American Software, Inc. (NASDAQ:AMSWA) Q3 2021 Earnings Conference Call February 24, 2021 5:00 PM ET

Company Participants

Vincent Klinges - CFO
Allan Dow - CEO, President & Director

Conference Call Participants

Matthew Pfau - William Blair & Company
Zachary Cummins - B. Riley Securities
Matthew Galinko - Sidoti & Company

Operator

Good afternoon, everyone, and welcome to today's third quarter fiscal year 2021 preliminary financial results call. [Operator Instructions].

It is now my pleasure to turn today's program over to Vince Klinges, Chief Financial Officer of American Software. Please go ahead.

Vincent Klinges

Thank you, Jamie, and good afternoon, everyone, and welcome to American Software's Third Quarter Fiscal 2021 Earnings Conference Call. On the call with me is Allan Dow, President and CEO of American Software. Alan will provide some opening remarks and then I will review the numbers.

But first, our safe harbor statement. This conference call may contain forward-looking statements, including statements regarding, among other things, our business strategy and growth strategy. Any such forward-looking statements speak only as of this date. These forward-looking statements are based largely on our expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future developments and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.

There are a number of factors that could cause the actual results to differ materially from those anticipated by statements made on this call. Such factors include, but are not limited to, changes and uncertainty in general economic conditions, the growth rate of the market for our products and services, the timely availability and market acceptance of these products and services, the effect of competitive products and pricing and other competitive pressures, and the irregular and unpredictable pattern of revenues. In light of these risks and uncertainties, there can be no assurance that the forward-looking information will prove to be accurate.

At this time, I'd like to turn the call over to Allan for opening remarks.

Allan Dow

Thank you, Vince. As the pandemic continues beyond any of our expectations in the number of individuals, families and companies that have been adversely impacted, continues to grow, we want to encourage everyone to stay strong. There is a path to a more normal environment and we can see the light at the end of the tunnel.

Again, I want to personally, and on behalf of the company, express our gratitude to all the frontline workers and first responders who continue to work tirelessly in response to this crisis and help us to move to a safe and healthy place as we battle through this incredible global pandemic. As an organization, we have been blessed with good health and the diversity of our team has allowed us to serve our customers well while maintaining a safe and productive work environment.

During the pandemic and the ensuing global crisis, there has been a heightened attention to the responsibility of supply chains to help ensure the ethical treatment of workers around the world and the impact that supply chains have on the environment. In alignment with this responsibility, the United States Customs and Border Protection has taken action to seize imports suspected of containing materials produced with forced labor. We are on the forefront of addressing these economic, environmental, and social sustainability imperatives.

Just one example is the release of our digital supply chain traceability solution to help companies ensure transparency across their supply chains and exceed their corporate and social responsibility goals while sustaining the flow of goods that we all rely on for our daily lives.

And in regard to our third quarter results, I am pleased with how our team has remained focused on serving existing customers, delivering on our implementation commitments and bringing new customers into our customer community. We generated solid net new ACV growth and our customer community has remained strong, resulting in a normal churn rates with our cloud and on-prem customers and improving collectability of accounts receivable as reflected in the reduction of our DSOs to 65 and the increase in our cash and investments on hand.

Our third quarter services performance in our supply chain segment was generally in line with our expectations, although the traditional seasonal slowdown during the holiday period was a little more pronounced than we originally anticipated. We continue to derive more backlog for future work, which is consuming most of the resource capacity we have on hand. When combined with the more efficient 100% virtual working strategy, we expect fourth quarter services revenue in our supply chain segment to trend higher than what we achieved in each of the prior 3 quarters.

We're pleased to see the continued growth in our recurring revenue stream of cloud services and maintenance, which now represents approximately 64% of the total revenues, a milestone achievement when compared to 62% for the last reported quarter and up from 54% in the same period last year.

Our subscription revenue in the third quarter grew 29% year-over-year and the growth in annual contract value for cloud services over the prior year period was 24%. We expect the percentage of recurring revenue to continue trending higher in the future, considering that subscription contracts represent virtually all of our new contract revenue.

Sales activity is running at a strong pace. And as a result, we're continuing to see growth in our pipelines, both in the number of opportunities and the size of the transactions. During the third quarter, we welcomed 7 new customers and completed subscription or license fee transactions in 11 countries, reflecting our strong global presence.

