Agilysys Inc (AGYS) 2010 Q2 法說會逐字稿

Good morning and welcome to the Agilysys unaudited fiscal 2010 second-quarter financial results conference call. All participants will be in a listen-only mode and there will be an opportunity for you to ask questions at the end of today's presentation.

Before we begin, the Company would like to remind you that remarks made today may include forward-looking statements based on current expectations. These forward-looking statements may involve risks and uncertainties that could cause the Company's results to differ materially from management's current expectations. Please refer to the risk factors that can materially affect results outlined in Agilysys's corporate filings with the Securities and Exchange Commission and the Company's earnings release.

Today's conference is being broadcast live on Agilysys's website. At the conclusion of the call, it will be archived and available for replay via the investor relations section of Agilysys's website.

At this time I would like to introduce your host for today's conference call, Agilysys's President and CEO, Martin Ellis. Please go ahead, sir.

Thank you and good morning, everyone. Thank you for joining us today to review our fiscal 2010 second-quarter and first-half results. With me today is Ken Kossin, our Senior Vice President and Chief Financial Officer.

As we announced in our press release issued early this morning, we will be using a slide presentation as the basis for today's review. If you have not already done so, we invite you to access presentation from the investor relations section of our website. Please note that additional important 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 using non-GAAP financial data, namely adjusted EBITDA, which we define as operating income plus depreciation and amortization. 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 pleased with the strong sequential improvement given our difficult first quarter. More importantly, after an extended period of generating consecutive quarterly net losses, we were very pleased to report the first quarterly net profit for Agilysys since calendar 2007, as diluted earnings for the second quarter swung to a positive $0.12 per share from last year's loss of $4.72 per share.

Historically our second-quarter revenues are comparable with or slightly down compared to the first three months of the fiscal year. However, IT budgets started to loosen in our second quarter, and we delivered revenue growth that was well above normal seasonality, reporting sequential growth in sales of 20%.

Year-over-year gross margin contracted during the quarter to 28.1% of sales compared with 29.2% in the prior year. For the most part, this was due to lower rebates earned during the quarter.

We're now starting to see the full impact of the cost-cutting initiatives undertaken over the past 12 months. Selling, general, and administrative expenses again decreased sharply, declining $12.4 million year-over-year. In addition, we have identified a further $9 million of cost reductions, the benefits of which we will begin to realize in the fiscal third quarter.

This brings the cumulative cost-cutting actions taken over the past 12 to 15 months to approximately $44 million on an annualized basis. We estimate that roughly $3 million of that cost-savings number is not sustainable, as we intend to reinstate certain employee benefits as business conditions improve.

In the quarter, EBITDA improved to $7.4 million or 4.8% of sales from $5.1 million a year earlier. And EBITDA was up $13.8 million sequentially from the negative $6.3 million reported in this year's first quarter.

Consolidated revenues for the second quarter declined 9% to $156 million, down from $171 million in last year's second quarter. While sales were up sequentially, we continued to experience some softness in hardware and services demand. Software revenue increased 14% from a year ago; however, hardware and services posted declines of 4% and 33%, respectively.

Notwithstanding the decline in sales year-over-year and the decline of $6.2 million in gross profit, we were able to improve EBITDA year-over-year. We successfully reduced SG&A expense by $12.4 million from the year-ago quarter, with lower compensation and benefits, T&E expenses, professional fees, and lower bad debt charges all contributing to the improvement.

EBITDA increased $2.3 million year-over-year as the significant cost reductions during the quarter more than offset the lower gross profit. In addition, operating income for the quarter benefited from the absence of intangible amortization related to the Innovativ acquisition, which was fully amortized as of the first quarter of fiscal 2010. This was the first time since calendar 2007 that we have reported positive quarterly operating income.

All of this culminated in a return to profitability, as income from continuing operations rose to $2.9 million or $0.12 per diluted share compared with a net loss from continuing operations of $105.3 million or a loss of $4.66 per share last year.

At this time I would like to turn the call over to Ken to review segment results, the balance sheet, and cash flow.

