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AGILYSYS INC - Quarter Report: 2017 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________.

Commission file number 0-5734
 
AGILYSYS, INC.
(Exact name of registrant as specified in its charter)
 
Ohio
 
34-0907152
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
425 Walnut Street, Suite 1800,
Cincinnati, Ohio
 
45202
(Address of principal executive offices)
 
(ZIP Code)
 
 
 
(770) 810-7800
(Registrant’s telephone number, including area code)
 
 
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
 
Accelerated filer
x
 
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of Common Shares of the registrant outstanding as of October 31, 2017 was 23,202,476.


Table of Contents

AGILYSYS, INC.
Index

 
 
 
 
 
 
Item 1
Financial Statements
 
 
 
 
 
 
Condensed Consolidated Balance Sheets (Unaudited) - September 30, 2017 and March 31, 2017
 
 
 
 
 
 
Condensed Consolidated Statements of Operations (Unaudited) - Three and Six Months Ended September 30, 2017 and September 30, 2016
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss (Unaudited) - Three and Six Months Ended September 30, 2017 and September 30, 2016
 
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended September 30, 2017 and September 30, 2016
 
 
 
 
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
Item 3
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
 
 
Item 4
Controls and Procedures
 
 
 
 
Part II. Other Information
 
 
 
 
 
 
Item 1    
Legal Proceedings
 
 
 
 
 
Item 1A
Risk Factors
 
 
 
 
 
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
 
Item 3
Defaults Upon Senior Securities
 
 
 
 
 
Item 4
Mine Safety Disclosures
 
 
 
 
 
Item 5
Other Information
 
 
 
 
 
Item 6
Exhibits
 
 
 
 
Signatures
 
 
 



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AGILYSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2017
 
March 31,
2017
(In thousands, except share data)
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
38,532

 
$
49,255

Accounts receivable, net of allowance for doubtful accounts of $698 and $509, respectively
14,742

 
15,598

Inventories
2,299

 
2,211

Prepaid expenses and other current assets
5,428

 
6,456

Total current assets
61,001

 
73,520

Property and equipment, net
16,858

 
16,000

Goodwill
19,622

 
19,622

Intangible assets, net
8,507

 
8,530

Software development costs, net
47,185

 
46,999

Other non-current assets
2,524

 
2,634

Total assets
$
155,697

 
$
167,305

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
8,860

 
$
8,702

Deferred revenue
22,172

 
29,183

Accrued liabilities
7,770

 
8,331

Capital lease obligations, current
116

 
121

Total current liabilities
38,918

 
46,337

Deferred income taxes, non-current
3,349

 
3,181

Capital lease obligations, non-current
77

 
116

Other non-current liabilities
3,925

 
4,002

Commitments and contingencies (see Note 6)

 

Shareholders' equity:
 
 
 
Common shares, without par value, at $0.30 stated value; 80,000,000 shares authorized; 31,606,831 shares issued; and 23,318,471 and 23,210,682 shares outstanding at September 30, 2017 and March 31, 2017, respectively
9,482

 
9,482

Treasury shares, 8,288,360 and 8,396,149 at September 30, 2017 and March 31, 2017, respectively
(2,488
)
 
(2,519
)
Capital in excess of stated value
(3,129
)
 
(5,782
)
Retained earnings
105,745

 
112,692

Accumulated other comprehensive loss
(182
)
 
(204
)
Total shareholders' equity
109,428

 
113,669

Total liabilities and shareholders' equity
$
155,697

 
$
167,305


See accompanying notes to condensed consolidated financial statements.

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AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands, except share data)
2017
 
2016
 
2017
 
2016
Net revenue:
 
 
 
 
 
 
 
Products
$
7,318

 
$
10,731

 
$
17,601

 
$
20,251

Support, maintenance and subscription services
17,108

 
15,906

 
33,775

 
30,854

Professional services
5,703

 
6,039

 
12,618

 
12,524

Total net revenue
30,129

 
32,676

 
63,994

 
63,629

Cost of goods sold:
 
 
 
 
 
 
 
Products (inclusive of developed technology amortization)
5,419

 
8,155

 
13,042

 
14,687

Support, maintenance and subscription services
4,446

 
4,394

 
8,478

 
8,250

Professional services
4,894

 
4,248

 
10,430

 
8,622

Total cost of goods sold
14,759

 
16,797

 
31,950

 
31,559

Gross profit
15,370

 
15,879

 
32,044

 
32,070

 
51.0
%
 
48.6
%
 
50.1
%
 
50.4
%
Operating expenses:
 
 
 
 
 
 
 
Product development
6,812

 
6,946

 
13,438

 
13,799

Sales and marketing
4,207

 
5,113

 
9,337

 
10,748

General and administrative
5,561

 
5,140

 
12,361

 
10,014

Depreciation of fixed assets
700

 
595

 
1,312

 
1,193

Amortization of intangibles
465

 
342

 
950

 
678

Restructuring, severance and other charges
826

 

 
863

 
89

Legal Settlements

 
85

 

 
85

Operating loss
(3,201
)
 
(2,342
)
 
(6,217
)
 
(4,536
)
Other (income) expense:
 
 
 
 
 
 
 
Interest income
(23
)
 
(16
)
 
(51
)
 
(49
)
Interest expense
2

 
4

 
4

 
8

Other expense, net
(37
)
 
(12
)
 
(147
)
 
78

Loss before taxes
(3,143
)
 
(2,318
)
 
(6,023
)
 
(4,573
)
Income tax expense
105

 
82

 
183

 
124

Net loss
$
(3,248
)
 
$
(2,400
)
 
$
(6,206
)
 
$
(4,697
)
 
 
 
 
 
 
 
 
Weighted average shares outstanding
22,760

 
22,606

 
22,740

 
22,603

Loss per share - basic and diluted:
 
 
 
 
 
 
 
Loss per share
$
(0.14
)
 
$
(0.11
)
 
$
(0.27
)
 
$
(0.21
)
 
 
 
 
 
 
 
 

See accompanying notes to condensed consolidated financial statements.

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AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)


 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Net loss
$
(3,248
)
 
$
(2,400
)
 
$
(6,206
)
 
$
(4,697
)
Other comprehensive gain/(loss), net of tax:
 
 
 
 
 
 
 
Unrealized foreign currency translation adjustments
(22
)
 
1

 
22

 
(7
)
Total comprehensive loss
$
(3,270
)
 
$
(2,399
)
 
$
(6,184
)
 
$
(4,704
)

See accompanying notes to condensed consolidated financial statements.

