AGYS 10-Q Quarterly Report Sept. 30, 2018 | Alphaminr
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AGYS 10-Q Quarter ended Sept. 30, 2018

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Cash Flow
Income Statement
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10-Q 1 agys-9302018x10q.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 September 30, 2018
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.)
1000 Windward Concourse, Suite 250, Alpharetta, Georgia
30005
(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 24, 2018 was 23,528,311 .


AGILYSYS, INC.
Index

Item 1
Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) - September 30, 2018 and March 31, 2018
Condensed Consolidated Statements of Operations (Unaudited) - Three and Six Months Ended September 30, 2018 and September 30, 2017
Condensed Consolidated Statements of Comprehensive Loss (Unaudited) - Three and Six Months Ended September 30, 2018 and September 30, 2017
Condensed Consolidated Statements of Cash Flows (Unaudited) - Six Months Ended September 30, 2018 and September 30, 2017
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)
September 30,
2018
March 31,
2018
(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents
$
32,904

$
39,943

Accounts receivable, net of allowance for doubtful accounts of $830 and $900, respectively
18,963

16,389

Contract assets
4,696

—

Inventories
1,678

1,999

Prepaid expenses and other current assets
5,089

5,593

Total current assets
63,330

63,924

Property and equipment, net
16,355

17,512

Goodwill
19,622

19,622

Intangible assets, net
8,461

8,484

Software development costs, net
41,159

45,181

Other non-current assets
4,699

2,484

Total assets
$
153,626

$
157,207

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable
$
7,381

$
8,400

Contract liabilities
25,789

26,820

Accrued liabilities
9,459

9,241

Capital lease obligations, current
72

120

Total current liabilities
42,701

44,581

Deferred income taxes, non-current
274

227

Capital lease obligations, non-current
45

57

Other non-current liabilities
3,632

3,911

Commitments and contingencies (see Note 8)


Shareholders' equity:
Common shares, without par value, at $0.30 stated value; 80,000,000 shares authorized; 31,606,831 shares issued; and 23,530,629 and 23,324,679 shares outstanding at September 30, 2018 and March 31, 2018, respectively
9,482

9,482

Treasury shares, 8,076,202 and 8,282,152 at September 30, 2018 and March 31, 2018, respectively
(2,424
)
(2,486
)
Capital in excess of stated value
(451
)
(1,911
)
Retained earnings
100,687

103,601

Accumulated other comprehensive loss
(320
)
(255
)
Total shareholders' equity
106,974

108,431

Total liabilities and shareholders' equity
$
153,626

$
157,207


See accompanying notes to condensed consolidated financial statements.

3


AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended
Six months ended
September 30,
September 30,
(In thousands, except share data)
2018
2017
2018
2017
Net revenue:
Products
$
8,769

$
7,318

$
17,849

$
17,601

Support, maintenance and subscription services
18,856

17,108

36,785

33,775

Professional services
6,578

5,703

13,576

12,618

Total net revenue
34,203

30,129

68,210

63,994

Cost of goods sold:
Products (inclusive of developed technology amortization)
7,703

5,419

14,833

13,042

Support, maintenance and subscription services
3,977

4,446

8,051

8,478

Professional services
4,774

4,894

9,688

10,430

Total cost of goods sold
16,454

14,759

32,572

31,950

Gross profit
17,749

15,370

35,638

32,044

51.9
%
51.0
%
52.2
%
50.1
%
Operating expenses:
Product development
10,151

6,812

17,240

13,438

Sales and marketing
4,393

4,207

9,146

9,337

General and administrative
5,176

5,561

11,181

12,361

Depreciation of fixed assets
676

700

1,282

1,312

Amortization of intangibles
674

465

1,217

950

Restructuring, severance and other charges
448

826

889

863

Legal settlements
35

—

126

—

Total operating expense
21,553

18,571

41,081

38,261

Operating loss
(3,804
)
(3,201
)
(5,443
)
(6,217
)
Other expense (income):
Interest (income)
(97
)
(23
)
(152
)
(51
)
Interest expense
3

2

5

4

Other expense (income), net
28

(37
)
228

(147
)
Loss before taxes
(3,738
)
(3,143
)
(5,524
)
(6,023
)
Income tax expense
53

105

4

183

Net loss
$
(3,791
)
$
(3,248
)
$
(5,528
)
$
(6,206
)
Weighted average shares outstanding
23,131

22,760

23,113

22,740

Loss per share - basic and diluted:
Loss per share
$
(0.16
)
$
(0.14
)
$
(0.24
)
$
(0.27
)

See accompanying notes to condensed consolidated financial statements.

4


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


Three months ended
Six months ended
September 30,
September 30,
(In thousands)
2018
2017
2018
2017
Net loss
$
(3,791
)
$
(3,248
)
$
(5,528
)
$
(6,206
)
Other comprehensive (loss)/gain, net of tax:
Unrealized foreign currency translation adjustments
(58
)
(22
)
(66
)
22

Total comprehensive loss
$
(3,849
)
$
(3,270
)
$
(5,594
)
$
(6,184
)

See accompanying notes to condensed consolidated financial statements.