Transformational projects are continuing to drive the pipeline in both the number of opportunities as well as the average size of the transactions. This, in turn, is also driving the services backlog up. We are seeing customers adopt a broader footprint from our platform to improve the speed and quality of decision-making that allows them to achieve the agility and resiliency needed to thrive in this new economy.

The new calendar year has shown a resurgence of these investments and a likely -- a trend back towards the gross spending and supply chain solutions that we expected. As we have mentioned previously, we had expected to convert more of our pipeline during the back half of the fiscal year. While some of the opportunities have taken a little longer to close, we have already secured several bookings subsequent to the end of Q3. Had those closed just a little earlier, our net new ACV growth in Q3 would have matched our pre-COVID levels. Regardless, we remain confident in achieving stronger growth as we exit the year and head into the fiscal year 2022.

In summary, we're pleased by our progress as we strive for continued success to deliver exceptional value to our customers. Our mission of making our customers more successful year after year is paying off in customer retention and expansion as we introduce innovative new capabilities like the new traceability solution.

We're confident that we can continue to grow both in revenue and profitability in the years ahead and are proud to be delivering the incremental benefits our customers need in this time is that they need most.

At this time, I'll turn the call over to Vince, who will provide the details on our financial results.

Vincent Klinges

Thanks, Allan. So for the third quarter of fiscal '21, revenues were $27.7 million. That's down from $30.6 million in the same period last year as we continue to transition to the SaaS model. Subscription fees increased 29% year-over-year compared to $7.5 million -- excuse me, year-over-year to $7.5 million, while the software license revenue was $0.5 million compared to $3.7 million in the prior year.

As a reminder, our third quarter '20 license revenue benefited from the closure of 2 large transactions that we did not expect to repeat this quarter. We anticipate license revenues will remain relatively consistent with recent levels in the near term and decline over time. So our cloud services ACV or annual contract value increased 24% to $31.6 million versus $25.5 million in year ago period. Approximately 2/3 of our net new ACV was from new customers and the remainder was from the existing customers.

Similar to last quarter, our churn rate has improved from the early days of the pandemic and has returned to levels more consistent with our pre-COVID rate. We are encouraged that the churn experienced earlier in the year has not expanded beyond a few customers we mentioned previously. As Allan noted, our pipeline opportunities also increased, leaving us well positioned to deliver strong ACV growth in Q4 and beyond.

Professional services and other revenues decreased to 8% and $9.5 million from $10.3 million a year ago period. The year-over-year decline reflects a 15% decrease in our supply chain management unit, partially offset by a 2% increase in our TPM or our IT consulting business unit. As note -- we note that the restrictions of travel reduced the amount of pass-through reimbursements of our supply chain management services revenue to 0 in effect compared to $0.4 million last year.

On a sequential basis, the decline in service revenue was primarily attributable to TPM. Our supply chain management services declined slightly from the prior quarter as several projects progressed a little more slowly during the holiday season than we anticipated. Still, our backlog of supply chain implementation remains robust and we anticipate an uptick in our services this quarter -- in the fourth quarter.

Maintenance revenue declined 6% year-over-year to $10.2 million, reflecting a normal fall off as we transition away from perpetual license sales. Total recurring revenues comprised of subscription and maintenance fees represented 64% of total revenues in the third quarter and that's up from 54% in the same period last year.

Our gross margin was 55% for the current period compared to 57% in the same period last year. Our subscription fees were 59% compared to 66% in the prior year period, and that's primarily due to an increase in the allocation mix of capitalized software amortization to the cost of subscription area.

Excluding the noncash amortization of cap software expense of $866,000 in the third quarter, our subscription gross margin would have been 71% and that compares to 74% last year period. The amortization of cap software last year was $460,000. So our license fee margin was 46%. That compares -- that's down from 57% in the same period last year and that's due to lower license fees and relatively fixed costs from amortization expenses.

Services margin was 24% and was down slightly from 25% last year, and that's due to a higher mix of revenue coming from our lower-margin TPM business unit. And our maintenance margin was 81% compared to 83% a year ago.

Gross R&D expenses were 16% of revenues versus 15% in the prior year period. Capitalized R&D expenses totaled $233,000, down from $806,000 in the same period last year, reflecting our transition to the cloud and adoption of agile development processes, and we expect only nominal levels of capitalized R&D in the going-forward periods.

