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Edited Transcript of AGYS earnings conference call or presentation 1-Aug-18 8:30pm GMT

Q1 2019 Agilysys Inc Earnings Call

Solon Aug 24, 2018 (Thomson StreetEvents) -- Edited Transcript of Agilysys Inc earnings conference call or presentation Wednesday, August 1, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Pritchett

Agilysys, Inc. - VP & CFO

* Norberto Aja

Agilysys, Inc. - IR

* Ramesh Srinivasan

Agilysys, Inc. - CEO, President & Director

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Conference Call Participants

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* Allen Robert Klee

Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst

* Frederick Tucker Golden

Solas Capital Management, LLC - Managing Partner and Portfolio Manager

* Phil Bernard

Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Agilysys Fiscal Year 2019 First Quarter Conference Call. (Operator Instructions) As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Norberto Aja, Investor Relations. Please go ahead.

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Norberto Aja, Agilysys, Inc. - IR [2]

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Thank you, Jonathan, and good afternoon, everyone. Thank you for joining the Agilysys Fiscal 2019 First Quarter Conference Call. We will get started in just a minute with management's comments. But before doing so, let me read the safe harbor language. Today's conference contains forward-looking statements within the meaning of the safe harbor provision 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, believe, estimate, expect, future, likely, may, should, will and other similar references to future periods. Examples of forward-looking statements include, among others, our guidance related to revenue, adjusted earnings from operations and cash and cash equivalent balance and statements we make regarding continuing sales momentum, our ability to achieve revenue and profitability growth, greater innovation, product development velocity and improvements in the financial results and shareholder value.

Forward-looking statements are either historical facts nor assurance of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements.

Important factors that could cause our actual results and financial conditions to differ materially from those indicated in the forward-looking statements today include, among others, our ability to achieve operational efficiencies and meet customer demand for products and solutions and the risks described in today's news announcement and in the company's filings with the Securities and Exchange Commission, including the company's reports on Form 10-K and Form 10-Q. Any forward-looking statement made by us in today's conference call is based solely on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statements that may be made from time-to-time, whether as a result of new information, future developments or otherwise.

Today's call and webcast will include non-GAAP financial measures within the meaning of the SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measures, calculated and presented in accordance with GAAP, can be found in today's press release as well as on the company's website.

With that, I'd now like to turn the call over to Mr. Ramesh Srinivasan, President and Chief Executive Officer of Agilysys. Ramesh, please go ahead.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [3]

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Thank you, Norberto. Good afternoon, and good evening, everyone. Thank you for joining us on the call today to review our fiscal 2019 first quarter results, some analysis of our recent past, our future outlook and expectations. Joining me on the call today is Tony Pritchett, our Chief Financial Officer.

To begin with a quick review of our financial results. Revenue was a record $34 million, a slight increase of $0.1 million compared to last fiscal year's first quarter, leading to a GAAP net loss of $1.7 million or a loss of $0.08 per share comparing favorably to a loss of $3 million or $0.13 per share in Q1 of fiscal 2018. Revenue this quarter was driven by a marked increase in recurring revenue, which rose about 7.6% to $17.9 million, that is $17.9 million, including a 19% increase in SaaS-based subscription revenue. Recurring revenue accounted for about 53% of total net revenue this quarter, increasing from approximately 49% of total net revenue for the same period in fiscal 2018.

With the predictable and repeatable services revenue, again, accounting for slightly more than 20% of total net revenue, close to 3/4 of our revenue remains easy to forecast. The increase in recurring revenue also helped improve the gross margin level from 49.2% in the prior year period to 52.6% this quarter. We expect to sustain the recurring revenue increases in the future as well. Our customer retention rates continue to improve. Given the growing preference of our customers for SaaS-based installs, we also expect SaaS-based subscription revenue to grow significantly faster than the overall recurring revenue growth rate.

We would suggest not reading too much significance into the fact, that we have now had 2 first quarters, in fiscal 2018 and in fiscal 2019, meaning 2 consecutive June ending quarters, where revenue have been at record levels. This is more of a coincidence than an indication of any significant seasonality in our top line.

While our cash flows tend to be seasonal, with the second half of each fiscal year being more favorable to us in terms of working capital-related cash flow fluctuation, we don't see any such seasonality with respect to top line revenue. Whatever good or not so good revenue levels we have seen in the past quarters, they are only indicative of performance in that particular quarter and are not due to any significant seasonality inherent in the business.

However, what will be important to take note of is the fact that this is our third consecutive sequential revenue growth quarter, which is reflective of our increasing business momentum, our increased R&D capacity, improved product development and innovation velocity, exponentially greater customer service and support levels and greater focus on all regions we are doing business in are all contributing towards much better business momentum, which has helped grow our revenue levels for 3 sequential quarters in a row.

