AGYS 10-Q Quarterly Report Dec. 31, 2016 | Alphaminr
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AGYS 10-Q Quarter ended Dec. 31, 2016

Balance Sheet
Cash Flow
Income Statement
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10-Q 1 agys-12312016x10q.htm 10-Q Document

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 December 31, 2016
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 February 3, 2017 was 23,228,660 .


AGILYSYS, INC.
Index

Item 1
Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) - December 31, 2016 and March 31, 2016
Condensed Consolidated Statements of Operations (Unaudited) - Three and Nine Months Ended December 31, 2016 and December 31, 2015
Condensed Consolidated Statements of Comprehensive Loss (Unaudited) - Three and Nine Months Ended December 31, 2016 and December 31, 2015
Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine Months Ended December 31, 2016 and December 31, 2015
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



2





AGILYSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31,
2016
March 31,
2016
(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents
$
52,713

$
60,608

Accounts receivable, net of allowance for doubtful accounts of $654 and $617, respectively
15,308

22,017

Inventories
2,084

2,692

Prepaid expenses and other current assets
8,593

10,184

Total current assets
78,698

95,501

Property and equipment, net
13,829

14,197

Goodwill
19,622

19,622

Intangible assets, net
8,542

8,576

Software development costs, net
48,537

44,215

Other non-current assets
2,477

3,046

Total assets
$
171,705

$
185,157

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable
$
8,623

$
7,761

Deferred revenue
27,243

33,241

Accrued liabilities
10,622

12,980

Capital lease obligations, current
119

118

Total current liabilities
46,607

54,100

Deferred income taxes, non-current
3,180

3,075

Capital lease obligations, non-current
136

215

Other non-current liabilities
4,076

4,294

Commitments and contingencies (see Note 7)


Shareholders' equity:
Common shares, without par value, at $0.30 stated value; 80,000,000 shares authorized; 31,606,831 shares issued; and 23,207,376 and 22,942,586 shares outstanding at December 31, 2016 and March 31, 2016, respectively
9,482

9,482

Treasury shares, 8,399,455 and 8,664,245 at December 31, 2016 and March 31, 2016, respectively
(2,521
)
(2,600
)
Capital in excess of stated value
(7,045
)
(7,645
)
Retained earnings
117,979

124,413

Accumulated other comprehensive loss
(189
)
(177
)
Total shareholders' equity
117,706

123,473

Total liabilities and shareholders' equity
$
171,705

$
185,157


See accompanying notes to condensed consolidated financial statements.

3


AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended
Nine months ended
December 31,
December 31,
(In thousands, except share data)
2016
2015
2016
2015
Net revenue:
Products
$
10,006

$
11,924

$
30,257

$
30,678

Support, maintenance and subscription services
16,234

14,896

47,087

44,460

Professional services
7,208

4,487

19,732

13,304

Total net revenue
33,448

31,307

97,076

88,442

Cost of goods sold:
Products (inclusive of developed technology amortization)
7,530

6,991

22,217

17,035

Support, maintenance and subscription services
4,464

4,076

12,714

11,413

Professional services
5,213

3,732

13,835

9,496

Total cost of goods sold
17,207

14,799

48,766

37,944

Gross profit
16,241

16,508

48,310

50,498

48.6
%
52.7
%
49.8
%
57.1
%
Operating expenses:
Product development
6,847

6,969

20,647

20,021

Sales and marketing
5,000

4,618

15,746

14,396

General and administrative
3,678

5,517

13,692

15,897

Depreciation of fixed assets
598

569

1,791

1,627

Amortization of intangibles
353

321

1,031

937

Restructuring, severance and other charges
1,394

8

1,484

(53
)
Asset write-offs and other fair value adjustments
—

—

—

(175
)
Legal settlements
—

185

85

185

Operating loss
(1,629
)
(1,679
)
(6,166
)
(2,337
)
Other (income) expense:
Interest income
(86
)
(21
)
(135
)
(70
)
Interest expense
3

8

11

20

Other expense, net
62

63

140

40

Loss before taxes
(1,608
)
(1,729
)
(6,182
)
(2,327
)
Income tax expense (benefit)
129

(56
)
252

(100
)
Net loss
$
(1,737
)
$
(1,673
)
$
(6,434
)
$
(2,227
)
Weighted average shares outstanding
22,611

22,493

22,605

22,479

Loss per share - basic and diluted:
Loss per share
$
(0.08
)
$
(0.07
)
$
(0.28
)
$
(0.10
)

See accompanying notes to condensed consolidated financial statements.

4


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


Three months ended
Nine months ended
December 31,
December 31,
(In thousands)
2016
2015
2016
2015
Net loss
$
(1,737
)
$
(1,673
)
$
(6,434
)
$
(2,227
)
Other comprehensive loss, net of tax:
Unrealized foreign currency translation adjustments
(5
)
(8
)
(12
)
(27
)
Total comprehensive loss
$
(1,742
)
$
(1,681
)
$
(6,446
)
$
(2,254
)

See accompanying notes to condensed consolidated financial statements.

