Agilysys (AGYS) 10-Q 2005 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   .

Commission file number 0-5734

AGILYSYS, INC.

(Exact name of registrant as specified in its charter)

Ohio	34-0907152
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

6065 Parkland Boulevard, Mayfield Heights, Ohio	44124
(Address of principal executive offices)	(Zip code)

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  x     No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  x     No  o

The number of shares of the registrant’s common stock outstanding as of July 30, 2004 was 32,208,156.

AGILYSYS, INC.

Index

Part I.	Financial Information
	Item 1	Financial Statements
		Condensed Consolidated Statements of Operations – Three Months Ended June 30, 2004 and 2003 (Unaudited)
		Condensed Consolidated Balance Sheets – June 30, 2004 (Unaudited) and March 31, 2004
		Condensed Consolidated Statements of Cash Flows – Three Months Ended June 30, 2004 and 2003 (Unaudited)
		Notes to Condensed Consolidated Financial Statements – June 30, 2004 (Unaudited)
	Item 2	Management’s Discussion and Analysis of Results of Operations and Financial Condition
	Item 3	Quantitative and Qualitative Disclosures About Market Risk
	Item 4	Controls and Procedures
Part II.	Other Information
	Item 1	Legal Proceedings
	Item 2	Unregistered Sales of Equity Securities and Use of Proceeds
	Item 3	Defaults Upon Senior Securities
	Item 4	Submission of Matters to a Vote of Security Holders
	Item 5	Other Information
	Item 6	Exhibits and Reports on Form 8-K
Signatures

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AGILYSYS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended
	June 30
(In Thousands, Except Share and Per Share Data)	2004			2003
Net Sales	$	386,672		$	279,593
Cost of Goods Sold		338,007			244,666
Gross Margin		48,665			34,927
Operating Expenses
Selling, General and Administrative Expenses		38,950			31,695
Restructuring Charges		189			463
Operating Income		9,526			2,769
Other (Income) Expense
Other (Income) Expense, net		(239	)		53
Interest Expense, net		1,289			2,414
Gain on Retirement of Mandatorily Redeemable Convertible
Preferred Securities		—			(734	)
Income Before Income Taxes		8,476			1,036
Provision for Income Taxes		3,102			414
Distributions on Mandatorily Redeemable Convertible Trust
Preferred Securities, net of Tax		1,360			1,330
Income (Loss) from Continuing Operations		4,014			(708	)
Loss from Discontinued Operations, net of Tax		164			749
Net Income (Loss)	$	3,850		$	(1,457	)
Earnings Per Share – Basic and Diluted
Income (Loss) from Continuing Operations	$	0.14		$	(0.02	)
Loss from Discontinued Operations		—			(0.03	)
Net Income (Loss)	$	0.14		$	(0.05	)
Weighted Average Shares Outstanding
Basic		28,014,938			27,748,037
Diluted		28,418,415			27,748,037
Cash Dividends Per Share	$	0.03		$	0.03

See accompanying notes to unaudited condensed consolidated financial statements.

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AGILYSYS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts at June 30, 2004 are Unaudited)

	June 30			March 31
(In Thousands, Except Share and Per Share Data)	2004			2004
ASSETS
Current Assets
Cash and Cash Equivalents	$	205,936		$	149,903
Accounts Receivable, net		273,880			295,272
Inventories, net		50,087			52,236
Deferred Income Taxes		7,279			9,255
Prepaid Expenses		1,851			2,234
Assets of Discontinued Operations		1,611			5,451
Total Current Assets		540,644			514,351
Goodwill		180,117			179,975
Investments		20,041			18,819
Other Assets		14,271			11,396
Property and Equipment, net		33,448			35,121
Total Assets	$	788,521		$	759,662
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts Payable	$	237,696		$	208,115
Accrued Liabilities		33,634			39,047
Liabilities of Discontinued Operations		4,028			4,006
Total Current Liabilities		275,358			251,168
Long-Term Debt		59,466			59,503
Deferred Income Taxes		3,503			4,426
Other Liabilities		10,455			10,150
Mandatorily Redeemable Convertible Trust Preferred Securities		125,425			125,425
Shareholders’ Equity
Common Stock, at $0.30 Stated Value; 32,198,156 and 32,115,614 Shares Outstanding, Including 3,589,940 Subscribed-for Shares and 53,273 Shares in Treasury at June 30, 2004 and March 31, 2004		9,577			9,553
Capital in Excess of Stated Value		126,921			126,070
Retained Earnings		222,696			219,594
Unearned Employee Benefits		(42,325	)		(42,325	)
Unearned Compensation on Restricted Stock		(2,118	)		(2,499	)
Accumulated Other Comprehensive Loss		(437	)		(1,403	)
Total Shareholders’ Equity		314,314			308,990
Total Liabilities and Shareholders’ Equity	$	788,521		$	759,662

See accompanying notes to unaudited condensed consolidated financial statements.