5

AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
September 30,
(In thousands)
2018
2017
Operating activities
Net loss
$
(5,528
)
$
(6,206
)
Adjustments to reconcile net loss to net cash used in operating activities
Net restructuring, severance and other charges
(126
)
19

Net legal settlements
126

—

Depreciation
1,282

1,312

Amortization
1,217

950

Amortization of developed technology
6,010

4,727

Deferred income taxes
54

87

Share-based compensation
1,674

2,318

Change in cash surrender value of company owned life insurance policies
(8
)
(6
)
Changes in operating assets and liabilities
(7,449
)
(4,849
)
Net cash used in operating activities
(2,748
)
(1,648
)
Investing activities
Capital expenditures
(1,333
)
(3,106
)
Capitalized software development costs
(2,189
)
(5,477
)
Investments in corporate-owned life insurance policies
(2
)
(2
)
Net cash used in investing activities
(3,524
)
(8,585
)
Financing activities
Repurchase of common shares to satisfy employee tax withholding
(557
)
(519
)
Principal payments under long-term obligations
(59
)
(61
)
Net cash used in financing activities
(616
)
(580
)
Effect of exchange rate changes on cash
(151
)
90

Net decrease in cash and cash equivalents
(7,039
)
(10,723
)
Cash and cash equivalents at beginning of period
$
39,943

$
49,255

Cash and cash equivalents at end of period
$
32,904

$
38,532

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Accrued capital expenditures
$
74

$
385

Accrued capitalized software development costs
—

357


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 and services for point-of-sale (POS), payment gateway, reservation and table management, property management (PMS), inventory and procurement, business analytics, document management, guest offers 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 headquarters 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 2019 refers to the fiscal year ending March 31, 2019.

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, 2018 , as well as the Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Comprehensive Loss, and the Condensed Consolidated Statements of Cash Flows for the three and six months ended September 30, 2018 and 2017 , are unaudited. However, these financial statements have been prepared on the same basis as those in the audited annual financial statements, except for the recently adopted accounting pronouncements described below. 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, 2018 , filed with the Securities and Exchange Commission (SEC) on May 25, 2018.

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, 2018 , included in our Annual Report on Form 10-K. Our accounting policy for revenue recognition changed with the adoption of Accounting Standards Update ("ASU") No. 2014-09 ("Topic 606"), as described further below. There have been no other material changes to our significant accounting policies and estimates from those disclosed therein.


7

Reclassification - Certain prior year balances have been reclassed to conform to the current year presentation. Specifically, we have elected to present our changes in operating assets and liabilities on the condensed consolidated statements of cash flows as a single line item. Prior year results have been condensed to be consistent with current year presentation.

Adopted and Recently Issued Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board ("FASB") issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract . ASU 2018-15 addresses the treatment of implementation costs incurred in a hosting arrangement that is a service contract. The update does not impact the accounting for the service element of a hosting arrangement that is a service contract. The update is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods, with early adoption (including early adoption in any interim period) permitted. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

In August 2018, FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement . ASU 2018-13 addresses the required disclosures around fair value measurement. The disclosure requirements of the reasons for transfers between Level 1 and Level 2, the policy for timing transfers between levels, and the valuation process for Level 3 measurements has been removed. Certain modifications were made to required disclosures and additional requirements were established. The standard is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

In July 2018, FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements and 2018-10, Codification Improvements to Topic 842, Leases . ASU 2018-11 provides for an additional optional adoption method of ASU 2016-02, Leases , allowing for the application of the new standard as of the adoption date and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2018-10 provides corrections and updates to the previously issued codification regarding Topic 842. Various areas of the codification were impacted from the update. The two standards follow the effective dates of ASU 2016-02, Leases . Consistent with the documentation below, we are still assessing the impact of the adoption of ASU 2016-02, however we anticipate the adoption of the standard will materially affect our consolidated financial statements given the significance of our leases.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). ASU 2018-02 addresses the effect of the change in the U.S. federal corporate tax rate on items within accumulated other comprehensive income or loss due to the enactment of the Tax Act on December 22, 2017. The new standard is effective for annual periods, and for interim periods within those annual periods beginning after December 15, 2018, with early adoption permitted. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

In January 2017, the 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. We have adopted this standard as of April 1, 2018; the adoption had no impact to our condensed consolidated financial statements. 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.


8

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. 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 have adopted this standard as of April 1, 2018; the adoption had no impact to our condensed consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments , which provides guidance with the intent of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim period. We have adopted this standard as of April 1, 2018; the adoption had no impact to our condensed consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . This new standard changes the impairment model for most financial assets and certain other instruments. Entities will be required to use a model that will result in the earlier recognition of allowances for losses for trade and other receivables, held-to-maturity debt securities, loans, and other instruments. For available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than as reductions in the amortized cost of the securities. The new standard is effective for annual periods, and for interim periods within those annual periods, beginning after December 15, 2019, with early adoption permitted. We are currently reviewing this standard to assess the impact on our future consolidated financial statements.

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 we 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 requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. We adopted ASU No. 2014-09 as of April 1, 2018 using the modified retrospective transition method. Please refer to Note 3, "Revenue Recognition" for further details.

3. Revenue Recognition

On April 1, 2018, we adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) , using the modified retrospective method applied to those contracts that were not completed as of the adoption date. Results for reporting periods beginning after the adoption date are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under prior guidance.

Disaggregation of Revenue

We derive and report our revenue from the sale of products (software and hardware including server, storage, and point of sale), support, maintenance and subscription services and professional services. Revenue recognized at a point in time (products) totaled $8.8 million and $17.8 million , and over time (support, maintenance and subscription services and professional services) totaled $25.4 million and $50.4 million for the three and six months ended September 30, 2018 . See Nature of Goods and Services section below for additional information regarding revenue recognition procedures for our revenue streams.

9


Nature of Goods and Services

Our customary business practice is to enter into legally enforceable written contracts with our customers. The majority of our contracts are governed by a master agreement between us and the customer, which sets forth the general terms and conditions of any individual contract between the parties, which is then supplemented by a customer purchase order to specify the different goods and services, the associated prices, and any additional terms for an individual contract. Multiple contracts with a single counterparty entered into at the same time are evaluated to determine if the contracts should be combined and accounted for as a single contract.

Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct and are distinct in the context of the contract. Capable of being distinct means the customer can benefit from the goods or services either on its own or together with other resources that are readily available from third parties or from us. Distinct in the context of the contract means the transfer of the goods or services is separately identifiable from other promises in the contract. The transaction price is determined based on the consideration to which we will be entitled and expect to receive in exchange for transferring goods or services to the customer. Typically, our contracts do not provide our customer with any right of return or refund; we do not constrain the contract price as it is probable that there will not be a significant revenue reversal due to a return or a refund.

Typically, our customer contracts contain one or more of the following goods or services which constitute performance obligations.

Our software licenses typically provide for a perpetual right to use our software. Generally, our contracts do not provide significant services of integration and customization and installation services are not required to be purchased directly from us. The software is delivered before related services are provided and is functional without professional services, updates and technical support. We have concluded that the software license is distinct as the customer can benefit from the software on its own. Software revenue is typically recognized when the software is delivered or made available for download to the customer.

Revenue for hardware sales is recognized when the product is shipped to the customer and when obligations that affect the customer's final acceptance of the arrangement have been fulfilled. A majority of our hardware sales involve shipment directly from its suppliers to the end-user customers. In these transactions, we are the primary obligor as we are responsible for negotiating price both with the supplier and the customer, payment to the supplier, establishing payment terms and product returns with the customer, and we bear the credit risk if the customer does not pay for the goods. As the principal contact with the customer, we recognize revenue and cost of goods sold when we are notified by the supplier that the product has been shipped. In certain limited instances, as shipping terms dictate, revenue is recognized upon receipt at the point of destination or upon installation at the customer site.

Support and certain maintenance revenue is derived from providing telephone and on-line technical support services, bug fixes, and unspecified software updates and upgrades to customers on a when-and-if-available basis. Each of these performance obligations provide benefit to the customer on a standalone basis and are distinct in the context of the contract. Each of these distinct performance obligations represent a stand ready obligation to provide service to a customer, which is concurrently delivered and has the same pattern of transfer to the customer, which is why we account for these support services as a single performance obligation, recognized over the term of the maintenance agreement.

Our subscription service revenue is comprised of fees for Software as a Service (“SaaS”) contracts that provide customers a right to access our software, which we maintain, and host in a data center, for a subscribed period. We do not provide the customer the contractual right to license the software outside of the data center at any time during the subscription period under these contracts. The customer can only benefit from the software and software maintenance when combined with the hosting service since the right to access is only provided to the software hosted in the data center. Accordingly, each of the rights to access the software, the maintenance services, and the hosting services is not considered a distinct performance obligation in the context of the contract and should be combined into a single performance obligation and recognized over the contract period. Typically, we invoice fees monthly.


10

Professional services revenues primarily consist of fees for consulting, installation, integration and training and are generally recognized over time as the customer simultaneously receives and consumes the benefits of the professional services as the services are being performed. Professional services that are billed on a time and materials basis are recognized over time as the services are performed. For contracts billed on a fixed price basis, revenue is recognized over time using an input method based on labor hours expended to date relative to the total labor hours expected to be required to satisfy the related performance obligation.

We estimate standalone selling price ("SSP") based on the price at which the performance obligations are sold by considering certain specific factors related to our company together with customer information. If the contract contains a single performance obligation, the entire transaction price is allocated to that performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative SSP basis.

Shipping and handling fees billed to customers are recognized as revenue and the related costs are recognized in cost of goods sold. Revenue is recorded net of any applicable taxes collected and remitted to governmental agencies.

Contract Balances

Contract assets are rights to consideration in exchange for goods or services that we have transferred to a customer when that right is conditional on something other than the passage of time. The majority of our contract assets represent unbilled amounts related to professional services. We expect billing and collection of our contract assets to occur within the next twelve months. We receive payments from customers based upon contractual billing schedules and accounts receivable are recorded when the right to consideration becomes unconditional. Contract liabilities represent consideration received or consideration which is unconditionally due from customers prior to transferring goods or services to the customer under the terms of the contract.

Revenue recognized during the three and six months ended September 30, 2018 from amounts included in contract liabilities at the beginning of the period was $ 8.2 million and $19.8 million . During the three and six months ended September 30, 2018 , we transferred $ 0.2 million and $3.2 million to accounts receivable from contract assets recognized at April 1, 2018 because the right to the transaction consideration became unconditional.

Our arrangements are for a period of one year or less. We had approximately $ 28 million of remaining performance obligations as of September 30, 2018 , which we expect to recognize over the next twelve months .

Assets Recognized from Costs to Obtain a Contract

We capitalize commission expenses paid to internal sales personnel as expenses that are incremental to obtaining customer contracts. We have determined that these commission expenses are in fact incremental and would not have occurred absent the customer contract. Capitalized sales commissions are amortized on a straight-line basis over the period the goods or services are expected to be transferred to the customer to which the assets relate, which can range as long as five years. We have determined that certain sales incentive programs meet the requirements to be capitalized. We have capitalized $ 1.9 million of sales incentive costs in prior periods as part of our opening retained earnings adjustment on April 1, 2018. These balances are included in other non-current assets on our condensed consolidated balance sheet and are amortized as we satisfy the underlying performance obligations, generally based on the contract terms and anticipated renewals. During the three and six months ended September 30, 2018 , we expensed $0.9 million and $1.8 million of sales commissions, which are included in operating expenses - sales and marketing in our condensed consolidated statement of operations. All other costs to obtain a contract are not considered incremental and therefore are expensed as incurred.

