**UNITEDSTATES SECURITIES A**ND EXCHANGE COMMISSION

**Washington, DC 20549**

 

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** **

**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, 2004**                                                                                                                                 |
| **or**                                                                                                                                                                   |
|                                                                                                                                                                     |
| **o**                                                                                                                                                                    | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.** |
|                                                                                                                                                                     |                                                                                            |
| **For the transition  period from            to             .** |
|                                                                                                                                                                     |                                                                                            |
| **Commission file number:  1-9158**                                                                                                                                      |

 

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** **

**MAI Systems Corporation**

(Exact name of registrant as specified in itscharter)

** **
| **Delaware**                                                                   |   | **22-2554549**                        |
|--------------------------------------------------------------------------------|--------|---------------------------------------|
| **(State or other jurisdiction of  incorporation or organization)**            |   | **(IRS Employer Identification No.)** |
|                                                                           |   |                                  |
| **26110 Enterprise Way,  Lake Forest, CA 92630**                               |
| **Address of principal executive offices**                                     |
|                                                                           |   |                                  |
| **Registrant’s telephone number including area code **(949) 598-6000 |

 

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Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.   Yes   ý     No  o

** **

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

Yes   o     No  ý

 

The aggregate market value ofthe common stock held by non-affiliates of the registrant, based upon the lastsale price of the Common Stock reported on the National Association ofSecurities Dealers Automated Quotation National Market System on May 14, 2004was $3,228,665. 

 

**The number of shares of commonstock issued, outstanding and subscribed as of May 14, 2004 was 14,675,752.**

 

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**MAISYSTEMS CORPORATION**

** **

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

** **

**(Unaudited)**

** **
|                                                                                                                                                                          |   | **(in thousands, except share data)** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                                                          |   | **As of  December  31, 2003 (a)**     |   | **As of  March  31, 2004** |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| **ASSETS**                                                                                                                                                                    |   |                                  |   |   |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Current assets:                                                                                                                                                               |   |                                  |   |   |   |
| Cash                                                                                                                                                                          |   | $                                     | 664    |   | $ | 510 |   |
| Receivables, less allowance for doubtful  accounts of  $335 in 2003 and $428 in  2004                                                                                    |   | 1,313                                 |   | 2,477 |   |
| Inventories                                                                                                                                                                   |   | 47                                    |   | 47 |   |
| Prepaids and other assets                                                                                                                                                     |   | 814                                   |   | 888 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total current assets                                                                                                                                                          |   | 2,838                                 |   | 3,922 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Furniture, fixtures and equipment, net                                                                                                                                        |   | 758                                   |   | 694 |   |
| Intangibles, net                                                                                                                                                              |   | 2,876                                 |   | 3,197 |   |
| Other assets                                                                                                                                                                  |   | 58                                    |   | 76 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total assets                                                                                                                                                                  |   | $                                     | 6,530  |   | $ | 7,889 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                             |   |                                  |   |   |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Current liabilities:                                                                                                                                                          |   |                                  |   |   |   |
| Current portion of long-term debt                                                                                                                                             |   | $                                     | 3,646  |   | $ | 878 |   |
| Accounts payable                                                                                                                                                              |   | 904                                   |   | 1,218 |   |
| Customer deposits                                                                                                                                                             |   | 2,334                                 |   | 1,825 |   |
| Accrued liabilities                                                                                                                                                           |   | 3,059                                 |   | 2,209 |   |
| Income taxes payable                                                                                                                                                          |   | 85                                    |   | 101 |   |
| Unearned revenue                                                                                                                                                              |   | 3,209                                 |   | 4,889 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total current liabilities                                                                                                                                                     |   | 13,237                                |   | 11,120 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Long-term debt                                                                                                                                                                |   | 7,135                                 |   | 10,511 |   |
| Other liabilities                                                                                                                                                             |   | 744                                   |   | 690 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total liabilities                                                                                                                                                             |   | 21,116                                |   | 22,321 |   |
|                                                                                                                                                                          |   |                                  |   |   |   |
| 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  24,000,000 shares;  14,875,752 shares issued, outstanding and subscribed at December 31, 2003 and  March 31, 2004. |   | 152                                   |   | 152 |   |
| Additional paid-in capital                                                                                                                                                    |   | 218,112                               |   | 218,112 |   |
| Accumulated other comprehensive loss                                                                                                                                          |   |                                  |   |   |   |
| Minimum pension liability                                                                                                                                                     |   | (1,005                                | )      | (1,005 | ) |
| Foreign currency translation                                                                                                                                                  |   | (2                                    | )      | (23 | ) |
| Unearned Compensation                                                                                                                                                         |   | (53                                   | )      | (44 | ) |
| Accumulated deficit                                                                                                                                                           |   | (231,790                              | )      | (231,624 | ) |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total stockholders’ deficiency                                                                                                                                           |   | (14,586                               | )      | (14,432 | ) |
|                                                                                                                                                                          |   |                                  |   |   |   |
| Total liabilities and stockholders’  deficiency                                                                                                                          |   | $                                     | 6,530  |   | $ | 7,889 |   |

