UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

 

Commission file number 0-5734

AGILYSYS, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (561) 999-8700

 

Securities registered pursuant to Section 12(b) of the Act:

Common Shares, without par value

Common Share Purchase Rights

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  o     Accelerated filer  þ     Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of Common Shares held by non-affiliates as of September 30, 2006 (the last business day of the registrant’s most recently completed second fiscal quarter) was $420,460,264 computed on the basis of the last reported sale price per share ($14.00) of such shares on the NASDAQ Stock Market LLC.

 

As of June 1, 2007, the Registrant had the following number of Common Shares outstanding: 31,395,348

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement to be used in connection with its Annual Meeting of Shareholders to be held on July 27, 2007 are incorporated by reference into Part III of this Form 10-K.

 

Except as otherwise stated, the information contained in this Annual Report on Form 10-K is as of March 31, 2007.

 

AGILYSYS, INC.
ANNUAL REPORT ON FORM 10-K
Year Ended March 31, 2007

 

TABLE OF CONTENTS

 

part I

Reference herein to any particular year or quarter refers to periods within the company’s fiscal year ended March 31. For example, 2007 refers to the fiscal year ended March 31, 2007.

 

Overview

Agilysys, Inc. (the “company” or “Agilysys”) is a leading provider of innovative IT solutions to corporate and public-sector customers with special expertise in select vertical markets, including retail and hospitality. The company delivers tailored solutions consisting of suppliers’ products and services, combined with proprietary software and services, directly to commercial end users of technology. Agilysys employs professional services consultants and systems engineers, who are leading professionals in IT, to evaluate, develop and implement solutions. To assure Agilysys solutions make use of the best available, highest quality products and leading-edge technologies, the company partners with leading suppliers in the IT industry — including Cisco, EMC, HP, IBM, Oracle and Motorola.

The company has customers and experience in many different industries including manufacturing, finance, healthcare, education, government, transportation, retail and hospitality.

Agilysys has special expertise in select vertical markets, including retail and hospitality. In the retail industry, Agilysys is a leader in designing and implementing hardware, software and service solutions for the supermarket, chain drug and general retail marketplace. In the hospitality industry, the company provides proprietary software solutions to automate functions for customers including hotels, casinos, resorts, conference centers, condominiums, golf courses and spas.

Headquartered in Boca Raton, Florida, Agilysys operates extensively throughout North America, with additional sales offices in the United Kingdom and China.

 

History and Significant Events

Agilysys was organized as an Ohio corporation in 1963. While originally focused on electronic components distribution, the company grew to become a leading distributor in both electronic components and enterprise computer systems products and solutions.

As of the fiscal year ended March 31, 2002, the company was structured into two divisions, the Computer Systems Division (CSD), which focused on the distribution and reselling of enterprise computer systems products and solutions, and the Industrial Electronics Division (IED), which focused on the distribution of electronic components. Each division represented, on average, approximately one-half of the company’s total revenues.

In 2002, the company conducted a review of strategic alternatives and developed a long-term strategic plan designed to increase the intrinsic value of the company. The company’s strategic transformation began with its divestiture of its broad-line electronic components distribution business, IED, to focus solely on the computer systems business. The sale of the electronic components business meant that the company would be less dependent on the more cyclical markets in the components business. In addition, this would allow the company to invest more in the computer systems business, which offered greater potential for sustainable growth at higher levels of profitability. The remaining CSD business consisted of the KeyLink Systems Distribution Business and the IT Solutions Business. The KeyLink Systems Distribution Business operated as a distributor of enterprise computing products selling to resellers, which then sold directly to end-user customers. The IT Solutions Business operated as a reseller providing enterprise servers, software, storage and services and sold directly to end-user customers. Overall, the company was a leading distributor and reseller of enterprise computer systems, software, storage and services from HP, IBM, Intel, Enterasys, Hitachi Data Systems, Oracle and other leading manufacturers.

The proceeds from the sale of the electronic components distribution business, combined with cash generated from the company’s ongoing operations, were used to retire long-term debt and accelerate the growth of the company, both organically and through a series of acquisitions. The growth of the company has been supported by a series of acquisitions that strategically expanded the company’s range of solutions and markets served, including:

In March 2007 the company completed its transformation with the sale of the assets and operations of its KeyLink Systems Distribution Business. This final event completes the Agilysys multi-year transformation to move closer to the customer and higher up the IT value scale, effectively positioning it to focus on its higher-growth IT Solutions Business. As a result of the divestiture, the company is freed from the increasing channel conflict and marketplace restrictions that existed in the business.

Today, Agilysys is a growing, vibrant technology company. The company is a high-value provider of IT solutions with low working capital needs and significant financial flexibility to fund growth, both organically and through acquisition. As discussed under Note 18 to the consolidated financial statements, the company continued to accelerate its growth in the first quarter of 2008 through the acquisitions of Stack Computer, Innovative Systems Design, Inc. and InfoGenesis, Inc.

 

Industry

According to information published in January 2007 by IDC, a leading provider of technology intelligence and market data, IT spending in North America, currently estimated at $470 billion, is projected to grow at approximately six percent in calendar year 2007. Since Agilysys is well entrenched in the solutions market — consisting of server and storage hardware, software and services — the company expects to benefit from this projected growth. However, a slowdown in this market could have a negative effect on the company’s revenues and results of operations.

The non-consumer IT industry consists of a supply chain made up of suppliers, distributors, resellers, and corporate and public-sector customers. Agilysys operates in the reseller category as a solution provider, as well as an independent software vendor (ISV) and system integrator specifically through its vertical offering in the retail and hospitality industries.

In recent years, the role of solution providers in the industry has become more important as suppliers have shifted an increasing portion of their business away from direct sales, and many end-users are working more with solution providers to develop, implement and integrate comprehensive and increasingly complex solutions.

To ensure the efficient and cost-effective delivery of products and services to market, IT suppliers increasingly have been outsourcing functions such as logistics, order management, sales and technical support. Solution providers play crucial roles in this outsourcing strategy by offering to customers technically skilled and market-focused sales and services organizations. Certain solution providers, such as Agilysys, offer additional proprietary products and services that complement a total, customer-focused solution.

 

Products and Services

Within the solutions segment in which Agilysys operates, product sets include enterprise servers, data storage hardware, systems infrastructure software, networking equipment and IT services related to the implementation and support of these systems. IDC and other researchers estimate North American spending in these product sets was $224 billion in calendar year 2006, and is expected to grow to $287 billion by calendar year 2011.

Total revenues from continuing operations for the company’s three specific product areas are as follows:

 

During 2007, 2006 and 2005, products purchased from the company’s two largest suppliers accounted for 69%, 75%, and 78%, respectively, of the company’s sales volume. The company’s largest supplier, HP, supplied 40%, 37%, and 45% of the company’s sales volumes in 2007, 2006, and 2005, respectively. Sales of IBM products accounted for 29%, 38%, and 33% in 2007, 2006, and 2005, respectively.