5

AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended
December 31,
(In thousands)
2016
2015
Operating activities
Net loss
$
(6,434
)
$
(2,227
)
Adjustments to reconcile net loss to net cash used in operating activities
Net restructuring, severance and other charges
819

(643
)
Net legal settlements
(100
)
170

Loss on disposal of property & equipment
5

262

Depreciation
1,791

1,627

Amortization
1,031

1,704

Amortization of developed technology
5,705

—

Deferred income taxes
105

—

Share-based compensation
782

2,318

Asset write-offs and other fair value adjustments
—

(175
)
Change in cash surrender value of company owned life insurance policies
—

—

Changes in operating assets and liabilities:
Accounts receivable
6,668

4,527

Inventories
597

(1,696
)
Prepaid expense
1,306

(2,769
)
Accounts payable
714

(4,399
)
Deferred revenue
(4,601
)
5,516

Accrued liabilities
(2,558
)
4,394

Income taxes payable
104

(65
)
Other changes, net
(541
)
(230
)
Net cash used in operating activities
5,393

8,314

Investing activities
Capital expenditures
(2,199
)
(3,617
)
Capitalized software development costs
(10,302
)
(13,488
)
Investments in corporate-owned life insurance policies
(1
)
(65
)
Net cash used in investing activities
(12,502
)
(17,170
)
Financing activities
Payments to settle contingent consideration arising from business acquisition
(197
)
—

Repurchase of common shares to satisfy employee tax withholding
(404
)
(435
)
Principal payments under long-term obligations
(86
)
(29
)
Net cash used in financing activities
(687
)
(464
)
Effect of exchange rate changes on cash
(99
)
(95
)
Net decrease in cash and cash equivalents
(7,895
)
(9,415
)
Cash and cash equivalents at beginning of period
$
60,608

$
75,067

Cash and cash equivalents at end of period
$
52,713

$
65,652

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Accrued capital expenditures
$
293

$
261

Accrued capitalized software development costs
684

505

Leasehold improvements acquired under lease arrangement
—

997


See accompanying notes to condensed consolidated financial statements.

6

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 for point-of-sale (POS), property management (PMS), inventory and procurement, workforce management, analytics, document management and mobile and wireless solutions and services to the hospitality industry. Our solutions and services allow property managers to better connect, interact and transact with their customers and enhance their customer relationships by streamlining operations, improving efficiency, increasing guest recruitment and wallet share, and enhancing the overall guest experience. We serve four major market sectors: Gaming, both corporate and tribal; Hotels, Resorts and Cruise; Foodservice Management; and Restaurants, Universities, Stadia and Healthcare. A significant portion of our consolidated revenue is derived from contract support, maintenance and subscription services.

We operate throughout North America, Europe and Asia, with corporate services located in Alpharetta, GA.

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 2017 refers to the fiscal year ending March 31, 2017.

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 December 31, 2016 , 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 nine months ended December 31, 2016 and 2015 , 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, 2016 , filed with the Securities and Exchange Commission (SEC) on June 10, 2016.

Correction of Errors

In connection with the preparation of our Condensed Consolidated Financial Statements for the second quarter of fiscal 2016, we identified errors in the manner in which we recognized revenue on contract support.  Contract support revenue is recognized ratably over the term of the customer arrangement.  In certain instances where contract support is an element of a multiple-element arrangement, we use a hierarchy to determine the fair value allocation for recognition of revenue on each deliverable.  An error related to an input used in this allocation resulted in the overstatement of contract, maintenance, and support revenue of $0.4 million for the three months ended June 30, 2015.  The error was identified and corrected during the second quarter of fiscal 2016.  Additionally, during the second quarter of fiscal 2016, we identified

7


errors in the manner in which we capitalize internal labor on software development projects.   An error in the method by which internal resources account for administrative time resulted in the over capitalization of costs during the last six months of fiscal 2015 and the first three months of fiscal 2016.  The error for each of the three months ended December 31, 2014, March 31, 2015, and June 30, 2015, was $0.1 million. We corrected these errors during the second quarter of fiscal 2016.

In accordance with accounting guidance found in ASC 250-10 (SEC Staff Accounting Bulletin No. 99, Materiality), we assessed the materiality of the errors and concluded that the errors were not material to any of our previously issued financial statements. Correction of the errors is also not material to the three and nine months ended December 31, 2015 or fiscal 2016 annual results.

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, 2016 , included in our Annual Report on Form 10-K. There have been no material changes to our significant accounting policies and estimates from those disclosed therein.

Adopted and Recently Issued Accounting Pronouncements

In August 2016, the FASB issued Accounting Standards Update (ASU) 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 clarifies the classification of receipts and payments in the statement of cash flows. ASU 2016-15 provides guidance related to (1) debt prepayment or debt extinguishment costs, (2) settlement and payment of zero coupon debt instruments, (3) contingent consideration, (4) proceeds from settlement of insurance claims, (5) proceeds from settlement of corporate and bank owned life insurance policies, (6) distributions from equity method investees, (7) cash receipts from beneficial interests obtained by a transferor, and (8) general guidelines for cash receipts and payments that have more than one aspect of classification. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, including interim periods. Early adoption is permitted. We are evaluating the impact the adopting this guidance will have on future financial statements and disclosures.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The amendments in this update involve several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards, and classification on the statement of cash flows. For public business entities, the amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We are evaluating the impact of adopting this guidance on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers. The amendments in this update clarify the implementation guidance on principals versus agent considerations in FASB ASC 606. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements of ASU 2014-09 described below. We are evaluating the impact of adopting this guidance on our consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which converges the FASB and the International Accounting Standards Board standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In August 2015, the FASB amended the effective date and early adoption is permitted only for fiscal years beginning after December 15, 2016. We are currently evaluating the impact that the adoption of ASU 2014-09 will have on our consolidated financial statements or related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases. The amendments in this update include a new FASB ASC Topic 842, which supersedes Topic 840. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for

8

all entities as of the beginning of interim or annual reporting periods. We are evaluating the impact of adopting this guidance on our consolidated financial statements.

The FASB has also issued the following standards which provide additional clarification and implementation guidance on the previously issued ASU 2014-09 and have the same effective date as the original standard: ASU 2016-12 and ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing (Topic 606). We are currently evaluating the impact that the adoption of the related ASU 2014-09 standards will have on our consolidated financial statements or related disclosures.

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.


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 2016 Restructuring Activity

Q4 - In the fourth quarter of fiscal 2016, we continued our efforts to better align product development and general and administrative functions with our company strategy and to reduce operating costs and announced a partnership to resell a third party workforce management solution. We recorded $0.3 million in restructuring charges related to the Q4 fiscal 2016 restructuring activity in fiscal 2016, comprised of severance and other employee related benefits.

