Agilysys Inc (AGYS) 2011 Q1 法說會逐字稿

Welcome to the Agilysys fiscal 2011 first-quarter 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 can cause results to differ materially. Important factors that could cause actual results to differ materially from those in the forward-looking statements are set forth in the Company's reports on Form 10-K and 10-Q and news releases filed within the Securities and Exchange Commission.

Today's conference is being broadcast live on Agilysys' website and will be available for replay on the site for approximately 30 days.

Now I would like to introduce your host for today's call, Agilysys' President and CEO, Martin Ellis. Please go ahead, Mr. Ellis.

Thank you, Devon. Good morning, everyone, and thank you for joining us today to review our unaudited first-quarter results. With me today is Ken Kossin, our Senior Vice President and Chief Financial Officer.

In our discussion today, we will be using adjusted EBITDA. Reconciliations to GAAP are provided at the end of the presentation as well as in the press release issued this morning. We will also be using a slide presentation as the basis for today's review. If you've not already done so, we invite you to access the presentation from the investor relations section of our website.

Turning to a quick review of the first-quarter highlights, the 11% increase in services revenue and 35% increase in software during the fiscal first quarter led the way to 2% higher consolidated revenue. On a segment basis, hospitality and retail met expectations while technology solutions revenue with some of our larger customers lagged expectations during the quarter. We successfully increased attach rates, funding more software and services with the hardware.

Improvements in software and services continued to validate our strategy of developing higher value solutions with more proprietary software and services. The increased software and services revenue helped expand gross margin 110 basis points from 24.5% last year to 25.6% this year.

Largely reflecting lower compensation and acquisition-related intangible amortization expense versus last year, quarterly SG&A also improved, down $4.7 million or approximately 11%. While we reported a pretax loss for the quarter, a one-time non-cash adjustment to the Company's deferred tax valuation allowance taken in 2009 contributed to an income tax expense of $4.5 million. Including this one-time tax charge, we reported an improvement of $0.10 per share or a net loss of $0.45 per share compared with a net loss of $0.55 a share a year ago. Excluding the one-time tax adjustment, earnings per share improved $0.30 year-over-year.

The increase in consolidated sales year-over-year was largely driven by strengthening demand across the board. We saw improvements in most segments in which we compete but as we have frequently discussed, we are partly impacted by the buying habits of our large customers, where purchases were lower this quarter than in the prior year. While hardware sales were down 7% versus a year ago, software and services more than offset the decline and were up 35% and 11% respectively.

The gross margin expansion reflected a higher mix of both software and services margins, which were partially offset by lower rebate margins in the quarter. Notwithstanding the improvement in overall gross margin, pricing remains competitive and acutely so in certain accounts, as well as generally for server and storage-related products.

Our costs remain in line with the expectations and as a result, adjusted EBITDA narrowed to a loss of $2.7 million from last year's loss of $6.6 million. We have made progress in improving profitability but continue to focus on driving the top line and managing our costs to further improve our overall profitability.

At this time, let me turn it over to Ken to review segment results, balance sheet, and cash flow.

Thanks, Martin. Sales for the Hospitality Solutions Group were $23 million for the first quarter of fiscal 2011, 44% higher than a year ago. This was in line with our expectations. We continued to see solid demand in both the crews and food service segments, while both the casino and resort segments of the market remained soft.

Overall gross margin declined compared to last year as a result of a higher mix of hardware sales in the current year. SG&A excluding depreciation and amortization decreased approximately 6% for the quarter, primarily as a result of reduced benefit costs.

In June, we announced the general availability of our Guest 360 Property Management system. Capitalized costs for Guest 360 were $1 million for the first quarter, same as last year. Going forward, these development costs will be expensed resulting in SG&A increasing by approximately $1 million per quarter for the remainder of fiscal 2011. Adjusted EBITDA was $3.3 million compared to $1 million loss last year and EBITDA margin was 14.4%.

Turning to our Retail Solutions Group, as we have discussed in the past, RSG results tend to be more volatile due to the timing of large customer rollouts. Despite a 3% decline in revenue, gross profit increased $300,000 for the first quarter compared to last year.

