Agilysys Inc

NASDAQ:AGYS

Earnings Call Transcript 2019-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to Agilysys Fiscal 2019 Third Quarter Conference Call. As a reminder, this conference call maybe recorded.

I would now turn the conference over to Dave Wood, VP of Finance with Agilysys. You may begin.

[Dave Wood, VP, Finance]

Thank you, Sonia, and good afternoon, everyone. Thank you for joining the Agilysys fiscal 2019 third 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 call 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 balance and statements we make regarding continued sales and business momentum.

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, risk and changes in circumstances that are difficult to predict and many of which are outside of our control.

Our actual results and financial conditions 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 within 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 speak only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statements that may have been 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 Ramesh Srinivasan, our President and Chief Executive Officer. Ramesh, please go ahead.

[Ramesh Srinivasan, CEO, President]

Thank you, Dave. Good afternoon, and good evening, everyone. Thank you for joining us on the call today to review our fiscal 2019 third quarter results. Joining me on this call is Tony Pritchett, our Chief Financial Officer.

Let's get started by taking a quick look at our financial results. Q3 revenue was again a quarterly record at $36 million, a good $1.8 million ahead of the previous record number in Q2 and an increase of $4.7 million, 15% increase, that is 1-5 [ph] percent increase compared to the fiscal 2018 third quarter, leading to a GAAP net loss of $4 million or a loss of 18, 1-8 cents [ph] per share, compared to a net loss of $1.9 million or a loss of $0.08 per share in the prior year Q3 period.

Last year's Q3 numbers included a onetime $1.6 million income tax benefit and a $1.8 million benefit from capitalized software development costs, which did not occur in this fiscal 2019 third quarter.

This was our third consecutive quarter with record revenue and fifth consecutive quarter of sequential revenue growth. This was also one of our best sales and competitive replacement quarters.

During the first three quarters of fiscal 2019, compared to the first three quarters of fiscal 2018, our revenue grew by 9.4% from $95.3 million to $104.2 million, in spite of a flat first quarter. The year-over-year revenue increase this quarter was driven by a 25% increase in subscription revenue. Our overall recurring revenue rose by 12.4% to a record $19.3 million.

One of the contributors to this increasing recurring revenue trend is the fact we have significantly reduced customer churn, both in absolute terms and as a percentage recurring revenue during the past few quarters.

During the first three quarters of fiscal 2019, our customer retention levels in absolute terms improved 12% compared to the first three quarters of fiscal 2018. Given our increasing recurring revenue levels, the improvement was significantly higher than 12% with respect to customer retention as a percentage of recurring revenue. The increasing customer satisfaction levels have helped, both with far better customer retention than before and as the good word spreads, better new business sales wins.

We look forward to the days in the not-too-distant future when our annual recurring revenue levels reach the $100 million. Between recurring revenue and the highly predictable services revenue base we continue to build, our revenue predictability and visibility are getting better, making our forecasting processes progressively easier and better. Both recurring and services revenue together constitute more than 70, 7-0, 70% of current revenue level.

Given our current sales and business momentum, we expect our full year fiscal 2019 revenue level to meet the 10% revenue growth guidance we provided at the beginning of the year.

The January through March quarter, the last quarter of this fiscal year, should be our third consecutive year-over-year double-digit revenue growth quarter and yet another quarter with record revenue.

Before I move on further, one thing to keep in mind. All our references to records or best ever performances and such refer only to our history starting mid-calender 2013 or fiscal 2014 when we divested various pieces of our business we were involved in previously and became the entirely hospitality software technology solutions-focused business that we are today.

Now switching back to our Q3 fiscal 2019 results. Adjusted EBITDA was $2.1 million in both the fiscal 2019 and fiscal 2018 third quarter periods. Last year fiscal 2018 third quarter had the benefit of $1.8 million in software development costs, which were capitalized.

Given our current agile software development and deployment practices that went into effect at the start of fiscal 2019 second quarter, there were no software development costs capitalized in the fiscal 2019 third quarter.