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AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six months ended
 
September 30,
(In thousands)
2017
 
2016
Operating activities
 
 
 
Net loss
$
(6,206
)
 
$
(4,697
)
 
 
 
 
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Net restructuring, severance and other charges
19

 
(286
)
Net legal settlements

 
(15
)
Depreciation
1,312

 
1,193

Amortization
950

 
678

Amortization of developed technology
4,727

 
3,399

Deferred income taxes
87

 
110

Share-based compensation
2,318

 
841

Change in cash surrender value of company owned life insurance policies
(6
)
 
(10
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
887

 
5,862

Inventories
(83
)
 
371

Prepaid expense and other current assets
1,308

 
534

Accounts payable
286

 
1,284

Deferred revenue
(7,036
)
 
(6,765
)
Accrued liabilities
(25
)
 
(2,525
)
Income taxes payable
(46
)
 
(33
)
Other changes, net
(140
)
 
(125
)
Net cash used in operating activities
(1,648
)
 
(184
)
Investing activities
 
 
 
Capital expenditures
(3,106
)
 
(2,272
)
Capitalized software development costs
(5,477
)
 
(5,824
)
Investments in corporate-owned life insurance policies
(2
)
 
(1
)
Net cash used in investing activities
(8,585
)
 
(8,097
)
Financing activities
 
 
 
Payments to settle contingent consideration arising from business acquisition

 
(197
)
Repurchase of common shares to satisfy employee tax withholding
(519
)
 
(404
)
Principal payments under long-term obligations
(61
)
 
(56
)
Net cash used in financing activities
(580
)
 
(657
)
Effect of exchange rate changes on cash
90

 
(41
)
Net decrease in cash and cash equivalents
(10,723
)
 
(8,979
)
Cash and cash equivalents at beginning of period
$
49,255

 
$
60,608

Cash and cash equivalents at end of period
$
38,532

 
$
51,629

 
 
 
 
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
 
 
 
Accrued capital expenditures
$
385

 
$
223

Accrued capitalized software development costs
357

 
1,003


See accompanying notes to condensed consolidated financial statements.

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AGILYSYS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Table amounts in thousands, except per share data)


1. Nature of Operations and Financial Statement Presentation
Nature of Operations

Agilysys is a leading technology company that provides innovative software and services for point-of-sale (POS), reservation and table management, property management (PMS), inventory and procurement, workforce management, business analytics, document management, and mobile and wireless solutions exclusively to the hospitality industry.  Our products and services allow operators to streamline operations, improve efficiency and understand customer needs across their properties to deliver a superior overall guest experience. The result is improved guest loyalty, growth in wallet share and increased revenue as they connect and transact with their guests based upon a single integrated view of individual preferences and interactions. We serve four major market sectors: Gaming, both corporate and tribal; Hotels, Resorts and Cruise; Corporate Foodservice Management; and Restaurants, Universities, Stadia and Healthcare. A significant portion of our consolidated revenue is derived from contract support, maintenance and subscription services.

Agilysys operates across North America, Europe, Asia-Pacific, and India with corporate services located in Alpharetta, GA. For more information, visit www.agilysys.com.


Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements include our accounts consolidated with our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Our fiscal year ends on March 31st. References to a particular year refer to the fiscal year ending in March of that year. For example, fiscal 2018 refers to the fiscal year ending March 31, 2018.

Our unaudited interim financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information, the instructions to the Quarterly Report on Form 10-Q (Quarterly Report) under the Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10-01 of Regulation S-X under the Exchange Act. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

The Condensed Consolidated Balance Sheet as of September 30, 2017, as well as the Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Comprehensive Loss, and the Condensed Consolidated Statements of Cash Flow for the three and six months ended September 30, 2017 and 2016, are unaudited. However, these financial statements have been prepared on the same basis as those in the audited annual financial statements. In the opinion of management, all adjustments of a recurring nature necessary to fairly state the results of operations, financial position, and cash flows have been made.

These unaudited interim financial statements should be read together with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended March 31, 2017, filed with the Securities and Exchange Commission (SEC) on June 2, 2017.







7






2. Summary of Significant Accounting Policies
A detailed description of our significant accounting policies can be found in the audited financial statements for the fiscal year ended March 31, 2017, included in our Annual Report on Form 10-K. Our accounting policy for share-based compensation changed with the adoption of Accounting Standards Update ("ASU") No. 2016-09, as described further below. There have been no other material changes to our significant accounting policies and estimates from those disclosed therein.

Reclassification - Certain prior year balances have been reclassified to conform to the current year presentation. Specifically, we reclassified certain software development costs to property and equipment during the year ended March 31, 2017, which impacted the Condensed Consolidated Statement of Cash Flows for the six months ended September 30, 2016 in the amount of $0.8 million.

Adopted and Recently Issued Accounting Pronouncements

In January 2017, the Financial Accounting Standards Board ("FASB") issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, and ASU No. 2017-04, Intangibles- Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment. ASU No. 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. ASU No. 2017-04 eliminates Step 2 of the goodwill impairment test and requires a goodwill impairment to be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of its goodwill. The ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. While we are still assessing the impact of this standard, we do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The new guidance is effective for annual reporting periods beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual reporting period. The new standard must be adopted using a modified retrospective transition method, with the cumulative effect recognized as of the date of initial adoption. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718), which amends the accounting for stock-based compensation. The guidance requires excess tax benefits and deficiencies to be recognized as a component of income tax expense rather than of stockholders’ equity and also allows an entity to make an accounting policy election to either estimate expected forfeitures or to account for them as they occur. ASU No. 2016-09 is effective for annual reporting periods beginning after December 15, 2016. The Company adopted the ASU in the quarter ended June 30, 2017, which is the first quarter for our annual period beginning April 1, 2017.  The following summarizes the effects of the adoption on the Company's unaudited condensed consolidated financial statements:

Income taxes - In the first quarter of 2018, we did not recognize the discrete benefit related to $4.4 million of tax deductions in excess of recorded windfall tax benefits associated with stock-based compensation due to the Company’s full valuation allowance on its U.S. federal net operating losses.

Forfeitures - Prior to adoption, the Company recognized share-based compensation expense net of estimated forfeitures based on a rate management updated at least annually to reflect expected forfeitures over the vesting period. Upon adoption, the Company will no longer apply a forfeiture rate and instead will account for forfeitures as they occur. The Company applied the modified retrospective adoption approach and recorded a cumulative-

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effect adjustment of approximately $0.7 million to opening retained earnings. Prior periods have not been adjusted.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will require lessees to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new guidance will require both types of leases to be recognized on the balance sheet. The new guidance is effective for all periods beginning after December 15, 2018 and we are currently evaluating the effects that the adoption of ASU No. 2016-02 will have on our consolidated financial statements, but anticipate that the new guidance will materially impact our consolidated financial statements given the significance of our leases.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific revenue recognition guidance throughout the Industry Topics of the Accounting Standards Codification. Additionally, this update supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. As originally issued, this guidance was effective for interim and annual reporting periods beginning after December 15, 2016, and early adoption was not permitted. In July 2015, the FASB deferred the effective date by one year, to interim and annual reporting periods beginning after December 15, 2017. The standard allows entities to apply the standard retrospectively to each prior reporting period presented (“full retrospective adoption”) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application (“modified retrospective adoption”). We plan to adopt ASU No. 2014-09 on its effective date for us beginning April 1, 2018 and we are still evaluating both options and their effect on our financial statements and business.