Thank you, Martin. The Hospitality Solutions Group rebounded from a challenging first quarter as revenue increased sequentially from $16 million in the first quarter to $23 million in the second quarter, while revenue was flat year-over-year.

Demand softness continued in commercial gaming and destination resort markets, which was offset by the relatively stable managed food services, cruise line, and education segments of Hospitality. Gross margin decreased slightly, due to a higher mix of hardware sales compared to last year.

SG&A excluding depreciation and amortization decreased $3.5 million or more than 27% from a year-ago quarter due to lower payroll and contract labor costs associated with last year's cost-savings initiatives, lower incentive compensation, and T&E expenses. Also, bad debt expense was down $1.2 million compared with last year. In addition, the capitalization of Guest 360 development costs reduced SG&A by $900,000, which were expensed in the prior-year quarter.

EBITDA excluding charges improved significantly over last year while revenue remained flat.

As we discussed in the past, our Retail Solutions Group sales are volatile, based on the timing of large customer rollouts. RSG sales decreased 20% compared to last year as point-of-sale hardware and implementation services volumes declined. Last year's results included a number of large customer rollouts, which are absent in the first six months results of fiscal 2010. The demand environment in retail remains challenging, but has improved from the lows we saw earlier in the year.

Gross profit percentage decreased due to pricing pressures on hardware sales. SG&A excluding depreciation and amortization decreased $1.9 million, reflecting lower payroll costs, outside services, and bad debt expense. Notwithstanding the softer revenue, we showed significant improvement in EBITDA year-over-year.

Decline in demand for IT infrastructure solutions has moderated, as our revenue for the Technology Solutions Group declined 8% compared to a more than 23% decline in year-over-year first-quarter revenue. In addition, we are pleased to see TSG sales increase more than 21% sequentially. The demand environment is stabilizing and we expect to see a seasonal increase in sales in our third quarter ending December 31.

Gross margins declined in the quarter due primarily to lower rebate margins. SG&A expense excluding depreciation and amortization increased $1.2 million, primarily as a result of severance-related expenses from cost-saving actions taken late in the quarter, in addition to an increase in bad debt expense. Also, as Martin mentioned earlier, due to the intangible asset amortization associated with the Innovativ acquisition being fully amortized as of the first quarter, intangible amortization was down $3.1 million.

In our Corporate segment, second-quarter gross profit declined $600,000 as a result of recording the miscellaneous pricing adjustments to the respective business segments. SG&A excluding depreciation and amortization decreased $4.8 million, due primarily to cost-saving actions taken in fiscal 2009. The majority of these savings were employee related, in addition to outside services and professional fees decreasing $900,000, and travel and entertainment expense decreasing $200,000.

Turning to the consolidated results for the first half, we have shown significant sequential improvement in both revenue, up 20%, and EBITDA, up $13.8 million. Our performance for the first six months was hampered by the weaker than anticipated demand for IT products for the first three months of our fiscal year.

Revenue for the six months ended September 30 declined 18.5% compared to the prior year, reflecting respective revenue decreases of 18.5%, 28.9%, and 15.6% for our Hospitality, Retail, and Technology businesses.

Gross margin declined during the first half of fiscal 2010 to 26.5% of sales compared to 28.1% of sales in the prior year. This was primarily a result of first-quarter pricing pressures and lower rebates.

On the cost structure side, we continue to recognize the benefit of cost-saving initiatives executed in fiscal 2009 and have executed an additional $9 million in annual savings late this quarter, of which $4 million will be recognized in the second half of fiscal 2010. Overall, we are pleased with our cost structure as a whole.

SG&A decreased $23.7 million year-over-year, reflecting lower payroll-related costs, bad debt expense, professional fees, outside services, and T&E expense, in addition to lower acquisition-related intangible amortization.

EBITDA excluding charges was $1.1 million for the first half of fiscal 2010 compared to $3.3 million in the prior year.