The loss of either of the top two suppliers or a combination of certain other suppliers could have a material adverse effect on the company’s business, results of operations and financial condition unless alternative products manufactured by others are available to the

company. In addition, although the company believes that its relationships with suppliers are good, there can be no assurance that the company’s suppliers will continue to supply products on terms acceptable to the company. Through agreements with its suppliers, Agilysys is authorized to sell all or some of the suppliers’ products. The authorization with each supplier is subject to specific terms and conditions regarding such items as product return privileges, price protection policies, purchase discounts and supplier incentive programs such as sales volume incentives and cooperative advertising reimbursements. A substantial portion of the company’s profitability results from these supplier incentive programs. These cooperative supplier incentive programs and advertising programs are at the discretion of the supplier. From time to time, suppliers may terminate the right of the company to sell some or all of their products or change these terms and conditions or reduce or discontinue the incentives or programs offered. Any such termination or implementation of such changes could have a material adverse impact on the company’s results of operations.

 

Customers

Agilysys customers include large and medium-sized companies; divisions or departments of corporations in the Fortune 1000, and public-sector institutions. The company serves customers in a wide range of industries, including education, finance, government, healthcare, hospitality, manufacturing and retail. No single customer accounted for more than 10 percent of Agilysys total sales during 2007, 2006, or 2005.

 

Uneven Sales Patterns and Seasonality

The company experiences a disproportionately large percentage of quarterly sales in the last month of its fiscal quarters. In addition, the company experiences a seasonal increase in sales during its fiscal third quarter ending in December. Third quarter sales were 32%, 29%, and 28% of annual revenues for 2007, 2006, and 2005, respectively. Agilysys believes that this sales pattern is industry-wide. Although the company is unable to predict whether this uneven sales pattern will continue over the long term, the company anticipates that this trend will remain the same in the foreseeable future.

 

Backlog

The company historically has not had a significant backlog of orders. There was no significant backlog at March 31, 2007.

 

Competition

The reselling of innovative computer technology solutions is competitive, primarily with respect to price, but also with respect to service levels. The company faces competition with respect to developing and maintaining relationships with customers. Agilysys competes for customers with other solution providers and occasionally with some of its suppliers.

There are very few large, public enterprise product reseller companies in the IT solution provider market. As such, Agilysys competition is typically small or regional, privately held technology solution providers with $50-$200 million in revenues. The company does occasionally compete with large companies such as Berbee Information Networks Corporation (a division of CDW Corporation), Forsythe Solutions Group, Inc., Logicalis Group and Micros Systems, Inc.

 

Growth through Acquisitions

With its existing cash and equivalents, as well as cash expected to be generated through operations, Agilysys has the financial flexibility to make acquisitions without immediately increasing leverage or diluting the holdings of existing shareholders. The company reviews acquisition prospects that could accelerate the growth of the business by expanding the company’s customer base, extending the company’s reach into new markets and/or broadening the range of solutions offered by the company. The company’s continued growth depends in part on its ability to find suitable acquisition candidates and to consummate and integrate acquisitions. To proceed, the prospect must have an appropriate valuation based on financial performance relative to acquisition price. However, acquisitions always present risks and uncertainties that could have a material adverse impact on the company’s business and results of operations.

 

Employees

As of March 31, 2007, Agilysys had 996 employees. The company is not a party to any collective bargaining agreements, has had no strikes or work stoppages and considers its employee relations to be excellent.

 

Markets

Agilysys sells its products principally in the United States and Canada and recently entered the China, Hong Kong and U.K. markets through acquisition. Sales to customers outside of the United States and Canada are not a significant portion of the company’s sales.

Access to Information

Agilysys makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports available free of charge through its Internet site (http://www.agilysys.com) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The information posted on the company’s Internet site is not incorporated into this Annual Report on Form 10-K. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

 

In order to achieve our stated objectives, we need to engage in a substantial acquisition program that will require successful execution and efficient integration of such acquisitions.

Following the divestiture of the assets and operations of the KeyLink Systems Distribution Business, our acquisition strategy will be potentially larger in scope and size than our previous acquisition strategy. We cannot assure you that we will successfully manage the challenges of a more aggressive acquisition program. We may not be able to identify suitable acquisition candidates at prices we consider appropriate. If we do identify an appropriate acquisition candidate, we may not be able to successfully and satisfactorily negotiate the terms of the acquisition. Our management may not be able to effectively implement our acquisition program and internal growth strategy simultaneously. Our failure to identify, consummate or integrate suitable acquisitions could lead to a reduced rate of revenue growth, operating income and net earnings in the future. We cannot readily predict the timing, size or success of our future acquisitions.

 

We may not successfully integrate recent or future acquisitions.

The integration of acquisitions involves a number of risks and presents financial, managerial and operational challenges. We may have difficulty, and may incur unanticipated expenses related to, integrating management and personnel from these acquired entities with our management and personnel. Failure to successfully integrate recent acquisitions or future acquisitions could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Our business could be materially adversely affected as a result of information technology risks inherent in supporting a changing business.

We may not be able to successfully manage the increased scope of our operations or a significantly larger and more geographically diverse workforce as we expand. Additionally, growth increases the demands on our management, our internal systems, procedures and controls. Our current information systems environment is principally designed for the distribution business. We may be unable to successfully support and implement improvements to our information and control systems in an efficient or timely manner as we now operate solely within the IT solutions business.

 

Initially our profitability will be dependent upon restructuring and executing planned cost savings.

If our cost reduction efforts are ineffective or our estimates of costs available to be saved are inaccurate, our revenues and profitability could be negatively impacted. We may not be successful in achieving the operating efficiencies and operating cost reductions expected from these efforts, and may experience business disruptions associated with the restructuring and cost reduction activities. These efforts may not produce the full efficiency and cost reduction benefits that we expect. Further, such benefits may be realized later than expected, and the costs of implementing these measures may be greater than anticipated. If these efforts are not successful, we intend to undertake additional cost reduction efforts, which could result in future charges.

 

We will be dependent on a long-term product procurement agreement with Arrow Electronics, Inc.

We have entered into a long-term product procurement agreement to purchase a wide variety of products from Arrow Electronics, Inc. Our success will be dependent on competitive pricing and availability of products on a timely basis.

 

We are highly dependent on key suppliers and supplier programs.

We presently depend on a small number of key suppliers, including IBM and HP. The loss of either of these suppliers or a combination of certain other suppliers could have a material adverse effect on the company’s business, results of operations and financial condition. From time to time, a supplier may terminate the company’s right to sell some or all of a supplier’s products or change the terms and conditions of

the supplier relationship or reduce or discontinue the incentives or programs offered. Any such termination or implementation of such changes could have a material negative impact on the company’s results of operations.

 

The market for our products and services is affected by changing technology and if we fail to anticipate and adapt to such changes, our results of operations may suffer.