Effectively, our adjusted EBITDA in Q3 of this year was about $1.8 million better than last year's Q3, assuming no capitalization of software cost in either quarter.

During the past couple of years, we have tried to give you a good financial view of our operations by using a non-GAAP measure, adjusted earnings from operations, which we also refer to as AOE.

AOE is essentially adjusted EBITDA minus capitalized software costs minus CapEx, and therefore, a measure of our overall revenue minus overall expenses, whether they are capitalized or not, and minus capital expenditures.

The items excluded from the AOE calculation are non-cash and certain nonrecurring cash expenditures such as restructuring costs or legal settlement payments. Over a full fiscal year, AOE should be a good proxy for free cash flow.

Q3 of fiscal 2019 was our fourth consecutive positive AOE quarter at $1.9 million compared to an AOE loss of $1.9 million during Q3 of last year. The cumulative AOE during the first three quarters of this fiscal year is $4.1 million compared to an AOE loss of $6.5 million during the first 3 quarters of last year. During the first three quarters of fiscal 2019, AOE therefore improved year-over-year by $10.6 million while revenue increased by $8.9 million.

At the beginning of fiscal 2019, during our May 2018 earnings call, we provided guidance stating that we expect to improve AOE of fiscal 2019 to a breakeven level compared to an AOE loss of $6 million in fiscal 2018. We have obviously exceeded those expectations so far.

During the current January to March fourth quarter, we are planning increased capital investments in a couple of areas. Number one, expanding the India Development Center from the current capacity of 330 to 660 personnel. While we've already started the expansion process, this does not mean we will do all the hiring right now.

As of now, we are creating the space and the infrastructure to grow the center, and we have completed some initial hiring. The actual pace of hiring will depend on how well our business continues to grow.

Number two, the second area of capital investment plan between now and the end of March is improvements in our SaaS development operation's IT infrastructure. We expect our subscription SaaS-based revenue to continue to grow and want to ensure our infrastructure to support such growth is improved accordingly.

Since AOE is a measure of adjusted EBITDA minus capital expenses, we expect AOE to be somewhere close to breakeven, not a bit less than that in Q4. Our cumulative AOE for the first three quarters of fiscal 2019 was $4.1 million. We expect to round out AOE for the entire fiscal 2019 year to around $3.5 million to $4.5 million, which is an increase from the original annual guidance provided of breakeven AOE and would also mean an annual year-over-year improvement of about $10 million.

Q3 fiscal 2019 was also one of our best quarters with respect to improving our cash balance. The cash balance at the end of the quarter rose to $37 million, an increase of $4.1 million from the end of the September quarter. This was achieved with no special onetime working capital management practices. We manage to a normal accounts payable and accounts receivable rhythm during the quarter.

This is one of our best cash balance increase quarters ever, and that's a good reflection of our improving business reality. We've narrowed our cash losses during the first three quarters of this fiscal year to about $2.9 million compared to a cash loss of $11.6 million during the first 3 quarters of the previous year.

At the beginning of fiscal 2019, we provided guidance that we expect our cash losses during fiscal 2019 to be somewhere between $3 million and $5 million compared to fiscal 2018, where our cash losses were about $9.3 million. We now expect to do better than that original guidance. We expect our cash loss for the current year to be somewhere between $0 and $3 million.

In addition, we have a reasonable expectation of turning the corner and having a positive cash flow the next fiscal year. We will provide more comprehensive guidance regarding the various aspects of our business for the next fiscal year, including cash flow expectations, during our next mid-May earnings call.

A word or two regarding sales. The last four quarters have been consistently good sales quarters for us, this December quarter being particularly good and one of our best sales quarters ever across all three of our current major geographical regions: U.S., Europe and Asia.

We continue to make excellent progress with expanding our relatively small market share in Asia and Europe. This was also one of our best-ever quarters with respect to new business added. We define new business as a sum of three types of sales, one, new logos, meaning new customers who have never used one of our core products before.