** **

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**(a)   Derived from the December 31, 2003 auditedfinancial statements.**

** **

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.**

 

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**MAISYSTEMS CORPORATION**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **

**(Unaudited)**

** **
|                                                                  |   | **For the  Three Months Ended March 31,** |   |
|-----------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                  |   | **(in thousands, except per share data)** |   |
|                                                                  |   | **2003**                                  |   | **2004** |   |
| Revenue:                                                              |   |                                      |   |   |   |
| Software                                                              |   | $                                         | 1,130  |   | $ | 1,289 |   |
| Network and computer equipment                                        |   | 149                                       |   | 74 |   |
| Services                                                              |   | 3,907                                     |   | 3,809 |   |
| Total revenue                                                         |   | 5,186                                     |   | 5,172 |   |
|                                                                  |   |                                      |   |   |   |
| Direct costs:                                                         |   |                                      |   |   |   |
| Software                                                              |   | 207                                       |   | 321 |   |
| Network and computer equipment                                        |   | 91                                        |   | 60 |   |
| Services                                                              |   | 1,174                                     |   | 1,069 |   |
| Total direct costs                                                    |   | 1,472                                     |   | 1,450 |   |
|                                                                  |   |                                      |   |   |   |
| Gross profit                                                          |   | 3,714                                     |   | 3,722 |   |
|                                                                  |   |                                      |   |   |   |
| Selling, general and administrative  expenses                         |   | 2,531                                     |   | 2,348 |   |
| Research and development costs                                        |   | 682                                       |   | 892 |   |
| Other operating expense (income)                                      |   | (51                                       | )      | 3 |   |
|                                                                  |   |                                      |   |   |   |
| Operating income                                                      |   | 552                                       |   | 479 |   |
|                                                                  |   |                                      |   |   |   |
| Interest income                                                       |   | 1                                         |   | — |   |
| Interest expense                                                      |   | (350                                      | )      | (291 | ) |
| Other non-operating expense                                           |   | —                                    |   | (16 | ) |
|                                                                  |   |                                      |   |   |   |
| Income before income taxes                                            |   | 203                                       |   | 172 |   |
|                                                                  |   |                                      |   |   |   |
| Income tax benefit (expense)                                          |   | 59                                        |   | (6 | ) |
|                                                                  |   |                                      |   |   |   |
| Net income                                                            |   | $                                         | 262    |   | $ | 166 |   |
|                                                                  |   |                                      |   |   |   |
| Net income per share:                                                 |   |                                      |   |   |   |
|                                                                  |   |                                      |   |   |   |
| Basic income per share                                                |   | $                                         | 0.02   |   | $ | 0.01 |   |
|                                                                  |   |                                      |   |   |   |
| Diluted income per share                                              |   | $                                         | 0.02   |   | $ | 0.01 |   |
|                                                                  |   |                                      |   |   |   |
| Weighted average common shares used in  determining income per share: |   |                                      |   |   |   |
|                                                                  |   |                                      |   |   |   |
| Basic                                                                 |   | 14,426                                    |   | 14,575 |   |
| Diluted                                                               |   | 14,876                                    |   | 14,875 |   |

 

**The accompanyingnotes are an integral part of these condensed consolidated financialstatements.**

 

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**MAISystems Corporation**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**(Unaudited)**

** **
|                                                  |   | **For the  Three Months Ended  March 31,** |   |
|-------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                  |   | **(in thousands)**                              |   |
|                                                  |   | **2003**                                        |   | **2004** |   |
|                                                  |   |                                            |   |   |   |
| Net cash provided by (used in) operating  activities: |   | $                                               | (35    | ) | $ | 466 |   |
|                                                  |   |                                            |   |   |   |
| Cash flows used in investing activities:              |   |                                            |   |   |   |
| Proceeds from note receivable                         |   | 250                                             |   | — |   |
| Capital Expenditures                                  |   | (128                                            | )      | (66 | ) |
| Capitalized software development costs                |   | (229                                            | )      | (321 | ) |
| Net cash used in investing activities                 |   | (107                                            | )      | (387 | ) |
|                                                  |   |                                            |   |   |   |
| Cash flows from financing activities:                 |   |                                            |   |   |   |
| Repayments on long-term debt                          |   | (103                                            | )      | (230 | ) |
| Net cash used in financing activities                 |   | (103                                            | )      | (230 | ) |
|                                                  |   |                                            |   |   |   |
| Net cash used in operations                           |   | (245                                            | )      | (151 | ) |
|                                                  |   |                                            |   |   |   |
| Effect of exchange rate changes on cash               |   | —                                          |   | (3 | ) |
|                                                  |   |                                            |   |   |   |
| Net change in cash                                    |   | (245                                            | )      | (154 | ) |
|                                                  |   |                                            |   |   |   |
| Cash at beginning of period                           |   | 545                                             |   | 664 |   |
|                                                  |   |                                            |   |   |   |
| Cash at end of period                                 |   | $                                               | 300    |   | $ | 510 |   |