The markets in which the company competes are characterized by technological change, new product introductions, evolving industry standards and changing needs of customers. The company’s future success will depend on its ability to anticipate and adapt to changes in technology and industry standards. If the company fails to successfully manage the challenges of rapidly changing technology, the company’s results of operations may suffer.

 

Market factors could cause a decline in spending for information technology, adversely affecting our financial results.

Our revenue and profitability depend on the overall demand for our products and services. Delays or reductions in demand for information technology by end users could materially adversely affect the demand for our products and services. If the markets for our products and services soften, our business, results of operations or financial condition could be materially adversely affected.

None.

The company’s principal corporate offices are located in a 10,387 square foot facility in Boca Raton, Florida. As of March 31, 2007, the company owned or leased a total of approximately 317,764 square feet of space for its continuing operations, of which approximately 127,316 square feet is devoted to product distribution and sales offices. The company’s major leases contain renewal options for periods of up to 10 years. For information concerning the company’s rental obligations, see the discussion of contractual obligations under Item 7 as well as note 7 to the consolidated financial statements contained in Part IV hereof. The company believes that its product distribution and office facilities are well maintained, are suitable and provide adequate space for the operations of the company.

The company’s facilities of 75,000 square feet or larger, as of March 31, 2007, are set forth in the table below.

 

The company is not a party to any material pending legal proceedings other than ordinary routine litigation incidental to its business.

A special meeting of shareholders was held on March 12, 2007 to approve the sale of the assets and operations of the company’s KeyLink Systems Distribution Business to Arrow Electronics, Inc. Shareholders voted as follows:

 

The information provided below is furnished pursuant to Instruction 3 to Item 401(b) of Regulation S-K. The following table sets forth the name, age, current position and principal occupation and employment during the past five years through June 1, 2007 of the company’s executive officers.

There is no relationship by blood, marriage or adoption among the listed officers. Mr. Rhein holds office until terminated as set forth in his employment agreement. All other executive officers serve until his or her successor is elected and qualified.

 

Executive Officers of the Registrant

 

part II

The company’s common shares, without par value, are traded on the NASDAQ Stock Market LLC. Common share prices are quoted daily under the symbol “AGYS.” The high and low market prices and dividends per share for the common shares for each quarter during the past two years are presented in the table below.

 

 

As of June 1, 2007, there were 31,395,348 common shares of Agilysys, Inc. outstanding, and there were 2,248 shareholders of record. The closing price of the common shares on June 1, 2007, was $22.16.

Cash dividends on common shares are payable quarterly upon authorization by the Board of Directors. Regular payment dates are the first day of August, November, February and May. The company expects to continue to pay similar cash dividends on its common shares.

The company maintains a Dividend Reinvestment Plan whereby cash dividends and additional monthly cash investments up to a maximum of $5,000 per month may be invested in the company’s common shares at no commission cost.

The company has adopted a Shareholder Rights Plan. For further information about the Shareholder Rights Plan, see note 14 to the consolidated financial statements contained in Part IV hereof.

Shareholder Return Performance Presentation

 

The following chart compares the value of $100 invested in the Common Shares with a similar investment in the Russell 2000 Index (the “Russell 2000”) and the companies listed in the SIC Code 5045-Computer and Computer Peripheral Equipment and Software (the Company’s “Peer Group”) for the period March 31, 2002 through March 31, 2007:

 

 

The following selected consolidated financial and operating data has been derived from the audited consolidated financial statements of the company and should be read in conjunction with the company’s consolidated financial statements and notes thereto, and Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are elsewhere included in this Annual Report on Form 10-K.

 

 

 

The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of Agilysys, Inc.’s consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and related notes that appear elsewhere in this document. Information set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” may include forward-looking statements that involve risks and uncertainties. Many factors could cause actual results to differ materially from those contained in the forward-looking statements. See “Forward-Looking Information” below and Item 1A “Risk Factors” in Part I of this annual report on Form 10-K for additional information concerning these items.

 

Overview

 

Agilysys, Inc. (“Agilysys” or “company”) is a leading provider of innovative IT solutions to corporate and public-sector customers, with special expertise in select vertical markets, including retail and hospitality. The company uses technology — including hardware, software and services — to help customers resolve their most complicated IT needs. The company possesses expertise in enterprise architecture and high availability, infrastructure optimization, storage and resource management, and business continuity; and provides industry-specific software, services and expertise to the retail and hospitality markets. Headquartered in Boca Raton, Florida, Agilysys operates extensively throughout North America, with additional sales offices in the United Kingdom and China.

In March 2007, Agilysys completed the sale of the assets and operations of its KeyLink Systems Group (“KSG”) to Arrow Electronics, Inc. for $485 million in cash, subject to a working capital adjustment. Through the sale of KSG, Agilysys exited all distribution-related businesses and now exclusively sells directly to end-user customers. By monetizing the value of the KSG distribution assets, Agilysys significantly increased its financial flexibility to redeploy the proceeds to accelerate growth, both organically and through acquisition, of its IT solutions business. With the sale of KSG, the company has established the following long-term goals:

For financial reporting purposes, the operating results of KSG have been classified as discontinued operations for all periods presented. Accordingly, the discussion and analysis presented below reflects the continuing business of Agilysys.

With respect to the remaining IT solutions business, the company continued to accelerate growth through the acquisition of Visual One Systems, Corp. (“Visual One”) in 2007. The acquisition of Visual One provides Agilysys expertise around the development, marketing and sale of Microsoft^® Windows^®-based software for the hospitality industry, including additional applications in property management, condominium, golf course, spa, point-of-sale, and sales and catering management. The company announced three additional acquisitions shortly after year-end, Stack Computer (“Stack”), Innovative Systems Design, Inc. (“Innovative”), and InfoGenesis, Inc. (“InfoGenesis”). Stack is a premier technology integrator with a strong focus in high availability storage infrastructure solutions. Stack’s customers, primarily concentrated on the West Coast, include leading corporations in the financial services, healthcare and manufacturing industries. Innovative is the largest U.S. commercial reseller of Sun Microsystems servers and storage products. InfoGenesis is an independent software vendor and solution provider to the hospitality market, offering enterprise-class point-of-sale solutions that provide end-users a highly intuitive, secure and easy way to process customer transactions. These acquisitions complement the company’s growth strategy to acquire businesses that enhance and differentiate its product and services offerings, broaden its customer base, and expand its markets.

The following discussion of the company’s results of operations and financial condition is intended to provide information that will assist in understanding the company’s financial statements, including key changes in financial statement components and the primary factors that accounted for those changes.

 

Results of Operations

 

2007 Compared with 2006

 

Net Sales and Operating Loss

 

Net sales.  The $5.6 million increase in net sales was driven by an increase in services revenue. Proprietary service revenue increased $3.0 million year-over-year. The increase in proprietary service revenue was principally due to higher revenues generated from the company’s hospitality solutions group. Remarketed service revenue, which is classified on a “net” basis within the statement of operations, increased $2.7 million year-over-year. The increase in remarketed service revenue was principally due to higher sales volume of HP remarketed services.