Two, new sites, meaning current customers beginning to use our core products in additional sites. And three, new products, meaning current customer sites adding one of our products they had not used before.

In addition, business from our current major strategic customers continues to increase. Our efforts to expand the base of such major strategic customers are also yielding good results with continuing good progress with multiple such prospective customers. Our current sales pipeline is at the healthiest level we have seen in a long while.

Our win percentage also continues to get better. Our competitive advantage is getting better with each passing month, especially on the point-of-sale, POS, side of the business, driven by our flagship InfoGenesis product complemented perfectly by rGuest Buy. We still have a few more quarters to go before we start commanding such a winning position in the property management, PMS, side of our business.

Our current growth continues to be driven mostly by our POS products. We continue to focus on and invest in our PMS products as well and are confident they, too, will become significant growth drivers within the next few quarters.

Our R&D and engineering resources trend has more than doubled during the past couple of years. While that helps continuing innovation and improvements in our core products, such increased strength has also helped us introduce multiple new ancillary software modules, providing the much needed innovation around POS and PMS our customers have been hungry for.

Multiple such modules have been sold and implemented at various customer sites during the past few months. Apart from providing additional upsell opportunities, such modules also help us sell our core POS and PMS products more effectively while retaining and improving our pricing levels. All these software modules have been developed, sold and implemented in relatively quick time and are based on specific customer requests.

We are encouraged by the possibilities in each market we serve. All the market segments we serve continue to invest in deploying technologies to improve efficiencies, to minimize disruptions, to increase process automation, to enable increasing levels of mobility and systems integration, to increase personalization levels throughout the guest journey in a resort, and every one of those aspects is in tune with our focus areas.

Gaming casinos and resorts are increasingly focused on the non-gaming hospitality-related areas with their investments, and that continues to be good for us. Hotel occupancy rates have risen from approximately 60, 6-0, percent in 2001 to approximately 66% in 2018, the highest occupancy rates in nearly 30 years.

Hotels, resorts, cruises, foodservice management, each of the market segments we serve has an increasing need for the kind of technology solutions we are specialized in. Technology is becoming increasingly interwoven into the guest experience in each of these industries.

And in Asia and Europe to a large extent, we are only getting started. There is obviously a growing need for hospitality-focused solutions in these continents, which we are beginning to serve well now.

Asia and Europe taken together, this fiscal year 2019 Q3 quarter was our best sales bookings quarter ever by a fair distance. And again, we are only getting started now.

We like how well we are currently positioned to continue our business momentum and create significant future shareholder value. Within reasonable business limits, we are also fairly well insulated from the vagaries of the general political and macroeconomic environment.

To start with, we serve a huge global market where the total addressable market size in terms of revenue possibilities for vendors like us runs into multiple billions, that's with a B, which is huge relative to our current size. We have a big runway to grow revenue in both the POS and PMS sides of our business. It's only a matter of how much better we can become. A small change in the rate of growth of the industry either way does not and should not affect our growth prospects.

In addition to that, enterprise software for the hospitality industry is inherently challenging. Serving the kind of big customers like we do and continuing to do so at a world-class level that we do is, by definition, difficult. There's a challenging need to get the core products right, enable various kinds of integrations with third-party products and customer internally developed ancillary modules and systems, innovate well within the core products and create various ancillary products, which create value for customers, handle major complex implementations all over the world, provide world-class customer support and be there every step of the way for our customers, pick up every call from customers and partners seeking help, be there for them.

Getting all of this right requires a combination of intense focus on day-to-day execution while also simultaneously keeping the innovation engine running at a high level. That combination is not an easy task for any software vendors, especially the smaller sized vendors.

Now the point of all that is there are big barriers to entry into this business. While there are promising software providers coming up in the retail restaurants, QSR and other market segments we don't currently operate in, where relatively standardized one size-fits-all approach could work, such approaches will not work for the industry segments we serve. And therefore, we don't see too many major competitive threats in the enterprise hospitality space we are essentially focused on.

