American Software, Inc. (NASDAQ:AMSWA) Q3 2019 Earnings Conference Call February 20, 2019 5:00 PM ET

Company Participants

Vincent Klinges - Chief Financial Officer
Allan Dow - President

Conference Call Participants

Zach Cummins - B. Riley FBR, Inc.
Joe Vidich - Manalapan Oracle Capital Management

Operator

Good day everyone and welcome to the Third Quarter Fiscal Year 2019 Preliminary Earnings Results Call. 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 keep in mind, today's conference is being recorded and I will be standing by should you need any assistance.

It is now my pleasure to turn today's program over to Vincent Klinges, CFO of American Software. Please go ahead, sir.

Vincent Klinges

Thank you Miranda and good afternoon everyone and welcome to American Software's third quarter of fiscal 2019 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 and after that -- but before that, 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 effective 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 looking at the third quarter of fiscal 2019 and compared to the same period last year, total revenues for the quarter has decreased 10% to $27 million compared to $30.1 million last year. This reflects our ongoing transition to SaaS and a difficult comparison stemming from an unusually large license fee transaction that closed in the prior year period. Subscription fees were $3.7 million for the quarter ended January 31, 2019, a 43% increase compared to $2.6 million the same period last year.

Software license fee revenues were $1.7 million or 71% decrease compared to $6 million for the same period last year, again, reflecting our continued transition to the SaaS engagement model.

Our cloud services' annual contract value or ACV increased by approximately 48% to $16.1 million for the current quarter and that compares to $10.9 million for the same period last year and $1.7 million or 12% sequential increase from the same quarter last year -- excuse me, the sequential quarter.

Professional services and other revenues were $10.2 million for the current quarter and that compares to $10.3 million for the same period last year. Maintenance revenues increased 2% to $11.4 million compared to $11.2 million last year. So our combined recurring revenue streams, which include maintenance and cloud services were 56% of total revenues for the current quarter and that compares to 46% for the same period last year.

Looking at costs, our overall gross margin was 52% for the current quarter compared to 57% the prior year quarter. License fee margin was negative 7% for the current quarter compared to 71% in the same period last year, due to lower license fees and a relatively fixed expense cost of license fees, which included $800,000 of amortization of cap software and $500,000 of amortization of intangibles for a total of $1.3 million of non-cash items.

Our subscription fee margin increased to 62% for the current quarter compared to 60% in the same period last year and that's due to the increase of subscription revenue. Services margin increased to 24% compared to 23% for the same period last year due to timing of some implementation projects. Our maintenance margin also increased to 82% for the current quarter compared to 79% in the same period last year and that's due to increase in maintenance revenues and cost containment efforts.

Looking at operating expenses, our gross R&D expenses were 18% of revenues for the current period compared to 14% in the same period last year and that's primarily due to increased development efforts. As a percentage of revenue, sales and marketing expenses were 17% of revenues compared to 18% in the prior year period and that's primarily due to lower sales commissions.

G&A expenses were 16% of total revenues for the current quarter compared to 14% last year and that's primarily due to lower revenues. So, operating income decreased 49% to $2.1 million for this quarter, compared $4.2 million the same period last year. Adjusted EBITDA, which excludes stock-based compensation, decreased 26% to $4.6 million this quarter compared to $6.1 million the same period last year.

Our GAAP net income decreased 58% to $2.3 million or earnings per diluted share of $0.07 for the current quarter compared to net income of $5.6 million or $0.18 per diluted share. Adjusted net income was $3.2 million or adjusted earnings per diluted share of $0.10 for the third quarter compared to a net income of $5.1 million or earnings adjusted per share of $0.16 for the same period last year.

These adjusted numbers exclude amortization of intangible expenses related to other acquisitions, our stock-based compensation expense and last fiscal year, a discrete tax adjustment related to the Tax Cut and Jobs Act of 2017. International revenues this quarter were approximately 17% of total revenues compared to 20% in the prior year quarter.

Looking at the numbers for the nine months year-to-date, total revenues year-to-date decreased 1% to $82.4 million compared to $83.3 million. Subscription fees were $10.2 million year-to-date, a 63% increase compared to $6.2 million same period last year, while software license revenues were $5.4 million, a 56% decrease compared to $12.4 million in the same period last year. And again, this reflects our continuing transition to the SaaS engagement model.