Adjusted EBITDA improved by about $1.5 million compared to Q1 of last fiscal year. Adjusted EBITDA has been about $3.1 million each for 2 consecutive quarters now. Our highest level since we transformed into a pure-play hospitality software solutions technology provider in fiscal 2014.

The first quarter of fiscal 2019 also marked our second conservative quarter of positive adjusted earnings from operations, the only 2 such positive quarters since before fiscal 2014.

This is a goal we set out to achieve from the early days of my joining Agilysys in January 2017. We're pleased to see our efforts to improve profitability, for which adjusted earnings from operation or AOE is the metric we focus on, are beginning to show results. AOE for Q1 fiscal 2019 was about a $3.7 million improvement over Q1 of fiscal 2018. As a reminder, AOE is essentially adjusted EBITDA minus capital spend, or stated differently, a measure of our overall revenue minus overall expenses, whether they're capitalized or not, minus capital expenditure and is a comprehensive measure of our business operations performance.

Aside from certain exceptional onetime cash expenditures, such as payments for restructuring or legal settlements, AOE is also a good proxy of free cash flow over a full fiscal year period.

While on the subject of capital expenditure, please note that Q1 fiscal 2019 will be the last quarter where we have capitalized a portion of our R&D efforts. Our approach to product development has changed substantially in the recent past. Our product development strategies are a lot more agile now in the true sense of that term. We have dramatically reduced the time lapse between design of a module and its deployment in the field. This has negated any significant need to capitalize our R&D cost going forward.

Barring any special exceptions, we don't expect to capitalize any significant portion of our R&D cost going forward. This will make comparisons with the past difficult with respect to our adjusted EBITDA, GAAP profitability metrics and our product development expense on our P&L as R&D cost included in the future calculations will not have the benefit of any capitalization-related exclusions.

Our various cost categories measured as a percentage of revenue have remained steady to lower over the past few quarters even as we continue to invest where we need to facilitate growth. This is especially true in R&D. Our R&D costs as a percentage of revenue have remained steady even as we have doubled our R&D capacity during the past year. Our India Development Center now has about has 310 personnel employed directly with us, all brought onboard with as strict as possible recruitment practices.

We are at near full capacity in the India Development Center now. Our IDC personnel continue to improve exponentially with every passing month with respect to their product expertise and contributions.

The doubling of R&D capacity during the past year has helped us increase product development and innovation velocity by leaps and bounds. A few examples of the progress we have made with our products during the recent past would include: One, about 10 months ago, towards the end of calendar 2017, a few customers suggested to us to develop our own online booking engine that integrates seamlessly with our property management system products. We completed development of rGuest Book, the online booking engine, in a matter of months and one of our customers actually implemented this module in production and took their first live reservation over 2 months ago.

There are multiple other customers going live on this module soon. Such software-based modules, obviously, contribute well to both our top line revenue and bottom line profitability growth. We have now greatly reduced the cost and the time it takes for us to take such software modules from design to development to fail to implementation. Two, we have recently launched rGuest Express, a new guest self-service kiosk solution for hotels. Both rGuest Book and rGuest Express will be tightly integrated with all our property management system products.

Example number 3, a new version of LMS, the property management system that many major hotels currently use, was released recently. This new version contains several new enhancements, including a modern web-based user interface.

Example 4, additional mobile capabilities have been added to both our property management system and point-of-sale products that provide key features to improve guest experience, including enabling guests to check in and check out online, features that help improve staff productivity with mobile housekeeping and tablet-based solutions for use in various remote areas within a resort.

Five, we recently released a new significantly enhanced version of our flagship InfoGenesis POS product. This new version includes an all new look and feel to the POS terminal application, providing more modern user interface themes with enhanced style and branding opportunities for our customers. This version also employs the latest Microsoft technology features, allowing customers to create more meaningful guest experiences.

In addition, we introduced a robust fiscal integration network -- integration framework that will enable a wider global reach for the product. We are continuing to see benefits from increased sell-through and customer adoption of our 2 point-of-sale products, InfoGenesis, which provides staff-oriented POS functions and reporting and rGuest Buy, our guest-facing kiosk POS solution. These 2 products complement each other well. Together, they provide a market-leading comprehensive POS solution.

InfoGenesis continues to differentiate itself in the marketplace through its strong reporting and analysis features, enterprise-grade menu and item configuration capabilities as well as multilanguage support. rGuest Buy, which leverages InfoGenesis' robust transaction engine is already installed in over 100 locations and continues to open up near and long-term sales opportunities for us.

Recently, rGuest Buy made its entry into the casino gaming market with a couple of recent casino openings featuring the product to provide self-service capability to their guests. Customers are also increasingly valuing rGuest Pay's complete and secure payment gateway services. rGuest Pay provides access to validated point-to-point encryption, includes a payment information proxy that secures data arriving via e-commerce interfaces and a full range of fixed and mobile EMV-ready payment devices, which facilitate compliance with payment card security regulations.

rGuest Stay, the property management system product built ground up to be a cloud SaaS-based cutting edge technology solution is beginning to see increased acceptance in limited services hotels. We continue to increase the speed at which we are adding various functionality features to this product to address the needs of middle market and full-service hotels. rGuest Stay is currently live in over 100 properties.

