UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K
AGILYSYS, INC.ANNUAL REPORT ON FORM 10-KYear Ended March 31, 2006TABLE OF CONTENTS
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casinos and many of the largest resorts use Agilysys to design, implement and support their property management systems (“PMS”) for the hotel front office, management accounting, customer service and housekeeping functions. Lodging Management Systems (“LMS”) by Agilysys is the hospitality industry’s leading property management software solution. Designed specifically to meet the unique needs of the hospitality industry, the comprehensive solution automates every aspect of hotel operations, allowing properties to provide a higher level of service more efficiently and more cost-effectively. Agilysys supplements its LMS offering with a Materials Management System (“MMS”) that enables the tracking and replenishment of food, beverage and other perishable and non-perishable inventory. In addition to gaming customers, the market for the MMS products includes restaurant chains and public arenas. With the acquisition of IAD, the company also develops and markets proprietary document management solutions, DataMagine, with a focus on the hospitality, health care, retail and government markets. DataMagine enables the capture, storage, control, manipulation and distribution of scanned and electronically originated images. In May 2005, the company acquired The CTS Corporations (“CTS”), a leading, independent services organization, specializing in information technology storage solutions for large and medium-sized corporate customers and public-sector clients. The addition of CTS enhances the company’s offering of comprehensive storage and enterprise infrastructure solutions. In December 2005, the company entered the China and Hong Kong markets through the purchase of the China and Hong Kong operations of Mainline Information Systems, Inc. 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, Hong Kong and Macau. Agilysys expects this business to provide it an opportunity to quickly begin operations in China with a nucleus of local talented people. Additionally, the company plans to expand the scope of products and services offered through this business.IndustryThe worldwide IT products and services industry generally consists of (1) hardware suppliers and software developers which sell directly to distributors, solution providers, resellers and end-users, (2) distributors, which sell to solution providers and resellers and, (3) solution providers and resellers, which sell directly to end-users. A variety of solution provider and reseller categories exist, including value-added resellers (“VARs”), corporate resellers, systems integrators, independent software vendors (ISVs), direct marketers and independent dealers. The large number of resellers makes it cost-efficient for suppliers and software developers to rely on a small number of distributors to serve this diverse customer base. Similarly, due to the large number of suppliers and products, solution providers and resellers often cannot or choose not to establish direct purchasing relationships. As a result, many of these companies are heavily dependent on distribution partners, such as Agilysys, that possess the necessary systems infrastructure, capital, inventory availability, and distribution and integration facilities to provide fulfillment and other services, such as financing, logistics, marketing and technical support. These services allow solution providers and resellers to reduce or eliminate their inventory and warehouse requirements, and reduce their staffing needs for marketing and systems integration, thereby reducing their costs. Enterprise computer products distribution continues to perform a vital role in delivering IT products to market in an efficient, cost-effective manner. Manufacturers are pursuing strategies to outsource functions such as logistics, market development services, order management and technical support to supply chain partners as they look to minimize costs and investments in pre- and post-sales support and focus on their core competencies. Distribution plays an important role in this outsource strategy by allowing the manufacturers to decrease fixed costs as the distributors deliver a streamlined approach to an extended customer base through their technically skilled sales organization. The company also believes that suppliers will continue to embrace the distribution channel for enterprise computer technology solutions in order to maintain sales, marketing and technical expertise in key markets such as the mid-market sector through distribution and the extended reseller network. The economies of scale and reach of large industry-leading enterprise computer solutions providers are expected to continue to be significant competitive advantages in this marketplace. Fiscal 2006 results were favorably impacted by increased marketing by Agilysys of its enterprise computer technology solutions, combined with an improving U.S. capital spending environment for information technology. According to information published in March 2005 by IDC, a leading provider of technology intelligence and market data, U.S. IT spending is projected to grow at approximately six percent in calendar year 2006. Since Agilysys is well entrenched in the server, storage and software markets, 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.2
Products and Services Distributed and Sources of SupplyAgilysys focuses on the distribution and reselling of three specific product areas — server and storage hardware, software and services. The company offers mid-range enterprise servers, comprehensive storage solutions including hardware and software, and database, Internet and systems management software. These products are packaged together as new systems or to enhance existing systems, depending on the customer’s needs. The company also resells supplier-provided services as well as proprietary services. Total revenues for the company’s three specific product areas are as follows:
provisions reduce the company’s risk of loss due to slow-moving inventory, supplier price reductions, product updates or obsolescence. In some cases, the industry practices discussed above are not embodied in agreements and do not protect the company in all cases from declines in inventory value. However, the company believes that these practices provide a significant level of protection from such declines, although no assurance can be given that such practices will continue or that they will adequately protect Agilysys against declines in inventory value. In addition, the company’s results of operations depend in part on successful management of the challenges of rapidly changing technology.CustomersAgilysys serves customers in most major and secondary markets of North America. The company’s customer base includes VARs, which often are privately held with annual sales that range from approximately $10 million to $400 million, and corporate end-users, which range from medium to large corporations, as well as the public sector. A substantial amount of the company’s business, whether through resellers or direct to end-users, is in the mid-market customer segment. No single customer accounted for more than 10 percent of Agilysys total sales during 2006, 2005, or 2004.Uneven Sales Patterns and SeasonalityThe 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 31%, 32%, and 33% of annual revenues for 2006, 2005, and 2004, 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.BacklogThe company historically has not had a significant backlog of orders. There was no significant backlog at March 31, 2006.CompetitionThe distribution and reselling of enterprise 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 distributors, resellers and occasionally with some of its suppliers. Several of the company’s distribution competitors are significantly larger primarily due to their international distribution presence as well as participation in other businesses; whereas, the company’s solution provider and reseller competitors are typically smaller. Also, it is possible that certain suppliers may decide to distribute products directly, which would further heighten competitive pressures.Growth through AcquisitionsWith 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.EmployeesAs of March 31, 2006, Agilysys had 1,483 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.MarketsAgilysys sells its products principally in the United States and Canada and recently entered the China and Hong Kong markets through acquisition. Sales to customers outside of the United States and Canada are not a significant portion of the company’s sales.4
