**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

----

 

**FORM 10-Q**

 
| **ý**                                      | **Quarterly report pursuant to Section 13  or 15(d) of the Securities Exchange Act of 1934.**  |
|-------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                      | ** **                                                                                               |
| **For the period ended March 31, 2005 or** |
| ** **                                      |
| **o**                                           | **Transition report pursuant to Section 13  or 15(d) of the Securities Exchange Act of 1934.** |

 

**For the transition periodfrom        to        .**

 

**Commission file number: 1-9158**

 

----

 

**MAI Systems Corporation**

(Exact name of registrant as specified in its charter) 

 
| **Delaware**                    | ** ** | **22-2554549**                    |
|---------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of | ** ** | (IRS Employer Identification No.) |
| incorporation or organization)  | ** ** | ** **                        |

 

**26110 Enterprise Way, Lake Forest, CA 92630Address of principal executive offices**

Registrant’s telephone number including area code  (949) 598-6000

 

----

 

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

 

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

Yes   o   No   ý

 

The aggregate marketvalue of the common stock held by non-affiliates of the registrant, based uponthe last sale price of the Common Stock reported on the National Association ofSecurities Dealers Automated Quotation National Market System on September 16,2005 was $510,669.

 

The number of shares ofcommon stock issued, outstanding and subscribed as of September 16, 2005was 57,847,862. 

 

 

----

 

**PART I- FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**MAI SYSTEMS CORPORATION**

** **

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

** **

**(Unaudited)**

** **
| ** **                                                                                                                                                           | ** ** | **(in thousands, except share  data)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **As of December 31,  2004 (a)**  | ** ** | **As of March  31,  2005** | ** ** |
|                                                                                                                                                                 |       |                                   |       |   |   |
| **ASSETS**                                                                                                                                                           |       |                                   |       |   |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Current assets:                                                                                                                                                      |       |                                   |       |   |   |
| Cash                                                                                                                                                                 |       | $                                      | 195        |   | $ | 179 |   |
| Receivables, less allowance for doubtful accounts of  $321 in 2003 and $317 in 2005                                                                                  |       | 2,171                                  |       | 2,658 |   |
| Inventories                                                                                                                                                          |       | 71                                     |       | 71 |   |
| Prepaids and other assets                                                                                                                                            |       | 748                                    |       | 848 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total current assets                                                                                                                                                 |       | 3,185                                  |       | 3,756 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Furniture,  fixtures and equipment, net                                                                                                                              |       | 629                                    |       | 599 |   |
| Intangibles, net                                                                                                                                                     |       | 7,470                                  |       | 7,242 |   |
| Goodwill                                                                                                                                                             |       | 4,622                                  |       | 4,622 |   |
| Other assets                                                                                                                                                         |       | 15                                     |       | 15 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total assets                                                                                                                                                         |       | $                                      | 15,921     |   | $ | 16,234 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                   |       |                                   |       |   |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Current  liabilities:                                                                                                                                                |       |                                   |       |   |   |
| Current portion of long-term debt                                                                                                                                    |       | $                                      | 1,003      |   | $ | 866 |   |
| Accounts payable                                                                                                                                                     |       | 1,077                                  |       | 958 |   |
| Customer deposits                                                                                                                                                    |       | 2,181                                  |       | 2,180 |   |
| Accrued liabilities                                                                                                                                                  |       | 2,901                                  |       | 2,698 |   |
| Income taxes payable                                                                                                                                                 |       | 103                                    |       | 97 |   |
| Unearned revenue                                                                                                                                                     |       | 3,456                                  |       | 5,058 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total current liabilities                                                                                                                                            |       | 10,721                                 |       | 11,857 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Long-term debt                                                                                                                                                       |       | 6,649                                  |       | 6,550 |   |
| Other  liabilities                                                                                                                                                   |       | 764                                    |       | 754 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total liabilities                                                                                                                                                    |       | 18,134                                 |       | 19,161 |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Commitments and  contingencies                                                                                                                                       |       |                                   |       |   |   |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Stockholders’  deficiency:                                                                                                                                      |       |                                   |       |   |   |
| Preferred Stock, par value $0.01 per share;  1,000,000 shares authorized, none issued or outstanding                                                                 |       | —                                 |       | — |   |
| Common Stock, par value $0.01 per share; authorized  99,000,000 shares; 57,847,862 shares issued and outstanding at December 31,  2004 and March 31, 2005. |       | 584                                    |       | 584 |   |
| Additional paid-in capital                                                                                                                                           |       | 47,856                                 |       | 47,856 |   |
| Accumulated  other comprehensive loss:                                                                                                                               |       |                                   |       |   |   |
| Minimum pension liability                                                                                                                                            |       | (1,250                                 | )          | (1,250 | ) |
| Foreign currency translation                                                                                                                                         |       | (69                                    | )          | (54 | ) |
| Accumulated  deficit                                                                                                                                                 |       | (49,334                                | )          | (50,063 | ) |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total stockholders’ deficiency                                                                                                                                  |       | (2,213                                 | )          | (2,927 | ) |
|                                                                                                                                                                 |       |                                   |       |   |   |
| Total  liabilities and stockholders’ deficiency                                                                                                                 |       | $                                      | 15,921     |   | $ | 16,234 |   |

** **

----

**(a)**          Derived from the December 31, 2004 audited financial statements.

 

**The accompanying notesare an integral part of these condensed consolidated financial statements.**

 

----

 

**MAI SYSTEMS CORPORATION**

** **

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** **

**(Unaudited)**

** **
| ** **                                                                   | *** *** | **For the Three Months Ended March 31,** | *** *** |
|------------------------------------------------------------------------------|--------------|-----------------------------------------------|--------------|
| ** **                                                                   | *** *** | **(in thousands, except per share  data)**    | *** *** |
| ** **                                                                   | ** **   | **2004**                                      | ** **   | **2005** | ** ** |
| Revenue:                                                                     |         |                                          |         |   |   |
| Software                                                                     |         | $                                             | 1,289        |   | $ | 954 |   |
| Network and computer equipment                                               |         | 74                                            |         | 189 |   |
| Services                                                                     |         | 3,809                                         |         | 3,612 |   |
| Total revenue                                                                |         | 5,172                                         |         | 4,755 |   |
|                                                                         |         |                                          |         |   |   |
| Direct costs:                                                                |         |                                          |         |   |   |
| Software                                                                     |         | 321                                           |         | 343 |   |
| Network and computer equipment                                               |         | 60                                            |         | 179 |   |
| Services                                                                     |         | 1,069                                         |         | 1,325 |   |
| Total direct costs                                                           |         | 1,450                                         |         | 1,847 |   |
|                                                                         |         |                                          |         |   |   |
| Gross profit                                                                 |         | 3,722                                         |         | 2,908 |   |
|                                                                         |         |                                          |         |   |   |
| Selling, general  and administrative expenses                                |         | 2,348                                         |         | 2,184 |   |
| Research and  development costs                                              |         | 892                                           |         | 1,121 |   |
| Amortization of  intangibles                                                 |         | —                                        |         | 112 |   |
| Other operating  expense                                                     |         | 3                                             |         | 13 |   |
|                                                                         |         |                                          |         |   |   |
| Operating income (loss)                                                      |         | 479                                           |         | (522 | ) |
|                                                                         |         |                                          |         |   |   |
| Interest expense                                                             |         | (291                                          | )            | (203 | ) |
| Other  non-operating expense                                                 |         | (16                                           | )            | — |   |
|                                                                         |         |                                          |         |   |   |
| Income (loss) before income taxes                                            |         | 172                                           |         | (725 | ) |
|                                                                         |         |                                          |         |   |   |
| Income tax  expense                                                          |         | (6                                            | )            | (4 | ) |
|                                                                         |         |                                          |         |   |   |
| Net income (loss)                                                            |         | $                                             | 166          |   | $ | (729 | ) |
|                                                                         |         |                                          |         |   |   |
| Net income  (loss) per share:                                                |         |                                          |         |   |   |
|                                                                         |         |                                          |         |   |   |
| Basic income (loss) per share                                                |         | $                                             | 0.01         |   | $ | (0.01 | ) |
|                                                                         |         |                                          |         |   |   |
| Diluted income (loss) per share                                              |         | $                                             | 0.01         |   | $ | (0.01 | ) |
|                                                                         |         |                                          |         |   |   |
| Weighted average  common shares used in determining income (loss) per share: |         |                                          |         |   |   |
|                                                                         |         |                                          |         |   |   |
| Basic                                                                        |         | 14,575                                        |         | 57,848 |   |
| Diluted                                                                      |         | 14,875                                        |         | 57,848 |   |