 

**The accompanying notes are an integral partof these condensed consolidated financial statements.**

 

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**MAISystems Corporation**

** **

**Notesto Condensed Consolidated Financial Statements**

** **

**ThreeMonths ended March 31, 2004**

** **

**(Unaudited)**

**NOTE1  - BASIS OF PRESENTATION**

 

Companies forwhich this report is filed are MAI Systems Corporation and its wholly-ownedsubsidiaries (the “Company”).  The informationcontained herein is unaudited, but gives effect to all adjustments (which arenormal recurring accruals) necessary, in the opinion of Company management, topresent fairly the condensed consolidated financial statements for the interimperiod.  All significant intercompanytransactions and accounts have been eliminated in consolidation.

 

Although theCompany believes that the disclosures in these financial statements areadequate to make the information presented not misleading, certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to the rules and regulationsof the Securities and Exchange Commission (the “SEC”), and these financialstatements should be read in conjunction with the financial statements includedin the Company’s Annual Report on Form 10-K for the year ended December 31,2003, which is on file with the SEC.

 

**NOTE2 - LIQUIDITY**

 

Although theCompany has a net stockholders’ deficiency of $14,432,000 and a working capitaldeficit of $7,198,000 at March 31, 2004, the Company expects to generatepositive cash flow from its continuing operations during 2004 from shipping outproducts and services from its current backlog as well as new orders. In theevent that the Company cannot generate positive cash flow from its continuingoperations during 2004, 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.  Thesefinancial statements have been prepared assuming the Company will continue tooperate as a going concern.

 

The restructureddebt, pursuant to the original inter-creditor agreement between Canyon Capitaland Coast, which was sold to Wamco on May 15, 2003, contains variousrestrictions and covenants.  In theevent that the Company were not in compliance with the various restrictions andcovenants and were unable to receive waivers for non-compliance, the term debtwould be immediately due and payable. The Company was in compliance with the amended debt covenants as of andfor the period ending March 31, 2004. There is no guaranty that the Company will meet its debt covenants inthe future.  In the event that theCompany were not in compliance with the various restrictions and covenants andwere unable to receive waivers for non-compliance, the term loan would beimmediately due and payable.

 

**NOTE3  - INVENTORY**

 

Inventories aresummarized as follows:

 
|              |   | **(dollars in thousands)** |   |
|-------------------|--------|----------------------------|--------|
|              |   | **December  31,  2003**    |   | **March 31,  2004** |   |
|              |   |                       |   |   |   |
| Finished goods    |   | $                          | 39     |   | $ | 40 |   |
| Replacement parts |   | 8                          |   | 7 |   |
|              |   | $                          | 47     |   | $ | 47 |   |

 

**NOTE4  - BUSINESS ACQUISITIONS**

 

**HospitalityServices & Solutions**

 

On June 23, 2002,the Company acquired substantially all of the assets and assumed certainliabilities of Hospitality Services & Solutions (“HSS”) including a 35%ownership in AMDB – HIS (“AMDB”) pursuant to a stock purchase agreement for100,000 shares of common stock valued at $32,000 (the quoted market price ofthe common stock at the time the terms were agreed), and $75,000 in cash.  Additionally, the shareholders of HSSreceived a 20% minority interest in the Company’s

 

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combinedoperations in Asia. HSS was acquired for the Company to expand its operationsin the Asian marketplace, strengthen its management team in the territory andcreate new opportunities for its new enterprise capable suite of products.  The net assets acquired from HSS are used inthe business of software design, engineering and service relating to hotelinformation systems.  The net assetsalso include subsidiaries of HSS in Malaysia, Singapore and Thailand.  The Company recorded $297,000 of goodwill(deductible for tax purposes) in connection with the acquisition of HSS.  Pro forma results of operations as if thisacquisition had occurred at the beginning of 2001 and 2002 are not shownbecause its impact would have been immaterial.

 

Included in theacquired assets of HSS was a 35% interest in AMDB, an online reservationservice, originally purchased by HSS for $66,000.  On February 20, 2003, the Company entered into an agreementwhereby it acquired the remaining 65% for $79,000 payable over 6 monthinstallments.  The net liabilities of$15,000 acquired are used to support an online reservation service related tohotel information systems.  The Companyrecorded $159,000 of goodwill in connection with the acquisition of AMDB.  Pro forma results of operations as if thisacquisition had occurred at the beginning of 2002 and 2003 are not shownbecause its impact would have been immaterial.

 

**NOTE5 - LONG TERM DEBT**

 

**Wamco32 Ltd.**

 

On January 13,2003, the Company re-negotiated the terms of its credit facility with CoastBusiness Credit (“Coast”) whereby the outstanding balance of $1,828,000 wasconverted to a term loan which accrues interest at 9.25% per annum and requiresmonthly payments of $58,000 over a 36 months period commencing March 1,2003.  On February 7, 2003, the FederalDeposit Insurance Corporation (“FDIC”) put Coast and its parent company,Southern Pacific Bank, into receivership and held all of Coast’s assets forsale 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 not change any of the terms of theCompany’s loan agreement.  The Companyis required to pay Wamco additional principal payments on a quarterly basisbased upon an EBITDA-based formula commencing March 31, 2003.  For the period ended March 31, 2004, thereare no additional principal payments required under the EBITDA-based formula.