Switching to the cash flow and balance sheet for the period ended September 30, 2009, we remain debt-free and currently have no outstanding balances against our $50 million revolver. On a sequential basis, cash was $48.2 million at September 30, a $2.8 million decrease from June 30 and a $12 million increase from the start of the fiscal year. The decrease in cash for the quarter was primarily due to cash consumed from accounts receivable of $20.2 million, offset by cash generated of $16.5 million from accounts payable.

DSOs improved slightly from 73 days at June 30 to 72 days at September 30 and a 16-day improvement from the 88 days at March 31.

Capital expenditures for the second quarter totaled $2.4 million, and $5.9 million for the first six months. The majority of the capital expenditures related to the implementation of the Oracle enterprise software and capitalized costs associated with Guest 360.

Additional information regarding our fiscal 2010 second-quarter and first-half financial and operational performance is in the quarterly report on Form 10-Q which will be filed later today.

I will now turn the call back to Martin for his comments on recent business trends and our expectations for the balance of the year, after which we will open up the call for questions. Martin?

Thanks, Ken. As discussed, sales have improved meaningfully since the lows reported earlier this year. June 2009 represents the low point for Hospitality and Technology Solutions and was followed by rebounds in the September quarter. Retail Solutions reported its low in the March quarter and was flat sequentially from June to September.

Although sales were down $15 million year-over-year on a consolidated basis, our second-quarter consolidated revenues bounced back $26 million sequentially, and we expect further sequential improvements in the December quarter.

The year-over-year decline in our business have moderated. And while some economic indicators have improved, market conditions still reflect uncertainty regarding the overall business environment and demand for IT products. However, the business is stabilizing. Our pipeline has improved, and we expect to see a seasonal increase in sales in our third quarter ending December. However, visibility beyond that still remains uncertain.

We have discussed our strategic cost initiatives for some time now and are pleased with the improvements we have made in cost structure to offset lost revenue and gross profit. We are well positioned to capitalize on any increases in IT spending and look forward to further leveraging our model as we grow future earnings.

As we look to the balance of fiscal 2010, we plan to continue to focus on those items under our control that can help produce tangible improvements in results.

Near-term, we are optimistic regarding our outlook for the third quarter of the fiscal year and expect financial performance in the second half to improve versus the first half.

Finally, from an operating standpoint, we have significant financial flexibility with $48 million in cash on hand and an undrawn revolver. Also, we expect to generate approximately $10 million in cash flow for this fiscal year.

With that as an overview, we will open up for questions. Operator?

(Operator Instructions)

Let's go ahead.

Brian Kinstlinger, Sidoti & Company.

Hi, good morning, guys. So I'm interested on TSG, the increase. Is that broad based? Or maybe give us a sense, because your biggest client has obviously been driving revenues there more so than others. Give us a sense if it was more Verizon and FiOS, the build-out, and what impact that had versus the rest of your client base.

Brian, I think it's a mix of both. Our largest customers continue to spend. However, from the lows of the June quarter we have seen improvements in our business. We saw improvements in our IBM business, some improvement in our HP business. And so while large customers have continued to spend, we've seen improvements generally across the board.

If I took your largest customer out of TSG, would you have still posted sequential revenue of -- maybe to what tune?

I don't have pro forma for largest customer or largest customers; but we would have still seen improvements in revenue.

Okay. Can you give us an update on what's -- obviously there's some uncertainty with the Sun/Oracle deal. What is going on in your Sun business? Is it declining even further sequentially? And in the meantime, are clients buying other product that you don't support? Or maybe give us a sense for how that's impacting business.

I think there is good and bad. The first part is, given the delay in closing the Oracle/Sun acquisition, customers have put investment decisions on hold as they have waited to learn more about the impact and the implications of the merger.

Having said that, in the last month or so Oracle and Sun have been far more articulate in expectations post-close as to what they are going to do. Oracle has made commitments to invest further in the Sun product line and to aggressively develop products that they have today.

So from that standpoint, I think customers have started to gain significantly more comfort than they potentially had earlier in the summer. From our business's standpoint, the Sun business has continued to perform relatively well, and we expect to see that business continue to perform well in the quarters ahead.

So Sun did improve then, I can infer, sequentially in the quarter just ended?

Yes.