 

**The accompanying notes are an integral part ofthese condensed consolidated financial statements.**

 

2

----

 

**MAI Systems Corporation**

** **

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

** **

**(Unaudited)**

** **
| ** **                                                            | *** *** | **For the Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------|--------------|------------------------------------------------|------------|
| ** **                                                            | *** *** | **(in thousands)**                             | ** ** |
| ** **                                                            | ** **   | **2004**                                       | ** ** | **2005** | ** ** |
|                                                                  |         |                                           |       |   |   |
| Net cash  provided by operating activities:                           |         | $                                              | 466        |   | $ | 232 |   |
|                                                                  |         |                                           |       |   |   |
| Cash flows used  in investing activities:                             |         |                                           |       |   |   |
| Capital expenditures                                                  |         | (66                                            | )          | (10 | ) |
| Capitalized software development costs                                |         | (321                                           | )          | — |   |
| Net cash used in  investing activities                                |         | (387                                           | )          | (10 | ) |
|                                                                  |         |                                           |       |   |   |
| Cash flows used  in financing activities-Repayments on long-term debt |         | (230                                           | )          | (241 | ) |
|                                                                  |         |                                           |       |   |   |
| Net cash used in  operations                                          |         | (151                                           | )          | (19 | ) |
|                                                                  |         |                                           |       |   |   |
| Effect of  exchange rate changes on cash                              |         | (3                                             | )          | 3 |   |
|                                                                  |         |                                           |       |   |   |
| Net decrease in  cash                                                 |         | (154                                           | )          | (16 | ) |
|                                                                  |         |                                           |       |   |   |
| Cash at  beginning of period                                          |         | 664                                            |       | 195 |   |
|                                                                  |         |                                           |       |   |   |
| Cash at end of  period                                                |         | $                                              | 510        |   | $ | 179 |   |

 

**The accompanying notes are an integral part ofthese condensed consolidated financial statements.**

 

3

----

 

**MAI Systems Corporation**

** **

**Notes to CondensedConsolidated Financial Statements**

** **

**Three Months ended March 31,2005**

** **

**(Unaudited)**

 

**NOTE 1 -BASIS OF PRESENTATION**

 

Companies for which this report is filed are MAISystems Corporation and its wholly-owned subsidiaries (the “Company”).  The information contained herein isunaudited, but gives effect to all adjustments (which are normal recurringaccruals) necessary, in the opinion of Company management, to present fairlythe condensed consolidated financial statements for the interim period.  All significant intercompany transactions andaccounts have been eliminated in consolidation. The results of operations for the quarter ended March 31, 2005 are notnecessarily indicative of the results to be expected for the entire year or forany future period.

 

Although the Company believes that the disclosures inthese financial statements are adequate to make the information presented notmisleading, certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to the rules and regulations of the Securities andExchange Commission (the “SEC”), and these financial statements should be readin conjunction with the financial statements included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2004, which is onfile with the SEC.

 

**NOTE 2 -LIQUIDITY**

 

Although the Company has a net stockholders’deficiency of $2,951,000 and a working capital deficit of $8,101,000 at March 31,2005, the Company believes it will generate sufficient funds from operations orobtain additional financing to meet its operating and capital requirements forat least the next 12 months.  The Companyexpects to generate positive cash flow from its continuing operations during2005 from shipping out products and services from its current backlog as of March 31,2005 as well as new orders.  In the eventthat the Company cannot generate positive cash flow from its continuingoperations during 2005, the Company can substantially reduce its research anddevelopment efforts to mitigate cash outflow to help sustain itsoperations.  There can be no assurancethat the Company will be able to sustain profitability or generate positivecash flow from operations or obtain additional financing as necessary.  These financial statements have been preparedassuming the Company will continue to operate as a going concern.  If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company.

 

The restructured debt, pursuant to the originalintercreditor agreement between Canyon and Coast, which was sold to Wamco on May 15,2003, contains various restrictions and covenants, including a minimum quickratio of 0.20 to 1.00 and minimum debt service coverage ratio of 0.50 to1.00.  In the event that we were not incompliance with the various restrictions and covenants and were unable toreceive waivers for non-compliance, the term debt would be immediately due andpayable (see note 5). The Company was not in compliance with but receivedwaivers for its covenants through March 31, 2005. There is no guarantythat the Company will meet its debt covenants in the future.

 

# **NOTE3 – MANAGEMENT EQUITY/CONVERSION TRANSACTION AND PRIVATIZATION PLANS**

# ** **

**Management Equity/Conversion Transaction**

 

On April 9, 2004, an investor group, consistingof Canyon, the Company’s Chairman of the Board, Chief Executive Officer &President and Chief Financial & Operating Officer (“Investor Group”),acquired 2,433,333 shares of the Company’s common stock held by CSA and$3,133,344 of secured indebtedness owed to CSA for $1 million in cash (see note8).  On September 22, 2004, theCompany received approval from its shareholders for the Investor Group toconvert the Company’s secured indebtedness acquired from CSA plus any accruedinterest through the date of conversion for shares of the Company’s commonstock based upon a conversion price of $0.10 per share.  Additionally, the shareholders also approvedfor the Investor Group to invest $1,000,000 of new cash proceeds into theCompany, which the Company received on September 24, 2004, in a privateplacement at $0.10 per share (the “Management Equity/Conversion Transaction”).    On November 1, 2004, the Company issued10 million shares of its common stock to the Investor Group in exchange for the$1,000,000 of cash proceeds and the $3,133,344 secured note, together with$183,867 of accrued interest, was converted into 33,172,110 shares of theCompany’s common stock.

 

4

----

 

We believe that theaforementioned transaction permitted but did not require us to use new basis orpush down accounting since the members of the Investor Group hold between 80%and 94% of the voting shares of the Company upon completion of the transaction.Application of push-down accountingrequires that the acquiring parent or control group obtain at least an 80%ownership interest, either in a single transaction, or though a series oftransactions. The Investor Group has acquired 78.84%, and the members of theInvestor Group previously personally held 17.85% ownership, not within theInvestor Group. The 17.85% personal ownership of the members outside of theInvestor Group was reduced to 4.53% after the Investor Group’s acquisition of78.84% of the Company’s common stock. The basis for considering the members as part of a control group is dueto the fact that the group’s intent was to mutually promote theacquisition and to collaborate on the subsequent control of the Company and, assuch, should be viewed effectively as one investor/group.  The 78.84% interest held by the InvestorGroup effectively ties the four members together into a control group, and thatthe remaining outside holdings of 4.53% (totaling 83.37%) should also betreated as held by the control group for purposes of applying push-downaccounting (therefore the Investor Group controls 83.37% of the Company’scommon stock).  Accordingly, theCompany has elected to apply push down accounting, and in accordance with SFAS No. 141 and using the guidance in Topic D-97.  This has resulted in a new valuation of theassets and liabilities of the Company based upon fair values as of November 1,2004, the date of the transaction.