With Don DeMarinis and Heather Foster, both of whom joined us earlier this calendar year, with Don and Heather leading the charge, our go-to-market strategy definition and execution continues to improve. Good product development and innovation momentum backed with greatly improved sales and marketing processes have resulted in increased sales momentum.

We are also encouraged by our Q1 results across several operational metrics, including another quarter of net positive competitive replacement, increase in sales of additional products to existing customers, growth in sales with large strategic accounts and some initial success in developing our international sales efforts. All of which will help drive revenue growth in fiscal 2019 and beyond.

Regarding our international efforts, we recently initiated a search for a new head of Asia and have identified several good candidates who are keen to join us. We expect to fill this position during the next couple of months.

Our Q1 results included many new customer wins, including the Ellis Island Hotel, Casino & Brewery in Las Vegas, who chose InfoGenesis and rGuest Pay; Silver Reef Casino, Hotel and Spa in Ferndale, Washington, who chose Visual One, InfoGenesis and Eatec; the Rosewood Mayakoba Resort in Mexico, who chose a suite of Agilysys solutions to replace a competitor set of products; and Hotel Interurban in Seattle, who selected Visual One and rGuest Pay.

Our management team is settled and working well now. Collectively, we are driving positive culture and work ethic changes, which are beginning to show in our hotels. We are now dramatically more passionate with our customer centricity. We are a lot more engineering and innovation driven. We also care a lot more seriously about supporting all the markets we play in.

In summary, we are off to a solid start in fiscal 2019. We remain confident in our strategy and direction. We're beginning to see good early results from our transformation process. We have unique and industry-leading product offerings that we continue to enhance and expand so that we can evolve successfully along with our customer demands. We're now finding a good rhythm working internally as a unified and cohesive team across all organizational areas and all geographies.

And most important of all, we are winning back the trust of our customers.

As stated in our earnings call last quarter, we continue to expect to achieve approximately 10% full year top line revenue growth in fiscal 2019, compared to the fiscal 2018 revenue level of approximately $127 million. In addition, we continue to expect our improving operational efficiencies will help us improve our full year adjusted earnings from operations by around $6 million for the full year fiscal 2019, compared to fiscal 2018 where our AOE loss was approximately $6 million, meaning we expect to be close to at or slightly above breakeven adjusted earnings from operations for full fiscal 2019.

Due to the negative working capital cash flow fluctuation that is typical of the first half of every fiscal year, our cash balance went down by close to $5 million in Q1 as forecasted. We expect a similar slightly lesser decrease in cash balance in Q2 as well. We expect Q3 and Q4 of this fiscal year to be positive cash flow quarters for us, bringing our cash balance back to the current level or higher at the end of fiscal 2019.

With that, I will now turn the call over to our CFO, Tony Pritchett, to provide more color on our financial results. Tony?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [4]

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Thank you, Ramesh. Our fiscal 2019 start provides evidence of the significant progress we are achieving across many key financial priorities, including lowering our overall cost as a percentage of revenue, growing our recurring revenue base and positioning the company for further growth. Our overall revenue grew by $0.1 million in the first quarter of fiscal 2019 to $34 million compared to $33.9 million in the prior year period, marking our highest revenue since we transformed our business into a pure-play hospitality software solutions technology provider in fiscal 2014.

First quarter revenue also marked the third consecutive sequential rise in overall revenue, growing from $32.1 million in Q4 of fiscal 2018. Importantly, as we mentioned in our earnings release, the adoption of the new revenue recognition standard had a very minimal impact on our overall revenue.

Under the old revenue recognition method, our current quarter revenue would have been about $50,000 higher. Please note that in accordance with the modified retrospective method of adopting the new revenue recognition standards, our March 31 balance sheet has not been restated to reflect the new guidance. Therefore, accounts receivable, prepaid expenses, other noncurrent assets, contract assets and contract liabilities are not directly comparable on the face of the balance sheet.

Please refer to the full disclosure in the notes to our consolidated financials in our 10-Q, which will be filed later this week for more disclosure to help the comparison.

Moving to installed endpoints, by the end of Q1, we serviced about 264,000 rooms in approximately 48,000 terminal endpoints, or a 6% and 18% increase, respectively compared to Q1 of last year. And total revenue related to our rGuest platform comprised approximately 8% of total fiscal 2019 first quarter revenue.