We expect to identify similar performance obligations under Topic 606 as compared with deliverables and separate units of account previously identified. As a result, we expect the timing of our revenue to occur in similar periods but we are still evaluating this theory especially with respect to multiple service contracts. We are assessing the new standard’s requirement to apply a single method to measure progress towards satisfaction of performance obligations recognized over time in our contracts that contain multiple services. We are evaluating our multiple service contracts to determine if the services are a single performance obligation under this new standard requiring a single method of measurement. We are assessing the new standards requirement to allocate the transaction prices of our contracts based on the relative stand-alone selling price of each our performance obligations. We are evaluating the stand-alone selling prices for our performance obligations. We are also assessing the new standard’s requirement to capitalize costs associated with obtaining customer contracts, including commission payments, which are currently expensed as incurred for all commissions earned subsequent to the year ended March 31, 2016. We are evaluating the period over which to amortize these capitalized costs and the applicability of the practical expediency exception which permits the continuation of expensing these costs for amortization periods of one year or less. In addition, for sales transactions that have been billed, but for which the recognition of revenue has been deferred and the related account receivable has not been collected, we currently do not recognize deferred revenue or the related accounts receivable on our consolidated balance sheet. Under the new standard, we will record accounts receivable and related contract liabilities for non-cancelable contracts with customers when the right to consideration is unconditional, which we currently expect will result in increases in accounts receivable and contract liabilities (currently presented as deferred revenue) on our consolidated balance sheet, compared to our current presentation. We are continuing to review the impacts of adopting ASU No. 2014-09 to our consolidated financial statements and these preliminary assessments of the impacts to our consolidated financial statements are subject to change. We expect to conclude our assessments of the impacts of adoption sometime during our fourth quarter ending March 31, 2018.

Management continually evaluates the potential impact, if any, of all recent accounting pronouncements on our consolidated financial statements or related disclosures and, if significant, makes the appropriate disclosures required by such new accounting pronouncements.


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3. Restructuring Charges

We recognize restructuring charges when a plan that materially changes the scope of our business or the manner in which that business is conducted is adopted and communicated to the impacted parties, and the expenses have been incurred or are reasonably estimable.

Fiscal 2018 Restructuring Activity

Q2 - In the second quarter of fiscal 2018, we recorded $0.8 million in restructuring charges related to our ongoing efforts to better allocate resources to our crucial revenue growth areas while increasing internal efficiencies in other non-revenue generating areas.

As of September 30, 2017, we had a remaining liability of approximately $31,000 recorded for the Q2 fiscal 2018 restructuring activity.

Following is a reconciliation of the beginning and ending balances of the restructuring liability:

 
Balance at
 
 
Balance at
 
March 31,
Provision/
 
September 30,
(in thousands)
2017
Adjustments
Payments
2017
Fiscal 2018 Restructuring Plan:
 
 
 
 
Severance and other employment costs
$

$
823

$
(792
)
$
31

 
 
 
 
 
Total restructuring costs
$

$
823

$
(792
)
$
31




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4. Intangible Assets and Software Development Costs

The following table summarizes our intangible assets and software development costs:
 
September 30, 2017
 
March 31, 2017
 
Gross
 
Net
 
Gross
 
Net
 
carrying
Accumulated
carrying
 
carrying
Accumulated
carrying
(In thousands)
amount
amortization
amount
 
amount
amortization
amount
Amortized intangible assets:
 
 
 
 
 
 
 
Customer relationships
$
10,775

$
(10,775
)
$

 
$
10,775

$
(10,775
)
$

Non-competition agreements
2,700

(2,700
)

 
2,700

(2,700
)

Developed technology
10,055

(10,055
)

 
10,055

(10,055
)

Trade names
230

(123
)
107

 
230

(100
)
130

Patented technology
80

(80
)

 
80

(80
)

 
23,840

(23,733
)
107

 
23,840

(23,710
)
130

Unamortized intangible assets:
 
 
 
 
 
 
 
Trade names
8,400

 N/A

8,400

 
8,400

 N/A

8,400

Total intangible assets
$
32,240

$
(23,733
)
$
8,507


$
32,240

$
(23,710
)
$
8,530

 
 
 
 
 
 
 
 
Software development costs
$
53,415

$
(15,083
)
$
38,332

 
$
46,598

$
(10,356
)
$
36,242

Project expenditures not yet in use
8,853


8,853

 
10,757


10,757

Total software development costs
$
62,268

$
(15,083
)
$
47,185

 
$
57,355

$
(10,356
)
$
46,999


During the second quarter of fiscal 2018, we announced general availability of our rGuest Buy point of sale solution and placed into service $6.8 million of related software development costs in the last month of the quarter. Amortization of this internally developed technology is included in Products cost of goods sold and was $0.1 million for the three and six months ended September 30, 2017. The useful life of the asset is 5 years.

The following table summarizes our remaining estimated amortization expense relating to in service intangible assets and software development costs.
 
Estimated
 
Amortization
(In thousands)
Expense
Fiscal year ending March 31,
 
2018
$
5,318

2019
10,513

2020
9,774

2021
9,689

2022
2,576

2023
569

Total
$
38,439


Amortization expense related to software development costs related to assets to be sold, leased, or otherwise marketed was $2.4 million and $2.1 million for the three months ended September 30, 2017 and 2016, and $4.7 million and $3.4 million for the six months ended September 30, 2017 and 2016, respectively. These charges are included as Products cost of goods sold within the Condensed Consolidated Statements of Operations.

Amortization expense relating to other definite-lived intangible assets was $11,500 for the three months ended September 30, 2017 and 2016, and $23,000 for the six months ended September 30, 2017 and 2016. These charges are classified as operating expenses within the Condensed Consolidated Statements of Operations.

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Capitalized software development costs for software internally developed to be sold, leased, or otherwise marketed, are carried on our balance sheet at net carrying value, net of accumulated amortization. We capitalized approximately $2.2 million and $3.0 million during the three months ended September 30, 2017 and 2016, and $4.9 million and $5.9 million during the six months ended September 30, 2017 and 2016, respectively.



5. Additional Balance Sheet Information
Additional information related to the Condensed Consolidated Balance Sheets is as follows:
(In thousands)
September 30,
2017
 
March 31,
2017
Accrued liabilities:
 
 
 
Salaries, wages, and related benefits
$
5,890

 
$
6,473

Other taxes payable
579

 
750

Accrued legal settlements
159

 
75

Restructuring liabilities
31

 

Severance liabilities
16

 
11

Professional fees
299

 
146

Deferred rent
411

 
433

Other
385

 
443

Total
$
7,770

 
$
8,331

Other non-current liabilities:
 
 
 
Uncertain tax positions
$
1,500

 
$
1,479

Deferred rent
2,347

 
2,444

Other
78

 
79

Total
$
3,925

 
$
4,002


Accounts Receivable, net

Accounts receivable, net of allowance for doubtful accounts was $14.7 million and $15.6 million as of September 30, 2017 and March 31, 2017, respectively. The related allowance for doubtful accounts was $0.7 million and $0.5 million as of September 30, 2017 and March 31, 2017, respectively.

On January 12, 2015, an involuntary bankruptcy petition was filed against Caesars Entertainment Operating Company, Inc. (Caesars) under Chapter 11 of the U.S. Bankruptcy Code. On January 15, 2015, Caesars and certain of its affiliates filed a voluntary bankruptcy petition under Chapter 11. Those cases have been consolidated in the United States Bankruptcy Court for the Northern District of Illinois. As of May 26, 2015, we filed a proof of claim with the Bankruptcy Court identifying approximately $0.7 million of pre-petition claims. In January 2016, we filed an amended proof of claim with the Bankruptcy Court identifying $0.2 million of pre-petition claim in addition to those filed on May 26, 2015. As of September 30, 2017, approximately $0.7 million of pre-petition claims remain outstanding. Subsequent to September 30, 2017, we have collected on all of the $0.7 million of pre-petition claims outstanding.