 

In connection with theManagement Equity/Conversion Transaction, the Company assigned a new usefullife for furniture, fixtures and equipment effective as of November 1,2004.  Following is our allocation of thepurchase price at estimated fair values and amortization periods (useful lives)for the groups of assets affected:

 

| ** **                         | ** ** | **Allocation of  Purchase  Price** | ** ** | **Amortization  Period  (Useful Life)** | ** ** |
|------------------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | ** **                         | ** ** | ** **                              | ** ** |
| Furniture,  fixtures and equipment |       | $                                  | 612,000    |                                    | 3 years    |   |
| Intangible  assets:                |       |                               |       |                                    |       |
| Goodwill                           |       | $                                  | 6,372,000  |                                    | *          |   |
| Tradenames                         |       | 2,659,000                          |       | 15 years                                |       |
| Customer relationships             |       | 2,285,000                          |       | 7 years                                 |       |
| Capitalized software               |       | 2,503,000                          |       | 7 years                                 |       |
|                               |       | $                                  | 13,819,000 |                                    |       |   |

 

----

*                 Reviewedannually for impairment, not amortized, as goodwill has an indefinite life (inaccordance with SFAS No. 142).

 

The following reflectsthe unaudited pro forma effect of the Management Equity/Conversion Transactionon continuing operations for the thee-month period ended March 31, 2004 (inthousands):

 
| ** **            | ** ** | **For the Three -  Months Ended  March 31, 2004** | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|
|                  |       |                                                   |       |
| Revenue               |       | $                                                      | 5,172      |   |
| Operating income      |       | 339                                                    |       |
| Net income            |       | 109                                                    |       |
| Net income per  share |       | $                                                      | 0.01       |   |

 

# **The unaudited pro formainformation provided above has been prepared by adjusting historical amountsfor the three month period ended March 31, 2004 to give effect to theManagement Equity/Conversion Transaction as if it had occurred on January 1,2004.  The pro forma adjustments to thehistorical results of operations for the three month period ended March 31,2004 include the pro forma impact of the push down accounting resulting in thereduction of depreciation expense of $75,000 and an increase of amortization ofidentifiable intangible assets of $215,000. The pro forma adjustments to thehistorical results of operations for the three month period ended March 31,2004 include the pro forma impact of the debt conversion resulting in thereduction of interest expense of $83,000.**

 

5

----

 

**Privatization Plans**

 

Our Board of Directors and the Investor Group are inthe process of furnishing an information statement to all holders of record ofthe issued and outstanding shares of our common stock, $0.01 par value, inconnection with a proposed Amendment tothe Company’s Amended and Restated Certificate of Incorporation (“Amendment”) toeffectuate a 1-for-150 reverse stock split. If consummated, the reverse stocksplit would enable the Company to terminate its periodic reporting obligationsunder Sections 13 and 15(d) of the Securities Exchange Act of 1934, asamended (“Exchange Act”), the registration of our common stock under Section 12(g) ofthe Exchange Act and the quotation of our common stock on the OTC BulletinBoard and become a “private” company.

 

**NOTE 4-  INVENTORY**

 

Inventories are summarized as follows:

 
| ** **         | ** ** | **(dollars in thousands)**  | ** ** |
|--------------------|------------|-----------------------------|------------|
| ** **         | ** ** | **December 31,  2004** | ** ** | **March 31,  2005** | ** ** |
|               |       |                        |       |   |   |
| Finished goods     |       | $                           | 65         |   | $ | 64 |   |
| Replacement  parts |       | 6                           |       | 7 |   |
|               |       |                        |       |   |   |
|               |       | $                           | 71         |   | $ | 71 |   |

 

**NOTE 5 -LONG TERM DEBT**

 

**Wamco 32 Ltd.**

 

On January 13, 2003, the Company re-negotiatedthe terms of its credit facility with Coast Business Credit (“Coast”) wherebythe outstanding balance of $1,828,000 was converted to a secured term loanwhich accrues interest at 9.25% per annum and requires monthly payments of$58,000 over a 36 months period commencing March 1, 2003.  The loan is secured by all the tangible andintangible assets for the Company, including intellectual property. On February 7,2003, the Federal Deposit Insurance Corporation (“FDIC”) put Coast and itsparent company, Southern Pacific Bank, into receivership and held all of Coast’sassets for sale to third parties.  On May 15,2003, the loan was sold to Wamco 32, Ltd. (“Wamco”).  This sale of the loan by the FDIC did notchange any of the terms of the Company’s loan agreement.

 

The loan matures on February 28, 2006, at whichtime all remaining principal and accrued interest is due and payable.  The Company will also be required to payWamco additional principal payments on a quarterly basis based upon anEBITDA-based formula commencing March 31, 2003.  For the years ended December 31, 2003and 2004, there were no additional principal payments required under theEBITDA-based formula. As of December 31, 2004 and March 31, 2005, thebalance of the term loan was $774,000 and $585,000, respectively.

 

The loan, pursuant to the original inter-creditoragreement between Canyon Capital and Coast, which was sold to Wamco on May 15,2003, contains various restrictions and covenants, including a minimum quickratio of 0.20 to 1.00 and minimum debt service coverage ratio of 0.50 tol.00.  In the event that the Company werenot in compliance with the various restrictions and covenants and were unableto receive waivers for non-compliance, the term loan would be immediately dueand payable.  The Company was not incompliance with but received waivers for such covenants through March 31,2005.  There is no guaranty that theCompany will meet its debt covenants in the future.

 

**CanyonCapital Management LP**

 

On January 13, 2003, the Company modified its 11%secured subordinated notes payable agreement with Canyon Capital Management LP(“Canyon”), whereby the Company is required to make monthly interest paymentsof $52,000 until the Wamco term loan is paid off in full at which time the notepayable will be converted into a three-year amortizing loan which will accrueinterest at 11% per annum and requires equal monthly payments of principal andinterest such that the subordinated debt will be paid in full at the end of theamended term.  Upon the repayment of theWamco debt in full, the Company will also be required to pay Canyon additionalprincipal payments on a quarterly basis based upon an EBITDA-basedformula.  Additionally, in connectionwith the January 13, 2003 modification, the Company issued to Canyon200,000 shares of its common stock valued at $20,000 (the quoted market priceof the common stock at the time the terms were agreed) and agreed to issue onemillion warrants at an exercise price of $0.40 per share valued at $42,000(using the Black-Scholes option-pricing model with the following weighted-averageassumptions: risk-free interest rate of 6.5%, volatility of 80% and an expectedlife of 5 years).  The $62,000 is beingamortized to interest expense over the term of the modified note.  The subordinated notes are secured by all thetangible and intangible assets for the Company, including

 

6

----

 

intellectual property, which lien is junior to thelien granted to Wamco. Accrued and unpaid interest outstanding on thesubordinate notes payable to Canyon was approximately $58,000 at March 31,2005.  The principal balance outstandingon the subordinate notes payable to Canyon was approximately $5,660,000 at December 31,2004 and March 31, 2005.

