Agilysys Inc (AGYS) 2011 Q3 法說會逐字稿

Good morning and welcome to the Agilysys fiscal 2011 third-quarter financial results conference call. All participants will be in a listen-only mode until the end of today's presentation, when there will be an opportunity for you to ask questions.

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' corporate filings with the Securities and Exchange Commission, and the Company's earnings release.

Today's conference call is being broadcast live on Agilysys' website. At the conclusion of the call, it will be archived and available for replay via the investor relations section of the Company's website for approximately 30 days.

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

Thank you. Good morning and thank you for joining us to review our unaudited fiscal 2011 third-quarter and nine-month results. With me today is Henry Bond, our 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 our investor relations section of our website.

Also during today's review, we will be discussing non-GAAP financial data mainly adjusted EBITDA. Reconciliations to GAAP are provided at the end of the presentation, as well as in the press release issued this morning.

From a revenue standpoint, we are pleased with the continued positive momentum. Revenues are up 7% year-to-date and we expect this to strengthen in our fourth quarter. Our strategy to expand our solution offerings in TSG showed real traction and continued success, which reflects our initiatives to accelerate software and services growth. In fact, we saw great success with some of our newest software lines, growing well over 30%.

Our point-of-sale businesses, being the hospitality and retail segments, continued to improve with our focus on driving higher proprietary software and services content, as well as driving increased cross-selling of our maintenance services and mobile and wireless solutions.

We recently brought our next-generation hotel management system, Guest360, to market and have offered it for general availability. However, we continue aggressive investments in Guest360 as we add cloud and international functionality. Guest360 together with our previous investments in market-leading and complementary property management point-of-sale and inventory and procurement software solutions positions us very well for long-term success in the hospitality industry.

As the leading provider of mobile and wireless point-of-sale solutions, we continue to expand our solution offerings to many leading retailers and hospitality customers that are leveraging the growing wave of mobile and wireless technology trends. We remain confident that our considerable and ongoing investments in hospitality and point-of-sale solutions will position us for robust growth.

The positive demand momentum continued in the current quarter and we experienced traditional seasonality for our business with third-quarter consolidated sales increasing 18% from the September quarter.

Year-over-year sales increased 1% in the quarter. The supply chain remains high especially as it relates to end of quarter sales.

However, the positive revenue traction in the marketplace was offset by lower gross margins primarily due to lower vendor rebates. As a result, gross margin contracted to 21.5% of sales versus 23.2% in the prior year.

Selling, general, and administrative expenses increased $4.3 million, largely due to $1.1 million of expense development costs related to Guest360. In the same quarter last year, Guest360 investments and development costs were capitalized; roughly $0.7 million of non-capitalized expenses associated with our new Oracle ERP system, these costs are expected to be substantially reduced from the fiscal fourth quarter going forward; and the absence of a $1.6 million litigation award recognized in the previous year's third quarter.

Net income for the quarter was $2 million or $0.08 per diluted share compared with $13.6 million or $0.59 per diluted share a year ago.

Our initiative to accelerate software and services volumes is gaining traction with software and services growing 7% and 8% respectively over prior year. This is a direct result of our efforts to attach more software and services in the solutions we develop and sell. These increases in sales were partially offset by a 2% decline in hardware revenue.

As mentioned, gross margin was impacted by a decline in vendor incentives or rebates. The change in rebates is primarily associated with Oracle's new vendor incentive program. As opposed to past practices, where Sun paid partners like Agilysys an incentive, Oracle has eliminated incentives to partners and replaced this with a model where incentives are paid to distributors.

In the process, Oracle has significantly reduced the overall rebate pool and associated programs and today we only earn our historical contractual Sun rebates as determined by our procurement agreement with Arrow.

Our cost structure is generally in line with our expectations, but it is not in line with our lower gross margins and as a result, we are executing on an additional $7 million of cost savings in this quarter.