During the third quarter of fiscal 2017, we completed these activities and recorded $0.2 million in restructuring charges comprised of severance and other employee related benefits and early contract termination costs. We do not anticipate any additional costs associated with this restructuring activity. As of December 31, 2016, we had a remaining liability of $0.2 million .

Following is a reconciliation of the beginning and ending balances of the restructuring liability:
Balance at
Balance at
March 31,
Provision /
December 31,
(In thousands)
2016
Adjustments
Payments
2016
Fiscal 2016 Restructuring Plan:
Severance and other employment costs
$
311

$
170

$
(305
)
$
176

Early contract termination costs
$
—

$
43

$
—

$
43

Total restructuring costs
$
311

$
213

$
(305
)
$
219




9

4. Intangible Assets and Software Development Costs

The following table summarizes our intangible assets and software development costs:
December 31, 2016
March 31, 2016
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
10,317

(10,055
)
262

10,660

(10,398
)
262

Accumulated impairment
(262
)
N/A

(262
)
(262
)
N/A

(262
)
Trade names
230

(88
)
142

230

(54
)
176

Patented technology
80

(80
)
—

80

(80
)
—

23,840

(23,698
)
142

24,183

(24,007
)
176

Unamortized intangible assets:
Trade names
9,200

N/A

9,200

9,200

N/A

9,200

Accumulated impairment
(570
)
N/A

(570
)
(570
)
N/A

(570
)
Finite life reclassification
(230
)
N/A

(230
)
(230
)
N/A

(230
)
8,400

N/A

8,400

8,400

N/A

8,400

Total intangible assets
$
32,240

$
(23,698
)
$
8,542

$
32,583

$
(24,007
)
$
8,576

Software development costs
$
47,989

$
(8,049
)
$
39,940

$
6,359

$
(2,344
)
$
4,015

Project expenditures not yet in use
9,988

—

9,988

41,591

—

41,591

Accumulated impairment
(1,391
)
N/A

(1,391
)
(1,391
)
N/A

(1,391
)
Total software development costs
$
56,586

$
(8,049
)
$
48,537

$
46,559

$
(2,344
)
$
44,215


During the first quarter of fiscal 2017, we announced general availability of our rGuest® Stay property management solution and placed into service $31.2 million of related software development costs. Additionally, during the second quarter of fiscal 2017, we announced general availability of our rGuest® Buy point of sale solution and placed into service $10.4 million of related software development costs. Amortization of these internally developed technologies are included in Products cost of goods sold and was $2.1 million for the three months ended December 31, 2016 , and $5.0 million for the nine months ended December 31, 2016 . The useful life of each 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,
2017
$
2,317

2018
9,272

2019
9,150

2020
8,411

2021
8,326

2022
1,215

Total
$
38,691



10

Intangible assets are comprised of acquired and internally developed technology to be sold, leased, or otherwise marketed and other non-software assets including, customer relationships, non-competition agreements, trade names and patented technology. Amortization expense of acquired and internally developed technology is included in Products cost of goods sold and was $2.3 million and $0.3 million for the three months ended December 31, 2016 and 2015 , and $5.7 million and $0.8 million for the nine months ended December 31, 2016 and 2015 . Amortization expense of non-software intangibles is included in operating expenses along with acquired and internally developed internal use software. Internal use software is classified as property and equipment in the Consolidated Balance Sheets. Total capitalization of internal use software was $0.3 million and $0.2 million during the three months ended December 31, 2016 and 2015 and $0.9 million and $0.5 million during the nine months ended December 31, 2016 and 2015. Amortization expense of non-software intangible and internal use assets was not significant for the three and nine months ended December 31, 2016 and 2015 .

Capitalized software development costs that are internally developed to be sold, leased, or otherwise marketed, are carried on our balance sheet at net realizable value, net of accumulated amortization. We capitalized approximately $3.3 million and $3.2 million during the three months ended December 31, 2016 and 2015 , and $10.0 million and $10.3 million during the nine months ended December 31, 2016 and 2015 .


11

5. Additional Balance Sheet Information
Additional information related to the Condensed Consolidated Balance Sheets is as follows:
(In thousands)
December 31,
2016
March 31,
2016
Accrued liabilities:
Salaries, wages, and related benefits
$
7,380

$
9,751

Other taxes payable
697

818

Accrued legal settlements
—

100

Restructuring liabilities
219

311

Severance liabilities
837

6

Professional fees
508

714

Deferred rent
428

400

Contingent consideration
—

197

Other
553

683

Total
$
10,622

$
12,980

Other non-current liabilities:
Uncertain tax positions
$
1,468

$
1,469

Deferred rent
2,532

2,746

Other
76

79

Total
$
4,076

$
4,294


Accounts Receivable, net

Accounts receivable, net of allowance for doubtful accounts was $15.3 million and $22.0 million as of December 31, 2016 and March 31, 2016 , respectively. The related allowance for doubtful accounts was $0.7 million and $0.6 million as of December 31, 2016 and March 31, 2016 , 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. At March 31, 2015, our accounts receivable owing by Caesars and its affiliates who have filed a bankruptcy petition totaled approximately $ 3.2 million, including both pre- and post-petition claims. 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 approximately $0.2 million of pre-petition claim in addition to those filed on May 26, 2015. As of December 31, 2016 , approximately $0.7 million of pre-petition claims remain outstanding. In January 2017, the Bankruptcy Court approved Caesars’ restructuring plan, which included assumption of our pre-petition contracts and payment of our pre-petition claims of approximately $0.7 million, subject to the condition of the plan.  The planned reorganization is expected to be occur later in 2017.