 

**CSAPrivate Limited**

 

In connection with a settlement agreement in February 2001with CSA Private Limited (“CSA”), the Company issued $2.8 million ofsubordinated debt to CSA.  The $2.8million of debt was secured by all the tangible and intangible assets for theCompany, including intellectual property, which was subordinate to Wamco andCanyon, accrued interest at 10% per annum and required payments of $37,500 fromMarch 1, 2002 through September 1, 2002 and monthly payments of$107,500 commencing on October 1, 2002 until October 2003 when all remainingunpaid principal and accrued interest was to be paid in full.

 

The agreement with CSA was amended whereby the Companywas required to make payments under the subordinated note unless and until itpaid $1 million by December 31, 2002. Upon payment of the $1 million, contractual payments under thesubordinated note would have ceased until a final payment in the amount of$400,000 is paid by February 28, 2003. If the Company did not make all of the modified payments to CSA, thesubordinated note would revert back to its original terms.  The Company did not make the modified paymentand have not made any payments since September 2002.  CSA did not formally notify the Company ofits default.

 

On April 9, 2004, the Company successfullyamended its agreement with CSA whereby the principal balance and accruedinterest through March 31, 2004, totaling $3,633,000, were converted totwo secured new notes.  The first notefor $500,000 accrues interest at 10% per annum and provides for monthlypayments of $10,000 until the Wamco and Canyon debt is paid in full.  Thereafter, the note provides for monthlypayments in an amount equal to the greater of i) $10,000 or ii) the amountrequired to fully amortize all remaining principal and interest in 24 equalmonthly payments.  The second note for$3,133,344 (“Other Note”) also accrued interest at 10% per annum and providedfor monthly payments of $7,500, or such other interest amount, not to exceed$10,000 per month, that Wamco and Canyon will allow.  Under the terms of the amended subordinationagreement between Wamco, Canyon and CSA, all payments under the new notes aresubordinated to the payment in full of the Wamco and Canyon loan agreements.The Company has not made any payments on the $500,000 note as of March 31,2005 and is currently in default.  Theinterest rate has been increased to 12.5% in line with the terms of that noteuntil the Company becomes current on its contractual payments.  As of March 31, 2005, the Company’saccrued and unpaid interest relating to the $500,000 secured note was $66,000.

 

On April 9, 2004, an investor group, consistingof Canyon, the Company’s Chairman of the Board, Chief Executive Officer andChief Financial and Operating Officer (“Investor Group”), acquired 2,433,333shares of the Company’s common stock held by CSA and the Other Note for $1million in cash .  On November 1,2004, the $3,133,344 Other Note, together with $183,867 of accrued interest,was converted into 33,172,110 shares of the Company’s common stock (see note 3).

 

**TaxClaims**

 

On September 30, 2003, the Company entered into asettlement agreement with the United States Internal Revenue Service (the “Service”)on a tax claim which resulted from the Company’s 1993 Chapter 11 proceedingswhereby it agreed to pay $489,000 in equal monthly installments of $7,438 overa period of six (6) years at an interest rate of 6%.  The $489,000 settlement is reflected as debtin the financial statements and resulted in a one-time gain of $262,000 whichis included in income tax benefit. In the event that the Company fails to paythe Service any payment, and such payment failure continues for sixty daysafter written notice of such failure, $1,832,100, plus accrued interestthereon, less any payments made by the Company will be immediately due andpayable to the Service.  As of March 31,2005, the Company was current with its payments to the Service and the debtbalance was $334,000.

 

In connection with the settlement agreement with theService, the Company’s 1993 Chapter 11 proceedings were officially closedpursuant to Court order effective as of September 30, 2003.

 

**NOTE 6-  RESTRICTED STOCK PLAN**

 

In May 2001, the Board of Directors adopted the2001 Restricted Stock Plan.  Under theplan, 1,250,000 authorized shares of the Company’s Common Stock are reservedfor issuance to officers and directors of the Company.  The shares will be issued as “RestrictedStock” within the meaning of Rule 144 of the Securities Act of 1933, asamended.  The Compensation Committee ofthe Board of Directors shall have the discretion to determine what terms andconditions shall apply, including the imposition of a vesting schedule.

 

In May 2002, the Company issued 612,500 shares ofrestricted common stock to its members of the board of directors and certain ofits corporate officers which vest equally over a four-year period.  Recipients are not required to provide

 

7

----

 

consideration to the Company other than rendering theservice and have the right to vote the shares. Under APB 25, compensation cost is recognized for the fair value of therestricted stock awarded, which is its quoted market price at the date ofgrant, which was $0.25 per share.  Thetotal market value of the shares of $153,000 was treated as unearnedcompensation and was amortized to expense in proportion to the vestingschedule.  The balance of unearnedcompensation was fully amortized as of March 31, 2005.

 

**NOTE 7****    - PREFERRED STOCK**

 

On May 20, 1997, the Company authorized theissuance of up to 1,000,000 shares of $0.01 par value preferred stock.  The Board of Directors has the authority toissue the preferred stock, in one or more series, and to fix the rights,preferences, privileges and restrictions thereof without any further vote bythe holders of Common Stock.

 

**NOTE 8****    - INTANGIBLE ASSETS**

 

As of March 31, 2005, intangible assets consistof developed technology, software trade names, customer lists and goodwill(which represents the excess of the purchase price over the estimated fairvalue of the net assets of the acquired businesses)  and capitalized software.  Identifiable intangible assets other thangoodwill are amortized on a straight-line basis over their estimated usefullives.  Goodwill is not to be amortizeduntil its life is determined to be finite, however, a recognized intangibleasset with an indefinite useful life should be tested for impairment annuallyor on an interim basis if events or circumstances indicate that the fair valueof the asset has decreased below its carrying value.

 

Intangible assets as of December 31, 2004 and March 31,2005 are as follows (in thousands):

 

| ** **                                   | ** ** | **December 31,  2004** | ** ** | **March 31,  2005** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Gross carrying  amount of intangible assets: |       |                        |       |                     |       |
| Capitalized software                         |       | $                           | 2,662      |                     | $          | 2,662 |   |
| Software trade names                         |       | 2,659                       |       | 2,659                    |       |
| Customer relationships                       |       | 2,285                       |       | 2,285                    |       |
| Total intangible assets                      |       | 7,606                       |       | 7,606                    |       |
| Accumulated  amortization:                   |       |                        |       |                     |       |
| Capitalized software                         |       | (39                         | )          | (154                     | )          |
| Software trade names                         |       | (41                         | )          | (74                      | )          |
| Customer relationships                       |       | (56                         | )          | (136                     | )          |
| Total accumulated amortization:              |       | (136                        | )          | (364                     | )          |
|                                         |       |                        |       |                     |       |
| Intangible  assets, net                      |       | $                           | 7,470      |                     | $          | 7,242 |   |
|                                         |       |                        |       |                     |       |
| Goodwill                                     |       | $                           | 4,622      |                     | $          | 4,622 |   |

 

A roll forward ofgoodwill is as follows (in thousands):

 

| Goodwill at December 31, 2003                          |   | $      | 1,121  |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Goodwill from Management  Equity/Conversion Transaction     |   | 5,251  |   |
| Private  placement by Investor Group (note 2)               |   | (1,000 | )      |
| Year end  adjustment to minimum pension liability           |   | (750   | )      |
| Impairment  identified in 2004                              |   | — |   |
|                                                        |   |   |   |
| Goodwill at December 31,  2004 and March 31, 2005 |   | $      | 4,622  |   |