12



6. Income Taxes

The following table compares our income tax expense and effective tax rates for the three and six months ended September 30, 2017 and 2016:
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(Dollars in thousands)
2017
 
2016
 
2017
 
2016
Income tax expense
$
105


$
82

 
$
183

 
$
124

Effective tax rate
(3.3
)%

(3.5
)%
 
(3.0
)%
 
(2.7
)%

For the three and six months ended September 30, 2017, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

For the three and six months ended September 30, 2016, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

We have recorded a valuation allowance offsetting substantially all of our deferred tax assets. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences are deductible. Because of our losses in prior periods, management believes that it is more-likely-than-not that we will not realize the benefits of these deductible differences.


7. Commitments and Contingencies

Agilysys is the subject of various threatened or pending legal actions and contingencies in the normal course of conducting its business. We provide for costs related to these matters when a loss is probable and the amount can be reasonably estimated. The effect of the outcome of these matters on our future results of operations and liquidity cannot be predicted because any such effect depends on future results of operations and the amount or timing of the resolution of such matters. While it is not possible to predict with certainty, management believes that the ultimate resolution of such individual or aggregated matters will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

On April 6, 2012, Ameranth, Inc. filed a complaint against us for patent infringement in the United States District Court for the Southern District of California. The complaint alleges, among other things, that point-of-sale and property management and other hospitality information technology products, software, components and/or systems sold by us infringe patents owned by Ameranth purporting to cover generation and synchronization of menus, including restaurant menus, event tickets, and other products across fixed, wireless and/or internet platforms as well as synchronization of hospitality information and hospitality software applications across fixed, wireless and internet platforms. The complaint seeks monetary damages, injunctive relief, costs and attorneys' fees. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit.  However, we dispute the allegations of wrongdoing and are vigorously defending ourselves in this matter.




8. Loss per Share

The following data shows the amounts used in computing loss per share and the effect on earnings and the weighted average number of shares of dilutive potential common shares.

13

Table of Contents

 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands, except per share data)
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Net loss
$
(3,248
)
 
$
(2,400
)
 
$
(6,206
)
 
$
(4,697
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding
22,760

 
22,606

 
22,740

 
22,603

 
 
 
 
 
 
 
 
Loss per share - basic and diluted:
 
 
 
 
 
 
 
Loss per share
$
(0.14
)
 
$
(0.11
)
 
$
(0.27
)
 
$
(0.21
)
 
 
 
 
 
 
 
 
Anti-dilutive stock options, SSARs, restricted shares and performance shares
1,788

 
1,291

 
1,728

 
1,363


Basic earnings (loss) per share is computed as net income available to common shareholders divided by the weighted average basic shares outstanding. The outstanding shares used to calculate the weighted average basic shares excludes 535,772 and 541,473 of restricted shares at September 30, 2017 and 2016, respectively, as these shares were issued but were not vested and, therefore, not considered outstanding for purposes of computing basic (loss) earnings per share at the balance sheet dates.

Diluted earnings (loss) per share includes the effect of all potentially dilutive securities on earnings per share. We have stock options, stock-settled appreciation rights ("SSARs"), unvested restricted shares and unvested performance shares that are potentially dilutive securities. When a loss is reported, the denominator of diluted earnings per share cannot be adjusted for the dilutive impact of share-based compensation awards because doing so would be anti-dilutive. In addition, when a net loss is reported, adjusting the denominator of diluted earnings per share would also be anti-dilutive to the loss per share, even if the entity has net income after adjusting for a discontinued operation. Therefore, for all periods presented, basic weighted-average shares outstanding were used in calculating the diluted net loss per share.


9. Share-based Compensation

We may grant non-qualified stock options, incentive stock options, SSARs, restricted shares, and restricted share units under our shareholder-approved 2016 Stock Incentive Plan (the 2016 Plan) for up to 2.0 million common shares, plus 957,575 common shares, the number of shares that were remaining for grant under the 2011 Stock Incentive Plan (the 2011 Plan) as of the effective date of the 2016 Plan, plus the number of shares remaining for grant under the 2011 Plan that are forfeited, settled in cash, canceled or expired. The maximum aggregate number of restricted shares or restricted share units that may be granted under the 2016 Plan is 1.25 million. With respect to awards that are intended to qualify for the performance-based exception to the deductibility limitations of Section 162(m) of the Internal Revenue Code, the maximum number of shares subject to stock options or SSARs that may be granted to an individual in a calendar year is 800,000 shares, and the maximum number of shares subject to restricted shares or restricted share units that may be granted to an individual in a calendar year is 400,000 shares.

We have a shareholder-approved 2006 Stock Incentive Plan (the 2006 Plan) that still has vested awards outstanding. Awards are no longer being granted from this incentive plan.

We may distribute authorized but unissued shares or treasury shares to satisfy share option and appreciation right exercises or restricted share and performance share awards.

We record compensation expense related to stock options, SSARs, restricted shares, and performance shares granted to certain employees and non-employee directors based on the fair value of the awards on the grant date. The fair value of restricted share and performance share awards is based on the closing price of our common shares on the grant date. The fair value of stock option and SSARs awards is estimated on the grant date using the Black-Scholes-Merton option pricing

14

Table of Contents

model, which includes assumptions regarding the risk-free interest rate, dividend yield, life of the award, and the volatility of our common shares.

The following table summarizes the share-based compensation expense for options, SSARs, restricted and performance awards included in the Condensed Consolidated Statements of Operations:
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Product development
$
105

 
$
200

 
$
526

 
$
328

Sales and marketing
187

 
32

 
356

 
53

General and administrative
808

 
262

 
1,436

 
460

Total share-based compensation expense
1,100

 
494

 
2,318

 
841



Stock-Settled Stock Appreciation Rights

SSARs are rights granted to an employee to receive value equal to the difference in the price of our common shares on the date of the grant and on the date of exercise. This value is settled in common shares of Agilysys.

The following table summarizes the activity during the six months ended September 30, 2017 for SSARs awarded under the 2011 and 2016 Plans:
 
Number
of Rights
 
Weighted-
Average
Exercise
Price
 
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
(In thousands, except share and per share data)
 
 
(per right)
 
(in years)
 
 
Outstanding at April 1, 2017
1,094,978

 
$
10.44

 
 
 
 
Granted
159,376

 
10.17

 
 
 
 
Exercised
(25,001
)
 
8.64

 
 
 
 
Forfeited
(55,530
)
 
9.98

 
 
 
 
Cancelled/expired
(40,766
)
 
9.32

 
 
 
 
Outstanding at September 30, 2017
1,133,057

 
$
10.51

 
5.6
 
$
1,741

Exercisable at September 30, 2017
275,667

 
$
10.26

 
3.5
 
$
573


As of September 30, 2017, total unrecognized stock based compensation expense related to non-vested SSARs was $1.6 million, which is expected to be recognized over a weighted-average vesting period of 2.2 years.


