Agilysys, Inc. (NASDAQ:AGYS) Q1 2020 Earnings Conference Call July 25, 2019 4:30 PM ET

Company Participants

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

Conference Call Participants

Allen Klee - Maxim Group
Tyler Wood - Northland Capital

Operator

Good day, ladies and gentlemen, and welcome to Agilysys' Fiscal 2020 First Quarter Conference Call. As a reminder, today's conference may be recorded.

I would now like to turn the conference over to Dave Wood, Vice President of Corporate Strategy and Investor Relations at Agilysys. You may begin.

Dave Wood

Thank you, Katherine, and good afternoon, everybody. Thank you for joining the Agilysys' fiscal 2020 first 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 continued sales and business momentum.

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 would 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. Good afternoon, everyone. Thank you for joining our fiscal year 2020 first quarter earnings call. Joining Dave and me on the call today is Tony Pritchett, our Chief Financial Officer.

We completed another strong quarter highlighted by revenue of $38.4 million, a 12.9% increase over Q1 of last year with increases in all three of our revenue lines, recurring revenue, product revenue, and professional services, driven by sales growth across our verticals.

This was our seventh consecutive sequential revenue increase, fifth consecutive record revenue, and fourth consecutive double-digit year-over-year revenue increase quarter. Recurring revenue was a record $20.1 million for the quarter, driven by a 24% year-over-year increase in subscription revenues.

Our cash balance decreased by $3.5 million during Q1 fiscal 2020 which is typical for us. While our revenue is not cyclical, our cash collections tends to be cyclical, Q1 being the most pronounced of them with each subsequent quarter thereafter improving during the fiscal year. We continue to expect fiscal year 2020 to be overall a significantly better free cash flow year compared to fiscal 2019.

As I get more deeply into my comments, I want to make it clear that, when we refer to sales, that encompasses everything, we have sold during a period, which we normally measure internally in terms of annual contract value.

Revenue on the other hand, is driven by product shipped or in the case of recurring revenue what has already been implemented and refers to the amounts we have recognized as revenue during a period.

Sales during a period contributes towards both, current and future revenue. That said, our strong sales momentum continues to drive good revenue growth. The last three quarters have been among our best ever in terms of sales.

The year-over-year increase in sales this quarter was the highest percentage than the corresponding revenue increase, which augurs well for continued future revenue growth.

We are particularly encouraged by the continued increases in sales across Asia, Europe and the domestic hotel resorts/cruises vertical and especially in the food service management vertical.

During the past few months, we have made substantial sales progress with a second major food service provider. Within food service management, we are also seeing good traction in healthcare, senior living, stadium arenas and higher education subverticals.

These subverticals have contributed minimally to our revenue profile in the past, in spite of their business requirements aligning quite well with our products and services. These verticals represent good new sales and revenue growth opportunities for us.

We recently had good success, implementing POS, and kitchen video system automation in a major cruise ship. We were successful in automating dining operations on the ship, which were practically all pen and paper based before.

This ship became our first customer, to have 100% flexible mobile tablets, with no fixed terminals across its numerous revenue centers. As a result of this implementation, their staff became significantly more mobile and could fill orders even while remaining at the guest's table, resulting in a significant increase in the speed of guest service.

The success of this recent ship implementation is beginning to open new doors for us across the cruise industry. Given our normally strong presence in gaming casinos, this sales momentum in other verticals, is making our growth increasingly more broad-based.

A significant portion of our current success is due to our continued focus, accountability and strategy between our sales efforts, across all verticals and regions. Our go to market strategies and execution, has become a lot more effective and are continuing to yield improved results.

We recently formed a product strategy team, consisting of Agilysys hospitality industry veterans that is helping guide the development and rollout of our integrated product sets in a thoughtful and coordinated way, directed by our medium and long-term strategies.

We also increased our global quota carrying sales team by approximately 10%, during the quarter. As an overall organization culturally, it is more prevalent with us now than ever before, that all of us work to support our sales teams and our customer facing personnel, including in services and support.

That is true for me as well. Sales, services and customer support do not work for me. I work for sales services and support and through them for our customers. From a product set standpoint, while point of sale POS solutions, consisting of InfoGenesis POS, InfoGenesis Flex, rGuest Buy Kiosk and rGuest Buy On-Demand continue to be the main drivers of our current success.

We are also making good progress with our property management systems, PMS, related product development initiatives both with respect to core products and with respect to innovations and software modules, surrounding the core product features.