 

8

----

 

# **The Company’s amortizationperiod for customer relationships is the greater of seven years on a straightline basis or specific identification. Capitalized software and software trade names are being amortized on astraight line basis over seven and fifteen years, respectively.  The following table shows the estimatedamortization expense for these assets for each of the succeeding years:**

 

| **Year Ending December 31,** | *** *** |
|-----------------------------------|--------------|
| **(in thousands)**                | ** **   |
| 2005                              |         | $ | 431 |   |
| 2006                              |         | 861 |   |
| 2007                              |         | 861 |   |
| 2008                              |         | 861 |   |
| 2009                              |         | 861 |   |
| Thereafter                        |         | 3,367 |   |
|                              |         | $ | 7,242 |   |

**NOTE 9****    - INCOME PER SHARE**

 

Basic and diluted income or loss per share is computedusing the weighted average shares of common stock outstanding during theperiod. Consideration is also given in the diluted income per share calculationfor the dilutive effect of stock options and warrants.

 

The following table illustrates the computation ofbasic and diluted earnings (loss) per share under the provisions of SFAS 128:

 

 

| ** **                                                                                                              | ** ** | **For The Three Months Ended**             | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **March 31,**                         | ** ** |
| ** **                                                                                                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
| ** **                                                                                                              | ** ** | **(in thousands, except per  share data)** | ** ** |
| Numerator:                                                                                                              |       |                                       |       |   |   |
|                                                                                                                    |       |                                       |       |   |   |
| Numerator for basic and diluted earnings per share –  net income (loss)                                            |       | $                                          | 166        |   | $ | (729 | ) |
|                                                                                                                    |       |                                       |       |   |   |
| Denominator:                                                                                                            |       |                                       |       |   |   |
|                                                                                                                    |       |                                       |       |   |   |
| Denominator for basic earnings (loss) per  Share-weighted average number of Common shares outstanding during the period |       | 14,575                                     |       | 57,848 |   |
|                                                                                                                    |       |                                       |       |   |   |
| Incremental common shares attributable  To exercise of outstanding options                                              |       | 300                                        |       | — |   |
|                                                                                                                    |       |                                       |       |   |   |
| Denominator for diluted earnings Per share                                                                              |       | 14,875                                     |       | 57,848 |   |
|                                                                                                                    |       |                                       |       |   |   |
| Basic earnings  (loss) per share                                                                                        |       | $                                          | 0.01       |   | $ | (0.01 | ) |
|                                                                                                                    |       |                                       |       |   |   |
| Diluted earnings  (loss) per share                                                                                      |       | $                                          | 0.01       |   | $ | (0.01 | ) |

 

The computation does not consider the additionalshares of common stock which may be issued in connection with pastacquisitions.  The number ofanti-dilutive options and warrants that were excluded from the computation ofincremental common shares were 3,104,000 and 2,647,750 in 2004 and 2005,respectively.

 

**NOTE 10 -STOCK OPTION PLANS**

 

TheCompany accounts for stock-based compensation in accordance with AccountingPrinciples Board, APB, No. 25, “Accounting for Stock Issued to Employees.”The Company has adopted the disclosure-only provisions of FAS No. 123 “Accountingfor Stock-Based Compensation.” Under APB No. 25, compensation expenserelating to employee stock options is determined based on the excess of themarket price of the Company’s stock over the exercise price on the date ofgrant, the intrinsic value method, versus the fair value method as providedunder FAS No. 123.

 

In December 2002, the FASB issued FAS No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure”, whichamended FAS No. 123, “Accounting for Stock-Based Compensation.” The newstandard provides

 

9

----

 

alternative methods of transition for a voluntarychange to the fair market value based method for accounting for stock-basedemployee compensation. Additionally, the statement amends the disclosurerequirements of FAS No. 123 to require prominent disclosures in bothannual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  In compliance with FAS No. 148,the Company has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation plan as defined by APB No. 25.

 

At March 31, 2005, the Company had twostock-based employee compensation plans. The Company accounts for these plans under the recognition andmeasurement principles of APB No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. Accordingly, no stock-based employeecompensation cost is reflected in net income (loss), as all options grantedunder the plan had an exercise price equal to the market value of theunderlying common stock on the date of grant. Had compensation cost for the Company’s stock option plan beendetermined based on the fair value at the grant date for awards for thethree-month periods ended March 31, 2004 and 2005, consistent with theprovisions of FAS No. 123, the Company’s net income (loss) and net income(loss) per share would have decreased. The following table represents the effect on net income and net incomeper share if the Company had applied the fair value based method andrecognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123,“Accounting for Stock-Based Compensation”, to stock-based employeecompensation.

 

 
| ** **                        | ** **                                                                                 | **For the three-months ended March 31,** | ** ** |
|-----------------------------------|--------------------------------------------------------------------------------------------|-----------------------------------------------|------------|
| ** **                        | ** **                                                                                 | **(in thousands, except per share  data)**    | ** ** |
| ** **                        | ** **                                                                                 | **2004**                                      | ** ** | **2005** | ** ** |
|                              |                                                                                       |                                          |       |   |   |
| Net income  (loss):               | As reported                                                                                |                                          | $          | 166 |   | $ | (729 | ) |
|                              | Add:  Stock-based employee compensation expense recorded                                   |                                          | —     |   | — |   |
|                              | Less:  Stock based employee compensation expense determined under fair value  calculations |                                          | (10        | ) | (10 | ) |
|                              | Pro forma                                                                                  |                                          | $          | 156 |   | $ | (739 | ) |
|                              |                                                                                       |                                          |       |   |   |   |
| Basic income  (loss) per share:   | As reported                                                                                |                                          | $          | 0.01 |   | $ | (0.01 | ) |
|                              | Add:  Stock-based employee compensation expense recorded                                   |                                          | —     |   | — |   |
|                              | Less:  Stock based employee compensation expense determined under fair value  calculations |                                          | —     |   | — |   |
|                              | Pro forma                                                                                  |                                          | $          | 0.01 |   | $ | (0.01 | ) |
|                              |                                                                                       |                                          |       |   |   |   |
| Diluted income  (loss) per share: | As reported                                                                                |                                          | $          | 0.01 |   | $ | (0.01 | ) |
|                              | Add:  Stock-based employee compensation expense recorded                                   |                                          | —     |   | — |   |
|                              | Less:  Stock based employee compensation expense determined under fair value  calculations |                                          | —     |   | — |   |
|                              | Pro forma                                                                                  |                                          | $          | 0.01 |   | $ | (0.01 | ) |

 

**NOTE 11-  LEGAL PROCEEDINGS**

 

*HotelInformation Systems, Inc.*

 

On March 25, 2003, the Company entered into asettlement agreement with Hotel Information Systems (“HIS”) and one of itsformer corporate officers whereby (i) the parties dismissed all claims,known and unknown, against each other; (ii) the Company forgave and wroteoff a note receivable from the former corporate officer of HIS in the amount of$66,000 (which was expensed to other expense in the 2002 consolidated statementof operations); (iii) the Company paid $50,000 in cash and issued anon-interest bearing unsecured promissory note which requires 35 consecutive monthlypayments of $5,000 each commencing April 1, 2003; and (iv) theremaining 374,116 shares in the escrow account will be released to theCompany.  If the Company is delinquentfour times in any twelve-month period during the term of the unsecured promissorynote in making its $5,000 monthly payments to HIS, and HIS issues respectivevalid default notices, the Company will be subject to a $225,000 penalty.  As of March 31, 2005, the Company wascurrent on its payments to HIS. The 374,116 shares have been received by MAItogether with the HIS authorization to legally transfer such shares to MAI.