Financial Statement Impact of Adoption on Previously Reported Results

We adopted Topic 606 using the modified retrospective method. The cumulative impact of applying the new guidance to all contracts with customers that were not completed as of April 1, 2018 was recorded as an adjustment to retained earnings as of the adoption date. As a result of applying the modified retrospective method to adopt the new standard, the following adjustments were made to noted accounts on the condensed consolidated balance sheet as of April 1, 2018:

11


(In thousands)
March 31, 2018
Adjustment from Topic 606
April 1, 2018
Assets:
Accounts receivable, net
16,389

3,124

19,513

Contract assets
—

4,583

4,583

Prepaid expenses and other current assets
5,593

(496
)
5,097

Other non-current assets
2,484

2,409

4,893

Liabilities:
Contract liabilities
26,820

7,006

33,826

Shareholders' equity:
Retained earnings
103,601

2,614

106,215


The acceleration of revenue that was deferred under prior guidance as of the adoption date was primarily attributable to the requirement of Topic 606 to allocate the transaction price to the performance obligations in the contract on a relative basis using SSP rather than allocating under the residual method, which allocates the entire arrangement discount to the delivered performance obligations.

Due to the Company's full valuation allowance as of the adoption date, there is no tax impact associated with the adoption of Topic 606.

We made certain presentation changes to our condensed consolidated balance sheet on April 1, 2018 to comply with Topic 606. Prior to adoption of the new standard, we offset accounts receivable and contract liabilities (previously presented as deferred revenue on our condensed consolidated balance sheet) for unpaid deferred performance obligations included in contract liabilities. Under the new standard, we record accounts receivable and related contract liabilities for non-cancelable contracts with customers when the right to consideration is unconditional. Upon adoption, the right to consideration in exchange for goods or services that have been transferred to a customer when that right is conditional on something other than the passage of time were reclassified from accounts receivable to contract assets.

Impact of Topic 606 on Financial Statement Line Items

The impact of adoption of Topic 606 on our condensed consolidated balance sheet as of September 30, 2018 and on our condensed consolidated statement of operations for the three and six months ended September 30, 2018 was as follows:

September 30, 2018
As reported
Balance without adoption of Topic 606
Effect of Change Higher (Lower)
(In thousands)
Assets:
Accounts receivable, net
18,963

18,312

651

Contract assets
4,696

—

4,696

Prepaid expenses and other current assets
5,089

5,532

(443
)
Other non-current assets
4,699

2,183

2,516

Liabilities:
Contract liabilities
25,789

21,120

4,669

Shareholders' equity:
Retained earnings
100,687

97,936

2,751


12


Three months ended September 30, 2018
As reported
Balance without adoption of Topic 606
Effect of Change Higher (Lower)
(In thousands)
Net revenue:
Products
8,769

8,391

378

Support, maintenance and subscription services
18,856

19,007

(151
)
Professional services
6,578

6,727

(149
)
Total net revenue:
34,203

34,125

78

Operating expenses:
Sales and marketing
4,393

4,536

(143
)
Net Loss
(3,791
)
(4,012
)
221


Six months ended September 30, 2018
As reported
Balance without adoption of Topic 606
Effect of Change Higher (Lower)
(In thousands)
Net revenue:
Products
17,849

17,093

756

Support, maintenance and subscription services
36,785

37,194

(409
)
Professional services
13,576

13,894

(318
)
Total net revenue:
68,210

68,181

29

Operating expenses:
Sales and marketing
9,146

9,254

(108
)
Net Loss
(5,528
)
(5,665
)
137



The adoption of Topic 606 had no impact to cash used in operating, investing or financing activities on our condensed consolidated statement of cash flows.


13

4. 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 Plan

As of September 30, 2018 , we had a remaining liability of approximately $20,000 recorded for the fiscal 2018 restructuring plan.

Following is a reconciliation of the beginning and ending balances of the restructuring liability:
Balance at
Provisions/Adjustments
Payments
Balance at
(In thousands)
March 31, 2018
September 30, 2018
Fiscal 2018 Restructuring Plan:
Restructuring and other employment costs
$
198

$
—

$
(178
)
$
20

Total restructuring costs
$
198

$
—

$
(178
)
$
20


14

5. Intangible Assets and Software Development Costs

The following table summarizes our intangible assets and software development costs:
September 30, 2018
March 31, 2018
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
10,398

(10,398
)
—

10,398

(10,398
)
—

Trade names
230

(169
)
61

230

(146
)
84

Patented technology
80

(80
)
—

80

(80
)
—

24,183

(24,122
)
61

24,183

(24,099
)
84

Unamortized intangible assets:
Trade names
8,400

N/A

8,400

8,400

N/A

8,400

Total intangible assets
$
32,583

$
(24,122
)
$
8,461


$
32,583

$
(24,099
)
$
8,484

Software development costs
$
67,541

$
(26,382
)
$
41,159

$
53,368

$
(20,372
)
$
32,996

Project expenditures not yet in use
—

—

—

12,185

—

12,185

Total software development costs
$
67,541

$
(26,382
)
$
41,159

$
65,553

$
(20,372
)
$
45,181


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,
2019
$
6,615

2020
12,599

2021
12,515

2022
5,403

2023
3,399

2024
689

Total
$
41,220


Amortization expense for software development costs related to assets to be sold, leased, or otherwise marketed was $3.4 million and $2.4 million for the three months ended September 30, 2018 and 2017 , and $6.0 million and $4.7 million for the six months ended September 30, 2018 and 2017 , 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, 2018 and 2017 , and $23,000 for the six months ended September 30, 2018 and 2017 . These charges are classified as Amortization of intangibles within the condensed consolidated statements of operations along with Amortization expense related to our Capitalized Internal-Use Software that we classify in Property and Equipment, net within the condensed consolidated balance sheets.