6. Income Taxes

The following table compares our income tax benefit and effective tax rates for the three and nine months ended December 31, 2016 and 2015 :
Three months ended
Nine months ended
December 31,
December 31,
(Dollars in thousands)
2016
2015
2016
2015
Income tax expense (benefit)
$
129


$
(56
)
$
252

$
(100
)
Effective tax rate
(8.0
)%

3.2
%
(4.1
)%
4.3
%


12


For the three and nine months ended December 31, 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, foreign and state taxes, and other U.S. permanent book to tax differences.

For the three and nine months ended December 31, 2015, 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, an adjustment to true-up indefinite-lived intangibles, a refunded settlement of an unrecognized tax benefit, foreign and state taxes, 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. Ameranth 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 a patent 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.


13

8. (Loss) Earnings per Share

The following data shows the amounts used in computing (loss) earnings per share and the effect on income and the weighted average number of shares of dilutive potential common shares.
Three months ended
Nine months ended
December 31,
December 31,
(In thousands, except per share data)
2016
2015
2016
2015
Numerator:
Net loss
$
(1,737
)
$
(1,673
)
$
(6,434
)
$
(2,227
)
Denominator:
Weighted average shares outstanding
22,611

22,493

22,605

22,479

Loss per share - basic and diluted:
Loss per share
$
(0.08
)
$
(0.07
)
$
(0.28
)
$
(0.10
)
Anti-dilutive stock options, SSARs, restricted shares and performance shares
1,471

1,804

1,399

1,633


Basic (loss) earnings per share is computed as net (loss) 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 595,625 and 455,574 of restricted shares at December 31, 2016 and 2015 , 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 (loss) earnings per share includes the effect of all potentially dilutive securities on earnings per share. We have stock options, stock-settled appreciation rights (SSARs) and unvested restricted shares that are potentially dilutive securities. When a loss is reported, the denominator of diluted (loss) earnings per share cannot be adjusted for the dilutive impact of share-based compensation awards because doing so would be anti-dilutive. Therefore, for the three months and nine months ended December 31, 2016 and 2015 , 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 2011 Plan, a 2006 Stock Incentive Plan (the 2006 Plan) and a 2000 Stock Incentive Plan that still have vested awards outstanding. Awards are no longer being granted from these incentive plans.

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.


14

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 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
Nine months ended
December 31,
December 31,
(In thousands)
2016
2015
2016
2015
Product development
$
498

$
326

$
826

$
802

Sales and marketing
124

46

177

38

General and administrative
(680
)
546

(221
)
1,478

Total share-based compensation expense
(58
)
918

782

2,318


Stock Options

The following table summarizes the activity during the nine months ended December 31, 2016 for stock options awarded under the 2006 Plan and the 2000 Stock Incentive Plan:

Number
of
Options
Weighted-
Average
Exercise
Price
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
(In thousands, except share and per share data)
(per share)
(in years)
Outstanding at April 1, 2016
545,000

$
15.54

Granted
—

—

Exercised
—

—

Cancelled/expired
(545,000
)
15.54

Outstanding and exercisable at December 31, 2016
—

$
—

—

$
—


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 nine months ended December 31, 2016 for SSARs awarded under the 2011 Plan:
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, 2016
794,365

$
10.06

Granted
64,231

10.47

Exercised
(324
)
9.60

Forfeited
(122,934
)
10.18

Cancelled/expired
(5,685
)
9.60

Outstanding at December 31, 2016
729,653

$
10.08

3.4
$
742

Exercisable at December 31, 2016
471,590

$
10.15

2.1
$
575



15

As of December 31, 2016 , total unrecognized stock based compensation expense related to non-vested SSARs was $0.5 million , which is expected to be recognized over a weighted-average vesting period of 1.43 years.

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 nine months ended December 31, 2016 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, 2016
335,773

$
12.06

Granted
404,328

10.30
Vested
(9,250
)
13.51

Forfeited
(134,226
)
12.05

Outstanding at December 31, 2016
596,625

$
10.84


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 December 31, 2016 , total unrecognized stock based compensation expense related to non-vested restricted stock was $4.6 million , which is expected to be recognized over a weighted-average vesting period of 1.36 years.

Performance Shares

The following table summarizes the activity during the nine months ended December 31, 2016 for performance shares awarded under the 2011 Plan:
Number
of
Shares
Weighted-
Average
Grant-
Date Fair
Value
(per share)
Outstanding at April 1, 2016
7,812

$
9.60

Granted
—

—

Vested
(7,812
)
9.60

Outstanding at December 31, 2016
—

$
—


During the three months ended December 31, 2016, 61,168 of additional performance shares were granted and forfeited during the period.


16

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 nine months ended December 31, 2016 and 2015 .

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)
December 31, 2016
(Level 1)
(Level 2)
(Level 3)
Assets:
Corporate-owned life insurance — current
$
2,357

—

—

$
2,357

Corporate-owned life insurance — non-current
$
782

—

—

$
782


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, 2016
(Level 1)
(Level 2)
(Level 3)
Assets:
Corporate-owned life insurance — current
$
2,357

—

—

$
2,357

Corporate-owned life insurance — non-current
$
765

—

—

$
765

Liabilities:
Contingent consideration — current
$
197

—

—

$
197


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 (income) expense, net” in the Condensed Consolidated Statements of Operations.

The fair value of the contingent consideration was determined by calculating the probability-weighted earn-out payments based on the assessment of the likelihood that certain milestones would be achieved.


