AGYS-9.30.2014-10Q
Table of Contents

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

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________.

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

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

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

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

The number of Common Shares of the registrant outstanding as of October 31, 2014 was 22,814,241.


Table of Contents

AGILYSYS, INC.
Index

 
 
 
 
 
 
Item 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
 
 
 
 
 
Item 3
 
 
 
 
 
Item 4
 
 
 
 
 
 
 
 
 
 
Item 1    
 
 
 
 
 
Item 1A
 
 
 
 
 
Item 2
 
 
 
 
 
Item 3
 
 
 
 
 
Item 4
 
 
 
 
 
Item 5
 
 
 
 
 
Item 6
 
 
 
 
 
 
 



2

Table of Contents





AGILYSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
September 30,
2014
 
March 31,
2014
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
67,168

 
$
99,566

Marketable securities
10,077

 

Accounts receivable, net of allowances of $838 and $1,101, respectively
23,519

 
23,615

Inventories
720

 
481

Prepaid expenses
2,901

 
3,300

Other current assets
585

 
2,892

Total current assets
104,970

 
129,854

Property and equipment, net
13,670

 
12,251

Goodwill
19,622

 
17,158

Intangible assets, net
9,985

 
10,626

Software development costs, net
24,498

 
17,221

Other non-current assets
3,851

 
3,785

Total assets
$
176,596

 
$
190,895

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
10,144

 
$
11,073

Deferred revenue
17,295

 
22,795

Accrued liabilities
9,555

 
14,232

Capital lease obligations, current
141

 
43

Total current liabilities
37,135

 
48,143

Deferred income taxes, non-current
3,444

 
3,422

Capital lease obligations, non-current
170

 
292

Other non-current liabilities
5,190

 
6,165

Commitments and contingencies (see Note 9)

 

Shareholders' equity:
 
 
 
Common shares, without par value, at $0.30 stated value; 80,000,000 shares authorized; 31,606,831 shares issued; and 22,814,241 and 22,467,970 shares outstanding at September 30, 2014 and March 31, 2014, respectively
9,482

 
9,482

Treasury shares, 8,792,590 and 9,138,861 at September 30, 2014 and March 31, 2014, respectively
(2,638
)
 
(2,741
)
Capital in excess of stated value
(12,363
)
 
(13,409
)
Retained earnings
136,319

 
139,675

Accumulated other comprehensive loss
(143
)
 
(134
)
Total shareholders' equity
130,657

 
132,873

Total liabilities and shareholders' equity
$
176,596

 
$
190,895


See accompanying notes to condensed consolidated financial statements.

3

Table of Contents


AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands, except per share data)
2014
 
2013
 
2014
 
2013
Net revenue:
 
 
 
 
 
 
 
Products
$
7,649

 
$
8,585

 
$
13,701

 
$
16,091

Support, maintenance and subscription services
13,775

 
12,881

 
27,594

 
25,755

Professional services
4,894

 
3,380

 
8,769

 
6,700

Total net revenue
26,318

 
24,846

 
50,064

 
48,546

Cost of goods sold:
 
 
 
 
 
 
 
Products
3,502

 
3,285

 
7,001

 
6,908

Support, maintenance and subscription services
2,961

 
2,578

 
6,091

 
4,847

Professional services
3,186

 
2,395

 
5,629

 
4,566

Total net cost of goods sold
9,649

 
8,258

 
18,721

 
16,321

Gross profit
16,669

 
16,588

 
31,343

 
32,225

 
63.3
%
 
66.8
%
 
62.6
%
 
66.4
%
Operating expenses:
 
 
 
 
 
 
 
Product development
6,191

 
6,714

 
12,056

 
12,946

Sales and marketing
3,825

 
4,068

 
7,710

 
7,035

General and administrative
6,079

 
5,065

 
11,196

 
9,694

Depreciation of fixed assets
532

 
513

 
1,146

 
994

Amortization of intangibles
594

 
794

 
2,377

 
1,588

Asset impairments and related charges

 
18

 

 
18

Restructuring, severance and other charges
448

 
562

 
818

 
617

Legal settlements
54

 

 
203

 

Operating loss
(1,054
)
 
(1,146
)
 
(4,163
)
 
(667
)
Other (income) expenses:
 
 
 
 
 
 
 
Interest income
(21
)
 
(20
)
 
(74
)
 
(33
)
Interest expense
14

 
45

 
27

 
106

Other (income) expense, net
(1
)
 
39

 
(46
)
 
11

Loss before income taxes
(1,046
)
 
(1,210
)
 
(4,070
)
 
(751
)
Income tax expense (benefit)
81

 
100

 
(714
)
 
(230
)
Loss from continuing operations
(1,127
)
 
(1,310
)
 
(3,356
)
 
(521
)
Income from discontinued operations, net of taxes

 
21,762

 

 
22,289

Net (loss) income
$
(1,127
)
 
$
20,452

 
$
(3,356
)
 
$
21,768

 
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
22,340

 
22,125

 
22,332

 
22,075

Net (loss) income per share - basic:
 
 
 
 
 
 
 
Loss per share from continuing operations
$
(0.05
)
 
$
(0.06
)
 
$
(0.15
)
 
$
(0.02
)
Income per share from discontinued operations

 
0.98

 

 
1.01

Net (loss) income per share
$
(0.05
)
 
$
0.92

 
$
(0.15
)
 
$
0.99

 
 
 
 
 
 
 
 
Weighted average shares outstanding - diluted
22,340

 
22,125

 
22,332

 
22,075

Net (loss) income per share - diluted:
 
 
 
 
 
 
 
Loss per share from continuing operations
$
(0.05
)
 
$
(0.06
)
 
$
(0.15
)
 
$
(0.02
)
Income per share from discontinued operations

 
0.98

 

 
1.01

Net (loss) income per share
$
(0.05
)
 
$
0.92

 
$
(0.15
)
 
$
0.99


See accompanying notes to condensed consolidated financial statements.

