Agilysys, Inc. (NASDAQ:AGYS) Q2 2020 Earnings Conference Call October 24, 2019 4:30 PM ET

Company Representatives

Ramesh Srinivasan - President, Chief Executive Officer
Tony Pritchett - Chief Financial Officer
David Wood - Vice President of Corporate Strategy & Investor Relations

Conference Call Participants

Tyler Wood - Northland Securities
Allen Klee - National Securities

Operator

Good day ladies and gentlemen, and welcome to the Agilysys, Fiscal 2020 Second Quarter Conference Call. As a reminder, today’s conference may be recorded. I would now like to turn the conference over to Mr. David Wood, Vice President of Corporate Strategy and Investor Relations at Agilysys. You may begin.

David Wood

Thank you Sarah and good afternoon everybody. Thank you for joining the Agilysys, fiscal 2020 second quarter conference call. We will get started in just a minute with management’s comments, but before doing so, let me read the safe harbor language.

Today’s conference call contains forward-looking statements within the meaning of the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as anticipate, intend, plan, goal, believe, estimate, expect, future, likely, may, should, will and other similar references to other periods.

Examples of forward-looking statements include among others our guidance related to revenue, adjusted EBITDA and free cash flow, and statements we make regarding revenue, recurring revenue and subscription revenue growth, continued sales and business momentum, and increasing investments and resources in R&D, SaaS operations, professional services and customer support.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in the circumstances that are difficult to predict and many of which are outside of our control.

Our actual results and financial conditions may differ materially from those indicated in the forward-looking statements. Therefore you should not rely on any of these forward-looking statements.

Important factors that could cause our actual results and financial conditions to differ materially from those indicated in the forward-looking statements today include among others, our ability to maintain operational efficiencies and meet customer demand for products and solutions, and the risks described in today’s news announcement and in the company’s filings within the Securities and Exchange Commission, including the company’s reports on Form 10-K and Form 10-Q.

Any forward-looking statement made by us in today’s conference call is based solely on information currently available to us and speaks only as of the date on which it was made. We undertake no obligation to publicly update any forward-looking statements that may have been made from time-to-time, whether as a result of new information, future developments or otherwise.

Today’s call and webcast will include non-GAAP financial measures within the meaning of SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP can be found in today’s press release, as well as on the company’s website.

With that, I’d now like to turn the call over to Mr. Ramesh Srinivasan, President and Chief Executive Officer of Agilysys. Ramesh, please go ahead.

Ramesh Srinivasan

Thank you Dave and good afternoon everyone. Welcome to our fiscal 2020 second quarter earnings call. Joining me on the call today is Tony Pritchett, our CFO.

We are pleased to report that we completed yet another strong quarter, highlighted by revenue of $40.7 million, a 19% increase over Q2 of last year, with increases across all three of our revenue lines: recurring revenue, product revenue and in particular, professional services revenue.

Professional services revenue is directly proportional to the number of software implementations we are involved in. It is therefore a good indicator of our current level of overall selling success and business activity. The fact that this was a record professional services revenue quarter exceeding the $8 million mark for the first time, all that is well for future recurring revenue growth, especially subscription revenue growth given a majority of the installs we are currently working on are subscription revenue related. Recurring revenue was a record $20.3 million, driven by a 16% year-over-year increase in subscription revenue.

Regarding overall quarterly revenue, this quarter marked the eighth consecutive sequential revenue increase, sixth consecutive record revenue and fifth consecutive double-digit year-over-year revenue increase. Fiscal 2020 second quarter was also a record quarter in terms of value of major competitive replacements won. In summary, we are improving with respect to almost all business indicators every quarter.

In addition, our cash balance increased by $1.7 million during fiscal 2020 second quarter, a significant improvement over the $2.2 million cash loss during the same period last year. The cash balance at the end of fiscal 2020 second quarter is about $6 million higher compared to the end of the second quarter last year. That is our largest year-over-year cash balance increase during a 12-month period since Q1 of fiscal 2015, which was only better due to the effect of the sale of the Retail Solutions Group.