17

The following table presents a summary of changes in the fair value of the Level 3 assets:
Nine months ended
December 31,
(In thousands)
2016
2015
Corporate-owned life insurance:
Balance on April 1
$
3,122

$
2,493

Unrealized gain relating to instruments held at reporting date
16

6

Purchases, sales, issuances and settlements, net
1

65

Balance on December 31
$
3,139

$
2,564


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

Nine months ended
December 31,
(In thousands)
2016
2015
Contingent consideration
Balance on April 1
$
197

$
112

Activity, payments and other charges (net)
(197
)
(8
)
Balance on December 31
$
—

$
104





18

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, 2016 , 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, 2016 . 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 29 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, 2016 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 for point-of-sale (POS), property management (PMS), inventory and procurement, workforce management, analytics, document management and mobile and wireless solutions and services to the hospitality industry. Our solutions and services allow property managers to better connect, interact and transact with their customers and enhance their customer relationships by streamlining operations, improving efficiency, increasing guest recruitment and wallet share, and enhancing the overall guest experience. Agilysys serves four major market sectors: Gaming, both corporate and tribal; Hotels, Resorts and Cruise; 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 extensively throughout North America, Europe and Asia, with corporate services located in Alpharetta, GA.

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

Our strategic plan specifically focuses on:

•    Strong customer focus, with clear and realistic service commitments.
•
Growing sales of our proprietary offerings: products, support, maintenance and subscription services and professional services.
•    Diversifying our customer base across industries and geographies.
•    Capitalizing on our intellectual property and emerging technology trends.

The primary objective of our ongoing strategic planning process is to create shareholder value by exploiting growth opportunities and strengthening our competitive position within the specific technology solutions and in the end markets

19

we service. The plan builds on our existing strengths and targets industry leading growth and peer beating financial and operating results driven by new technology trends and market opportunities. Industry leading growth and peer beating financial and operational results will be achieved through tighter coupling and management of operating expenses of the business and sharpening the focus of our investments to concentrate on growth opportunities with the highest return by seeking the highest margin revenue opportunities in the markets in which we compete.

20

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 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

Third Fiscal Quarter 2017 Compared to Third Fiscal Quarter 2016

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the three months ended December 31, 2016 and 2015 :
Three months ended
December 31,
Increase (decrease)
(Dollars in thousands)
2016
2015
$
%
Net revenue:
Products
$
10,006

$
11,924

$
(1,918
)
(16.1
)%
Support, maintenance and subscription services
16,234

14,896

1,338

9.0

Professional services
7,208

4,487

2,721

60.6

Total net revenue
33,448

31,307

2,141

6.8

Cost of goods sold:
Products (inclusive of developed technology amortization)
7,530

6,991

539

7.7

Support, maintenance and subscription services
4,464

4,076

388

9.5

Professional services
5,213

3,732

1,481

39.7

Total cost of goods sold
17,207

14,799

2,408

16.3

Gross profit
16,241

16,508

(267
)
(1.6
)
Gross profit margin
48.6
%
52.7
%
Operating expenses:
Product development
6,847

6,969

(122
)
(1.8
)
Sales and marketing
5,000

4,618

382

8.3

General and administrative
3,678

5,517

(1,839
)
(33.3
)
Depreciation of fixed assets
598

569

29

5.1

Amortization of intangibles
353

321

32

10.0

Restructuring, severance and other charges
1,394

8

1,386

nm

Legal settlements
—

185

(185
)
nm

Operating loss
$
(1,629
)
$
(1,679
)
$
50

(3.0
)%
Operating loss percentage
(4.9
)%
(5.4
)%

nm - not meaningful

21


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
December 31,
2016
2015
Net revenue:
Products
30.0
%
38.1
%
Support, maintenance and subscription services
48.5

47.6

Professional services
21.5

14.3

Total
100.0
%
100.0
%
Cost of goods sold:
Products (inclusive of developed technology amortization)
22.5
%
22.3
%
Support, maintenance and subscription services
13.3

13.0

Professional services
15.6

11.9

Total
51.4
%
47.3
%
Gross profit
48.6
%
52.7
%
Operating expenses:
Product development
20.5
%
22.3
%
Sales and marketing
14.9

14.8

General and administrative
11.0

17.6

Depreciation of fixed assets
1.8

1.8

Amortization of intangibles
1.1

1.0

Restructuring, severance and other charges
4.2

—

Asset write-offs and other fair value adjustments
—

—

Legal settlements
—

0.6

Operating loss
(4.9
)%
(5.4
)%

Net revenue. Total net revenue increased $2.1 million , or 6.8% , during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 . Products revenue decreased $1.9 million , or 16.1% , due primarily to a single, large hardware and remarketed software refresh of $1.3 million during the third quarter of fiscal 2016, as well as a $0.1 million in reduced proprietary software license revenue in line with the strategic shift in mix to subscription based services revenue. Support, maintenance and subscription services revenue increased $1.3 million , or 9.0% , compared to the third quarter of fiscal 2016 driven primarily by continued increases in subscription based service revenue, which increased approximately 48.0% during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016. Professional services revenue increased $2.7 million , or 60.6% , as a result of increased volume of customer installation and implementation projects, along with $1.1 million of previously deferred revenue for services provided in the past, where contractual commitments precluded revenue recognition until the third quarter of fiscal 2017.

Gross profit and gross profit margin. Our total gross profit decreased $0.3 million , or 1.6% , for the third quarter of fiscal 2017 and total gross profit margin decreased approximately 417 basis points to 48.6% from 52.7% . Products gross profit decreased $2.5 million and gross profit margin decreased approximately 1,670 basis points to 24.7% primarily as a result of an increase of $2.1 million of developed technology amortization as a result of the rGuest® Stay and Buy development costs being placed into service with the announcement of the property management system and point of sale solution as being generally available during the first and second quarter of fiscal 2017, respectively. Support, maintenance and subscription services gross profit remained consistent and gross margin decreased 10 basis points to 72.5% . Professional services gross profit increased $1.2 million and gross profit margin improved 1,090 basis points to 27.7% primarily as a result of more efficient use of labor during the third quarter of fiscal 2017 as compared to the third quarter of fiscal 2016.