 

10

----

 

### *Imputing interest at 11%, the present value of the$175,000 promissory note at the date of the settlement was $149,000.  The Company recorded the present value ofthis debt issuance and the $50,000 cash payment as a reduction to additionalpaid-in capital.*

### * *

*LogixDevelopment Corporation*

 

The Company entered into a settlement agreement withLogix Development Corporation (“Logix”) in July of 2002 whereby we (i) issuedLogix 200,000 shares of our Common Stock (ii) required the Company to makevarious cash installment payments totaling $175,000 to be paid within 1 yearand (iii) executed a contract with Logix for a consulting project in theamount of $50,000.  The Company has madeall required payments to Logix under this settlement agreement.

 

In December 2003, the Company entered intoanother settlement agreement with Logix whereby it (i) issued 200,000 freetrading shares in exchange for the 200,000 restricted Common Shares from theoriginal settlement agreement in July 2002 (ii) required the Companyto make monthly payments totaling $187,500 over a 25 month period and (iii) mutuallyreleased each other of all past, present and future claims associated with thelawsuit.  As of March 31, 2005, theCompany was current on its payments to Logix.

 

*Other Litigation*

 

We were also involved in various other legalproceedings that are incident to its business. Management believes the ultimateoutcome of these matters will not have a material adverse effect on ourconsolidated financial position, results of operations or liquidity.

 

**NOTE 12-  COMPREHENSIVE INCOME**

 

The following table summarizes components ofcomprehensive income:

 

| ** **                                    | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **March 31,**             | ** ** |
| ** **                                    | ** ** | **2004**                       | ** ** | **2005** | ** ** |
|                                          |       |                           |       |   |   |
| Net income  (loss)                            |       | $                              | 166        |   | $ | (729 | ) |
|                                          |       |                           |       |   |   |
| Change in  cumulative translation adjustments |       | (21                            | )          | 15 |   |
|                                          |       |                           |       |   |   |
| Comprehensive  income                         |       | $                              | 145        |   | $ | (714 | ) |

 

In accordance with SFAS No. 130, “ReportingComprehensive Income,” the Company reports accumulated other comprehensiveincome (loss) in its Consolidated Balance Sheets.  Comprehensive income (loss) includes netincome (loss), minimum pension liability and other comprehensive income (loss),which includes current period foreign currency translation adjustments andamortization of unearned compensation.

 

11

----

 

Item 2.  Management’s Discussion And Analysis Of Financial Condition And ResultsOf Operations

 

## **CriticalAccounting Policies and Estimates**

 

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect our reported assets,liabilities, revenues and expenses. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition, accounts receivableand intangible assets. We base our estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances. This forms the basis of judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults may materially differ from these estimates under different assumptionsor conditions.

 

We believe the following critical accounting policiesand the related judgments and estimates affect the preparation of ourconsolidated financial statements:

 

SoftwareDevelopment Costs

 

All costs incurred to establish the technologicalfeasibility of software products to be sold to others are expensed as researchand development. Once technological feasibility has been established, allsoftware production costs are capitalized. Amortization is computed on an individual product basis and isrecognized over the greater of the remaining economic lives of each product orthe ratio that current gross revenues for a product bear to the total ofcurrent and anticipated revenues for that product, commencing when the productsbecome available for general release to customers.  Software development costs are generallyamortized over a three-year period.  TheCompany continually assesses the recoverability of software development costsby comparing the carrying value of individual products to their net realizablevalue.

 

The Company capitalized $321,000 of softwaredevelopment costs during the three month period ended March 31, 2004relating to its new N-Tier, Internet-native corporate application suite ofproducts written in java.  The modules tothis suite of applications became available for general release in the firstquarter of 2005 at which time amortization of such costs shall commence.  We believe that these new products willproduce new sales adequate to recover amounts capitalized.

 

RevenueRecognition 

 

The Company earns revenue from sales of hardware, softwareand professional services and from arrangements involving multiple elements ofeach of the above. Revenue for multiple element arrangements are recorded byallocating revenue to the various elements based on their respective fairvalues as evidenced by vendor specific objective evidence. The fair value inmulti-element arrangements is determined based upon the price charged when soldseparately. Revenue is not recognized until persuasive evidence of anarrangement exists, delivery has occurred, the fee is fixed or determinable andcollectibility is probable. Sales of network and computer equipment arerecorded when title and risk of loss transfers. Software revenues are recordedwhen application software programs are shipped to end users, resellers anddistributors, provided the Company is not required to provide servicesessential to the functionality of the software or significantly modify,customize or produce the software. Professional services fees for softwaredevelopment, training and installation are recognized as the services areprovided. Maintenance revenues are recorded evenly over the related contractperiod.

 

AccountsReceivable 

 

We maintain allowances for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments. The amount of our reserves is based on historical experience and ouranalysis of the accounts receivable balances outstanding. If the financialcondition of our customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required which wouldresult in an additional general and administrative expense in the period suchdetermination was made. While such credit losses have historically been withinour expectations and the provisions established, we cannot guarantee that wewill continue to experience the same credit loss rates that we have in thepast.

 

Intangible andLong-Lived Assets 

 

At December 31, 2004 and March 31, 2005,goodwill and other long-lived assets represented 80% and 77%, respectively, ofthe Company’s total assets.

 

12

----

 

Goodwill must be tested at least annually forimpairment at a level of reporting referred to as the reporting unit and morefrequently if adverse events or changes in circumstances indicate that theasset may be impaired.   The Company didnot record an impairment charge upon its annual impairment review at December 31,2004.

 

Long-lived assets consist of property and equipmentand other identifiable intangible assets. These assets are depreciated or amortized over their estimated usefullife, and are subject to impairment reviews. The Company periodically reviews long-lived assets whenever adverseevents or changes in circumstances indicate the carrying value of such assetsmay not be recoverable.  In assessingrecoverability, the Company must make assumptions regarding estimated futurecash flows and other factors to determine if an impairment loss may exist, and,if so, estimate fair value.  The Companyalso must estimate and make assumptions regarding the useful lives assigned toits long-lived assets.  If theseestimates, or their related assumptions, change in the future, the Company maybe required to record impairment losses or change the useful life includingaccelerating depreciation or amortization for these assets.

 

Accrued Expenses 

 

TheCompany reviews its contingent liabilities, which arise primarily fromlitigation and litigation defense costs, in accordance with Statement of FinancialAccounting Standards No. 5 (SFAS 5), “Accounting for Contingencies”.  Contingent liabilities are recorded asliabilities when it is probable that a liability has been incurred and theamount of the loss is reasonably estimable. Contingent liabilities are often resolved over long periods.  Estimating probable losses requires judgmentsabout both the amount of liability, which may or may not be readilydeterminable, and the likelihood of liability, which involves ranges ofprobability that can at times be broad and depend on the potential actions ofthird parties.

 

Income Taxes

 

Income taxes are accounted for under the asset andliability method.  Deferred tax assetsand liabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating losscarryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.  The realizability of the deferred tax assetis assessed throughout the year and a valuation allowance is establishedaccordingly.

