Agilysys - 10-Q quarterly report FY

 

(Mark One)

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (440) 720-8500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The number of shares of the registrant’s common stock outstanding as of February 2, 2006 was 30,524,505

 

 

AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

AGILYSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts at December 31, 2005 are Unaudited)

AGILYSYS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

AGILYSYS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Table amounts in thousands, except per share data)

The accompanying unaudited condensed consolidated financial statements include the accounts of Agilysys, Inc. and its subsidiaries (the “company”). Investments in affiliated companies are accounted for by the equity or cost method, as appropriate. All inter-company accounts have been eliminated. The company’s fiscal year ends on March 31. References to a particular year refer to the fiscal year ending in March of that year. For example, 2006 refers to the fiscal year ended March 31, 2006.

The unaudited interim financial statements of the company are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions for Form 10-Q under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Article 10 of Regulation S-X under the Exchange Act. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

The condensed consolidated balance sheet as of December 31, 2005, as well as the condensed consolidated statements of operations and condensed consolidated statements of cash flows for the three and nine-months ended December 31, 2005 and 2004 have been prepared by the company without audit. The financial statements have been prepared on the same basis as those in the audited annual financial statements. In the opinion of management, all adjustments necessary to fairly present the results of operations, financial position, and cash flows have been made. Such adjustments were of a normal recurring nature. The results of operations for the three and nine-month periods ended December 31, 2005 are not necessarily indicative of the operating results for the full fiscal year or any future period.

Certain prior year amounts have been reclassified to conform to the current presentation.

A detailed description of the company’s significant accounting policies can be found in the audited financial statements for the fiscal year ended March 31, 2005, included in the company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission. There have been no material changes in the company’s significant accounting policies and estimates from those disclosed therein.

During the nine-months ended December 31, 2005, 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.

The company applies the recognition and measurement provisions of Accounting Principles Board 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 Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, as amended by Statement 148, Accounting for Stock-Based Compensation – Transition and Disclosure.

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:

On December 16, 2004, the Financial Accounting Standards Board issued 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 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.

On December 8, 2005, the company acquired the China and Hong Kong operations of Mainline Information Systems, Inc. Accordingly, the results of operations for the China and Hong Kong operations have been included in the accompanying condensed 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 Beihing, 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 $0.5 million.

Based on management’s initial allocation of the acquisition cost to the net assets acquired, approximately $0.5 million was assigned to goodwill in the current quarter. The company is still in the process of assessing the fair value of the acquired assets and liabilities. Accordingly, the preliminary allocation of the purchase price is subject to modification.

On 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 condensed 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 $2.6 million in assumed debt and $0.3 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 December 31, 2005, 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 current quarter, the CTS 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 is being amortized over four years using the straight-line method. The company is still in the process of assessing the fair value of the acquired net assets. Accordingly, the allocation of the purchase price is subject to modification in the near future. Goodwill resulting from the CTS acquisition will not be deductible for income tax purposes.

During 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 condensed consolidated statement of operations as loss from discontinued operations.

For the three-months ended December 31, 2005 and 2004, the company realized a loss from discontinued operations of $0.1 million (net of $0.1 million of income taxes) and $0.2 million (net of $0.1 million of income taxes), respectively. For the nine-months ended December 31, 2005 and 2004, the company realized a loss from discontinued operations of $0.4 million (net of $0.3 million of income taxes) and $0.5 million (net of $0.3 million of income taxes), respectively.

2006 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 nine-months ended December 31, 2005, 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 $1.8 million. The charges were classified as restructuring charges in the 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 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.

Following is a reconciliation of the beginning and ending balances of the restructuring liability:

In addition to the expenses identified as “additions” in the above reconciliation, the company incurred $0.2 million and $0.6 million of additional expenses for the three and nine-months ended December 31, 2005, respectively, which were classified as restructuring charges in the statement of operations. These expenses related to the write-off of leasehold improvements and differences between actual and accrued sub-lease income and common area maintenance costs.