We continue to expect fiscal 2020 to be a significantly better free cash flow positive year compared to fiscal 2019. We remain committed to both, being disciplined in driving revenue growth in a profitable manner, and supporting strategic investments that will help drive profitable revenue growth.

In terms of selling success, fiscal 2020 second quarter was our second best quarter ever. In fact, the past recent four quarters have been four of our five best quarters since we transformed to a pure play hospitality software solutions company in fiscal 2014. Our best quarter ever was back in fiscal 2016, and included a major hardware refresh project that skewed the number upwards.

So in terms of consistent successful sales activity, this trailing 12-month period is a new high mark for us. In addition, our last five quarters are all record quarters for close deals involving software subscription services. We are confident the year-over-year growth in quarterly subscription revenue will remain in the 20’s in percentage terms for the full fiscal year 2020, and during most quarters for the foreseeable future.

Our selling and revenue momentum are not only at record levels now, but just as important are also much more broad-based than before, providing us with added future growth areas and further diversifying and de-risking our revenue streams.

Our strong presence in the gaming and casinos vertical continues to expand as evidenced by our growing partnership with Choctaw Casinos and Resorts, well known for the top-rated casinos and the AAA Four-Diamond hotel in Durant, Oklahoma.

During Q2 Choctaw selected our PMS property management system suite of products, including subscription based versions of LMS, rGuest Book and rGuest Express Mobile for all three of their hotel properties in Oklahoma. Another well-known regional gaming operator, Maverick Gaming, joined our family of customers during Q2, purchasing subscription based versions of InfoGenesis, InfoGenesis Flex and rGuest Pay for their properties in Nevada, Colorado and Washington State.

Outside of gaming, we are particularly encouraged by our increased selling momentum across the hotels, resorts and cruise ships vertical. We expanded our partnership this quarter with The Kessler Collection Hotel Group who purchased InfoGenesis, rGuest Pay and rGuest Analyze, all subscription based for a few of their properties, including for the Beaver Creek Lodge, a Marriott Autograph Collection, ski-in / ski-out hotel in Colorado.

Also, in the hotels resorts category, Jackson Hole Mountain Resort in Teton Village, Wyoming purchased subscription based versions of InfoGenesis, InfoGenesis Flex, rGuest Pay and rGuest Seat for all their on-mountain ski resort fine dining and quick serve restaurants.

In the cruise vertical we expanded our partnership with Carnival UK during the quarter. Carnival UK is now looking to expand their deployment of InfoGenesis and InfoGenesis Flex onto their 5,200 passenger cruise ship, Iona, the biggest ever ship purpose built for the UK market that will launch in May 2020. This will be our second ship with Carnival UK after the successful pilot on their 3,000 plus passenger Grand class cruise ship, Ventura. We look forward to a long and successful partnership with Carnival UK, supporting their food and beverage point of sale needs.

In the foodservice management vertical we continue to expand our existing relationships and add new customer sites. We closed sale agreements and implemented our point of sale software at several outlets in multiple major airports during the quarter, leveraging a relatively new customer relationship that has evolved quickly over the last few quarters, as we continue to successfully install and support software in these high-volume, quick-turn food and beverage locations.

Outside of these customer segments that represent the majority of our current revenue, we also recently closed a major new logo stadium sales agreement in the sports and entertainment vertical. Within the foodservice management vertical, we also continued to make good progress in the areas of healthcare, senior living and higher education.

Another recent new logo win in a sector in which we have had no other installations before is Virgin Trains USA, the only privately owned and operated intercity passenger railroad in the United States. Virgin Trains purchased InfoGenesis, rGuest Buy Kiosk, rGuest Buy Mobile, rGuest Pay, Eatec and rGuest Analyze, all subscription based for one of their trains between Miami and West Palm Beach. These are just a few notable examples of the recent success we’ve had winning new customers and new kinds of customers, while expanding our partnerships with current customers.