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Table of Contents


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


 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Net (loss) income
$
(1,127
)
 
$
20,452

 
$
(3,356
)
 
$
21,768

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Unrealized foreign currency translation adjustments
(1
)
 
133

 
(4
)
 
184

Unrealized loss on sale of securities
(1
)
 

 
(5
)
 

Total comprehensive (loss) income
$
(1,129
)
 
$
20,585

 
$
(3,365
)
 
$
21,952


See accompanying notes to condensed consolidated financial statements.

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Table of Contents

AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six months ended
(In thousands)
September 30,
 
2014
 
2013
Operating activities
 
 
 
Net (loss) income
$
(3,356
)
 
$
21,768

Less: Income from discontinued operations

 
22,289

Loss from continuing operations
(3,356
)
 
(521
)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities
 
 
 
Restructuring, severance and other charges
818

 
617

Payments for restructuring, severance and other charges
(823
)
 
(896
)
Legal settlements
203

 

Payments for legal settlements
(1,714
)
 
(87
)
Asset impairments and related charges

 
18

Depreciation
1,146

 
994

Amortization
2,987

 
1,576

Share-based compensation
1,067

 
882

Excess tax benefit from equity awards

 
(139
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
104

 
(1,572
)
Inventories
(237
)
 
214

Prepaid expense
400

 
(333
)
Accounts payable
(1,432
)
 
(1,032
)
Deferred revenue
(5,503
)
 
(5,133
)
Accrued liabilities
(2,255
)
 
(2,055
)
Income taxes payable
(892
)
 
(539
)
Other changes, net
(17
)
 
339

Net cash used in operating activities from continuing operations
(9,504
)
 
(7,667
)
Net cash used in operating activities from discontinued operations

 
(1,011
)
Net cash used in operating activities
(9,504
)
 
(8,678
)
Investing activities
 
 
 
Capital expenditures
(3,036
)
 
(2,425
)
Capitalized software development costs
(7,974
)
 
(4,853
)
Proceeds from sale of business units
282

 
36,054

Proceeds from company-owned life insurance policies, net
1,969

 
(4
)
Cash paid for acquisition, net
(3,750
)
 
(1,750
)
Return of investment in marketable securities
119

 

Investments in marketable securities
(10,240
)
 

Net cash (used) provided in investing activities from continuing operations
(22,630
)
 
27,022

Net cash (used) provided in investing activities from discontinued operations

 
(154
)
Net cash (used) provided in investing activities
(22,630
)
 
26,868

Financing activities
 
 
 
Repurchase of common shares to satisfy employee tax withholding
(373
)
 
(777
)
Exercise of employee stock options
102

 
64

Excess tax benefit from equity awards

 
139

Principal payments under long-term obligations
(23
)
 
(38
)
Net cash used in financing activities from continuing operations
(294
)
 
(612
)
Net cash used in financing activities from discontinued operations

 
(80
)
Net cash used in financing activities
(294
)
 
(692
)
Effect of exchange rate changes on cash
30

 
3

Cash flows used in continuing operations
(32,398
)
 
18,746

Cash flows used in discontinued operations

 
(1,245
)
Net (decrease) increase in cash and cash equivalents
(32,398
)
 
17,501

Cash and cash equivalents at beginning of period
99,566

 
82,931

Cash and cash equivalents at end of period
$
67,168

 
$
100,432

Less cash presented in current assets of discontinued operations on balance sheet

 
678

Cash and cash equivalents at end of period - continuing operations
$
67,168

 
$
99,754


See accompanying notes to condensed consolidated financial statements.

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Table of Contents

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 developer and marketer of proprietary enterprise software, services and solutions to the hospitality industry. We specialize in market-leading point-of-sale (POS), property management, inventory and procurement, workforce management, analytics, document management and mobile and wireless solutions that are designed to streamline operations, improve efficiency and enhance the 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, and offices in Singapore, Hong Kong and Malaysia. Agilysys is comprised of a single operating segment and operates as a pure play software-driven solutions provider to the hospitality industry.

The sales of our RSG business and UK entity each represented a disposal of a component of an entity. As such, the operating results of RSG and the UK entity have been reported as a component of discontinued operations in the Condensed Consolidated Statement of Operations for the three and six months ended September 30, 2013 and the Condensed Consolidated Statement of Cash Flows for the six months ended September 30, 2013.

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 2014 refers to the fiscal year ending March 31, 2014.

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, 2014, as well as the Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Comprehensive (Loss) Income for three and six months ended September 30, 2014 and 2013, and the Condensed Consolidated Statements of Cash Flow for the six months ended September 30, 2014 and 2013, 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 present the results of operations, financial position, and cash flows have been made. Further, we have evaluated all significant events occurring subsequent to the date of the Condensed Consolidated Financial Statements and through the filing of this Quarterly Report.

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, 2014, filed with the Securities and Exchange Commission (SEC) on June 4, 2014.


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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, 2014, included in our Annual Report on Form 10-K. Except as described below, there have been no material changes to our significant accounting policies and estimates from those disclosed therein.

Marketable Securities

Marketable securities can consist of certificates of deposits, commercial paper, corporate bonds and other investments with established commercial banking institutions with readily determinable fair values and stated maturities of greater than three months.  We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date.  Our marketable securities are classified as available for sale and have original maturity dates from 90 to 365 days.

Adopted and Recently Issued Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements - Going Concern, which provides guidance on disclosure of uncertainties about an entity’s ability to continue as a going concern. This is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements or related disclosures.
In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, which provides guidance requiring that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. This is effective for the fiscal years and interim reporting periods beginning after December 15, 2015. We are currently evaluating the impact that the adoption of ASU 2014-12 will have on our consolidated financial statements or related disclosures.
In May 2014, FASB issued 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. This is effective for the fiscal years and interim reporting periods 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 April 2014, FASB issued ASU No. 2014-08, Presentation of Financial Statements and Property, Plant and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which requires only disposals representing a strategic shift in operations that have a major effect on operations and financial results to be presented as discontinued operations. The guidance also requires expanded financial disclosures about discontinued operations and significant disposals that do not qualify as discontinued operations. This is effective for the fiscal years and interim reporting periods beginning after December 15, 2014. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements or related disclosures.
In July 2013, FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 clarifies guidance and eliminates diversity in practice on the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This new guidance is effective on a prospective basis for fiscal years and interim reporting periods within those years, beginning after December 15, 2013. We adopted the provisions of ASU 2013-11 beginning April 1, 2014. The adoption of the ASU did not have any impact on our financial statements.
Management continually evaluates the potential impact, if any, of all recent accounting pronouncements on our consolidated financial statements or related disclosures and, if significant, makes the appropriate disclosures required by such new accounting pronouncements.