 

On April 9, 2004,the Company successfully re-negotiated the terms of its loan whereby thematurity date was extended to February 28, 2006.  In addition, various restrictions and covenants, pursuant to theinter-creditor agreement between Canyon and Wamco, were amended to modify thefinancial covenants to a  minimum quickratio of  0.20 to 1.00 and a minimumdebt coverage ratio of 0.50 to 1.00 effective for the three month period endedMarch 31, 2004 and for each and every fiscal quarter ending thereafter.  The Company was in compliance with theamended debt covenants as of and for the period ending March 31, 2004.  There is no guaranty that the Company willmeet its debt covenants in the future. In the event that the Company were not in compliance with the various restrictionsand covenants and were unable to receive waivers for non-compliance, the termloan would be immediately due and payable. As of December 31, 2003 and March 31, 2004, the balance of the term loanwas $1,366,000 and $1,175,000 respectively.

 

**CanyonCapital Management LP**

 

On January 13,2003, the Company modified its 11% subordinated notes payable agreement withCanyon Capital Management LP (“Canyon”), whereby the Company is required tomake monthly interest payments of $52,000 until the Wamco term loan is paid offin full at which time the note payable will be converted into a three-yearamortizing loan which will accrue interest at 11% per annum and requires equalmonthly payments of principal and interest such that the subordinated debt willbe paid in full at the end of the amended term.  Upon the repayment of the Wamco debt in full, the Company willalso be required to pay Canyon additional principal payments on a quarterlybasis based upon an EBITDA-based formula. Additionally, the Company issued to Canyon 200,000 shares of its commonstock valued at $20,000 (the quoted market price of the common stock at thetime the terms were agreed) and agreed to issue one million warrants at anexercise price of $0.40 per share valued at $42,000 (using the Black-Scholesoption-pricing model with the following weighted-average assumptions: risk-freeinterest rate of 6.5%, volatility of 80% and an expected life of 5 years).  The $62,000 is being amortized to interestexpense over the term of the modified note. The principal balance outstanding on the subordinate notes payable toCanyon was approximately $5,662,000 at December 31, 2003 and March 31, 2004.

 

**CSAPrivate Limited**

 

In connection witha settlement agreement in February 2001 with CSA Private Limited (“CSA”), theCompany issued $2.8 million of subordinated debt to CSA.  The $2.8 million of debt was secured by allof the Company’s assets, which was subordinate to Wamco and Canyon, accruedinterest at 10% per annum and required payments of $37,500 from March 1, 2002through September 1, 2002 and monthly payments of $107,500 commencing onOctober 1, 2002 until October 2003 when all remaining unpaid principal andaccrued interest was to be paid in full.

 

6

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The agreement withCSA was amended whereby the Company was required to make payments under thesubordinated note unless and until it paid $1 million by December 31,2002.  Upon payment of the $1 million,contractual payments under the subordinated note would have ceased until afinal payment in the amount of $400,000 is paid by February 28, 2003.  If the Company did not make all of themodified payments to CSA, the subordinated note would revert back to itsoriginal terms.  The Company did notmake the modified payment and have not made any payments since September2002.  CSA did not formally notify theCompany of its default.

 

On April 9, 2004,the Company successfully amended its agreement with CSA whereby the principalbalance and accrued interest through March 31, 2004, totaling $3,633,000, wereconverted to two new notes.  The firstnote for $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$3,133,000 (“Other note”) also accrues interest at 10% per annum and providesfor 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 subordination agreement betweenWamco, Canyon and CSA, all payments under the new notes are subordinated to thepayment in full of the Wamco and Canyon loan agreements.

 

On April 9, 2004,an investor group, consisting of Canyon, the Company’s Chairman of the Board,Chief Executive Officer and Chief Financial / Operation Officer (“InvestorGroup”), acquired 2,433,333 of the Company’s common stock held by CSA and theOther Note for $1 million in cash  (seeNote 13).

 

**TaxClaims**

 

On September 30,2003, the Company entered into a settlement agreement with the United StatesInternal Revenue Service (the “Service”) on a tax claim which resulted from theCompany’s 1993 Chapter 11 proceedings whereby it agreed to pay $489,000 inequal monthly installments of $7,438 over a period of six (6) years at aninterest rate of 6%.  The $489,000settlement is reflected as debt in the financial statements and resulted in aone-time gain of $262,000 which was included in income tax benefit in thefourth quarter of 2003.  In the eventthat the Company fails to pay the Service any payment, and such payment failurecontinues for sixty days after written notice of such failure, $1,832,100, plusaccrued interest thereon, less any payments made by the Company will beimmediately due and payable to the Service. As of December 31, 2003 and March 31, 2004, the debt balance was$428,000 and $412,000, respectively.