Gross Margin.  The $13.7 million increase in gross margin was driven by the overall increase in sales as well as a higher mix of software and service revenue, which traditionally result in higher gross margin.

Operating Expenses.  The company’s operating expenses consist of selling, general, and administrative (“SG&A”) expenses and restructuring (credits) charges. The $10.1 million increase in SG&A expenses was mainly driven by the following key factors: incremental operating expenses of $3.0 million associated with the company’s entrance into the China market, incremental operating expenses of $0.9 million related to the acquisition of Visual One, share-based compensation expense of $3.6 million; offset by a $2.5 million decline in bad debt expense. Regarding the increase in stock-based compensation expense, the company began to expense stock option awards at the beginning of 2007 upon adoption of Statement 123R. Regarding the decline in bad debt expense, the company continued to experience an overall improvement in its accounts receivable base. The remaining increase in SG&A was principally due to higher compensation and benefits costs driven by annual wage increases for the company’s employee base.

Restructuring (credits) charges decreased $7.9 million during 2007. The decline was principally due to the $4.9 million reversal of the remaining restructuring liability that was initially recognized in 2003 for an unutilized leased facility. In connection with the sale of KSG, management determined that the company would utilize the leased facility to house the majority of its remaining IT Solutions Business and corporate personnel. Accordingly, the reversal of the remaining restructuring liability was classified as a restructuring credit in the

consolidated statement of operations. The restructuring credit was offset by a charge of approximately $1.7 million for the termination of a facility lease that was previously exited as part of a prior restructuring effort and a $0.5 million charge for one-time termination benefits resulting from a workforce reduction that was executed in connection with the sale of the Company’s KeyLink Systems Distribution Business Additionally, 2006 included charges of $4.2 million to consolidate a portion of the company’s operations to reduce costs and increase future operating efficiencies. As part of the 2006 restructuring effort, the company exited certain leased facilities, reduced its workforce and executed a senior management realignment and consolidation of responsibilities.

 

Other (Income) Expenses

 

Other (expense) income, net.  The $7.1 million unfavorable change in other expense (income), net was principally due to a $0.9 million decline in earnings from the company’s equity method investment and $5.9 million impairment charge for the write-down of the company’s equity method investment to its estimated realizable value. The write-down was driven by changing market conditions and the equity method investee’s recent operating losses that indicated an other-than-temporary loss condition.

Interest expense.  The $3.3 million favorable change in interest expense was largely driven by the company’s lower debt level resulting from the retirement of its 9.5% Senior Notes in August 2006.

Loss on redemption of Mandatorily Redeemable Convertible Trust Preferred Securities.  In connection with the company’s redemption of its 6.75% Mandatorily Redeemable Convertible Trust Preferred Securities (“Trust Preferred Securities”) in the first quarter of 2006, the company wrote off deferred financing fees of $2.7 million. The financing fees, incurred at the time of issuing the Trust Preferred Securities, were being amortized over a 30-year period ending on March 31, 2028, which was the maturity date of the Trust Preferred Securities. The write off of deferred financing fees, along with the $2.1 million premium paid for the redemption, resulted in a loss of $4.8 million in 2006.

 

Income Taxes

The company recorded an income tax benefit from continuing operations at an effective tax rate of 14.3% in 2007 compared with an income tax benefit at an effective rate of 26.0% in 2006. The decrease in the rate is primarily attributable to the indefinite reinvestment of all earnings (losses) generated by the company’s foreign equity method investment, including the 2007 impairment charge recognized by the company for the write-down of its investment. In 2007, the company recognized a tax benefit (reduction in valuation allowance) for $1.2 million of Canada deferred tax assets.

2006 Compared with 2005

 

Net Sales and Operating Loss

 

Net sales.  The $57.1 million increase in net product sales was principally driven by higher sales volume of proprietary, midrange, and industry standard server technology. The $34.8 million increase in service revenue was principally driven by incremental proprietary services sales from the company’s two business acquisitions in 2006.

Gross Margin.  The $18.5 million increase in gross margin was principally due to the overall increase in sales year-over-year. Gross margin percentage remained relatively consistent year-over-year.

Operating Expenses.  The company’s operating expenses consist of selling, general, and administrative (“SG&A”) expenses and restructuring charges. The $11.0 million increase in SG&A expenses was principally driven by incremental operating expenses associated with the company’s two business acquisitions made in 2006.

The $4.8 million increase in restructuring charges reflects restructuring efforts executed by the company in 2006. During the first half of 2006, the company consolidated a portion of its operations to reduce costs and increase future operating efficiencies. As part of that restructuring effort, the company exited certain leased facilities and reduced the workforce of its KeyLink Systems Group and professional services business. The company also executed a senior management realignment and consolidation of responsibilities. Costs incurred for one-time termination benefits and other associated costs resulting from the workforce reductions amounted to $2.5 million. These termination benefits were paid over the 12 months following termination. Costs incurred for the exit of leased facilities amounted to $1.7 million and represent the present value of qualifying exit costs, offset by an estimate for future sublease income. Facilities obligations, which will represent ongoing lease payments and common maintenance costs, are expected to continue to 2017.

Other (Income) Expenses

 

Other income, net.  The $0.9 million unfavorable change in other income, net was principally due to lower earnings from the company’s equity method investment, which decreased $1.4 million. The decrease in equity method investment income was offset by a $0.6 million gain realized upon partial redemption of the company’s cost investment by the investee.

Interest income.  The $1.7 million favorable change in interest income reflects higher yields earned on the company’s short term investments due to a rising interest rate environment experienced during 2006.

Loss (gain) on redemption of Trust Preferred Securities.  In connection with the company’s redemption of its 6.75% Trust Preferred Securities in the first quarter of 2006, the company wrote off deferred financing fees of $2.7 million. The financing fees, incurred at the time of issuing the Trust Preferred Securities, were being amortized over a 30-year period ending on March 31, 2028, which was the maturity date of the Trust Preferred Securities, The write off of deferred financing fees, along with the $2.1 million premium paid for the redemption, resulted in a loss of $4.8 million.

 

Income Taxes

The company recorded an income tax benefit from continuing operations at an effective tax rate of 26.0% in 2006 compared with an income tax benefit at an effective rate of 21.0% in 2005. The increase in the rate is primarily attributable to a $2.5 million valuation allowance established in 2005 for the Canadian subsidiary deferred tax assets, including net operating losses.

 

Off-Balance Sheet Arrangements

The company has not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Contractual Obligations

The following table provides aggregated information regarding the company’s contractual obligations as of March 31, 2007. These obligations are discussed in detail in the preceding paragraphs and notes 7 and 8 to the consolidated financial statements.

