SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission file number 0-5734

AGILYSYS, INC.

(Exact name of registrant as specified in its charter)

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

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

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

Common Shares, without par value

Common Share Purchase Rights

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

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

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

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

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

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

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

     The aggregate market value of Common Shares held by non-affiliates as of September 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter) was $501,423,057 computed on the basis of the last reported sale price per share ($16.84) of such shares on the NASDAQ National Market.

     As of June 2, 2006, the Registrant had the following number of Common Shares outstanding: 30,526,505

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant’s definitive Proxy Statement to be used in connection with its Annual Meeting of Shareholders to be held on July 28, 2006 are incorporated by reference into Part III of this Form 10-K.

     Except as otherwise stated, the information contained in this Annual Report on Form 10-K is as of March 31, 2006.

AGILYSYS, INC.

ANNUAL REPORT ON FORM 10-K

Year Ended March 31, 2006

TABLE OF CONTENTS

part I

Item 1.    Business.

Reference herein to any particular year or quarter refers to periods within the company’s fiscal year ended March 31. For example, 2006 refers to the fiscal year ended March 31, 2006.

Overview

Agilysys, Inc. (the “company” or “Agilysys”) 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 is a critical link in the information technology supply chain and is operated through two routes to market. The Agilysys Enterprise Solutions Group (ESG) delivers tailored solutions consisting of suppliers’ products and services, combined with proprietary software and services, directly to end-user customers. The Agilysys KeyLink Systems Group (KSG) links reseller partners with leading suppliers of server and storage hardware, software and services and offers a wide range of programs and services to help these reseller partners grow their businesses, compete successfully and serve their customers.

     In addition to serving the overall IT market, Agilysys has industry-specific expertise in providing mission-critical solutions, including proprietary software, to support industries such as retail and hospitality. In the retail industry the company is a leader in designing and implementing hardware, software and service solutions for the supermarket, chain drug and general retail marketplace. In the hotel casino and destination resort segments of the hospitality industry, we provide solutions encompassing design, implementation, training and support for the property and activity management, material and inventory management and purchasing, and electronic document storage, which is also integrated with a broad range of core business applications in other industries.

     Headquartered in Mayfield Heights, Ohio, the company has sales offices throughout the United States, Canada and Asia. In January 2006, the company announced plans to move its corporate headquarters to Boca Raton, Florida in fiscal 2007. Agilysys also maintains a strategic investment in Europe.

History and Significant Events

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

     Prior to February 2003, the company was structured into two divisions, the Computer Systems Division (CSD), which focused on the distribution and reselling of enterprise computer systems products and solutions, and the Industrial Electronics Division (IED), which focused on the distribution of electronic components. Each division represented, on average, approximately one-half of the company’s total revenues. On February 28, 2003, the company completed the sale of substantially all of the assets and liabilities of IED and announced its strategic transformation to focus solely on its enterprise computer solutions business and, as a result, became one reportable business segment. The proceeds from the sale increased the company’s financial flexibility and were used to reduce debt and fund growth of the company’s enterprise computer solutions business, both organically and through acquisition.

     In September 2003, shareholders of the former Pioneer-Standard Electronics, Inc. approved an amendment to the company’s amended Articles of Incorporation to change the name of the company from Pioneer-Standard Electronics, Inc. to Agilysys, Inc. Following the approval of the name change, the company launched a new identity branding campaign, positioning the Agilysys name with employees, customers, suppliers, shareholders and industry analysts.

     In September 2003, the company acquired Kyrus Corporation, an IBM^® Master Distributor and Premier Business Partner in retail sales solutions. With this acquisition, Agilysys is the leading provider of IBM retail solutions and services across three major market segments: supermarket, chain drug, and general retail. Agilysys now offers a wide range of services and solutions nationwide, including hardware and software products and extensive professional services that ensure continuous retail operations. Professional services include technology consulting, software customization, staging, implementation, hardware and software maintenance and 24/7 support service capabilities. Agilysys also makes these products and services available to its existing partners and customers.

     In February 2004, the company acquired substantially all of the assets of Inter-American Data, Inc. (“IAD”). As with the Kyrus acquisition, the addition of IAD opened up a new market, broadened the company’s customer base, and increased its services and product offerings. With this acquisition, Agilysys is the leading developer and provider of technology solutions for property and inventory management in the casino and destination resort segments of the hospitality industry in the United States. Most of the major

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     Lodging Management Systems (“LMS”) by Agilysys is the hospitality industry’s leading property management software solution. Designed specifically to meet the unique needs of the hospitality industry, the comprehensive solution automates every aspect of hotel operations, allowing properties to provide a higher level of service more efficiently and more cost-effectively.

     Agilysys supplements its LMS offering with a Materials Management System (“MMS”) that enables the tracking and replenishment of food, beverage and other perishable and non-perishable inventory. In addition to gaming customers, the market for the MMS products includes restaurant chains and public arenas.

     With the acquisition of IAD, the company also develops and markets proprietary document management solutions, DataMagine, with a focus on the hospitality, health care, retail and government markets. DataMagine enables the capture, storage, control, manipulation and distribution of scanned and electronically originated images.

     In May 2005, the company acquired The CTS Corporations (“CTS”), a leading, independent services organization, specializing in information technology storage solutions for large and medium-sized corporate customers and public-sector clients. The addition of CTS enhances the company’s offering of comprehensive storage and enterprise infrastructure solutions.

     In December 2005, the company entered the China and Hong Kong markets through the purchase of the China and Hong Kong operations of Mainline Information Systems, Inc. The business specializes in IBM information technology enterprise solutions for large and medium-sized businesses and banking institutions in the China market, and has sales offices in Beijing, Guangzhou, Shanghai, Hong Kong and Macau. Agilysys expects this business to provide it an opportunity to quickly begin operations in China with a nucleus of local talented people. Additionally, the company plans to expand the scope of products and services offered through this business.