Gross margin percentage increased 22% -- from 22% to 23.8% as a result of improved hardware and software pricing in addition to a higher proportion of services as a percentage of total revenue. SG&A excluding depreciation and amortization was essentially flat.

As a result of higher gross margins, adjusted EBITDA increased $300,000 to $1.8 million from $1.5 million reported in Q1 last year. In addition, EBITDA margin improved from 6% last year to 7.7% for the first quarter this year.

Switching to our Technology Solutions Group, TSG sales were lower than expected as we saw weak demand in the quarter from some of our large TSG customers. In addition, gross profit percentage declined 240 basis points compared to last year as a result of lower vendor rebates and continued competitive pricing pressure on hardware. Demand across our TSG customer portfolio was broader than in the past several quarters. We saw an increase in IT infrastructure demand in both the financial services and manufacturing industries. In addition, we successfully increased attach rates, bundling more software and services with hardware sales.

SG&A excluding depreciation and amortization decreased by $800,000 for the quarter, primarily as a result of reduced benefit costs. Adjusted EBITDA declined $2 million to a loss of $1 million for the quarter compared with $1 million in the prior year. This was primarily due to lower revenue and gross margin pressure on hardware.

In our Corporate segment, SG&A excluding depreciation and amortization declined $1.1 million, primarily due to lower benefit costs compared to prior year. In addition, a $400,000 restructuring charge was taken in the quarter related to a benefit payment.

For fiscal 2011, we are maintaining our run rate of approximately $7 million per quarter for corporate adjusted EBITDA excluding the restructuring charge.

The tax calculation I referenced earlier in the presentation was related to the improper netting of deferred tax assets and deferred tax liabilities resulting in an understatement of the tax valuation allowance recorded in fiscal 2009. The impact of this one-time non-cash adjustment recorded in Q1 fiscal 2011 was approximately $0.20 per share.

Switching to the cash flow and the balance sheet, we continue to remain debt free and currently have no outstanding balances against our $50 million revolver. Cash and cash equivalents were $50 million at June 30, 2010, a decrease of $1 million from June 30, 2009 and a decrease of $15.5 million from March 31, 2010. The decrease in cash for the quarter was primarily related to a $17.3 million increase in accounts receivable and an $11.4 million temporary increase in inventory which was more than offset by a $17.7 million increase in accounts payable.

As a result of the increase in accounts receivable, DSOs increased to 83 days at June 30, 2010 from 69 days at March 31, 2010. The increase was primarily related to the transition of invoicing to the Company's new Oracle ERP implementation. The transition has been largely completed and we expect DSO to return to a more normalized level over future quarters.

Capital expenditures for the first quarter totaled $1.8 million, the majority of which related to the capitalization of Guest 360 and the implantation of our integrated Oracle ERP platform. Additional information regarding our fiscal 2011 first quarter financial and operational performance is in our quarterly report on Form 10-Q which we expect to file by Monday, August 9.

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

Thanks, Ken. Since the loss experienced early in 2010 -- that was fiscal 2010 -- market conditions have improved and the demand environment has improved. As mentioned this morning, we are beginning to see increased activity but pricing is competitive, which continues to pressure gross margins. However, our strategy of developing higher value solutions with more proprietary software and services is contributing to improved margins.

Our investments in people, infrastructure, and product development are starting to make the contributions that we expected. The improving demand environment bodes well for the future and our integrated Oracle ERP platform will over time contribute to improved financial reporting, internal controls and operating efficiencies, as well as enhanced customer service.

Finally, the outlook for cash flow generation remains good and we expect to generate $10 million to $15 million in cash flow in fiscal 2011.

With that, we will open the call up for questions.

(Operator Instructions) Brian Kinstlinger, Sidoti & Company.

Good morning. The first one -- a minor question on the cash flow. When you give that guidance of $10 million to $15 million, is that before CapEx or is that including CapEx $10 million to $15 million?

That includes CapEx, Brian.

Okay, can you maybe comment on the proprietary server market? Last quarter, you talked about it being a major cause for some depressed profitability. What happened this quarter in the proprietary server market? And what does your pipeline look for when that might return if it hasn't yet?