Sales and marketing expenses were 18% of revenues for both the current and prior year periods. The year-over-year decline in absolute dollars continues to reflect reductions in travel and marketing events due to COVID-19 pandemic. And our G&A expenses were 18% of total revenues compared to 17% a year ago.

So on a GAAP basis, our operating income decreased 67% to $0.9 million for the current quarter, and that compares to $2.8 million in the same period last year. Our net income decreased 30% to $2.3 million, our earnings per diluted share of $0.07 compared to net income of $3.3 million or $0.10 earnings per diluted share. On an adjusted basis, which excludes noncash amortization of intangible expenses related to acquisitions and stock-based compensation expense, adjusted operating income was $1.7 million compared to $3.7 million in the same period last year. The year-over-year decrease reflects the lack of any material license transactions in the current period compared to 2 in the prior year period.

Adjusted EBITDA was $2.9 million, down from $5.3 million for the third quarter. Adjusted net -- yes, adjusted net income was $3 million or adjusted diluted share of $0.09 for the third quarter, and that compares to adjusted net income of $4 million or adjusted earnings per share of $0.12 in the prior year period.

International revenues this quarter were approximately 15% of revenues and that compares to 19% in the prior year quarter. Looking at the 9-month year-to-date period, total revenues declined 4% to $82.8 million as a 32% increase in subscription fees to $20.8 million was offset by lower license fees, services, and maintenance revenues. Adjusted operating income was $5.1 million, representing an operating margin of 6%, down from $7.3 million or 8% margin in the same period last year.

Adjusted EBITDA was $8.8 million versus $12.3 million in the year ago period. And adjusted net income was $7.3 million or $0.22 per earnings per diluted share, down from $8.6 or $0.27 earnings per diluted share in the same period last year.

Looking at our balance sheet, our financial position remains strong with cash and investments approximately $100.8 million at the end of the quarter. Our day sales outstanding as of January 31, 2021, was 65 days for the current period. That compares to 70 days in the same period last year. And during the quarter, we paid $3.6 million out in dividends.

At this time, I'd like to turn the call over for any questions.

Question-and-Answer Session

Operator

[Operator Instructions]. We'll take our first question from Matt Pfau.

Matthew Pfau

I wanted to ask a little bit about customer purchasing behavior and just wondering if the spike in COVID cases in December and January impacted anything in terms of getting contracts across the finish line. And now that we've seen a substantial drop off and potentially maybe more broader re-openings later on in 2021, how do you expect that to impact your pipeline and close rates, things of that nature?

Allan Dow

Matt, this is Allan. Thanks for the question, and thank you for joining us. The Christmas period, the end of December, was quieter than we had ever seen in the past. I think some of that was COVID. I think some of it was just pure exhaustion as well. People just deserved and wanted a break and slowed down a bit and a little bit easier to do that when you aren't commuting to work, I think. So there was a bit of that effect in there. What we've seen in the New Year is the activities picked up across the board. The approval rates have gotten better. People have turned their attentions to it and we're seeing new projects coming online where people are engaging on them. So the overall news of the spring awakening, the COVID rates dropping, the fact that we've got -- vaccines are starting to get out there, I think people are anticipating that life is coming back and the pace is picking up. So it's really gotten quite a bit more busy across the board when we look at everything we're doing. Projects, sales-wise, close rate wise engagements, we're starting to get people's attention.

Now we are still dealing with the pandemic. And the challenge of that is not so much that people don't want to move forward, but the fact that they're not in the office together and they -- it's a more deliberate process to get people together to get through an approval cycle. That seems to be what's dragging things out and just getting on the executive meetings to get approval sometimes if they -- it may be on the agenda as a project to be discussed. And if it doesn't get discussed and it gets delayed a week, a month, sometimes 3 months if it's a Board of Directors type meeting and it just goes silent for a time period. So that's been the challenge really of just getting it on people's agenda and getting their attention. Does that make sense?

Matthew Pfau

Yes, it does. Thanks for that color. It's really helpful. And then I wanted to ask on the transformational projects. How do these roll into ACV? And, I guess, do they all roll in when these get signed? Or are these projects sort of roll in there in multiple components as they're rolled out, which I suspect maybe could be over sort of a multiyear period?