 

 

At March 31, 2007 the company had $3.6 million accrued for potential income tax uncertainties and $20.2 million accrued for employee benefit plan obligations, both of which are excluded from the contractual obligations table as the timing of payment cannot be reasonably estimated.

The company anticipates that cash on hand, funds from continuing operations, the revolving credit agreement, and access to capital markets will provide adequate funds to finance acquisitions, capital spending and working capital needs and to service its obligations and other commitments arising during the foreseeable future.

 

Liquidity and Capital Resources

 

Overview

The company’s operating cash requirements consist primarily of working capital requirements, scheduled payments of principal and interest on indebtedness outstanding and capital expenditures. The company believes that cash flow from operating activities, cash on hand, available borrowings under its credit facility, and access to capital markets will provide adequate funds to meet its short and long-term liquidity requirements.

As of March 31, 2007, the company’s total debt was approximately $0.1 million and consisted of capital lease obligations. As of March 31, 2006, the company’s total debt was approximately $59.7 million, and consisted of 9.5% Senior Notes, and capital lease obligations. The significant decrease in total debt from March 31, 2006 to March 31, 2007 is due to the retirement of the company’s 9.5% Senior Notes in August 2006.

 

Revolving Credit Facility

The company currently has available a $200 million unsecured credit facility (“Facility”) that expires in 2011. The Facility includes a $20 million sub-facility for letters of credit and a $20 million sub-facility for swingline loans. The Facility is available to refinance existing debt, provide for working capital requirements, capital expenditures and general corporate purposes of the company including acquisitions. Borrowings under the Facility will generally bear interest at various levels over LIBOR. The Facility contains restrictive and financial covenants that are normal and customary. At March 31, 2007, the company was not in violation of any of the Facilities covenants. There were no amounts outstanding under the Facility at March 31, 2007 or 2006.

 

Cash Flow

 

Cash flow provided by (used for) operating activities.  The $178.6 million increase in cash provided by operating activities was initiated by the $9.1 million improvement in loss from continuing operations. The remainder of the increase was principally driven by changes in working capital. Most notably, income taxes payable increased $130.9 million, principally due to the sale of KSG on March 31, 2007.

Cash flow provided by (used for) investing activities.  The $507.0 million increase in cash provided by (used for) investing activities was principally due to the $485.0 million proceeds received from the sale of KSG. Additionally, less cash was used in 2007 for business acquisitions compared with 2006. The company’s cash outflow for the acquisition of Visual One in 2007 was $10.6 million (net of cash acquired) compared with $28.0 million for the acquisitions of The CTS Corporations and the China and Hong Kong operations of Mainline Information Systems, Inc. (net of cash acquired). Additionally, the company acquired $6.8 million of marketable securities during 2006 to satisfy future obligations of its employee benefit plans. There were no marketable securities purchased in 2007.

Cash flow used for financing activities.  The $54.7 million decline in cash used for financing activities was principally driven by the company’s redemption of its Trust Preferred Securities in 2006 for a total cash outflow of $107.5 million. The absence of this cash outflow in 2007 was offset by the company’s retirement of its Senior Notes in 2007 for $59.4 million.

 

Commitments for Capital Expenditures

As discussed above, with the sale of KSG in 2007 the company will use a previously unutilized leased facility to house the majority of its remaining IT Solutions business and corporate personnel. The company expects to incur costs of approximately $5.5 million to complete certain shell and finish work in accordance with the lease agreement as well as leasehold improvements. These costs are anticipated to be funded from the cash flow of the company.

 

Critical Accounting Policies, Estimates & Assumptions

The company’s discussion and analysis of its financial condition and results of operations are based upon the company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the company to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. The company regularly evaluates its estimates, including those related to bad debts, inventories, investments, intangible assets, income taxes, restructuring and contingencies, litigation and supplier incentives. The company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

The company’s most significant accounting policies relate to the sale, purchase, and promotion of its products. The policies discussed below are considered by management to be critical to an understanding of the company’s consolidated financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. No material adjustments to the company’s accounting policies were made in 2007. Specific risks for these critical accounting policies are described in the following paragraphs.

For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.

Revenue recognition.  The company derives revenue from three primary sources: server and storage hardware, software, and services. Revenue is recorded in the period in which the goods are delivered or services are rendered and when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price to the customer is fixed or determinable, and collectibility is reasonably assured. The company reduces revenue for discounts, sales incentives, estimated customer returns and other allowances. Discounts are offered based on the volume of products and services purchased by customers. Shipping and handling fees billed to customers are recognized as revenue and the related costs are recognized in cost of goods sold.

Regarding hardware sales, revenue is generally recognized when the product is shipped to the customer and when there are not unfulfilled obligations that affect the customer’s final acceptance of the arrangement. A portion of the company’s hardware sales involves shipment directly from its suppliers to the end-user customers. In such transactions, the company is responsible for negotiating price both with the supplier and the customer, payment to the supplier, establishing payment terms with the customer and product returns, and bears credit risk if the customer does not pay for the goods. As the principal with the customer, the company recognizes revenue and cost of goods sold when it is notified by the supplier that the product has been shipped. In certain limited instances, as shipping terms dictate, revenue is recognized upon receipt at the point of destination.

Regarding software sales, the company offers proprietary software as well as remarketed software to its customers. Generally, software sales do not require significant production, modification, or customization at the time of shipment (physically or electronically) to the customer. As such, revenue from both proprietary and remarketed software sales is generally recognized when the software has been shipped. For software delivered electronically, delivery is considered to have occurred when the customer either takes possession of the software via downloading or has been provided with the requisite codes that allow for immediate access to the software.

Regarding sales of services, the company offers proprietary and third-party services to its customers. Proprietary services generally are as follows: consulting, installation, integration, and maintenance. Revenue relating to consulting, installation, and integration services is recognized when the service is performed. For certain long-term proprietary service contracts, the company follows the percentage-of-completion method of accounting. Accordingly, income is recognized in the ratio that work performed bears to estimated total work to be performed on the contract. Adjustments to contract price and estimated service hours are made periodically, and losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. The aggregate of billings on uncompleted contracts in excess of related costs is shown as a current liability. Revenue relating to maintenance services is recognized

evenly over the coverage period of the underlying agreement. In addition to proprietary services, the company offers third-party service contracts to its customers. In such instances, the supplier is the primary obligor in the transaction and the company bears credit risk in the event of nonpayment by the customer. Since the company is acting as an agent or broker with respect to such sales transactions, the company reports revenue only in the amount of the “commission” (equal to the selling price less the cost of sale) received rather than reporting revenue in the full amount of the selling price with separate reporting of the cost of sale.

Allowance for Doubtful Accounts.  The company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. These allowances are based on both recent trends of certain customers estimated to be a greater credit risk as well as historical trends of the entire customer pool. If the financial condition of the company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. To mitigate this credit risk the company performs frequent credit evaluations of its customers.