15

Table of Contents

Restricted Shares

We granted shares to certain of our Directors, executives and key employees, the vesting of which is service-based. The following table summarizes the activity during the six months ended September 30, 2017 for restricted shares awarded under the 2016 and 2011 Plan:
 
Number
of Shares
 
Weighted-
Average
Grant-
Date Fair
Value
(In thousands, except share and per share data)
 
 
(per share)
Outstanding at April 1, 2017
490,355

 
$
10.72

Granted
115,026

 
9.91
Vested
(83,147
)
 
13.40

Forfeited
(77,925
)
 
10.69

Outstanding at September 30, 2017
444,309

 
$
10.02


The weighted-average grant date fair value of the restricted shares is determined based upon the closing price of our common shares on the grant date. As of September 30, 2017, total unrecognized stock based compensation expense related to non-vested restricted stock was $2.0 million, which is expected to be recognized over a weighted-average vesting period of 1.6 years.

Performance Shares

We awarded certain restricted shares to our Chief Executive Officer, the vesting of which is performance based. The number of shares that vest will be based on the stock price and relative attainment of performance metric.

The following table summarizes the activity during the six months ended September 30, 2017 for the performance shares awarded under the 2016 Plan:
 
Number
of
Shares
 
 
 
 
Outstanding at April 1, 2017

 
Granted
91,463

 
Vested

 
Outstanding at September 30, 2017
91,463

 

Based on the performance goals, management estimates a liability of $260,283 to be settled through the vesting of a variable number of the performance shares subsequent to March 31, 2018. As of September 30, 2017, total unrecognized stock based compensation expense related to non-vested performance shares was $156,170, which is expected to be recognized over the remaining vesting period of 6 months.



16

Table of Contents

10. Fair Value Measurements
We estimate the fair value of financial instruments using available market information and generally accepted valuation methodologies. We assess the inputs used to measure fair value using a three-tier hierarchy. The hierarchy indicates the extent to which pricing inputs used in measuring fair value are observable in the market. Level 1 inputs include unadjusted quoted prices for identical assets or liabilities and are the most observable. Level 2 inputs include unadjusted quoted prices for similar assets and liabilities that are either directly or indirectly observable, or other observable inputs such as interest rates, foreign currency exchange rates, commodity rates, and yield curves. Level 3 inputs are not observable in the market and include our own judgments about the assumptions market participants would use in pricing the asset or liability. The use of observable and unobservable inputs is reflected in the hierarchy assessment disclosed in the tables below.
 
There were no significant transfers between Levels 1, 2, and 3 during the six months ended September 30, 2017 and 2016.

The following tables present information about our financial assets and liabilities measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized to determine such fair value:
 
Fair value measurement used
 
Recorded
value
as of
 
Active
markets
for
identical
assets or
liabilities
 
Quoted
prices in
similar
instruments
and
observable
inputs
 
Active
markets for
unobservable
inputs
(In thousands)
September 30, 2017
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Corporate-owned life insurance — non-current
$
815

 

 

 
$
815


 
Fair value measurement used
 
Recorded
value
as of
 
Active
markets
for
identical
assets or
liabilities
 
Quoted
prices in
similar
instruments
and
observable
inputs
 
Active
markets for
unobservable
inputs
(In thousands)
March 31, 2017
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Corporate-owned life insurance — non-current
$
809

 

 

 
$
809


The recorded value of the corporate-owned life insurance policies is adjusted to the cash surrender value of the policies obtained from the third party life insurance providers, which are not observable in the market, and therefore, are classified within Level 3 of the fair value hierarchy. Changes in the cash surrender value of these policies are recorded within “Other expenses (income), net” in the Condensed Consolidated Statements of Operations.


17

Table of Contents

The following table presents a summary of changes in the fair value of the Level 3 assets:
 
Six months ended
 
September 30,
(In thousands)
2017
 
2016
Corporate-owned life insurance:
 
 
 
Balance on April 1
$
809

 
$
3,122

Unrealized gain relating to instruments held at reporting date
4

 
10

Purchases, sales, issuances and settlements, net
2

 
1

Balance on September 30
$
815

 
$
3,133


The following tables present a summary of changes in the fair value of the Level 3 liabilities:

 
Six months ended
 
September 30,
(In thousands)
2017
 
2016
Contingent consideration
 
 
 
Balance on April 1
$

 
$
197

Activity, payments and other charges (net)

 
(197
)
Balance on September 30
$

 
$

 
 
 
 




18

Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”), management explains the general financial condition and results of operations for Agilysys and subsidiaries including:

—    what factors affect our business;
—    what our earnings and costs were;
—    why those earnings and costs were different from the year before;
—    where the earnings came from;
—    how our financial condition was affected; and
—    where the cash will come from to fund future operations.

The MD&A analyzes changes in specific line items in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows and provides information that management believes is important to assessing and understanding our consolidated financial condition and results of operations. This Quarterly Report on Form 10-Q updates information included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2017, filed with the Securities and Exchange Commission (SEC). This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and related Notes that appear in Item 1 of this Quarterly Report as well as our Annual Report for the year ended March 31, 2017. Information provided in the MD&A may include forward-looking statements that involve risks and uncertainties. Many factors could cause actual results to be materially different from those contained in the forward-looking statements. See “Forward-Looking Information” on page 28 of this Quarterly Report, Item 1A "Risk Factors" in Part II of this Quarterly Report, and Item 1A “Risk Factors” in Part I of our Annual Report for the fiscal year ended March 31, 2017 for additional information concerning these items. Management believes that this information, discussion, and disclosure is important in making decisions about investing in Agilysys.

Overview

Agilysys is a leading technology company that provides innovative software and services for point-of-sale (POS), reservation and table management, property management (PMS), inventory and procurement, workforce management, business analytics, document management, and mobile and wireless solutions exclusively to the hospitality industry.  Our products and services allow operators to streamline operations, improve efficiency and understand customer needs across their properties to deliver a superior overall guest experience. The result is improved guest loyalty, growth in wallet share and increased revenue as they connect and transact with their guests based upon a single integrated view of individual preferences and interactions.  We serve four major market sectors: Gaming, both corporate and tribal; Hotels, Resorts and Cruise; Corporate Foodservice Management; and Restaurants, Universities, Stadia and Healthcare. A significant portion of our consolidated revenue is derived from contract support, maintenance and subscription services.

Agilysys operates across North America, Europe, Asia, and India with corporate services located in Alpharetta, GA. For more information, visit www.agilysys.com.

Our top priority is to increase shareholder value by improving operating and financial performance and profitably growing the business through superior products and services.  To that end, we expect to invest a certain portion of our cash on hand to fund enhancements to existing software products, to develop and market new software products, and to expand our customer breadth, both vertically and geographically.

Our strategic plan specifically focuses on:

Putting the customer first
Accelerating our product development
Improving organizational efficiency and teamwork
Developing our employees and leaders
Growing revenue by improving the breadth and depth of our product set across both our well established products and our newer rGuest platform
Growing revenue through international expansion

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Table of Contents


The primary objective of our ongoing strategic planning process is to create shareholder value by capitalizing on growth opportunities, turning profitable and strengthening our competitive position within the specific technology solutions and end markets we serve. Profitability and industry leading growth will be achieved through tighter management of operating expenses and sharpening the focus of our investments to concentrate on growth opportunities that offer the highest returns.