During our fiscal 2020 first quarter call in May earlier this year, we guided that the full year fiscal 2020 revenue would be about 11% higher than the full year fiscal 2019 revenue level of about $141 million. Given our increased business momentum, we feel it prudent now to increase that revenue growth guidance to 14% for the full year fiscal 2020.

We continue to make good progress with our product development initiatives with respect to property management systems, PMS and related additional software modules, and also recently announced a major PMS win against stiff competition. However, our revenue growth continues to be largely dependent on point-of-sale, POS, side of our business.

Alongside our star performer InfoGenesis, rGuest Buy continues to build good momentum in the marketplace, with increasing instances of rGuest Buy replacing competitor systems in cafeterias, in multiple large prestigious campuses, all across the U.S. While POS by itself is good enough to keep driving our revenue and profitability levels forward at a significant pace, we are steadily reaching the stage where our growth will be driven by both major product segments, point-of-sale and property management systems.

The hospitality industry is in need of a world-class PMS technology provider who can create value by improving guest experience and increasing guest loyalty with well-integrated solutions that are able to incorporate modules like direct channel web booking systems, mobile check-in / check-out, kiosk check-in / check-out and service optimization, to better manage tasks and operations across an increased number of property initiatives. We now have multiple examples of customers who have implemented such additional value-adding software modules offered by us around our PMS offers.

Given the demand we see in the market, we will be bringing to market an additional software module called the Agilysys Customer Engagement Suite during fiscal Q3. This module will serve as a launching pad for our proprietary offering that will provide customers the platform for loyalty programs, stored value, gift card and meal card type applications. We are excited to be one of the very few hospitality solution providers to be focused on developing and offering fully integrated guest self-service solutions.

Encouraged by our successes during the past couple of years, we continue to increase our R&D resources and continue to do so without significantly increasing R&D costs as a percentage of revenue to ensure we drive our increasing competitive advantage in top line growth down to increasing profitability levels. Our R&D teams, including technical services are currently about 650 people strong compared to approximately 230 at the beginning of calendar 2017. This increase has afforded us the ability to strengthen and modernize our core products more quickly and effectively, while also increasing innovation levels.

We recently leased additional space at our India Development Center and we’ll staff it in line with how our business momentum continues to evolve. In addition, we continue to increase our R&D resources and capabilities in the U.S. in addition to increasing our SaaS operation support, professional services, technical services and customer support, U.S. based staff.

In summary, we are operating in an industry with the total addressable market, which is a couple of orders of magnitude larger than our current relatively modest annual revenue size, providing us with ample runway for growth.

The hospitality industry continues to grow. Our customers have an increasing need for the products and solutions we provide. The success we are seeing across our business is not only improving and growing, but also doing so consistently. Our continuing success is well grounded on the stable foundation we have built over the past few years.

Possible downward macroeconomic dips, if and when they happen, tend to actually increase the need for software solutions like ours, which help improve operational efficiencies and attract and manage guests better. During challenging economic times there is often an increased need for tools to attract and retain guests.

We look forward to talking to all of you again in about three months from now to report on the December ending Q3 fiscal 2020 quarter, which given our current selling momentum should be our seventh consecutive record revenue quarter.

With that, let me hand the call over to our CFO, Tony Pritchett, for more color on our financial results and future outlook. Tony?

Tony Pritchett

Thanks Ramesh. We are pleased with the results for the fiscal 2020 second quarter both as it relates to the quarter itself, as well as with the trend that the results show. We continue to see improvements across many facets of the business and in our financial results that reflect the success we are achieving. We are confident the success will continue.