Inventories.  Inventories are stated at the lower of cost or market, net of related reserves. The cost of inventory is computed using a weighted-average method. The company’s inventory is monitored to ensure appropriate valuation. Adjustments of inventories to lower of cost or market, if necessary, are based upon contractual provisions governing price protection, stock rotation (right of return status), and technological obsolescence, as well as turnover and assumptions about future demand and market conditions. If assumptions about future demand change and/or actual market conditions are less favorable than those projected by management, additional adjustments to inventory valuations may be required. The company provides a reserve for obsolescence, which is calculated based on several factors including an analysis of historical sales of products and the age of the inventory. Actual amounts could be different from those estimated.

Deferred Taxes.  The carrying value of the company’s deferred tax assets is dependent upon the company’s ability to generate sufficient future taxable income in certain tax jurisdictions. Should the company determine that it is not able to realize all or part of its deferred tax assets in the future, an adjustment to the deferred tax assets is expensed in the period such determination is made to an amount that is more likely than not to be realized. The company presently records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that the company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount (including valuation allowance), an adjustment to the tax valuation allowance would decrease tax expense in the period such determination was made.

Goodwill and Long-Lived Assets.  In assessing the recoverability of the company’s goodwill and other long-lived assets, significant assumptions regarding the estimated future cash flows and other factors to determine the fair value of the respective assets must be made, as well as the related estimated useful lives. The fair value of goodwill is estimated using a discounted cash flow valuation model. If these estimates or their related assumptions change in the future as a result of changes in strategy or market conditions, the company may be required to record impairment charges for these assets in the period such determination was made.

Restructuring and Other Special Charges.  The company recorded a reserve in connection with reorganizing its ongoing business. The reserve principally includes estimates related to employee separation costs and the consolidation and impairment of facilities deemed inconsistent with continuing operations. Actual amounts could be different from those estimated. Determination of the impairment of assets is discussed above in Goodwill and Long-Lived Assets. Facility reserves are calculated using a present value of future minimum lease payments, offset by an estimate for future sublease income provided by external brokers. Present value is calculated using a credit-adjusted risk-free rate with a maturity equivalent to the lease term.

Valuation of Accounts Payable.  The company’s accounts payable has been reduced by amounts claimed to vendors for returns, price protection and other amounts related to incentive programs. Amounts related to price protection and other incentive programs are recorded as adjustments to cost of goods sold or operating expenses, depending on the nature of the program. There is a time delay between the submission of a claim by the company and confirmation of the claim by our vendors. Historically, the company’s estimated claims have approximated amounts agreed to by vendors.

Supplier Programs.  The company receives funds from suppliers for price protection, product sales incentives and marketing and training programs, which are generally recorded, net of direct costs, as adjustments to cost of goods sold or operating expenses according to the nature of the program. The product sales incentives are generally based on a particular quarter’s sales activity and are primarily formula-based. Some of these programs may extend over one or more quarterly reporting periods. The company accrues supplier sales incentives and other supplier incentives as earned based on sales of qualifying products or as services are provided in accordance with the terms of the related program. Actual supplier sales incentives may vary based on volume or other sales achievement levels, which could result in an increase or reduction in the estimated amounts previously accrued, and can, at times, result in significant earnings fluctuations on a quarterly basis.

Recently Issued Accounting Standards

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 ( “Statement 159”). Statement 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item will be reported in current earnings at each subsequent reporting date. Statement 159 also establishes presentation and disclosure requirements designed to draw comparison between the different measurement attributes the company elects for similar types of assets and liabilities. Statement 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The company does not expect the adoption of Statement 159 to have a material impact on its financial position, results of operations or cash flows.

In September 2006, the SEC released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. Prior practice allowed the evaluation of materiality on the basis of (1) the error quantified as the amount by which the current year income statement was misstated (rollover method) or (2) the cumulative error quantified as the cumulative amount by which the current year balance sheet was misstated (iron curtain method). SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 by the company in 2007 did not have a material impact on its financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, and amendment of FASB Statements No. 87, 88, 106, and 132(R) (“Statement 158”). Statement 158 requires companies with publicly traded equity securities that sponsor postretirement benefit plans to fully recognize, as an asset or liability, the overfunded or underfunded status of its benefit plans in its balance sheet. The funded status is measured as the difference between the fair value of the plan’s assets and its benefit obligation. Statement 158 also requires companies to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The company was required to adopt the recognition and disclosure provisions of Statement 158 on March 31, 2007. As a result of adopting Statement 158 on March 31, 2007, the company’s Supplemental Executive Retirement Plan benefit obligation increased $3.7 million before taxes, with a corresponding offset to accumulated other comprehensive loss.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“Statement 157”). Statement 157 provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. Statement 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS No. 123R and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for the company on April 1, 2008. The company does not expect the adoption of Statement 157 to have a material impact on its financial position, results of operations or cash flows.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of SFAS No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. The pronouncement prescribes a recognition threshold and measurement attributable to financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition associated with tax positions. FIN 48 is effective for the company as of April 1, 2007. The cumulative effect of applying the provisions of FIN 48 will be reported by the company in its first quarter of fiscal year 2008 consolidated financial statements as an adjustment to the beginning balance of retained earnings. The company is currently evaluating the effect the adoption of FIN 48 will have on its financial position, results of operations and related disclosures; however, the company expects that the adoption of the pronouncement may decrease the beginning balance of retained earnings within a range of $2.5 million to $4.0 million. This estimate is subject to revision as the company continues its analysis.

 

Business Combinations

 

2007 Acquisition

 

Visual One Systems Corporation

On January 23, 2007, the company acquired Visual One Systems Corporation, a leading developer and marketer of Microsoft^® Windows^® -based software for the hospitality industry. Accordingly, the results of operations for Visual One Systems have been included in the accompanying consolidated financial statements from that date forward. The acquisition provides Agilysys additional expertise

around the development, marketing and sale of software applications for the hospitality industry, including property management, condominium, golf course, spa, point-of-sale, and sales and catering management applications. Visual One Systems customers include well-known North American and international full-service hotels, resorts, conference centers and condominiums of all sizes. The aggregate acquisition cost was $14.3 million. Based on management’s preliminary allocation of the acquisition cost to the net assets acquired, approximately $11.9 million has been assigned to goodwill. The company is still in the process of valuing certain intangible assets; accordingly, allocation of the acquisition cost is subject to modification in the future. Goodwill resulting from the Visual One Systems acquisition will not be deductible for income tax purposes.

 

2006 Acquisitions

 

Mainline China and Hong Kong

On December 8, 2005, the company acquired the China and Hong Kong operations of Mainline Information Systems, Inc. Accordingly, the results of operations for the China and Hong Kong operations have been included in the accompanying consolidated financial statements from that date forward. The business specializes in IBM information technology enterprise solutions for large and medium-sized businesses and banking institutions in the China market, and has sales offices in Beijing, Guangzhou, Shanghai and Hong Kong. The business provides the company the opportunity to begin operations in China with a nucleus of local workforce. The aggregate acquisition cost for the China and Hong Kong operations was $0.8 million. Based on management’s allocation of the acquisition cost to the net assets acquired, approximately $0.8 million was assigned to goodwill. Goodwill resulting from the acquisition of the China and Hong Kong acquisitions will not be deductible for income tax purposes.