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3. Acquisitions

Purchase of assets from Dining Ventures - Fiscal 2015

On July 3, 2014 Agilysys purchased certain assets from Dining Ventures, Inc. The acquired assets are the base for our rGuest Seat product, a dining reservations and table management application. The purchase consideration consisted of approximately $3.8 million and was funded with cash on hand. Management concluded that this acquisition was not a material acquisition under the provisions of ASC 805, Business Combinations (ASC 805). The results derived from this purchased asset have been included in our Condensed Consolidated Financial Statements from the date of acquisition and did not have a material impact on our condensed consolidated financial statements or related disclosures. 
The following is a summary of the fair values of the assets acquired in the acquisition:
(In thousands)
 
Goodwill
$
2,464

Developed technology
1,286

Total assets acquired
$
3,750


The goodwill of approximately $2.5 million arising from the acquisition consists largely of synergies expected from combining the developed technology of Dining Ventures with Agilysys' operations. The goodwill from this acquisition is deductible for tax purposes over a period of 15 years.

The following is a summary of the intangible asset acquired and the weighted-average useful life over which it will be amortized.
 
 
 
Weighted-average
 
Purchased assets
 
useful life
Developed technology
$
1,286

 
5 years

The developed technology acquired from Dining Ventures was determined to be an internal use asset and is therefore carried in fixed assets on the balance sheet and amortized in operating expenses.

Purchase of TimeManagement Corporation - Fiscal 2014

On June 10, 2013, Agilysys purchased certain assets and assumed certain liabilities of TimeManagement Corporation (TMC), a privately-owned Minneapolis-based technology provider with solutions that streamline workforce management environments for hospitality operators. This technology based acquisition is consistent with the core value we provide to the industry and integrates with our point-of-sale, inventory and procurement systems, including InfoGenesis™ point of sale system and Eatec® inventory and procurement solution. The purchase consideration consisted of $1.8 million in cash paid and $1.8 million of contingent consideration and is still assessed at the same value. The fair value of the contingent consideration was estimated to be $1.8 million at the date of acquisition and is expected to be paid out over the next 5 years and payments could vary based on actual revenue during that time. 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. The acquisition was funded with cash on hand. Management concluded that this acquisition was not a material acquisition under the provisions of ASC 805, Business Combinations. The operations of the purchased business have been included in our Condensed Consolidated Financial Statements from the date of acquisition and did not have a material impact on our condensed consolidated financial statements or related disclosures.


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The following is a summary of the fair values of the assets acquired and liabilities assumed from the acquisition:
(In thousands)
 
Current assets
$
327

Property and equipment
88

Goodwill
3,444

Developed technology
605

Total assets acquired
4,464

Total liabilities assumed (all current)
914

Net assets acquired
$
3,550


The goodwill of approximately $3.4 million arising from the acquisition consists largely of synergies and economies of scale expected from combining the operations of Agilysys and TMC. The goodwill from this acquisition is deductible for tax purposes over a period of 15 years.

The following is a summary of the intangible asset acquired and the weighted-average useful life over which it will be amortized.
 
 
 
Weighted-average
 
Purchased assets
 
useful life
Developed technology
$
605

 
5 years

The developed technology acquired from TMC was determined to be an asset held for sale and is therefore carried in intangible assets on the balance sheet and amortized in cost of goods sold.


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4. Discontinued Operations

UK Entity - Fiscal 2014

In March 2014, we completed the sale of our UK entity to Verteda Limited (Verteda), a U.K. based company, for total consideration of approximately $0.6 million, comprised of $0.7 million in cash and a receivable due to Agilysys from Verteda of $0.8 million, net of cash on hand of $0.9 million. We received $0.3 million in cash during the first half of fiscal 2015, resulting in a remaining receivable of $0.5 million. We expect to receive the remainder of this balance within fiscal 2015. In connection with the sale, we have entered into a multi-year distribution agreement whereby Verteda will distribute certain Agilysys products within the U.K. We will continue to manage all property management system accounts as well as key global accounts in the EMEA market.

Sale of Assets of RSG - Fiscal 2014

In July 2013, we completed the sale of our RSG business to Kyrus Solutions, Inc. (Kyrus), an affiliate of Clearlake Capital Group, L.P., for total consideration of approximately $37.6 million in cash, including a working capital adjustment of $3.1 million. Upon the close of the transaction, the aggregate purchase price was reduced by fees of approximately $1.6 million for transaction related costs, resulting in net proceeds received of approximately $36.0 million. In addition to the purchase agreement, we entered into a transition services agreement (TSA) with Kyrus, under which we provided certain transitional administrative and support services to Kyrus through January 31, 2014.

The sales of our RSG business and UK entity each represented a disposal of a component of an entity. As such, the operating results of RSG and the UK entity have been reported as a component of discontinued operations in the Condensed Consolidated Statement of Operations and Condensed Consolidated Statement of Cash Flows for the three months ended September 30, 2013. In addition, the assets and liabilities of RSG and the UK entity have been classified as discontinued operations in our Condensed Consolidated Balance Sheet as of September 30, 2013.

Components of Results of Discontinued Operations

Income from discontinued operations was comprised of the following:
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(In thousands)
 
2013
 
 
2013
Discontinued operations:
 
 
 
 
 
Net revenue
 
$
1,733

 
 
$
26,848

 
 
 
 
 
 
Income from operations
 
36

 
 
781

Other expense, net
 
44

 
 
(9
)
Gain on sale
 
23,135

 
 
23,135

Income before tax from discontinued operations
 
23,215

 
 
23,907

Income tax expense
 
1,453

 
 
1,618

Income from discontinued operations
 
$
21,762

 
 
$
22,289


Income tax expense recorded during the three months and six months ended September 30, 2013 is due to intra-period tax allocation rules associated with discontinued operations.