Product revenue decreased 11.7% to $9.1 million on the back of significant hardware shipments in the same period last year. However, when compared to the average product revenue for the trailing 4 quarters of $8.4 million and the prior quarter's product revenue of $7.9 million, the results for fiscal 2019 Q1 reflect growth of 8% and 14%, respectively.

Looking at the support maintenance and subscription services line item, our recurring revenue rose 7.6% to $17.9 million compared to the prior year period. Keep in mind that our fiscal 2019 first quarter revenue for this line item was reduced with the adoption of the new revenue standards compared to prior quarters as presented by about $250,000, meaning using comparable numbers, the growth will be even stronger.

We are pleased that the recurring revenue increase included a 19% increase in SaaS-based subscription revenue. Recurring revenue now represents 53% of total revenue with SaaS-based subscription revenue representing approximately 32% of recurring revenues, marking steady growth compared to 29% in Q1 of last year. Professional services revenue was up 1.2% to $7 million compared to the prior year period even with the $170,000 headwind from the adoption of the new revenue rules.

Going forward, we expect sales momentum to continue in fiscal '19 leading the top line revenue growth, while SaaS revenue will continue to outpace the rate of total recurring revenue growth.

While the overall fiscal 2019 first quarter revenue was only slightly up compared to fiscal 2018 first quarter, we continue to achieve a much higher quality revenue mix that provided us with higher margins given the added contribution from SaaS subscription and other recurring revenue.

Recurring revenue grew by $1.2 million and recurring margin grew by $1.2 million, reflecting the scalable nature of our infrastructure to host and support our customer installed base going forward.

Moving down the income statement, cost of goods sold decreased by 6.3% or $1.1 million in the first quarter to $16.1 million versus the prior year period, mainly as a result of a lower mix of third-party products and the success we've had with the realignment of our professional services teams to support more revenue on a lower cost basis.

This overall decrease in cost of goods sold on our slight increase in revenue, including lower professional services costs on similar revenue and flat recurring revenue costs on meaningful revenue growth reflects the success we are having with our cost initiatives.

The revenue mix and reduction in cost of goods sold led to improvement in gross profit margin, which rose nearly 340 basis points to 52.6% from 49.2% in the prior year period. Taking a closer look, products' gross profit decreased $0.7 million with gross profit margin decreasing to 21.5%, primarily as a result of lower sales and higher amortization of developed technology.

Support, maintenance and subscription services gross profit increased $1.2 million leading to a total gross margin of 77.3% compared to 75.8% in Q1 of fiscal 2018, reflecting the positive impact of the operational changes we have implemented.

Professional services gross profit increased by $0.7 million with gross profit margin increasing to 29.8% compared to 19.9% in Q1 of fiscal 2018.

Looking at operating expenses, excluding the charges for legal settlements and restructuring severance and other charges, the first quarter saw a 3.3% decrease in operating expenses to $19 million compared to $19.7 million in the prior year period.

Product development expenses increased by $0.5 million or 7% compared to fiscal Q1 of last year, while doubling the size of our R&D teams over the same period of time.

However, we did realize the benefit of about $500,000 related to stock compensation expense reversals in Q1 of fiscal 2019.

Also, as Ramesh pointed out, we will no longer be capitalizing software development costs. As some of you may remember, these costs largely reflect the investments made in our rGuest platform over the past few years. Starting with the fiscal second quarter, we will report these costs in our income statement as product development expense rather than in our cash flow statement and balance sheet as capitalized software development cost.

The change in accounting treatment is dictated by our newly implemented development practices being much more nimble and faster to bring products to market. We expect this change hitting the P&L, along with normalized stock comp expense level starting next quarter and a full quarter of the IDC being fully ramped, we'll increase product development expense by around $3 million. However, when you see this increase, remember that our total spend on product development, including OpEx and CapEx will be comparable to recent quarters as a percentage of revenue, still lower than Q3 and Q4 of fiscal '17 when we began the effort to double our R&D strength.

Starting next quarter, when this begins to impact our GAAP P&L, we will provide disclosure to help reconcile quarterly expense trends. Sales and marketing expenses decreased $0.4 million or 7.3% compared to fiscal Q1 of last year, while general and administrative expenses decreased $0.8 million or 11.7% compared to fiscal Q1 of last year as we continue to focus on more efficient and cost-effective ways to operate.

As was the case in the prior quarter, our overall expense level as a percentage of revenue was lower in Q1 fiscal 2019, compared to the same period last year, and our expectation remains that we will grow revenue at a faster rate than cost increases as we leverage the operating scale of the business.

Our operating loss of $1.6 million for the first quarter favorably compares to an operating loss of $3 million for the first quarter of fiscal 2018.

This led to a net loss of $1.7 million for the first quarter, also favorably comparing to a net loss of $3 million for the first quarter of fiscal 2018.

Adjusted EBITDA was a gain of approximately $3.1 million in the first quarter, almost double the $1.6 million gain in the first quarter of fiscal 2018. As Ramesh highlighted, we achieved our second quarter -- our second consecutive quarter of positive AOE as this metric rose more than $3.7 million year-over-year.