 

In connection withthe settlement agreement with the Service, the Company’s 1993 Chapter 11proceedings were officially closed pursuant to Court order effective as ofSeptember 30, 2003.

 

**NOTE6  - RESTRICTED STOCK PLAN**

 

In May 2001, theBoard of Directors adopted the 2001 Restricted Stock Plan.  Under the plan, 1,250,000 authorized sharesof the Company’s Common Stock are reserved for issuance to officers anddirectors of the Company.  The shareswill be issued as “Restricted Stock” within the meaning of Rule 144 of theSecurities Act of 1933, as amended.  TheCompensation Committee of the Board of Directors shall have the discretion todetermine what terms and conditions shall apply, including the imposition of avesting schedule.

 

In May 2002, theCompany issued 612,500 shares of restricted common stock to its members of theboard of directors and certain of its corporate officers which vest equallyover a four-year period.  Recipients arenot required to provide 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 is being amortized to expense in proportion to the vestingschedule.  The unamortized balance as ofMarch 31, 2004 is $44,000 and is included in accumulated other comprehensiveloss in the accompanying consolidated balance sheet.

 

**NOTE7  - PREFERRED STOCK**

 

On May 20, 1997,the Company authorized the issuance of up to 1,000,000 shares of $0.01 parvalue preferred stock.  The Board ofDirectors has the authority to issue the preferred stock, in one or moreseries, and to fix the rights, preferences, privileges and restrictions thereofwithout any further vote by the holders of Common Stock.

 

7

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**NOTE8  - INTANGIBLE ASSETS**

 

Intangible assetsconsist primarily of goodwill and capitalized software.  Intangible assets other than goodwill areamortized on a straight-line basis over their estimated useful lives.  Prior to 2002, goodwill, representing theexcess of the purchase price over the estimated fair value of the net assets ofthe acquired business, was amortized over the period of expected benefit offive to seven years.  However, effectiveJanuary 1, 2002, the Company adopted Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets, (“SFAS No. 142”)which requires that the Company cease amortization of all goodwill andintangible assets having indefinite useful economic lives.  The Company determined that there was noimpairment upon adoption.   Such assetsare not to be amortized until their lives are determined to be finite, however,a recognized intangible asset with an indefinite useful life should be testedfor impairment annually or on an interim basis if events or circumstancesindicate that the fair value of the asset has decreased below its carryingvalue.  At March 31, 2004, the Companyevaluated its goodwill and determined that fair value had not decreased belowcarrying value and no adjustment to impair goodwill was necessary in accordancewith SFAS No. 142.

 

Goodwill andcapitalized software as of December 31, 2003 and March 31, 2004 are as follows:

 
|                      |   | **(dollars in thousands)** |   |
|---------------------------|--------|----------------------------|--------|
|                      |   | **December  31,  2003**    |   | **March 31,  2004** |   |
|                      |   |                       |   |   |   |
| Goodwill                  |   | $                          | 1,121  |   | $ | 1,121 |   |
| Accumulated amortization  |   | —                     |   | — |   |
| Goodwill, net             |   | 1,121                      |   | 1,121 |   |
|                      |   |                       |   |   |   |
| Capitalized software      |   | 1,755                      |   | 2,076 |   |
| Accumulated amortization  |   | —                     |   | — |   |
| Capitalized software, net |   | 1,755                      |   | 2,076 |   |
|                      |   |                       |   |   |   |
| Total                     |   | $                          | 2,876  |   | $ | 3,197 |   |

 

Net goodwill iscomprised of $665,000 on the purchase of Hotel Information Systems Inc. (HIS)in 1996,  $297,000 on the purchase ofHSS in 2002 and $159,000 on the purchase of AMDB in 2003 (see Note 3).

 

The Company’sweighted average amortization period for capitalized software is expected to bethree years.  The Company expects thatcertain of our new products will be available for general release during thethird quarter of 2004 at which time amortization of such costs shallcommence.  The following table shows theestimated amortization expense for these assets for each of the five succeedingyears:

 
| **Year Ending December 31,  (in thousands)** |   |   |   |
|----------------------------------------------|--------|--------|--------|
| 2004                                         |   | $      | 346    |   |
| 2005                                         |   | 692    |   |
| 2006                                         |   | 692    |   |
| 2007                                         |   | 692    |   |
| 2008                                         |   | 346    |   |
|                                         |   | $      | 2,076  |   |

 

**NOTE9  - INCOME PER SHARE**

 

Basic and dilutedincome or loss per share is computed using the weighted average shares ofcommon stock outstanding during the period. Consideration is also given in thediluted income per share calculation for the dilutive effect of stock optionsand warrants.