EBITDA for the quarter was $5.4 million and the decrease year-over-year was due to the lower rebates and the cost items already discussed.

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

Thanks, Martin. Sales in the Hospitality Solutions Group increased 8.2% from last year, driven by higher software and services sales. From an industry perspective, the strength in HSG has come from the managed food services and cruise line sectors, with commercial gaming and destination resort markets remaining soft.

Gross margin decreased to 54.8% from 63.6% last year, primarily due to lower services margins. The lower services margins were largely driven by proprietary services. Lower hardware margins also contributed to the decline.

SG&A excluding depreciation and amortization increased $1.2 million during the quarter, which was primarily due to the $1.1 million in expense related to Guest360. As Martin mentioned previously, the comparable costs were capitalized last year.

Adjusted EBITDA was $3.0 million, reflecting the lower gross margin and expensing of previously capitalized development costs.

Turning to RSG, revenue was down 8.2% for the quarter, primarily driven by lower hardware sales. The prior year quarter included a large order that was not repeated in the current quarter. This order accounted for more than 100% of the revenue decline.

Gross margin contracted during the quarter to 16.9% of sales, compared with 19.8% last year. The decline in gross margins was primarily driven by lower services margins. SG&A excluding depreciation and amortization was essentially flat during the quarter. Adjusted EBITDA decreased $1.6 million year-over-year on the lower revenue and margin.

Turning to TSG, revenue increased 1.6% in the quarter. We continue to successfully increase our attach rates of software and service bundles with hardware sales in the TSG business. Services grew 19% and software grew 7% in the quarter, while hardware revenue declined 1%.

Gross margins contracted by 70 basis points during the third quarter due to the decline in Sun Oracle vendor incentives. Excluding the impact of vendor incentives, gross margin increased by 90 basis points. SG&A expense was flat and adjusted EBITDA declined $0.7 million on the gross margin pressure.

In our corporate segment, SG&A expense excluding depreciation and amortization was up $2.9 million. This was due primarily to $0.7 million of ERP-related development costs, as well as the aforementioned $1.6 million credit we received last year from a litigation settlement. The EBITDA loss excluding charges was $6.8 million for the quarter or $2.9 million more than last year's $3.9 million loss.

Turning to consolidated results for the fiscal year-to-date, revenues grew 6.7% versus the prior year with all reporting segments posting revenue improvements. HSG, RSG, and TSG posted increases of 10%, 2%, and 7% respectively from the 2010 nine-month periods. Gross margins declined 240 basis points due to the previously mentioned lower vendor rebates as well as the competitive pricing environment.

SG&A excluding depreciation and amortization was up a little more than 5% due to the $2.3 million of Guest360 development efforts, $2.5 million of non-capitalized ERP expenses, and the absence of the litigation award of $1.6 million included in the prior year. In spite of these increases, SG&A excluding depreciation and amortization as a percentage of sales declined to 22.5% of sales from 22.8% in last year's comparable period.

Moving forward, we still expect to make non-capitalized investments in the development of Guest360. However, expenses related to the ERP implementation are substantially behind us now, with future ERP-related expenses expected to decline sharply.

Adjusted EBITDA excluding charges was $3.2 million compared with $13.0 million last year due to the previously mentioned lower gross margin and higher SG&A.

Switching to the balance sheet and liquidity for the period ended December 2010, cash and equivalents at the end of December increased approximately $6.2 million to $45.3 million compared with $39.1 million at the September end of quarter.

DSOs increased to 87 days at the end of the quarter from 77 days at the end of September. We were operating at DSOs in the low to mid 70-day range throughout most of the quarter and saw it grow at the end of the quarter. DSO is a significant focus and we expect the 87 days to be reduced by our March year-end.

Capital expenditures were $2.1 million for the third quarter versus $3.8 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 third-quarter and nine-month financial and operational performance is in the quarterly report on Form 10-Q, which will be filed within the next few 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?