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AGILYSYS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended
	June 30
(In Thousands)	2004			2003
Operating Activities:
Net Income (Loss)	$	3,850		$	(1,457	)
Loss from Discontinued Operations		164			749
Income (Loss) from Continuing Operations		4,014			(708	)
Adjustments to Reconcile Income (Loss) from Continuing Operations to Net Cash Provided by (Used for) Operating Activities:
Gain on Buyback of Convertible Preferred Securities		—			(734	)
Gain on Sale of Plant and Equipment		34			—
Depreciation		1,027			1,180
Amortization		1,153			1,470
Deferred Income Taxes		2,169			(1,766	)
Other Non-Cash Items		—			289
Changes in Working Capital
Accounts Receivable		21,392			(44,647	)
Inventory		2,149			(8,992	)
Accounts Payable		29,581			9,279
Accrued Liabilities		(6,494	)		(4,298	)
Other Working Capital		383			477
Other		(3,005	)		(1,690	)
Total Adjustments		48,389			(49,432	)
Net Cash Provided by (Used for) Operating Activities		52,403			(50,140	)
Investing Activities:
Proceeds from Sale of Property and Equipment		105			—
Additions to Property and Equipment		(228	)		(111	)
Net Cash Used for Investing Activities		(123	)		(111	)
Financing Activities:
Buyback of Convertible Preferred Securities		—			(16,973	)
Dividends Paid		(748	)		(842	)
Other		803			514
Net Cash Used for Financing Activities		55			(17,301	)
Cash Flows Provided by (Used for) Continuing Operations		52,335			(67,552	)
Cash Flows Provided by Discontinued Operations		3,698			3,854
Net Increase (Decrease) in Cash		56,033			(63,698	)
Cash at Beginning of Period		149,903			318,543
Cash at End of Period	$	205,936		$	254,845

See accompanying notes to unaudited condensed consolidated financial statements.

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AGILYSYS, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Table Amounts in Thousands, Except Per Share Data)

1. Basis of Presentation and Significant Accounting Policies

Basis of Presentation

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 intercompany accounts have been eliminated.

The unaudited interim financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“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 June 30, 2004, as well as the condensed consolidated statements of operations and condensed consolidated statements of cash flows for the three-months ended June 30, 2004 and 2003 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, which include only normal recurring adjustments, necessary to fairly present the results of operations, financial position, and cash flows have been made. The results of operations for the three-month period ended June 30, 2004 are not necessarily indicative of the operating results for the full fiscal year or any future period.

Critical Accounting Policies

A detailed description of the Company’s critical accounting policies can be found in the audited financial statements for the fiscal year ended March 31, 2004, 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 critical accounting policies and estimates from those disclosed therein.

Stock-Based Compensation

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 (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”

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1. Basis of Presentation and Significant Accounting Policies – continued

The following table shows the effects on net income (loss) and earnings (loss) per share had compensation cost been measured on the fair value method pursuant to SFAS No. 123:

	Three Months Ended
	June 30
	2004		2003
Net income (loss), as reported	$	3,850	$	(1,457	)
Compensation cost based on fair value method		181		1,353
Pro forma net income (loss)	$	3,669	$	(2,810	)
Earnings (loss) per share – basic and diluted
As reported	$	0.14	$	(0.05	)
Pro forma	$	0.13	$	(0.10	)

Reclassifications

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

2. Recent Acquisitions

In accordance with SFAS No. 141, “Business Combinations,” the Company allocates the purchase price of its acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. Last year, the Company acquired two businesses, Kyrus Corporation (“Kyrus”) and Inter-American Data, Inc. (“IAD”).