 

## **Liquidity andCapital Resources**

 

At March 31, 2005, our working capital deficiencyincreased from a working capital deficiency of $7,536,000 at December 31,2004 to a working capital deficiency of $8,101,000.  Excluding unearned revenue of $5,058,000,working capital deficiency at March 31, 2005 was $3,043,000.  Excluding unearned revenue of $3,456,000, theCompany’s working capital deficiency at December 31, 2004 was $4,080,000.  Excluding unearned revenue, the decrease inthe working capital deficiency of $1,037,000 was primarily attributable toincreases in receivables of $487,000 and decreases in current portion of longterm debt of $137,000, accounts payable of $119 and accrued liabilities of $203,000offset by decrease in cash of $16,000.

 

Net cash used in investing activities for the periodended March 31, 2005 totaled $10,000, which is comprised of capitalexpenditures.

 

Net cash used in financing activities for the periodended March 31, 2005 totaled $241,000, which represents repayments onlong-term debt.  On January 13,2003, the Company converted its credit facility to a term loan which requiresmonthly principal and interest payments of $58,000 and matures on February 28,2006.  In addition, the Company amendedits subordinated note to require monthly interest only payments of $52,000through February 28, 2006, at which time it will convert to a term loan tobe amortized over a three years period. The restructured debt, pursuant to the original intercreditor agreementbetween Canyon and Coast, which was sold to Wamco on May 15, 2003,contains various restrictions and covenants, including a minimum quick ratio of0.20 to 1.00 and minimum debt service coverage ratio of 0.50 to 1.00.  In the event that we were not in compliancewith the various restrictions and covenants and were unable to receive waiversfor non-compliance, the term debt would be immediately due and payable. TheCompany was not in compliance with but received waivers for its covenantsthrough March 31, 2005. There is no guaranty that the Company will meetits debt covenants in the future.

 

Stockholders’ deficiency increased from $2,213,000 at December 31,2004 to $2,927,000 at March 31, 2005, mainly as a result of net lossduring the period of $729,000.

 

13

----

 

Although the Company has a net stockholders’deficiency of $2,927,000 and a working capital deficit of $8,101,000 at March 31,2005, the Company believes it will generate sufficient funds from operations orobtain additional financing to meet its operating and capital requirements forat least the next 12 months.  The Companyexpects to generate positive cash flow from its continuing operations during2005 from shipping out products and services from its current backlog as of March 31,2005 as well as new orders.  In the eventthat the Company cannot generate positive cash flow from its continuingoperations during 2005, the Company can substantially reduce its research anddevelopment efforts to mitigate cash outflow to help sustain itsoperations.  There can be no assurancethat the Company will be able to sustain profitability or generate positivecash flow from operations or obtain additional financing as necessary.  These financial statements have been preparedassuming the Company will continue to operate as a going concern.  If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company.

 

# **Order,Shipment and Backlog**

# ** **

We record and enter into backlog a purchase order forequipment and software when we receives a customer’s written order requestingdelivery within twelve months, and systems configuration and contractprovisions are verified.  Orders that arecanceled by the customer and orders that are not shipped within one year are removedfrom backlog.  Orders that are removedfrom backlog for non-shipment are restored if they are reinstated by thecustomer.  We include in backlog signedgovernment contracts which have not yet been fully funded that are expected tocommence delivery within the next twelve months.  As of March 31, 2005, we haveapproximately $9.7 million included in backlog relating to the Air Force, ofwhich $1.2 million is expected to be shipped within fiscal 2005 and the balanceof the contract shipped by December 31, 2008.  Our backlog as of March 31, 2004 and2005 was $2,100,000 and $13,500,000, respectively.

 

Our backlog is not necessarily indicative of futurerevenues.

 

## **ContractualObligations and Commercial Commitments**

 

The following table summarizes the Company’sobligations and commitments as of March 31, 2005:

 
| ** **                       | ** ** | **Payments Due by Period (in  thousands)** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| **Contractual Cash Obligations** | ** ** | **Total**                                  | ** ** | **Less Than 1  Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
|                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                   |       | $                                          | 7,416      |   | $ | 866 |   | $ | 2,004 |   | $ | 3,962 |   | $ | 584 |   |
| Operating Leases                 |       | 3,317                                      |       | 591 |   | 967 |   | 992 |   | 767 |   |
| Consulting Agreements            |       | 60                                         |       | 60 |   | — |   | — |   | — |   |
|                             |       | $                                          | 10,793     |   | $ | 1,517 |   | $ | 2,971 |   | $ | 4,954 |   | $ | 1,351 |   |

 

14

----

 

**Results of Operations**

 

Three Months Ended March 31, 2004 Compared to ThreeMonths Ended March 31, 2005

 
| ** **                                    | ** ** | **March 31, 2004** | ** ** | **Percentage of  Revenue** | ** ** | **March 31, 2005** | ** ** | **Percentage of  Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|----------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                          |       |                    |       |                       |       |                    |       |                       |       |
| Revenue                                       |       | $                       | 5,172      |                       | 100.0      | %                       | $          | 4,755                      |       | 100.0 | % |
| Gross profit                                  |       | 3,722                   |       | 72.0                       | %          | 2,908                   |       | 61.2                       | %          |
| Selling, general  and administrative expenses |       | 2,348                   |       | 45.4                       | %          | 2,184                   |       | 45.9                       | %          |
| Research and  development costs               |       | 892                     |       | 17.1                       | %          | 1,121                   |       | 23.6                       | %          |
| Amortization of  intangibles                  |       | —                  |       | 0.0                        | %          | 112                     |       | 2.4                        | %          |
| Other operating  expense                      |       | 3                       |       | 0.0                        | %          | 13                      |       | 0.0                        | %          |
| Interest  expense, net                        |       | 291                     |       | 5.6                        | %          | 203                     |       | 4.3                        | %          |
| Other  non-operating expense                  |       | 16                      |       | 0.3                        | %          | —                  |       | 0.0                        | %          |
| Income tax  expense                           |       | 6                       |       | 0.1                        | %          | 4                       |       | 0.0                        | %          |
| Net income  (loss)                            |       | $                       | 166        |                       | 3.2        | %                       | $          | (729                       | )          | (15.3 | )% |

 

The decrease in revenue in 2005 was mainlyattributable to a decrease in the volume of software sales, which resulted in adecrease of approximately $417,000. Although the general health of the hospitality industry continues toimprove from the detrimental effects of “9/11” that severely affected thehospitality and travel industries, the Company did not ship certain orders itexpected to ship from its backlog during the three month period ended March 31,2005 resulting in decreased revenue from the comparable period of 2004.  Revenue for 2005 was $4,755,000 compared to $5,172,000in 2004 or a 8.1% decrease. Our continuing hospitality business is expected togenerate sufficient cash from operations to adequately fund its ongoingoperating activities.

 

Gross profit for 2005 decreased to $2,908,000 from$3,722,000 in 2004.  The decrease ingross profit is mainly due to the decrease in software sales as well as anincrease in professional and support services costs.        The increase in professional and supportservices costs was mainly attributable to an increase in global headcountcombined with salary increases from 2004 to 2005.  Additionally, the Company amortizedapproximately $115,000 of capitalized software to software cost of sales during2005.  There was no such amortizationcharges during 2004.

 

Selling, general and administrative expenses (“SG&A”)decreased from $2,348,000 in 2004 to $2,184,000 in 2005.  The decrease is mainly due to the closing ofthe Company’s Mexico office in January, 2004 and the ongoing effects of themanagement cost control program resulting in reduced, building rent andconsulting services.