22

Operating expenses

Operating expenses, excluding the charges for asset write-offs and other fair value adjustments, legal settlements, and restructuring, severance and other charges, decreased $1.5 million , or 8.4% , during the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016 .
Product development. Product development includes all expenses associated with research and development. Product development decreased $(0.1) million , or (1.8)% in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016 . This decrease is primarily driven by reduced incentive expense for the full year fiscal 2017 as compared to the full year fiscal 2016, offset by an increase from our continued investment in resources related to both our rGuest® and legacy product enhancements to expand the customer experience across our install base as well as our future offerings with existing and new customers. In addition, certain research and development costs are capitalized as software development costs upon achieving specific milestones in the development life-cycle. We capitalized approximately $3.5 million and $3.4 million as software development costs for future use during the three months ended December 31, 2016 and 2015 , respectively.

Sales and marketing. Sales and marketing increased $0.4 million , or 8.3% , in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016 . The change is primarily the result of an increase of $0.2 million in employee wages and share-based compensation expense, as well as increased spend in advertising and promotion of $0.2 million related to new lead generation investment in content, search engine marketing, and target prospect databases in order to accelerate the growth in lead acquisition and pipeline velocity in support of future revenue growth.

General and administrative. General and administrative declined $1.8 million , or 33.3% , in the third quarter of fiscal 2017 compared with the third quarter of fiscal 2016 due primarily to $1.0 million in forfeiture credits related to unvested share-based compensation expense and a $0.2 million reversal of accrued incentive awards for the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) whose departures from the company were announced during the third quarter of fiscal 2017. An additional reduction of $0.2 million was related to reduced incentive expense for other employees for the full year fiscal 2017 as compared to the full year fiscal 2016. Additionally, during the third quarter of fiscal 2016, we disposed of $0.2 million of internal use software for our support ticketing system.

Restructuring, severance, and other charges. Restructuring, severance, and other charges increased $1.4 million during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016. The increase was the result of the following:

•
CEO separation benefits and related transition costs. During the third quarter of fiscal 2017, the company incurred costs associated with the replacement of the current CEO, including $0.8 million in separation benefits and $0.3 million in search fees incurred in connection with identifying a successor CEO.

•
Restructuring related severance and early contract termination costs. During the third quarter of fiscal 2017, we completed activities associated with the partnership to resell a third party workforce management solution, and recorded $0.2 million in restructuring charges comprised of severance and other employee related benefits and early contract termination costs. We do not anticipate any additional costs associated with this restructuring activity. Our restructuring actions are discussed further in Note 3, Restructuring Charges.
•
Non-restructuring severance. During the third quarter of fiscal 2017, we incurred $0.1 million in non-restructuring severance and other employee benefits.

Legal settlements. During the third quarter of fiscal 2016, we recorded $0.2 million in legal settlements for employment and other business related matters.


23

Other Expenses (Income)
Three months ended
December 31,
(Unfavorable) favorable
(Dollars in thousands)
2016
2015
$
%
Other (income) expense:
Interest income
$
(86
)
$
(21
)
$
65

309.5
%
Interest expense
3

8

5

62.5
%
Other expense, net
62

63

1

nm

Total other (income) expense, net
$
(21
)
$
50

$
71

142.0
%

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 income increased $65,000 during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 due to interest earned for the redemption of corporate-owned life insurance policies during fiscal 2017.

Interest expense. Interest expense consists of costs associated with capital leases and loans on corporate-owned life insurance policies. Interest expense remained flat in the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 .

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
Three months ended
December 31,
(Unfavorable) favorable
(Dollars in thousands)
2016
2015
$
%
Income tax expense (benefit)
$
129

$
(56
)
$
(185
)
nm
Effective tax rate
(8.0
)%
3.2
%

nm - not meaningful
For the three months ended December 31, 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, foreign and state taxes, and other U.S. permanent book to tax differences. Tax expense primarily results from foreign taxable jurisdictions.

For the three months ended December 31, 2015, 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, an adjustment to true-up indefinite-lived intangibles, a refunded settlement of an unrecognized tax benefit, foreign and state taxes, and other U.S. permanent book to tax differences. During this same period, our tax benefit resulted from an adjustment to amortization expense on indefinite lived assets and expiration of statute of limitations on uncertain tax positions offset by taxes withheld in foreign jurisdictions.

The increase in the tax provision year over year is due to non-recurring benefits recognized in fiscal 2016 and increased profitability in foreign jurisdictions during fiscal 2017.

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.


24

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.

Results of Operations

First Nine Months Fiscal 2017 Compared to First Nine Months Fiscal 2016

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the nine months ended December 31, 2016 and 2015 :
Nine months ended
December 31,
Increase (decrease)
(Dollars in thousands)
2016
2015
$
%
Net revenue:
Products
$
30,257

$
30,678

(421
)
(1.4
)%
Support, maintenance and subscription services
47,087

44,460

2,627

5.9

Professional services
19,732

13,304

6,428

48.3

Total net revenue
97,076

88,442

8,634

9.8

Cost of goods sold:
Products (inclusive of developed technology amortization)
22,217

17,035

5,182

30.4

Support, maintenance and subscription services
12,714

11,413

1,301

11.4

Professional services
13,835

9,496

4,339

45.7

Total cost of goods sold
48,766

37,944

10,822

28.5

Gross profit
48,310

50,498

(2,188
)
(4.3
)
Gross profit margin
49.8
%
57.1
%
Operating expenses:
Product development
20,647

20,021

626

3.1

Sales and marketing
15,746

14,396

1,350

9.4

General and administrative
13,692

15,897

(2,205
)
(13.9
)
Depreciation of fixed assets
1,791

1,627

164

10.1

Amortization of intangibles
1,031

937

94

10.0

Restructuring, severance and other charges
1,484

(53
)
1,537

nm

Asset write-offs and other fair value adjustments
—

(175
)
175

nm

Legal settlements
85

185

(100
)
nm

Operating loss
$
(6,166
)
$
(2,337
)
$
(3,829
)
163.8
%
Operating loss percentage
(6.4
)%
(2.6
)%

nm - not meaningful

25


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:
Nine months ended
December 31,
2016
2015
Net revenue:
Products
31.2
%
34.7
%
Support, maintenance and subscription services
48.5