Kyrus Corporation

Kyrus was acquired on September 30, 2003 during the second quarter of fiscal 2004. The results of Kyrus’ operations have been included in the Company’s consolidated financial statements since that date. Kyrus was an IBM Master Distributor and Premier Business Partner in retail sales solutions. The acquisition expands the Company’s operations to include a wide range of services and solutions, including hardware and software products and extensive professional services to customers in the retail industry. The purchase price was $29.6 million, offset by approximately $0.9 million of cash acquired, with approximately $26.6 million assigned to goodwill in fiscal 2004 based on the estimated fair vales of the assets acquired and liabilities assumed. During the three-months ended June 30, 2004, the Company recorded an additional $17,500 of costs that were directly associated with the Kyrus acquisition. These additional costs resulted in an increase to goodwill.

The Company is in the process of finalizing its assessment of the fair value of assets acquired and liabilities assumed, including whether there were any identifiable intangible assets in the transaction. Accordingly, the allocation of the purchase price is preliminary and subject to change. The Company anticipates completing its assessment by September 30, 2004.

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2. Recent Acquisitions – continued

Inter-American Data, Inc.

Inter-American Data was acquired on February 17, 2004 during the fourth quarter of fiscal 2004. The results of IAD’s operations have been included in the Company’s consolidated financial statements since that date. IAD was a leading developer and provider of software and services to hotel casinos and major resorts in the United States. The acquisition provides significant opportunities for growth in the hospitality industry. The purchase price was $38.0 million, with approximately $35.7 million assigned to goodwill in fiscal 2004 based on the estimated fair value of assets acquired and liabilities assumed. During the three-months ended June 30, 2004, the Company recorded an additional liability of $151,000 assumed in the acquisition, with a corresponding increase to goodwill. The liability related to one-time involuntary termination costs for employees of IAD whose job functions were terminated during the integration of IAD. Termination benefits are expected to continue through the current fiscal year.

The Company is in the process of finalizing its assessment of the fair value of assets acquired and liabilities assumed, including whether there were any identifiable intangible assets in the transaction. Accordingly, the allocation of the purchase price is preliminary and subject to change. The Company anticipates completing its assessment within 12 months of the date of acquisition.

3. Discontinued Operations

During fiscal 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 and Germany. In connection with the sale of IED, the Company discontinued the operations of Aprisa, Inc. (“Aprisa”), 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 SFAS No. 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 June 30, 2004 and 2003, the Company realized a loss from discontinued operations of $0.2 million (net of $0.1 million in income taxes) and $0.7 million (net of $0.4 million in income taxes), respectively.

In April 2004, a distribution facility that was held for sale was sold for approximately $2.9 million. The excess of book value over the sale price of $0.2 million was recognized as a loss on sale of fixed assets.

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4. Restructuring Charges

Continuing Operations

In the fourth quarter of fiscal 2003, concurrent with the sale if 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 to be 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:

	Severance and Other
	Employee Costs			Facilities			Total
Balance at April 1, 2004	$	25		$	5,794		$	5,819
Accretion of lease obligations		—			110			110
Amounts paid		(25	)		(135	)		(160	)
Balance at June 30, 2004	$	—		$	5,769		$	5,769

Of the remaining $5.8 million reserve at June 30, 2004, approximately $0.6 million is expected to be paid during the remainder of fiscal 2005 for facilities obligations. Facilities obligations are expected to continue to 2017.

Discontinued Operations

In connection with the sale of IED in fiscal 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 for 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.

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4. Restructuring Charges – continued

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

	Severance and Other
	Employee Costs			Facilities			Other		Total
Balance at April 1, 2004	$	24		$	3,260		$	55	$	3,339
Accretion of lease obligations		—			29			—		29
Amounts paid		(24	)		(795	)		—		(819	)
Adjustments		—			(13	)		—		(13	)
Balance at June 30, 2004	$	—		$	2,481		$	55	$	2,536

Of the remaining $2.5 million reserve at June 30, 2004, approximately $1.0 million is expected to be paid during the remainder of fiscal 2005 for facilities obligations. Facilities obligations are expected to continue to 2010.