We are making good progress with the recently launched ancillary PMS modules, like one, rGuest Book, a booking engine which integrates directly with major property management systems and can enable full package booking including spa and golf appointments along with room bookings and upsell features based on the profile of each guest.

Two, rGuest Express Mobile, a fully integrated check-in, check-out solution with digital ID verification, and digital key delivery. Three, rGuest Express Kiosk, a self-service check-in, check-out kiosk. And four, rGuest Service, a resort-wide customer service and task management module, also offering a staff communication platform designed to mobilize all internal paths and workflows utilizing variable technology.

All these modules have been implemented in multiple locations and offer good value and return on investment for our customers. About 40 new sales agreements have been signed for these new emerging software modules during the past 12 months.

The increasing sales pipeline we are beginning to see in property management systems, PMS gives us good reason to believe that our future growth will be driven in a more balanced manner across both POS and PMS solutions. PMS solutions were implemented in nearly 2,400 additional rooms during Q1 fiscal 2020 and we believe we can do much better in the future with this metric.

With respect to our continuing momentum with POS solutions, the rGuest Buy guest facing kiosk solution has been a star performer for us during the past year, with rGuest Buy Kiosk installations more than doubling during the past 12 months from 266 to 676 endpoints.

The rGuest Product Suite now represents 11% of total revenue in Q1 of fiscal 2020 compared to 8% during Q1 last fiscal year. We continue to increase our R&D spend without impacting profitability. The adjusted EBITDA for the quarter was a record $3.2 million in spite of not having the benefit of capitalizing software development costs as was the case prior to Q2 of last year.

Our R&D strength including personnel and technical services across the U.S. and India development center was 540 as of June 30, compared to around 230 2.5 years ago. We are improving our core products now at a faster rate than ever before and simultaneously increasing innovation within both our core products and complementary modules.

The hospitality industry currently has a big need for modular and well integrated POS and PMS software solutions and even the biggest providers in the space are unable to deliver the kind of end-to-end solutions customers increasingly demand at the level we currently are able to provide. That gives us a significant competitive advantage in the hospitality industry, the only industry we are focused on. That will continue to drive topline revenue growth for us and we remain confident we can do so by also simultaneously growing profitability.

On the international front, I recently returned from a two-week trip to Singapore and to our 400 plus strong India development center. We also held a successful EMEA customer summit in London during the quarter. It is exciting to see the extent of international revenue growth opportunities in front of us.

Our revenue from international regions during Q1 of fiscal 2020 was an all-time record. This quarter also marked five consecutive quarters of increasing international revenue. Some of our recent international wins include the St. George's Hotel in London and the Angsana Teluk Bahang hotel in Pinang, Malaysia.

During the past few quarters, we have made significant improvements in expanding SaaS development operations infrastructures partnerships in Netherlands, Singapore, China and Australia to accommodate our growing global SaaS implementation needs. During my recent visit to our India development center, it was exciting to see that rate at which various product improvements and innovation initiatives are getting done and the extraordinary work culture.

In summary, we continue to see multiple avenues for sustainable growth that we can and I expect we will execute well on. We operate in the growing hospitality industry that is massive compared to our current modest annual revenue size. And it's an industry with an increasing need for a world-class technology-solutions provider who can provide end-to-end modular and well-integrated POS and PMS software solutions and a partner who continues to invest in people, products and customer service.

I firmly believe that our future success continues to be entirely within our own control and as such we are about as well-insulated as is reasonable to expect from the ups and downs of the daily macro headlines, economic predictions, trade wars, interest rate fluctuations and virtually everything else we read and hear about every day.

Given these characteristics, I remain optimistic about the investment case for Agilysys at the current share price level given the many opportunities we have in our hands to continue to grow shareholder value.

I look forward to talking to all of you again about three months from now to report on the Q2 September quarter, which given our current sales momentum should be our sixth 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. As Ramesh highlighted, we are pleased with the results for the fiscal 2020 first quarter. When we look back at the last 12 months to 18 months, we see clear and tangible proof of improvement in growth across just about every facet of our business.

As we look ahead, we are very encouraged with the growth potential in the markets and remain confident in our ability to grow top-line and improve profitability and shareholder value.

The results reflect the significant progress we are making on the operational side of the business including managing OpEx and CapEx spend in total so that it declines as a percentage of revenue while at the same time investing in the right areas of the company that will afford us the clearest and surest path to growth.