 

Research and development costs increased from $892,000in 2004 to $1,121,000 in 2005.  Thecompany capitalized $321,000 of software development costs in 2004. As of January 1,2005, the Company released its new N-Tier, Internet-native corporate applicationsuite of products written in java and ceased capitalizing costs relating to themodules associated with this suite of applications. After considering theamount capitalized in 2004, gross research and development costs decreased from2004 to 2005 by approximately $92,000 due to a decrease in engineers andquality assurance personnel in the United States which were replaced with lessexpensive resources in the Company’s Malaysia operations.

 

Amortization of intangibles was $112,000 in 2005 as aresult of the Company recording approximately $10 million of intangible assetsin connection with the Management Equity/Conversion Transaction on November 1,2004, of which approximately $4,786,000 related to identifiable intangibleassets which commenced amortization in November 2004 over their estimateduseful lives of seven to fifteen years.

 

Net interest expense was $291,000 in 2004 compared to$203,000 in 2005.  The decrease is due tolower balances of interest bearing debt during 2005 as compared to 2004 mainlydue to the conversion of approximately $3.3 million of indebtedness by theInvestor Group to the Company’s common stock on November 1, 2004.

 

15

----

 

**Item 3.  Quantitative And Qualitative DisclosuresAbout Market Risk**

** **

***Market RiskDisclosures***

*** ***

The following discussion about our market riskdisclosures contains forward-looking statements.  Forward-looking statements are subject torisks and uncertainties.  Actual resultscould differ materially from those discussed in the forward-lookingstatements.  We are exposed to marketrisk related to changes in interest rates and foreign currency exchangerates.  We do not have derivative financialinstruments for hedging, speculative, or trading purposes.

 

***Interest Rate Sensitivity***

*** ***

Of our $7.4 millionprincipal amount of indebtedness at March 31, 2005, none bears interest ata variable rate.  However, $5.7 millionbears interest at a fixed rate of 11%, $0.5 million bears interest at a fixedrate of 12.5%, $0.6 million bears interest at 9.25% and $0.6 million bearsfixed interest rates ranging from zero to 6%. Since these debt instruments bearinterest at fixed rates, we have exposure to decreases in interest ratesbecause we still are required to pay the fixed rate even if current interestrates are lower.

 

***Foreign CurrencyRisk***

*** ***

We believe that our exposure to currency exchangefluctuation risk is reduced because our transactions with international vendorsand customers are generally transacted in US dollars. The currency exchangeimpact on intercompany transactions was immaterial for the quarter ended March 31,2005.

 

**Item 4.  Evaluation of Disclosure Controls andProcedures**

** **

#### ***(a)***                                 Evaluationof disclosure controls and procedures

#### *** ***

We evaluated the design and operation of ourdisclosure controls and procedures to determine whether they are effective inensuring that we disclose the required information in a timely manner and inaccordance with the Securities Exchange Act of 1934, as amended, or theExchange Act, and the rules and forms of the Securities and ExchangeCommission. Management, including our principal executive officer and principalfinancial officer, supervised and participated in the evaluation. Theevaluation was completed within 90 days of the filing of this report. Theprincipal executive officer and principal financial officer concluded, based ontheir review, that our disclosure controls and procedures, as defined byExchange Act Rules 13a-14(c) and 15d-14(c), are effective and ensurethat we disclose the required information in reports that we file under theExchange Act and that the filings are recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms. No significant changes were made to ourinternal controls or other factors that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Becauseof the inherent limitations in all control systems no evaluation of controlscan provide absolute assurance that all control issues if any, within a companyhave been detected.

 

On November 17, 2004, the Company’sindependent auditors orally notified the Company’s Audit Committee that theyhad identified significant deficiencies regarding the Company’s internalcontrols. The deficiencies noted were mainly (a) the lack of segregationof duties and (b) the lack of adequate account analysis andreconciliations, and (c) insufficient supervision of the Company’saccounting personnel.  The Company believes such deficiencies wereprimarily attributable to changes in personnel within the accounting departmentcombined with the lack of adequate resources given the size of theCompany.  However, the Company has takensteps to improve these internal control weaknesses such as hiring of additionalaccounting personnel and the reallocation of duties to better facilitate segregationof duties and supervision.  Additionally,the Company has implemented procedures for timely and complete account analysisand reconciliations.  We have implementednew accounting software during the first quarter of 2005, which we believemitigates certain weaknesses in our systems to ensure our financial statementsare fairly presented in accordance with United States Generally AcceptedAccounting Principles.

 

16

----

 

Based on the investigation by the Company’sAudit Committee and additional procedures performed by management, the principal executive officer and principalfinancial officer have concluded that our disclosure controls and proceduresare effective and will timely alert the Company’s management to materialinformation relating to the Company that is required to be included in ourperiodic Securities and Exchange Committee filings, and that the internalcontrols are sufficient to provide reasonable assurance that the consolidatedfinancial statements are fairly presented in conformity with generally acceptedaccounting principles.

 

#### ***(b)***                                 Changesin internal controls and Limitations of Disclosure Controls &Procedures

#### *** ***

There were no significantchanges in our internal controls or to our knowledge, in other factors thatcould significantly affect our disclosure controls and procedures subsequent tothe Evaluation Date.

 

**PART II -OTHER INFORMATION**

** **

**Item 1.**           Legal Proceedings

** **

None

 

**Item 2.  Changes in Securities and Use of Proceeds**

** **

(a)                                  None.

 

(b)                                 None.

 

(c)                                  None

 

(d)                                 None.

 

**Item 3.  Defaults Upon Senior Securities**

** **

(a)                                  None

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

** **

(a)                                  None

 

(b)                                 None

 

(c)                                  None

 

(d)                                 None

 

**Item 5.  Other Information**

** **

(a)                                  None.

 

17

----

 

**Item 6.  Exhibits and Reports on Form 8-K**

** **
| **(a)**    | ** ** | **Exhibits**                                                                                                                |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                  |
| 31.1       |       | Certification of Chief Executive Officer, W. Brian  Kretzmer, as required by Section 3.02 of Sarbane-Oxley Act of 2002 |
|       |       |                                                                                                                        |
| 31.2       |       | Certification of Chief Financial Officer, James W.  Dolan, as required by Section 3.02 of Sarbane-Oxley Act of 2002    |
|       |       |                                                                                                                        |
| 32.1       |       | Certification of Chief Executive Officer, W. Brian  Kretzmer, as required by Section 9.06 of Sarbane-Oxley Act of 2002 |
|       |       |                                                                                                                        |
| 32.2       |       | Certification of Chief Financial Officer, James W.  Dolan, as required by Section 9.06 of Sarbane-Oxley Act of 2002    |
|       |       |                                                                                                                        |
| (b)        |       | Reports on Form 8-K:                                                                                                   |
|       |       |                                                                                                                        |
|       |       | Filed March 1, 2005                                                                                                    |
|       |       |                                                                                                                        |
|       |       | Filed September 22, 2005                                                                                               |

18

----

 

**SIGNATURES**

** **

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                           | MAI  SYSTEMS CORPORATION                  |
|--------------------------------|-------------------------------------------|
|                           | (Registrant)                              |
|                           |                                      |
|                           |                                      |
| Date:  September 23, 2005 | By:                                       |   | /s/  James W. Dolan |   |
|                           | James W. Dolan                            |
|                           | Chief Financial  and Operating Officer    |
|                           | (Chief Financial  and Accounting Officer) |
|                                |                                           |  |  |  |

 

19

----