Firstly, from an overall market statement or standpoint, our proprietary service have been mediocre when you compare demand to Intel architecture products. From an Agilysys standpoint, we actually had a reasonably good quarter in proprietary service. Obviously we are partly driven by the buying habits of our customers. But from a proprietary service standpoint, our performance was reasonably good. We expect that to continue in the quarters going forward but certainly a growth rate for proprietary service have not been anywhere close to what you have seen in Intel architecture products.

I guess reconcile that with the much lower gross margin compared to the fourth quarter, when high-margin proprietary servers weren't so good.

I think part of it is customer mix. In addition to that, you've got rebate changes that have taken place here in the last quarter or so that have also impacted margin. And so I would probably put it in three buckets, customer mix, and associated with that is also product mix. And then changes in rebate programs with our primary vendors.

Will those rebate programs continue to impact you in the foreseeable future?

Yes, I think each of the vendors have their own particular rebate programs. Against the programs, we execute pretty well. But as they change their programs, they impact everybody in the channel including us. And so I would expect current levels of rebates to probably be the trend going forward.

Okay, I guess the next question I have is if you could reconcile Arrow, your biggest supplier, growing 20% sequentially and fairly -- if not as strong if not better year-over-year on their enterprise business, and you guys posting the declines that you are, would you say you're losing market share? If so, can you point to why you are?

I think, Brian, you've got to go a level deeper on products and ultimately end-user customers. From a product standpoint, Arrow, as does the other distributors, sell a lot of Intel architecture product. IBM was up about 30% and Intel architecture and HP back when they last reported were up about 40%. If you look at Intel's results, there was significant strength in the Intel architecture space.

We certainly sell Intel architecture product and a reasonable amount of it, but not as much as we do proprietary servers. And so I think partly behind Arrow's numbers is the strength of the Intel architecture product and then depending on individual resellers that are tiered to Arrow and their customer purchases, that would influence Arrow's performance too.

Okay, I guess if you could also then talk about the Sun and Oracle relationship. Is that coming closer to being resolved? And do you think Sun is going to sell directly a little bit more into your markets? Maybe you will lose share there as well.

From the overall channel programs, I think a lot of progress is being made over the last 90 days as Oracle has started transferring customers from what was the Sun Partner Network to Oracle's Partner Network. Programs are becoming defined and we are learning the new Oracle Partner Network particularly as it relates to hardware products quickly, and the implications that has for business going forward.

I think the clarity is certainly a lot better now than it was 90 days ago and we are actually starting to gain traction. From an overall go-to-market strategy standpoint, I think as we have discussed our relationship with Oracle and of (inaudible), what they have communicated in the market place, the objective of the channel with Oracle is to add value. And where we are adding value to the customers, we will continue to participate.

I think there are certain customers where there may be a direct relationship and an Agilysys relationship, but at this point, I think Oracle's focus is more broadly on expanding their footprint in the marketplace than necessarily squeezing the channel, except for comments that they've made where partners are purely providing fulfillment services to customers. And that historically has not been our go-to-market strategy.

Is there a timeline where they expect to announce who their relationships or vendors are going forward -- resellers? Is there a date they expect -- you expect to hear a consolidation from how many ever resellers they have for Sun right now into a much smaller number?

No, and I think that that question is probably better addressed to Oracle. But I think Oracle's view is that they are happy with the partner -- the objective is for the partners to create value in the channel. But, Brian, I would suggest a conversation with Oracle, because I don't know of any announcement that says a change in their list of partners.

Okay, was there a gain in the quarter on your insurance -- self-insurance program that I saw in the cash flow that flowed through the income statement?

Yes, we did see, if you recall last year's quarter, we had a significant increase in medical and benefits. This year, that actually did not repeat itself and we saw a slight pickup that flowed through the income statement for the quarter.

A gain?

It was -- compared to last year, yes, there was a reduction, but it wasn't a gain on the P&L. It was a reduction in medical claims.

