American Software, Inc. (NASDAQ:AMSWA) Q2 2020 Earnings Conference Call November 21, 2019 5:00 PM ET

Company Participants

Vince Klinges - CFO
Allan Dow - President

Conference Call Participants

Matt Pfau - William Blair
Zach Cummins - B. Riley FBR

Operator

Good day, everyone, and welcome to the American Software Second Quarter Fiscal Year 2020 Preliminary Earnings Results Call. At this time, all participants are in listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note this call may be recorded, and I will be standing by if you should need any assistance.

It is now my pleasure to turn today's conference over to Vincent Klinges, Chief Financial Officer of American Software.

Vincent Klinges

Thank you, David, and good afternoon, everyone, and welcome to American Software's Second Quarter Fiscal 2020 Earnings Conference Call. On the call with me is Allan Dow, President of American Software. I will review the numbers and then Allan will give some remarks after that.

But I would like to remind you that 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 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.

So taking a look at the second quarter fiscal '20, the same period last year, total revenue has increased 1% to $28.2 for the current quarter compared to $28 million in the same period last year. Subscription fees increased 64% to $5.5 million for the quarter compared to $3.3 million for the same period last year, while our software license revenues decreased 48% to $1 million for the current quarter compared to $2 million the prior year period, as we continue to transition to the SaaS engagement model. Our cloud services annual contract value or ACV increased by approximately 55% to $22.4 million for the quarter, and that compares to $14.5 for the same period last year. Our professional services and other revenues decreased 2% to $10.8 million for the current quarter, compared to $11.1 million for the same quarter last year, and that's primarily due to a decrease in our IT consulting business unit, The Proven Method, as a result of timing of project work. This was partially offset by a 16% increase in our supply chain management unit due to stronger bookings in recent quarters, and our backlog remains solid heading into Q3.

Maintenance revenues decreased 7% to $10.8 million, compared to $11.6 million due to normal retention falloff combined with lower license fees in recent quarters. Our combined recurring revenue streams of maintenance and cloud services were 58% of total revenues for the current quarter, and that compares to 53% from the same period last year. Looking at costs, our overall gross margin was 54% for the current quarter compared to 52% in the same period last year. Our license fee margin was 4% in the current quarter compared to 13% in the same period last year, and that's primarily due to lower license fee revenue with the relatively fixed costs related to non-cash amortization of cap software and intangibles from recent acquisitions.

Our subscription fee margins decreased to 52% compared to 61% for the same period last year, and that's primarily due to increase in the allocation of amortization of cap software, which is $1.2 million or 46% of the total $2.6 million in costs. Due to increase in subscription revenue, more revenue gets allocated to subscription margins. The second quarter '20 gross margin without non-cash cap software allocation would have been 73% compared to 70% in the same period last year. Our service margin increased to 30% compared to 27% in the same period last year, and that's due to a higher portion of our professional services revenue coming from a higher margin supply chain business, which had margins of 37% compared to 28% in the same period last year. Our maintenance margin increased to 83% for the current quarter compared to 81% in the same period last year, and that's due to cost containment efforts.

Taking a look at operating expenses, our gross R&D expenses were 17% of total revenues for the current period compared with 16% in the same period last year. As a percentage of revenue, sales and marketing expenses were 18% of revenues for the current quarter compared to 19% from the prior year, and that's primarily due to timing of marketing related costs. G&A expenses were 17% of total revenues for the current period compared to 16% from the prior year quarter, and that's primarily due to increased variable compensation and to a lesser extent, insurance and legal fees. So our operating income decreased 45% to $843,000 this quarter compared to $1.5 million in the same quarter a year ago. Adjusted EBITDA, which excludes stock-based compensation, decreased 9% to $3.5 million for this quarter compared to -- $3.5 million compared to $3.9 million same period last year. GAAP net income increased 42% to $1.8 million or earnings diluted share of $0.05 for the current quarter, and that compares to net income of $1.2 million or $0.04 earnings per diluted share.

Adjusted net income was $2.5 million or adjusted earnings per diluted share of $0.08 for the second quarter, and that compares to net income of $2.2 million or adjusted earnings per diluted share of $0.07 for the same period last year, and these adjusted numbers exclude amortization of intangible expense related acquisitions and stock-based compensation expense. Both GAAP and adjusted net income included discrete tax benefit of approximately $400,000 this quarter, associated with the exercise of employee stock options. While we continue to anticipate a normal tax effective rate of approximately 13% on the balance of the year, future option exercise may continue to affect this reported tax rate. International revenues this quarter were approximately 19% of total revenues compared to 20% in the same period last year.