5. Goodwill

Changes in the carrying amount of goodwill during the three-months ended June 30, 2004 are summarized in the following table:

Balance at April 1, 2004	$	179,975
Goodwill adjustment – Kyrus (see Note 2)		18
Goodwill adjustment – IAD (see Note 2)		151
Impact of foreign currency translation		(27	)
Balance at June 30, 2004	$	180,117

In accordance with SFAS No. 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, 2004, which was the latest annual impairment test performed, the Company concluded that the fair value of its reporting unit exceeded the carrying value, including goodwill. As such, step two of the goodwill impairment test was not necessary and no impairment loss was recognized. As of June 30, 2004, the Company was not aware of any circumstances or events requiring an interim impairment test of goodwill.

6. Mandatorily Redeemable Convertible Trust Preferred Securities

In 1998, Pioneer-Standard Financial Trust (the “Pioneer-Standard Trust”) issued 2,875,000 shares relating to $143.7 million of 6.75% Mandatorily Redeemable Convertible Trust Preferred Securities (the “Trust Preferred Securities”). The Pioneer-Standard Trust, a statutory business trust, is a wholly-owned consolidated subsidiary of the Company, with its sole asset being $148.2 million aggregate principal amount of 6.75% Junior Convertible Subordinated Debentures of Agilysys, Inc. due March 31, 2028 (the “Trust Debentures”). The Company has executed a guarantee with regard to the Trust Preferred Securities. The guarantee, when taken together with the Company’s obligations under the Trust Debentures, the indenture pursuant to which the Trust Debentures were issued and the applicable trust document, provide a full and unconditional guarantee of the Pioneer-Standard Trust’s obligations under the Trust Preferred Securities.

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6. Mandatorily Redeemable Convertible Trust Preferred Securities – continued

The Trust Preferred Securities are non-voting (except in limited circumstances), pay quarterly distributions at an annual rate of 6.75%, carry a liquidation value of $50 per share and are convertible at the option of the holder into the Company’s Common Shares at any time prior to the close of business on March 31, 2028. Subsequent to March 31, 2003, the Trust Preferred Securities became redeemable, at the option of the Company, for a redemption price of 103.375% of par reduced annually by 0.675% to a minimum of $50 per Trust Preferred Security.

No Trust Preferred Securities were repurchased during the three-months ended June 30, 2004. During the same period last year, the Company repurchased 365,000 Trust Preferred Securities for a cash purchase price of approximately $17.0 million. The repurchased securities had a face value of approximately $18.3 million. The difference between the face value and cash paid, offset by the expensing of related deferred financing fees, resulted in a net gain of $0.7 million.

As of June 30, 2004, a total of 366,500 Trust Preferred Securities have been redeemed by the Company.

7. Contingencies

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.

8. Comprehensive Income

The components of comprehensive income, net of tax, for the three-months ended June 30, 2004 and 2003 are as follows:

	Three Months Ended
	June 30
	2004		2003
Net income (loss)	$	3,850	$	(1,457	)
Other comprehensive income
Unrealized gain on equity securities		—		2,364
Foreign currency translation adjustment		966		2,232
Total other comprehensive income		966		4,596
Comprehensive income	$	4,816	$	3,139

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9. Earnings Per Share

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

	Three Months Ended
	June 30
	2004		2003
Numerator:
Income (loss) from continuing operations – basic	$	4,014	$	(708	)
Distributions on convertible debt, net of tax		—		—
Income (loss) from continuing operations – diluted	$	4,014	$	(708	)
Denominator:
Weighted average shares outstanding – basic		28,015		27,748
Effect of dilutive securities
Stock options and unvested restricted stock		403		—
Convertible debt		—		—
Weighted average shares outstanding – diluted		28,418		27,748
Earnings (loss) per share from continuing operations – basic and diluted	$	0.14	$	(0.02	)

Diluted earnings (loss) per share is computed by sequencing each issue or series of issues of potential common shares from the most dilutive to the least dilutive. Diluted earnings (loss) per share is determined as the lowest earnings (loss) per incremental share in the sequence of potential common shares.

Options on 2.2 million and 3.3 million shares of common stock at June 30, 2004 and 2003, respectively, were not included in computing diluted earnings (loss) per share nor were 8.0 million and 8.3 million shares issuable upon conversion of the Trust Preferred Securities at June 30, 2004 and 2003, respectively, because their effects were antidilutive.

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Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

AGILYSYS, INC.

Management’s Discussion and Analysis of
Results of Operations and Financial Condition

The following discussion should be read in conjunction with the condensed consolidated financial statements and the related notes that appear elsewhere in this document as well as the Company’s Annual Report on Form 10-K for the year ended March 31, 2004.