The $0.5 million classified as “other” in the table during the first quarter represents the net cost of certain incentive and benefit plan obligations that were included in the restructuring charge and subsequently reclassified. The $0.2 million classified as “other” in the table during the current quarter represents adjustments to the remaining facility obligations for sublease agreements and early termination agreements, with an offset to the restructuring charges in the statement of operations. Of the remaining $7.1 million reserve at December 31, 2005, approximately $0.2 million is expected to be paid during the remainder of 2006 for severance and other employment costs and $0.4 million is expected to be paid for facilities obligations. Severance and other employee costs are expected to continue to 2007 and facilities obligations are expected to continue to 2017.

In connection with the sale of IED in 2003, the company recognized a restructuring charge of $28.7 million. The significant components of the charge were as follows: $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.

Following is a reconciliation of the beginning and ending balances of the restructuring liability:

Of the remaining $1.1 million reserve at December 31, 2005, approximately $0.2 million is expected to be paid during the remainder of 2006 for facilities obligations. Facilities obligations are expected to continue to 2010.

Changes in the carrying amount of goodwill during the nine-months ended December 31, 2005 are summarized in the following table:

The company acquired Kyrus Corporation (“Kyrus”) on September 30, 2003. The $0.4 million adjustment to goodwill relating to Kyrus is for the settlement of tax uncertainties that existed at the date of acquisition. The company may have to record additional amounts for similar tax uncertainties in the future; however, such amounts cannot be estimated at this time. Any additional amounts recorded by the company for tax uncertainties that existed at the date of acquisition will result in a change to goodwill.

In accordance with FASB Statement 142, Goodwill and Other Intangible Assets, the company does not amortize goodwill; rather, goodwill is tested for impairment on an annual basis, or more often if conditions exist which indicate potential impairment. The company uses a measurement date of February 1 for its annual impairment test of goodwill. As of February 1, 2005, 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 December 31, 2005, the company was not aware of any circumstances or events requiring an interim impairment test of goodwill.

The following table summarizes the company’s specifically identifiable intangible assets at December 31, 2005:

Amortization expense for the three-months ended December 31, 2005 and 2004 was $1.7 million. Amortization expense for the nine-months ended December 31, 2005 and 2004 was $2.8 million and $2.3 million, respectively. Estimated amortization expense for 2006 for the intangible assets identified above is approximately $3.7 million.

On October 18, 2005, the company entered into a $200 million five-year unsecured credit facility. The new credit facility includes a $20 million sub-facility for letters of credit and a $20 million sub-facility for swingline loans. The new credit facility is available to refinance existing debt, provide for working capital requirements, capital expenditures and general corporate purposes of the company including acquisitions. Borrowings under the new credit facility will generally bear interest at various levels over LIBOR.

In connection with entry into the new credit facility, the company terminated its three-year $100 million unsecured credit facility, dated April 16, 2003, as amended. As a result of the termination, the company wrote off deferred financing fees of $0.1 million in the third quarter of 2006. The financing fees, incurred at the time of entering into the facility, were being amortized over the life of the facility. No amounts were outstanding under the credit facility during 2006 or upon termination.

The principal amount of Senior Notes outstanding at December 31, 2005 and March 31, 2005 was $59.4 million. The Senior Notes are due August 2006. Accordingly, the Senior Notes have been classified as a current liability in the accompanying balance sheet at December 31, 2005. 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 December 31, 2005 and March 31, 2005 was approximately $2.4 million and $0.9 million, respectively.

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.

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. 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.

The 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.

The components of comprehensive income, net of taxes, for the three and nine-months ended December 31, 2005 and 2004 are as follows:

The following table sets forth the computation of basic and diluted earnings per share:

For the nine-month period ended December 31, 2004, options on 0.9 million shares of common stock were not included in computing diluted earnings per share because their effects were anti-dilutive.

AGILYSYS, INC.

Agilysys, Inc. (“company”) is one of the foremost distributors and premier resellers of enterprise computer technology solutions. The company sells complex servers, software, storage and services to resellers and corporate customers across a diverse set of industries. The company also provides customer-centric software applications and services focused on the retail and hospitality markets. As an integrator of server, storage, software and services needs, the company is able to partner with its customers to become a single solutions provider for enterprise computing requirements.