Ongoing improvement in AOE clearly demonstrates that the various strategic initiatives we have been working on for the past year or so are positioning Agilysys well for sustainable and consistent profitable growth.

Moving to the balance sheet and cash flow statement, cash and marketable securities as of June 30, 2018, was $35.1 million compared to $39.9 million at March 31, 2018. The decrease in cash reflects approximately $2.9 million in spend for our ongoing product development investments and investments in our internal assets as well as a normal cash outflow from operations that we experience in the first fiscal quarter due to the timing of when we bill and collect annual maintenance and pay bonuses.

And in terms of our NOLs, we continue to carry approximately $200 million of NOL carryforwards with a full valuation allowance on our book that will help us remain liable for taxes paid only in certain foreign jurisdictions, along with minimal state taxes for the foreseeable future.

Our current NOLs expire between fiscal years 2031 and 2038. As a reminder, the tax law in place stipulates that all preexisting NOLs prior to our fiscal 2019 can be utilized at 100% and are not subject to the 80% limit that any future created NOLs will be subject to.

Going forward, we expect cash to come down some from our current balance before rising again to end fiscal 2019 at $35 million to $37 million, a decline of approximately $3 million to $5 million from the fiscal 2018 year-end balance of $39.9 million. This will mark a meaningful improvement from the over $9 million decline in fiscal 2018 and much higher rates of cash burn in years prior to that, providing us with healthy financial flexibility to achieve our near and long-term goals.

Regarding guidance, we have reiterated our previously provided forecast for fiscal 2019 full year revenue growth of approximately 10% compared to $127 million in revenue during fiscal 2018, and we expect to realize an improvement of about $6 million in adjusted earnings from operations in fiscal 2019, compared to fiscal 2018.

In closing, we are pleased with the solid start to the year and with the progress toward meeting our fiscal 2019 and beyond financial goals as we increase the visibility and sustainability of our sales momentum and remain on track to achieve our guidance for full year revenue growth of approximately 10% and significant profitability gains.

I would now like to open the call to questions. Jonathan?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Allen Klee from Maxim Group.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [2]

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Congratulations on a great quarter. Question of the change in R&D that the amortization will stop and then this will go into product development expense. How -- what did you say in terms of the -- what the impact will be of that? Were you talking about for a full year or for quarters? When you -- could you maybe just walk through that a little bit?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [3]

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Yes. Allen, so just to clarify, the amortization won't stop. What's going to stop is the capitalization of certain R&D costs. If you look at our current P&L, you'll see that there is capitalized software development costs -- I'm sorry, not the P&L but the cash flow statement, there's capitalized software development costs. Those costs in future quarters won't show up on the cash flow statement like that. They'll actually be included in the P&L in product development expenses.

So our expectation if you look at Q2 of this fiscal year, so next quarter, our expectation is that product development expense will go up by about $3 million compared to Q1, and that should be the ongoing -- roughly the ongoing rate of product development expenses for the next few quarters. But keep in mind that increase in product development expenses really is not comparable to prior quarters. You have to incorporate that capitalized software development cost along with product development expense from the P&L in order to get a full view of product development expense.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [4]

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Okay. But one thing, Allen -- thank you. One thing to keep in mind, this doesn't mean that our R&D expenses is going up, right? In reality, that's not going up, but part of what we spend in R&D today gets capitalized, gets removed out of the GAAP P&L and goes into the balance sheet and that practice stops. We won't be capitalizing any of our R&D costs anymore. But in terms of what we are really spending in R&D, that doesn't change. If anything, it will only go down with time as a percentage of revenue.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [5]

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Okay. How would you -- in terms of the growth coming from your different vertical end markets, would -- is there any way you would kind of rank it in terms of the casinos, the hotels, foodservice. How would we think about that?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [6]

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Yes, Allen. I mean, I don't know about ranking it because our growth opportunities are pretty high in each of those. So let's look at it in 2 ways, Allen. One from a product segmentation perspective. For the next, say, 9 to 12 months, a significant portion of our growth comes from our point of sale products, meaning InfoGenesis and rGuest Buy. InfoGenesis is more of the staff-facing functionality product, and rGuest Buy is more of the guest-facing kiosk-related product. Those 2 products together will be a majority of our growth for the next 9 months or so, and we expect PMS to really become a major product -- property management systems to be a major driver of growth in -- starting FY '20 and beyond. So that's from a product standpoint. So there if you have to rank it, I would rank point-of-sale first and property management system second.

