGYS)

F2Q 2014 (Qtr End 09/30/2013) Earnings Call

November 7, 2013, 8:30 AM ET

Executives

James Dennedy - President and Chief Executive Officer

Janine Seebeck - Senior Vice President, Chief Financial Officer and Treasurer

Analysts

Brian Kinstlinger - Sidoti & Company

Operator

Good afternoon, ladies and gentlemen, and welcome to the Agilysys Fiscal 2014 second quarter conference call. (Operator Instructions)

Some statements made on today's call will be predictive and are intended to be made as forward-looking with the Safe Harbor protection of Private Securities Litigation Reform Act of 1995. Although, the company believes that its forward-looking statements are based on reasonable assumption. Such statements are subject to risks and uncertainties that could cause results to differ materially.

Important factors that could cause actual results to differ materially from these in the forward-looking statements are set forth in the company's report on Form 10-K and 10-Q and news release is filed with the Securities and Exchange Commission.

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

James Dennedy

Thank you, Nicole, and good morning, everyone. We appreciate you joining us on the call today to review our fiscal 2014 second quarter results. With me this morning is our Chief Financial Officer, Janine Seebeck.

Before we get started, I'd like to remind everyone that we'll be discussing some non-GAAP metrics on today's call, primarily adjusted operating income from continuing operations and adjusted net income from continuing operations, which eliminates the effect of restructuring and other items that are either non-cash or non-recurring. Reconciliations to GAAP metrics are provided in the financials in the press release issued earlier today.

Our second quarter and year-to-date financial results continue to reflect the success of the business strategy we have implemented. Our second quarter and first half fiscal year 2014, each delivered 10% year-over-year revenue growth. This rate of growth is greater than the market rate of growth, an important commitment we have made to our shareholders.

Our gross margin in the second quarter exceeded our historical gross margin. The gross margin performance in the quarter reflects a favorable mix shift towards proprietary product revenues and a favorable impact from the amortization of capitalized software. Janine will comment further on our margin performance during her more detailed review of our financial results.

Our entire team remains committed to strong capital discipline in the business. This includes balance sheet deployment, working capital and operating expenses. While total operating expenses, which include product development, selling and marketing, general and administrative and depreciation expense, increased in the quarter by approximately 7%. These expenses declined as a percentage of total revenue by over 150 basis points.

Our tighter controls on operating expenses as a percentage of revenue combined with our higher than historical gross margins resulted in an operating loss of $1.1 million, which is a $1.1 million improvement from the $2.2 million loss in the same period a year ago. Our business and financial strategy remains governed by our focus on capital discipline and pursuing the highest return on capital opportunities. This focus informs the markets we pursue, the products we develop and the businesses we own.

Through last several years of corporate development activities, we have transitioned to a more focused business model and improved our return on invested capital opportunities. We are intact on being the leader in transforming the guest service experience to enable our customers to deliver a memorable connection with their guests. To that end, our solutions enable our customers to achieve greater recruitment success, increased wallet share and improved guest experience.

Our products are deployed across several segments of the hospitality industry. Based on our trailing 12 months, commercial and tribal gaming represents approximately 50% of our revenue. Managed food service, which includes the food service management companies, stadiums, arenas, higher education and healthcare represents approximately 28% of our revenue. Hotels and resorts represent approximately 17% of our revenue. And the cruise segment represents approximately 4% of total revenues.

We are seeking to improve our participation in the international components of the end-markets we serve. Currently, over 90% of our revenue is tied to U.S. based customers. We believe international markets provide a growth opportunity for our business.

In summary, we now have a more focused business, a stronger balance sheet and improved operating structure to execute on our growth initiatives. Our operating modal permits us to further invest in new product development, make important investments in our business to improve the quality of service we provide, and pursue select acquisitions to advance our product roadmap and expand our market reach.

With that, I would now like to turn the call over to Janine to review the financial results for the quarter, the balance sheet and cash flow. I will then provide some additional insight on the business before opening the lines for questions.

Janine Seebeck

Thank you, Jim, and good morning, everyone. Let me begin by highlighting that the results we reported in the fiscal 2014 second quarter and that we'll be discussing today are related to our hospitality business only, and do not include any contributions from our former retail division, which are now included in discontinued operations.

In addition, as we have previously discussed, we will be reporting as one business segment going forward, and as such, our previously reported corporate service expenditures are now included within our hospitality business.