Access to InformationAgilysys 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.Item 1A. Risk Factors." -->
The company’s business could be materially adversely affected as a result of the risks associated with acquisitions and investments.As part of the company’s business strategy, the company seeks acquisition prospects that could accelerate the growth of its business by expanding its customer base, extending its reach into new markets and/or broadening the range of solutions it offers. However, acquisitions always present risks and uncertainties. These factors could have a material adverse effect on the company’s business, results of operations or financial condition.Item 1B. Unresolved Staff Comments." -->
Executive Officers of the Registrant
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Item 6. Selected Financial Data." -->
margin software and services offerings. These performance improvements, combined with management’s successful efforts to control operating costs, resulted in a 31.6% increase in operating income year-over-year. The company continued to increase its financial flexibility during 2006 with the redemption of its 6.75% Convertible Trust Preferred Securities, which eliminated the associated annual distribution on the securities as well as the potential dilution of approximately 6.7 million shares. The company also entered into a $200 million five-year unsecured credit facility, which can be used to retire existing debt, fund working capital and capital expenditures, or for general corporate purposes including acquisitions that improve our business model. 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 Operations2006 Compared with 2005Net Sales and Operating Income
services costs, and bad debt provision; offset by lower occupancy costs, non-income tax provision, and other miscellaneous operating costs of the company. Compensation and benefits increased $3.1 million compared with 2005. However, excluding the incremental costs resulting from the two acquisitions made in 2006, compensation and benefits costs decreased by approximately $3.0 million. The decrease in normalized compensation and benefits costs was mainly due to cost savings realized from the company’s recent restructuring efforts. Outside services costs increased approximately $2.3 million. This increase was primarily due to an increase in information technology consulting costs. The company’s bad debt provision increased approximately $1.9 million. The company records a provision for uncollectible accounts based on customer-specific information as well as the overall mix of customer receivables outstanding. Occupancy costs decreased $1.3 million during 2006, which can also be attributed to cost savings from recent restructuring efforts. The company’s provision for sales and franchise tax expense decreased $1.4 million during 2006, which was based on ongoing tax audits and assessments during the current year. Other miscellaneous general and administrative costs of the company decreased $1.3 million during 2006. Restructuring charges increased $4.8 million during 2006, which reflects restructuring efforts executed by the company in the current year. 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 are expected to be 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
Income TaxesThe company recorded an income tax provision from continuing operations at an effective tax rate of 41.7% in 2006 compared with an income tax provision at an effective rate of 38.1% in 2005. The increase in the effective tax rate is the result of an increase in the provision for state income taxes and settlement of income tax audits, partially offset by a reduction in the valuation allowance. In 2006, the company recognized a tax benefit (reduction in valuation allowance) for $1.5 million of state income tax net operating loss carryforwards more likely than not to be realized, in addition to the benefit of $3.5 million recognized in 2005. The benefit is based on management’s forecasted taxable income for the two-year period ending March 31, 2008. These net operating loss carryforwards expire, if unused, in years 2008 through 2019. In 2005, the company established a $2.5 million valuation allowance for the Canadian subsidiary deferred tax assets, including net operating losses, because it is more likely than not that the deferred tax assets will not be realized. In 2006 the valuation allowance was increased an additional $208,000 primarily for current year net operating loss.2005 Compared with 2004Net Sales and Operating Income
mainly due to a decrease in gross margin realized on the sale of hardware products, fundamentally the sale of IBM Intel-architecture products. A significant component of gross margin is the realization and timing of incentive payments from the company’s suppliers. Incentive programs are principally designed to reward sales performance. The decrease in fourth quarter sales in 2005 compared with 2004 resulted in lower incentive payments recognized in the fourth quarter of 2005 versus 2004, which negatively impacted gross margin in 2005. Operating Expenses. The company experienced a $20.0 million increase in operating expenses in 2005 compared with 2004. Operating expenses includes selling, general and administrative (“SG&A”) expenses and restructuring charges. The increase was primarily caused by higher compensation and benefits costs, which increased $15.4 million, mainly resulting from the two 2004 business acquisitions having a full-year impact in 2005. The higher compensation and benefits also reflect a $3.0 million increase in the company’s Supplemental Executive Retirement Plan expense during 2005 as well as a $1.5 million expense to accrue for a long-term incentive plan. Additionally, the company incurred $2.8 million in amortization of intangible assets during 2005 compared with zero in 2004. The intangible assets were recognized in 2005 as the purchase accounting adjustments were finalized for the two business acquisitions made in 2004. Further, professional fees were $2.6 million higher in 2005 as a result of acquisition exploration activities and Sarbanes-Oxley Section 404 professional services. Other activity in operating costs resulted in an overall decrease of $0.8 million during 2005 compared with 2004.Other (Income) Expenses
In 2005, the company recognized a tax benefit of $3.5 million for state income tax net operating loss carryforwards more likely than not to be realized. The benefit is based on management’s forecasted taxable income for the three-year period ending March 31, 2008, significantly discounted to reflect the uncertainty of projecting future events. These net operating loss carryforwards expire, if unused, in years 2008 through 2019. In 2005, the company established a $2.5 million valuation allowance for the Canadian subsidiary deferred tax assets, including net operating losses, because it is more likely than not that the deferred tax assets will not be realized. In 2005, the company established a $45,000 valuation allowance for Federal net operating loss carryforwards of a non-consolidated affiliated subsidiary. The valuation allowance was established because it is more likely than not that the net operating loss carryforwards will not be utilized.Off-Balance Sheet ArrangementsThe 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 ObligationsThe following table provides aggregated information regarding the company’s contractual obligations as of March 31, 2006. These obligations are discussed in detail in the preceding paragraphs and notes 7, 8, and 9 to the consolidated financial statements.