If you move to our market segments, in terms of how you rank, gaming is doing very well for us, right? Gaming, that business continues to grow for us. But I would guess a major portion of our growth would come from HRC, hotel, resorts, cruises and also foodservice management, where the business is really beginning to come back to us. And I expect a major portion of our growth to come from Asia and EMEA as well because our market share is extremely low in those regions. And services -- technical and professional services will also be a significant contributor to our growth.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [7]

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Okay. And what percent -- or how -- what was the international for the quarter and how did that grow year-over-year?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [8]

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Allen, international remains in the high single-digits as a percentage of revenue, not a lot of change in the first quarter compared to the prior year results. We're seeing some significant opportunity there, we're gaining some momentum there. But as far as growth in the first quarter, it wasn't a whole lot different than the prior year.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [9]

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Okay. And then with the rGuest Stay and with the larger hotel chains, it's been a long term -- a lot of time working on these products. And I know you just said fiscal 2020 where you think more traction, but to what degree do you have higher confidence now of the products coming out and the reception?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [10]

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Yes. What used to be long term, Allen, is now short term. So now we are talking in terms of months and quarters. So I do understand what you are saying, that rGuest Stay has been in the development phase for multiple years now. But now since we've added a lot more R&D capacity without increasing the cost too much, things are happening much quicker in Stay. The last quarter, we saw a lot more opportunities for Stay come to us than probably 3, 4 quarters before that combined. So Stay is really beginning to pick up steam, and FY '20 is only like 2, 3 quarters away for us. So it is in the short term, it is a matter of months and quarters now before Stay really starts pulling our growth engine forward.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [11]

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Okay. And any comments just on the sales pipeline today? And how that -- maybe that compares to how it's been over the last couple of quarters?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [12]

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The pipeline is looking healthier now, Allen. The large hotel chain opportunities that were captured, say, about a year or 2 ago, the pipeline from those large hotel chains is a lot more significant than it was before. Our pipeline from international and Asia regions have definitely increased. We are working on several significant size deals now and those significant size deals are more in number now than it used to be in the past. And with our products getting better now, we've added a number of new products just in the last -- just since the last quarter, like couple of quarters ago, we didn't have rGuest Book, we didn't have the rGuest Express kiosk, we didn't have our new product, rGuest Service, the guest tablet ordering, a lot more simplified mobile ordering. We didn't have all those software modules with us. So those software modules are driving their own sets of opportunities that we didn't have before. So we have a lot more software modules selling opportunities now than we have before.

And probably more than anything else, our traction with rGuest Buy has really picked up in the last couple of quarters. So I would say, our pipeline is more than it was in the previous quarters. It is a lot more broad-based. It comes from multiple vertical segments, and it is also more broad-based in terms of the number of software modules that we have in our bag now to sell. So our pipeline is looking a lot healthier than it used to before.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [13]

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Okay, great. And then, you said that the SaaS revenue is expected to grow faster than overall revenue. Is there a way that we can think of the relative margins of the SaaS relative to the company overall? Or perhaps, like an incremental margin? Or how should we think about that?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [14]

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Allen, the SaaS margins are definitely good margins and incremental SaaS revenue comes without much incremental costs. So that's the way to think about it. I mean, as you can see in our results, our recurring revenue in total increased by about the same amount as our recurring margin increase. So that's the way to think about that. I mean, there's going to be some incremental cost, as we expand internationally, there's potential incremental cost that could come in. But there's significant scalability in all of our recurring revenue, and that applies to SaaS as well.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [15]

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So one comment I would add to that, Allen, as you break that down. Well more than 50%, like 53%, 54% of our revenue now is recurring revenue. And all recurring revenue is very good margin for us. What we said was, recurring revenue will continue to grow but SaaS within recurring revenue will grow faster than the non-SaaS part of recurring revenue, right? So SaaS will continue to grow at a much faster pace, and all recurring revenue is very good margin for us. Now when you look at services revenue behind that, which is about 20% of our revenue, and if you see our P&L, you will see our services margins have also increased compared to last year Q1. So that aspect of our business is also producing much better margins for us now.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [16]

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Okay. My last question is more just a minor thing. But on the balance sheet, you have an item called contract assets, which I hadn't seen before. I don't know if you redefined something. Could you just explain what that is?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [17]

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So Allen, that is essentially unbilled revenue. That has always been in our balance sheet, and previously, it was included in accounts receivable. So I mentioned that in my remarks that the June 30 balance sheet isn't directly comparable to the March 31 balance sheet. That's just the way that the new accounting guidance was implemented. But essentially, contract assets in the balance sheet is unbilled revenue. We've always had it, and if you'll look in the 10-Q that comes out later this week, there'll be a lot more disclosure around that.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [18]

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That's related to the 606.

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [19]

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Yes, related to the new revenue recognition standard.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [20]

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But it's not deferred revenue?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [21]

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No. If you look on the balance sheet, there is a line item called contract liabilities. That is the old deferred revenue.

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Allen Robert Klee, Maxim Group LLC, Research Division - Senior VP & Senior TMT Analyst [22]

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Thank you so much and congrats on the great quarter.

