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.

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 neither 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.

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 three-fourth 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 two first quarters, in fiscal 2018 and in fiscal 2019, meaning two consecutive June ending quarters,…

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 liability are not directly comparable on the basis 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…

[Operator Instructions] Our first question comes from the line of Allen Klee from Maxim Group.

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?

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 cost. 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 grow 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 costs along with product development expense from the P&L in order to get a full view of product development expense.

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.

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?

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 two 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 two 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, resource, 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.

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

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 getting some momentum there. But as far as growth in the first quarter, it wasn't a whole lot different than the prior year.

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?

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.

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?

The pipeline is looking healthier now, Allen. The large hotel chain opportunities that were captured, say, about a year or two 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 did have the rGuest Express kiosk, we didn't have our new product, rGuest Service, the guest tablet ordering, 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 module 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.

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?

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.

So one comment I would like to add, 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, we'll 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.

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?

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 look in the 10-Q that comes out later this week, there'll be a lot more disclosure around that.

That's related to the 606.

Yes, related to the new revenue recognition standard.

But it's not deferred revenue?

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

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

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

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.

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?

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.

Let's see. The professional services gross margin this quarter had a pretty good bump. 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?

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.

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.

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 operating versus the -- any prior teams because there has been kind of quite a bit of turnover in that part of the business over the years.

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

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.

There's one more question?

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.

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?

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 request. 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.

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

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.

That's great. And then this last one likely 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?

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 made. Does that answer the question?

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

The amortization is unfavorable, absolutely.

Thank you. 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.

Thank you, Jonathan. We started off 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.

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