The company’s results for the three and nine-months ended December 31, 2005 reflect an increase in sales in each of our major product categories, as sales increased 3.2% and 6.4% during these periods, respectively. Continued IT spending in North America has driven the improvements in hardware and software sales. The successful integration of our recent acquisitions has driven the improvements in services revenue, as we have expanded our service solutions into the retail and hospitality industries and, most recently, increased our storage solutions offerings with the acquisition of The CTS Organizations, a leading independent services organization, specializing in information technology storage solutions for large and medium-sized corporate customers and public-sector clients.

During the current quarter, the company acquired the China and Hong Kong operations of Mainline Information Systems. This business specializes in IBM enterprise solutions for large and medium-sized businesses and banking institutions in the Hong Kong and China markets and allows the company to begin operations in China with a nucleus of a local talented workforce. The acquisition also provides the company the ability to better serve our hospitality customers with new and growing operations in Macau.

The company experiences a disproportionately large percentage of quarterly sales in the last month of its fiscal quarters. In addition, the company experiences a seasonal increase in sales during its fiscal third quarter ending in December. Accordingly, the results of operations for the three and nine-month periods ended December 31, 2005 are not necessarily indicative of the operating results for the full fiscal year or any future period.

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.

Net Sales. Sales volume from the company’s Enterprise Solutions Group (“ESG”), which serves large and medium-sized corporations across many industries, increased $31.9 million. The increase in ESG sales was mainly due to higher sales from its Technology Solutions group. Additionally, incremental sales generated from the company’s acquisition of The CTS Corporations (“CTS”) accounted for $4.6 million of the ESG increase. The increase in ESG sales were offset by a $15.4 million decrease in sales volume from the company’s KeyLink Systems Group (“KeyLink”), which is the company’s primary connection with its reseller partners.

Changes in sales by major product category were as follows: hardware sales increased $11.1 million, or 3%, software sales increased $2.7 million, or 3%, and services revenue increased $2.7 million, or 11%. The increase in hardware sales was mainly driven by higher sales of storage technology. The increase in software sales was the result of higher sales of remarketed software. The increase in service revenue was driven by higher proprietary service revenue, which was complemented by the incremental service revenue generated from the acquisition of CTS.

The company experiences a seasonal increase in sales during its fiscal third quarter ending in December. Accordingly, the results of operations for the three-months ended December 31, 2005 are not necessarily indicative of the operating results for the full fiscal year 2006. The company anticipates net sales for the full year to increase approximately 5% to 7% compared with the prior year.

Gross Margin. The $4.3 million increase in gross margin was due to higher sales volume in the current quarter versus the comparable quarter last year and an improvement in gross margin percentage from 12.8% last year to 13.2% for the current quarter. This improvement was mainly due to the increase in ESG sales, which generally achieve a higher gross margin compared to KeyLink sales. The improvement in gross margin percentage was also due to the increase in proprietary services revenue, which generally carries a higher gross margin compared to the company’s other product categories. A significant component of the company’s gross margin is the realization and timing of incentive payments from its suppliers. Incentive programs are principally designed to reward the attainment of certain supplier defined goals. The company anticipates gross margin to be approximately 12.9% of net sales for the 2006 fiscal year.

Operating Expenses. The company’s operating expenses consist of selling, general, and administrative (“SG&A”) expenses and restructuring charges. The $3.8 million increase in SG&A expenses in the current quarter versus the comparable quarter last year was driven by higher compensation and benefit costs and higher bad debt expense. Compensation and benefits costs increased approximately $2.8 million, which was mainly due to incremental headcount from the two acquisitions made in the current year, one-time costs associated with the integration of CTS, as well as incentive compensation; offset by cost savings from the company’s recent restructuring efforts. The company’s bad debt expense increased approximately $2.0 million. The company records a provision for uncollectible accounts based on customer-specific information as well as the overall mix and age of customer receivables outstanding. These increases were offset by a $1.0 million reduction on other miscellaneous general and administrative costs of the company.