As we continue to increase our R&D and customer services resource levels and talent strengths, as we continue to decrease our cost per unit of R&D output and become a stronger company financially, and from a management team's standpoint, we do have multiple other organic and inorganic avenues to grow our business, which we can evaluate carefully when the time is right and make well thought out, good, solid growth-driving decisions.

Now on the other hand, the hospitality industry is growing and will continue to grow. Our customers are now dealing with guests who are increasingly more demanding with their technology and customer service needs. The demand for our products has never been higher.

Our success depends mainly on how well we can serve such needs. From our vantage point, even if the economic conditions become a bit rocky, to a certain extent, that will only make our products even more important as our customers have to ensure they serve their guests who they are competing for even better.

Due to a general lack of software technology providers of our size in this industry who are not too big, not small by any stretch and stable, focused only on the hospitality industry and improving with respect to products and customer service, we feel we are well positioned and will continue to grow if we keep our focus and work relentlessly hard and smart.

We believe our fate is essentially in our hands. We are not too dependent on the economic environment around us. And one cannot ask for a better position than that. Without question, like all businesses, we do wish for a good business, political and economic environment to help us continue to do well. But we like our position of not being too dependent on such external variables.

In summary, we like our current sales and business momentum. We are now moving past the turnaround phase and entering into a growth phase in our business. During the past two years, we have worked hard. We have worked smart to turn around our business. And starting now, it's a matter of how well we manage our growth possibilities. This is an exciting time for us.

With the turnaround-related heavy lifting behind us, we are now focused on our future growth path, which frankly is a lot more fun to manage. We are determined to stay humble, work hard, serve our employees, our customers, our products, our processes well, outwork our competition as best as we can, be the most reliable, always available, most innovative and improving partner for our customers and an organization which always keeps the best interest of our shareholders in mind.

Consistent profitable growth is the road ahead for us. We like the pathway we are marching along now and remain confident in our future. We look forward to discussing our January through March quarter, Q4 of fiscal 2019 results mid-May. We have every expectation that will be yet another record revenue quarter for us.

With that, let me turn the call over to our CFO, Tony Pritchett, to provide additional perspective on our financial results and other aspects of our business. Tony?

[Anthony Pritchett, VP & CFO]

Thank you, Ramesh, and hello, everyone. Echoing Ramesh's remarks, we are pleased with our fiscal 2019 third quarter results. More so, we are pleased with the continued progress we are making with our initiatives and their benefit to our operations and key financial metrics, including double-digit topline growth, progress towards becoming a cash-generating company and positioning the company for further growth.

Starting with our topline. Overall revenue grew by 15% or $4.7 million in the third quarter of fiscal 2019 to $36 million. That compares to $31.3 million in the prior year period, marking the fifth consecutive quarter of sequential revenue growth and the third consecutive quarterly revenue record since becoming a pure-play hospitality technology provider in calendar 2013, fiscal 2014.

Third quarter revenue grew by over $1.8 million or 5% sequentially from $34.2 million in the second quarter of this fiscal year. Importantly, we continue to improve and grow the business while being laser-focused on our cost line items. As a reminder, and as discussed on our Q2 call, we adopted agile development and deployment practices across all of our products earlier this fiscal year that preclude the ability for us to capitalize internal labor cost onto the balance sheet. The second quarter of this fiscal year was the first quarter we saw the effect of these practices on our income statement. The same effect has carried into the third quarter.

As a result, our product development expense line item on the income statement is significantly higher than in prior year quarters since the cost that was previously removed from the P&L as capitalized software development costs and capitalized onto the balance sheet is now being reflected as an expense. In Q3 of fiscal 2018, this was about $1.8 million.

In the back of our earnings release, you will see a reconciliation of product development expense for Q3 of fiscal 2018 to include this amount. As an effect, our operating loss and net loss are higher this quarter than they would have been if we had capitalized labor.

In addition, our operating cash flows on the cash flow statement now including wages and contract labor payments that were previously capitalized, whereas previous quarters reflected a fixed expenditure as an investing activity.

