Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Martin Ellis – President and CEO

Henry Bond – SVP and CFO

Analysts

Brian Kinstlinger – Sidoti & Company

Zachary Prensky – Koyote Capital

Agilysys, Inc. (AGYS) F2Q2011 Earnings Call Transcript November 4, 2010 11:00 AM ET

Operator

Welcome to the Agilysys fiscal second quarter 2011 conference call. Some statements made on today's call will be predictive and are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, 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 are those in the forward-looking statements that are set forth in the company's reports on Form 10-K and 10-Q and news releases filed with the Securities and Exchange Commission.

Today's live broadcast will be archived and available on Agilysys' Website. At this time, I would like to introduce your host for today’s call, Agilysys’ President and CEO, Martin Ellis. Thank you, sir. You may begin.

Martin Ellis

Thank you Donna. Good morning everyone and thank you for joining us today to review our unaudited second quarter and first half results. With me today is Henry Bond, who recently joined our company as Senior Vice President and Chief Financial Officer. We will be using a slide presentation as the basis for today’s review. If you have not already done so, we encourage you to access the slide deck from the Investor Relations section of our Website.

Please not that additional information and risk factors can be found in our SEC filings, all of which are available on our Website. Also during today’s discussion, we will be discussing non-GAAP financial data, namely adjusted EBITDA. Reconciliations to GAAP are provided at the end of the presentation as well as in the press release issued this morning.

Turning to the quarter, we were very pleased with the strong year-over-year and sequential improvements in revenue generated during the second quarter. In fact, this is the first quarter since 2007 that we have reported revenue growth for the consolidated company, reinforcing that we continue to gain traction with our focus on bundling more software and services in the solutions we sell.

Historically, our second quarter revenues are comfortable with the first quarter of the fiscal year. However, we reported strong sequential growth with sales up 39% sequentially, which made up for some of the softness we experienced in our TSG segment in the first quarter. Year-over-year, sales were up 18%, however gross margin contracted during the quarter to 22.2% of sales compared to 28.1% in the prior year. This was largely the result of significantly lower vendor rebates in the quarter, ongoing competitive pricing in the market as well as a mix shift with the higher proportion of hardware sales compared to the prior quarter, given the strong growth in TSG this year.

Selling, general and administrative expenses decreased as a percentage of sales, but total SG&A was up slightly over $3 million, primarily due to $1 million of expense development costs related to Guest360. In the same quarter last year, investments and development costs related to Guest360 were capitalized. We also incurred roughly $1.1 million of non-capitalized expenses associated with our new Oracle ERP implementation. These costs are expensed – are expected not to continue beyond our third quarter. And we also incurred approximately $500,000 related to severance and transition costs. Notwithstanding the strong sales growth we reported, the reduced gross margin and loss of rebates pressured our bottom line, resulting in a second quarter loss from continuing operations of $0.10 per share compared with last year’s earnings of $0.12 per diluted share.

On a consolidated basis, revenues were higher in each of our broad product lines culminating in the 18% increase over the second quarter last year. Hardware sales were up 21% year-over-year and software and services increased 9% and 11% respectively. Gross margins were disappointing and were down 590 basis points, reflecting the lower rebates, competitive pricing, and a shift in product mix with higher hardware sales during the quarter.

As mentioned, SG&A excluding depreciation and amortization was up $3.5 million, primarily due to expensing of software development costs and severance costs. Despite strong sales volume this quarter, pricing pressure and lower vendor rebates impacted margins and profitability. The $2.8 million operating loss posted during the quarter compared with last year’s operating income of $3.8 million.

Before I turn the floor over to Henry who is making his debut on our call today, I would like o take this opportunity to thank Ken Kossin for his service to the company and his role in our transformation over the last number of years. Last month, we welcomed Henry on board as the company’s new CFO, and on behalf of the entire Agilysys’ management team, we look forward to work with him as we continue to execute our strategy.