acquisitions. Borrowings under the Facility will generally bear interest at various levels over LIBOR. There were no amounts outstanding under the Facility at March 31, 2006. In connection with entry into the Facility, the company terminated its prior unsecured credit facility. As a result of the termination, the company wrote off deferred financing fees of $0.1 million in 2006. The financing fees, incurred at the time of entering into the prior facility, were being amortized over the life of the prior facility. No amounts had been borrowed under the prior facility during the current year prior to its termination or at March 31, 2005.Mandatorily Redeemable Convertible Trust Preferred SecuritiesOn June 15, 2005, the company completed the redemption of its Securities. The carrying value of the Securities as of March 31, 2005 was $125.3 million. Securities with a carrying value of $105.4 million were redeemed for cash at a total expense of $109.0 million, which includes accrued interest of $1.5 million and a premium of $2.1 million. The company funded the redemption with existing cash. In addition, 398,324 Securities with a carrying value of $19.9 million were converted into common shares of the company. The Securities were converted at the conversion rate of 3.1746 common shares for each share of the Securities converted resulting in the issuance of 1,264,505 common shares of the company. As a result of the redemption, the company wrote off deferred financing fees of $2.7 million. The financing fees incurred at the time of issuing the Securities were being amortized over a 30-year period ending March 31, 2028. Prior to redemption the Securities were non-voting (except in limited circumstances) and paid quarterly distributions at an annual rate of 6.75%. The Securities were convertible into common shares at the rate of 3.1746 common shares for each Security (equivalent to a conversion price of $15.75 per common share).Senior NotesThe principal amount of Senior Notes outstanding at March 31, 2006 and 2005 was $59.4 million. The Senior Notes are due August 2006. Accordingly, the Senior Notes have been classified as a current liability at March 31, 2006. The Senior Notes pay interest semi-annually on February 1 and August 1 at an annual rate of 9.5%. Interest accrued on the Senior Notes as of March 31, 2006 and March 31, 2005 was approximately $0.9 million. The indenture under which the Senior Notes were issued limits the creation of liens, sale and leaseback transactions, consolidations, mergers and transfers of all or substantially all of the company’s assets, and indebtedness of the company’s restricted subsidiaries. The Senior Notes are subject to mandatory repurchase by the company at the option of the holders in the event of a change in control of the company.Cash Flow
from 2005 to 2006; whereas, accounts payable increased approximately $20.7 million in 2005. The decline in use of cash for accounts payable settlement during 2005 resulted in an increase in cash provided by operations. Cash flow used for investing activities. The $35.4 million increase in cash used for investing activities was mainly due to the two acquisitions made in 2006, which were funded by cash. The CTS Corporations was acquired for $27.8 million and the China and Hong Kong operations of Mainline Information Systems, Inc. were acquired for $0.2 million, which is net of $0.6 million cash acquired in the transaction. In addition, the company acquired $6.8 million of marketable securities during 2006 to satisfy future obligations of its employee benefit plans. The securities are currently held in a Rabbi Trust. Cash flow provided by (used for) financing activities.The $106.3 million increase in cash used for financing activities was mainly due to the company’s redemption of its Mandatorily Redeemable Convertible Trust Preferred Securities during the first quarter of 2006. Securities with a carrying value of $105.4 million were redeemed at a premium of 2.025%, for a total use of cash of $107.5 million. The company funded the redemption with cash on hand. The remaining Securities, which had a carrying value of $19.9 million, were converted into common shares of the company.Critical Accounting Policies, Estimates & AssumptionsThe 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. On an ongoing basis, the company 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, distribution 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 2006. 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, 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 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 integration17
services is recognized when the service is performed. 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 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, the age of the inventory and return provisions provided by the distribution agreements. 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. 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 deferred tax asset 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. For further information concerning the company’s calculation of impairment, see Notes 1 and 5 in the accompanying consolidated financial statements. 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, 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 inGoodwill and Long-Lived Assets. Facilities reserves are calculated using a probability-weighted 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 agreement 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 sales18
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 StandardIn December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) 123 (revised 2004), Share Based Payment, which is a revision of Statement 123. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in operating results based on their fair values. Statement 123(R) will be effective for the company on April 1, 2006, the beginning of the company’s fiscal 2007. Statement 123(R) permits public companies to adopt its requirements using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date, or (2) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The company plans to use the modified prospective method to adopt the provisions of Statement 123(R). As permitted by Statement 123, the company currently accounts for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have an impact on the company’s operating results. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the company adopted Statement 123(R) in prior periods, the company believes the impact would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions has not been significant. In May 2005, the FASB issued Statement 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and Statement 3,Reporting Accounting Changes in Interim Financial Statements, and provides guidance on the accounting for and reporting of accounting changes and error corrections. Statement 154 applies to all voluntary changes in accounting principle and requires retrospective application (a term defined by the statement) to prior periods’ financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. In addition, Statement 154 redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The company will adopt Statement 154 beginning April 1, 2006. In November 2004, the FASB issued Statement 151, Inventory Costs — An amendment of ARB No. 43. Statement 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, Statement 151 requires that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Companies must apply the standard prospectively. The adoption of Statement 151 is not expected to have a material impact on the company’s results of operations or financial position.Business CombinationsMainline China and Hong KongOn 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 acquisition price for the China and Hong Kong operations was $0.8 million, which included $0.3 million of direct acquisition costs. 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management’s preliminary allocation of the acquisition cost to the net assets acquired, approximately $0.8 million was assigned to goodwill in the current year.The CTS CorporationsOn May 31, 2005, the company acquired The CTS Corporations (“CTS”), 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 acquisition price was $27.8 million, which included repayment of $2.6 million of CTS debt and $0.2 million of direct acquisition expenses. Additionally, the company would be obligated to pay an earn-out to former CTS shareholders if the acquired business achieves specific financial performance targets. As of March 31, 2006, it is not likely that the financial performance targets will be met by the end of the earn-out period. Based on management’s initial allocation of the acquisition cost to the net assets acquired, approximately $24.1 million was assigned to goodwill in the first quarter of 2006. During the second quarter, the company adjusted the estimated fair value of acquired tax assets and liabilities by approximately $0.5 million, with a corresponding decrease to goodwill. During the third quarter, specifically identifiable intangible assets were assigned a fair value of $9.8 million with a corresponding reduction to goodwill. The resulting deferred tax adjustment was $3.8 million with a corresponding offset to goodwill. 