Overview

Agilysys, Inc. is one of the foremost distributors and premier resellers of enterprise computer technology solutions. The Company delivers 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.

Net sales grew by 38.3% for the three-months ended June 30, 2004 compared with the same period last year. Several factors contributed to the improvement in sales. In particular, the Company experienced an increase in sales to its core customers as improvements in market trends that began in fiscal 2004 continued into the first quarter of fiscal 2005. The Company also was able to successfully integrate the two business acquisitions made in fiscal 2004 into its business. This successful integration expanded the Company’s solutions offerings into the retail and hospitality markets.

Net income for the three-months ended June 30, 2004 increased to $3.9 million, or earnings of $0.14 per diluted share, versus a net loss of $1.5 million, or a loss of $0.05 per diluted share, for the comparable period last year. The improvement in net income can be attributed to efficiencies realized from recent restructuring efforts, initiatives to reduce discretionary spending, and a reduction in interest expense resulting from lower debt levels compared with last year.

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

Results of Operations

Net Sales and Operating Income

	Three Months Ended						Increase
	June 30						(Decrease)
(Dollars In Thousands)	2004			2003			$			%
Net sales	$	386,672		$	279,593		$	107,079			38.3	%
Cost of goods sold		338,007			244,666			93,341			38.2
Gross margin		48,665			34,927			13,738			39.3
Gross margin percentage		12.6	%		12.5	%
Operating expenses
Selling, general and administrative expenses		38,950			31,695			7,255			22.9
Restructuring expenses		189			463			(274	)		(59.2	)
Operating income	$	9,526		$	2,769		$	6,757			244.0	%
Operating income percentage		2.5	%		1.0	%

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Net Sales

The Company experienced a $107.1 million, or 38.3%, increase in net sales versus the comparable period last year. Sales generated from the two business acquisitions made last year contributed 13.8% to the increase, with the remaining 24.5% attributed to sales from the Company’s base business. Overall, the increase in net sales was the result of the Company’s focused efforts in marketing its products and services in an improving information technology spending environment.

The Company experienced the following sales increases, by product category, when compared with the same period last year: hardware sales increased $55.7 million, or approximately 52.0% of the overall increase; software sales increased $14.4 million, or approximately 13.4% of the overall increase; services and other revenue increased $37.0 million, or approximately 34.6% of the overall increase.

The increase in hardware sales was driven by a higher volume of server and storage sales, which contributed $30.7 million and $25.0 million, respectively, to the increase. Sales to small to medium-sized enterprises through the Company’s distribution channels were the primary sources of these increases. The increase in software sales was largely due to a higher volume of IBM-based software sales as well as the proprietary software the Company is now supplying as a result of recent business acquisitions. The increase in service and other revenue was primarily due to the incremental sales generated from the Company’s two business acquisitions completed last year, as the Company has been able to successfully integrate the two acquisitions into its business and expand its solutions offerings into the retail and hospitality markets.

The Company anticipates net sales for the full fiscal year to increase approximately 20% to 25% compared with prior fiscal year. 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-months ended June 30, 2004 are not necessarily indicative of the operating results for the full fiscal year.

Gross Margin

The $13.8 million, or 39.3%, increase in gross margin is a result of higher sales volume in the current quarter versus the comparable period last year. However, gross margin as a percentage of net sales remained relatively constant with last year. Gross margin as a percentage of sales was 12.6% for the three-months ended June 30, 2004 compared with 12.5% for the same period last year. The consistency in this measure year over year, despite the increase in net sales, is due to the sales mix during the current quarter. Although the Company recognized higher sales in predominantly all aspects of its business, the Company recognized sales growth in its distribution business at a rate higher than its direct solutions businesses. As the distribution business traditionally has lower gross margins, the margins resulting from higher sales in the Company’s distribution business curtailed the favorable gross margin impact of higher sales in the Company’s direct solutions businesses.

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 sales performance and on average tend to rise as a percent of sales as the Company’s fiscal year progresses and it achieves predefined sales goals. Provided sales goals are achieved, the Company generally earns higher levels of incentive payments in the third and fourth fiscal quarters as compared with the first and second quarters. The Company anticipates gross margin to be approximately 12.8% to 13.1% of net sales for the entire fiscal year.