Thanks, Henry. As discussed earlier, sales demand has improved both year-over-year and sequentially. We started to trend up from the lows reported in the spring of 2010 and have posted 7% revenue growth year to date. And we expect this to further accelerate in our fourth quarter.

For the current fiscal year ending in March, we expect to generate revenue of $690 million to $710 million and EBITDA of $3 million to $6 million. Depreciation and amortization is expected to be between $13 million and $13.5 million and stock compensation, which is included as an expense in calculating EBITDA, is expected to be approximately $3.5 million.

CapEx is anticipated to be between $8 million and $9 million, of which $3 million is related to capitalized costs associated with the development of Guest360 and $2 million for the implementation of the Company's new Oracle ERP system. Cash on hand is expected to be $60 million to $75 million as of March 31, 2011.

While year-to-date revenue and expenses have largely met our expectations, our bottom-line results have been disappointing. Given the loss of rebates incurred, we are executing on $7 million in cost savings in the current quarter. These savings will position the Company for approximately breakeven operating income on a go-forward basis. However, we are currently developing comprehensive profitability targets focused on materially improving our bottom-line as part of our fiscal 2012 budgeting and planning process.

In closing, demand is improving and we expect to report improved results for the final quarter of the fiscal year. In fact, we forecast revenue to grow approximately 10% this fiscal year. As we close the fiscal year, we will continue to focus on our long-term strategic initiatives and on improving our financial performance.

With that, we will open up for questions.

(Operator Instructions) Brian Kinstlinger, Sidoti & Company.

Thanks. Martin, I'm wondering, the lower rebates, is that only a Sun Oracle issue or are you seeing that across other vendors as well?

This is predominately a Sun Oracle issue. Other rebates have been consistent with prior trends based on performance with the individual vendors. So this has been largely a change in the rebate program that Oracle has instituted post their acquisition of Sun.

And so then you mentioned that Arrow, you will receive rebates based on your potential Arrow relationship. Is Arrow not giving you any rebates as well, just explain that relationship and are you getting absolutely nothing on rebates? And then is it the right thing -- the business of working with Sun Oracle, is that something that you are considering no longer being a partner for?

As far as the Arrow relationship is concerned, we have a long-term procurement agreement with Arrow that establishes our pricing service levels and rebates and incentives with Arrow based on our performance. That agreement has been in place for many years now and includes rebates associated with the purchase of Sun product from Arrow.

We continue to earn rebates under that program with Arrow and as Oracle has sort of gone down the past year of finalizing their channel structure and incentive programs, they have now set up their incentive structure to be paid through the distributors, and so part of what ultimately ends up with Arrow I am assuming funds part of our rebate from Arrow today. But we no longer earn rebates from Oracle.

Zachary Prensky.

Thank you, I would like to ask a more bigger picture question here, if I may. When you look at the balance sheet as of December 31, you have gross assets of $418 million and really when you back out the goodwill and intangible, we've got $290 million of current assets and $149 million sitting in the payables box. So really we are putting let's say our accumulated and so on shareholder equity of $191 million. You back out the goodwill and intangibles. We have $100 million, $120 million of assets that we are putting to work in a business that an Oracle is basically setting our profit margin in.

Going through your cost cutting and assuming a bit of growth, I just don't see an adequate return on capital invested in our business. Now, that may be a big picture question, but clearly there are other people like an NCR who could do a better job with our customer base. Are we just swimming in the wrong direction here end putting our assets into a business that will for the next three to five years generate a diminishing return on investment?

And if so, is this business better in somebody else's hands as opposed to a stand-alone business?

The question around the return on capital I think is a very good one, which is how do we generate an adequate return on capital given the assets? I think without getting into comments around portfolio restructuring, the objective is obviously to get the bottom line in line with now new gross margin for the business. And there are probably three ways in which we can address the return on capital issue.