Services revenues increased 1% to $32.3 million year-to-date compared to $31.8 million year-to-date last year and maintenance revenues increased 5% to $34.6 million compared to $32.9 million last year. So, our overall gross margin was 52% year-to-date compared to 56% last year and license fee margin decreased 2% from 62% last year due to lower license fees, while our subscription fee gross margin increased to 63% year-to-date compared to 55% in the same period last year and that's primarily due to increase in the SaaS deployments.

Our services margin was 24% compared to 29% last year, due to timing of some implementation projects and due to increases in services revenue from our lower margin IT consulting business unit. Maintenance margin was 81% year-to-date compared to 79% in the same period last year and that's due to higher revenues, primarily from our Halo acquisition last year.

Looking at operating expenses, our gross R&D expenses were 17% of total revenues for the nine month period ended January 31, 2019 compared to 14% in the same period last year and that's due to increased headcount from the Halo acquisition and increased development efforts.

As a percentage of total revenue, sales and marketing expenses were 18% for the current and prior year period. G&A expenses were 16% of revenues for the current year period compared to 14% the same period last year and that's due to expenses from the Halo acquisition.

So, our operating income year-to-date decreased 61% to $4.3 million compared to operating income of $11.1 million last year. Adjusted EBITDA year-to-date decreased 32% to $11.2 million compared to $16.5 million the same period last year. Our GAAP income was $4.9 million year-to-date or $0.16 earnings per diluted share compared to $10.8 million or $0.36 earnings per diluted share.

Adjusted net income year-to-date was $7.8 million, earnings per diluted share of $0.25, compared to a net income of $11.3 million or earnings per diluted share of $0.38 same period last year. Year-to-date international revenues were 19% of total revenues compared to 20% for the same period last year.

Looking at the balance sheet, the company's financial position remains strong with cash and investments of approximately $84.2 million at the end of January 31, 2019. During the quarter, we paid $3.4 million of dividends. Other aspects of the balance sheet, our ARR balance was $20.3 million, unbilled was roughly $3 million. So, $23 million in accounts receivables in total.

Our deferred revenues increased to $32.9 million and our shareholder equity is $114 million. Our current ratio was 2.7 as of January 31, 2019, and that compares to 2.3 in the same period last year. Our days sales outstanding as of January 31st, 2019 was 78 days compared to 70 days and that's due to timing of billings.

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

Allan Dow

Thank you, Vince. We continued the transition to a software-as-a-service engagement model, which was evidenced by the 43% year-over-year increase in subscription revenue and the 48% growth in annual contract value for cloud services over the prior year period. The trend toward the subscription model is driven by our ability to deliver solution faster and provide better long-term support for the applications.

We are still feeling the effect of delayed or deferred projects, but as you've seen in the numbers, we've continued the upward results trend based on a better close rate at the end of the third quarter. The annual contract value for cloud services associated with new contracts increased from a $0.5 million in Q1 of this fiscal year to $1.3 million in Q2 and now $1.6 million in Q3. This was another good quarter for customer acquisition.

We added 20 new logos to our customer community and completed subscription or licensing transactions in 11 different countries. Although we are disappointed in the market activity over the Christmas and New Year period, it was much slower than we had historically seen, which impacted our services revenue and our close rate in the quarter. But we were pleased with our team's achievements and their alignment to our customers' buying objectives, which continue to trend toward this preference for the subscription model over the traditional on-premise model.

The subscription model is better value for our customers with a higher return on their investment and a faster time to go live, while at the same time improving our financial performance and our predictability. During the third quarter, our recurring revenue streams of maintenance and cloud services represented approximately 56% of total revenues, which is compared to 46% in the same period the prior year due to the growth in our subscription contracts.

We expect the percentage of recurring revenue to continue trending higher in the future, which will improve our financial predictability and our profitability. We're pleased to report that we're on track with our business strategy to deliver a digital planning suite to enable our customers to better manage their business from product concept to customer delivery, achieving the increased visibility, digital planning and new insights necessary to create a more connected enterprise and transform into an automated digital supply chain.

As further evidence of achieving this important shift, we showcased an entirely new user experience for our retail optimization suite at the NRF 2019 show in January, providing a streamlined user experience, leveraging progressive disclosure techniques to guide the user through their day-to-day operations. During the event, one industry analyst declared our new Inspiration Board as "One of the coolest things I've seen at the show."