With that, I will turn the call over to Henry to discuss segments and balance sheet information.

Henry Bond

Thanks Martin. I would like to start off by saying that in the little more than two weeks I have been on the ground here, my enthusiasm about where the company is heading have increased beyond my early observations, which were already positive. I believe there are strong prospects for sustained profitable growth, and I look forward to playing a role in realizing these opportunities. I have spent the past few weeks coming up the learning curve, which is still pretty steep, and thus far, everyone I have met is clearly dedicated to contributing to the company’s success. That said, I am excited to be part of the management team here at Agilysys, and I look forward to meeting those of you on the call today.

Starting off our discussion of the business segments, the Hospitality Solutions Group had large customer rollout in last year’s second quarter, which created a very difficult year-over-year comparison. In the current quarter, HSG had no major rollouts by comparison, resulting in the 12% revenue decline. However, when you look at the six-month comparables, you can see that year-to-date revenue increased approximately 11% from the same period last year, primarily reflecting solid demand in food services and cruise lines.

Demand for HSG remained soft in commercial gaming and destination resort markets, which is partially offset by relatively stable conditions in the managed food services and cruise line sectors. We continue to see great opportunity for our product suite in the cruise market. Furthermore, we expect that the gaming market will eventually rebound, provided of course that broader economic conditions continue to improve.

Gross margin decreased slightly to 59.4% compared with 61% last year due to a product mix favoring the relatively lower margin hardware lines. For the six-month period, gross margin came in at 58.5%. The $1.7 million increase in SG&A, excluding depreciation and amortization, for this segment during the quarter was primarily due to $1 million in costs related to Guest360, which as Martin mentioned previously, were capitalized last year. Adjusted EBITDA was down $3.6 million, primarily on the lower revenue and expensing of previously capitalized developments costs.

Turning to Retail Solutions, revenue increased 23% for the quarter compared with last year and 10% for the first half. A vast majority of the revenue growth resulted from higher hardware sales and increased services revenue. While the market in retail remains competitive, it has exhibited meaningful improvements from prior periods. Gross margin contracted approximately 80 basis points during the quarter, but was up slightly for the half. Most of the growth in both periods was in hardware, however pricing pressure on hardware sales was more intense in Q2, which resulted in the variance.

SG&A, excluding depreciation and amortization, increased $700,000 during the quarter, reflecting higher incentive and overtime compensation related to the increased sales volume. Adjusted EBITDA increased $200,000 year-over-year on the higher revenue, partially offset by lower gross margin and higher SG&A.

Turning to Technology Solutions, revenue increased 23% in the quarter and 11% for the half, with all products and services contributing positively. Hardware grew 23%, software 26%, and services 15%. We also continued to increase the software and services attach rate in the TSG business. The improvements were the result of better demand for IT infrastructure. As Martin indicated, the demand environment is stabilizing for IT products and we expect to realize the typical seasonal increase in TSG during our fiscal third quarter ending December 31st.

Gross margins contracted sharply during the first and second quarters, due primarily to lower rebate margins and competitive pricing. SG&A expense decreased slightly in the quarter and adjusted EBITDA was down $1.8 million on the gross margin pressure. In our corporate segment, SG&A, excluding depreciation and amortization, increased $1.4 million in the second quarter. This was largely the result of higher severance costs and professional fees related to the new Oracle ERP system, which went live in the first quarter of this year. The adjusted EBITDA loss, excluding charges, was $7 million for the quarter, an increase of $1.4 million from last year.

Turning to consolidated results for the fiscal year-to-date, revenues increased 10.5% versus the prior year, with all segments increasing more than 10%. Gross margin declined by 290 basis points due to the previously-mentioned lower vendor rebates and ongoing competitive pricing. SG&A, excluding depreciation and amortization, was up a little more than 2% due primarily to Guest360 development efforts, non-capitalized ER expenses and severance costs.