The first is revenue growth and expanded operating income. Second is through managing our cost structure more efficiently and reducing the cost structure. The third is by managing our capital more efficiently.

From a revenue growth standpoint, we're starting to see an improvement in demand and share over the last couple of quarters have reported positive revenue growth and expect that to continue here in calendar 2011.

From a gross margin standpoint, it's our view that gross margins are now stable given some of the trends that we've seen over the last 12 months, and so understanding the impact of revenue growth with stable gross margins gives us a better sense of ultimately where we need to set cost structure to ensure that we have adequate profitability and that is a process that is going on right now as we do budgeting and planning for fiscal 2012.

And then the third and your comment around capital invested is something that is a high priority on my and Henry's agenda and how we ultimately make better use of our capital or effectively reduce the capital invested in the business so that we can drive appropriate returns on capital.

The question I think is right on where we are today we've got three levers. The revenue under the assumption of more stable gross margins going forward, cost structure and capital invested in the business.

Brian Kinstlinger, Sidoti & Company.

You mentioned you were going make some plans and talk about in fiscal '12 about better returns and you've talked about your levers and the revenue lever seems to be at the expense of lower profitability each time. So what can you do to offset the pricing pressure really and the rebate pressure that you are seeing without substantially higher volumes?

Brian, I think as we look at the last 12 months and if you reflect back on the comments made by Henry, we have certainly seen a decline in overall gross margin. But as you peel it back, vendor incentives have been a large part of that. There was certainly in the earlier part of the fiscal year fairly significant competitive pricing, but here in the last quarter, our underlying gross margins ex rebates have stabilized and have actually expanded slightly.

So from a gross margin standpoint, I think we are reasonably comfortable that a lot of the pressure that we've seen here over the last year has abated and that we are now managing under what has been reported here this last quarter approximately 17.5% gross margins in TSG and 21% to 22% for the overall Company depending on mix.

With that as a backdrop, our next task and that's what we will be working on is ultimately developing cost structure and business model to support that level of profitability. And we have already initiated on some improvements in cost structure here this quarter and we will work on further improving that as we go through our budgeting and planning in this fiscal year so that we start to report profit levels that are in line with what the business should report and then generate returns on capital that meet required investors returns on capital for the businesses that we are in.

Just to follow up on the Arrow side, in the December quarter, did you receive the level of rebates that you would expect going forward or are they getting an increased portion of that rebate pie that going in forward quarters you could get more?

At this point, Brian, we are receiving rebates under the procurement agreement with Arrow, as described in that agreement. And we expect that to be consistent going forward.

Last question I have is related to the service gross margin pressure you are starting to see and I think if I understood Henry's comments, it was on a proprietary services side, which I would expect it to be at lease on the other side.

So maybe about we have seen three consecutive quarters of the margins coming down on services. Is that going to get worse before it gets better? And what do you think is driving that?

I think there are a number of factors driving that. Some of it has been competitive pricing over the last year on the services side. Part of it has been customer work that we've done in customer mix, particularly here at the end of the calendar year, with performing services for customers in the retail market where there was an end of year push and customers wanted to roll out new technology.

And then part of it has been some competitive pricing out in the marketplace. As we have evaluated our services margins, we think they -- our proprietary services margins -- we think they are stable where they are and the prospect for some expansion in the proprietary services margin in the RSG business.

So I think going forward, Brian, we don't expect our proprietary services margins to contract much from where they are here and maybe even have some expansion on the RSG side going forward.

Zachary Prensky.

Thank you. Just sort of a follow-up and clarification to what you said. I understand everything in terms of the high-level analysis that you're talking about. You want to figure out how to gear the assets towards a 17.5% in the TSG in 22% overall Company profit margin. But I guess my question is a more fundamental question.