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Selling, General and Administrative Expenses

The Company experienced a $7.3 million, or 23.0%, increase in selling, general and administrative expenses (“SG&A”). The increase was largely due to costs from the two acquisitions that were made last year, which contributed approximately $6.7 million to SG&A during the current quarter. Overall, the Company was able to control discretionary spending, and combined with the efficiencies gained from recent restructuring activities, SG&A as a percentage of net sales decreased to 10.1% versus 11.3% during the comparable period last year and are expected to be approximately 9.5% of net sales for the entire fiscal year.

Other (Income) Expense

	Three Months Ended						Favorable
	June 30						(Unfavorable)
(In Thousands)	2004			2003			$			%
Other (income) expense:
Other (income) expense, net	$	(239	)	$	53		$	292			550.9	%
Interest expense, net		1,289			2,414			1,125			46.6
Gain on retirement of Mandatorily Redeemable Convertible Trust Preferred Securities		—			(734	)		(734	)		100.0
Total other (income) expense, net	$	1,050		$	1,733		$	683			39.4	%

The 39.4% decrease in other (income) expense is primarily due to lower interest expense, offset by the absence of a gain on retirement of Convertible Preferred Securities in the current quarter. The decrease in interest expense is attributable to lower average debt levels in the current quarter versus the comparable quarter in the prior year, as the interest rates applicable to the Company’s long-term debt outstanding are fixed. During fiscal 2004, the Company repurchased $71.6 million in Senior Notes and $18.3 million in Convertible Preferred Securities. The lower debt levels were realized for the entire quarter in the current year; whereas, only the Convertible Preferred Securities had been repurchased as of the end of the same quarter in the prior year. The repurchase of Convertible Preferred Securities in the first quarter of last year resulted in the $0.7 million gain. No such repurchase occurred during the three-months ended June 30, 2004.

Income Tax Expense

The effective tax rate for continuing operations for the three-months ended June 30, 2004 was 36.6% compared with 39.9% for the same quarter in the prior year. The decrease in the effective tax rate primarily reflects the recognition of State net operating loss carryforwards.

Liquidity and Capital Resources

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

Cash and cash equivalents were $205.9 million at June 30, 2004 compared with $149.9 million at March 31, 2004. Working capital at June 30, 2004 was $265.3 million and the current ratio was 2.0 to 1 compared to working capital at March 31, 2004 of $263.2 million and a current ratio of 2.1 to 1. Working

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capital and current ratio remained relatively consistent as the decreases in accounts receivable, inventory, and accrued liabilities were largely offset by the increase in accounts payable.

Total debt at June 30, 2004 was $185.1 million, compared to $185.2 million at March 31, 2004. The slight decrease in the Company’s total debt reflects ongoing payment of capital lease obligations. The Company did not voluntarily repurchase Senior Notes or Convertible Preferred Securities during the three-months ended June 30, 2004. The Senior Notes and Convertible Preferred Securities are due in August 2006 and March 2028, respectively. In addition, there were no borrowings outstanding under the Company’s revolving credit facility at June 30, 2004, with unused availability of $100 million as of June 30, 2004. The Company was compliant with all quarterly financial covenants contained in its revolving credit facility and anticipates that it will continue to comply with such covenants in the foreseeable future.

The Company’s total debt consists primarily of Senior Notes and Convertible Preferred Securities. The principal amount of Senior Notes outstanding at June 30, 2004 was $59.4 million. The Senior Notes pay interest semi-annually at an annual rate of 9.5%. 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 carrying value of Convertible Preferred Securities at June 30, 2004 was $125.4 million. The Convertible Preferred Securities are non-voting (except in limited circumstances), pay quarterly distributions at an annual rate of 6.75%, carry a liquidation value of $50 per share and are convertible into the Company’s common shares at the option of the holder at any time prior to the close of business on March 31, 2028. The Convertible Preferred Securities are convertible into common shares at the rate of 3.1746 common shares for each Convertible Preferred Security (equivalent to a conversion price of $15.75 per common share).

The Company maintains a revolving credit agreement (“Revolver”), which provides the ability to borrow up to $100 million, limited to certain borrowing base calculations, and allows for increases under certain conditions up to $150 million during the life of the facility. Advances on the Revolver bear interest at various levels over LIBOR, and a facility fee is required, both of which are determined based on the Company’s leverage ratio. The Revolver does not contain a pre-payment penalty. There were no amounts outstanding under the Revolver at June 30, 2004.