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. Goodwill resulting from the CTS acquisition will not be deductible for income tax purposes.Discontinued OperationsDuring 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 the company’s Industrial Electronics Division (“IED”), which distributed semiconductors, interconnect, passive and electromechanical components, power supplies and embedded computer products in North America and Germany. The assets sold consisted primarily of accounts receivable and inventories and the company’s shares of common stock in World Peace Industrial Co., Ltd., an Asian distributor of electronic components. The buyer also assumed certain liabilities. 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 loss from discontinued operations. Such costs primarily relate to retained leases.Restructuring ChargesContinuing Operations. During 2006, the company consolidated a portion of its operations to reduce costs and increase operating efficiencies. As part of that restructuring effort, the company shut down 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 in connection with the restructuring comprise 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. For 2006, costs incurred for one-time termination benefits and other associated costs resulting from workforce reductions amounted to $2.5 million and facilities costs resulting from the exit of leased facilities amounted to $1.7 million. The charges were classified as restructuring charges in the consolidated statement of operations. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income. In the fourth quarter of 2003, concurrent with the sale of IED, the company announced it would restructure its remaining enterprise computer solutions business and facilities to reduce overhead and eliminate assets that were inconsistent with the company’s strategic plan and were no longer required. In connection with this reorganization, the company recorded restructuring charges totaling $20.7 million for the impairment of facilities and other assets no longer required as well as severance, incentives, and other employee benefit costs for personnel whose employment was involuntarily terminated. The charges were classified as restructuring charges in the consolidated statement of operations. Severance, incentives, and other employee benefit costs were paid to approximately 110 personnel. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income for a vacant warehouse that represents excess capacity as a result of the sale of IED.20
Approximately $0.1 million is expected to be paid in 2007 for severance and other employment costs and $1.2 million is expected to be paid in 2007 for facilities obligations. Severance and other employee costs are expected to continue to 2007 and facilities obligations are expected to continue to 2017. Discontinued operations. In connection with the sale of IED in 2003, the company recognized a restructuring charge of $28.7 million. Of the total charge, $5.9 million related to severance and other employee benefit costs to be paid to approximately 525 employees previously employed by IED and not hired by the acquiring company; $5.0 million related to facilities costs for approximately 30 vacated locations no longer required as a result of the sale that were determined as the present value of qualifying exit costs offset by an estimate of future sublease income; and $17.4 million related to the write down of assets to fair value that were abandoned or classified as “held for sale,” as a result of the disposition and discontinuance of IED and Aprisa, respectively. During 2006, the restructuring reserve was reduced by ongoing payments of facilities obligations. Approximately $0.6 million is expected to be paid in 2007 for facilities obligations, representing the accretion of lease obligations and the absence of sub-lease income that was assumed when the restructuring charge was initially recorded. Facilities obligations are anticipated to continue until 2010.InvestmentsThe 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 investments in marketable equity securities are held for an indefinite period and thus are classified as available for sale. Unrealized holding gains on such securities, which were added to shareholders’ equity during 2006, were $13,000. The securities are recorded at fair value in other non-current assets on the balance sheet, with the change in fair value during the period excluded from earnings and recorded net of tax as a component of other comprehensive income. The aggregate fair value of the securities at March 31, 2006 was $6.8 million. The aggregate unrealized holding gain for the securities at March 31, 2006 was $13,000. 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 affiliated company. During 2004, the company sold its investment in Eurodis Electron PLC (“Eurodis”), a publicly traded European enterprise computer systems distributor. The realized gain was determined on the basis of specific identification of securities sold since the company liquidated its entire securities holding. Sales proceeds and realized gain on the sale were $3.3 million and $0.9 million, respectively.Risk Control and Effects of Foreign Currency and InflationThe 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 2006, 2005 or 2004 fiscal years. The company believes that inflation has had a nominal effect on its results of operations in fiscal 2006, 2005 and 2004 and does not expect inflation to be a significant factor in fiscal 2007.Forward Looking InformationPortions 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 suppliers21
and supplier programs, risks and uncertainties involving acquisitions, instability in world financial markets, downward pressure on gross margins, the ability to meet financing obligations based on the impact of previously described factors and uneven patterns of quarterly sales.Item 7A. Quantitative and Qualitative Disclosures About Market Risk." -->
— Implemented a more extensive analysis and enhanced the review process relating to the valuation of service parts inventory and amounts due to vendors within the retail hardware services business. As a result of these control improvements and other measures the company has taken to date, management believes the control deficiencies that, when aggregated, constituted a material weakness in internal control over the financial statement close process as of March 31, 2005 have been remediated. During 2006, the following control improvements were implemented in an effort to remediate the control deficiencies that contributed to the material weakness related to the vendor debits process:— Enhanced the reconciliation and review process relating to vendor debits and the reserve for collectibility of vendor debits.— Enhanced and formalized the process of estimating the reserve for collectibility of vendor debits.— Implemented process improvements designed to improve the initiation and recording of vendor debits.— Implemented detect controls to review the completeness and accuracy of vendor debits once recorded.— Implemented other management review procedures to minimize the risk that the company’s vendor debits are materially misstated at the end of a period. As a result of these control improvements and other measures the company has taken to date, management believes the control deficiencies identified over the vendor debit process that, when combined, constituted a material weakness in internal control over the vendor debit process as of March 31, 2005 have been remediated. In addition to the control improvements identified above, management performed additional analysis and other procedures to ensure the consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles. Accordingly, management believes that the consolidated financial statements included in this annual report present fairly in all material respects the company’s financial position, results of operations and cash flows for the periods presented. Based upon, and as of the date of, this evaluation, the company’s Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures were effective for the purpose of ensuring that material information required to be in this annual report was made known to them by others on a timely basis.Management’s Report on Internal Control over Financial ReportingThe 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, 2006 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, 2006. Management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.Changes in Internal ControlOther than the control improvements discussed above, there have been no changes in the company’s internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.Item 9B. Other Information." -->