 

8

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The followingtable illustrates the computation of basic and diluted earnings  per share under the provisions of SFAS 128:

 
|                                                                                                                              |   | **For The  Three Months Ended  March 31,**      |     |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|----------|
|                                                                                                                              |   | **2003**                                        |     | **2004** |   |
|                                                                                                                              |   | **(in thousands, except per  share data)** | * * |
| Numerator:                                                                                                                        |   |                                            |     |   |   |
|                                                                                                                              |   |                                            |     |   |   |
| Numerator for basic and diluted  earnings  per share – net income                                                       |   | $                                               | 262      |   | $ | 166 |   |
|                                                                                                                              |   |                                            |     |   |   |
| Denominator:                                                                                                                      |   |                                            |     |   |   |
|                                                                                                                              |   |                                            |     |   |   |
| Denominator for basic earnings per  Share-weighted average number of  Common shares outstanding during  the period |   | 14,426                                          |     | 14,575 |   |
|                                                                                                                              |   |                                            |     |   |   |
| Incremental common shares attributable  To exercise of outstanding options                                                   |   | 450                                             |     | 300 |   |
|                                                                                                                              |   |                                            |     |   |   |
| Denominator for diluted earnings  Per share                                                                                  |   | 14,876                                          |     | 14,875 |   |
|                                                                                                                              |   |                                            |     |   |   |
| Basic earnings per share                                                                                                          |   | $                                               | 0.02     |   | $ | 0.1 |   |
|                                                                                                                              |   |                                            |     |   |   |
| Diluted earnings per share                                                                                                        |   | $                                               | 0.02     |   | $ | 0.1 |   |

 

The computationdoes not consider the additional shares of common stock which may be issued inconnection with past acquisitions.  Thenumber of anti-dilutive options and warrants that were excluded from thecomputation of incremental common shares were 3,676,355 and 3,104,000 in 2003and 2004, respectively.

 

**NOTE10  - STOCK OPTION PLANS**

 

The Companyaccounts for stock-based compensation in accordance with Accounting PrinciplesBoard, APB, No. 25, “Accounting for Stock Issued to Employees.” The Company hasadopted the disclosure-only provisions of FAS No. 123 “Accounting forStock-Based Compensation.” Under APB No. 25, compensation expense relating toemployee stock options is determined based on the excess of the market price ofthe Company’s stock over the exercise price on the date of grant, the intrinsicvalue method, versus the fair value method as provided under FAS No. 123.

 

In December 2002,the FASB issued FAS No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure”, which amended FAS No. 123, “Accounting forStock-Based Compensation.” The new standard provides alternative methods oftransition for a voluntary change to the fair market value based method foraccounting for stock-based employee compensation. Additionally, the statementamends the disclosure requirements of FAS No. 123 to require prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results. This statement is effective for financial statementsfor the year ended December 31, 2002. In compliance with FAS No. 148, the Company has elected to continue tofollow the intrinsic value method in accounting for its stock-based employeecompensation plan as defined by APB No. 25.

 

At March 31, 2004,the Company had two stock-based employee compensation plans.  The Company accounts for that plan under therecognition and measurement principles of APB No. 25, “Accounting for StockIssued to Employees,” and related interpretations. Accordingly, no stock-basedemployee compensation cost is reflected in net income (loss), as all optionsgranted under 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, 2003 and 2004, 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.

 

9

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|                      |   |                                                                                             |   | **For the  three-months ended March 31,**  |   |
|---------------------------|--------|--------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                      |   |                                                                                             |   | **(in  thousands, except per share data)** |   |
|                      |   |                                                                                             |   | **2003**                                   |   | **2004** |   |
|                      |   |                                                                                             |   |                                       |   |   |   |
| Net income:               |   | As reported                                                                                      |   | $                                          | 262    |   | $ | 166 |   |
|                      |   | Add: Stock-based employee compensation  expense recorded                                         |   | —                                     |   | — |   |
|                      |   | Less:   Stock based employee compensation expense determined under fair value  calculations |   | (17                                        | )      | (10 | ) |
|                      |   | Pro forma                                                                                        |   | $                                          | 245    |   | $ | 156 |   |
|                      |   |                                                                                             |   |                                       |   |   |   |
| Basic income per share:   |   | As reported                                                                                      |   | $                                          | 0.02   |   | $ | 0.01 |   |
|                      |   | Add: Stock-based employee compensation  expense recorded                                         |   | —                                     |   | — |   |
|                      |   | Less:   Stock based employee compensation expense determined under fair value  calculations |   | —                                     |   | — |   |
|                      |   | Pro forma                                                                                        |   | $                                          | 0.02   |   | $ | 0.01 |   |
|                      |   |                                                                                             |   |                                       |   |   |   |
|                      |   |                                                                                             |   |                                       |   |   |   |
| Diluted income per share: |   | As reported                                                                                      |   | $                                          | 0.02   |   | $ | 0.01 |   |
|                      |   | Add: Stock-based employee compensation  expense recorded                                         |   | —                                     |   | — |   |
|                      |   | Less:   Stock based employee compensation expense determined under fair value  calculations |   | —                                     |   | — |   |
|                      |   | Pro forma                                                                                        |   | $                                          | 0.02   |   | $ | 0.01 |   |