Taking a look at our financial results beginning with our income statement first quarter fiscal 2020 revenue was $38.4 million, a 12.9% increase from total net revenue of $34 million in the prior year period. This marks our fifth consecutive record revenue quarter and the seventh consecutive quarter of sequential revenue growth.

We are pleased to see growth across all three of our revenue line items and record revenue in two of these revenue lines. The increase in top-line largely reflects a 19.7% increase in product revenue to $10.9 million and a 12% increase in recurring revenue to a record $20.1 million as well as a 6.3% increase in professional services to a record $7.4 million.

Total recurring revenue represented 52.3% of total net revenue for the fiscal first quarter compared to 52.7% of total net revenue in the first quarter of fiscal 2019. It is important to note that within that recurring revenue growth, we enjoyed robust subscription revenue growth which continues to outpace our overall revenue growth.

Subscription revenue grew at 24% for the first quarter of fiscal 2020. Subscription revenue comprised approximately 35% of total recurring revenue compared to 32% of total recurring revenue in the first quarter of fiscal 2019. Both total recurring revenue and subscription revenue are good reference points regarding the health of the business.

Going forward, we expect total recurring revenue to continue to grow and for subscription revenue growth to continue to outpace the rate of total recurring revenue growth and continue to grow faster than 20% for the balance of fiscal 2020.

With regard to endpoints, we currently service approximately 273,000 rooms and have approximately 55,000 terminals reflecting an increase of 4% and 14%, respectively compared to Q1 of last year.

Total gross profit of $20 million represents an 11.9% increase from $17.9 million in the first quarter of fiscal 2019. The increase in gross profit is mostly attributable to the growth in recurring revenue with minimal increases in associated cost of goods sold, resulting from the scalable nature of our existing infrastructure to support and host customers.

Gross profit margin was 52.1% compared to 52.6% in the first quarter of fiscal 2019. Gross profit margin decreased 50 basis points, due primarily to a decrease in professional services gross profit margin from 29.8% in Q1 of fiscal 2019 to 25.1% in Q1 of fiscal 2020. As a reminder professional services margins vary greatly depending on the mix of projects that we are engaged in. And during the quarter just ended, we experienced an impact on margins due to our ramp in hiring to help manage our growing backlog of projects, resulting from our recent sales momentum.

Having said that, we continue to expect that our margins for professional services will be in the mid to high-20% range as we get our new professional services personnel trained and deployed on customer projects. Gross profit margin for products was 20.7% compared to 21.5% in the first quarter of fiscal 2019, while gross profit margin for recurring revenue was 79.2% compared to 77.3% in the first quarter of fiscal 2019.

Looking at operating expenses. Excluding charges for legal settlements and restructuring severance and other charges, the first quarter saw a 12.3% increase in operating expenses to $21.3 million, compared to $19 million in the prior year period. As expected, this increase is attributable to the increase in product development expense which increased by $3 million or 42% compared to fiscal Q1 of last year, about 70% of which is due to the change in treatment of software development costs.

As we have mentioned on prior calls, we instituted agile development and deployment practices across all of our products during the second quarter of fiscal 2019 that preclude us from capitalizing internal labor costs on the balance sheet. As a result, our product development expense line item on the income statement is significantly higher now than in prior years, since the cost that was previously removed from the P&L and capitalized software development costs and reflected on the balance sheet is now being reflected as an expense on the income statement.

In the back of our press release, you will find a reconciliation of product development expense to include these amounts. As an effect of this change, our operating loss and net loss are higher this quarter than they would have been if we had capitalized labor. The development costs capitalized in the first quarter of fiscal 2019 of $2.1 million was a benefit to product development expense that did not recur in the first quarter of fiscal 2020.

This also affects operating cash flows as wages and contract labor payments that were previously capitalized, now reflect as an operating cash output. The increase in product development expense was slightly offset by decreases in sales and marketing expense and general and administrative expense.

Sales and marketing expenses decreased by $0.3 million or 5.4%, compared to fiscal Q1 of last year. And general and administrative expenses decreased by $0.1 million or 2.2% compared to fiscal Q1 of last year, due to the timing of certain events that will occur later this fiscal year compared to last year.