Taking a look at the year-to-date numbers for the six-month ended October 31, 2019, year-to-date, we were at $55.6 million compared $55.4 million. Subscription fees were $10 million year-to-date, a 53% increase compared to $6.5 million the same period last year, while software license revenues were at $2.8 million or 24% decrease compared to $3.7 million in the same period last year, and again reflecting our continued transition to the SaaS engagement model. Services revenue decreased 5% to $21 million year-to-date compared to $22.1 million last year due to lower revenue at The Proven Method. This was partially offset by a 9% increase at our supply chain business unit. Maintenance revenues decreased 6% year-to-date to $21.9 million, and that compares to $23.1 million year-to-date last year. Taking a look at costs, our overall gross margin was 54% for the current year-to-date period compared to 51%. License fees increased to 15% gross margin compared to 6% year-to-date. And subscription fee gross margin decreased to 52% year-to-date compared to 64% in the same period last year, and that's due to increase in allocation and amortization of cap software costs.

Our gross margin was 29% year-to-date compared to 24% the same period last year, and that's due to increased service revenues coming from our higher margins supply chain management unit. Our maintenance margins are 83% year-to-date compared to 81% same period last year, due to cost containment efforts. Our gross R&D expenses were 17% of total revenues for the year-to-date compared to 16% same period last year. As a percentage of total revenue, sales and marketing expenses were 19% for both the current and same period last year. G&A expenses were 18% of revenues for the current year-to-date period compared to 16% same period last year. So our operating income year-to-date decreased 23% to $1.6 million compared to operating income of $2.1 million last year. Adjusted EBITDA year-to-date increased 5% to $7 million compared to $6.7 million the same period last year. Our GAAP net income increased 11% to $2.9 million or $0.09 earnings per diluted share, and that compares to $2.6 million or $0.08 the same period last year.

Our adjusted net income year-to-date was $4.5 million or earnings per diluted share of $0.14, and that compares to net income of $4.6 million or $0.15 earnings per diluted share. International revenues year-to-date were 21% of total revenues compared to 20% same period last year.

Taking a look at our balance sheet, the company's financial position remains strong with cash and investments of $94.7 million at the end of October 31, 2019. And this increased approximately $12 million since the same period last year. During the current quarter, we paid $3.5 million in dividends. Some other aspects for the balance sheet, our billed accounts receivable was $15.4 million, unbilled is $2.7 million for a total a little over $18 million in accounts receivable. Our deferred revenues, both current and long-term, are $32.6 million, and our shareholder equity is $117.9 million. Our current ratio is 2.7 as of October 31, 2019, and that compares to 2.8 in the same period last year. Our day sales outstanding as of October 31, 2019 was 58 days compared to 66 days the same period last year.

At this time, I would like to turn the call over to Allan Dow.

Allan Dow

Thank you, Vince. During the second quarter, we saw a strong growth in our cloud revenue, driven by the software's of service engagement model, which was evidenced by the 64% year-over-year increase in subscription revenue and the 55% growth in the annual contract value for cloud services over the prior year period. The cloud model is our standard today, so going forward, we expect that traditional perpetual licenses will be limited to smaller incremental expansions within the existing customer community.

This was a good quarter for customer acquisition. We added 10 new logos across 12 different countries, which brings us to 26 new customers year-to-date. The annual contract value for cloud services associated with new contracts increased from $14.5 million in Q2 of last fiscal year to $22.4 million last quarter. We're pleased to see our growth rate in the ACV exceed in the 50% level for the second consecutive quarter. Furthermore, we are off to a good start in the third quarter, which is traditionally our strongest quarter, having gotten the summer period behind us with the ability to leverage both the year-end funding as well as the beginning of the new calendar year spending authorizations coming available.

Given our performance to date in a robust pipeline, which includes several significant opportunities, we remain confident in our ability to achieve solid ACV growth in fiscal '20 and beyond. Based on the close rate in Q1 and Q2, we are now operating our supply chain services organization at near full capacity, which is evidenced by the 16% growth in our supply chain services revenue. This quarter, we will be battling the Thanksgiving and Christmas holiday period, which is a drag on the number of billable hours that are available, but we do expect to show strong growth when compared to Q3 of last year, and continued services revenue growth as we progress through the year.