Looking at the detailed results for the fiscal 2014 second quarter, total net revenue increased 10% or $2.4 million to $26.6 million driven principally by a 30% increase in product sales during the quarter. The mix of our product sales revenue continued to improve as revenue related to software typically comprises just over half of our total product revenue.

Recurring revenues comprised of support, maintenance and subscription services, grew 3% in the quarter, as an increase in revenue from both subscription service and proprietary product support sales were offset in part by reduced remarketed support revenue, as a third-party vendor made a strategic change, which lowered cost that we pass along to our customers and recognize as revenue.

Professional services revenue decline 9% year-over-year on the back of some timing issues for the installation of certain projects that got pushed from the end of the second quarter into the current quarter. Our domestic revenues grew 8% for the quarter, ahead of the market rate of growth, while our international revenues grew approximately 29% from the prior year, due to the timing of several projects being completed.

Gross margin of 66% in the quarter improved approximately 350 basis points from 62% in the prior year quarter, primarily driven by lower software amortization expense, as some recently developed products have not yet been placed into service and therefore the development cost for these projects are not yet being amortized.

With the recent release of these new products and updating versions of existing products, combined with our efforts to expand our subscription base business, we expect margins for the second half of fiscal 2014 will compress and move closer to our historical level.

Operating expenses, which include product development, selling and marketing, general and administrative and depreciation expense, increased 7% from $16 million to $17.1 million. The increase was driven by selling and marketing expenses related to higher incentive compensation costs as well as the timing of certain tradeshow-related costs, which were incurred in the second quarter this year versus the third quarter in fiscal 2013.

Our operating expense related to product development decreased approximately 4% from $7.3 million to $7 million. Overall spend continues to increase consistent with our strategy, as we capitalized approximately $2.9 million in software development cost for future years in the second quarter of 2014.

Moving down the income statement, adjusted operating income from continuing operations increased $1.4 million year-over-year to $0.8 million from a loss $0.6 million in the year ago period. Adjusted net income from continuing operations of $0.8 million or $0.03 per diluted share compared favorably with an adjusted net loss from continuing operations of $0.4 million or $0.02 per share last year.

Loss from continuing operations for the quarter of $0.06 million or $0.03 diluted share compared to a loss from continuing operation of $1.4 million or a loss of $0.06 per share in the prior year period. Inclusive of this continued operations, which is comprised of our former retail solutions group, net income for the quarter was $20.5 million or $0.92 per diluted share compared to a net loss of $4 million or $0.01 per share in the prior year period.

Looking briefly at the results for the first half of the fiscal 2014, total net revenues increased $4.5 million or 10% to $51.1 million from $46.6 million in the comparable prior year period. Gross margins for the first half of fiscal 2014 was 66% versus 62% in the comparable prior year period.

Looking at expenses, total operating expense increased 6% to $32.2 million from $30.5 million in the fiscal 2013 first half. Adjusted operating income from continuing operations increased to $2.3 million from an adjusted operating loss from continuing operations of $1 million in the year ago period.

Adjusted net income from continuing operations of $2.2 million or $0.10 per diluted share for the fiscal 2014 first half compared favorably with an adjusted net loss from continuing operations of $1.3 million or $0.06 per share last year.

The loss from continuing operations in the first half of 2014 was $0.3 million or $0.01 per share compared to a loss from continuing operations of $4.1 million or $0.19 per share in the prior year period. Inclusive of discontinuing operations, net income for the first half of fiscal 2014 was $21.8 million or $0.99 per diluted share compared to a net loss of $2.1 million or $0.10 per share a year ago.

Moving on to the balance sheet, cash as of September 30 was $100.4 million, which includes the net proceeds from the sale of our retail business unit, which occurred on July 1.

Through the use of our existing NOLs, which are currently worth approximately $160 million, we were able to realize the full benefit of the sale of retail business and did not pay any regular income taxes on the proceeds of the sale. However, we will be subject to nominal alternative minimum tax.

Our NOLs, which have a full valuation allowance against them at this time, we'll keep our cash taxes limited to taxes paid in foreign jurisdiction along with minimal state taxes for the foreseeable future.

Overall, our second quarter results reflect the ongoing transition in our business and clearly point to the potential, the refocus business holds as exhibited in our ability to delivering improved operating results, above market revenue growth, a year-over-year improvement in gross margin and a significant increase in our adjusted operating income. And with over $100 million in cash and no debt, we have ample financing flexibility to continue growing our business.