Looking at appreciation of fixed assets, we had a $0.4 million benefit in the fiscal 2020 first quarter that did not impact the fiscal 2019 first quarter and will not affect our ongoing depreciation expense in future quarters. This led to an operating loss of $1.5 million for the first quarter compared to an operating loss of $$1.6 million for the first quarter of fiscal 2019. Net loss for the first quarter was $1.6 million or $0.07 per diluted share compared to $1.7 million and $0.08 per diluted share for the first quarter of fiscal 2019.

Moving to the balance sheet. Cash and marketable securities as of June 30, 2019, was $37.2 million compared to $40.8 million at March 31, 2019. You'll notice a large increase in long-term assets as well as to short-term and long-term liabilities. 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, a new lease accounting standard that became effective for us in the quarter. This new accounting standard requires companies to record liabilities, which were previously off balance sheet obligations and the associated assets onto the balance sheet. For us, there is no impact to the income statement classification of rent expense or depreciation expense.

As we have previously stated, we expect the first half of the fiscal year to pose a drag on cash, especially during the first fiscal quarter, when we pay our annual bonuses, which will then be more than offset in the second half of the fiscal year.

As it relates to our cash flow, we reported an increase in net cash used by operating activities, which rose from $1.4 million to $1.9 million for the three months ended June 30, 2019, and which included the headwind of previously capitalized engineering costs not reflected in operating cash flows.

Free cash flow, however, which is a more comparable metric since it includes the software development costs in both periods, improved by 41% compared to last year from a $4.2 million outflow last year to a $2.5 million outflow this year.

For the fiscal 2020 first quarter, adjusted EBITDA was a record $3.2 million compared to $3.1 million in the year ago quarter. However, assuming no software development costs were capitalized in the fiscal 2019 first quarter, adjusted EBITDA for the fiscal 2019 first quarter would have been around $1 million or over $2 million less than the current year.

Regarding our NOLs, we continue to carry approximately $210 million of NOL carry forwards with the full valuation analysis on our books that will enable us to remain libel for taxes only in certain foreign jurisdictions as well as minimal state taxes for the foreseeable future. Our current NOLs that expire do so between fiscal years 2031 and 2038.

Finally, taking a look at our guidance, this afternoon we reiterated our forecast for fiscal 2020 full year revenue growth of approximately 11% compared to fiscal 2019 revenue of approximately $141 million, and expect to record an approximate 25% improvement in adjusted EBITDA in fiscal 2020, compared to fiscal 2019 adjusted EBITDA of approximately $10 million.

We also 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, we are pleased with the start to the year and with the improvements across our business, particularly around our ability to grow the top line, including recurring revenue. We are pleased with the consistent progress we are making as we prudently manage working capital, so that going forward we can further optimize operating cash flows and continue to strategically leverage our healthy balance sheet.

With that, I would now like to turn the call over to the operator for questions. Katherine?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Allen Klee with Maxim Group. Your line is now open.

Allen Klee

Yes. Good afternoon. Your results topped my expectations. I was just curious if there was anything that you would point out that might have been one-time in nature in this quarter that I should think about?

Tony Pritchett

Hey, Allen, this is Tony. Thanks for listening in today and continuing to follow the stock. As far as one-time items ago we mentioned the depreciation expense, which is not even part of EBITDA. But that depreciation expense item was a non-recurring item.

Otherwise things were generally consistent this quarter. Nothing unusually outside the norm from a revenue perspective. There was nothing material. That was a one-time item. You know from time-to-time, we do have operating expenses that hit us in different quarters of the year. So, for example, we had some trade shows and events that hit us in Q1 of last year that don't come in until later this year. So there is some lumpiness in OpEx. But from a general business perspective, ongoing operations there was nothing materially unusual in the quarter.

Allen Klee

Okay. Great. And then in terms of the Indian development center, and I think I heard you say around 400 people in it now. Can you help us think about like the cost of -- that you're spending like the run rate of building that out? And is there a sense of like that to any degree that that's like will normalize in a certain time period?

Ramesh Srinivasan

Yeah. Hi, Allen. This is Ramesh. So as far as the CapEx is involved, the CapEx is already done. Those costs have been incurred and we have built out the facility to accommodate about 660 to 670 people. And in my prepared remarks I told you it's 400 plus. It is well north of 400 now.