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Operator [23]

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(Operator Instructions) Our next question comes from the line of Phil Bernard from Eilers & Krejcik Gaming.

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Phil Bernard, Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment [24]

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Congrats on a solid quarter. First question. With respect to the new products that you mentioned, the rGuest Express, the rGuest Service, the new LMS version, are all of those available as we speak right now?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [25]

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Yes. The quick answer to your question is yes, Phil. But in terms of them getting integrated with each of our property management system products, they are happening one by one. So most of these products were demoed in the HITEC show, which was, what it is, a month or 2 ago. And so yes, they are all available. They're being actively sold by our sales team.

The integration efforts with all our other products, they continue to make progress with every passing week, right? But the quick answer to your question is yes, these are all products that we are selling actively now.

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Phil Bernard, Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment [26]

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Okay. And so you mentioned, let's see, specifically the rGuest Book, there is a trial that started 2 months ago. How long does it generally take for one of these to be ready for general availability for all of your clients?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [27]

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Yes, that was not a trial, Phil. That customer is actually using it in production and that -- it's the first install, right? So it is not a trial install, it's the first install. And it is working very well for them. It has actually helped them sell certain kinds of rooms. They have certain 5-bedroom villas that they were not selling great before. Now those sales have really picked up because with our booking engine, you can actually show pictures of the place. And so that is really helping them out. So they are making good progress in terms of using the product, and they are taking reservations in it, and they are doing very well with it. So they are live and in production.

And what we are working on the product now is the Phase 2 of enhancements and also making sure it's integrated with all our PMS products. So that product is being sold actively to other customers as well.

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Phil Bernard, Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment [28]

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Let's see. The professional services gross margin this quarter had a pretty good bump. I'm curious -- and I know you guys mentioned that the team has been retooled somewhat to be -- to more efficiently serve your customers. Is this the new kind of run rate? Or was this an anomaly?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [29]

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No. This -- Phil, this is Tony. This isn't an anomaly. This is a level that you should see going forward. I mean, this has kind of been our target over the past year, we've been working and the professional services margin is up. So this is -- this Q1 is not an anomaly.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [30]

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So if you compare Q1 of last year with Q1 of this year, when you look at the P&L, you will see that the services revenue is around the $6.9 million range for both those quarters. The $6.9 million or close to $7 million this quarter was achieved at -- on a much less cost basis than last year's Q1. And you should expect that to continue.

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Phil Bernard, Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment [31]

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Okay. That's good to know. And that will actually --- oh, actually one more question on the new sales and marketing duo that you have in place. I'm curious from a high-level if you could speak to what the major differences are between the way that this current marketing team and sales is offering -- is operating versus the -- any prior teams because there has been kind of a -- quite a bit of turnover in that part of the business over the years.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [32]

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Yes, sure. So in terms of Heather Foster in marketing and Don DeMarinis in sales, let me talk about marketing first, right? Our marketing efforts are getting a lot more professional and pointed now, especially in the area of demand and pipeline generation. I cannot tell you that we did a great job of demand generation before and now the turnover in marketing is sort of a positive turnover. And Heather and the professionals we are getting in place in marketing are more demand-generation experts, right? So that is one area we could have done a lot better in. So our demand generation efforts are a lot more metric driven, a lot more pointed and a lot more professional now. That's a big improvement in marketing.

And also if you have been to HITEC, you would have seen that the look and feel of our booth is a lot more modern, a lot more high-tech, which is what our products deserve. And if you come to G2E, you will see that our booth has tripled in size and has a lot more modern high-tech look now. That's on the marketing side.

Now on the sales side, I know far bigger changes there with Don, who has worked at MICROS for many years when that company grew from kind of our size to $1 billion revenue company. Our sales process is a lot more disciplined and granular now. There's a lot more accountability in sales forecasting, right? We take our sales forecasting a lot more serious, it's granular, it is monitored on a weekly basis, and there is a lot more accountability there, right? When people make forecasts, we are supposed to meet those forecasts. So Don is a lot more disciplined in those areas.

And Don along with the Sales Directors working with him have realigned sales territories. And probably the most important thing in sales is a culture change in our company but all of us work for sales. Not just the people in the sales department but everyone else, R&D, services, customer support, all of us are part of sales. So when sales needs help, all of us jump up, right? So there's much better cross-function teamwork now. And we are focusing on new customers. That's one big change that Don has brought to the place, that we are going after a lot more bigger, newer customers, especially in the foodservices management, FSM space, in that vertical, and a lot more customer touches. A lot more of our executive team is getting closer and closer to prospective and current customers.

So it's an entirely different, more disciplined, more granular, more accountable sales processes in place now.

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Phil Bernard, Eilers & Krejcik Gaming, LLC - VP of Gaming Equipment [33]

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Great. Well, it seems like you guys are getting things in order and good luck to you going forward.