Capitalized software development costs for software internally developed to be sold, leased, or otherwise marketed, are carried on our balance sheet at carrying value, net of accumulated amortization. The Company did not capitalize any amounts for external-use software development costs during the three months ended September 30, 2018 due to the current active projects which carry a sufficiently short amount of time between achieving technological feasibility and

15

reaching general availability to preclude capitalization. We capitalized approximately $2.2 million during the three months ended September 30, 2017 , and $2.0 million and $4.9 million during the six months ended September 30, 2018 and 2017 , respectively.



6. Additional Balance Sheet Information
Additional information related to the condensed consolidated balance sheets is as follows:
(In thousands)
September 30,
2018
March 31,
2018
Accrued liabilities:
Salaries, wages, and related benefits
$
6,794

$
6,793

Other taxes payable
836

769

Restructuring liabilities
20

198

Accrued legal settlements
126

—

Severance liabilities
169

—

Professional fees
228

288

Deferred rent
420

407

Other
866

786

Total
$
9,459

$
9,241

Other non-current liabilities:
Uncertain tax positions
$
1,442

$
1,519

Deferred rent
2,115

2,313

Other
75

79

Total
$
3,632

$
3,911


Accounts Receivable, net

Accounts receivable, net of allowance for doubtful accounts was $19.0 million and $16.4 million as of September 30, 2018 and March 31, 2018 , respectively. The related allowance for doubtful accounts was $0.8 million and $0.9 million as of September 30, 2018 and March 31, 2018 , respectively.

7. Income Taxes

The following table compares our income tax (benefit) expense and effective tax rates for the three and six months ended September 30, 2018 and 2017 :
Three months ended
Six months ended
September 30,
September 30,
(Dollars in thousands)
2018
2017
2018
2017
Income tax expense
$
53


$
105

$
4

$
183

Effective tax rate
(1.4
)%

(3.3
)%
(0.1
)%
(3.0
)%

For the three and six months ended September 30, 2018 , 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 uncertain tax positions, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

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.


16


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.

On December 22, 2017, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB No. 118 allows registrants to record provisional amounts for a period up to one year from the date of enactment of the Tax Act when the registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. It is uncertain if and to what extent various states will enact legislation to conform to the Tax Act. Because legislative guidance and accounting interpretations are expected in the future, we consider the accounting of the deferred tax remeasurement including the ability to offset indefinite lived deferred tax liabilities with certain deferred tax assets to be incomplete and therefore only consider amounts related to these items to be reasonably estimated as of March 31, 2018 and September 30, 2018 . We expect to refine and complete the accounting for the Tax Act during fiscal 2019 as we obtain, prepare and analyze additional information and as additional legislative, regulatory and accounting guidance and interpretations become available.

8. 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.


17

9. (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.
Three months ended
Six months ended
September 30,
September 30,
(In thousands, except per share data)
2018
2017
2018
2017
Numerator:
Net loss
$
(3,791
)
$
(3,248
)
$
(5,528
)
$
(6,206
)
Denominator:
Weighted average shares outstanding
23,131

22,760

23,113

22,740

Loss per share - basic and diluted:
Loss per share
$
(0.16
)
$
(0.14
)
$
(0.24
)
$
(0.27
)
Anti-dilutive stock options, SSARs, restricted shares and performance shares
1,481

1,788

1,419

1,728


Basic 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 486,701 and 535,772 of restricted shares at September 30, 2018 and 2017 , respectively, as these shares were issued but were not vested and therefore, not considered outstanding for purposes of computing basic loss per share at the balance sheet dates.

Diluted 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. Therefore, for all periods presented, basic weighted-average shares outstanding were used in calculating the diluted net loss per share.

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


18

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)
2018
2017
2018
2017
Product development
$
514

$
105

$
429

$
526

Sales and marketing
134

187

199

356

General and administrative
617

808

1,046

1,436

Total share-based compensation expense
1,265

1,100

1,674

2,318


Stock-Settled 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, Inc.

The following table summarizes the activity during the six months ended September 30, 2018 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, 2018
1,103,160

$
10.60

Granted
158,244

14.22

Exercised
(176,181
)
10.32

Forfeited
(43,417
)
10.80

Cancelled/expired
(3,492
)
9.60

Outstanding at September 30, 2018
1,038,314

$
11.19

5.4
$
3,035

Exercisable at September 30, 2018
529,923

$
10.57

4.8
$
3,035


As of September 30, 2018 , total unrecognized stock based compensation expense related to non-vested SSARs was $0.9 million , which is expected to be recognized over a weighted-average vesting period of 3.0 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 six months ended September 30, 2018 for restricted shares awarded under the 2011 and 2016 Plans:
Number of Shares
Weighted-Average Grant-Date Fair Value
(In thousands, except share and per share data)
(per share)
Outstanding at April 1, 2018
243,354

$
10.78

Granted
238,703

14.25
Vested
—

—

Forfeited
(58,647
)
10.54

Outstanding at September 30, 2018
423,410

$
12.77


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, 2018 , total unrecognized stock based compensation expense related to non-vested restricted stock was $3.4 million , which is expected to be recognized over a weighted-average vesting period of 2.1 years.