Adjusted EBITDA was down $2.6 million due to the lower gross margin and higher SG&A excluding depreciation and amortization. Other income benefitted from a company-owned life insurance payment. Income tax expense was $4.6 million, of which $3.8 million was a charge for valuation allowance related to deferred tax assets.

Switching to the balance sheet and liquidity for the period ended September 30th, 2010, we remained debt-free and have more than $39 million in cash and equivalents on hand at the end of September. Cash decrease thus far during the fiscal year as a result of higher accounts receivable and higher inventories associated with the increased sales volumes. DSOs decreased to 77 days at the end of the quarter from 83 days at June 30th. Capital expenditures were $1.9 million for the second quarter versus $2.5 million last year, as the majority of the Oracle and Guest360-related costs were expensed in the current period.

Additional information regarding our fiscal 2011 second quarter and six-month financial and operational performance is in the quarterly report on Form 10-Q, which will be filed within the next few business days.

I will now turn the call back to Martin for his remaining comments on business trends and our outlook for the balance of the year. Martin?

Martin Ellis

Thanks Henry. As discussed earlier, sales improved meaningfully both year-over-year and sequentially and have started to trend upward on a trailing 12-month basis from the lows of a quarter ago. We look forward to continue to drive this upward trend. And as we move forward into the second half of the year, we will continue to focus on growing our business, including our higher margin proprietary software and services revenues, as well as address cost structure to improve overall profitability.

For the full year, we expect to generate revenues of $690 million to $700 million, EBITDA of $7 million to $10 million, stock compensation is expected to be approximately $3.5 million, and depreciation and amortization is expected to be between $12.5 million and $13 million. Stock compensation is included as an expense in calculating EBITDA.

CapEx is anticipated to be $8 million to $9 million, of which $5 million is related to capitalized costs associated with the implementation of the company’s new Oracle ERP system and the development of Guest360. We will continue to invest in Guest360 by building additional features and functions into the software, which will be brought to market in the next year.

By the end of the fiscal year, we expect cash on hand to be approximately $60 million to $75 million. As far as the revenue guidance is concerned, the range was $690 million to $710 million. In closing, demand is improving and we expect to report improved results for the second half of the fiscal year.

And with that, Donna, we will open up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from Brian Kinstlinger of Sidoti & Company. Please proceed with your question.

Brian Kinstlinger – Sidoti & Company

Hi good morning.

Martin Ellis

Good morning Brian.

Henry Bond

Good morning.

Brian Kinstlinger – Sidoti & Company

The first question on the revenue guidance. Is there any assumption on the mix versus what we saw here in the third quarter from hardware and services, and maybe even software, or do you expect it to be similar to the mix that you saw in this quarter?

Martin Ellis

I think in terms of mix for Q3, we would certainly expect hardware to be a little bit higher given the seasonality associated with the TSG business. But as we look at the remainder of the year, I think the overall mix, Brian, is somewhat similar to what you saw in this second quarter.

Brian Kinstlinger – Sidoti & Company

And then, so if I look at TSG, the gross margin, you mentioned the lower rebates, you mentioned the pricing pressure.

Martin Ellis

Yes.

Brian Kinstlinger – Sidoti & Company

If I look at the last four quarters, three of them have been a gross margin of 17%; one a little bit more than 18%. Is that kind of a new range you are thinking about given the ongoing pressures? I think three, four, five years ago, it was more like the low-to-mid 20s. Is that what we are seeing with the new competitive pressures if it’s 17 to 18ish?

Martin Ellis

Yes, I think so. If you go back a few years ago, Brian, the overall margin profile of this space was slightly higher. Given the competitive dynamics over the last couple of years, some of that margin has been squeezed and our expectation is that without a change in mix, you are probably looking at gross margins in the range of 17% to 18%, but we continue to focus on increasing our software and services attach rate that overtime we look to improve the gross margin, but based on current mix, that’s probably a pretty good estimate.