part III" -->
Consolidated Statements of Operations for the years ended March 31, 2006, 2005, and 2004 Consolidated Balance Sheets as of March 31, 2006 and 2005 Consolidated Statements of Shareholders’ Equity for the years ended March 31, 2006, 2005, and 2004 Consolidated Statements of Cash Flows for the years ended March 31, 2006, 2005, and 2004 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 57: 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 58 of this Annual Report on Form 10-K.25
signatures" -->
agilysys, inc. and subsidiariesANNUAL REPORT ON FORM 10-KYear Ended March 31, 2006INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
report of independent registered public accounting firm" -->
report of independent registered public accounting firm on internal control over financial reporting" -->
agilysys, inc. and subsidiariesConsolidated Statements of Operations" -->
agilysys, inc. and subsidiariesConsolidated Balance Sheets" -->
agilysys, inc. and subsidiariesConsolidated Statement of Cash Flows" -->
agilysys, inc. and subsidiariesConsolidated Statements of Shareholders’ Equity" -->
agilysys, inc. and subsidiariesNotes to Consolidated Financial Statements" -->
recorded as a reduction of cost of sales when earned. In addition, the company receives incentives from suppliers related to cooperative advertising allowances, price protection and other programs. These incentives generally relate to agreements with the suppliers and are recorded, when earned, as a reduction of cost of sales or advertising expense, as appropriate. All costs associated with advertising and promoting products are expensed in the year incurred. Cooperative reimbursements from suppliers, which are earned and available, are recorded in the period the related advertising expenditure is incurred. 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. Income taxes. Income tax expense includes U.S. and foreign income taxes and is based on reported income before income taxes. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes. These deferred taxes are measured by applying currently enacted tax laws. Valuation allowances are recognized to reduce the deferred tax assets to an amount that is more likely than not to be realized. In determining whether it is more likely than not that deferred tax assets will be realized, the company considers such factors as (a) expectations of future taxable income, (b) expectations of material changes in the present relationship between income reported for financial and tax purposes, and (c) tax-planning strategies. Foreign currency. The functional currency of the company’s Canadian subsidiary is its local currency. For this foreign operation, the assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet dates. Statement of operations accounts are translated at the monthly average exchange rates prevailing during the year. The gains or losses resulting from these translations are recorded as a separate component of shareholders’ equity. Foreign currency gains and losses from changes in exchange rates have not been material to the consolidated operating results. Cash and cash equivalents. The company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Other highly liquid investments considered cash equivalents with no established maturity date are fully redeemable on demand (without penalty) with settlement of principal and accrued interest on the following business day after instruction to redeem. Such investments are readily convertible to cash with no penalty. 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 investments in marketable equity securities are held for an indefinite period and thus are classified as available for sale. The securities are recorded at fair value in other non-current assets on the balance sheet, with the change in fair value during the period excluded from earnings and recorded net of tax as a component of other comprehensive income. The aggregate fair value of the securities at March 31, 2006 was $6.8 million. The aggregate unrealized holding gain for the securities at March 31, 2006 was $13,000.35
Fair value of financial instruments. Estimated fair value of the company’s financial instruments are as follows:
protection, stock rotation (right of return status), and technological obsolescence, as well as turnover and assumptions about future demand and market conditions. Intangible assets. Purchased intangible assets with finite lives are primarily amortized using the straight-line method over the estimated economic lives of the assets. Purchased intangible assets relating to customer relationships are being amortized using an accelerated method, which reflects the period the asset is expected to contribute to the future cash flows of the company. The company’s finite-lived intangible assets are being amortized over periods ranging from three to ten years. The company has an indefinite-lived intangible asset relating to purchased trade names. The indefinite-lived intangible asset is not amortized; rather, it is tested for impairment at least annually by comparing the carrying amount of the asset with the fair value. An impairment loss is recognized if the carrying amount is greater than fair value. Goodwill. Goodwill represents the excess purchase price paid over the fair value of the net assets of acquired companies. Goodwill is subject to periodic impairment testing at least annually. The company conducted its annual goodwill impairment test as of February 1, 2006 and 2005 and, based on the analyses, concluded that goodwill was not impaired. Goodwill will also be tested as necessary if changes in circumstances or the occurrence of certain events indicate potential impairment. Long-lived assets. Property and equipment are recorded at cost. Major renewals and improvements are capitalized, as are interest costs on capital projects. Minor replacements, maintenance, repairs and reengineering costs are expensed as incurred. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is recognized. Depreciation and amortization are provided in amounts sufficient to amortize the cost of the assets, including assets recorded under capital leases, which make up a negligible portion of total assets, over their estimated useful lives using the straight-line method. The estimated useful lives for depreciation and amortization are as follows: buildings and building improvements — 7 to 30 years; furniture — 7 to 10 years; equipment — 3 to 10 years; software — 3 to 10 years; and leasehold improvements over the shorter of the economic life or the lease term. Internal use software costs are expensed or capitalized depending on the project stage. Amounts capitalized are amortized over the estimated useful lives of the software, ranging from 3 to 10 years, beginning with the project’s completion. Total depreciation and amortization expense on property and equipment was $6.2 million, $7.0 million and $7.8 million during 2006, 2005 and 2004, respectively. The company evaluates the recoverability of its long-lived assets whenever changes in circumstances or events may indicate that the carrying amounts may not be recoverable. An impairment loss is recognized in the event the carrying value of the assets exceeds the future undiscounted cash flows attributable to such assets. Stock-based compensation. The company applies the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, to account for employee stock compensation costs, which is referred to as the intrinsic value method. Since the exercise price of the company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost is recognized for the company’s stock option plans. The company has adopted the disclosure provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, as amended by FASB Statement 148, Accounting for Stock-Based Compensation — Transition and Disclosure.37
The following table shows the effects on net income and earnings per share had compensation cost been measured on the fair value method pursuant to Statement 123. The pro forma expense determined under the fair value method presented in the table below relates only to stock options that were granted as of March 31, 2006, 2005 and 2004. Accordingly, the impact of applying the fair value method is not indicative of future amounts.