 

The CTS Corporations

On May 31, 2005, the company acquired The CTS Corporations, a leading independent services organization, specializing in information technology storage solutions for large and medium-sized corporate customers and public-sector clients. Accordingly, the results of operations for CTS have been included in the accompanying consolidated financial statements from that date forward. The addition of CTS enhances the company’s offering of comprehensive storage solutions. The aggregate acquisition cost was $27.8 million, which included repayment of $2.6 million of CTS debt. Based on management’s initial allocation of the acquisition cost to the net assets acquired, approximately $17.6 million was assigned to goodwill in 2006. Additionally, specifically identifiable intangible assets were assigned a fair value of $9.8 million. Of the intangible assets acquired, $9.4 million was assigned to customer relationships, which is being amortized over ten years using an accelerated method and $0.4 million was assigned to non-compete agreements, which are being amortized over four years using the straight-line method. During 2007, the company adjusted the estimated fair value of acquired tax assets by $0.8 million, with a corresponding decrease to goodwill. Goodwill resulting from the CTS acquisition will not be deductible for income tax purposes.

 

Discontinued Operations

 

Sale of KeyLink Systems Distribution Business Assets and Operations

During 2007, the company sold the assets and operations of its KeyLink Systems Distribution Business (“KSG”) for $485.0 million in cash, subject to a working capital adjustment. At March 31, 2007, the preliminary working capital adjustment was $10.0 million, which is subject to preparation and review of the final closing balance sheet. Through the sale of KSG, the company exited all distribution-related businesses and exclusively sells directly to end-user customers. By monetizing the value of KSG, the company significantly increased its financial flexibility and intends to redeploy the proceeds to accelerate the growth, both organically and through acquisition, of its IT Solutions Business. The sale of KSG represented a disposal of a component of an entity. As such, the operating results of KSG, along with the gain on sale, have been reported as a component of discontinued operations.

 

Sale of Industrial Electronics Division Business

During 2003, the company announced its strategic transformation to focus solely on its enterprise computer systems business. The transformation included the sale of substantially all of the assets and liabilities of IED, which distributed semiconductors, interconnect, passive and electromechanical components, power supplies and embedded computer products in North America and Germany. In connection with the sale of IED, the company discontinued the operations of Aprisa, Inc. (“Aprisa”), which was an internet-based start up corporation that created customized software for the electronic components market. The disposition of IED and discontinuance of Aprisa represented a disposal of a component of an entity. The company continues to incur certain costs related to IED and Aprisa, which are reported as a component of discontinued operations. Such costs primarily relate to retained leases.

Components of Results of Discontinued Operations

For 2007, income from discontinued operations was comprised of the following:

 

 

Restructuring Charges

 

2007 Restructuring Activity

During 2007, the company recorded a restructuring charge of approximately $0.5 million for one-time termination benefits resulting from a workforce reduction that was executed in connection with the sale of KSG. The workforce reduction was comprised mainly of corporate personnel. The majority of one-time termination benefits associated with the workforce reduction will be paid during 2008. The company also recorded a charge of $1.7 million for the termination of a facility lease.

In addition to the restructuring charge noted above, the company recognized a $4.9 million restructuring credit for the reversal of the remaining restructuring liability that was initially recognized in 2003 for an abandoned leased facility. In connection with the sale of KSG, management determined that the company would utilize the leased facility to house the majority of its remaining IT Solutions Business and corporate personnel. Accordingly, the reversal of the remaining restructuring liability was classified as a restructuring credit in the consolidated statement of operations.

 

2006 Restructuring Activity

During 2006, the company recorded restructuring charges of $4.2 million to consolidate a portion of its operations in order to reduce costs and increase operating efficiencies. Costs incurred in connection with the restructuring comprised one-time termination benefits and other associated costs resulting from workforce reductions as well as facilities costs relating to the exit of certain leased facilities. Facilities costs represented the present value of qualifying exit costs, offset by an estimate for future sublease income. As part of the restructuring effort, the company incurred costs of $1.7 million to shut-down certain leased facilities, of which approximately $0.1 million remains to be paid at March 31, 2007. The remaining $2.5 million of the restructuring charge was incurred to reduce the workforce of KSG, professional services business and to execute a senior management realignment and consolidation of responsibilities. The one-time termination benefits associated with the workforce reduction were paid as of March 31, 2007.

 

Investments

 

Investment in Marketable Securities

The company invests in marketable securities to satisfy future obligations of its employee benefit plans. The marketable securities are held in a Rabbi Trust. The company’s investment in marketable equity securities are held for an indefinite period and thus are classified as available for sale. The aggregate fair value of the securities at March 31, 2007 was $6.2 million. During 2007, sale proceeds and realized gain were $1.1 million and $6,500, respectively. The company used the sale proceeds to fund corporate-owned life insurance policies.

 

Investments in Affiliated Companies

The company maintains an equity interest in Magirus AG (“Magirus”), a privately-owned European enterprise computer systems distributor headquartered in Stuttgart, Germany. The company has a 20% interest in Magirus and accounts for the investment under the equity method. Because of changing market conditions, Magirus has recently experienced several consecutive quarterly operating losses which indicated an other than temporary loss condition. Accordingly, at March 31, 2007, the company’s investment has been written down to its estimated realizable value. The amount of the write-down of $5.9 million was charged to operations in 2007.

During 2006, a portion of the company’s investment in an affiliated company was redeemed by the affiliated company for $2.2 million, of which $1.4 million was a non-cash exchange and $0.8 million was received in cash. The investment, which is accounted for using the cost method, had a carrying value of $1.6 million, resulting in a $0.6 million gain on redemption of investment in the affiliated company.

 

Stock Based Compensation

The company accounts for stock based compensation in accordance with the fair value recognition provisions of Statement 123R, which was adopted on April 1, 2006. The company adopted the provisions of Statement 123R using the modified prospective application and, accordingly, results for prior periods have not been restated. Prior to April 1, 2006, the company accounted for stock based compensation in accordance with the intrinsic value method. As such, no stock based employee compensation cost was recognized by the company for stock option awards, as all options granted to employees had an exercise price equal to the market value of the underlying stock on the date of grant.

Compensation cost charged to operations relating to stock options during 2007 was $3.6 million. As of March 31, 2007, total unrecognized stock based compensation expense related to non-vested stock options was $2.9 million, which is expected to be recognized over a weighted-average period of 16 months.

 

Risk Control and Effects of Foreign Currency and Inflation

The company extends credit based on customers’ financial condition and, generally, collateral is not required. Credit losses are provided for in the consolidated financial statements when collections are in doubt.