It did? Okay. Then the margin this quarter in your TSG business, I believe -- and it's not in front of me right now. I believe it increased sequentially. How much of that was mix?

With services down so much compared to hardware, I guess I am shocked. What was the driving factors or the factors that led to the margin improvement on the gross margin?

Selling margins were stronger in the quarter. That is a function of mix of products and mix of customers. And from mix of customers, as we've discussed in the past, we have the opportunity to execute on some fairly sizable transactions with some customers and in this quarter had decided to forego one or two opportunities that had low margins.

So when you look year-over-year at mix of customers, mix of products, and then in the quarter selling margins, our overall margin improved largely due to selling margins, given the comments we made about rebates and rebate margins being down year-over-year.

Maybe give us a sense for -- would rebates rebound with volume? Historically you said this business can run, I think, long time about a 20%, 21%, 20% to 22% gross margin. Is that still what we're thinking?

I think generally that still in line with what we are thinking. It's a function of products. Rebates are obviously set by our vendors, and there are a variety of rebate programs, some of which are volume driven, others of which are first-dollar rebates, and others of which are there to incent and motivate specific performance, whether it's in geographic markets or in developing and selling specific products.

Over time, with stronger performance we would expect rebates to strengthen. However, that will be a function of our performance relative to vendor expectations.

Okay. Looking at Hospitality, maybe talk about what that quick rebound -- I think you mentioned that more food services. Maybe then give us a sense also of how the resort and casino budgets in Vegas and Atlantic City, how they are looking. And should we expect an improvement here in the second half of the fiscal year?

Yes, I think from the rebound standpoint it is probably worthwhile putting Q1 in context. Last quarter we indicated that we didn't believe that the Q1 performance was a new revenue run rate for that business and believed that it was more of an aberration. So from an HSG standpoint I think we are closer to what we expect as a revenue run rate.

As far as specific markets are concerned, clearly the overall gaming market has been challenged here in the last 12 to 18 months. Growth rates that were there previously -- 12, 18 months, two years ago -- have abated meaningfully. And as you know, properties that are being developed in gaming markets have either slowed and some have been put on hold.

Having said that, we have had some growth in the gaming market as companies have restructured their product portfolio and sold properties out to new owners. With that is the potential for new opportunities. However, the overall gaming market has certainly been soft here over the last 12 to 18 months.

We have seen reasonable stability in the cruise line market and in education and in corporate food service providers. So those three markets have probably been more stable; a little bit more of a challenging environment in the commercial gaming space.

Okay. Then if I look at the retail business, if you believe expectations, we're about to this week have the second straight month finally of year-over-year improvements in same-store sales. I'm curious what you're -- you have mentioned a couple times the lack of a couple of large deals that you have had in years past or last year.

What are your customers saying in terms of the next couple of quarters? Are they still reluctant to either roll out new stores or update software systems? Do we expect to see some bigger demand, some stronger demand here in the fourth quarter, third and fourth quarter?

Well, we certainly think the current market environment is a lot better than it was earlier this year. From a retail standpoint -- and this is also true of many other customers -- customers are looking for a payback period that is less than 12 months or effectively a high ROI given uncertainty regarding the overall market.

We've seen a pipeline with potential large opportunities; but ultimately it will be a function of whether customers are willing to invest in new product going forward. I think part of that goes back to your comment around sequential improvements in retail sales. The other part goes to customer-specific issues.

As you are probably aware, a number of retailers have closed storefronts and so there is that part of the change in the overall retail technology space, as many storefronts have closed and customers in the retail space look at their overall IT environment. On the other side, there has been some meaningful restructuring in that space, with changes in ownership; and that also provides opportunities.

I think generally speaking things are better, but at this point don't have expectations for robust increase in retail IT spending.

What do you think the return on investment is on average for your customers that either are replacing a system or new stores? You said less than 12 months is generally what your customers are looking for.

Well, here in the last number of months, I think whether it's retail or even in a number of other opportunities with Technology Solutions customers, the customers are looking for a short payback period given everybody's focus on profitability and the need for investments to pay off quickly.