Allan Dow

Yes. Well, actually what's happening is they're taking them on as the whole block. Sometimes the rollouts might be geographic. But from a stock standpoint and from an ACV standpoint, it's the contractual commitment rate at the beginning. So it's coming in on a block and it's more akin the projects of the past. It's in a subscription format now. But of course -- but it's coming in as the whole block and they're tackling that entire scope because they want to see that they've got a solution that addresses their global -- the global needs. So it truly is looking at bigger transactions showing up on the pipeline and some bigger transactions flowing through the pipeline.

Matthew Pfau

Okay. Got it. And then as we think about reopening the economies and the impact from perhaps either a sales implementation or expense perspective, anything we should be thinking about there in terms of the way you guys -- changes that you guys may make in your own business once we're all able to more freely move around?

Allan Dow

Yes. I think we're starting to see people come back. We're having a few dialogue where folks are in the office. Of course, we've kept our office open and we operate here from the office, as you may know. But we're seeing a few more of our clients and prospective clients that are actually showing up. None of them are asking for us to come on-site yet. They're still, in most cases, where people are at the office. It's voluntary office time and they don't want outside presence coming in. So we're anticipating we're at least one more quarter, probably the end of the summer, before we see any material change in that. And I think it will be a slow progression back. So I really anticipate, Matt, that we're going to look at the rest of this calendar year where there won't be a lot of travel more than we've had in the past. I mean, we went through quarters where there really was none, it was 0, as Vince reflected in our pass-through cost for travel and implementations were 0. But we may pick up a little bit towards the backend of the year, but it's not going to swing back immediately to where we used to be.

Matthew Pfau

Okay. So should we still expect that even once things reopen, then a portion of your implementations are going to be performed remotely versus on-site?

Allan Dow

Absolutely. I think we're in a permanent world of -- even when the pandemic is completely behind us, I don't believe we'll go back to all implementations being on-site, which is where we used to be. Nothing was virtual. I think, I'm speculating, but would it be 50-50? Would it be 60% done remotely? I think it's going to be a high percentage of the work will be done remotely on a permanent basis.

Operator

We will take our next question from Zach Cummins.

Zachary Cummins

Allan, I just wanted to highlight some of the executive hires that you announced in some of the recent quarters. I mean, can you talk about the strategy with this new team in being able to really upgrade some of the executive talent that we've seen over the past couple of quarters?

Allan Dow

Yes. Great question, Zach. We've made some great strides in consolidating our operations and bringing some new leadership in. We've got new leadership in the R&D space that's really accelerating what we're doing, putting a restructured approach across the entire platform to accelerate the development activities, move to more agile methodologies and embrace more insights from the customer community on future requirements. So for instance the new capabilities we announced around traceability came through that whole new development cycle that Kevin's put in place. So we're really excited about the work he is doing there. We've got a great team. Longer term, we brought in leadership on our direct sales in Mac McGary. Mac is doing a fantastic job of really focusing on enterprise sales and getting a focus there. And some new leadership we talked about more recently around our channel business and that team over there is really doing a nice job to build our channel, expand the footprint more globally and get more focus on pushing us outside of our traditional North American and Western Europe markets. So they're doing a super job.

In the marketing space we brought in Shawn and Shawn has brought a whole new perspective on this world which has been really fortunate in the current market we're in, a real strong focus on digital marketing and interacting with people in a non-face-to-face way which was kind of the traditional marketing methods that we used most effectively in the past. So Shawn has brought some great perspective and implemented programs and got us up and running on a new digital perspective. So that's been beneficial. And then most recently we brought in Keith Charron and we put an announcement about him out. And Keith is really an operational expert and has really helped us to get focused on day-to-day execution. So I'm spending more time with the R&D team and marketing team on branding and strategy, and Keith is working the day-to-day operations, really starting to see an impact on that as well. So we're very excited about the new leadership and the help that they've done to augment what we're already doing, but bring some new ideas and disciplines.

Zachary Cummins

Got it. That's helpful. Thanks for the commentary. And Allan, I know you've sort of quantified the impact of some of these delayed closings near the end of the quarter. I was hoping you could just dig down a little bit deeper on that in terms of the potential ACV growth that we could have seen if these deals closed a little earlier and kind of the start you've seen thus far in Q4.