Brian Kinstlinger – Sidoti & Company

So, that takes me to the next question, because I thought in your prepared remarks, you said a higher attach rate, but it seems that hardware or it seems like the mix has gotten worse, which may imply less of an attach rate. So, maybe reconcile the two if you could.

Martin Ellis

In terms of an attach rate, we have increasing growth in what we refer to as our second tier products, which would be software and services. Firstly, these are products are coming off a lower base relative to hardware. And so, growth rates in many of these products are meaningfully higher than the hardware, but in terms of the overall contribution to topline revenues, hardware is still a significant portion of that. And when you look at the relative mix of hardware, it will take some time before that mix shift becomes evident.

Brian Kinstlinger – Sidoti & Company

That was my point actually. Hardware increased 18%, but – sorry, yes, hardware increased 21%, but services only increased – software 9% and services 11%. So, what I am saying is even on the higher base, hardware seems to be going much faster so it seems the attach rate is going down, no?

Martin Ellis

In the quarter, Brian, we had some meaningful hardware transactions, but in terms of the overall trends, if we look at underlying products, we have got some pretty high growth rates with new relationships that we brought on over the last couple of quarters.

Brian Kinstlinger – Sidoti & Company

Okay. And then on the cost cutting, it seemed that maybe I read it wrong because I didn't hear anything in your comments, by your comments that there is some costs being evaluated and coming out of the business. Are you thinking about cutting costs right now, or are you waiting for an evaluation from your new fresh set of eyes there? And then can you also just highlight the costs that are going away? You mentioned a couple after the third quarter; which costs are actually going away?

Martin Ellis

Well, of the two primary software-related and development costs that we addressed, the Guest360 costs will continue to be both capitalized and expensed depending on the nature of the cost. And so, we would expect to see ongoing costs that are expensed with respect to Guest360 as we continue to develop that product against which at this point, revenues are smaller and are expected to grow overtime, but right now, we are expensing against Guest360.

As far as the Oracle implementation is concerned, we expect those costs to start to decline here in this December quarter, and for those to disappear from an ongoing expense run rate, by the end of the calendar year or very early in the New Year. As it relates to the question regarding overall costs, we will continue to look at cost structure. The objective is to run the business with positive operating income and to the extent that topline and profitability growth is not getting us there. We will have to address it through cost structure. So, it’s going to be a combination of evaluating prospects going forward given our expectations for the remainder of the year and looking out quarters beyond that, as well as looking at overall cost structure.

Brian Kinstlinger – Sidoti & Company

And where you sit today, in the evaluation you have done so far, it's not necessary. Is that accurate or no?

Martin Ellis

I know, we are looking at both the revenue and the profit side as well as the cost structure side. At this point, don’t have anything to share, but we are going to look at all components.

Brian Kinstlinger – Sidoti & Company

Okay. I will get back in the queue and see if others have some questions and then I will get back.

Operator

Thank you. (Operator instructions) Our next question is coming from Zachary Prensky of Koyote Capital. Please proceed with your question.

Zachary Prensky – Koyote Capital

Thank you. Can you give us a list of the top three vendors from whom you are buying the hardware from in order of the amount of money you spend with them on this quarter?

Martin Ellis

Our top three vendors from an OEM perspective are going to be HP, Sun, and IBM.

Zachary Prensky – Koyote Capital

Okay.

Martin Ellis

But we procure a large portion of these products through our primary distributor, Arrow, but the OEMs are –

Zachary Prensky – Koyote Capital

That’s right. Okay. So, I mean it's clear that the margin compression that we have seen on the hardware side has gone to renew [ph] the benefit of those three vendors. They are using their muscle to push us around; that is at least from what I am hearing from this call and other calls. So, I guess my follow-up question is, what is our ability to swap out boxes of various vendors and have you been using that leverage to go to, let's say, an IBM and say, look, I can take half of my Sun business and put it on your platform provided you give me better pricing. What work have you been doing to muscle each vendor? I mean, it seems to me that the value that we have is as much in our gross margin as our ability to deliver gross margin to the box manufacturers. So, what are we doing to extrapolate value?