19

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 relative attainment of a performance metric and any unvested shares will forfeit upon settlement of the bonus.

The following table summarizes the activity during the six months ended September 30, 2018 for the performance shares awarded under the 2016 Plan:
Number of Shares
(In thousands, except share and per share data)
Outstanding at April 1, 2018
91,463

Granted
63,291

Forfeited
(75,641
)
Vested
(15,822
)
Outstanding at September 30, 2018
63,291


Based on the performance goals, management estimates a liability of $450,000 to be settled through the vesting of a variable number of the performance shares subsequent to March 31, 2019 . As of September 30, 2018 , total unrecognized stock based compensation expense related to non-vested performance shares was $270,000 , which is expected to be recognized over the remaining vesting period of 6 months .


20

11. 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, 2018 and 2017 .

The following tables present information about our financial assets 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, 2018
(Level 1)
(Level 2)
(Level 3)
Assets:
Corporate-owned life insurance — non-current
$
863

—

—

$
863


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, 2018
(Level 1)
(Level 2)
(Level 3)
Assets:
Corporate-owned life insurance — non-current
$
853

—

—

$
853


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) expenses, net” in the Condensed Consolidated Statements of Operations.

The following table presents a summary of changes in the fair value of the Level 3 assets:
Six months ended
September 30,
(In thousands)
2018
2017
Corporate-owned life insurance:
Balance on April 1
$
853

$
809

Unrealized gain relating to instruments held at reporting date
8

4

Purchases, sales, issuances and settlements, net
2

2

Balance on September 30
$
863

$
815





21

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, 2018 , 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, 2018 . 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 27 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, 2018 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), payment gateway, reservation and table management, property management (PMS), inventory and procurement, business analytics, document management, guest offers 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 headquarters 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

22

•
Growing revenue through international expansion

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.



23

Revenue - Defined

On April 1, 2018 we adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) , using the modified retrospective method applied to the contracts that were not completed as of the adoption date. Results for operating periods beginning after the adoption date are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under prior guidance in effect at that time. For additional information regarding the adoption of this accounting standard, please refer to Note 3, "Revenue Recognition" in our condensed consolidated financial statement in Part I, Item I of this report for further details.

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:

•
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.


24

Results of Operations

Second Fiscal Quarter 2019 Compared to Second Fiscal Quarter 2018

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the three months ended September 30, 2018 and 2017 :
Three months ended
September 30,
Increase (decrease)
(Dollars in thousands)
2018
2017
$
%
Net revenue:
Products
$
8,769

$
7,318

$
1,451

19.8
%
Support, maintenance and subscription services
18,856

17,108

1,748

10.2

Professional services
6,578

5,703

875

15.3

Total net revenue
34,203

30,129

4,074

13.5

Cost of goods sold:
Products (inclusive of developed technology amortization)
7,703

5,419

2,284

42.1

Support, maintenance and subscription services
3,977

4,446

(469
)
(10.5
)
Professional services
4,774

4,894

(120
)
(2.5
)
Total cost of goods sold
16,454

14,759

1,695

11.5

Gross profit
$
17,749

$
15,370

$
2,379

15.5
%
Gross profit margin
51.9
%
51.0
%
Operating expenses:
Product development
$
10,151

$
6,812

$
3,339

49.0
%
Sales and marketing
4,393

4,207

186

4.4

General and administrative
5,176

5,561

(385
)
(6.9
)
Depreciation of fixed assets
676

700

(24
)
(3.4
)
Amortization of intangibles
674

465

209

44.9

Restructuring, severance and other charges
448

826

(378
)
nm

Legal settlements
35

—

35

nm

Operating loss
$
(3,804
)
$
(3,201
)
$
(603
)
18.8
%
Operating loss percentage
(11.1
)%
(10.6
)%

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:
Three months ended
September 30,
2018
2017
Net revenue:
Products
25.6
%
24.3
%
Support, maintenance and subscription services
55.1

56.8

Professional services
19.3

18.9

Total
100.0
%
100.0
%
Cost of goods sold:
Products (inclusive of developed technology amortization)
22.5
%
18.0
%
Support, maintenance and subscription services
11.6

14.8

Professional services
14.0

16.2

Total
48.1
%
49.0
%
Gross profit
51.9
%
51.0
%
Operating expenses:
Product development
29.7
%
22.6
%
Sales and marketing
12.8

14.0

General and administrative
15.1

18.5

Depreciation of fixed assets
2.0

2.3

Amortization of intangibles
2.0

1.5

Restructuring, severance and other charges
1.3

2.7

Legal settlements
0.1

—

Operating loss
(11.1
)%
(10.6
)%

Net revenue. Total net revenue increased $4.1 million , or 13.5% , during the second quarter of fiscal 2019 compared to the second quarter of fiscal 2018 . Products revenue increased $1.5 million , or 19.8% , due primarily to increased number of sales of third party hardware. Support, maintenance and subscription services revenue increased $1.7 million , or 10.2% , compared to the second quarter of fiscal 2018 driven by growth in 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 26.8% during the second quarter of fiscal 2019 compared to the second quarter of fiscal 2018 . Professional services revenue increased $0.9 million , or 15.3% , as a result of growth in our customer base including installations of our traditional on premise and subscription based software solutions and increased use of our technical services team for customer specific software development projects.

Gross profit and gross profit margin. Our total gross profit increased $2.4 million , or 15.5% , for the second quarter of fiscal 2019 and total gross profit margin increased approximately 0.9% to 51.9% from 51.0% . Products gross profit decreased $0.8 million and gross profit margin decreased approximately 13.7% to 12.2% primarily as a result of increased developed technology amortization. Support, maintenance and subscription services gross profit increased $2.2 million and gross margin increased 4.9% to 78.9% due to the scalable nature of our infrastructure supporting and hosting customers. Professional services gross profit increased $1.0 million and gross profit margin increased 13.2% to 27.4% due to increased revenue with relatively consistent cost.