During the second quarter, our recurring revenue streams for maintenance in cloud services represented approximately 58% of the total revenues, as compared to 53% in the same period of the prior year, due to the growth in our subscription contracts. This trend toward a higher mix of recurring revenue is on track with our prior expectations, and thus we're confident we can achieve the 60% level before the end of the fiscal year that I stated on the last call. Obviously, the growth in recurring revenue improves the financial predictability and the profitability of our company, but more importantly, it is a strong reflection of our customers' belief that this business model drives higher value for them and opens doors for incremental expansion of our services within the existing customer community.

Overall, we had a very good quarter and we're pleased with our team's achievements. Looking forward, we are continuing to see an uptick in the transformational projects, which leverage our digital supply chain solutions, and take advantage of the optimization depth, the advanced analytics, the machine learning capabilities and the optimized simulation capabilities of our platform. Customers are looking for greater supply chain agility and dramatically shorter time to market for their new products as they strive for higher customer service levels to achieve and retain brand loyalty. Our ability to help them transform their supply chain to continuous and autonomous planning allows our customers to leverage their supply chain as a strategic market advantage.

In summary, we are encouraged by the progress we're making in our go-to-market execution on these transformational projects. We will continue to focus on making our customers more successful as we look to expand our relationships with existing customers and continue to expand our customer community. As we achieve that mission, we will see an acceleration of our recurring revenue streams. We're confident that we can continue to grow both revenue and profitability in the year ahead, and are proud to be delivering incremental benefits for customers.

So David, at this time, we'd like to open the call for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Matt Pfau with William Blair. Please go ahead. Your line is open.

Matt Pfau

Thanks for taking my questions and great job on the quarter. Just hoping to dig into a little bit more detail on this ACV growth acceleration now two quarters in a row; looks pretty good. Any more details on specifically what is driving that acceleration? And related to that, Mac has now been in the sales seat for roughly 3/4 of a year or so. Are some of the changes that he made in the sales organization. I'm starting to become evident in the ACV number.

Allan Dow

Couple of things, first of all we don't provide any specific guidance, but as we maintain the pace ACV bookings over the last couple of quarters, we should be able to sustain or accelerate that growth rate and Mac is having an impact. We're seeing his influence on the timing of contracts being able to get them closed a little faster and actually the scope of some of those contracts as we look forward, the scope of the projects are starting to increase. So we're seeing some larger deals in the pipeline as we look forward. So certainly he's starting to have an influence on our P&L.

Matt Pfau

And what you've done in terms of sales capacity, I guess how was that trended since Mac's?

Allan Dow

We are up a couple of headcount. We had some turnover in the time period that Max did on board, I don't attribute that specifically to him, but we got a little bit of turnover over there and we will see in the quarter forward, we have a number of offerings out and acceptances so, our headcount will grow as we look forward. So this time next quarter when we're talking we can be able to share with you, even some additional headcount increases that coming into effect there.

Matt Pfau

Got it. In terms of the mix of the pipeline, should we think of the pipeline now as just primarily cloud business versus license given that the comments you made and have you seen existing customers that are running the on premise products transition over cloud or is it still primarily due sales that driving the ACP?

Allan Dow

As we look forward we are not seeing a just in lifting ship conversion of customers into the cloud. So that is not there. What we are seeing is that existing customers are expanding their footprint, which is a really exciting news that they're doing that. We have a number of those contracts that were in the process working our way through where they will lift and shift the existing capabilities that they have, already license they will move those to the cloud. So we anticipate that looking forward we will see some lift and shift, there are some conversions, but they will be primarily driven by expansion projects that are bringing that lift and shift with it.

So there will be a bit of a mix in that flavor but not just a lift and ship, were not seeing that. We are seeing that the pipeline as we look forward is substantially all subscription with the exception as I said that the small incremental add-ons are if they got an existing perpetual license they're doing a small add on, they are probably stay in that model, they will not convert just for that purpose. Other than that I think it would be something exceptional that they drive a transaction towards the license fee, but we're not even seen that at this point.