Interest Income. The increase in interest income was achieved through higher investment yields on the company’s cash equivalents during the current quarter versus the comparable quarter last year.

The effective tax rate for continuing operations for the three-months ended December 31, 2005 was 41.1% versus 37.8% for the comparable quarter in the prior year. The increase in the effective tax rate primarily reflects the recognition of State net operating loss carryforwards in the third-quarter of the prior year and additional income tax expense of $0.1 million resulting from interest costs associated with filing amended tax returns during the current quarter.

Net Sales. Of the $81.0 million increase in net sales, $73.1 million was achieved by higher sales volume from the company’s Enterprise Solutions Group (“ESG”), which serves large and medium-sized corporations across many industries. The increase in ESG sales was mainly due to higher sales from its Technology Solutions group along with increased sales in the retail industry. Additionally, incremental sales generated from the company’s acquisition of The CTS Corporations accounted for $11.7 million of the ESG increase. The remaining $7.9 million increase in net sales was achieved by higher sales volume from the company’s KeyLink Systems Group, which is the company’s primary connection with its reseller partners.

Changes in sales by major product category were as follows: hardware sales increased $51.1 million, or 5%, software sales increased $14.2 million, or 8%, and services revenue increased $15.7 million, or 24%. The increase in hardware sales was driven by higher sales of server and storage technology. The increase in software sales was primarily the result of higher remarketed software sales. The increase in services revenue was due to higher sales of proprietary services in the retail and hospitality industries as well as the incremental revenue resulting from the acquisition of CTS.

The company experiences a seasonal increase in sales during its fiscal third quarter ending in December. Accordingly, the results of operations for the nine-months ended December 31, 2005 are not necessarily indicative of the operating results for the full fiscal year 2006. The company anticipates net sales for the full year to increase approximately 5% to 7% compared with the prior year.

Gross Margin. The $11.2 million increase in gross margin is mainly due to the increase in net sales compared with last year, as the gross margin percentage remained consistent between the nine-month periods. A significant component of the company’s gross margin is the realization and timing of incentive payments from its suppliers. Incentive programs are principally designed to reward the attainment of certain supplier defined goals. The company anticipates gross margin to be approximately 12.9% of net sales for the 2006 fiscal year.

Operating Expenses. The company’s operating expenses consist of selling, general, and administrative (“SG&A”) expenses and restructuring charges. The $5.5 million increase in SG&A expenses in the current year versus the comparable period last year was mainly driven by higher compensation and benefit costs, higher costs for third-party professional services and higher bad debt expense.

Compensation and benefits costs increased approximately $4.9 million, which was mainly due to incremental headcount from the acquisition of CTS, one-time integration costs associated with the acquisition of CTS, and long-term incentive compensation; offset by cost savings from the company’s restructuring efforts in the current year. Third-party professional services costs increased $0.7 million, which was mainly due to an increase in external auditor fees as well as information technology consulting costs. The company’s bad debt expense increased approximately $2.4 million. The company records a provision for uncollectible accounts based on customer-specific information as well as the overall mix of customer receivables outstanding. These increases were offset by a $2.5 million reduction of other miscellaneous general and administrative costs of the company.

Restructuring charges increased $4.7 million compared with last year, which reflects restructuring efforts executed by the company in 2006. During the current year, 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 $1.8 million and represent the present value of qualifying exit costs, offset by an estimate for future sublease income. Severance and other employment termination costs are expected to continue to 2007 and facilities obligations are expected to continue to 2017.

Interest Income. The increase in interest income was achieved through higher investment yields on the company’s cash equivalents during the current period versus the comparable period of the prior year.

Interest Expense. The increase in interest expense was due to the write-off of unamortized issuance costs relating to the company’s prior credit facility, which was terminated in October 2005. The prior credit facility was replaced with a $200 million five-year unsecured credit facility. Deferred issuance costs associated with the prior credit facility were being recognized as additional interest expense over the life of the prior credit facility. Direct and incremental costs associated with the new credit facility have been deferred and will be recognized as additional interest expense over the life of the new credit facility.