The following table presents cash flow results from operating activities, investing activities, and financing activities for the three-months ended June 30, 2004 and 2003:

	Three Months Ended
	June 30						Increase
							(Decrease)
(In Thousands)	2004			2003			$
Net cash provided by (used for) continuing operations:
Operating activities	$	52,403		$	(50,140	)	$	102,543
Investing activities		(123	)		(111	)		(12	)
Financing activities		55			(17,301	)		17,356
Cash flows provided by (used for) continuing operations		52,335			(67,552	)		119,887
Net cash provided by discontinued operations		3,698			3,854			(156	)
Net increase (decrease) in cash and cash equivalents	$	56,033		$	(63,698	)	$	119,731

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Cash Flow from Operating Activities

Cash provided by operating activities improved $102.5 million during the three-months ended June 30, 2004 as compared to the corresponding period last year. The increase in operating cash flow is attributed to improvements in customer payment patterns, lower inventory levels, and increased net earnings. Customer payment patterns have improved, in part, due to the Company’s focused initiatives in collection efforts as well as an increase in customers utilizing third-party financing which has resulted in shorter payment periods and, as a result, accounts receivable decreased approximately $21.4 million during the current quarter. In addition, inventory control efforts have resulted in lower levels of inventory carried by the Company, which led to a $2.2 million inventory reduction during the current quarter. Operating cash flow was also positively impacted by the timing of payments of accounts payable, as the balance of accounts payable increased $29.6 million during the current quarter.

Cash Flow Used for Investing Activities

Cash used for investing activities for the three-months ended June 30, 2004 and 2003 were for capital expenditures. The estimated capital expenditures for the full fiscal year are expected to be approximately $2 million and relate primarily to information systems and facility projects.

Cash Flow from Financing Activities

During the three-months ended June 30, 2004, the Company paid dividends of approximately $0.7 million. Dividend payments were offset primarily by proceeds from the issuance of common stock under the Company’s stock-based compensation plans. During the three-months ended June 30, 2003, net cash used for financing activities was mainly used for the repurchase of Convertible Preferred Securities approximating $17.0 million.

Contractual Obligations

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, 2004 (“Annual Report”). 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.

Off-Balance Sheet Arrangements

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

Critical Accounting Policies and Recent Accounting Standards

A detailed description of the Company’s critical accounting policies as well as a description of recent accounting standards can be found in the Company’s Annual Report.

Forward-Looking Information

Portions of this report contain current management expectations, which may constitute forward-looking information. When used in this Management’s Discussion and Analysis of Results of Operations and

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Financial Condition and elsewhere throughout this 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.

The Company experiences a disproportionate percentage of quarterly sales in the last month of the fiscal quarters. This uneven sales pattern makes the prediction of revenues, earnings and working capital for each quarterly financial period difficult and increases the risk of unanticipated variations in quarterly results and financial condition. The Company 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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, 2004.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer, with the participation of Company management, have concluded that the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 (c) and 15d-14(c)) are sufficiently effective to ensure that the information required to be disclosed by the Company in the reports it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, based on an evaluation of such controls and procedures conducted within 90 days prior to the date hereof.

Changes in Internal Controls

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None.

Item 3. Defaults Upon Senior Securities

     None.

Item 4. Submission of Matters to a Vote of Security Holders

     None.

Item 5. Other Information

     None.

Item 6. Exhibits and Reports on Form 8-K

     (a) Exhibits

31.1	Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

     (b) Reports on Form 8-K

          On May 5, 2004, the Company furnished a Current Report on Form 8-K announcing an update to its previously issued guidance for
          fiscal 2004.

          On May 13, 2004, the Company furnished a Current Report on Form 8-K announcing its fourth quarter and year ended March 31, 2004
          results.

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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.

	AGILYSYS, INC.
Date: August 9, 2004	/s/ Arthur Rhein
	Arthur Rhein
	Chairman, President and Chief Executive Officer
	(Principal Executive Officer)
Date: August 9, 2004	/s/ Steven M. Billick
	Steven M. Billick
	Executive Vice President, Treasurer and Chief
	Financial Officer
	(Principal Financial and Accounting Officer)

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