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5. 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 2015 Restructuring Activity

In the second quarter of fiscal 2015, we implemented restructuring actions to better align product development, sales and marketing and general and administrative functions with our company strategy and to reduce operating costs. To date, we have recorded $0.2 million in restructuring charges related to the fiscal 2015 restructuring activity, comprised of severance and other employee related benefits. As of September 30, 2014, we had a remaining liability of approximately $0.2 million recorded for the fiscal 2015 restructuring activity.

Fiscal 2014 Restructuring Activity

In the first quarter of fiscal 2014, we announced restructuring actions to better align corporate functions and to reduce operating costs, following the sale of RSG. In addition, in the fourth quarter of fiscal 2014, we initiated a restructuring plan to maximize sales effectiveness and more closely align sales and marketing efforts for targeted vertical growth, new product launches, and marketing alliances, and to shift development resources to the next generation products. To date, we have recorded $1.6 million in restructuring charges related to the fiscal 2014 restructuring activity, of which $1.2 million was recorded in fiscal 2014. We recorded approximately $0.4 million in restructuring charges during the first quarter of fiscal 2015, comprised of severance and other employee related benefits. As of September 30, 2014, we had a remaining liability of approximately $0.1 million recorded for the fiscal 2014 restructuring activity.

Following is a reconciliation of the beginning and ending balances of the restructuring liability:
 
Balance at
 
 
 
 
 
Balance at
 
March 31,
 
 
 
 
 
September 30,
(In thousands)
2014
 
Provision
 
Payments
 
2014
Fiscal 2015 Restructuring Plan:
 
 
 
 
 
 
 
Severance and employment costs
$

 
$
178

 
$

 
$
178

Fiscal 2014 Restructuring Plan:
 
 
 
 
 
 
 
Severance and employment costs
$
534

 
$
370

 
$
(823
)
 
$
81

Total restructuring costs
$
534

 
$
548

 
$
(823
)
 
$
259


The remaining severance and other employment costs of approximately $0.3 million will be paid in fiscal 2015.


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6. Intangible Assets and Software Development Costs

The following table summarizes our intangible assets and software development costs:
 
September 30, 2014
 
March 31, 2014
 
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

$
(10,530
)
$
245

 
$
10,775

$
(10,080
)
$
695

Non-competition agreements
2,700

(2,604
)
96

 
2,700

(2,473
)
227

Developed technology
10,660

(10,216
)
444

 
10,660

(10,156
)
504

Patented technology
80

(80
)

 
80

(80
)

 
24,215

(23,430
)
785

 
24,215

(22,789
)
1,426

Unamortized intangible assets:
 
 
 
 
 
 
 
Trade names
10,100

 N/A

10,100

 
10,100

 N/A

10,100

Accumulated impairment
(900
)
 N/A

(900
)
 
(900
)
 N/A

(900
)
 
9,200

 N/A

9,200

 
9,200

 N/A

9,200

Total intangible assets
$
33,415

$
(23,430
)
$
9,985

 
$
33,415

$
(22,789
)
$
10,626

 
 
 
 
 
 
 
 
Software development costs
$
15,561

$
(820
)
$
14,741

 
$
14,587

$
(270
)
$
14,317

Project expenditures not yet in use
19,250


19,250

 
12,397


12,397

Accumulated impairment
(9,493
)
N/A

(9,493
)
 
(9,493
)
N/A

(9,493
)
Total software development costs
$
25,318

$
(820
)
$
24,498

 
$
17,491

$
(270
)
$
17,221


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,
 
2015
$
1,003

2016
1,335

2017
1,335

2018
1,335

2019
959

2020
65

Total
$
6,032


Amortization expense relating to intangible assets was $0.3 million for the three months ended September 30, 2014, and 2013, and $0.6 million for the six months ended September 30, 2014 and 2013. Amortization expense relating to developed technology software intangible assets was $0.3 million for the three months ended September 30, 2014, and $0.6 million and $0.1 million for the six months ended September 30, 2014 and 2013, respectively. Amortization expense for acquired and internally developed intangibles that are related to products held for sale is included in Products cost of goods sold and amortization expense for acquired and internally developed intangibles that are related to internal use assets is included in operating expenses as amortization of intangibles.

Capitalized software development costs that are internally developed are carried on our balance sheet at net realizable value, net of accumulated amortization. We capitalized approximately $3.9 million and $2.9 million during the three

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months ended September 30, 2014 and 2013, respectively, and $7.8 million and $5.8 million during the six months ended September 30, 2014 and 2013, respectively.

7. Additional Balance Sheet Information
Additional information related to the Condensed Consolidated Balance Sheets is as follows:
(In thousands)
September 30,
2014
 
March 31,
2014
Accrued liabilities:
 
 
 
Salaries, wages, and related benefits
$
5,775

 
$
8,308

Other taxes payable
1,181

 
1,122

Accrued legal settlements
70

 
1,630

Restructuring liabilities
259

 
534

Professional fees
808

 
674

Software license fees

 
500

Deferred rent
353

 
477

Contingent consideration
180

 
127

Other
929

 
860

Total
$
9,555

 
$
14,232

Other non-current liabilities:
 
 
 
Uncertain tax positions
$
1,533

 
$
2,440

Deferred rent
1,742

 
1,755

Contingent consideration
1,557

 
1,612

Other
358

 
358

Total
$
5,190

 
$
6,165


8. Income Taxes

The following table compares our income tax benefit and effective tax rates for the three and six months ended September 30, 2014 and 2013:
 
Three months ended
 
Six months ended
 
September 30,
 
September 30,
(Dollars in thousands)
2014
 
2013
 
2014
 
2013
Income tax expense (benefit)
$
81

 
$
100

 
$
(714
)
 
$
(230
)
Effective tax rate
(7.7
)%
 
(8.3
)%
 
17.5
%
 
30.6
%

For the three and six months ended September 30, 2014, the effective tax rate was different than the statutory rate due primarily to the decrease in unrecognized tax benefits attributable to the expiration of statute of limitations, recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, and other U.S. permanent book to tax differences.