Matt Pfau

Got it. Last one from, one of your last comments was cloud open the door for incremental expansions within customers, with some of the early cloud customers that you had how are those expansions progressed and I guess what's typically the catalyst for customer do to expand the scope of their engagement with you.

Allan Dow

Some of the earlier ones were doing projects on an incremental basis. So they anticipated a larger scope and now we're moving into phase 2 of the deployment whether coming back and adding the second tier or second phase of that implementation. In a few cases, there is actually new functionality that we brought the market where there actually expanding as well into that area. So that's has been incremental for us in some areas. One of the other influences that Mac has had on it is actually structure projects, some of the more transformational projects are structured around two deployments to they are actually committing upfront. So a few of those contracts may as they play out and they take longer for us to move to a true phase 2, because the phases have been built-in. But that's a bit of a contrast to the way our experience was at the beginning of our subscription experience, where the customer was taking the first bite and then they will wait for the second bite until they finished the first one and then they step up to the second one. So we're still seeing some of that but these transformational projects, they are looking at the whole project in its entirety and looking at how do I phases those together.

Matt Pfau

That's it for me guys. Thanks a lot.

Allan Dow

Matt, thanks for the questions.

Operator

[Operator Instructions] We will take our next question from Zach Cummings with B. Riley FBR. Please go ahead. Your line is now open.

Zach Cummings

Hi, good afternoon Alan and Vince, thanks for taking my questions. I guess it was nice to see, kind of saw a rebound there in the professional services team for supply chain management and sounds like you have a pretty solid backlog going into Q3. How are you feeling about the capacity you have or the number of headcount that you have to service that backlog as we move forward going here?

Vince Klinges

A couple of things there are in play there. We have because of the backlog we have actually expanded the team that we been able to pull in some very solid talent to help us in a variety of areas. We've actually also redeployed some resources in areas that are stronger than maybe in other areas. And we've also been able to leverage some third parties to help us with that backlog as well and bringing them into the mix, which is always a nice mix as well. We build the ecosystem, we build their knowledge base. They in turn go on and create additional demand for us out there. So that combination of resources of being able to expand our team, flex our team and leverage third parties is been a really positive influence and right now we're servicing the projects at the level that we need to be servicing them, so we're running at the pace that the customer deployment model allows, were not constraining that model at this point. We do see continue to build and we will look to leverage all three strings there, pull the resources in whatever direction we need to make sure we're servicing the customers and capitalizing on that revenue opportunity for us and then.

Zach Cummings

Understood, that's helpful. And in terms of sales team and sounds like there's a little bit of turnover but it sounds like you do have some new people coming into the door there. I mean how are you feeling currently about the ability to service your large pipeline of opportunities. And what really is the expected ramp up time for some of these expected new hires?

Vince Klinges

What's exciting about right now is we are a known commodity in the marketplace; there is an uptick positive result that we are showing, really making us attractive for people that understand our industry and know the markets. So the ramp up time for them is pretty efficient. Right now we're seeing some good productivity out of the people that started just a few months ago. There are not closing transactions yet but there actives, they are productive, they are working transactions, executing sale strategy. So we feel good about the headcount add that we made those that are on board. We feel really good about the folks that were anticipating to join us here in the coming weeks. So I think the ramp up time is going to be even faster with this full the resources that we experienced in years past.

Zach Cummings

Understood and then just final question for me, when thinking about the current macro environment. How are you feeling customer spending trends, compared to say this time 12 months ago?

Vince Klinges

It settles dramatically, I think 12 months ago we were seeing some severe influence on the macro behaviors out there, that said, still people got a watchful eye out into what's going on but it not a reason that were seeing right now. I think one of the other challenges we face as the deal size grows those just getting the overall approval on a larger transaction is a little more complicated and sometimes can be contracted but that which we're getting through those today is much better than we were 12 months ago.

Zach Cummings

Understood. Well, thanks for taking my questions and best of luck with the upcoming quarter.

Vince Klinges

Alright Zach, thanks for joining us.

Operator

[Operator Instructions] And there are no further questions on the lines at this time. I will turn the program to our speakers.

Vince Klinges

David, thank you very much. And for all those who joined us this afternoon, we appreciate your time and attention and look forward to speaking with you again in three months.

Operator

This does conclude today's program. Thank you for your participation and you may now disconnect.