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Operator [34]

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Thank you, ladies and gentlemen. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Ramesh Srinivasan for any further remarks.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [35]

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Is there one more question?

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Operator [36]

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We just got one -- yes, we just got one question in the queue. Our next question comes from the line of Tucker Golden from Solas Capital.

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Frederick Tucker Golden, Solas Capital Management, LLC - Managing Partner and Portfolio Manager [37]

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I just had a question on some of the sales drivers you've mentioned. It seems like there's a lot to be excited about. You mentioned net positive competitive replacements. Can you maybe discuss the competitive environment? Where you are seeing your products as most advantaged, maybe where they're challenged, any color there?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [38]

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Tucker, thank you for joining the call. So in terms of competitive environment, it has not changed much during the last few quarters. If anything, it has become a bit more favorable to us. And the reason is, we are in a very good space now in terms of -- this business, this B2B enterprise software business requires enormous customer focus and it requires enormous flexibility. You just can't be a product company and say this is our product, take it or leave it. You can't be that way. You have to be a solutions-oriented company that remains flexible to customer needs around our products. We have to maintain our products, keep them upgradable, but we need to be very flexible, very close to customers. So that requires a very flexible sort of culture, and the team that is used to the fact that things change based on customer requests.

And that kind of culture is not easy to create, right? So we have very big competitors for whom that kind of flexibility is, obviously, quite difficult, it's not easy. And then we have much smaller competitors, who are -- it's not easy to scale. So there is reasonable barrier to entry into the space, right? You just can't get into a B2B space like ours and can't scale up that quickly, right? So that barrier to entry is there.

And so I would say our competitive environment is quite encouraging. It is the same. If anything, it's improved a little bit in our favor. And also the fact that we have improved our product development velocity now is putting that in a -- putting us in a much better competitive situation now. So I like our positioning now. I think it really will facilitate future growth for us.

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Frederick Tucker Golden, Solas Capital Management, LLC - Managing Partner and Portfolio Manager [39]

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That's great, that's great. And in terms of the large strategic accounts, I know you already provided some color on the call. Are there any anecdotes or specific color you can give us on a case study of maybe an account where you've made progress and where you see significant opportunity?

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [40]

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Yes, we don't want to name customers, Tucker. But there is one major strategic customer in the hotel, resorts, cruise space that we did sign about 1.5, 2 years ago and across the literally hundreds of hotels that they have, that is providing us good fuel for growth as we go through those hotels one by one and replacing competitive products in those hotels. And like I told you, in the FSM space now, we are focused on a couple of bigger size customers with whom we did not do any business before. So we are adding to the bigger customers, bigger strategic customers, in terms of numbers. And the strategic customers we already had, the bigger ones, we are increasing our business breadth with them.

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Frederick Tucker Golden, Solas Capital Management, LLC - Managing Partner and Portfolio Manager [41]

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That's great. And then this last one might be for Tony. In terms of the gross margins, if we just want to compare year-over-year, I understand there's lower product mix and then I know the timing of product rollout can impact cost of goods as well. Can you just kind of bridge the increase because they were up pretty significantly, over 300 basis points? Can you just discuss sort of what's going on within gross margin?

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [42]

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Yes, the main impact on gross margin is the improvement in the professional services gross margin that we mentioned as well as the increase in recurring revenue that came with very little incremental cost. That's offset a little bit with some incremental amortization that's coming in to the product cost of goods sold line. But in effect, the increase in gross margins is due to the recurring revenue and the professional services cost improvements that we've made. Does that answer the question?

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Frederick Tucker Golden, Solas Capital Management, LLC - Managing Partner and Portfolio Manager [43]

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That's great. So the amortization was actually not favorable. This is really more operating leverage. Great.

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Anthony Pritchett, Agilysys, Inc. - VP & CFO [44]

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The amortization is unfavorable, absolutely.

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Operator [45]

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This does conclude the question-and-answer session of today's program. I would like to hand the program back to Ramesh Srinivasan for any further remarks.

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Ramesh Srinivasan, Agilysys, Inc. - CEO, President & Director [46]

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Thank you, Jonathan. We started our fiscal 2019 with growing momentum, driven by recurring revenue, healthy margins and balance sheet, a world-class leadership team, a fully functional India Development Center and an entirely new attitude across the organization, focused on being customer centric and engineering driven, devoted to all the markets we serve. If you're planning to be at G2E at the G2E show in Las Vegas in early October, please let us know, and we'll be happy to meet you there and also provide product demonstrations, especially of the newer software modules we have going now. We'll have a much larger presence at the show this year, which will highlight our improving and growing product portfolio.

I also look forward to reporting on the additional progress we are achieving in the business when we announce our second quarter results later this fall. Thank you.

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Operator [47]

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Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program, you may now disconnect. Good day.