The company sells internationally and enters into transactions denominated in foreign currencies. As a result, the company is subject to the variability that arises from exchange rate movements. The effects of foreign currency on operating results did not have a material impact on the company’s results of operations for the 2007, 2006 or 2005 fiscal years.

The company believes that inflation has had a nominal effect on its results of operations in fiscal 2007, 2006 and 2005 and does not expect inflation to be a significant factor in fiscal 2008.

 

Forward Looking Information

Portions of this report contain current management expectations, which may constitute forward-looking information. When used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere throughout this Annual Report on Form 10-K, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect management’s current opinions and are subject to certain risks and uncertainties that could cause actual results to differ materially from those stated or implied.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Risks and uncertainties include, but are not limited to: competition, dependence on the IT market, softening in the computer network and platform market, rapidly changing technology and inventory obsolescence, dependence on key suppliers and supplier programs, risks and uncertainties involving acquisitions, instability in world financial markets, downward pressure on gross margins, the ability to meet contractual obligations based on the impact of previously described factors and uneven patterns of quarterly sales.

The company has assets, liabilities and cash flows in foreign currencies creating foreign exchange risk. Systems are in place for continuous measurement and evaluation of foreign exchange exposures so that timely action can be taken when considered desirable. Reducing exposure to foreign currency fluctuations is an integral part of the company’s risk management program. Financial instruments in the form of forward exchange contracts are employed, when deemed necessary, as one of the methods to reduce such risk. There were no foreign currency exchange contracts executed by the company during 2007, 2006, or 2005.

The company is currently exposed to interest rate risk from the floating-rate pricing mechanisms on its revolving credit facility; however, there were no borrowings under the credit facility in 2007, 2006, or 2005.

The information required by this item is set forth beginning at page 29 of this Annual Report on Form 10-K.

None.

 

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

 

Management’s Report on Internal Control Over Financial Reporting

The management of Agilysys, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2007 based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, management has concluded that it maintained effective internal control over financial reporting as of March 31, 2007.

Management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2007 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.

 

Change in Internal Control over Financial Reporting

No change in our internal control over financial reporting occurred during the company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

None.

part III

Information required by this Item as to the Directors of the company, the Audit Committee and the procedures by which shareholders may recommend nominations appearing under the headings “Election of Directors” and “Corporate Governance and Related Matters” in the company’s Proxy Statement to be used in connection with the company’s 2007 Annual Meeting of Shareholders to be held on July 27, 2007 (the “2007 Proxy Statement”) is incorporated herein by reference. Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 by the company’s Directors, executive officers, and holders of more than five percent of the company’s equity securities will be set forth in the 2007 Proxy Statement under the heading “Section 16 (a) Beneficial Ownership Reporting Compliance.” Information required by this Item as to the executive officers of the company is included as Item 4A in Part I of this Annual Report on Form 10-K as permitted by Instruction 3 to Item 401(b) of Regulation S-K.

The company has adopted a code of ethics that applies to the Chief Executive Officer, Chief Financial Officer, and Controller known as the “Code of Ethics for Senior Financial Officers” as well as a code of business conduct that applies to all employees of the company known as the “Code of Business Conduct.” Each of these documents is available on the company’s website at http://www.agilysys.com.

The information required by this Item is set forth in the company’s 2007 Proxy Statement under the headings, “Executive Compensation” and “Corporate Governance Related Matters.”

The information required by this Item is set forth in the company’s 2007 Proxy Statement under the headings “Share Ownership,” and “Equity Compensation Plan Information,” which information is incorporated herein by reference.

The information required by this item is set forth in the company’s 2007 Proxy Statement under the headings “Corporate Governance and Related Matters” and “Related Person Transactions,” which information is incorporated herein by reference.

The information required by this Item is set forth in the company’s 2007 Proxy Statement under the heading “Independent Registered Public Accounting Firm,” which information is incorporated herein by reference.

part IV

(a)(1) Financial statements.  The following consolidated financial statements are included in this Annual Report on Form 10-K beginning on page 27:

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

Consolidated Statements of Operations for the years ended March 31, 2007, 2006, and 2005

Consolidated Balance Sheets as of March 31, 2007 and 2006

Consolidated Statements of Shareholders’ Equity for the years ended March 31, 2007, 2006, and 2005

Consolidated Statements of Cash Flows for the years ended March 31, 2007, 2006, and 2005

Notes to the Consolidated Financial Statements

 

(a)(2) Financial statement schedule.  The following financial statement schedule is included in this Annual Report on Form 10-K on page 56:

Schedule II — Valuation and Qualifying Accounts

 

All other schedules have been omitted since they are not applicable or the required information is included in the consolidated financial statements or notes thereto.

 

(a)(3) Exhibits.  See the Index to Exhibits beginning at page 57 of this Annual Report on Form 10-K.

signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Agilysys, Inc. has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Cleveland, State of Ohio, on June 12, 2007.

 

AGILYSYS, INC.

 

Arthur Rhein

Chairman, President, Chief Executive Officer and Director

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities as of June 12, 2007.

 

agilysys, inc. and subsidiaries

 

 

ANNUAL REPORT ON FORM 10-K

Year Ended March 31, 2007

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

report of ernst & young llp, independent registered public accounting firm

The Board of Directors and Shareholders

of Agilysys, Inc. and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of Agilysys, Inc. and subsidiaries as of March 31, 2007 and 2006, and the related consolidated statements of operations, cash flows and shareholders’ equity for each of the three years in the period ended March 31, 2007. We have also audited the accompanying financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Agilysys, Inc. and subsidiaries at March 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2007, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, on April 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, and on March 31, 2007, the Company adopted Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Agilysys, Inc. and subsidiaries’ internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 8, 2007 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

June 8, 2007

report of ernst & young llp, independent registered public accounting firm on internal control over financial reporting

The Board of Directors and Shareholders

of Agilysys, Inc. and Subsidiaries

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting included elsewhere herein, that Agilysys, Inc. and subsidiaries maintained effective internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Agilysys, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Agilysys, Inc. and subsidiaries maintained effective internal control over financial reporting as of March 31, 2007, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Agilysys, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 31, 2007, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Agilysys, Inc. and subsidiaries as of March 31, 2007 and 2006 and the related consolidated statements of operations, cash flows and shareholders’ equity for each of the three years in the period ended March 31, 2007, and our report dated June 8, 2007 expressed an unqualified opinion thereon.

 

 

Cleveland, Ohio

June 8, 2007

agilysys, inc. and subsidiaries

 

 

 

See accompanying notes to consolidated financial statements.

agilysys, inc. and subsidiaries

 

 

 

See accompanying notes to consolidated financial statements.

agilysys, inc. and subsidiaries

 

 

 

See accompanying notes to consolidated financial statements.

agilysys, inc. and subsidiaries