When you look at that and you say, okay, our cash and assets need to be X and they are X plus and we can return the plus to shareholders, my comment is a little different. You just told us as we've well known that Oracle is cutting the reimbursements back to people at our level. They are in control of the ball here and when you were asked whether or not you want to cease doing business with them, obviously that's not an option for us and you indicated such.

So it feels like that our gross margins as we would say in the banking business are other than temporally impaired. And if you look at the gross margins on the box players, they are hitting 40% plus.

So if I took the midpoint of your revenue of $700 million and I would go to somebody who already has a hardware business and a service business and endpoint customer business and said, look, I've got assets of X and I've got revenue of $700 million, what's that worth to you? What I'm trying to hear from you is whether or not you're going to make that analysis before you decide whether or not it's worth returning to us this excess capital that you will decide that we don't need given our lower gearing.

I would like to hear that there's some analysis going on between you and the Board that whatever could possibly squeeze out of returning assets is or is not dwarfed by the value of our business being in the hands of somebody who wouldn't have unimpaired gross margin.

Yes, well, in answer to that, the evaluation of creating wealth for shareholders is reviewed by the Board on a regular basis and it includes business performance, historical as well as potential changes to business performance. And it includes all other strategic alternatives, including alternatives that you have outlined. The Board regularly goes through a process of evaluating those alternatives.

So are we going through a process right now as you put together your 2012 plan? Are you putting together a comparison between what that number would look like versus what your 2012 plan looks like?

We go through an evaluations with the Board on an annual basis of our strategic plan and in that is a broader discussion of the overall business including performance, budgets, and ultimately the impact on stock price and value creation for shareholders.

There are no further questions at this time. (Operator Instructions). Zachary Prensky.

I'm sorry, operator, I was in the middle of responding to the comments and I'd just like to finish this train of thought.

I think it's important for everybody to hear the answer to this question. What I wanted to hear is a little more concrete. You mentioned earlier in your intro that you are working on your 2012 plan and that's fantastic, whether it takes four, six or eight weeks. My question is a more specific one.

Forget about whether the Board analyzes this on an annual basis. Once the 2012 plan is complete, will the Board go through a process of comparing the value on a return of asset basis to the value that the Company could get in the hands of somebody else?

Is that comparison going to be done once your 2012 budgeting and forecast is complete? Because I would assume only then we could have a comparison as to what the return on assets are of your plan versus what a strategic acquirer would pay for the assets.

The Board -- I understand the question. The Board goes through a comprehensive evaluation on an annual basis, and more regular basis. I can't get into specifics of each agenda item. And I know what you are looking for in the way of a response. But practically, until we have anything to share about changes, there's nothing to share. I mean, the Board goes through its evaluation on a regular basis and it is comprehensive.

I get that, and I'm not trying to be argumentative here, just quite the contrary. I'm a shareholder and I want the Company and its management to do well. My question again is -- I'm not asking you to tell me what you are or are not doing today. I'm asking at a certain point when your 2012 forecast and projections are complete and you will know what your targeted return on assets are, will the Board at that point compare your projected return on assets to what the assets could fetch in a sale to another strategic partner? That's my question.

I don't know if that specific question is going to be (inaudible) but there will definitely be a discussion around alternatives that are in front of the Board, as is always the case. And given that we haven't had that Board meeting yet, I'm not in a position to respond to specific evaluations the Board will or will not perform.

Okay, but don't you think that's a fair question to ask? I mean if you are going to take the Company's assets forward the next year or two and you have a strategic plan, it would make sense to shareholders that the Board should analyze your return on assets versus, you know, what a strategic acquirer could generate from those assets, right? I mean that's a fair question?

It is a fair question. I am just not in a position to share with you all Board deliberations and how the Board goes about evaluating alternatives.

Okay, thank very much, sir.

Thank you.

The are no further questions at this time. I would like to turn the floor back --

Thank you. If there are no further questions, we will wrap up today's call and we look forward to reporting our fourth-quarter results and outlook for fiscal 2012 at our next regularly scheduled call.

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