 

**NOTE11  - LEGAL PROCEEDINGS**

 

*Hotel Information Systems, Inc.*

 

On March 25, 2003,the Company entered into a settlement agreement with Hotel Information Systems(“HIS”) and one of its former corporate officers whereby (i) the partiesdismissed all claims, known and unknown, against each other; (ii) the Companyforgave and wrote off a note receivable from the former corporate officer ofHIS in the amount of $66,000 (which was expensed to other expense in the 2002consolidated statement of operations); (iii) the Company paid $50,000 in cashand issued a non-interest bearing unsecured promissory note which requires 35consecutive monthly payments of $5,000 each commencing April 1, 2003; and (iv)the remaining 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 unsecuredpromissory note in making its $5,000 monthly payments to HIS, and HIS issuesrespective valid default notices, the Company will be subject to a $225,000penalty.  The 374,116 shares have beenreceived by MAI together with the HIS authorization to legally transfer suchshares to MAI.

 

### *Imputing interest at 11%, the present value of the $175,000promissory 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.*

### * *

*Logix Development Corporation*

 

The Companyentered into a settlement agreement with Logix Development Corporation(“Logix”) in July of 2002 whereby we (i) issued Logix 200,000 shares of ourCommon Stock (ii) required the Company to make various cash installmentpayments totaling $175,000 to be paid within 1 year and (iii) executed acontract with Logix for a consulting project in the amount of $50,000.  The Company has made all required paymentsto Logix under this settlement agreement.

 

In December 2003,the Company entered into another settlement agreement with Logix whereby it (i)issued 200,000 free trading shares in exchange for the 200,000 restrictedCommon Shares from the original settlement agreement in July 2002 (ii) requiredthe Company to make monthly payments totaling $187,500 over a 25 month periodand (iii) mutually released each other of all past, present and future claimsassociated with the lawsuit.

 

10

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*Other Litigation*

 

We were alsoinvolved in various other legal proceedings that are incident to its business.Management believes the ultimate outcome of these matters will not have amaterial adverse effect on our consolidated financial position, results ofoperations or liquidity.

 

**NOTE12  - COMPREHENSIVE INCOME**

 

The followingtable summarizes components of comprehensive income:

 
|                                          |   | **For The  Three Months Ended  March 31,** |   |
|-----------------------------------------------|--------|--------------------------------------------|--------|
|                                          |   | **2003**                                   |   | **2004** |   |
|                                          |   |                                       |   |   |   |
| Net income                                    |   | $                                          | 262    |   | $ | 166 |   |
|                                          |   |                                       |   |   |   |
| Change in cumulative translation  adjustments |   | (1                                         | )      | (21 | ) |
|                                          |   |                                       |   |   |   |
| Comprehensive income                          |   | $                                          | 261    |   | $ | 145 |   |

 

Accumulated othercomprehensive income in the accompanying consolidated balance sheets consistsof cumulative translation adjustments.

 

**NOTE13  - SUBSEQUENT EVENTS**

 

CSA was the holderof 2,433,333 shares of the Company’s common stock and $3,633,000 of Companyindebtedness as of March 31, 2004.   OnApril 9, 2004, an investor group, consisting of Canyon, the Company’s Chairmanof the Board, Chief Executive Officer and Chief Financial / Operation Officer(“Investor Group”), has acquired the 2,433,333 of the Company’s common stockheld by CSA and the Other Note for $1 in million cash.

 

Subject toshareholder approval, the Investor Group has agreed to convert the Company indebtednessacquired from CSA plus any accrued interest through the date of shareholderapproval for approximately 32 million shares of the Company’s common stockbased upon a conversion price of $0.10 per share, and will invest $1,000,000 ofnew cash proceeds into the Company in a private placement at $0.10 per shareand receive 10,000,000 shares of the Company’s common stock.  This Investor Group  transaction is subject to certain terms andconditions, including the fact that it will initially be ‘restricted’ stock,not available for sale.  TheCompany’s  annual shareholders meetingis expected to occur in  June 2004.

 

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

** **

## **Critical AccountingPolicies and Estimates**

 

The discussion andanalysis of our financial condition and results of operations are based uponour condensed consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect our reported assets, liabilities, revenues and expenses.On an on-going basis, we evaluate our estimates, including those related torevenue recognition, accounts receivable and intangible assets. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances. This forms the basis ofjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe thefollowing critical accounting policies and the related judgments and estimatesaffect the preparation of our consolidated financial statements:

 

**Revenue Recognition**

 

The Company earnsrevenue from sales of hardware, software and professional services and fromarrangements involving multiple elements of each of the above. Revenue formultiple element arrangements are recorded by allocating revenue to the variouselements based on their respective fair values as evidenced by vendor specificobjective evidence. The fair value in multi-element arrangements is determinedbased upon the price charged when sold separately. Revenue is not recognizeduntil persuasive evidence of an arrangement exists, delivery has occurred, thefee is fixed or determinable and collectibility is probable. Sales of networkand computer equipment are recorded when title and risk of loss transfers.Software revenues are

 

11

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recorded whenapplication software programs are shipped to end users, resellers anddistributors, provided the Company is not required to provide services essentialto the functionality of the software or significantly modify, customize orproduce the software. Professional services fees for software development,training and installation are recognized as the services are provided.Maintenance revenues are recorded evenly over the related contract period.