Non-cash Investing Activities. 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 affiliated company. Recently Issued Accounting Standards. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) 123 (revised 2004), Share Based Payment, which is a revision of Statement 123. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in operating results based on their fair values. Statement 123(R) will be effective for the company on April 1, 2006, the beginning of the company’s fiscal 2007. Statement 123(R) permits public companies to adopt its requirements using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date, or (2) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The company plans to use the modified prospective method to adopt the provisions of Statement 123(R). As permitted by Statement 123, the company currently accounts for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have an impact on the company’s consolidated operating results. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the company adopted Statement 123(R) in prior periods, the company believes the impact would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions has not been significant. In May 2005, the FASB issued Statement 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and Statement 3,Reporting Accounting Changes in Interim Financial Statements, and provides guidance on the accounting for and reporting of accounting changes and error corrections. Statement 154 applies to all voluntary changes in accounting principle and requires retrospective application (a term defined by the statement) to prior periods’ financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. In addition, Statement 154 redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will adopt Statement 154 beginning April 1, 2006. In November 2004, the FASB issued Statement 151,Inventory Costs — An amendment of ARB No. 43. Statement 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, Statement 151 requires that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Companies must apply the standard prospectively. The adoption of Statement 151 is not expected to have a material impact on the Company’s results of operations or financial position. Reclassifications. Certain amounts in the prior periods’ Consolidated Financial Statements have been reclassified to conform to the current period’s presentation. In 2006, the company has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.39
2.RECENT ACQUISITIONSIn accordance with FASB Statement 141, Business Combinations, the company allocates the cost of its acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the cost over the fair value of the net assets acquired is recorded as goodwill.Mainline China and Hong KongOn 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 acquisition price for the China and Hong Kong operations was $0.8 million, which included $0.3 million of direct acquisition costs. Based on management’s preliminary allocation of the acquisition cost to the net assets acquired, approximately $0.8 million was assigned to goodwill in the current year.The CTS CorporationsOn May 31, 2005, the company acquired The CTS Corporations (“CTS”), 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 acquisition price was $27.8 million, which included repayment of $2.6 million of CTS debt and $0.2 million of direct acquisition expenses. Additionally, the company would be obligated to pay an earn-out to former CTS shareholders if the acquired business achieves specific financial performance targets. As of March 31, 2006, it is not likely that the financial performance targets will be met by the end of the earn-out period. Based on management’s initial allocation of the acquisition cost to the net assets acquired, approximately $24.1 million was assigned to goodwill in the first quarter of 2006. During the second quarter, the company adjusted the estimated fair value of acquired income tax assets and liabilities by approximately $0.5 million, with a corresponding decrease to goodwill. During the third quarter, specifically identifiable intangible assets were assigned a fair value of $9.8 million with a corresponding reduction to goodwill. The resulting deferred tax adjustment was $3.8 million with a corresponding increase to goodwill. 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. Goodwill resulting from the CTS acquisition will not be deductible for income tax purposes.3.DISCONTINUED OPERATIONSDuring 2003, the company sold substantially all of the assets and liabilities of its Industrial Electronics Division (“IED”), which distributed semiconductors, interconnect, passive and electromechanical components, power supplies, and embedded computer products in North America. 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 as defined by FASB Statement 144,Accounting for the Impairment or Disposal of Long-Lived Assets. The company continues to incur certain costs related to IED and Aprisa, which are reported in the consolidated statements of operations as loss from discontinued operations.40
For the years ended March 31, 2006, 2005, and 2004, the company realized a loss from discontinued operations of $0.5 million (net of $0.3 million in taxes), $0.9 million (net of $0.5 million in taxes), and $2.9 million (net of $2.7 million in taxes), respectively. Ongoing expenses mainly relate to occupancy costs associated with exited facilities. At March 31, 2006, the assets of discontinued operations were $0.4 million and related to accounts receivable and deferred income taxes. The liabilities of discontinued operations were $0.9 million and related to liabilities for ongoing lease commitments and deferred income taxes.4.RESTRUCTURING CHARGESContinuing Operations2006 Restructuring. During 2006, the company consolidated a portion of its operations to reduce costs and increase operating efficiencies. As part of that restructuring effort, the company shut down 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 in connection with the restructuring comprise 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. For the twelve-months ended March 31, 2006, costs incurred for one-time termination benefits and other associated costs resulting from workforce reductions amounted to $2.5 million and facilities costs resulting from the exit of leased facilities amounted to $1.7 million. The charges were classified as restructuring charges in the consolidated statement of operations. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income. 2003 Restructuring. In the fourth quarter of 2003, concurrent with the sale of IED, the company announced it would restructure its remaining enterprise computer solutions business and facilities to reduce overhead and eliminate assets that were inconsistent with the company’s strategic plan and were no longer required. In connection with this reorganization, the company recorded restructuring charges totaling $20.7 million for the impairment of facilities and other assets no longer required as well as severance, incentives, and other employee benefit costs for personnel whose employment was involuntarily terminated. The charges were classified as restructuring charges in the consolidated statement of operations. Severance, incentives, and other employee benefit costs were paid to approximately 110 personnel. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income for a vacant warehouse that represents excess capacity as a result of the sale of IED.41