Industry

The worldwide IT products and services industry generally consists of (1) hardware suppliers and software developers which sell directly to distributors, solution providers, resellers and end-users, (2) distributors, which sell to solution providers and resellers and, (3) solution providers and resellers, which sell directly to end-users.

     A variety of solution provider and reseller categories exist, including value-added resellers (“VARs”), corporate resellers, systems integrators, independent software vendors (ISVs), direct marketers and independent dealers. The large number of resellers makes it cost-efficient for suppliers and software developers to rely on a small number of distributors to serve this diverse customer base. Similarly, due to the large number of suppliers and products, solution providers and resellers often cannot or choose not to establish direct purchasing relationships. As a result, many of these companies are heavily dependent on distribution partners, such as Agilysys, that possess the necessary systems infrastructure, capital, inventory availability, and distribution and integration facilities to provide fulfillment and other services, such as financing, logistics, marketing and technical support. These services allow solution providers and resellers to reduce or eliminate their inventory and warehouse requirements, and reduce their staffing needs for marketing and systems integration, thereby reducing their costs.

     Enterprise computer products distribution continues to perform a vital role in delivering IT products to market in an efficient, cost-effective manner. Manufacturers are pursuing strategies to outsource functions such as logistics, market development services, order management and technical support to supply chain partners as they look to minimize costs and investments in pre- and post-sales support and focus on their core competencies.

     Distribution plays an important role in this outsource strategy by allowing the manufacturers to decrease fixed costs as the distributors deliver a streamlined approach to an extended customer base through their technically skilled sales organization. The company also believes that suppliers will continue to embrace the distribution channel for enterprise computer technology solutions in order to maintain sales, marketing and technical expertise in key markets such as the mid-market sector through distribution and the extended reseller network. The economies of scale and reach of large industry-leading enterprise computer solutions providers are expected to continue to be significant competitive advantages in this marketplace.

     Fiscal 2006 results were favorably impacted by increased marketing by Agilysys of its enterprise computer technology solutions, combined with an improving U.S. capital spending environment for information technology. According to information published in March 2005 by IDC, a leading provider of technology intelligence and market data, U.S. IT spending is projected to grow at approximately six percent in calendar year 2006. Since Agilysys is well entrenched in the server, storage and software markets, the company expects to benefit from this projected growth. However, a slowdown in this market could have a negative effect on the company’s revenues and results of operations.

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Agilysys focuses on the distribution and reselling of three specific product areas — server and storage hardware, software and services. The company offers mid-range enterprise servers, comprehensive storage solutions including hardware and software, and database, Internet and systems management software. These products are packaged together as new systems or to enhance existing systems, depending on the customer’s needs. The company also resells supplier-provided services as well as proprietary services.

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

     During 2006, 2005 and 2004, products purchased from the company’s two largest suppliers accounted for 86%, 88% and 88%, respectively, of the company’s sales volume. The company’s largest supplier, IBM, supplied 71%, 72% and 72% of the company’s sales volumes in 2006, 2005 and 2004, respectively. Sales of HP products accounted for 15%, 16% and 16% in 2006, 2005 and 2004, respectively.

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

     Through its acquisition of Kyrus and additional business development since the acquisition, Agilysys is a leader in designing solutions that help make its retail industry customers more productive and improve their customers’ satisfaction. Agilysys retail offerings help improve operational efficiency, technology utilization, a retailer’s overall shopping experience and in-store profitability through customized relationship, pricing and inventory management systems. Agilysys also provides implementation plans and supplies complete hardware bundles needed to operate the systems, including servers, receipt printers, point-of-sale monitors and wireless devices for use by the retailer’s store associates.

     Through its acquisition of IAD and business development since the acquisition, Agilysys develops and delivers fully integrated solutions designed exclusively for the hotel casino and destination resort segments of the hospitality industry. The company’s property management systems, LMS^tm, automate every aspect of hotel operations, including reservations, dining, guest activities and departure, to provide a higher level of service more efficiently and cost effectively. Agilysys also offers a material management system, MMS^tm, that automates all aspects of inventory and procurement, ranging from food and beverage and retail operations (hotel casino spas, gift shops, etc.) to general property needs. In addition, Agilysys offers a proprietary document management software solution, DataMagine^tm.

Inventory

The company maintains levels of inventory sufficient to ensure that the lead times to its customers remain competitive. The majority of the products sold by Agilysys are purchased pursuant to distributor agreements, which generally provide for inventory return privileges by the company upon cancellation of a distributor agreement. The distributor agreements also typically provide protection to the company for product obsolescence and price erosion. Along with the company’s inventory management policies and practices, these

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     In some cases, the industry practices discussed above are not embodied in agreements and do not protect the company in all cases from declines in inventory value. However, the company believes that these practices provide a significant level of protection from such declines, although no assurance can be given that such practices will continue or that they will adequately protect Agilysys against declines in inventory value. In addition, the company’s results of operations depend in part on successful management of the challenges of rapidly changing technology.

Customers

Agilysys serves customers in most major and secondary markets of North America. The company’s customer base includes VARs, which often are privately held with annual sales that range from approximately $10 million to $400 million, and corporate end-users, which range from medium to large corporations, as well as the public sector. A substantial amount of the company’s business, whether through resellers or direct to end-users, is in the mid-market customer segment. No single customer accounted for more than 10 percent of Agilysys total sales during 2006, 2005, or 2004.