Looking forward, we're continuing to see an uptick in the transformational projects, which leverage the optimization depth, advanced analytics, machine learning and optimize simulation capabilities of our suite. Transforming their supply chain enabled by continuous and autonomous planning, will allow our customers to leverage their supply chain as a strategic advantage. We believe that those companies who do embrace this transformation, will become industry leaders and those who don't, will become irrelevant within a decade.

On another note, earlier today we announced a significant addition to our leadership team. Mac McGary has joined us as the Executive Vice President of Global Sales. Late last year, we implemented a market segmentation strategy that aligned and focused our direct sales team on enterprise companies who are embarking on a supply chain transformation.

As such, we opened this new role to lead the global direct sales force and after a comprehensive market search, we engaged Mac because of his extensive background in successfully leading software companies in a high growth SaaS model. I believe that our focus on assisting customers to achieve a strategic advantage from their supply chain transformation by leveraging our product investments which enable the autonomous digital supply chain necessary to achieve that level success will -- we will be able to accelerate our growth in the years ahead.

In summary, we're pleased with the overall results this quarter as we strive for continued success. We continue to focus on our core purpose, which is to make our customers more successful and we'll leverage our investments to help them achieve a supply chain competitive advantage. We are confident that we can continue to grow our -- both our revenue and our profitability during this transition to a SaaS engagement model, and we are proud to be delivering incremental benefits for our customers.

The results are exciting and continue to fuel our investments to maintain a leadership role in the supply chain retail planning space.

Miranda, at this time, we'd like to open the call to any questions.

Question-and-Answer Session

Operator

Definitely. [Operator Instructions]. And we'll take our first question of the day from Zach Cummins with B. Riley FBR. Please go ahead.

Zach Cummins

Hi, good afternoon, Allan and Vince. Thanks for taking my questions. First question for me is, can you talk about your new hire, this new EVP of Global Sales and how this is really going to affect your go-to-market strategy?

Allan Dow

Yes, for sure, we -- as I mentioned earlier in the call, Zach. Late last year, we really put a focus and emphasis on those prospective customers and customers who are focused on a transformational strategy for their supply chain. And that really speaks to the capabilities that we have in our solution and the investments both in organic R&D efforts, and our acquisitions that we've made over the last couple of years.

And we feel that it is important to really change our sales strategy as well. Those transformation projects, those are driven at the executive level, they're not user-based. Mac's experience in the marketplace at that level of engagement as well as just being in a high-growth environment in this transformation is really critical for our long-term success. And we felt that it was important to add that additional capability to our team. And we're really pleased to be able to attract Mac to our team at this point.

Zach Cummins

Great, that's helpful. And then in terms of the license decline in the quarter, can you give me an idea of how much of this is due to the ongoing SaaS transition versus the unusually large license transaction last year that was cited in the press release?

Allan Dow

Yes, a little bit of both. There were a couple of things that happened -- we mentioned to it earlier in the call about the slowdown. It was a really amazing to me that historically, it's always been busy around Christmas and New Year, this year was extraordinarily quiet. So we saw a bit of a delay and some hangover of projects that went off. So that was a bit of a factor.

The Software-as-a-Service transition is quite impactful on our short-term earnings numbers because of the deferred nature of the subscription licenses. And then of course, last year third quarter and last fiscal year third quarter, we had a number of large transactions and one specifically very large transaction that was a traditional on-premise license transaction, and that inflated the numbers. We didn't see that in prior quarters or subsequent quarters that same magnitude. So -- and that all three factors had an impact in the way that the numbers played out for us in the third quarter this year.

Zach Cummins

Understood. And then can you talk a little bit more about some of your customers' spending patterns? Is there still some hesitation to really pull the trigger on some of these projects, given the kind of the ongoing economic conditions, and some of the geopolitical uncertainty that's still out there?

Allan Dow

The projects in the pipeline is still strong, we're not seeing a pullback at that level. What we're seeing is a much higher disciplined review of the capital spending authorization or the OpEx, whichever the case may be, just the spending authority whichever term you want to put on that. So the review process is much more thorough, it's been elongated to some extent, where we see -- traditionally seen projects maybe getting served up for the final approval and getting authorized, they get sent back for a little more clarification or due diligence process in there.