Martin Ellis

That’s a good question. I think a number of factors play into this. The first is that, from an overall market standpoint, there is significant competition between those three vendors. You layer into that competition emerging from Cisco and EMC in their unified computing offering, and then from Dell as it moves further up into the data center and into infrastructure It, what you are seeing is competitive pricing between vendors before you get to how that may impact us. And then at the other end, you have got customers leveraging the competition between vendors. And so, the overall competitive dynamic is not specifically the OEM to Agilysys or to other solution providers, it includes competitive dynamics between vendors as well as with the customer. From a standpoint of how we interact with the vendors and with customers, our objective is obviously to be successful and a key solution provider with each of our vendors, but from the customer’s standpoint, provide them an overall IT solution that meets their needs.

And so, when you put yourself in the shoes of the customer, our objective is to be the trusted advisor in helping them deal with their IT implementation and infrastructure requirements. And so, the overall dynamic there is partly driven by platforms that the customer runs with their –

Zachary Prensky – Koyote Capital

And so, that limits our ability to swap out?

Martin Ellis

It does in some sense, because the customer has to be able to move applications from an existing platform to a new platform.

Zachary Prensky – Koyote Capital

Right. Look, I have been following these calls and obviously management is trying very hard to fix our overall margin problem, but I am getting the sneaking sense that we are basically operating as a conduit for those three entities. And that they are basically using us, in a sense, to do their dirty work for them and deliver sales opportunities and not sharing in the gross margins. So, I hope that in the coming quarter or two, we can figure out a way to solve this problem, and if not try to put this business in the hands of somebody who can, because these kind of margins on a go-forward basis are really not sustainable long term.

Martin Ellis

Your point is well made. I would just make one comment with respect to the vendors using the channel. They certainly do use the channel, but they use that as an alternative distribution mechanism to get to customers. And if you think about the overall demand for IT in the marketplace, the primary OEMs are looking at wherever you want to draw that line, the Fortune 1000, their named accounts, the top of the customer pyramid, and then the channel which includes us and others would focus on, sort of, part of that Fortune 500, Fortune 1000 target market as well as the mid-market and then small and medium businesses.

We historically played and have continued to play in that mid-tier section. So, we don’t generally play in the small and medium space. But ultimately, the channel structure as established by the OEMs is to where resellers and distributors ultimately get to compete in the overall market.

Zachary Prensky – Koyote Capital

Yes, but I mean, that is just a factual statement of what the market looks like. But ultimately, those three vendors that you mentioned are rigging our margins such that this business is not sustainable over the long term when you look at what your cost of capital is to invest in this business. We are putting in an Oracle system. We have got the 360 system, and when you are spending CapEx on a go-forward basis, the margins don't allow you a sustainable rate of return over the long haul. That is all I am trying to point out, is something has to break here.

Either these people want to do this themselves and sell to these customers directly or they are going to have to (inaudible) the pricing, or you find one of those vendors or somebody else, like an NCR, who would say, hey, look, we are willing to respect the value add that you bring to the table. But currently these vendors aren't allowing us to do that. As a shareholder that this is extraordinarily frustrating. So, I hope instead of talking about cost-cutting measures that management can focus on the underlying issue of our business model, which I think is really, really broken if you look at it from the long term.

Martin Ellis

Appreciate your comments.

Zachary Prensky – Koyote Capital

Okay. Thank you. No further questions.

Operator

(Operator instructions) Gentlemen, at this time, I would like to turn the floor back over for any additional or closing comments.

Martin Ellis

Well, if there are no further questions, we would like to thank you for joining us today, and we look forward to reporting on our progress after the third quarter. Thank you.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Agilysys CEO Discusses F2Q2011 Results – Earnings Call Transcript
This Transcript
All Transcripts