Uneven Sales Patterns and Seasonality

The company experiences a disproportionately large percentage of quarterly sales in the last month of its fiscal quarters. In addition, the company experiences a seasonal increase in sales during its fiscal third quarter ending in December. Third quarter sales were 31%, 32%, and 33% of annual revenues for 2006, 2005, and 2004, respectively. Agilysys believes that this sales pattern is industry-wide. Although the company is unable to predict whether this uneven sales pattern will continue over the long term, the company anticipates that this trend will remain the same in the foreseeable future.

Backlog

The company historically has not had a significant backlog of orders. There was no significant backlog at March 31, 2006.

Competition

The distribution and reselling of enterprise computer technology solutions is competitive, primarily with respect to price, but also with respect to service levels. The company faces competition with respect to developing and maintaining relationships with customers. Agilysys competes for customers with other distributors, resellers and occasionally with some of its suppliers. Several of the company’s distribution competitors are significantly larger primarily due to their international distribution presence as well as participation in other businesses; whereas, the company’s solution provider and reseller competitors are typically smaller. Also, it is possible that certain suppliers may decide to distribute products directly, which would further heighten competitive pressures.

Growth through Acquisitions

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

Employees

As of March 31, 2006, Agilysys had 1,483 employees. The company is not a party to any collective bargaining agreements, has had no strikes or work stoppages and considers its employee relations to be excellent.

Markets

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

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

Item 1A.    Risk Factors.

The company is highly dependent on its key suppliers and supplier programs.

The company depends on a small number of key suppliers. During fiscal 2006, products purchased from IBM and HP, the company’s two largest suppliers, accounted for 71% and 15%, respectively, of the company’s sales volume. The loss of either of these suppliers or a combination of certain other suppliers could have a material adverse effect on the company’s business, results of operations and financial condition. From time to time, a supplier may terminate the company’s right to sell some or all of a supplier’s products or change the terms and conditions of the supplier relationship or reduce or discontinue the incentives or programs offered. Any such termination or implementation of such changes could have a material negative impact on the company’s results of operations.

Risks associated with the indirect distribution of the company’s products and services may materially adversely affect the company’s financial results.

In addition to direct sales, the company markets and sells products and services indirectly through systems integrators, resellers and original equipment manufacturers. The company may, from time to time, derive a significant percentage of its revenues from sales through these reseller partners. The company’s financial results could be materially adversely affected if the company’s agreements with its reseller partners were terminated, if the company’s relationships with its reseller partners were to deteriorate or if the financial condition of its reseller partners were to weaken. In addition, as the company’s market opportunities change, the company may have an increased reliance on its reseller partners, which may negatively impact the company’s gross margins. There can be no assurance that the company will be successful in maintaining or expanding the sales revenue generated by the indirect distribution of its products and services. If the company is not successful, the company may lose sales opportunities, customers and market share. In addition, there can be no assurance that the company’s reseller partners will not develop, market or sell products or services in competition with the company in the future.

The market for the company’s products and services is affected by rapidly changing technology and inventory obsolescence and if the company fails to anticipate and adapt to such changes and protect against inventory obsolescence, the company’s results of operations may suffer.

The markets in which the company competes are characterized by rapid technological change, frequent new product introductions, evolving industry standards and changing needs of customers. The company’s future success will depend on its ability to anticipate and adapt to changes in technology and industry standards. In addition, because the company maintains certain levels of inventory in order to ensure that the lead times to customers remain competitive, the company is subject to the risk of inventory obsolescence. If the company fails to successfully manage the challenges of rapidly changing technology and inventory obsolescence risks, the company’s results of operations may suffer.

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

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

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As part of the company’s business strategy, the company seeks acquisition prospects that could accelerate the growth of its business by expanding its customer base, extending its reach into new markets and/or broadening the range of solutions it offers. However, acquisitions always present risks and uncertainties. These factors could have a material adverse effect on the company’s business, results of operations or financial condition.

Item 1B.    Unresolved Staff Comments.

None.

Item 2.    Properties.

The company’s principal corporate offices are located in a 60,450 square foot facility in Mayfield Heights, Ohio. The company recently announced plans to move its corporate headquarters to Boca Raton, Florida during 2007. As of March 31, 2006, the company owned or leased a total of approximately 744,205 square feet of space for its continuing operations, of which approximately 644,205 square feet is devoted to product distribution and sales offices. The company’s major leases contain renewal options for periods of up to 10 years. For information concerning the company’s rental obligations, see the discussion of contractual obligations under Item 7 as well as note 7 to the consolidated financial statements contained in Part IV hereof. The company believes that its distribution and office facilities are well maintained, are suitable and provide adequate space for the operations of the company.

     The company’s facilities of 100,000 square feet or larger, as of March 31, 2006, are set forth in the table below.

Item 3.    Legal Proceedings.

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

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

No matters were submitted to a vote of the company’s security holders during the last quarter of the fiscal year ended March 31, 2006.

Item 4A.    Executive Officers of the Registrant.

The information provided below is furnished pursuant to Instruction 3 to Item 401(b) of Regulation S-K. The following table sets forth the name, age, current position and principal occupation and employment during the past five years through June 2, 2006 of the company’s executive officers.

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

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part II

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

     As of June 2, 2006, there were 30,526,505 common shares of Agilysys, Inc. outstanding, and there were 2,376 shareholders of record. The closing price of the common shares on June 2, 2006, was $17.18.

     Cash dividends on common shares are payable quarterly upon authorization by the Board of Directors. Regular payment dates are the first day of August, November, February and May. The company expects to continue to pay comparable cash dividends on its common shares. The company also made quarterly distributions on its 6.75% Mandatorily Redeemable Convertible Trust Preferred Securities (the “Securities”) to shareholders of record on the fifteenth day preceding the distribution date. However, on June 15, 2005, the company completed the redemption of its Securities.