50.3

Professional services
20.3

15.0

Total
100.0
%
100.0
%
Cost of goods sold:
Products (inclusive of developed technology amortization)
22.9
%
19.3
%
Support, maintenance and subscription services
13.0

12.9

Professional services
14.3

10.7

Total
50.2
%
42.9
%
Gross profit
49.8
%
57.1
%
Operating expenses:
Product development
21.4
%
22.6
%
Sales and marketing
16.2

16.3

General and administrative
14.1

18.0

Depreciation of fixed assets
1.8

1.8

Amortization of intangibles
1.1

1.1

Restructuring, severance and other charges
1.5

(0.1
)
Asset write-offs and other fair value adjustments
—

(0.2
)
Legal settlements
0.1

0.2

Operating loss
(6.4
)%
(2.6
)%

Net revenue. Total net revenue increased $8.6 million , or 9.8% , during the first nine months of fiscal 2017 compared to the first nine months of fiscal 2016 . Products revenue remained relatively flat, decreasing $0.4 million , or 1.4% , during the first nine months of fiscal 2017 as compared to the first nine months of fiscal 2016. Support, maintenance and subscription services revenue increased $2.6 million , or 5.9% , compared to the first nine months of fiscal 2016 driven primarily by continued increases in subscription based service revenue, which increased approximately 42.3% during the first nine months of fiscal 2017 . Professional services revenue increased $6.4 million , or 48.3% , as a result of increased volume of customer installation and implementation projects, along with $1.1 million of previously deferred revenue for services provided in the past, where contractual commitments precluded revenue recognition until the third quarter of fiscal 2017 .

Gross profit and gross profit margin. Our total gross profit decreased $2.2 million , or 4.3% , for the first nine months of fiscal 2017 and total gross profit margin decreased approximately 730 basis points to 49.8% , from 57.1% . Products gross profit decreased $5.6 million and gross profit margin decreased approximately 1,790 basis points to 26.6% primarily as a result of an increase of $5.0 million of developed technology amortization as a result of the rGuest® Stay and Buy development costs being placed into service with the announcement of the property management system and point of sale solution as being generally available during the first and second quarter of fiscal 2017 , respectively. Support, maintenance and subscription services gross profit remained consistent and gross margin decreased 130 basis points to 73.0% as we continue to invest in our subscription platform. Professional services gross profit increased $2.1 million and gross profit margin remained relatively flat, increasing approximately 130 basis points to 29.9% .


26

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 consistent during the first nine months of fiscal 2017 compared with the first nine months of fiscal 2016 .
Product development. Product development includes all expenses associated with research and development. Product development increased $0.6 million , or 3.1% in the first nine months of fiscal 2017 compared with the first nine months of fiscal 2016 . This increase is primarily driven by our continued investment in resources related to both our rGuest® and legacy product enhancements to expand the customer experience across our install base as well as our future offerings with existing and new customers. In addition, certain research and development costs are capitalized as software development costs upon achieving specific milestones in the development life-cycle. We capitalized approximately $10.5 million and $10.9 million as software development costs for future use during the nine months ended December 31, 2016 and 2015 , respectively.

Sales and marketing. Sales and marketing increased $1.4 million , or 9.4% , in the first nine months of fiscal 2017 compared with the first nine months of fiscal 2016 . The change is due primarily to an increase of approximately $0.6 million in employee wages and related expense in line with booking growth, specifically in subscription based bookings, whose total contract value increased 98% year over year. In addition, advertising and promotion increased $0.8 million related to new lead generation investment in content, search engine marketing, and target prospect databases in order to accelerate the growth in lead acquisition and pipeline velocity in support of future revenue growth.

General and administrative. General and administrative declined $2.2 million , or 13.9% , in the first nine months of fiscal 2017 compared with the first nine months of fiscal 2016 due to a reduction of $1.0 million in share-based compensation expense driven primarily by the timing of grants in fiscal 2017 compared to fiscal 2016 , and $0.7 million in forfeiture credits related to unvested share-based compensation expense for the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) whose departures from the company were announced during the third quarter of fiscal 2017 . An additional reduction of $0.7 million was related to reduced incentive expense for other employees for the full year fiscal 2017 as compared to the full year fiscal 2016 . Additionally, during the third quarter of fiscal 2016 , we disposed of $0.2 million of internal use software for our support ticketing system.

Restructuring, severance, and other charges. Restructuring, severance, and other charges increased $1.5 million during the first nine months of fiscal 2017 compared to the first nine months of fiscal 2016 . The increase was the result of the following:

•
CEO separation benefits and related transition costs. During the third quarter of fiscal 2017 , the company incurred costs associated with the replacement of the current CEO, including $0.8 million in separation benefits and $0.3 million in search fees incurred in connection with identifying a successor CEO.

•
Restructuring related severance and early contract termination costs. During the third quarter of fiscal 2017 , we completed activities associated with the partnership to resell a third party workforce management solution, and recorded $0.2 million in restructuring charges comprised of severance and other employee related benefits and early contract termination costs. We do not anticipate any additional costs associated with this restructuring activity. Our restructuring actions are discussed further in Note 3, Restructuring Charges.
•
Non-restructuring severance. During the third quarter of fiscal 2017 , we incurred $0.2 million in non-restructuring severance and other employee benefits.

Asset write-offs and other fair value adjustments. During the first nine months of fiscal 2016 , we recorded a gain of $0.2 million related to the write-off of product transition costs previously accrued for in connection with an impairment of our Guest 360™ property management solution in fiscal 2012. The customer associated with this residual reserve became insolvent during the second quarter of fiscal 2016 .