I think that as market conditions improve, the payback period or the willingness for companies to invest in IT with a longer payback period will return. But here over the last couple, three quarters, the focus has been on short-term returns. And less companies are in the midst of meaningful investments or building out a data center or consolidating IT infrastructure moving or moving onto new IT platforms.

Okay. You mentioned a couple times you expect the third quarter to be stronger in terms of demand than the second, which I don't think is overly surprising. Do you think that the seasonality will be more or less pronounced than the typical quarter, based on the first month that you have already had on the books and what customers are saying?

You know, as we look at seasonality, obviously the expectation is for a seasonal improvement as we've mentioned. I think when you look at the industry -- and before I get to company-specific comments -- the industry and our competitors, suppliers, and vendors have indicated seasonal improvements that are slightly below prior years to slightly above prior-year improvements in seasonality.

I think from our standpoint at this time, we expect to see seasonal improvement but maybe not quite at the same levels as we have historically.

Is that across all industries mainly? Because mainly it is stronger in Retail and TSG. Is it both of those segments that you expect that?

The seasonal improvements in December are largely Technology and Retail. Hospitality customers can do some refresh of their hardware and infrastructure platforms that run our software. But generally speaking, it's more of a Technology and Retail segment.

But with one caveat. As you know, many retailers slow down on any IT implementations late in December as they are dealing with the holiday season. So typically, services decline at that point. But customers may do purchases for product rollouts in the new calendar year.

Okay. I'm going to ask two more because it didn't sound like anyone else was in the queue. The first one is on the cost cutting that you mentioned, the $9 million. Can you break that down by which -- and maybe you did and I missed it. Can you break it down by the three or the four segments including Corporate, where the costs are coming out?

About $4 million in TSG; about $400,000 or $500,000 in RSG; almost $2 million in HSG; and about $2.7 million in Corporate.

Then you had mentioned a comment about some benefits coming back as the business -- how much was that that you said?

Approximately $3 million.

So that will offset the $9 million starting next quarter, partially offset the $9 million starting next quarter?

No, that would be at some future date. I don't know when that could be.

But as I've mentioned, we would look to reinstate some of the benefits as business conditions improve. But that return of the $3 million will not impact the next couple of quarters.

Okay. The last question I had, I didn't expect that you would be recognizing tax this quarter. Will you be recognizing tax or is there NOLs you can recognize in the second half of the year? What should we think about there?

This is Ken. The tax expense that we recognize is primarily related to our STS acquisition, and it's New Jersey state income taxes. And going forward, as that business continues to be profitable, we will probably have a slight tax expense going forward.

But if I can just look back now at my numbers real quickly, I think you paid 26% tax rate. That's pretty high for one small division to be paying taxes, no? $1 million on that business was taxable; so STS provided something almost like $2 million of your $4 million of EBIT?

I am not sure exactly how you did your calculations, but --

I just drew about a 40% tax rate.

(multiple speakers) businesses in subsidiaries, and depending on which business is in the subsidiary and what expenses are allocated to the subsidiary, we end up paying taxes assuming there is profit. So I don't think you can compare directly subsidiary profitability with overall Corporate profitability.

So how would you model taxes if you were me?

I think the run rate that you have here in this quarter is probably a reasonable estimate for taxes going forward.

Okay. Thank you, guys.

Thanks, Brian.

(Operator Instructions) Brian Kinstlinger.

So I'll only ask one more. I'm curious if there is earnout dates that are close in fiscal 2010, or even next year. And maybe speak to the likelihood of those payments being made or need to be made.

Brian, there are no additional earnouts in place on any acquisitions.

This year or next year?

This year or next year. All earnout periods have ended.

Were you required to make any earnout payments this year that I didn't see?

Not in this year. We made earnouts payments last year.

Okay. Thank you.

Thanks, Brian.

Thank you, Mr. Ellis. There are no further questions at this time. I would like to turn the floor back over to you.

Thank you. With that, we will wrap up today's call. We would like to thank you for joining us today and look forward to reporting on our progress at the end of the third quarter.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time.