     In 2006, the company issued 1,264,505 common shares upon conversion of 398,324 Securities. The common shares were not registered under the Securities Act of 1933 (the “Securities Act”) in reliance on an exemption from registration afforded by Section 3(a)(9) of the Securities Act.

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

     On April 27, 1999, the company adopted a Shareholder Rights Plan. For further information about the Shareholder Rights Plan, see note 14 to the consolidated financial statements contained in Part IV hereof.

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Item 6.    Selected Financial Data.

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

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The following discussion should be read in conjunction with the consolidated financial statements and related notes that appear elsewhere in this document.

Overview

Agilysys, Inc. (the “company” or “Agilysys”) 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 is a critical link in the information technology supply chain and is operated through two routes to market. The Agilysys Enterprise Solutions Group (ESG) delivers tailored solutions consisting of suppliers’ products and services, combined with proprietary software and services, directly to end-user customers. The Agilysys KeyLink Systems Group (KSG) links reseller partners with leading suppliers of server and storage hardware, software and services and offers a wide range of programs and services to help these reseller partners grow their businesses, compete successfully and serve their customers.

     The 7.4% increase in sales reflects year-over-year growth in each of the company’s major product categories, hardware, software, and services. Sales growth has been accomplished by the company’s focus on providing enterprise computer technology solutions and entry into the growing retail and hospitality solutions markets through recent acquisitions. Additionally, the company has experienced increases in gross margin due, in part, to higher growth in direct sales to end-user customers and a sales mix shift more towards higher

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     The company continued to increase its financial flexibility during 2006 with the redemption of its 6.75% Convertible Trust Preferred Securities, which eliminated the associated annual distribution on the securities as well as the potential dilution of approximately 6.7 million shares. The company also entered into a $200 million five-year unsecured credit facility, which can be used to retire existing debt, fund working capital and capital expenditures, or for general corporate purposes including acquisitions that improve our business model.

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

Results of Operations

2006 Compared with 2005

Net Sales and Operating Income

     Net sales. The $119.5 million increase in net sales was attributed to higher sales volume achieved in each of the company’s routes to market. Sales from the company’s Enterprise Solutions Group (“ESG”), which serves large and medium-sized corporations across many industries, increased $92.0 million. Of the total ESG sales increase, incremental sales generated from the company’s two business acquisitions in 2006 accounted for $22.5 million. Additionally, higher sales to the retail industry accounted for $28.6 million of the increase in ESG sales. Sales from the company’s KeyLink Systems Group, which is the company’s primary connection with its reseller partners, increased $27.5 million.

     Changes in sales by major product category were as follows: hardware sales increased $55.8 million, or 4.2%, software sales increased $38.8 million, or 17.5%, and services revenue increased $24.9 million, or 31.3%. The increase in hardware sales was the result of higher sales volume of both storage and server technology. The increase in software sales was achieved by higher sales of remarketed software solutions. The increase in services revenue was primarily driven by incremental sales of proprietary services generated from the company’s acquisition of The CTS Corporations in the first quarter of 2006.

     Gross Margin. The $21.5 million increase in gross margin was mainly due to the increase in net sales compared with last year and the realization of incentive payments from suppliers. Additionally, sales generated from ESG increased as a percentage of total company sales in 2006. ESG sales traditionally result in higher gross margin. 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.

     Operating Expenses. The company’s operating expenses consist of selling, general, and administrative (“SG&A”) expenses and restructuring charges. The $3.3 million increase in SG&A expenses was due to higher compensation and benefits costs, outside

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

Other (Income) Expenses

     Other income, net. The $0.6 million decline in other income, net was mainly due to lower earnings from the company’s equity investment, which decreased $1.4 million. The decrease in equity investment income was offset by a $0.6 million gain realized upon partial redemption of a cost investment by the investee and $0.2 million of other miscellaneous changes.

     Interest income. The $1.5 million increase in interest income was due to higher investment yields earned on the company’s cash equivalents during the current year. The average annual yield earned on cash equivalents increased 187 basis points year-over-year from 1.85% in 2005 to 3.72% in 2006.

     Loss (gain) 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.

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The company recorded an income tax provision from continuing operations at an effective tax rate of 41.7% in 2006 compared with an income tax provision at an effective rate of 38.1% in 2005. The increase in the effective tax rate is the result of an increase in the provision for state income taxes and settlement of income tax audits, partially offset by a reduction in the valuation allowance.

     In 2006, the company recognized a tax benefit (reduction in valuation allowance) for $1.5 million of state income tax net operating loss carryforwards more likely than not to be realized, in addition to the benefit of $3.5 million recognized in 2005. The benefit is based on management’s forecasted taxable income for the two-year period ending March 31, 2008. These net operating loss carryforwards expire, if unused, in years 2008 through 2019.

     In 2005, the company established a $2.5 million valuation allowance for the Canadian subsidiary deferred tax assets, including net operating losses, because it is more likely than not that the deferred tax assets will not be realized. In 2006 the valuation allowance was increased an additional $208,000 primarily for current year net operating loss.

2005 Compared with 2004

Net Sales and Operating Income

     Net sales. Of the $219.7 million increase in net sales in 2005, $79.7 million is attributable to incremental solutions offerings from the two business acquisitions made during 2004. IAD was acquired on February 17, 2004; thus, it marginally impacted prior year results. In addition, Kyrus only contributed six months of sales activity in 2004 as the business was acquired on September 30, 2003. The remaining $140.0 million increase can be attributed to higher sales volume through the company’s distribution business. As discussed below, the sale of server and storage hardware to the company’s reseller partners during 2005 reflected the strong demand for information technology by end-user customers. Demand for the products we provide softened, however, towards the end of 2005 resulting in a 4.0% decrease in hardware sales for the quarter ended March 31, 2005 compared with the comparable period in 2004.