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

of deferred financing fees, along with the $2.1 million premium paid for the redemption, resulted in a loss of $4.8 million.

The effective tax rate for continuing operations for the nine-months ended December 31, 2005 was 41.2% versus 37.5% for the comparable period in the prior year. The increase in the effective tax rate primarily reflects the recognition of State net operating loss carryforwards in the prior year as well as the impact of tax legislation enacted by the State of Ohio during the first quarter of 2006 and additional income tax expense of $0.1 million resulting from interest costs associated with filing amended tax returns during the quarter. The impact of the tax legislation enacted by the State of Ohio on existing deferred tax assets, including State net operating loss carryforwards and related valuation allowance, resulted in additional income tax expense of $0.2 million.

On December 8, 2005, the company acquired the China and Hong Kong operations of Mainline Information Systems, Inc. The purchase price was $0.5 million. 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 is anticipated to provide the opportunity for the company to begin operations in China with a nucleus of a local talented workforce.

On May 31, 2005, the company acquired CTS, a leading independent services organization, specializing in information technology storage solutions for large and medium-sized corporate customers, and public-sector clients. The acquisition of CTS initiated a relationship with EMC Corporation and positions the company as a leading provider of storage solutions. CTS works closely with corporate and public-sector end-users to help optimize the value and performance of their IT storage systems, implementing storage solutions around major storage providers. The purchase price was $27.8 million, which included $2.6 million in assumed debt and $0.3 million of direct acquisition expenses, and was funded by cash on hand. Additionally, the company would be obligated to pay an earn-out to CTS shareholders if the acquired business achieves specific financial performance targets. As of December 31, 2005, it is not likely that the financial performance targets will be met by the end of the earn-out period. CTS had annual revenues of approximately $35.0 million and, based on the timing of the close of the transaction, contribution to 2006 revenues since the date of acquisition are $11.7 million.

Continuing 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 the nine-months ended December 31, 2005, 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 $1.8 million. The charges were classified as restructuring charges in the 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 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.

Approximately $0.2 million is expected to be paid during the remainder of 2006 for severance and other employment costs and $0.4 million is expected to be paid 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. As of December 31, 2005, $1.1 million of the restructuring reserve remained, all of which relates to facilities obligations.

Approximately $0.2 million is expected to be paid during the remainder of 2006 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.

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

As of December 31, 2005, the company’s total debt was $59.7 million and consisted of Senior Notes and capital lease obligations. As of March 31, 2005, the company’s total debt was $185.2 million, and consisted of Senior Notes, capital lease obligations and Mandatorily Redeemable Convertible Trust Preferred Securities (“Securities”). The significant decrease in total debt from March 31, 2005 to December 31, 2005 is due to the redemption of the company’s Securities in June 2005.

On October 18, 2005, the company entered into a $200 million five-year unsecured credit facility (“Facility”). The Facility includes a $20 million sub-facility for letters of credit and a $20 million sub-facility for swingline loans. The Facility is available to refinance existing debt, provide for working capital requirements, capital expenditures and general corporate purposes of the company including acquisitions. Borrowings under the Facility will generally bear interest at various levels over LIBOR. There were no amounts outstanding under the Facility at December 31, 2005.

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 the current quarter. 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.

On 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 cost of $109.0 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).

The principal amount of Senior Notes outstanding at December 31, 2005 and March 31, 2005 was $59.4 million. The Senior Notes are due August 2006. Accordingly, the Senior Notes have been classified as a current liability in the accompanying balance sheet at December 31, 2005. 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 December 31, 2005 and March 31, 2005 was approximately $2.4 million and $0.9 million, respectively.

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.

The following table presents cash flow results from operating activities, investing activities, and financing activities for the nine-months ended December 31, 2005 and 2004:

Cash Flow from Operating Activities. The decrease in cash provided by operating activities was principally due to the change in working capital requirements, which were a use of cash during the current year compared with a source of cash last year. The working capital change was principally due to the increase in customer receivables resulting from the timing of cash receipts from customers; offset by the increase in accounts payable resulting from the timing of payment to our vendors.