Also, please note that in accordance with the modified retrospective method of adopting the new revenue recognition standards, which we adopted beginning with Q1 of fiscal 2019, our March 31 balance sheet has not been restated to reflect the accounting standards.

Therefore, accounts receivable, prepaid expenses, other non-current 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 soon, for more disclosure to help with comparison.

Now looking at revenue in greater detail. Product revenue increased 25.5% to $10.2 million compared to $8.2 million in the prior year period as a result of higher hardware and proprietary software license sales on the back of one of our best sales quarters.

Professional services revenue was up 8.4% to $6.4 million compared to $5.9 million in the prior year period, reflecting growth in our customer base. Support, maintenance and subscription services or recurring revenue rose 12.4% to a quarterly record $19.3 million compared to $17.2 million in the prior year period.

We are pleased with our continued growth across our recurring revenue, particularly the 25% increase in subscription revenue, which continues to trend ahead of previously stated expectations of approximately 20% year-over-year growth.

Recurring revenue was 54% of total revenue with subscription revenue representing approximately 32% of recurring revenues, marking steady growth compared to 29% in Q3 of last year.

Also of note is that total revenue related to our rGuest platform comprised approximately 9% of total fiscal 2019 third quarter revenue. We are pleased to see rGuest gaining traction in the marketplace and are very anxious to see what we expect to be a significant contribution as we further leverage rGuest Buy, rGuest Stay and bring to market emerging modules such as rGuest OnDemand, rGuest Book and rGuest Service.

Looking ahead to the fiscal fourth quarter, we expect the sales momentum to continue and help us to further our top line growth and for subscription revenue to outpace the rate of total recurring revenue growth.

Regarding installed endpoints, by the end of Q3, we serviced about 53,000 terminal endpoints and 271,000 rooms. That translates to a 19% and 6% increase, respectively, compared to Q3 of last year.

Moving down the income statement. Cost of goods sold increased by 10.7% or $1.7 million during the third quarter to $17.4 million versus $15.7 million in the prior year period. Of note is that gross margin of all product lines increased compared to the third quarter of last year, meaning that although cost of goods sold increased, it increased at a lower rate than revenue.

The largest contribution to the overall cost of goods sold increase was products cost of goods sold, which increased by $1.6 million, of which $700,000 was due to the increase in amortization of developed technology. And the balance was due to an increase in third party hardware and related operating system software, which carries with it a hard cost of buying the products from vendors.

This led to a gross profit margin of 51.8% or a 190 basis point improvement over the prior year period. Products gross profit increased $0.5 million with gross profit margin improving to 18.2%.

The increase in gross profit margin can be attributed to higher software license sales and reduced supply chain costs as a result of processing customer orders directly out of our own warehouse.

Professional services gross profit increased by $0.1 million with gross profit margin increasing to 21% compared to 20.4% in Q3 of fiscal 2018 as a result of increased revenue and higher utilization and billability of our professional services resources.

Our margins were at the low end of our expected range due to the mix of projects handled during the quarter. We continue to expect services margins to range from the low 20s to the high 20s, depending on the mix of projects in any particular quarter.

Support, maintenance and subscription services gross profit increased $2.4 million, leading to a total gross margin of 79.8% compared to 76% in Q3 of fiscal 2018, reflecting the positive impact of the operational changes we have implemented and the success of our initiatives to grow recurring revenue at a faster pace than cost.

Looking at operating expenses and excluding the charges for legal settlements and restructuring severance and other charges, the third quarter saw a 20.1% increase in operating expenses to $22.5 million compared to $18.7 million in the prior year period.

The increase in operating expenses is due primarily to product development expenses, which increased by $2.8 million compared to fiscal Q3 of last year. As discussed, we have dramatically reduced the timelapse between design of a software product or feature and its deployment in the field.

In Q3, this precluded capitalization of software development costs, and we expect similar outcomes going forward. This change, along with the growth in our number of global R&D resources, led to the increase.