As noted, we again generated above market revenue growth in the fiscal 2014 second quarter. Going forward, we will continue to focus on maintaining that trend through the balance of the current fiscal year, as we operate the business with a goal of increasing investments in our people, our products and our customers. And we expect to do all of this, while generating positive adjusted operating income for the fiscal year.

To conclude, we are pleased with our results in the quarter as well as year-to-date, and feel good about how our business is positioned as we move ahead with our planned investment around international market opportunities, expansion of our product portfolio and increase levered of our existing client base.

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

James Dennedy

Thanks, Janine. Before opening the call to your questions, I'd like to highlight several customer wins and product launches from the past few months and comment further on our strategy and capital discipline.

In our gaming segment, Treasure Island Resort & Casino acquired our InfoGenesis Point-of-Sale and DataMagine signature capture solutions. Muckleshoot Indian Casino acquired our InfoGenesis Point-of-Sale solution. And Resorts World acquired our LMS property management solution for its latest property, Resorts World Casino in New York City, based in Jamaica, New York. And our [indiscernible] restaurant segment with [indiscernible] American acquired the Agilysys' WMx Workforce Management Solution for their [ph] Mimi Cafe's outlet.

In our higher education segment, the University of Wisconsin-Platteville acquired our Eatec inventory and procurement solution via multiyear subscription agreement delivered in a hosted model from our data center. In our international business, Mandarin Hotel Group expanded their business with us, once again, by selecting our InfoGenesis Point-of-Sales solution for its latest property in Taipei, Taiwan.

Our product development teams are also working hard to bring new and exciting products to market. New products introduced in our second fiscal quarter, include the Insight Mobile Manager and InfoGenesis Mobile. These products reflect our focus on next-generation functionality and provide our view on the evolving evolution of guest service delivery.

In particular, the Mandarin Oriental in Las Vegas has been using IG Mobile to provide faster and more efficient customer service at its pool by allowing servers to remain on-desk side and a more continuous contact with its customers. Thereby driving increased order flow and higher guest satisfaction.

Also in the quarter, we announced the general availability of SWS Direct. A hosted above premises module that delivers new features and functionality to the Stratton Warren Systems, inventory and procurement solution by providing a convenient, efficient and intuitive shopping card experience to users of the Stratton Warren System. The application streamlines operations and is easy-to-learn, significantly reducing staff training cost.

Looking at further capital deployment, we see several attractive areas, where we can invest and support our growth in the hospitality industry, both organically as well as through strategic acquisitions. We remain focused on developing and delivering solutions to our customers to recruit more guests, maximize volunteer and stay more connected to their guests throughout the engagement process. In summary, we are pleased with the results for this quarter and remain optimistic about our future performance.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Brian Kinstlinger of Sidoti & Company.

Brian Kinstlinger - Sidoti & Company

The first question I had is based on software titles, where you're seeing the increased demand of the 10% growth, maybe which are growing faster than your company average? Which are slower? And maybe which are declining?

Janine Seebeck

Brian, I'll take that one. I don't think that it's anything growing slower. I think it's pretty much consistent with the mix that we've seen. So we have talked about the fact that IG continues to be our largest products and we continue to see that. On the top, we did see some good traction with Eatec this quarter as well as obviously with the portal for SWS. I don't think there was any significant change or shift in the overall mix. So it's kind of good that we're seeing.

Brian Kinstlinger - Sidoti & Company

And then, maybe on revenue growth again, how much is weighted towards existing customers and new customers?

Janine Seebeck

So actually in the quarter of our top 10 wins, four were actually new logos. So we are starting to see traction, as we have talked about with you guys before, with moving towards some of those new and existing. So still growing in the base, but we did see some really good traction with some of the new logos we're bringing in.

Brian Kinstlinger - Sidoti & Company

And something I want to ask, every quarter going forward is, maybe you can update on the statistics or how many customers you have in total? And then how many have just one app?

Janine Seebeck

It's about 3,100 customers in total. And consistently today, it's still consistently with about a third of them and having only more than one app, so about 65% to 67% have less, don't have more than one. But I hear you, Brian, and we'll make sure we track that for you.

Brian Kinstlinger - Sidoti & Company

The gaming industry and casino industry you highlighted is a big chunk of your revenue? And you've talked about I think in the past, those capital spending trends have been pretty slower. I'm wondering if there has been any improving in a last three or six months from that market?