Allan Dow

Yes. I think all of our projects now, the only license fee transactions we're doing are small incremental add-ons to existing customers where they're adding users or maybe at best one component and extending their footprint a little bit. So all of our transactions are really in the cloud at this point, as I mentioned. Had we had a little luck on the timing and pulled those ones in in the quarter instead of just after the end of the quarter, as I mentioned, we would have been in the range that we had historically been pre-pandemic in the kind of growth rates that we were seeing back there.

So we're excited about that. We're glad that we -- even though we were late in getting them done a little later than anticipated, we're great to have them on, and we're up and running and working on those implementations. And we're seeing that we've got a robust pull-through the pipeline now. So we anticipate the close rates are really starting to get back to a more normal pattern that we had seen before the pandemic. And we basically burned through 4 quarters in the pandemic. We didn't think it was going to last that long, but it surely did and we're all living it right now. But we're starting to see that we're on the backside of that.

Zachary Cummins

Got it. And just final question from me around the professional services team. I mean, you saw the typical seasonal tick down, but it sounds like the backlog here is pretty strong going forward in Q4. And I mean, can you speak about the expected utilization rates that we should be assuming in the upcoming quarters after what have been pretty challenging from a work perspective over the past 2.

Allan Dow

Yes. I think as we mentioned, we -- I think on the last call, we had commented that we thought that we were going to be relatively flat and we pretty much were within a margin of error there. So pretty much flat, which was actually we thought quite positive because had we had the traditional slowdown, we would have dropped quite substantially. So we didn't see that on Q3 over Q2. Today, we have higher utilization rates than we did coming in to the back half of last year -- last calendar year. So we're going to see an uptick in the days ahead. As I mentioned, we're near capacity now.

We're running at pretty much up there. But the good news is we've been able to onboard some critical new resources and we're continuing to build the partnership network with systems integrators who are really starting to augment some of our work as well. And we see that as a good level to give us the capacity we need to keep going on some of these projects, plus just build out the ecosystem where we have the influence of others in the marketplace around our solutions. So I think we're going to see an uptick. We're going to be running near capacity in the coming months. We'll see what happens over the summer. But I think as well, we might see people want to take a break. We may see a little blip in the summer. But as we get closer to that, we'll give you some more insight into what we're seeing in that time period. But the team is definitely -- is busier at this point.

Operator

[Operator Instructions]. It appears we have no further questions at this time. I'll turn over -- I apologize. We just got one question queue from Matthew Galinko.

Matthew Galinko

So I'm just curious, what if any leverage you have for the subscription higher from this point or are you starting to kind of hit mature levels on that revenue stream?

Allan Dow

Hey, Matt. If you would mind, your line or our line was cutting out a little bit. And I don't -- I didn't really catch the whole question. Could you try that one more time for us?

Matthew Galinko

All right. How am I coming in now?

Allan Dow

It's good.

Matthew Galinko

All right. So I'm curious about your subscription margin going forward. Do you have any leverage you can pull to lift it from this level or are you starting to touch mature level -- mature margin in the subscription line?

Vincent Klinges

Matt, this is Vince. No, I don't think so. I think we had some levers to pull. We're actually working with Microsoft who is our main hosting provider to provide volume discounts in the future as we increase the amount of usage. We're working with them. So I think that will help the margin as we grow the subscription piece. And just naturally the margins -- we anticipate the margins growing close to high 70s probably and they maybe at the back half of next year or early the following year. So we don't think we're at the top part of the gross margins for that at this point.

Matthew Galinko

Got it, thanks. And then just real quick on DSOs. You've made some nice progress through the year. But just curious if we're at a sustainable level or how do you feel of the current rate?

Vincent Klinges

Yes, 65 has kind of been our natural trend area, around mid-60s. Couple of quarters ago we were in the high 80s and we've come down nicely because there was just a natural delay based on the pandemic. But we've kind of had some good success in collecting from our customers.

Operator

We have no further questions at this time.

Vincent Klinges

All right. Jamie, thank you very much, and thank you all for joining us. We appreciate your time this afternoon. And we'll continue to work forward and we will look forward to reconnecting with everyone in a couple of months. Have a good afternoon.

Operator

This does conclude our program. Thank you for your participation.