Cash Flow Used for Investing Activities. Cash used for investing activities during the current year was predominantly for the acquisition of CTS during the first quarter of 2006, which was funded by cash on hand. The purchase price was $27.8 million. The acquisition of CTS initiates a relationship with EMC Corporation and positions the company as a leading provider of storage solutions. The Company’s acquisition of the China and Hong Kong operations of Mainline Information Systems, Inc. during the current quarter was essentially cash neutral net of cash acquired in the transaction.

Cash Flow from Financing Activities. Cash used for financing activities during the current year was mainly for the redemption of the company’s 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. The company also continued to pay quarterly cash dividends of $0.03 per share to its shareholders in the current year, totaling $2.7 million. These uses of cash were offset by $4.9 million in proceeds received from the issuance of common stock during 2006 upon the exercise of stock options by option holders.

The company has contractual obligations for long-term debt, capital leases and operating leases that were summarized in a table of contractual obligations in the company’s Annual Report on Form 10-K for the year ended March 31, 2005 (“Annual Report”). On June 15, 2005, the company completed the redemption of its Securities. Securities with a carrying value of $105.4 million were redeemed for cash at a total cost of $109.0 million. The company funded the redemption with cash on hand. 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.

Other than the redemption of the Securities, there have been no material changes to the contractual obligations summarized in the table included in the Annual Report outside the ordinary course of business.

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

A detailed description of the company’s critical accounting policies can be found in the company’s Annual Report.

In December 2004, the FASB issued Statement 123 (revised 2004), Share Based Payment, which is a revision of Statement 123. Statement 123(R) supersedes APB Opinion No. 25 and amends Statement 95,Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, 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. Pro forma disclosure is no longer an alternative. Statement 123(R) will be effective for the company at the beginning of the first fiscal year beginning after June 15, 2005, or 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 for 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 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 to the accompanying condensed consolidated financial statements. 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 have not been significant.

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

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

For quantitative and qualitative disclosures about market risk affecting the company, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of the company’s Annual Report. There have been no material changes in the company’s market risk exposures since March 31, 2005.

(a) Evaluation of disclosure controls and procedures. The company’s management, with the participation of the company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. The company’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in the company’s Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. The company’s disclosure controls and procedures include components of the company’s internal control over financial reporting.

In Item 9A of the company’s Annual Report on Form 10-K for the year ended March 31, 2005, as filed with the Securities and Exchange Commission, management reported that two material weaknesses related to the company’s vendor debits process and financial statement close process existed in the company’s internal control over financial reporting as of March 31, 2005. Those material weaknesses in internal control over financial reporting also impacted the effectiveness of the company’s disclosure controls and procedures, resulting in management’s conclusion that the company’s disclosure controls and procedures were not effective as of March 31, 2005.

In fiscal 2006, and through the date of this filing, the following control improvements have been implemented in an effort to remediate the control deficiencies that contributed to the two material weaknesses identified above:

Financial Statement Close Process

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 substantially remediated. While management has tested the remediated controls and found them to be operating effectively, the results of our remediation efforts have not yet been evaluated by Ernst & Young LLP, our independent registered public accounting firm.

Although the company has implemented the control improvements identified above relating to the vendor debit process, the material weakness in internal control over the vendor debit process will not be considered remediated until additional improvements have been implemented during the remainder of the current fiscal year and the company concludes that the controls over the vendor debit process designed to mitigate the risk of material error are operating effectively.

In addition to the control improvements identified above, management performed additional analysis and other procedures to ensure the condensed consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles. Accordingly, management believes that the condensed consolidated financial statements included in this quarterly 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 quarterly report was made known to them by others on a timely basis.

(c) Changes in internal control over financial reporting. Other than the control improvements discussed in (a) above, which were implemented in response to the two material weaknesses in internal control over financial reporting identified in the company’s Annual Report on Form 10-K for the year ended March 31, 2005, 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.

A detailed description of the company’s risk factors can be found in the company’s Annual Report. There have been no material changes from the risk factors summarized in our Annual Report.

Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.