20

Table of Contents

Revenue - Defined

As required by the SEC, we separately present revenue earned as products revenue, support, maintenance and subscription services revenue or professional services revenue in our Condensed Consolidated Statements of Operations. In addition to the SEC requirements, we may, at times, also refer to revenue as defined below. The terminology, definitions, and applications of terms we use to describe our revenue may be different from those used by other companies and caution should be used when comparing these financial measures to those of other companies. We use the following terms to describe revenue:

•    Revenue – We present revenue net of sales returns and allowances.
Products revenue – Revenue earned from the sales of hardware equipment and proprietary and remarketed software.
Support, maintenance and subscription services revenue – Revenue earned from the sale of proprietary and remarketed ongoing support, maintenance and subscription or hosting services.
Professional services revenue – Revenue earned from the delivery of implementation, integration and installation services for proprietary and remarketed products.

Results of Operations

Second Fiscal Quarter 2018 Compared to Second Fiscal Quarter 2017

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the three months ended September 30, 2017 and 2016:
 
Three months ended
 
 
 
 
 
September 30,
 
  Increase (decrease)
(Dollars in thousands)
2017
 
2016
 
$
 
%
Net revenue:
 
 
 
 
 
 
 
Products
$
7,318

 
$
10,731

 
$
(3,413
)
 
(31.8
)%
Support, maintenance and subscription services
17,108

 
15,906

 
1,202

 
7.6

Professional services
5,703

 
6,039

 
(336
)
 
(5.6
)
Total net revenue
30,129

 
32,676

 
(2,547
)
 
(7.8
)
Cost of goods sold:
 
 
 
 
 
 
 
Products (inclusive of developed technology amortization)
5,419

 
8,155

 
(2,736
)
 
(33.5
)
Support, maintenance and subscription services
4,446

 
4,394

 
52

 
1.2

Professional services
4,894

 
4,248

 
646

 
15.2

Total cost of goods sold
14,759

 
16,797

 
(2,038
)
 
(12.1
)
Gross profit
$
15,370

 
$
15,879

 
$
(509
)
 
(3.2
)%
Gross profit margin
51.0
 %
 
48.6
 %
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Product development
$
6,812

 
$
6,946

 
$
(134
)
 
(1.9
)%
Sales and marketing
4,207

 
5,113

 
(906
)
 
(17.7
)
General and administrative
5,561

 
5,140

 
421

 
8.2

Depreciation of fixed assets
700

 
595

 
105

 
17.6

Amortization of intangibles
465

 
342

 
123

 
36.0

Restructuring, severance and other charges
826

 

 
826

 
          nm
Legal settlements

 
85

 
(85
)
 
          nm
Operating loss
$
(3,201
)
 
$
(2,342
)
 
$
(859
)
 
36.7
 %
Operating loss percentage
(10.6
)%
 
(7.2
)%
 
 
 
 

nm - not meaningful

21

Table of Contents


The following table presents the percentage relationship of our Condensed Consolidated Statement of Operations line items to our consolidated net revenues for the periods presented:
 
Three months ended
 
September 30,
 
2017
 
2016
Net revenue:
 
 
 
Products
24.3
 %
 
32.8
 %
Support, maintenance and subscription services
56.8

 
48.7

Professional services
18.9

 
18.5

Total
100.0
 %
 
100.0
 %
Cost of goods sold:
 
 
 
Products (inclusive of developed technology amortization)
18.0
 %
 
25.0
 %
Support, maintenance and subscription services
14.8

 
13.4

Professional services
16.2

 
13.0

Total
49.0
 %
 
51.4
 %
Gross profit
51.0
 %
 
48.6
 %
Operating expenses:
 
 
 
Product development
22.6
 %
 
21.3
 %
Sales and marketing
14.0

 
15.6

General and administrative
18.5

 
15.7

Depreciation of fixed assets
2.3

 
1.8

Amortization of intangibles
1.5

 
1.0

Restructuring, severance and other charges
2.7

 

Legal settlements

 
0.3

Operating loss
(10.6
)%
 
(7.2
)%

Net revenue.  Total net revenue decreased $2.5 million, or 7.8%, during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. Products revenue decreased $3.4 million, or 31.8%, due primarily to decreased hardware sales. Support, maintenance and subscription services revenue increased $1.2 million, or 7.6%, compared to the second quarter of fiscal 2017 driven by new customers using our on premise software products which require the payment of support and maintenance along with continued increases in subscription based service revenue, which increased approximately 28.8% during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. Professional services revenue decreased $0.3 million, or 5.6%, as a result of decreased volume of customer installation and implementation projects related to the sale of on premise and subscription based solutions.

Gross profit and gross profit margin.  Our total gross profit decreased $0.5 million, or 3.2%, for the second quarter of fiscal 2018 and total gross profit margin increased 2.4% to 51.0% from 48.6%. Products gross profit decreased $0.7 million and gross profit margin increased 1.9% to 25.9% primarily as a result of an increase in the proportion of proprietary software revenue to total product revenue compared to the second quarter of fiscal 2017. Support, maintenance and subscription services gross profit increased $1.2 million and gross margin increased 1.6% to 74.0% due to the scalable nature of our infrastructure supporting and hosting customers. Professional services gross profit decreased $1.0 million and gross profit margin decreased 15.5% to 14.2% due to lower quarterly professional services revenues on a higher cost structure following a recent alignment toward enabling the Company to provide more customer-centric services going forward.

Operating expenses

Operating expenses, excluding the charges for asset write-offs and other fair value adjustments, legal settlements, and restructuring, severance and other charges, increased $0.4 million, or 2.2%, during the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017.

22

Table of Contents

  
Product development.  Product development decreased $0.1 million, or 1.9%, in the second quarter of fiscal 2018 due primarily to a $0.6 million reclassification of employee cost from product development to cost of goods sold related to the restructuring of our professional services workforce to better address customer needs, offset by an increase in engineering related compensation costs due to increased headcount. We capitalized approximately $2.7 million and $3.6 million in total development costs during the three months ended September 30, 2017 and 2016, respectively.

Sales and marketing.  Sales and marketing decreased $0.9 million, or 17.7%, in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017. The change is due primarily to a decrease of $0.8 million in incentive commissions related to the revision of our commission plan from total contract value to annual contract value.

General and administrative.  General and administrative increased $0.4 million, or 8.2%, in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 due primarily to increases of $0.5 million in stock compensation expense related to executive stock grants and the impact of removing forfeiture rates as a result of adopting ASU No. 2016-09.

Restructuring, severance, and other charges. Restructuring, severance, and other charges increased $0.8 million during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017 due to our ongoing efforts to better allocate resources to our crucial revenue growth areas while increasing internal efficiencies in other non-revenue generating areas. The restructuring initiative outlined below will result in annual savings of $2.7 million across all of our operating expense categories.

 
Balance at
 
 
Balance at
 
March 31,
Provision/
 
September 30,
(in thousands)
2017
Adjustments
Payments
2017
Fiscal 2018 Restructuring Plan:
 
 
 
 
Severance and other employment costs

823

(792
)
31

 
 
 
 
 
Total restructuring costs

823

(792
)
31




Other Expenses (Income)
 
Three months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2017
 
2016
 
$
 
%
Other (income) expense:
 
 
 
 
 
 
 
Interest income
$
(23
)
 
$
(16
)
 
$
7

 
43.8
%
Interest expense
2

 
4

 
2

 
50.0
%
Other (income) expense, net
(37
)
 
(12
)
 
25

 
nm

Total other (income) expense, net
$
(58
)
 
$
(24
)
 
$
34

 
nm


nm - not meaningful

Interest income. Interest income consists of interest earned on investments in certificates of deposit, commercial paper, corporate bonds, and corporate-owned life insurance policies.