Looking at our financial results, second quarter of fiscal 2020 revenue was a record $40.7 million or 19% higher than total net revenue of $34.2 million in the prior year period. As Ramesh highlighted, this represents our eighth consecutive quarter of sequential revenue growth, our sixth consecutive quarter of record revenue and our fifth consecutive quarter of double digit year-over-year revenue improvement.

We are pleased to see that growth came from all three of our revenue line items, including record revenue across support, maintenance and subscription services revenue, as well as for professional services revenue. The increase in our top line was driven by a 35.4% increase in product revenue to $11.9 million, a 7.8% increase in recurring revenue to a record $20.3 million and a 29.5% increase in professional services revenue to a record $8.5 million.

I want to highlight that the 7.8% recurring revenue growth includes subscription revenue growth of 16% for the quarter. Subscription revenue comprised approximately 36.1% of total recurring revenue, compared to 33.6% of total recurring revenue in the second quarter of fiscal 2019.

Total recurring revenue represented 49.9% of total net revenue for the fiscal second quarter compared to 55.1% of total net revenue in the second quarter of fiscal 2019. It’s important to keep in mind that the strong selling momentum we have generated which Ramesh discussed earlier, is not only driving our product and professional services revenue growth but also have a high correlation to future performance for our total recurring and subscription revenue growth. As such, this trend provides us with added confidence that both total recurring and subscription revenues will see increased growth in future quarters.

Following our comments from our Q1 call, we continue to expect total recurring revenue to grow, and for subscription revenue growth to outpace the rate of total recurring revenue growth, and we continue to expect subscription revenue to grow faster than 20% for the entire year as we have discussed previously.

With regard to endpoints, we currently service approximately 274,000 rooms and have approximately 57,000 terminals, reflecting an increase of 2% and 12% respectively, compared to Q2 of last year.

Moving down the income statement, total gross profit was $20.2 million, representing a 13.9% increase from $17.7 million in the second quarter of fiscal 2019. The increase in gross profit is the result of growth across our three revenue line items.

Gross profit margin was 49.6% compared to 51.9% in the second quarter of fiscal 2019. Total gross profit margin is down slightly compared to last year, due to the acceleration of selling momentum as mentioned earlier, which results in converting products and professional services contracts to revenue in the near term. This should lead to better than originally expected recurring revenue growth rates in the coming quarters.

We have also hired some additional people for our support team, as well as adding some people and infrastructure around our SaaS operations, which puts temporary pressure on our recurring gross profit margins. One important fact to note is that even though total gross profit margins are down compared to last year, gross profit margins for product and professional services are both up compared to last year and we continue to expect on an annual basis for total gross profit margins to expand slightly from last year.

Moving on to operating expenses, excluding charges for legal settlements and restructuring, severance and other charges, the second quarter saw 9.3% increase in operating expenses to $23 million compared to $21.1 million in the prior year period. This increase is in line with our operating plan to increase cost at a slower pace than we increase revenue.

Combined our three main operating expense line items, product development expenses, sales and marketing expenses and general and administrative expenses were 53% of revenue this quarter compared to 58% of revenue during Q2 of fiscal 2019, and the increase in those same operating expense lines combined was only 10% while revenue increased 19%.

There is still much work to be done and many more opportunities to grow. As such, and as Ramesh pointed out, we will continue to invest in the business, including in R&D, SaaS operations, customer services and support, while maintaining our focus to increase the cost well below the pace of revenue growth.

Operating loss of $2.9 million for the second quarter is an improvement compared to an operating loss of $3.8 million for the second quarter of fiscal 2019, and net loss for the second quarter was $2.9 million or $0.13 per diluted share, favorably comparing to a loss of $3.8 million or $0.16 per diluted share for the second quarter of fiscal 2019.

Moving to the balance sheet, cash and marketable securities as of September 30, 2019 was $38.9 million compared to $40.8 million at March 31, 2019, and compared to $32.9 million at September 30, 2018. As we previously stated, we expected the first half of the fiscal year to pose a drag on cash due to the timing of collections, as well as the payment of annual bonuses. This loss will be offset in the second half of the fiscal year.