27

Legal settlements. During the each of the first nine months of fiscal 2017 and fiscal 2016 , we recorded $0.1 million and $0.2 million in legal settlements for employment and other business related matters.

Other Expenses (Income)
Nine months ended
December 31,
(Unfavorable) favorable
(Dollars in thousands)
2016
2015
$
%
Other (income) expense:
Interest income
$
(135
)
$
(70
)
$
65

(92.9
)%
Interest expense
11

20

$
9

45.0
%
Other expense, net
140

40

(100
)
nm

Total other expense (income), net
$
16

$
(10
)
$
(26
)
nm


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 income increased $65,000 during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 due to interest earned during the processing of claims related to the redemption of corporate-owned life insurance policies during fiscal 2017 .

Interest expense. Interest expense consists of costs associated with capital leases and loans on corporate-owned life insurance policies.

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

Income Taxes
Nine months ended
December 31,
(Unfavorable) favorable
(Dollars in thousands)
2016
2015
$
%
Income tax expense (benefit)
$
252

$
(100
)
$
(352
)
nm
Effective tax rate
(4.1
)%
4.3
%

nm - not meaningful
For the first nine months of fiscal 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, foreign and state taxes, and other U.S. permanent book to tax differences. Tax expense primarily results from foreign taxable jurisdictions.

For the first nine months of fiscal 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, an adjustment to true-up indefinite-lived intangibles, a refunded settlement of an unrecognized tax benefit, foreign and state taxes, and other U.S. permanent book to tax differences. During this same period, our tax benefit resulted from an amended state return refund, an adjustment to amortization expense on indefinite lived assets, expirations of statute of limitations on uncertain tax positions offset by taxes withheld in foreign jurisdictions.

The increase in the tax provision year over year is due to non-recurring benefits recognized in fiscal 2016 and increased profitability in foreign jurisdictions during fiscal 2017 .

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

28

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, capital expenditures, and payments of principal and interest on indebtedness outstanding, which primarily consists of lease and rental obligations at December 31, 2016 . We believe that cash flow from operating activities, cash on hand of $52.7 million as of December 31, 2016 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 December 31, 2016 and March 31, 2016 , our total debt was approximately $0.3 million , comprised of capital lease obligations in both periods.

At December 31, 2016 , 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 92% 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
Nine months ended
December 31,
(In thousands)
2016
2015
Net cash provided by (used in):
Operating activities
$
5,393

$
8,314

Investing activities
(12,502
)
(17,170
)
Financing activities
$
(687
)
$
(464
)
Effect of exchange rate changes on cash
(99
)
(95
)
Net decrease in cash and cash equivalents
$
(7,895
)
$
(9,415
)

Cash flow provided by operating activities. Cash flow provided by operating activities was $5.4 million in the first nine months of fiscal 2017. Our operating loss, adjusted for restructuring, severance, and other charges, depreciation, amortization, and share based compensation, was $3.7 million . Positive net working capital movements contributed an additional $1.7 million associated mainly with $6.7 million in increased collections on accounts receivable, offset by a $4.6 million decrease in deferred revenue related to revenue recognized for annual support and maintenance services.

Cash flows provided by operating activities was $8.3 million in the first nine months of fiscal 2016. The use of cash was attributable to $5.3 million in net working capital movements associated mainly with $4.5 million in increased collections on accounts receivable partially associated with the timing of annual support billings, $5.5 million increase deferred revenue related to support services, offset by increases in inventory and other prepaid expenses of $4.5 million. Working capital movements were positively impacted by $3.5 million related to our operating loss adjusted for depreciation, amortization, share based compensation, asset write-offs and fair value adjustments, and loss on disposal of property & equipment.


29

Cash flow used in investing activities. For the first nine months of fiscal 2017, the $12.5 million in cash used in investing activities was primarily comprised of $10.3 million for the development of proprietary software and $2.2 million for purchase of property and equipment, including internal use software.

In fiscal 2016, the $17.2 million in cash used in investing activities was primarily comprised of $13.5 million for the development of proprietary software and $3.6 million for purchase of property and equipment, including internal use software.

Cash flow used in financing activities. During the first nine months of fiscal 2017, the $0.7 million used in financing activities was primarily comprised of $0.4 million related to the repurchase of shares to satisfy employee tax withholding and to cover the price of the options and $0.2 million in payments to settle the contingent consideration related to the fiscal 2014 acquisition of TimeManagement Corporate (TMC).

During the first nine months of fiscal 2016, the $0.5 million used in financing activities was primarily comprised of the repurchase of shares to satisfy employee tax withholding and to cover the price of the options, and payments on capital lease obligations.

Contractual Obligations

As of December 31, 2016 , there were no significant changes to our contractual obligations as presented in our Annual Report for the year ended March 31, 2016 .

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, 2016 . There have been no material changes in our significant accounting policies and estimates since March 31, 2016 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, 2016 . 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk


30

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, 2016 . There have been no material changes in our market risk exposures since March 31, 2016 .

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) and Chief Financial Officer (CFO), 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 and CFO 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.

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, 2016 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
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

31


32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

101
The following materials from our quarterly report on Form 10-Q for the quarter ended December 31, 2016 , formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at December 31, 2016 and March 31, 2016 , (ii) Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2016 and 2015 , (iii) Condensed Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended December 31, 2016 and 2015 , (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2016 and 2015 , and (v) Notes to Condensed Consolidated Financial Statements for the three and nine months ended December 31, 2016 .



32





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:
February 9, 2017
/s/ Anthony S. Pritchett
Anthony S. Pritchett
Interim Chief Financial Officer
(Principal Accounting Officer and Duly Authorized Officer)


33
TABLE OF CONTENTS