     The increase in full year net sales for 2005 was attributed to the following changes in net sales by product category compared with the same period in 2004: hardware sales increased $187.1 million, software sales increased $9.7 million, and services revenue increased $22.9 million.

     Despite a slight decrease in hardware sales during the fourth quarter of 2005, annual hardware sales were favorably impacted by higher server and storage sales primarily through the company’s distribution business. The increase in software sales was mainly the result of proprietary software revenue generated from IAD, which was acquired during the fourth quarter of 2004. Thus, 2005 was favorably impacted by a full year of IAD revenue. The increase in services revenue can be attributed to incremental solutions offerings from the company’s two acquisitions made in 2004.

     Gross Margin. The $26.5 million increase in gross margin in 2005 is mainly attributed to incremental sales generated from the two 2004 business acquisitions, which increased gross margin by $24.7 million in 2005. The increase in sales volume in the company’s business, excluding the two 2004 business acquisitions, resulted in higher gross margin dollars as well; however, these gains were negatively impacted by a reduction in gross margin percentage year-over-year. The lower levels of gross margin percentage were

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mainly due to a decrease in gross margin realized on the sale of hardware products, fundamentally the sale of IBM Intel-architecture products.

     A significant component of gross margin is the realization and timing of incentive payments from the company’s suppliers. Incentive programs are principally designed to reward sales performance. The decrease in fourth quarter sales in 2005 compared with 2004 resulted in lower incentive payments recognized in the fourth quarter of 2005 versus 2004, which negatively impacted gross margin in 2005.

     Operating Expenses. The company experienced a $20.0 million increase in operating expenses in 2005 compared with 2004. Operating expenses includes selling, general and administrative (“SG&A”) expenses and restructuring charges. The increase was primarily caused by higher compensation and benefits costs, which increased $15.4 million, mainly resulting from the two 2004 business acquisitions having a full-year impact in 2005. The higher compensation and benefits also reflect a $3.0 million increase in the company’s Supplemental Executive Retirement Plan expense during 2005 as well as a $1.5 million expense to accrue for a long-term incentive plan. Additionally, the company incurred $2.8 million in amortization of intangible assets during 2005 compared with zero in 2004. The intangible assets were recognized in 2005 as the purchase accounting adjustments were finalized for the two business acquisitions made in 2004. Further, professional fees were $2.6 million higher in 2005 as a result of acquisition exploration activities and Sarbanes-Oxley Section 404 professional services. Other activity in operating costs resulted in an overall decrease of $0.8 million during 2005 compared with 2004.

Other (Income) Expenses

     Other income, net. The 70.3% decrease in other income, net is explained by a favorable litigation settlement of $5.0 million received in 2004.

     Interest income. The 47.1% increase in interest income reflects higher yields earned on the company’s short term investments due to a rising interest rate environment experienced during the 2005. The 36.8% decrease in interest expense is attributable to lower average debt levels in 2005 compared to prior year, as the interest rates applicable to the company’s long-term debt are fixed. The company’s average long-term debt was $59.6 million in 2005 versus $95.2 million in 2004.

     Loss (gain) on redemption of Mandatorily Redeemable Convertible Trust Preferred Securities. The 2004 gain resulted from the company’s repurchase of approximately $17.0 million of Convertible Trust Preferred Securities. No such repurchases occurred during 2005.

     Loss on retirement of Senior Notes. The loss on retirement of Senior Notes in 2004 relates to the premiums paid, as well as the write-off of other deferred financing fees associated with the company’s repurchase of approximately $71.6 million of its Senior Notes. No such repurchases occurred during 2005.

Income Taxes

The company recorded an income tax provision from continuing operations at an effective tax rate of 38.1% in 2005 compared with an income tax provision at an effective rate of 36.3% in 2004. The change in rate from 2005 to 2004 was the net sum of the increase in the valuation allowance for Canadian deferred tax assets, the increase in state income tax expense, the decrease in the valuation allowance for state net operating loss carryforwards, and the favorable settlement of state income tax audits in 2004.

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     In 2005, the company established a $2.5 million valuation allowance for the Canadian subsidiary deferred tax assets, including net operating losses, because it is more likely than not that the deferred tax assets will not be realized.

     In 2005, the company established a $45,000 valuation allowance for Federal net operating loss carryforwards of a non-consolidated affiliated subsidiary. The valuation allowance was established because it is more likely than not that the net operating loss carryforwards will not be utilized.

Off-Balance Sheet Arrangements

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

Contractual Obligations

The following table provides aggregated information regarding the company’s contractual obligations as of March 31, 2006. These obligations are discussed in detail in the preceding paragraphs and notes 7, 8, and 9 to the consolidated financial statements.

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

Liquidity and Capital Resources

Overview

The company’s operating cash requirements 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 March 31, 2006, 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 March 31, 2006 is due to the redemption of the company’s Securities in June 2005.

Revolving Credit Facility

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

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     In connection with entry into the Facility, the company terminated its prior unsecured credit facility. As a result of the termination, the company wrote off deferred financing fees of $0.1 million in 2006. The financing fees, incurred at the time of entering into the prior facility, were being amortized over the life of the prior facility. No amounts had been borrowed under the prior facility during the current year prior to its termination or at March 31, 2005.

Mandatorily Redeemable Convertible Trust Preferred Securities

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 expense of $109.0 million, which includes accrued interest of $1.5 million and a premium of $2.1 million. The company funded the redemption with existing cash. In addition, 398,324 Securities with a carrying value of $19.9 million were converted into common shares of the company. The Securities were converted at the conversion rate of 3.1746 common shares for each share of the Securities converted resulting in the issuance of 1,264,505 common shares of the company. As a result of the redemption, the company wrote off deferred financing fees of $2.7 million. The financing fees incurred at the time of issuing the Securities were being amortized over a 30-year period ending March 31, 2028.