One important fact to note, during the previous five second quarters, we have lost several million dollars of cash or more. This is the first time since July 2013 when we sold the Retail Solutions Group and received the cash for that transaction, that we have increased our cash balance during the second fiscal quarter of the year.

During the fiscal 2020 first quarter, we recorded a right of use asset of $13.4 million and operating lease liabilities of $15.7 million, split between current and long-term liabilities. These balances are the result of our implementation of ASC 842, the new lease accounting standard that became effective for us in the first quarter of this fiscal year. This new accounting standard requires companies to record liabilities, which were previously off-balance sheet obligations and the associated assets onto the balance sheet. There is no impact to the income statement classification of rent expense or depreciation expense for us.

As it relates to our cash flow, we reported net cash provided by operating activities of $3.1 million compared to $1.4 million of net cash used for the three months ended September 30, 2018. Free cash flow also showed a significant improvement from an outflow of $2 million in the second quarter of fiscal 2019 to an inflow of $1.8 million during the second quarter of fiscal 2020. Through the first six months of fiscal 2020, free cash flow has improved by approximately $5.5 million compared to the first half of fiscal 2019.

For the fiscal 2020 second quarter, adjusted EBITDA was $3 million compared to adjusted EBITDA of $2.6 million in the year ago quarter. We continue to carry approximately $218 million of NOL carry-forwards with a full valuation allowance on our books that will enable us to remain liable for taxes only in certain foreign jurisdictions, as well as minimal state taxes for the foreseeable future. Our NOLs will expire between fiscal years 2031 and 2038.

As it relates to our guidance, given the continued improvement across our business, we are confident in raising our guidance for fiscal 2020 year-over-year revenue growth from 11% to 14% compared to full year fiscal 2019 revenue of approximately $141 million. We continue to expect an approximate 25% improvement in adjusted EBITDA in fiscal 2020 compared to fiscal 2019, adjusted EBITDA of approximately $10 million.

The reason we are not raising adjusted EBITDA guidance is that given the increased business momentum we are currently enjoying in the global hospitality marketplace, we have made the decision to slightly increase our investments in SaaS operations, in preparation for future increases in subscription based services, as well as in R&D professional services and customer support resources. Please keep in mind that fiscal 2019 adjusted EBITDA of $10.3 million had the benefit of about $2.2 million of capitalized software costs, which did not occur in fiscal 2020.

Growing adjusted EBITDA by 25% between fiscal 2019 and fiscal 2020 is actually the equivalent of growing adjusted EBITDA by 60% if we remove the $2.2 million capitalization benefit in the prior year.

Growing revenue by 14% and adjusted EBITDA by around 60% after normalizing for software development capitalization costs reflects the significant operating leverage we continue to work with as we manage expense-related investments carefully to continue to support future profitable revenue growth. And regarding free cash flow, we continue to expect fiscal 2020 free cash flow will be significantly more than the $1.7 million of free cash flow generated in fiscal 2019.

In closing, our business is improving as reflected in the consistent progress across multiple quarters and we are confident that we’ll continue to do so. We have spent much of the past couple of years working toward building a company to deliver world-class solutions and service that is second to none, and we hope you can see the results of our efforts coming through in our financial results.

We’ve been laser-focused on improving this company and the great set of products we have and feel our efforts are beginning to pay off. Going forward, we will continue to stay focused, work hard and work every day toward making our hospitality industry customers happy and successful.

With that, I’d now like to turn the call over to the operator for questions. Sarah?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Tyler Wood with Northland Securities. Your line is now open.

Tyler Wood

Hey, I’ll ask a question on the gaming side of the business. How big do you think the opportunity is there outside of Las Vegas and how are you approaching that market differently, and how far along are those customers been – their transformation to – what were they using previously? Is it a competitive displacement or were they using something homegrown? Thank you.