So that's the impact we're really seeing at this point. We have not seen a pullback in the overall project flow and the number of engagements that we have out there. And what we're actually seeing now is people are putting an eye toward being ready for the uncertainty that may come, and it's actually triggering some of these transformational projects that I spoke off.

Zach Cummins

Understood. And then, Vince. Can you talk about what was behind the big jump in capitalized R&D and is that going to stay elevated going forward?

Vincent Klinges

I mentioned that we've -- increased our R&D effort, and Allan in his script mentioned about the retail optimization effort we are doing. So, that's what really drove this quarter, about $1 million compared to last year. I anticipate it's going back closer to trend, which would be closer to $1 million a quarter.

Zach Cummins

Understood. That's helpful. Well, thanks again for taking my questions and best of luck closing out 2019.

Allan Dow

Great Zach. Thank you for joining us.

Operator

And we'll take our next question from Joe Vidich with Manalapan Oracle Capital Management. Please go ahead.

Joe Vidich

Yes, hello, guys, thanks for taking my questions. I guess to start with, I was just wondering with regard to the SaaS transition. One, how far along do you think you are in that transition? And two, what percentage of your clients are opting for the SaaS subscription model?

Allan Dow

Joe, this is Allan, thank you for joining us, and thank you for the question. It's a good one. We are, I would say mid-point of that transition. What we're seeing in the marketplace are our strategy, Joe, on those transactions is that, first of all, we believe that the subscription model is a better model for our customers, and we like it for that point and obviously that helps us from a predictability and long-term profitability as well, even though it has a short-term impact. So, we like that model for customer stickiness in the long-term engagement with them.

But we still see in the supply chain space, we still see some companies that are unwilling to engage with the model level, that trend is slowing substantially toward an awareness and acknowledgment and willingness to move to a subscription model. But there are still some companies that view this particular area as being so strategic that they keep that information close to the vest and they want to keep the solutions in-house at this point.

So our first preference is to take the business and get the customer, but we do have a preference for the subscription model. We're mid-term in that, we see the trend -- expect the trend to continue to grow, maybe the best way to comment on it is that as we look forward in our pipeline, we see the predominance of the engagements being proposed and being requested by the prospects of the subscription model. Predominance being something like 60%, maybe 70% of our pipeline as we look forward, particularly when we look at new customers, the trend even goes higher.

So, we're going to see that continue to go. We'll see a mix -- we believe we'll see a mix next year, that's even higher leveraged against the subscription model. And wouldn't be surprised if we see in the next two or three years that essentially this the add-on business will be what comes in on the perpetual model, licensing model. Did that help, Joe?

Joe Vidich

It does. It does, it helps a lot. I guess I have one other question, I don't know how to frame this, but what do you see as your competitive positioning in the marketplace? Your strengths that a large corporation would come to you versus the competitors out there?

Allan Dow

Yes, another good question. Happy to answer that one. So, the key component we have is the depth of capability. Based on our history and experience in the marketplace, we've been able to structure a solution that's tailor-fit for the supply chain marketplace. We've built in the functionality, so our time to deployment, our cost of deployment and risk of deployment is much lower compared to those companies who could deliver the same solution footprint and capabilities functionality that would have allow a company to leverage it for transformation. The predominance of our business, the bulk of our customers are our main bread is around those transformational type, very complex supply chains that need robust capabilities. So, we stand out in that area.

Fortunately, with a longevity and good management practices, we are able to continue to invest over the years and make strategic acquisitions that help build out the portfolio, and as we look forward, we are really driving the forefront of an automated continuous planning operations and that's starting to reduce the manpower associated with it, speed the time to market, cutting it dramatically, improving the revenue picture. So, we're on the forefront of that leading technology moving from what is historically been personnel-managed to solution-managed, continuous automated planning. So, very robust solution, easy to implement, low risk with cutting-edge technology.

Joe Vidich

Right. That's great. I really appreciate it and I applaud you with your hire with Mac McGary, that should really help, I would hope.

Allan Dow

Yes, we're excited to have him on the team, Joe.

Joe Vidich

Anyway, thanks very much. And I'll talk to you, I guess tomorrow.

Allan Dow

Very good. Thank you.

Operator

[Operator Instructions].

Allan Dow

Miranda, thank you very much for helping us on that. We appreciate everyone joining us on the call this afternoon and look forward to further dialog in the future. Have a good evening.

Operator

This will conclude today's program. Thank you for your participation, you may now disconnect and have a wonderful day.