     Prior to redemption the Securities were non-voting (except in limited circumstances) and paid quarterly distributions at an annual rate of 6.75%. The Securities were convertible into common shares at the rate of 3.1746 common shares for each Security (equivalent to a conversion price of $15.75 per common share).

Senior Notes

The principal amount of Senior Notes outstanding at March 31, 2006 and 2005 was $59.4 million. The Senior Notes are due August 2006. Accordingly, the Senior Notes have been classified as a current liability at March 31, 2006. The Senior Notes pay interest semi-annually on February 1 and August 1 at an annual rate of 9.5%. Interest accrued on the Senior Notes as of March 31, 2006 and March 31, 2005 was approximately $0.9 million.

     The indenture under which the Senior Notes were issued limits the creation of liens, sale and leaseback transactions, consolidations, mergers and transfers of all or substantially all of the company’s assets, and indebtedness of the company’s restricted subsidiaries. The Senior Notes are subject to mandatory repurchase by the company at the option of the holders in the event of a change in control of the company.

Cash Flow

     Cash flow provided by (used for) operating activities. The $41.1 decrease in cash provided by operating activities was principally due to the change in working capital requirements. Specifically, customer payment patterns normalized in 2006; whereas, the company experienced higher collection results in 2005. Additionally, the company experienced a relatively consistent accounts payable balance

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     Cash flow used for investing activities. The $35.4 million increase in cash used for investing activities was mainly due to the two acquisitions made in 2006, which were funded by cash. The CTS Corporations was acquired for $27.8 million and the China and Hong Kong operations of Mainline Information Systems, Inc. were acquired for $0.2 million, which is net of $0.6 million cash acquired in the transaction. In addition, the company acquired $6.8 million of marketable securities during 2006 to satisfy future obligations of its employee benefit plans. The securities are currently held in a Rabbi Trust.

     Cash flow provided by (used for) financing activities. The $106.3 million increase in cash used for financing activities was mainly due to the company’s redemption of its Mandatorily Redeemable Convertible Trust Preferred Securities during the first quarter of 2006. Securities with a carrying value of $105.4 million were redeemed at a premium of 2.025%, for a total use of cash of $107.5 million. The company funded the redemption with cash on hand. The remaining Securities, which had a carrying value of $19.9 million, were converted into common shares of the company.

Critical Accounting Policies, Estimates & Assumptions

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

     The company’s most significant accounting policies relate to the sale, purchase, distribution and promotion of its products. The policies discussed below are considered by management to be critical to an understanding of the company’s consolidated financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. No material adjustments to the company’s accounting policies were made in 2006. Specific risks for these critical accounting policies are described in the following paragraphs.

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

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

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

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

     Regarding sales of services, the company offers proprietary and third-party services to its customers. Proprietary services generally are as follows: consulting, installation, integration, and maintenance. Revenue relating to consulting, installation, and integration

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

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

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

     Goodwill and Long-Lived Assets. In assessing the recoverability of the company’s goodwill and other long-lived assets, significant assumptions regarding the estimated future cash flows and other factors to determine the fair value of the respective assets must be made, as well as the related estimated useful lives. The fair value of goodwill is estimated using a discounted cash flow valuation model. If these estimates or their related assumptions change in the future as a result of changes in strategy or market conditions, the company may be required to record impairment charges for these assets in the period such determination was made. For further information concerning the company’s calculation of impairment, see Notes 1 and 5 in the accompanying consolidated financial statements.

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

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

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

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Recently Issued Accounting Standard

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) 123 (revised 2004), Share Based Payment, which is a revision of Statement 123. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in operating results based on their fair values. Statement 123(R) will be effective for the company on April 1, 2006, the beginning of the company’s fiscal 2007.

     Statement 123(R) permits public companies to adopt its requirements using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date, or (2) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The company plans to use the modified prospective method to adopt the provisions of Statement 123(R).

     As permitted by Statement 123, the company currently accounts for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have an impact on the company’s operating results. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the company adopted Statement 123(R) in prior periods, the company believes the impact would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share in Note 1. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions has not been significant.

     In May 2005, the FASB issued Statement 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and Statement 3, Reporting Accounting Changes in Interim Financial Statements, and provides guidance on the accounting for and reporting of accounting changes and error corrections. Statement 154 applies to all voluntary changes in accounting principle and requires retrospective application (a term defined by the statement) to prior periods’ financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. In addition, Statement 154 redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The company will adopt Statement 154 beginning April 1, 2006.

     In November 2004, the FASB issued Statement 151, Inventory Costs — An amendment of ARB No. 43. Statement 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, Statement 151 requires that allocation of fixed production overheads to conversion costs should be based on normal capacity of the production facilities. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Companies must apply the standard prospectively. The adoption of Statement 151 is not expected to have a material impact on the company’s results of operations or financial position.

Business Combinations

Mainline China and Hong Kong

On December 8, 2005, the company acquired the China and Hong Kong operations of Mainline Information Systems, Inc. Accordingly, the results of operations for the China and Hong Kong operations have been included in the accompanying consolidated financial statements from that date forward. The business specializes in IBM information technology enterprise solutions for large and medium-sized businesses and banking institutions in the China market, and has sales offices in Beijing, Guangzhou, Shanghai and Hong Kong. The business provides the company the opportunity to begin operations in China with a nucleus of local workforce. The acquisition price for the China and Hong Kong operations was $0.8 million, which included $0.3 million of direct acquisition costs. Based on

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The CTS Corporations

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 consolidated financial statements from that date forward. The addition of CTS enhances the company’s offering of comprehensive storage solutions. The acquisition price was $27.8 million, which included repayment of $2.6 million of CTS debt and $0.2 million of direct acquisition expenses. Additionally, the company would be obligated to pay an earn-out to former CTS shareholders if the acquired business achieves specific financial performance targets. As of March 31, 2006, it is not likely that the financial performance targets will be met by the end of the earn-out period.