James Dennedy

Brian, there has been, if you recall in our material at the beginning of September when we did the Investors Day, the gaming segment represented about 47% of our total revenues, again that was based on a trailing 12 months. So as we reported our most recent quarter results and update the trailing 12 months, gaming has improved from 47% of our total revenues to approximately 50% of total revenues.

So as Janine indicated, the combination of the products or the mix of products being sold has been relatively consistent quarter-to-quarter. What we've seen in the most recent quarters is that the gaming segment has been contributing more revenues and it's been more helpful for our overall growth in some of the other segment.

Brian Kinstlinger - Sidoti & Company

And so do you expect that to continue over the next year or two, strengthening I mean?

James Dennedy

Based on what we see in our pipeline, I would say the pipeline opportunities that we're tracking, I would say, yes, for the next several quarters. It does appear as if the gaming segment is going to contribute more revenue growth than some of the other segments we serve. That said, as soon as I said that, I know some of the other sales directors are going to get pretty active and try to ramp up their segments, so that their directorates are participating more fulsomely than the gaming segment.

Brian Kinstlinger - Sidoti & Company

I'm going to ask two more questions, and then I've got a bunch more. I'll get back in the queue and see if others do, but can you separate out the early impact from your two new mobile offerings and maybe it hadn't had enough time to have much of an impact, but then maybe when you expected to have a more meaningful contribution?

James Dennedy

The mobile products were released in the quarter, but they were released relatively late in the quarter. We don't necessarily disclose our bookings data. But again, some of the folks in our sales team have been pretty active with our customers and we have started to see deals closed already in this third quarter that have revenues associated with these two new products. In terms of their contribution to topline that will move the needle for topline, I would imagine it's going to be later in this fiscal year, and the start of our next fiscal year, fiscal '15, before they'll start moving the needle on topline.

Brian Kinstlinger - Sidoti & Company

And then just maybe, you gave the number of total data customers for both at the Investor Day, maybe you can give us number of deals you've closed so far or is that not possible?

James Dennedy

I would prefer not to.

Operator

And we have a follow-up question from Brian Kinstlinger of Sidoti & Company.

Brian Kinstlinger - Sidoti & Company

So I guess maybe I wanted to focus a little bit on V.NEXT. Maybe just give us an update of generally where you are there? Remind us where you are, if you're in beta testing, if you're still in development? Then maybe just give us an updated timeline of that product?

James Dennedy

The timeline remains consistent. We haven't moved off of our projected timeframe. Development continues to progress reasonably on schedule and within budget. The timeframe I think we previously indicated was that we would be in private data, this would be with the customers who are active in our customer advisory board for this product before the end of this current fiscal year, so in first part of next calendar year.

We would be in public data in the first half of next calendar year, the first half of our next fiscal year. We don't anticipate that we would see $1 of revenue until late in fiscal '15 or at the start of fiscal '16. That remains the target that we've previously indicated and I think that's the target that that we're going to realize.

I think what's important to note is that while we have this ongoing investment activity in V.NEXT, we have a substantial investment activity going on in our end market products. Those investments activity for our end market products are designed not only to keep those products at the leading edge of innovation for their peers in the market or their competing products in the market, but also to help us expand or penetrate more deeply into the markets we serve today and to open up tangential market segments next to the markets we presently serve to help increase the market opportunity.

Some of these products like Insight Mobile Manager contained bits associated with our V.NEXT investment. These bits do things such as add a layer over the top of LMS or Visual One, but deliver the information to a V.NEXT inspired user interface on a mobile device. So while we're making investments in V.NEXT some products like Insight Mobile Manager are coming to market generating revenue dollars associated with the technology used in V.NEXT.

Brian Kinstlinger - Sidoti & Company

Just one follow-up on V.NEXT. At the Analyst Day you mentioned, the product won't be ready for the gaming market given some regulations they've got right away. First, when do you think, because I'm sure you gave a date then, when do you think that gaming piece or the platform will be prepared for the gaming industry? And since that half your revenue, is that generally when you think this product line will take off from a revenue standpoint much more so, or the first release will be just as impactful?