Following is a reconciliation of the beginning and ending balances of the restructuring liability:
Following is a reconciliation of the beginning and ending balances of the restructuring liability related to discontinued operations:
Statement 131, Disclosures About Segments of an Enterprise and Related Information. Goodwill has been allocated to the company’s reporting units that are anticipated to benefit from the synergies of the business combinations generating the underlying goodwill. As of February 1, 2006, which was the latest annual impairment test performed, the company concluded that the fair value of its two reporting units exceeded their carrying value, including goodwill. As such, step two of the goodwill impairment test was not necessary and no impairment loss was recognized. As of March 31, 2006, the company was not aware of any circumstances or events requiring an interim impairment test of goodwill.Intangible AssetsThe following table summarizes the company’s intangible assets at March 31, 2006 and 2005:
6.INVESTMENTSAt March 31, 2006 and 2005, the company’s investments consisted of the following:
Minimum future lease payments under capital leases as of March 31, 2006 for each of the next five years and in the aggregate are:
8.FINANCING ARRANGEMENTSThe following is a summary of long-term obligations at March 31, 2006 and 2005:
a minimum of $50 per Trust Preferred Security. As of March 31, 2005, the Trust Preferred Securities were redeemable at the option of the company for a redemption price of 102.025%. During 2005, 2,152 Trust Preferred Securities were converted into 6,831 shares of the company’s common stock. The conversion reduced the carrying value of the Trust Preferred Securities to $125.3 million. As of March 31, 2005, a total of 368,652 Trust Preferred Securities had been redeemed or converted by the company. On June 15, 2005, the company completed the redemption of its 6.75% Mandatorily Redeemable Convertible Trust Preferred Securities (“Securities”). The carrying value of the Securities as of March 31, 2005 was $125.3 million and was classified as a current liability. Securities with a carrying value of $105.4 million were redeemed for cash at a total cost of $109.0 million, which included accrued interest of $1.5 million and a 2.025% premium of $2.1 million. The company funded the redemption with existing cash. In addition, 398,324 Securities with a carrying value of $19.9 million were converted into common shares of the company. Approximately $0.5 million of deferred financing fees were applied against capital in excess of stated value in connection with the conversion. The Securities were converted at the conversion rate of 3.1746 common shares for each share of the Securities converted, resulting in the issuance of 1,264,505 common shares of the company. As a result of the redemption, the company wrote off deferred financing fees of $2.7 million in the first quarter of 2006. The financing fees, incurred at the time of issuing the Securities, were being amortized over a 30-year period ending on March 31, 2028, which was the initial maturity date of the Securities. The write-off of deferred financing fees, along with the premium payment discussed above, resulted in a loss on retirement of debt of $4.8 million.10.INCOME TAXESThe components of income (loss) before income taxes from continuing operations and income tax provision are as follows:
A reconciliation of the federal statutory rate to the company’s effective income tax rate for continuing operations is as follows:
At March 31, 2006, the company had $0.9 million of federal net operating loss carryforwards that expire, if unused, in years 2023 through 2025, a $2.2 million capital loss carryforward acquired in the 2006 acquisition of CTS that expires, if unused, in 2007, and $6.1 million of foreign net operating loss carryforwards that expire, if unused, in years 2007 through 2013. At March 31, 2006, the company also had $146.9 million of state net operating loss carryforwards that expire, if unused, in years 2007 through 2024. Of the total state net operating loss carryforwards, $5.9 million resulted from the company’s 2004 acquisition of Kyrus Corporation. At March 31, 2006 the total valuation allowance against deferred tax assets of $6.5 million was mainly comprised of a valuation allowance of $2.9 million associated with deferred tax assets in Canada and China that more likely than not will not be realized, a valuation allowance of $0.8 million related to the capital loss carryforward acquired in the CTS acquisition, and a valuation allowance for state net operating loss carryforwards of $2.8 million that more likely than not will not be realized. In the current year, the company recognized tax expense and reduced goodwill for the tax benefit of $0.2 million related to the valuation allowance on acquired state net operating loss carryforwards in the Kyrus transaction. If realized in future years, $0.1 million of the valuation allowance related to the Kyrus Corporation state net operating loss carryforwards will reduce goodwill. In the year ended March 31, 2006, the company recognized tax expense and reduced goodwill for the tax benefit of $0.2 million related to the valuation allowance on acquired capital loss carryforwards in the CTS acquisition. If realized in 2007, $0.8 million of the valuation allowance related to the CTS capital loss carryforwards will reduce goodwill.11.EMPLOYEE BENEFIT PLANSThe company maintains profit-sharing and 401(k) plans for employees meeting certain service requirements. Generally, the plans allow eligible employees to contribute a portion of their compensation, with the company matching a percentage thereof. The company may also make discretionary contributions each year for the benefit of all eligible employees under the plans. Total profit sharing and company matching contributions were $2.9 million, $2.9 million, and $2.2 million for 2006, 2005, and 2004, respectively. The company also provides a non-qualified benefit equalization plan covering certain employees, which provides for employee deferrals and company retirement deferrals so that the total retirement deferrals equal amounts that would have been contributed to the company’s 401(k) plan if it were not for limitations imposed by income tax regulations. Contribution expense for the benefit equalization plan was $0.1 million in 2006, 2005, and 2004. The company also provides a supplemental executive retirement plan (“SERP”) for certain officers of the company. The SERP is a non-qualified plan designed to provide retirement benefits and life insurance for the plan participants. The projected benefit obligation related to the SERP was $12.0 million at March 31, 2006, of which $9.9 million