For the three and six months ended September 30, 2013, the effective tax rate was different than the statutory rate due primarily to the intra-period tax allocation rules associated with the discontinued operations. Other items affecting the rate include a decrease in unrecognized tax benefits attributable to the expiration of statute of limitations, recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, 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.

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9. Commitments and Contingencies

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

On April 6, 2012, Ameranth, Inc. filed a complaint against us for patent infringement in the United States District Court for the Southern District of California. The complaint alleges, among other things, that point-of-sale and property management and other hospitality information technology products, software, components and/or systems sold by us infringe three patents owned by Ameranth purporting to cover generation and synchronization of menus, including restaurant menus, event tickets, and other products across fixed, wireless and/or internet platforms as well as synchronization of hospitality information and hospitality software applications across fixed, wireless and internet platforms. The complaint seeks monetary damages, injunctive relief, costs and attorneys' fees. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit.  However, we dispute the allegations of wrongdoing and are vigorously defending ourselves in this matter. The litigation is currently stayed pending a covered business method review by the United States Patent and Trademark Office of a subset of the patents alleged to be infringed by Agilysys. The covered business method review was instituted on March 26, 2014, and must be completed within one year of institution, except that the time to complete the review may be extended by up to six months for good cause.


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10. (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
 
Six months ended
 
September 30,
 
September 30,
(In thousands, except per share data)
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Loss from continuing operations
$
(1,127
)
 
$
(1,310
)
 
$
(3,356
)
 
$
(521
)
Income from discontinued operations

 
21,762

 

 
22,289

Net (loss) income
$
(1,127
)
 
$
20,452

 
$
(3,356
)
 
$
21,768

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
22,340

 
22,125

 
22,332

 
22,075

Weighted average shares outstanding - diluted
22,340

 
22,125

 
22,332

 
22,075

 
 
 
 
 
 
 
 
(Loss) earnings per share - basic:
 
 
 
 
 
 
 
Loss per share from continuing operations
$
(0.05
)
 
$
(0.06
)
 
$
(0.15
)
 
$
(0.02
)
Income per share from discontinued operations

 
0.98

 

 
1.01

Net (loss) income per share
$
(0.05
)
 
$
0.92

 
$
(0.15
)
 
$
0.99

 
 
 
 
 
 
 
 
(Loss) earnings per share - diluted:
 
 
 
 
 
 
 
Loss per share from continuing operations
$
(0.05
)
 
$
(0.06
)
 
$
(0.15
)
 
$
(0.02
)
Income per share from discontinued operations
$

 
$
0.98

 
$

 
$
1.01

Net (loss) income per share
$
(0.05
)
 
$
0.92

 
$
(0.15
)
 
$
0.99

 
 
 
 
 
 
 
 
Anti-dilutive stock options, SSARs, restricted shares and performance shares
1,467

 
1,406

 
1,316
 
1,502

Basic earnings (loss) per share is computed as net income available to common shareholders divided by the weighted average basic shares outstanding. The outstanding shares used to calculate the weighted average basic shares excludes 470,956 and 283,596 of restricted shares and performance shares at September 30, 2014 and 2013, respectively, as these shares were issued but were not vested and, therefore, not considered outstanding for purposes of computing basic earnings per share at the balance sheet dates.

Diluted earnings (loss) per share includes the effect of all potentially dilutive securities on earnings per share. We have stock options, stock-settled appreciation rights (SSARs), unvested restricted shares and unvested performance shares that are potentially dilutive securities. When a loss is reported, the denominator of diluted earnings per share cannot be adjusted for the dilutive impact of share-based compensation awards because doing so would be anti-dilutive. Therefore, for the three months ended September 30, 2014, basic weighted-average shares outstanding were used in calculating the diluted net loss per share.


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Table of Contents

11. Share-based Compensation

We may grant non-qualified stock options, incentive stock options, stock-settled stock appreciation rights, restricted shares, and restricted share units for up to 3.0 million common shares under our 2011 Stock Incentive Plan (the 2011 Plan). 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. The maximum aggregate number of restricted shares or restricted share units that may be granted under the 2011 Plan is 1.0 million.

We have a shareholder-approved 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.

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
 
Six months ended
 
September 30,
 
September 30,
(In thousands)
2014
 
2013
 
2014
 
2013
Product development
$
242

 
$
215

 
$
409

 
$
356

Sales and marketing
12

 
37

 
32

 
50

General and administrative
448

 
265

 
626

 
476

Total share-based compensation expense
702

 
517

 
1,067

 
882


Stock Options

The following table summarizes the activity during the six months ended September 30, 2014 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, 2014
627,500

 
$
15.26

 
 
 
 
Granted

 

 
 
 
 
     Exercised
(15,000
)
 
13.76

 
 
 
 
     Cancelled/expired
(30,000
)
 
13.11

 
 
 
 
Outstanding and exercisable at September 30, 2014
582,500

 
$
15.41

 
1.6
 
$


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A total of 8,065 shares, net of 6,935 shares withheld to cover the applicable exercise price of the award, were issued from treasury shares to settle stock options exercised during the first six months of fiscal 2015.


Stock-Settled Stock Appreciation Rights

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

The following table summarizes the activity during the six months ended September 30, 2014 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, 2014
320,236

 
$
9.05

 
 
 
 
Granted
113,900

 
14.43

 
 
 
 
Exercised
(16,078
)
 
7.75

 
 
 
 
Forfeited
(10,668
)
 
7.46

 
 
 
 
Expired

 

 
 
 
 
Outstanding at September 30, 2014
407,390

 
$
10.64

 
5.3
 
$
806

Exercisable at September 30, 2014
179,078

 
$
8.54

 
4.4
 
$
590


As of September 30, 2014, total unrecognized stock based compensation expense related to non-vested SSARs was $1.1 million, which is expected to be recognized over a weighted-average vesting period of 2.0 years.

A total of 5,463 shares, net of 1,446 shares withheld to cover the employee’s minimum applicable income taxes, were issued from treasury shares to settle SSARs exercised during the six months ended September 30, 2014. The shares withheld were returned to treasury shares.