Ramesh Srinivasan

Yeah, hi Tyler. So the opportunity in gaming continues to be good for us and its good both in Las Vegas and outside, and a good portion of the opportunity is outside Las Vegas. So we generally do well in gaming – in the gaming casino industry and that is true for both, within Las Vegas and outside Las Vegas, and a significant portion of the opportunity is outside Las Vegas as well.

And the two things, the two reasons why our gaming business will continue to improve: number one, all the customers in general are relatively more focused on the non-gaming hospitality side of their business and that gradually continues to improve. They are more and more focused on the hospitality non-gaming part of the business. And in terms of competitor systems there, most of the competitive replacements we do there are of a couple of major competitors. That space has been dominated by a couple of major competitors and most of the replacements we do are switches from those major competitors.

Tyler Wood

Thank you, that’s helpful. And one more, any progress during the quarter on the international opportunity worth mentioning, and then could you just remind us what sales resources do you have internationally? Thank you.

Ramesh Srinivasan

Yeah, thanks Tyler. Yeah, the international opportunities continue to make good progress and like I described in the earnings call, the major cruise ship customer that we are beginning to make great progress with is an international customer, and we are also making good progress with a major hotel chain that is our customer, both domestic and in international.

And outside of these two major customers we continue to make good progress in both the APAC region and the EMEA region and we do have future plans to look at Mexico, and the rest of Latin America as well. So international is going to be a major growth area for us. And the number of salespeople there, I don’t know the exact number Tyler, but it is sufficient to cover the area. And we are always open to increasing our sales staff as the market demands.

So currently we are more focused on sales productivity. We are giving them more products to sell and as and when it is required, we will increase our sales staff there, but currently our coverage is very good, both APAC and EMEA.

Tyler Wood

Alright, thank you.

Ramesh Srinivasan

Thanks Tyler.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Allen Klee with National Securities. Your line is now open.

Allen Klee

Yes, hi. Can you just give us an update on the – and I apologize if you mentioned this and I missed it, the Indian Development Center in terms of number of people and the products and modules and things that are getting added from there? Thank you.

Ramesh Srinivasan

Yeah, hi Allen. Thank you for the question. Our India Development Center, IDC, our original capacity for a number of sources was about 670 or so and so far we have about 570 resources there.

Allen Klee

Do you have a sense of where you want that to be kind of percentage wise by the end of the year and…

Ramesh Srinivasan

Are you talking to us, Allen? Hi, Allen. Yeah, so as far as India Development Center is concerned, our capacity is about 670 and we have about 570 resources and we continue to hire there, and recently we have taken up, we have leased some extra space at our IDC as well.

Now in terms of products and modules, all our products, all our modules are developed across U.S. and India. So we don’t have any demarcation of certain modules and products that are done in the U.S. and certain that are done in India. All our products have teams both in the U.S. and in India. So everything that we described in our call so far is done both in the U.S. and in India.

You said something else like the – grew organic growth in light of the legacy business was and if we could think about what series this was, if it was last year for both of them?

Allen Klee

You said something else like the – grew organic growth in light of the legacy business was and if we could think about what series this was, if it was last year for both of them?

Okay, thank you very much.

Ramesh Srinivasan

Thanks Allen.

Operator

Thank you. This concludes today’s question-and-answer session. I would now like to turn the call back over to Ramesh for closing remarks.

Ramesh Srinivasan

Thank you, Sarah. Thank you all for joining us on the call today and for your continued interest and support. Agilysys continues to be well positioned to increase shareholder value. There is a great value creation opportunity we are determined to make good on for our employees, customers and shareholders.

I want to also take this opportunity to give a special thanks to our 1,000 plus team members across the globe, who are working hard every day to make Agilysys a world-class company, and to our customers who trust us with their investments now more than ever before.

Our best wishes to all for a joyful and safe holiday season. We look forward to our next earnings call in late January. Talk to you then. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.