James Dennedy

Our plan, Brian, is that the initial release of the product, we'll open up at the hotel space in which we don't compete effectively today and that's in the more limited service, limited needs property from a property management perspective. The time to market for when V.NEXT would be ready to address the needs of, let's say, the super-tanker casinos in Vegas or the resort properties in our Tribal Gaming customer base or even in the resort market that we serve, the non-gaming resort market, it will take some time.

And while it's not necessarily regulator related, it is related to the library of interfaces that have been developed over the years that LMS and Visual One contain. These would be to key lock systems, to phone systems, to gaming management systems and all of these interfaces have to not only be developed, but robustly tested because of their critical importance and the operations of a gaming casino or a resort.

Brian Kinstlinger - Sidoti & Company

Two more questions. The first is if I look at the deferred revenue line, it's been in the steady decline. Are your bookings slowing significantly or what does this suggest about the demand for your SaaS offerings?

Janine Seebeck

This has to deal with the fact that our InfoGenesis, which is the primary support billings that we do. They are done on an annual basis and they're done on a calendar year. So we always see this quarter on being the lowest, and you know that we have obviously because we will ramp and do that quarter, so having that large hit happen once a year, we will traditionally see a drop. And then next quarter you will see that going back up significantly.

So we're not seeing any significant drop when it comes to overall bookings and obviously the software is continuing to be more than half of our product sales, which is driving that line, so we're not seeing anything that would indicate other than just the timing and the ebbs and flows of our billing, that's actually driving that.

Brian Kinstlinger - Sidoti & Company

Your balance sheet, obviously you have revised it for the divesture, so maybe there are some deferred revenue in there from RSG, but you've been on steady decline for six quarters and even if I look from the fourth quarter of '13, the readjusted one, you've been down two straight quarters. And I figure just SaaS offering -- when I look at the SaaS companies they're growing much faster than core software license and so I want to figure, if more your booking are head that way and would offset that annual drop, if you will.

James Dennedy

Well, I will say that if you look at our bookings trends over the last year, we did have in our fourth fiscal quarter subscription based sales were a lower percentage of total contract value bookings in our fourth fiscal quarter of 2013 than in the prior quarters. So some of the contraction you're seeing today maybe related to a lighter bookings quarter for our subscription related revenues in our fourth quarter. I'd have to take a closer look, Brian, to try to understand the six quarter trend to what you're referring.

Janine Seebeck

And I think, Brian, to just to give a gauge right, the impact of that IG billing that comes off the balance sheet is about $3 million a quarter. So when you're looking at the driver going from yearend until now, that would indicate it would be lower, and the part I was doing was dropping off the actual numbers. So it is not an indicator, I don't think of anything seriously negative, I think it is just that some of that timing and then probably the skew of the RSG.

Brian Kinstlinger - Sidoti & Company

The last question I had is you mentioned in your prepared remarks at the Analyst Day and in the press release you've talked about deploying capital for strategic acquisitions. And I get this sense that something is close, to maybe what's your strategy for acquisitions, where are you looking, what kind of functionality are you trying to look to acquire?

James Dennedy

We're not going to comment specifically on targets that we maybe pursuing. However, what we would we would say, it was a message I delivered to our senior leadership team yesterday, that we remain intent on acquiring solutions that would advance our roadmap. And when you think about the roadmap and what we're trying to help our customers do, it will be to invest in solutions that will help our customers increase their guest recruitment, improve their wallet share and elevate the overall level of guest experience to satisfaction that they deliver.

To that end as we evaluate targets, we're through looking for them to slot into one of those three potential outcomes and the second step in that would be, are they going to bring meaningful improvements to the talented pool of people that we have in the business today. So we'll be looking at, are we acquiring talent, technology and more market opportunity.

To the extent that we're acquiring greater talent and that talent is contributing to the overall business, we are going to be developing better products that we can bring to market, that will then deliver greater financial results to the company. So that's the way we look at it. It's tough for us to give you any more insight, because we'll also be communicating that generally to the market as well.

Operator

And I am showing no further questions at this time. I would like to turn the call back over to Mr. Dennedy for any closing remarks.

James Dennedy

Thank you, Nicole. Thank you for your participation on the call today. I would like to take this opportunity to thank the talented and dedicated team of Agilysys who are responsible for our success and express my thanks to our customers who entrust us with their business.

To conclude, we believe our strong balance sheet, positive operating income and focused strategy presents a compelling and financially strong partner for our customers. We are making progress against our strategic agenda, in the areas we're focused on to deliver growth and increase value to our shareholders. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Have a great day everyone.

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