Interest expense. Interest expense consists of costs associated with capital leases.

Other (income) expense. Other (income) expense consists mainly of the impact of foreign currency due to movement of European and Asian currencies against the US dollar.

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Table of Contents


Income Taxes
 
Three months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2017
 
2016
 
$
 
%
Income tax expense
$
105

 
$
82

 
$
(23
)
 
nm
Effective tax rate
(3.3
)%
 
(3.5
)%
 
 
 
 

nm - not meaningful
For the three months ended September 30, 2017, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

For the three months ended September 30, 2016, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of zero to $0.1 million of tax and zero to $0.1 million of interest based on the outcome of tax examinations and as a result of the expiration of various statutes of limitations. We are routinely audited; due to the ongoing nature of current examinations in multiple jurisdictions, other changes could occur in the amount of gross unrecognized tax benefits during the next 12 months which cannot be estimated at this time.

We have recorded a valuation allowance offsetting substantially all of our deferred tax assets. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences are deductible. Because of our losses in prior periods, management believes that it is more-likely-than-not that we will not realize the benefits of these deductible differences.

24

Table of Contents



Results of Operations

First Half Fiscal 2018 Compared to First Half Fiscal 2017

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the six months ended September 30, 2017 and 2016:
 
Six months ended
 
 
 
 
 
September 30,
 
  Increase (decrease)
(Dollars in thousands)
2017
 
2016
 
$
 
%
Net revenue:
 
 
 
 
 
 
 
Products
$
17,601

 
$
20,251

 
(2,650
)
 
(13.1
)%
Support, maintenance and subscription services
33,775

 
30,854

 
2,921

 
9.5

Professional services
12,618

 
12,524

 
94

 
0.8

Total net revenue
63,994

 
63,629

 
365

 
0.6

Cost of goods sold:
 
 
 
 
 
 
 
Products (inclusive of developed technology amortization)
13,042

 
14,687

 
(1,645
)
 
(11.2
)
Support, maintenance and subscription services
8,478

 
8,250

 
228

 
2.8

Professional services
10,430

 
8,622

 
1,808

 
21.0

Total cost of goods sold
31,950

 
31,559

 
391

 
1.2

Gross profit
32,044

 
32,070

 
(26
)
 
(0.1
)
Gross profit margin
50.1
%
 
50.4
%
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Product development
13,438

 
13,799

 
(361
)
 
(2.6
)
Sales and marketing
9,337

 
10,748

 
(1,411
)
 
(13.1
)
General and administrative
12,361

 
10,014

 
2,347

 
23.4

Depreciation of fixed assets
1,312

 
1,193

 
119

 
10.0

Amortization of intangibles
950

 
678

 
272

 
40.1

Restructuring, severance and other charges
863

 
89

 
774

 
         nm
Legal settlements

 
85

 
(85
)
 
         nm
Operating loss
$
(6,217
)
 
$
(4,536
)
 
$
(1,681
)
 
37.1
 %

nm - not meaningful

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The following table presents the percentage relationship of our Condensed Consolidated Statement of Operations line items to our consolidated net revenues for the periods presented:
 
Six months ended
 
September 30,
 
2017
 
2016
Net revenue:
 
 
 
Products
27.5
 %
 
31.8
 %
Support, maintenance and subscription services
52.8

 
48.5

Professional services
19.7

 
19.7

Total
100.0
 %
 
100.0
 %
Cost of goods sold:
 
 
 
Products (inclusive of developed technology amortization)
20.4
 %
 
23.1
 %
Support, maintenance and subscription services
13.2

 
12.9

Professional services
16.3

 
13.6

Total
49.9
 %
 
49.6
 %
Gross profit
50.1
 %
 
50.4
 %
Operating expenses:
 
 
 
Product development
 
 
 
Sales and marketing
21.1
 %
 
21.7
 %
General and administrative
14.6

 
16.9

Depreciation of fixed assets
19.3

 
15.7

Amortization of intangibles
2.1

 
1.9

Restructuring, severance and other charges
1.5

 
0.1

Legal settlements

 
0.1

Operating loss
(9.7
)%
 
(7.1
)%

Net revenue.  Total net revenue increased $0.4 million, or 0.6%, during the first half of fiscal 2018 compared to the first half of fiscal 2017. Products revenue decreased $2.7 million, or 13.1%, during the first half of fiscal 2018 as compared to the first half of fiscal 2017 due primarily to decreased hardware sales. Support, maintenance and subscription services revenue increased $2.9 million, or 9.5%, compared to the first half of fiscal 2017 driven primarily by continued increases in subscription based service revenue, which increased approximately 41.5% during the first half of fiscal 2018. Professional services revenue increased $0.1 million, or 0.8%.

Gross profit and gross profit margin.  Our total gross profit remained relatively flat, decreasing $26,000, or 0.1%, for the first half of fiscal 2018 and total gross profit margin decreased 0.3% to 50.1%, from 50.4%. Products gross profit decreased $1.0 million and gross profit margin decreased 1.6% to 25.9% from 27.5% primarily as a result of an increase of $1.3 million of developed technology amortization related to our rGuest solutions. Support, maintenance and subscription services gross profit increased $2.7 million or 11.9% and gross margin increased 1.6% to 74.9% as we continue to invest in our subscription platform. Professional services gross profit decreased $1.7 million and gross profit margin decreased 13.8% to 17.3% as a re-deployment of internal resources that were previously not billable were converted into billable functions as a part of restructuring our professional services workforce into teams responsible for named customer accounts.

Operating expenses

Operating expenses, excluding the charges for asset write-offs and other fair value adjustments, legal settlements, and restructuring, severance and other charges, remained relatively consistent during the first half of fiscal 2018 compared with the first half of fiscal 2017, increasing 2.7%.
  
Product development.  Product development decreased $0.4 million, or 2.6% in the first half of fiscal 2018 compared with the first half of fiscal 2017 due primarily to a $1.0 million reclassification of employee cost from product development to

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cost of goods sold related to the restructuring of our professional services workforce to better address customer needs, offset by approximately $0.7 million related to increased engineering related compensation costs due to increased headcount.

Sales and marketing.  Sales and marketing decreased $1.4 million, or 13.1%, in the first half of fiscal 2018 compared with the first half of fiscal 2017. The change is due primarily to a decrease of $1.9 million in incentive commissions related to the revision of our commission plan from total contract value to annual contract value, offset by a $0.3 million increase in stock compensation and a $0.2 million increase in bad debt.

General and administrative.  General and administrative increased $2.3 million, or 23.4%, in the first half of fiscal 2018 compared with the first half of fiscal 2017 due primarily to increases of $1.0 million in stock compensation expense related to executive stock grants and the impact of removing forfeiture rates as a result of adopting ASU No. 2016-09 and $0.6 million in salaries and wages as a result of additional headcount. Other increases included $0.4 million in professional and legal fees and $0.2 million in incremental costs related to executive turnover.