Okay, and then I may have missed it when you were mentioning it. It seems that given where the EBITDA and profitability of the Company are versus the revenue trends your cost once again like a year and a half ago or two are a little bit out of line from where the demand is. What are your plans for getting it back into the appropriate level so you can start generating more profits or is that not the case right now and you are not planning to be cutting costs?

Well, we have -- as we've mentioned in the past, Brian, we continue to look at cost structure and profitability as well as the overall pipeline and demand environment. From a retail and hospitality standpoint, I think as I opened my comments with this morning, both retail and hospitality are largely on track. TSG broadly speaking in the market place is on track. What we had was -- as I've commented -- some of our larger customers that didn't procure as much in these quarter as they have had in the past.

And so as we look at overall cost and cost structure and profitability, part of it relates to pipeline. Part of it relates to quarterly issues. And then part of it relates to overall profitability. And we go through that process on a regular basis and continue to evaluate the overall profitability. But at this point, we don't have anything to announce or discuss around changes in cost structure.

Okay, I guess the last question, and then I'm going to get back in the queue in case someone else is in the queue to ask questions. You're talking about your top customers being one of the problems in this quarter. Talk about your top customers disclosed as Verizon. Can you talk about their trends and maybe the pipeline with them over the next year so we can gauge whether profits are going to improve or not?

Well, from a customer standpoint, let me talk generally first. Out in the marketplace, we have seen improvements in the demand environment across most of the segments in which we compete. From a customer standpoint, we have a number of large customers, some of whom procure with us most quarters or every quarter, and some that procure with us some quarters during a year. That would certainly influence total revenues.

From an overall Verizon standpoint without getting into pipeline-related issues, our relationship with Verizon continues to be very strong. We have grown the account and have continued to diversify the overall solution -- product solution that we offer to Verizon. So the relationship is good. The product solution has diversified and we have grown it. Outside of that, I am not in a position to talk about a pipeline with specific customers.

All right, I'm going to give -- I've got a handful more questions. I'll get back in the queue just in case someone else is in there.

Matt Sheerin, Stifel Nicolaus.

Good morning. Most of the questions, my questions, were already asked and answered. So just looking at the proprietary server business versus the Intel architecture, do you have a percentage breakdown? And in the open architecture business, have you seen the kind of growth rates than other companies have in terms of either sequentially or year-over-year?

We have seen similar growth rates in the Intel architecture space that other companies have seen that, but in terms of total mix, Intel architecture for us is a smaller component of total sales. We certainly do a far greater proportion of total revenue in proprietary and storage products than in Intel architecture. But we saw similar trends.

And was -- did you state who your top or 10% suppliers are?

Well, the top four or five would be IBM, HP, Sun, EMC, Net Apps, Hitachi, and we also include in the 10-K of if you look at the front of the annual report, our primary suppliers. But in terms of top five or six, those customers -- those suppliers would be in the top five or six. And then have meaningful relationships with Cisco, Brocade, and Oracle I would include on the software side were we have a meaningful relationship with Oracle. Symantec around security is a sizable relationship.

Okay, I know that in your fiscal year report you talked about Sun accounting for I think 32% of revenue. And that was for the full year. I don't know what it was in the March quarter, but is that a number that is significantly below that right now?

I don't know that we had Sun broken out. I think we had Verizon broken out. But in terms of overall mix, Sun for us has been reasonably stable the last few quarters. I don't have the mix for you in this specific quarter, Matt. I can -- we can certainly get back to that. We'll see if we disclose it in the (multiple speakers)

Okay, I am just trying to figure out the trends there. And then just lastly, having followed Agilysys for a few years, I know you've gone through lots of different changes and transformations, if you will. Just help us understand kind of what your vision for the Company is over the next two to three years.

Over the last nine months or so, we've spent a good deal of time in each of our businesses developing a three strategic plan and roadmap for the businesses. And without getting into specific details, each of our segments, retail, and hospitality, and technology solutions, have been focused around increasing the value that we offer to customers through driving higher proprietary content. And across the board, that's a primary objective. Proprietary content is our own professional services and proprietary software.

Depending on which of the segments you are looking at, we obviously have different mixes of proprietary software and services. But each of retail, hospitality, and technology solutions have that as a primary objective. Supporting that are then business-specific initiatives.