Restricted Shares

We granted shares to certain of our Directors, executives and key employees under the 2011 Plan, the vesting of which is service-based. The following table summarizes the activity during the six months ended September 30, 2014 for restricted shares awarded under the 2011 Plan:
 
Number
of Shares
 
Weighted-
Average
Grant-
Date Fair
Value
 
 
 
(per share)
Outstanding at April 1, 2014
139,501

 
$
10.72

Granted
344,443

 
13.90
Vested
(16,840
)
 
8.64

Forfeited
(13,876
)
 
13.15

Outstanding at September 30, 2014
453,228

 
$
13.13


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, 2014, total unrecognized stock based compensation expense related to non-vested restricted stock was $4.8 million, which is expected to be recognized over a weighted-average vesting period of 2.4 years.


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Table of Contents

Performance Shares

The following table summarizes the activity during the six months ended September 30, 2014 for performance shares awarded under the 2011 Plan:
 
Number
of
Shares
 
Weighted-
Average
Grant-
Date Fair
Value
 
 
 
(per share)
Outstanding at April 1, 2014
17,728

 
$
8.64

Granted

 

Outstanding at September 30, 2014
17,728

 
$
8.64


The weighted-average grant date fair value of the performance shares is determined based upon the closing price of our common shares on the grant date and assumed that performance goals would be met at target. As of September 30, 2014, total unrecognized stock based compensation expense related to non-vested performance shares was $0.1 million, which is expected to be recognized over a weighted-average vesting period of 0.3 years.


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Table of Contents

12. 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, 2014 and 2013.

Our cash equivalents consist of highly liquid investments with original maturity dates of three months or less and can include certificates of deposit, commercial paper, treasury bills, money market funds and other investments. The fair value of our marketable securities, comprised of commercial paper, corporate bonds and certificates of deposit, was determined using a market approach, based on prices and other relevant information generated by market transactions involving similar assets, and therefore, is classified within Level 2 of the fair value hierarchy. Our marketable securities consist of investments with original maturity dates of 90 to 365 days and are classified as available for sale.

The following data summarizes our cash equivalents and marketable securities:
 
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cash
 
Marketable
(In thousands)
cost basis
 
gains
 
losses
 
value
 
equivalents
 
securities
Level 2:
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
$
2,999

 
$

 
$

 
$
2,999

 
$
2,999

 
$

Certificates of deposit
5,006

 

 

 
5,006

 

 
5,006

Corporate bonds
5,076

 

 
5

 
5,071

 

 
5,071

Total
$
13,081

 
$

 
$
5

 
$
13,076

 
$
2,999

 
$
10,077

 
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cash
 
Marketable
(In thousands)
cost basis
 
gains
 
losses
 
value
 
equivalents
 
securities
Level 2:
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
$
19,993

 
$

 
$

 
$
19,993

 
$
19,993

 
$

Certificates of deposit
9,006

 

 

 
9,006

 
9,006

 

Total
$
28,999

 
$

 
$

 
$
28,999

 
$
28,999

 
$


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:

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Table of Contents

 
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, 2014
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Corporate-owned life insurance — non-current
$
2,419

 
$

 
$

 
$
2,419

Liabilities:
 
 
 
 
 
 
 
Contingent consideration — current
$
180

 
$

 
$

 
$
180

Contingent consideration — non-current
1,557

 

 

 
1,557


 
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, 2014
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Corporate-owned life insurance — current
$
1,989

 
$

 
$

 
$
1,989

Corporate-owned life insurance — non-current
2,371

 

 

 
2,371

Liabilities:
 
 
 
 
 
 
 
Contingent consideration — current
$
127

 
$

 
$

 
$
127

Contingent consideration — non-current
1,612

 

 

 
1,612


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

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.

The following table presents a summary of changes in the fair value of the Level 3 assets:
 
Six months ended
 
September 30,
(In thousands)
2014
 
2013
Corporate-owned life insurance:
 
 
 
Balance on April 1
$
4,360

 
$
3,673

Unrealized gain relating to instruments held at reporting date
28

 
30

Purchases, sales, issuances and settlements, net
20

 

Proceeds from corporate-owned life insurance policy
(1,989
)
 

Balance on September 30
$
2,419

 
$
3,703



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Table of Contents

The following tables present a summary of changes in the fair value of the Level 3 liabilities:
Level 3 assets and liabilities
Six months ended September 30, 2014
(In thousands)
Contingent consideration
Balance at April 1, 2014
$
1,739

Foreign currency translation adjustments

Amortization

Provisions

Purchases

Activity, payments and other charges (net)
(2
)
Balance at September 30, 2014
$
1,737


Level 3 assets and liabilities
Six months ended September 30, 2013
(In thousands)
Contingent consideration
Balance at April 1, 2013
$

Foreign currency translation adjustments

Amortization

Provisions

Purchases

Activity, payments and other charges (net)
1,800

Balance at September 30, 2013
$
1,800





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Table of Contents

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

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

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

The MD&A analyzes changes in specific line items in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows and provides information that management believes is important to assessing and understanding our consolidated financial condition and results of operations. This Quarterly Report on Form 10-Q updates information included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014, 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, 2014. 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 37 of this Quarterly Report and Item 1A “Risk Factors” in Part I of our Annual Report for the fiscal year ended March 31, 2014 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 developer and marketer of proprietary enterprise software, services and solutions to the hospitality industry. We specialize in market-leading point-of-sale (POS), property management, inventory and procurement, workforce management, analytics, document management and mobile and wireless solutions that are designed to streamline operations, improve efficiency and enhance the 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, Georgia, and offices in Singapore, Hong Kong and Malaysia.

The primary objective of our ongoing strategic planning process is to create shareholder value by targeting accretive growth opportunities, by strengthening our competitive position within the highest value technology solutions we provide to the technology differentiated end markets 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.

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Table of Contents

Our strategic plan specifically focuses on:

Transforming the guest experience by improving quality of service through technology.
Enabling lasting connections with our customers and our customers with their guests through the entire guest lifecycle.
Enabling lasting connections with our customers and our team through differentiated customer service and customer driven development.
Industry led innovation, capitalizing on our intellectual property and emerging technology trends.