And in terms of how you model the cost, I would think of R&D as a whole as an entirety, Allen. And R&D as a percentage of revenue will remain stable may tick up a point or two this year. But in general over the medium-term, R&D as a percentage of revenue will keep going down. Meaning, we will grow revenue at a faster rate than we grew R&D this fiscal year. This fiscal year you may see a one or two point tick up in R&D. So the IDC and how we manage the U.S. development centers gives us a way to manage R&D in a responsible and prudent way is the way I would think about it.

Allen Klee

Okay. Thank you so much. Maybe my last question would just be if you could comment on the competitive environment if you're seeing anything new or different in terms of the level or products and pricing and that type of stuff.

Ramesh Srinivasan

No major change Allen in the competitive environment. We feel in many areas our competitive advantage is increasing mainly because of two reasons. I think we are investing in our core products more than what the competition is I suspect. And also in terms of also investing in the ancillary modules, that is the software modules that surround the core POS and PMS products, we are investing more in that than I suspect the competition is.

So in terms of the end-to-end solutions we are able to provide both on the POS side and the PMS side, I can see raised eyebrows with our prospect to the customers. They're appreciating it more and more. So I think we are working hard to increase our competitive advantage. Nothing major has changed in the competitive environment in terms of pricing or anything else, but I would say on the other side of the ledger, the PMS competition is improving.

I think PMS products in general are improving in the industry, which is good for the industry. And also POS competition in APAC in Asia is getting better is increasing. So we are doubling our efforts in APAC to make sure we compete well. But the fact that one or two vendors are doing well here and there should not bother us, because it's a massive industry compared to our size. And we remain very confident about our sales and revenue growth prospects.

Allen Klee

Okay. Thank you so much.

Ramesh Srinivasan

Thanks Allen.

Tony Pritchett

Thanks Allen.

Operator

Thank you. [Operator Instructions] Our next question comes from Tim Klasell with Northland Capital. Your line is open.

Tyler Wood

Hi. This is Tyler Wood on for Tim. Thanks for taking our question. Can you just talk a little bit more about what you saw in terms of customer retention for the customer? Obviously, we've been seeing it steadily pick up under the new management. Are we kind of seeing that flatten out a bit now or how much more room for improvement, do you see there?

Ramesh Srinivasan

Yeah. Hi Tyler, thanks for joining the call. The measure customer retention as a percentage of recurring revenue and that is continuing to do better. That is continuing to do better than the past.

So this fiscal year 2020, in percentage terms, in terms of customer retention as a percentage of recurring revenue should improve over previous years. And we have room to improve there.

We have room to number one grow the denominator. Number one grow recurring revenue which is steadily occurring. And we also have room to improve customer retention.

So in percentage terms, we are doing better year after year, for the past two or three years. That will continue to improve. But we do have room to improve there. Right we are working hard to make that even better Tyler.

Tyler Wood

One more, as we look at the international opportunity growing, could you talk a little bit about maybe how the international buyers differ from domestically? You know are they taking on-premise versus hosted more or are there certain modules that you're seeing resonate internationally?

Ramesh Srinivasan

Yeah. So, when you think of international regions Tyler, what you need to keep in mind is our market share there is very low, right. In the past, since we didn't do a great job. We did not do a great job with international regions, our market share there is extremely low.

So, there are massive opportunities to improve there to grow our revenue, which is why we've had like five consecutive quarters of revenue growth in international regions.

It tends to be a reasonable mix of on-prem and SaaS, like it is here. If anything it's probably a little bit more on-prem oriented than SaaS as things stand now, especially in APAC.

And our standing in both Europe and Asia is improving, because more and more customers are taking notice of the improvements we have made in the last two years.

So, international regions is just a matter of making sure we improve our products, we provide the kind of functionality features, that our international customers require. We provide the kind of language translations and localization in our product that we require. And since all that is improving now, they are taking more and more notice of us.

Tyler Wood

All right congrats on the performance.

Ramesh Srinivasan

Thank you, Tyler. I appreciate it.

Dave Wood

Thanks, Tyler.

Operator

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Ramesh, for any closing comments.

Ramesh Srinivasan

Thank you, Katherine. To conclude we had a solid start to fiscal 2020. We continue to focus on maintaining our operational discipline, while pursuing the highest value growth opportunities.

We continue to make progress in evolving our solutions portfolio to better address our customer needs, transform our sales efforts and improve our organization to better complement our solutions. And generally improve how we serve our customers.

We remain confident that we will continue to make consistent progress. We will see added growth. And will increase shareholder value in continuing future periods. As always, we thank you for your interest, your investment in our company and for joining us today. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.