Sales and marketing expenses increased $0.9 million or 21.9% compared to fiscal Q3 of last year due to increased incentive compensation and the timing of tradeshows, while general and administrative expenses decreased $0.2 million or 4.1% compared to fiscal Q3 of last year.

As was the case in the prior quarter, our overall expense level, when normalizing the treatment of capitalized software development by taking both capital expense and operating expense together as a percentage of revenue, was lower in the fiscal 2019 third quarter compared to the same period last year. And our expectation remains that we will leverage the operating scale of the business and grow revenue at a faster rate than cost.

Our fiscal 2019 third quarter results led to an operating loss of $3.9 million compared to an operating loss of $3.6 million for the third quarter of fiscal 2018. Our operating loss mainly widened as a result of the classification of capitalized software development costs.

Our fiscal 2019 third quarter net loss was $4 million compared to $1.9 million in the third quarter of fiscal 2018. Our net loss widened due to the classification of capitalized software development costs as well as a $1.6 million tax benefit recognized in the third quarter of last year.

Adjusted EBITDA was approximately $2.1 million in the third quarter of both fiscal 2019 and fiscal 2018. However, as reconciled in the back of our earnings release, if software development costs were not capitalized in either period, adjusted EBITDA would show an improvement of $1.9 million over a gain in the fiscal 2018 third quarter of $300,000.

Adjusted earnings from operations or AOE for Q3 of fiscal 2019 was $1.9 million, a $3.8 million improvement compared to a loss of $1.9 million in Q3 of fiscal 2018. This is a metric unaffected by the classification of capitalized software development costs.

Moving to the balance sheet and cash flow statement. Cash and marketable securities as of December 31, 2018, was $37 million compared to $32.9 million at September 30, 2018.

Free cash flow, defined as cash used in operating activities plus cash used for capital expenditures and cash used for capitalized software development costs, is a good cash flow metric to look at for us.

Free cash flow for the 9 months ended December 31, 2018, was a record for us. Free cash outflows of $2.1 million in the first 9 months of this year favorably compares to $10.5 million in the first half - in the first 9 months of last year, which is over an $8 million improvement.

Going forward, we expect fiscal 2019 year-end cash and cash equivalents to be flat to down $3 million from the fiscal 2018 year-end balance of $39.9 million. And we expect to end the year with $37 million to $40 million of cash on hand, a significant improvement from the $9.3 million decline in fiscal 2018.

Regarding our revenue and AOE guidance, we reiterated this afternoon our forecast for fiscal 2019 full year revenue growth of approximately 10% compared to fiscal 2018 revenue of approximately $127 million.

In addition, we expect to report full year adjusted earnings from operations of between $3.5 million and $4.5 million in fiscal 2019. That compares to a loss of approximately $6 million for this metric last year.

In closing, while we have a lot of work ahead, we should not lose sight of the fact that fiscal 2019 is so far proving to be a very strong year. We have set several financial records this year and at the same time set ourselves up for future growth and consistent profitability. As Ramesh noted, we continue to be bullish on the outlook for the balance of fiscal 2019 and beyond.

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

[Operator]

Thank you. [Operator Instructions] Our first question comes from Allen Klee of Maxim Group. Your line is now open.

[Allen Klee, Maxim Group]

Yes, hello. Congrats on a great quarter. I had a couple financial questions to start with. In terms of gross margins, if I look at your segments, the product segment and the recurring-type revenues, they're continuing to improve the last couple of quarters. And you had a little uptick in the professional one this quarter.

Is that - are those a trend that I should think as kind of continuing and it kind of ends up with the overall gross margin roughly flat? Or is there any other color you can add to that?

[Anthony Pritchett, VP & CFO]

Allen, I think the way to think of it is if you just take our overall gross margin, it should continue to improve. We expect our recurring revenue to continue to grow, and our subscription revenue should grow faster than any the line of revenue. And those lines of revenue carry the highest gross margins that we have, right? Incremental revenue added to recurring revenue comes with really high gross margins.