Revenue - Defined

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

Revenue - We present revenue net of sales returns and allowances.

Products revenue - Revenue earned from the sales of hardware equipment and proprietary and remarketed software.

Support, maintenance and subscription services revenue - Revenue earned from the sale of proprietary and remarketed ongoing support, maintenance and subscription or hosting services.

Professional services revenue - Revenue earned from the delivery of implementation, integration and installation services for proprietary and remarketed products.

Matters Affecting Comparability

On July 1, 2013, we completed the sale of RSG to Kyrus Solutions, Inc., an affiliate of Clearlake Capital Group, L.P. For financial reporting purposes, RSG’s operating results for fiscal 2014 through the completion of the sale were classified within discontinued operations.

On March 31, 2014, we completed the sale of our UK entity to Verteda Limited, a U.K. based company. For financial reporting purposes, the UK entity operating results for all periods presented were classified within discontinued operations.

Accordingly, the discussion and analysis presented below, reflects the continuing business of Agilysys.


24

Table of Contents

Results of Operations

Second Fiscal Quarter 2015 Compared to Second Fiscal Quarter 2014

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for continuing operations for the three months ended September 30, 2014 and 2013:
 
Three months ended
 
 
 
 
 
September 30,
 
  Increase (decrease)
(Dollars in thousands)
2014
 
2013
 
$
 
%
Net revenue:
 
 
 
 
 
 
 
Products
$
7,649

 
$
8,585

 
$
(936
)
 
(10.9
)%
Support, maintenance and subscription services
13,775

 
12,881

 
894

 
6.9
 %
Professional services
4,894

 
3,380

 
1,514

 
44.8
 %
Total net revenue
26,318

 
24,846

 
1,472

 
5.9
 %
Cost of goods sold:
 
 
 
 
 
 
 
Products
3,502

 
3,285

 
217

 
6.6
 %
Support, maintenance and subscription services
2,961

 
2,578

 
383

 
14.9
 %
Professional services
3,186

 
2,395

 
791

 
33.0
 %
Total net cost of goods sold
9,649

 
8,258

 
1,391

 
16.8
 %
Gross profit
16,669

 
16,588

 
81

 
0.5
 %
Gross profit margin
63.3
 %
 
66.8
 %
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Product development
6,191

 
6,714

 
(523
)
 
(7.8
)%
Sales and marketing
3,825

 
4,068

 
(243
)
 
(6.0
)%
General and administrative
6,079

 
5,065

 
1,014

 
20.0
 %
Depreciation of fixed assets
532

 
513

 
19

 
3.7
 %
Amortization of intangibles
594

 
794

 
(200
)
 
(25.2
)%
Asset impairments and related charges

 
18

 
(18
)
 
nm

Restructuring, severance and other charges
448

 
562

 
(114
)
 
nm

Legal settlements
54

 

 
54

 
nm

Operating loss
$
(1,054
)
 
$
(1,146
)
 
$
92

 
nm

Operating loss percentage
(4.0
)%
 
(4.6
)%
 
 
 
 

nm - not meaningful


25

Table of Contents


The following table presents the percentage relationship of our Condensed Consolidated Statement of Operations line items to our consolidated net revenues for the periods presented:
 
Three months ended
 
September 30,
 
2014
 
2013
Net revenue:
 
 
 
Products
29.1
 %
 
34.6
 %
Support, maintenance and subscription services
52.3

 
51.8

Professional services
18.6

 
13.6

Total
100.0

 
100.0

Cost of goods sold:
 
 
 
Products
13.3

 
13.2

Support, maintenance and subscription services
11.3

 
10.4

Professional services
12.1

 
9.6

Total
36.7

 
33.2

Gross profit
63.3

 
66.8

Operating expenses:
 
 
 
Product development
23.5

 
27.0

Sales and marketing
14.5

 
16.4

General and administrative
23.1

 
20.4

Depreciation of fixed assets
2.0

 
2.1

Amortization of intangibles
2.3

 
3.2

Asset impairments and related charges

 
0.1

Restructuring, severance and other charges
1.7

 
2.3

Legal settlements
0.2

 

Operating (loss) income
(4.0
)%
 
(4.6
)%

Net revenue.  Total net revenue increased 5.9% during the second quarter of fiscal 2015 compared to the second quarter of fiscal 2014. Products revenue decreased $0.9 million, or 10.9%, primarily as a result of a reduction in product sales in the second quarter of fiscal 2015 due to the continued ramp up time associated with our planned transition within our sales force and our strategic initiatives to drive more recurring revenue. Support, maintenance and subscription services revenue increased $0.9 million, or 6.9%, as a result of continued focus on selling subscription based hosting revenue which saw a 13.5% increase over the same period a year ago, and ongoing support from our growing proprietary product sales. Professional services revenue increased $1.5 million or 44.8% due to timing of customer installations including two large services projects with significant effort in the second quarter of fiscal 2015 that resulted in approximately $1.0 million of revenue.

Gross profit and gross profit margin.  Our total gross profit increased $0.1 million, or 0.5%, for the second quarter of fiscal 2015 and total gross profit margin decreased 350 basis points to 63.3%. Products gross profit decreased $1.2 million and gross profit margin decreased 750 basis points to 54.2% mainly as a result of lower sales of higher margin proprietary software sales in the second quarter of fiscal 2015 as compared to the second quarter of fiscal 2014. Also impacting gross profit margin was $0.3 million of incremental amortization expense of software products that were recently placed into service. Support, maintenance and subscription services gross profit increased $0.5 million while gross margin decreased 150 basis points to 78.5% due to a change in the mix of labor resources needed for maintenance of our products. Professional services gross margin increased $0.7 million and gross profit margin increased 580 basis points to 34.9% as a result of more efficient use of labor required to meet the needs of timing of customer installations, including the two large service projects mentioned above.


26

Table of Contents

Operating expenses

Operating expenses, excluding the charges for legal settlements and restructuring, severance and other charges, increased $0.1 million, or 0.3%, in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014.
  