     Based on management’s initial allocation of the acquisition cost to the net assets acquired, approximately $24.1 million was assigned to goodwill in the first quarter of 2006. During the second quarter, the company adjusted the estimated fair value of acquired tax assets and liabilities by approximately $0.5 million, with a corresponding decrease to goodwill. During the third quarter, specifically identifiable intangible assets were assigned a fair value of $9.8 million with a corresponding reduction to goodwill. The resulting deferred tax adjustment was $3.8 million with a corresponding offset to goodwill. Of the intangible assets acquired, $9.4 million was assigned to customer relationships, which is being amortized over ten years using an accelerated method and $0.4 million was assigned to non-compete agreements, which are being amortized over four years using the straight-line method. Goodwill resulting from the CTS acquisition will not be deductible for income tax purposes.

Discontinued Operations

During 2003, the company announced its strategic transformation to focus solely on its enterprise computer systems business. The transformation included the sale of substantially all of the assets and liabilities of the company’s Industrial Electronics Division (“IED”), which distributed semiconductors, interconnect, passive and electromechanical components, power supplies and embedded computer products in North America and Germany. The assets sold consisted primarily of accounts receivable and inventories and the company’s shares of common stock in World Peace Industrial Co., Ltd., an Asian distributor of electronic components. The buyer also assumed certain liabilities. In connection with the sale of IED, the company discontinued the operations of Aprisa, Inc. (“Aprisa”), which was an internet-based start up corporation that created customized software for the electronic components market. The disposition of IED and discontinuance of Aprisa represented a disposal of a component of an entity. The company continues to incur certain costs related to IED and Aprisa, which are reported as loss from discontinued operations. Such costs primarily relate to retained leases.

Restructuring Charges

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 2006, costs incurred for one-time termination benefits and other associated costs resulting from workforce reductions amounted to $2.5 million and facilities costs resulting from the exit of leased facilities amounted to $1.7 million. The charges were classified as restructuring charges in the consolidated statement of operations. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income.

     In the fourth quarter of 2003, concurrent with the sale of IED, the company announced it would restructure its remaining enterprise computer solutions business and facilities to reduce overhead and eliminate assets that were inconsistent with the company’s strategic plan and were no longer required. In connection with this reorganization, the company recorded restructuring charges totaling $20.7 million for the impairment of facilities and other assets no longer required as well as severance, incentives, and other employee benefit costs for personnel whose employment was involuntarily terminated. The charges were classified as restructuring charges in the consolidated statement of operations. Severance, incentives, and other employee benefit costs were paid to approximately 110 personnel. Facilities costs represent the present value of qualifying exit costs, offset by an estimate for future sublease income for a vacant warehouse that represents excess capacity as a result of the sale of IED.

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     Discontinued operations. In connection with the sale of IED in 2003, the company recognized a restructuring charge of $28.7 million. Of the total charge, $5.9 million related to severance and other employee benefit costs to be paid to approximately 525 employees previously employed by IED and not hired by the acquiring company; $5.0 million related to facilities costs for approximately 30 vacated locations no longer required as a result of the sale that were determined as the present value of qualifying exit costs offset by an estimate of future sublease income; and $17.4 million related to the write down of assets to fair value that were abandoned or classified as “held for sale,” as a result of the disposition and discontinuance of IED and Aprisa, respectively. During 2006, the restructuring reserve was reduced by ongoing payments of facilities obligations. Approximately $0.6 million is expected to be paid in 2007 for facilities obligations, representing the accretion of lease obligations and the absence of sub-lease income that was assumed when the restructuring charge was initially recorded. Facilities obligations are anticipated to continue until 2010.

Investments

The company invests in marketable securities to satisfy future obligations of its employee benefit plans. The marketable securities are held in a Rabbi Trust. The Company’s investments in marketable equity securities are held for an indefinite period and thus are classified as available for sale. Unrealized holding gains on such securities, which were added to shareholders’ equity during 2006, were $13,000. The securities are recorded at fair value in other non-current assets on the balance sheet, with the change in fair value during the period excluded from earnings and recorded net of tax as a component of other comprehensive income. The aggregate fair value of the securities at March 31, 2006 was $6.8 million. The aggregate unrealized holding gain for the securities at March 31, 2006 was $13,000.

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

     During 2004, the company sold its investment in Eurodis Electron PLC (“Eurodis”), a publicly traded European enterprise computer systems distributor. The realized gain was determined on the basis of specific identification of securities sold since the company liquidated its entire securities holding. Sales proceeds and realized gain on the sale were $3.3 million and $0.9 million, respectively.

Risk Control and Effects of Foreign Currency and Inflation

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

     The company sells internationally and enters into transactions denominated in foreign currencies. As a result, the company is subject to the variability that arises from exchange rate movements. The effects of foreign currency on operating results did not have a material impact on the company’s results of operations for the 2006, 2005 or 2004 fiscal years.

     The company believes that inflation has had a nominal effect on its results of operations in fiscal 2006, 2005 and 2004 and does not expect inflation to be a significant factor in fiscal 2007.

Forward Looking Information

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

     Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Risks and uncertainties include, but are not limited to: competition, dependence on the IT market, softening in the computer network and platform market, rapidly changing technology and inventory obsolescence, dependence on key suppliers

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The company has assets, liabilities and cash flows in foreign currencies, primarily the Canadian dollar, creating foreign exchange risk. Systems are in place for continuous measurement and evaluation of foreign exchange exposures so that timely action can be taken when considered desirable. Reducing exposure to foreign currency fluctuations is an integral part of the company’s risk management program. Financial instruments in the form of forward exchange contracts are employed, when deemed necessary, as one of the methods to reduce such risk. There were no foreign currency exchange contracts held by the company at March 31, 2006 or 2005.