In addition to growing proprietary content, we have had a look at geographic footprint and where we can expand the overall geographic footprint both in North America and from a hospitality standpoint internationally. And then the third component would be around diversifying our customer base more broadly and that would be applicable across all three segments.

From a three-year standpoint on that, we have not put out any communication as to what we have in the way of objectives from both a revenue or a bottom line or a cash flow perspective. But those primary components are the underlying foundations for our three-year plans, which is proprietary content, geographic growth, and then broadening the customer base. And then under each of the business units we have specific initiatives to achieve those goals.

Okay, great. Thanks a lot and good luck.

(Operator Instructions) A follow-up from Brian Kinstlinger, Sidoti & Company.

Great, just to follow through with the questions on the larger clients, is a percentage of your TSG business -- what are the top 10 customers makeup of that revenue?

The top 10 customers, Brian, on an annual basis because quarterly it can move around a good amount are probably going to be in excess -- well in excess of 50%. But changes are an anomaly that will influence that from quarter to quarter and annually. We obviously disclose Verizon, but there are other large customers that depending on their buying habits may influence top 10 mix in any one quarter or fiscal year.

I guess I'm confused, 50% because you only disclose one 10% client, how it gets to be that large. It should -- maybe go through that.

Well, you asked of TSG.

But it is still very -- 50%, that's 80% of your business to begin with, so you would think there would be more than one customer there unless Verizon makes up a huge portion of that 50%.

Well, Verizon makes up 30% to 40% of TSG.

I se. So basically when you are talking about bigger customers, Verizon apparently would have been very weak this quarter and hopefully that will rebound? Can I infer that? Because otherwise you have such a broad set of customers and the market is improving. It doesn't make a lot of sense.

Yes, Verizon is a large customer. There are other large customers that bought in the prior year, but Verizon is obviously an important contributor to overall revenue.

Okay, in terms of taxes maybe for this year and next, how should we think about what your tax is going to look like going forward?

Brian, I would say excluding the one-time non-cash charge that we took this quarter, I would say a good estimate for FY '11 effective tax rate is probably between 5% and 10%. And then probably in FY '12 going back up to about 35%, because we'll still be utilizing in FY '11 our NOLs.

Okay, so even if you have losses, then you will have -- you won't be -- taxes won't be zero? You'll actually have a benefit? Is that the case at about 5% to 10%?

Yes.

Okay, in terms of the hospitality business, two questions there. First of all, the margins were one of the weakest in two years. I think you said that was because of mix, more hardware and less software. What did the pipeline look like going forward there? Do you expect it to be a lot more hardware-related or is it going to return to some normalized mix that you've traditionally had in the last year or two?

I think mix will remain largely consistent with what we have seen. The hardware wasn't significantly greater than it is in terms of normal mix compared to prior year. It certainly was higher than the June quarter in the prior year. But in terms of historical and recent mix, it's largely consistent. Going forward, we would expect that mix to remain largely stable.

Maybe talk about is there any signs in the gaming market, whether it be Vegas, Atlantic City, or even Asia that there is going to be a return in that market in the near future? Or is capital spending there too weak to think about upgrades in technology?

Well, in Asia you've got growth in gaming and some construction of new hotels, and so we would expect some growth in Asia. In North America, less so. There is a little bit of portfolio restructuring taking place with owners of various casino hotels looking at their portfolio of assets. That doesn't necessarily result in obviously in a new footprint but it does lead to potentially upgrades at certain customers.

So I think if you sort of bifurcate markets, North America weak and probably for the remainder of our fiscal year continues to be weak. Asia has had some growth with new properties being built.

Okay, then the last question on the DSO, you mentioned it would take some time to -- over time you would get back to normalized DSO levels. Give us a timeframe. Is that next quarter when you report we should expect it has corrected itself or it could take a couple of quarters?

I think internally we've discussed a couple of quarters. We would like to get there by the end of this quarter, but realistically a couple quarters.

Okay. Great, thank you.

We have no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thank you, Devon. With that, we would like to thank you for joining us today and look forward to reporting our second-quarter results in November.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.