So over time, our margins should start to tick up or continue to tick up. If you think about the different product lines, product revenue and services revenue can be somewhat lumpy when it comes to gross margin percentages.

Services changes from quarter-to-quarter just kind of based on the project mix that we have going on in a given quarter, and like I mentioned on the call, we expect services margins to be somewhere in the low 20s to high 20% range. But again, it kind of varies quarter-to-quarter. And then product margins can vary depending on the mix of software license revenue that we have.

It can vary a decent amount as far as the percentage goes, but the way to think about it over time is just that on an ongoing basis and over the next several quarters and years, our overall margin should continue to improve.

[Allen Klee, Maxim Group]

Great. And then the operating expenses below gross margins, is it reasonable to think that kind of stays at kind of the run rate it's been at as a percent of sales?

[Anthony Pritchett, VP & CFO]

Yes. So where we are now for the next few quarters is a generally good expectation. We have said - I think we said it on the last call that product development expense next year probably ticks up a couple or 3 percentage points from where it is now.

On the whole though, if you think about on an annual basis and you start thinking about next year, our overall cost as a percentage of revenue should continue to be about in this range or maybe come down a little bit with that nuance for product development expense ticking up a little bit. Does that answer your question?

[Allen Klee, Maxim Group]

Yes. And then just remind me with the building out of the India Development Center. I wasn't quite sure of what the impact that has on CapEx. Maybe you said it and I missed it, I'm sorry.

[Anthony Pritchett, VP & CFO]

So the initial cost to build out the facility - in that facility, we rent space in a complex in India. So we have about 68,000 square feet there. We're building out about half of that right now.

We will see a decent contribution to CapEx in Q4 from that build-out. That's why we expect AOE to be close to breakeven, possibly slightly negative in Q4. It's because of that CapEx that we are going to spend in Q4.

[Allen Klee, Maxim Group]

That's right. Thank you. And you - could you just repeat the percentage increases of point-of-sale and hotel rooms served, what that was year-over-year? And what I'm trying to think about is right now, it sounds like point of sales has been growing high double digits and PMS has been growing kind of like high single digit. But you've alluded to that in a couple of quarters, it's possible that PMS could pick up its growth rate once you build out the products.

So was there a way to think about the relative kind of size of a typical POS versus a hotel type of a deal and profitability so that maybe that can help us think about what this could mean a couple of quarters out when the PMS hopefully ramps up?

[Ramesh Srinivasan, CEO, President]

Yes. So - Allen, thank you. This is Ramesh. We would think of POS and PMS as two fairly distinct separate businesses. POS sales involve both software and hardware typically because you sell terminals along with the POS software. PMS is a classic application software sale. It's only software when we sell PMS. And the two are fairly independent.

I mean, certain customers will prefer buying both from us. That is always there. But in general, they are not going to make a decision to buy one just because they have the other from us. We have to win each of them based on the merit of our products and service and support and all the variables that go into a selection process.

So dollar-for-dollar, I would say PMS is more profitable for us because it doesn't involve hardware. And currently, competitive advantage-wise, it is difficult to say no to us on a POS RFP. PMS, we have a bit more work to do. That doesn't mean we don't win PMS deals now. But in order for PMS growth to also reach the 20% range, we just have a few more quarters of work to do on the product.

And all our success, all our growth is mostly product-driven, Allen. When the products become - when the products reach a stage when they are obviously competitively the better products, everything else flows easier for us.

And on the PMS products, we just have a few more quarters of work to do, and that only makes me think positive as far as revenue growth is concerned. Currently, POS is pulling as well, but once PMS also starts pulling, our revenue should really start growing at an even faster pace.

[Allen Klee, Maxim Group]

That's very helpful because it sounds like not only it was could revenue growth better but also profitability if PMS is a little more profitable. Thank you. And then on the competitive position, you talked about your advantages versus some of companies that are maybe smaller than yourselves and can't be as innovative.

But how do you think you're competing with the kind of £800 gorilla, the big guy out there? Are you seeing anything that makes you worry more than normal? Or what are you thinking?