Restructuring, severance, and other charges. Restructuring, severance, and other charges increased $0.8 million during the first half of fiscal 2018 compared to the first half of fiscal 2017 due to our ongoing efforts to better allocate resources to our crucial revenue growth areas while increasing internal efficiencies in other non-revenue generating areas. The restructuring initiative outlined below will result in annual savings of $2.7 million across all of our operating expense categories.

Other Expenses (Income)
 
Six months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2017
 
2016
 
$
 
%
Other (income) expense:
 
 
 
 
 
 
 
Interest income
$
(51
)
 
$
(49
)
 
$
(2
)
 
4.1
 %
Interest expense
4

 
8

 
$
(4
)
 
(50.0
)%
Other expense, net
(147
)
 
78

 
(225
)
 
(288.5
)%
Total other expense (income), net
$
(194
)
 
$
37

 
$
(231
)
 
(624.3
)%

Interest income. Interest income consists of interest earned on investments in certificates of deposit, commercial paper, corporate bonds, and corporate-owned life insurance policies.

Interest expense. Interest expense consists of costs associated with capital leases.

Other (income) expense. Other (income) expense consists mainly of the impact of foreign currency due to movement of European and Asian currencies against the US dollar.

Income Taxes
 
Six months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2017
 
2016
 
$
 
%
Income tax expense
$
183

 
$
124

 
$
(59
)
 
nm
Effective tax rate
(3.0
)%
 
(2.7
)%
 
 
 
 

nm - not meaningful
For the six months ended September 30, 2017, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state tax effects, and other U.S. permanent book to tax differences.


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For the six months ended September 30, 2016, the effective tax rate was different than the statutory rate due primarily to the recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, certain foreign and state taxes, and other U.S. permanent book to tax differences.

Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of zero to $0.1 million of tax and zero to $0.1 million of interest based on the outcome of tax examinations and as a result of the expiration of various statutes of limitations. We are routinely audited; due to the ongoing nature of current examinations in multiple jurisdictions, other changes could occur in the amount of gross unrecognized tax benefits during the next 12 months which cannot be estimated at this time.

We have recorded a valuation allowance offsetting substantially all of our deferred tax assets. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences are deductible. Because of our losses in prior periods, management believes that it is more-likely-than-not that we will not realize the benefits of these deductible differences.



Liquidity and Capital Resources

Overview

Our operating cash requirements consist primarily of working capital needs, operating expenses, and capital expenditures. We believe that cash flow from operating activities, cash on hand of $38.5 million as of September 30, 2017 and access to capital markets will provide adequate funds to meet our short- and long-term liquidity requirements in the next 12 months.

As of September 30, 2017 and March 31, 2017, our total debt was approximately $0.2 million, comprised of capital lease obligations in both periods.

At September 30, 2017, 100% of our cash and cash equivalents were deposited in bank accounts or invested in highly liquid investments with original maturities of three months or less. We maintain approximately 90% of our cash and cash equivalents in the United States. Therefore, we believe that credit risk is limited with respect to our cash and cash equivalents.

Cash Flow
 
Six months ended
 
September 30,
(In thousands)
2017
 
2016
Net cash provided by (used in):
 
 
 
Operating activities
$
(1,648
)
 
$
(184
)
Investing activities
(8,585
)
 
(8,097
)
Financing activities
(580
)
 
(657
)
Effect of exchange rate changes on cash
90

 
(41
)
Net decrease in cash and cash equivalents
$
(10,723
)
 
$
(8,979
)

Cash flow used in operating activities.  Cash flow used in operating activities was $1.6 million in the first six months of fiscal 2018. A working capital decrease of $5.1 million and operating loss of $6.2 million were offset by $7.0 million in depreciation and amortization, and $2.3 million in share-based compensation. Total share-based compensation increased $1.5 million for the six months ended September 30, 2017 due to higher value executive stock grants and the impact of removing forfeiture rates.

Cash flow used in investing activities. For the first six months of fiscal 2018, the $8.6 million in cash used in investing activities was primarily comprised of $5.5 million for the development of proprietary software and $3.1 million for purchase of property and equipment, and internal use software development.

Cash flow used in financing activities.  During the first six months of fiscal 2018, the $0.6 million used in financing activities was primarily comprised of $0.5 million related to the repurchase of shares to satisfy employee tax withholding.

Contractual Obligations

As of September 30, 2017, there were no significant changes to our contractual obligations as presented in our Annual Report for the year ended March 31, 2017.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that have had or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies

A detailed description of our significant accounting policies is included in our Annual Report for the year ended March 31, 2017. There have been no material changes in our significant accounting policies and estimates since March 31, 2017 except as noted in Note 2, Summary of Significant Accounting Policies.

Forward-Looking Information
This Quarterly Report and other publicly available documents, including the documents incorporated herein and therein by reference, contain, and our officers and representatives may from time to time make, "forward-looking statements" within the meaning of the safe harbor provisions 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," "seek," "believe," "project," "estimate," "expect," "strategy," "future," "likely," "may," "should," "will" and similar references to future periods. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict. These statements are based on management’s current expectations, intentions, or beliefs and are subject to a number of factors, assumptions, and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Factors that could cause or contribute to such differences or that might otherwise impact the business include the risk factors set forth in Item 1A in Part II of this Quarterly Report and Item IA of our Annual Report for the fiscal year ended March 31, 2017. We undertake no obligation to update any such factor or to publicly announce the results of any revisions to any forward-looking statements contained herein whether as a result of new information, future events, or otherwise.


28

Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative disclosures about market risk affecting us, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” contained in our Annual Report for the fiscal year ended March 31, 2017. There have been no material changes in our market risk exposures since March 31, 2017.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision of and with the participation of our Chief Executive Officer (CEO), Chief Financial Officer (CFO) and Corporate Controller and Treasurer, management evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this Quarterly Report. Based on that evaluation, the CEO, CFO and Corporate Controller and Treasurer concluded that, as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were effective.

Change in Internal Control over Financial Reporting

None.

PART II. OTHER INFORMATION
Item 1.     Legal Proceedings
None.


29



Item 1A. Risk Factors

There have been no material changes in the risk factors included in our Annual Report for the fiscal year ended March 31, 2017 that may materially affect our business, results of operations, or financial condition.

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.    Defaults Upon Senior Securities

None.

Item 4.    Mine Safety Disclosures
Not applicable.
Item 5.    Other Information
None.

Item 6.    Exhibits

31.1

31.2
31.3

32
101
The following materials from our quarterly report on Form 10-Q for the quarter ended September 30, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at September 30, 2017 and March 31, 2017, (ii) Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2017 and 2016, (iii) Condensed Consolidated Statements of Comprehensive (Loss) Income for the three and six months ended September 30, 2017 and 2016, (iv) Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2017 and 2016, and (v) Notes to Condensed Consolidated Financial Statements for the three and six months ended September 30, 2017.



30







SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned thereunto duly authorized.


AGILYSYS, INC.



Date:
November 2, 2017
/s/ Anthony S. Pritchett
 
 
Anthony S. Pritchett
 
 
Chief Financial Officer
 
 
(Principal Financial Officer and Duly Authorized Officer)


31