Operating expenses

Operating expenses, excluding the charges for legal settlements, restructuring, severance and other charges, increased $3.3 million , or 18.7% , during the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018 .
Product development. Product development increased $3.3 million , or 49.0% , in the second quarter of fiscal 2019 due primarily to the absence of cost capitalization. The products in our rGuest platform for which we had capitalized costs

26

reached general availability by the beginning of the second quarter of fiscal 2019. These products join our well established products with the application of agile development methodologies in a more dynamic development process that involves higher frequency releases of product features and functions. The Company did not capitalize any amounts for external-use software development costs during the second quarter of fiscal 2019 due to the relatively short development cycle associated with the agile development of our current active products. We capitalized approximately $2.7 million in total development costs during the three months ended September 30, 2017 . Total product development costs, including operating expenses and capitalized amounts, were $10.2 million in the second quarter of fiscal 2019 compared to $9.5 million in the second quarter of fiscal 2018. The $0.7 million increase is mostly due to the continued expansion of the India Development Center.

Sales and marketing. Sales and marketing increased slightly by $0.2 million , or 4.4% , in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018 .

General and administrative. General and administrative decreased $0.4 million , or 6.9% , in the second quarter of fiscal 2019 compared with the second quarter of fiscal 2018 mostly due to a $0.2 million reduction in stock compensation for executive grants.

Restructuring, severance, and other charges. Restructuring, severance, and other charges decreased $0.4 million during the second quarter of fiscal 2019 compared to the second quarter of fiscal 2018 due to decreased restructuring charges.


Other Expenses (Income)
Three months ended
September 30,
(Unfavorable) favorable
(Dollars in thousands)
2018
2017
$
%
Other expense (income):
Interest (income)
$
(97
)
$
(23
)
$
74

nm

Interest expense
3

2

(1
)
(50.0
)%
Other expense (income), net
28

(37
)
(65
)
nm

Total other expense, net
$
(66
)
$
(58
)
$
8

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 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
Three months ended
September 30,
(Unfavorable) favorable
(Dollars in thousands)
2018
2017
$
%
Income tax expense
$
53

$
105

$
52

nm
Effective tax rate
(1.4
)%
(3.3
)%

nm - not meaningful
For the three months ended September 30, 2018 , 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.

27


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.

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 $0.2 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.



Results of Operations

First Half Fiscal 2019 Compared to First Half Fiscal 2018

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for the six months ended September 30, 2018 and 2017 :
Six months ended
September 30,
Increase (decrease)
(Dollars in thousands)
2018
2017
$
%
Net revenue:
Products
$
17,849

$
17,601

$
248

1.4
%
Support, maintenance and subscription services
36,785

33,775

3,010

8.9

Professional services
13,576

12,618

958

7.6

Total net revenue
68,210

63,994

4,216

6.6

Cost of goods sold:
Products (inclusive of developed technology amortization)
14,833

13,042

1,791

13.7

Support, maintenance and subscription services
8,051

8,478

(427
)
(5.0
)
Professional services
9,688

10,430

(742
)
(7.1
)
Total cost of goods sold
32,572

31,950

622

1.9

Gross profit
$
35,638

$
32,044

$
3,594

11.2
%
Gross profit margin
52.2
%
50.1
%
Operating expenses:
Product development
$
17,240

$
13,438

$
3,802

28.3
%
Sales and marketing
9,146

9,337

(191
)
(2.0
)
General and administrative
11,181

12,361

(1,180
)
(9.5
)
Depreciation of fixed assets
1,282

1,312

(30
)
(2.3
)
Amortization of intangibles
1,217

950

267

28.1

Restructuring, severance and other charges
889

863

26

nm

Legal settlements
126

—

126

nm

Operating loss
$
(5,443
)
$
(6,217
)
$
774

(12.4
)%
Operating loss percentage
(8.0
)%
(9.7
)%
nm - not meaningful

28



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,
2018
2017
Net revenue:
Products
26.2
%
27.5
%
Support, maintenance and subscription services
53.9

52.8

Professional services
19.9

19.7

Total
100.0
%
100.0
%
Cost of goods sold:
Products (inclusive of developed technology amortization)
21.7
%
20.4
%
Support, maintenance and subscription services
11.7

13.2

Professional services
14.2

16.3

Total
47.8
%
49.9
%
Gross profit
52.2
%
50.1
%
Operating expenses:
Product development
25.4
%
21.1
%
Sales and marketing
13.4

14.6

General and administrative
16.4

19.3

Depreciation of fixed assets
1.9

2.1

Amortization of intangibles
1.8

1.5

Restructuring, severance and other charges
1.3

1.3

Legal settlements
0.2

—

Operating loss
(8.0
)%
(9.7
)%

Net revenue. Total net revenue increased $4.2 million , or 6.6% , during the first half of fiscal 2019 compared to the first half of fiscal 2018 . Products revenue increased $0.2 million , or 1.4% . Support, maintenance and subscription services revenue increased $3.0 million , or 8.9% , compared to the first half of fiscal 2018 driven by growth in 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 22.8% during the first half of fiscal 2019 compared to the first half of fiscal 2018 . Professional services revenue increased $1.0 million , or 7.6% , as a result of growth in our customer base including installations of our traditional on premise and subscription based software solutions and increased use of our technical services team for customer specific software development projects.