[Ramesh Srinivasan, CEO, President]

I think if anything, I'm worrying a bit less these days. If anything, during the last couple of quarters, as can be seen by the sales results, our competitive advantage is increasing. Our position is becoming better. Based on what we see in the marketplace, it does feel like we are making more progress with our core products, with our innovation within the core products in terms of adding features and doing what will produce value for customers.

We are coming out with ancillary products around POS and PMS at a faster rate than the competition. That's how it seems like to us. And given our - the current momentum of increasing sales, I'll tell you that I think our competitive advantage is getting better. It's a positive move.

And from the bigger competitors, I think we are better in terms of customer service and how much attention we pay to customers, mainly because this is the only industry we are focused on. So things are getting better, Allen, from a competitive advantage and from a selling standpoint.

[Allen Klee, Maxim Group]

Okay. Great. And then it was nice to hear how international has ticked up in the quarter. Any - is there anything you can point to of your actions that you think is going to be supporting that going forward?

[Ramesh Srinivasan, CEO, President]

Yes, Allen. So majority of why we are beginning to make an impact with our international selling and revenue is also product-driven. The products needed features that our European and Asian customers required, which for a long time we did not get done. So those features are getting done now. And therefore, our products have competitive advantage in Asia and Europe as well.

And in addition, we are also increasing our presence there. We've added sales staff there. We've added support staff there. The fact that the India Development Center is in Asia obviously helps. We are able to service our Asia customers a lot quicker these days.

So all of that is contributing to our international sales and revenue levels picking up. The products are - now have the features those markets require, plus we have more stable offices there. We are adding sales staff. We are adding support staff. All that is helping.

[Allen Klee, Maxim Group]

Okay. And then maybe just lastly, could you talk about some of the newer software modules or maybe stuff that came from the customer that you feel most promising about?

[Ramesh Srinivasan, CEO, President]

All of them are beginning to make an impact, but I will just touch on a couple of them for you, Allen. One is rGuest Book, which is a web-based booking engine, that multiple customers came to us and wanted us to develop our own booking engine which integrates well with our property management system because customers want -- when you go to a website to book a room, they want to differentiate between, say, a platinum player and a gold player and make different kinds of offers to them. And that booking engine can do only if it has visibility to the PMS data.

So we develop that. One customer went live, if I'm not mistaken, in the May-June time frame. One major Vegas customer is going live as we speak now in the next couple of weeks. And one other major customer in Vegas is in the process of going live, say, in the next three, four weeks or so. So that process is making -- that product is making good progress.

And then we have rGuest Express Mobile, which is a mobile phone-based check-in, checkout, so that you don't need to stand in a queue. We also have an Express Kiosk that has gone live and is in the process of expanding to more kiosks in the casino in Las Vegas again.

rGuest OnDemand is a product that enables desktop ordering and mobile ordering. And a couple of major customers are looking at it now, and we have actually signed a couple of deals just in the last one or two weeks.

rGuest car, golf activity. So basically, we have additional modules to our PMS that handles car management and golf management. There are customers who are in the process of buying that. And in addition to all of this, like we have other mobile ordering features that we are adding to InfoGenesis, and there is a whole lot of features we have recently added in the last six months to our rGuest Stay product. So that product is getting filled up with PMS features.

So in terms of software improvements, ancillary products and core products, we are a long way ahead now than we were six months ago. And we expect that rate of improvement to continue over the next six months and only get quicker after that.

[Allen Klee, Maxim Group]

That’s great. Thank you so much.

[Ramesh Srinivasan, CEO, President]

You’re welcome, Allen.

[Operator]

Thank you. [Operator Instructions] And this does conclude for question-and-answer session. I would now like to turn the call back over to Ramesh for any closing remarks.

[Ramesh Srinivasan, CEO, President]

Thank you, Sonia. Thank you all for your continued interest in Agilysys. Please enjoy a couple of terrific weeks around the Super Bowl, and we'll talk to you soon mid-May. Thank you.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.