has been accrued in accordance with FASB Statement 87, Employers Accounting for Pensions. The company also recognized an intangible asset of $2.0 million in 2006 in accordance with Statement 87. The projected benefit obligation related to the SERP was $11.9 million at March 31, 2005, of which $8.8 million had been accrued at March 31, 2005. The annual expense for the SERP was $2.0 million, $3.6 million, and $0.6 million in 2006, 2005, and 2004, respectively. In conjunction with the benefit equalization plan and SERP, the company has invested in life insurance policies related to certain employees and marketable securities held in a Rabbi Trust to satisfy future obligations of the plans. The value of the policies and marketable securities was $19.5 million and $6.3 million at March 31, 2006 and 2005, respectively. The life insurance policies are valued at their cash surrender value and the marketable securities held in a Rabbi Trust are valued at the fair market value.12.CONTINGENCIESThe company is the subject of various threatened or pending legal actions and contingencies in the normal course of conducting its business. The company provides for costs related to these matters when a loss is probable and the amount can be reasonably estimated. The effect of the outcome of these matters on the company’s future results of operations and liquidity cannot be predicted because any such effect depends on future results of operations and the amount or timing of the resolution of such matters. While it is not possible to predict with certainty, management believes that the ultimate resolution of such matters will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the company.50
13.BUSINESS SEGMENTSThe company is a leading distributor and premier reseller of enterprise computer technology solutions. The company is principally engaged in the distribution and reselling of three specific product areas: server and storage hardware, software, and services. These technology solutions are offered to two primary customer groups, value-added resellers, which often are privately held with annual sales ranging from approximately $10 million to $400 million, and end-user customers, which range from medium to large corporations as well as the public sector. The company’s chief operating decision maker (i.e., chief executive officer) reviews financial information presented at varying levels of detail for purposes of making operating decisions and assessing financial performance. The chief operating decision maker’s primary review, however, focuses on the company’s two primary customer groups. In accordance with FASB Statement 131, Disclosures about Segments of an Enterprise and Related Information, the company has two operating segments separated between the customer group focus. Given the similar economic characteristics between the two operating segments and the other aggregation criteria established by Statement 131, the company’s two operating segments have been combined into one reportable business segment. Reporting segment information as a consolidated entity is consistent with the company’s focus on providing enterprise computer technology solutions to its customers. The company’s assets are primarily located in the United States. Further, revenues attributable to customers outside the United States accounted for less than 5% of total revenues for 2006, 2005, and 2004. Total revenues for the company’s three specific product areas are as follows:
common share at a price of $4.00, or $40.00 per whole share, subject to adjustment. The Rights may be exercised only if a person or group acquires 20% or more of the company’s common shares, or announces a tender offer for at least 20% of the company’s common shares. Each Right will entitle its holder (other than such acquiring person or members of such acquiring group) to purchase, at the Right’s then-current exercise price, a number of the company’s common shares having a market value of twice the Right’s then-exercise price. The Rights trade with the company’s common shares until the Rights become exercisable. If the company is acquired in a merger or other business combination transaction, each Right will entitle its holder to purchase, at the Right’s then-exercise price, a number of the acquiring company’s common shares (or other securities) having a market value at the time of twice the Right’s then-current exercise price. Prior to the acquisition by a person or group of beneficial ownership of 20% or more of the company’s Common Shares, the Rights are redeemable for $0.001 per Right at the option of the company’s Board of Directors. The Rights will expire May 10, 2009.15.EARNINGS PER SHAREThe following data show the amounts used in computing earnings per share from continuing operations and the effect on income and the weighted average number of shares of dilutive potential common stock.
16.STOCK-BASED COMPENSATIONThe company has a stock incentive plan. Under the plan, the company may grant stock options, stock appreciation rights, restricted shares, restricted share units, and performance shares for up to 3.2 million shares of common stock. For stock option awards, the exercise price is equal to the market price of the company’s stock on the date of grant. The maximum term of the options is 10 years, and, generally, vest ratably over three years. Stock appreciation rights may be granted in conjunction with a stock option granted under the plan. Stock appreciation rights are exercisable only to the extent that the stock option to which it relates is exercisable and terminate upon the termination or exercise of the related stock option. Restricted shares and restricted share units may be issued at no cost or at a purchase price which may be below their fair market value but which are subject to forfeiture and restrictions on their sale or other transfer. Performance share awards may be granted, where the right to receive shares in the future is conditioned upon the attainment of specified performance objects and such other conditions, restrictions and contingencies. The exercise price of performance share awards would be equal to the market price of the company’s stock on the date of grant. As of March 31, 2006, there were no stock appreciation rights, restricted share units, or performance shares awarded from the plan.Stock OptionsThe following table summarizes stock option activity during 2006, 2005, and 2004 for stock options awarded by the company under the stock incentive plan and prior plans.
The fair market value of each option granted is estimated on the grant date using the Black-Scholes method. The following assumptions were made in estimating fair value:
determined as the market value of the shares at the date of grant, is being amortized over the restriction period. Compensation cost charged to operations for the restricted share awards was as follows: 2006 — $0.6 million; 2005 — $1.3 million; and 2004 — $2.1 million.17.QUARTERLY RESULTS (UNAUDITED)
agilysys, inc.Schedule II -- Valuation and Qualifying Accounts Years ended March 31, 2006, 2005 and 2004" -->
agilysys, inc.Exhibit Index