Product development.  Product development includes all expenses associated with research and development. Product development decreased $0.5 million, or 7.8% in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014. Although we have increased our gross investment in the product development team, a larger percentage of that team's time is being used for development of our future generation products and are being capitalized than in the prior year. These research and development costs are capitalized as software development costs for future use. We capitalized approximately $3.9 million and $2.9 million during the three months ended September 30, 2014 and 2013, respectively. In addition, we saw increased efforts in the second quarter of fiscal 2015 for customer specific engagements which resulted in certain headcount costs being included in cost of goods sold, which also contributed to the lower product development expense in the period.

Sales and marketing.  Sales and marketing decreased $0.2 million, or 6.0%, in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014. The decrease is due mainly to the timing of our sales and marketing reorganization as we continue to try to better align and ramp our sales force to better serve our customers and our longer term strategy.

General and administrative.  General and administrative increased $1.0 million, or 20.0%, in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 as a result of increased cost surrounding the ongoing effort to streamline and rationalize our back-office processes, including the cost of resources involved in an enterprise resource planning system (ERP) replacement project.

Depreciation of fixed assets.  Depreciation of fixed assets increased less than $0.1 million, or 3.7%, in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 due to the timing of asset acquisitions.

Amortization of intangibles.  Amortization of intangibles decreased $0.2 million or 25.2% in the second quarter of fiscal 2015 compared with the second quarter of fiscal 2014 partially due to reduced expense related to our previous ERP system which was fully amortized by the start of the second quarter of fiscal 2015 once replaced.

Restructuring, severance and other charges. In the second quarter of fiscal 2015, we implemented restructuring actions to better align product development, sales and marketing and general and administrative functions and to reduce operating costs and recorded $0.2 million in restructuring charges related to the fiscal 2015 restructuring activity, comprised of severance and other employee related benefits.

In the second quarter of fiscal 2014, we announced restructuring actions to better align corporate functions and to reduce operating costs, following the sale of RSG. In addition, in the fourth quarter we initiated a restructuring plan to maximize sales effectiveness and more closely align sales and marketing efforts for targeted vertical growth, new product launches, and marketing alliances, and to shift development resources to the next generation products. To date, we have recorded $1.6 million in restructuring charges related to the fiscal 2014 restructuring activity, of which $1.2 million was recorded in fiscal 2014. We recorded approximately $0.4 million in restructuring charges during the first quarter of fiscal 2015, comprised of severance and other employee related benefits.

As of September 30, 2014, we had a remaining liability of approximately $0.2 million recorded for the fiscal 2015 restructuring activity and $0.1 million recorded for the fiscal 2014 restructuring activity. We do not anticipate any significant additional restructuring charges related to these actions. Our restructuring actions are discussed further in Note 5, Restructuring Charges.

Legal settlements. During the second quarter of fiscal 2015, we recorded $0.1 million in legal settlements to finalize legal settlements originally estimated and recorded in the first quarter of fiscal 2015.


27

Table of Contents

Other (Income) Expenses
 
Three months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2014
 
2013
 
$
 
%
Other (income) expenses:
 
 
 
 
 
 
 
Interest income
$
(21
)
 
$
(20
)
 
$
1

 
5.0
%
Interest expense
14

 
45

 
31

 
68.9
%
Other (income) expense, net
(1
)
 
39

 
40

 
102.6
%
Total other expense (income), net
$
(8
)
 
$
64

 
$
72

 
112.5
%

Interest income. Interest income consists of interest earned on investments in certificates of deposit, commercial paper and corporate bonds.

Interest expense. Interest expense consists of costs associated with capital leases and loans on corporate-owned life insurance policies. Interest expense decreased in the second quarter of fiscal 2015 compared to the second quarter of fiscal 2014 due to non-renewal of certain capital leases.

Income Taxes
 
Three months ended
 
 
 
 
 
September 30,
 
(Unfavorable) favorable
(Dollars in thousands)
2014
 
2013
 
$
 
%
Income tax expense
$
81

 
$
100

 
$
19

 
nm
Effective tax rate
(7.7
)%
 
(8.3
)%
 
 
 
 

nm - not meaningful
For the second quarter of fiscal 2015, the effective tax rate was different than the statutory rate due primarily to the decrease in unrecognized tax benefits attributable to the expiration of statute of limitations, recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, and other U.S. permanent book to tax differences.
For the second quarter of fiscal 2014, the effective tax rate was different than the statutory rate due primarily to the intra-period tax allocation rules associated with the discontinued operations. Other items affecting the rate include decrease in unrecognized tax benefits attributable to the expiration of statute of limitations, recognition of net operating losses as deferred tax assets, which were offset by increases in the valuation allowance, and other U.S. permanent book to tax differences.
Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of zero to $0.1 million of tax and zero to $0.1 million of interest based on the outcome of tax examinations and as a result of the expiration of various statutes of limitations. We are routinely audited; due to the ongoing nature of current examinations in multiple jurisdictions, other changes could occur in the amount of gross unrecognized tax benefits during the next 12 months which cannot be estimated at this time.
We have recorded a valuation allowance offsetting substantially all of our deferred tax assets. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences are deductible. Because of our losses in prior periods, management believes that it is more-likely-than-not that we will not realize the benefits of these deductible differences.





28

Table of Contents

First Half Fiscal 2015 Compared to First Half Fiscal 2014

Net Revenue and Operating Loss

The following table presents our consolidated revenue and operating results for continuing operations for the six months ended September 30, 2014 and 2013:
 
Six months ended
 
 
 
 
 
September 30,
 
  Increase (decrease)
(Dollars in thousands)
2014
 
2013
 
$
 
%
Net revenue:
 
 
 
 
 
 
 
Products
$
13,701

 
$
16,091

 
$
(2,390
)
 
(14.9
)%
Support, maintenance and subscription services
27,594

 
25,755

 
1,839

 
7.1
 %
Professional services
8,769

 
6,700

 
2,069

 
30.9
 %
Total net revenue
50,064

 
48,546

 
1,518

 
3.1
 %
Cost of goods sold:
 
 
 
 
 
 
 
Products
7,001

 
6,908

 
93

 
1.3
 %
Support, maintenance and subscription services
6,091

 
4,847

 
1,244

 
25.7
 %
Professional services</