Gross profit and gross profit margin. Our total gross profit increased $3.6 million , or 11.2% , for the first half of fiscal 2019 and total gross profit margin increased approximately 2.1% to 52.2% from 50.1% . Products gross profit decreased $1.5 million and gross profit margin decreased approximately 9.0% to 16.9% primarily as a result of increased developed technology amortization. Support, maintenance and subscription services gross profit increased $3.4 million and gross margin increased 3.2% to 78.1% due to the scalable nature of our infrastructure supporting and hosting customers. Professional services gross profit increased $1.7 million and gross profit margin increased 11.3% to 28.6% due to increased revenue with lower cost from restructuring of our professional services workforce during the first quarter of 2018 into a more efficient operating structure with more limited use of contract labor.

Operating expenses

Operating expenses, excluding the charges for legal settlements, restructuring, severance and other charges, increased $2.7 million , or 7.1% , during the first half of fiscal 2019 compared with the first half of fiscal 2018 .
Product development. Product development increased $3.8 million , or 28.3% , in the first half of fiscal 2019 compared to the first half of fiscal 2018 due primarily to the absence of cost capitalization. The products in our rGuest platform for

29


which we had capitalized costs reached general availability by the beginning of the second quarter of fiscal 2019. These products join our well established products with the application of agile development methodologies in a more dynamic development process that involves higher frequency releases of product features and functions. The Company capitalized $2.0 million in the six months ended September 30, 2018 , with the full balance being captured in Q1 fiscal 2019. We capitalized approximately $4.9 million in total development costs during the six months ended September 30, 2017 . Total product development costs, including operating expenses and capitalized amounts, were $19.2 million in the first half of fiscal 2019 compared to $18.3 million in the first half of fiscal 2018. The $0.9 million increase is mostly due to the continued expansion of the India Development Center.

Sales and marketing. Sales and marketing decreased $0.2 million , or 2.0% , in the first half of fiscal 2019 compared with the first half of fiscal 2018 .

General and administrative. General and administrative decreased $1.2 million , or 9.5% , in the first half of fiscal 2019 compared with the first half of fiscal 2018 due to approximately $0.5 million reduction in salaries and contract labor costs, $0.4 million reduction in stock compensation for executive grants, and $0.3 million reduction in professional and outside service costs.

Restructuring, severance, and other charges. Restructuring, severance, and other charges during the first half of fiscal 2019 compared to the first half of fiscal 2018 were consistent.


Other Expenses (Income)
Six months ended
September 30,
(Unfavorable) favorable
(Dollars in thousands)
2018
2017
$
%
Other expense (income):
Interest (income)
$
(152
)
$
(51
)
$
101

198.0
%
Interest expense
5

4

(1
)
(25.0
)%
Other expense (income), net
228

(147
)
(375
)
nm

Total other expense (income), net
$
81

$
(194
)
$
(275
)
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 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
Six months ended
September 30,
(Unfavorable) favorable
(Dollars in thousands)
2018
2017
$
%
Income tax expense
$
4.0

$
183

$
179

nm
Effective tax rate
(0.1
)%
(3.0
)%

nm - not meaningful
For the six months ended September 30, 2018 , 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

30


adjustment to true-up uncertain tax positions, certain foreign and state tax effects, and other U.S. permanent book to tax differences.

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.

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 $0.2 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 $32.9 million as of September 30, 2018 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, 2018 and March 31, 2018 , our total debt was approximately $0.1 million and $0.2 million , comprised of capital lease obligations in both periods.

At September 30, 2018 , 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)
2018
2017
Net cash (used in):
Operating activities
$
(2,748
)
$
(1,648
)
Investing activities
(3,524
)
(8,585
)
Financing activities
(616
)
(580
)
Effect of exchange rate changes on cash
(151
)
90

Net decrease in cash and cash equivalents
$
(7,039
)
$
(10,723
)

Cash flow used in operating activities. Cash flow used in operating activities was $2.7 million in the first six months of fiscal 2019 . A decrease in operating assets and liabilities of $7.4 million and operating loss of $5.4 million were mostly offset by $ 8.5 million in depreciation and amortization and $ 1.7 million in share-based compensation.

Cash flow used in investing activities. For the first six months of fiscal 2019 , the $3.5 million in cash used in investing activities was primarily comprised of $2.2 million for the development of proprietary software and $1.3 million for purchase of property and equipment, and internal use software development.


31

Cash flow used in financing activities. During the first six months of fiscal 2019 , the $0.6 million used in financing activities was primarily comprised of $0.6 million related to the repurchase of shares to satisfy employee tax withholding on share based compensation.

Contractual Obligations

As of September 30, 2018 , there were no significant changes to our contractual obligations as presented in our Annual Report for the year ended March 31, 2018 .

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, 2018 . There have been no material changes in our significant accounting policies and estimates since March 31, 2018 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, 2018 . 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

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, 2018 . There have been no material changes in our market risk exposures since March 31, 2018 .

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.

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, 2018 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






101
The following materials from our quarterly report on Form 10-Q for the quarter ended September 30, 2018 , formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at September 30, 2018 and March 31, 2018 , (ii) Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2018 and 2017 , (iii) Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended September 30, 2018 and 2017 , (iv) Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2018 and 2017 , and (v)

32


Notes to Condensed Consolidated Financial Statements for the three and six months ended September 30, 2018 .





33





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:
October 26, 2018
/s/ Anthony S. Pritchett
Anthony S. Pritchett
Chief Financial Officer
(Principal Financial Officer and Duly Authorized Officer)


34
TABLE OF CONTENTS