     The company is currently exposed to interest rate risk from the floating-rate pricing mechanisms on its revolving credit facility; however, at March 31, 2006 or 2005, there were no borrowings outstanding.

The information required by this item is set forth beginning at page 30 of this Annual Report on Form 10-K.

None.

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.

     As disclosed in Item 4 of the company’s Form 10-Q for the quarter ended December 31, 2005, in fiscal 2006 the following control improvements were implemented in an effort to remediate the control deficiencies that contributed to the material weakness related to the financial statement close process:

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     During 2006, the following control improvements were implemented in an effort to remediate the control deficiencies that contributed to the material weakness related to the vendor debits process:

     As a result of these control improvements and other measures the company has taken to date, management believes the control deficiencies identified over the vendor debit process that, when combined, constituted a material weakness in internal control over the vendor debit process as of March 31, 2005 have been remediated.

     In addition to the control improvements identified above, management performed additional analysis and other procedures to ensure the consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles. Accordingly, management believes that the consolidated financial statements included in this annual report present fairly in all material respects the company’s financial position, results of operations and cash flows for the periods presented.

     Based upon, and as of the date of, this evaluation, the company’s Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures were effective for the purpose of ensuring that material information required to be in this annual report was made known to them by others on a timely basis.

Management’s Report on Internal Control over Financial Reporting

The management of Agilysys, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2006 based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, management has concluded that it maintained effective internal control over financial reporting as of March 31, 2006.

     Management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2006 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.

Changes in Internal Control

Other than the control improvements discussed above, there have been no changes in the company’s internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

None.

23

part III

Information required by this Item as to the Directors of the company appearing under the caption “Election of Directors” in the company’s Proxy Statement to be used in connection with the company’s 2006 Annual Meeting of Shareholders to be held on July 28, 2006 (the “2006 Proxy Statement”) is incorporated herein by reference. Information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 by the company’s Directors, executive officers, and holders of more than five percent of the company’s equity securities will be set forth in the 2006 Proxy Statement under the heading “Section 16 (a) Beneficial Ownership Reporting Compliance.” Information required by this Item as to the executive officers of the company is included as Item 4A in Part I of this Annual Report on Form 10-K as permitted by Instruction 3 to Item 401(b) of Regulation S-K.

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

The information required by this Item is set forth in the company’s 2006 Proxy Statement under the heading, “Election of Directors,” under the sub-heading “Information Regarding Meetings and Committees of the Board of Directors and Compensation of Directors,” and under the heading “Compensation of Executive Officers” under the sub-headings “Summary Compensation Table,” “Option Grants in Last Fiscal Year,” “Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values,” “Supplemental Executive Retirement Plan,” and “Employment Agreements,” which information is incorporated herein by reference. The information set forth in the 2006 Proxy Statement under the subheadings, “Shareholder Return Performance Presentation,” “Compensation Committee Report on Executive Compensation,” and “Audit Committee Report” is not incorporated herein by reference.

The information required by this Item is set forth in the company’s 2006 Proxy Statement under the heading “Share Ownership,” and under the heading “Compensation of Executive Officers” under the sub-heading “Equity Compensation Plan Information,” which information is incorporated herein by reference.

None.

The information required by this Item is set forth in the company’s 2006 Proxy Statement under the heading “Independent Registered Public Accounting Firm,” which information is incorporated herein by reference.

part IV

     (a)(1) Financial statements. The following consolidated financial statements are included in this Annual Report on Form 10-K beginning on page 28:

24

     (a)(2) Financial statement schedule. The following financial statement schedule is included in this Annual Report on Form 10-K on page 57:

     Schedule II — Valuation and Qualifying Accounts

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

     (a)(3) Exhibits. See the Index to Exhibits beginning at page 58 of this Annual Report on Form 10-K.

25

signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Agilysys, Inc. has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Cleveland, State of Ohio, on June 9, 2006.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities as of June 9, 2006.

26

ANNUAL REPORT ON FORM 10-K

Year Ended March 31, 2006

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

27

report of independent registered public accounting firm

The Board of Directors and Shareholders

of Agilysys, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Agilysys, Inc. and subsidiaries as of March 31, 2006 and 2005, and the related consolidated statements of operations, cash flows and shareholders’ equity for each of the three years in the period ended March 31, 2006. We have also audited the accompanying financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

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

     In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Agilysys, Inc. and subsidiaries at March 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Agilysys, Inc. and subsidiaries’ internal control over financial reporting as of March 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 6, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Cleveland, Ohio

June 6, 2006

28

report of independent registered public accounting firm

on internal control over financial reporting

The Board of Directors and Shareholders of

Agilysys, Inc. and Subsidiaries

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting included elsewhere herein, that Agilysys, Inc. and subsidiaries maintained effective internal control over financial reporting as of March 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Agilysys, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

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

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

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

     In our opinion, management’s assessment that Agilysys, Inc. and subsidiaries maintained effective internal control over financial reporting as of March 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Agilysys, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 31, 2006, based on the COSO criteria.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Agilysys, Inc. and subsidiaries as of March 31, 2006 and 2005 and the related consolidated statements of operations, cash flows and shareholders equity for each of the three years in the period ended March 31, 2006, and our report dated June 6, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Cleveland, Ohio

June 6, 2006

29

Consolidated Statements of Operations

See accompanying notes to the consolidated financial statements

30

agilysys, inc. and subsidiaries

Consolidated Balance Sheets

See accompanying notes to the consolidated financial statements

31

Consolidated Statement of Cash Flows