 

**Accounts Receivable**

 

We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. The amount of ourreserves is based on historical experience and our analysis of the accountsreceivable balances outstanding. If the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be required which would result in anadditional general and administrative expense in the period such determinationwas made. While such credit losses have historically been within ourexpectations and the provisions established, we cannot guarantee that we willcontinue to experience the same credit loss rates that we have in the past.

 

**Intangible and Long-Lived Assets**

 

At December 31, 2003 and March 31, 2004,goodwill and other long-lived assets represented 44% and 40%, respectively, ofthe Company’s total assets.

 

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 completion of the initial impairmentreviews on January 1, 2002 or upon its annual impairment review at December 31,2003.

 

Long-lived assetsconsist of property and equipment and other identifiable intangibleassets.  These assets are depreciated oramortized over their estimated useful life, and are subject to impairmentreviews.  The Company periodicallyreviews long-lived assets whenever adverse events or changes in circumstancesindicate the carrying value of such assets may not be recoverable.  In assessing recoverability, the Companymust make assumptions regarding estimated future cash flows and other factorsto determine if an impairment loss may exist, and, if so, estimate fair value.  The Company also must estimate and makeassumptions regarding the useful lives assigned to its long-lived assets.  If these estimates, or their relatedassumptions, change in the future, the Company may be required to recordimpairment losses or change the useful life including accelerating depreciationor amortization for these assets.

 

**Accrued Expenses**

 

The Companyreviews its contingent liabilities, which arise primarily from litigation andlitigation defense costs, in accordance with Statement of Financial AccountingStandards 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 requiresjudgments about 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 of thirdparties.

 

**Provision for Income Taxes**

 

Provision for income taxes is based upon theCompany’s estimate of taxable income or loss for each respective accountingperiod.  An asset or liability isrecognized for the deferred tax consequences of temporary differences betweenthe tax bases of assets and liabilities and their reported amounts in thefinancial statements.  These temporarydifferences will result in taxable or deductible amounts in future periods whenthe reported amounts of assets are recovered or liabilities are settled. TheCompany regularly reviews its deferred tax assets to determine the amount thatis more likely than not to be realized. When this amount is less than thedeferred tax asset recorded, the Company records a valuation allowance toreduce the asset to its estimated realizable value.  If the Company determined that it was not going to be able tofully realize its recorded deferred tax assets, it would make an adjustment tothe valuation allowance.  This wouldreduce net income in the period that the Company made its determination.  Similarly, if the Company realized that itwas going to be able to fully realize a deferred tax asset in excess of its netrecorded value, net income would be increased in the period that the Companymade its determination.

 

12

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The Company also reviews its deferred taxliabilities on a regular basis to determine that the amount recorded isadequate to cover the expected reversal of temporary income tax liabilities.  In the event that the amount recorded wasless than adequate, the deferred tax liability would be increased to itsestimated realizable value and net income would be decreased accordingly.  In the event that the deferred tax liabilitywas determined to be overstated, it would be reduced to its estimatedrealizable value and net income would increase accordingly.

 

The Companygenerally determines its effective tax rate by considering the statutoryfederal income tax rate, the statutory state and local tax rates (net of thefederal income tax benefit) and any nondeductible expenses.  This rate could also be affected byincreases or decreases to deferred tax assets or liabilities as describedabove.

 

**Software Development Costs**

 

All costs incurredto establish the technological feasibility of software products to be sold toothers are expensed as research and development. Once technological feasibilityhas been established, all software production costs are capitalized.  Amortization is computed on an individualproduct basis and is recognized over the greater of the remaining economiclives of each product or the ratio that current gross revenues for a productbear to the total of current and anticipated revenues for that product,commencing when the products become available for general release tocustomers.  Software development costsare generally amortized over a three-year period.  The Company continually assesses the recoverability of softwaredevelopment costs by comparing the carrying value of individual products totheir net realizable value.

 

The Companycapitalized $229,000 and $321,000 of software development costs for the periodending March 31, 2003 and 2004 respectively, relating to our new N-Tier,Internet-native corporate application suite of products written in java.  Although we have not yet sold any of themodules to this suite of applications, we believe that these new products willproduce new sales adequate to recover amounts capitalized.  We expect that certain of our new products willbe available for general release during the third quarter of 2004 at which timeamortization of such costs shall commence.

 

## **Liquidity and CapitalResources**

 

At March 31, 2004,our working capital deficiency decreased from a working capital deficiency of$10,399,000 at December 31, 2003 to a working capital deficiency of$7,198,000.  Excluding unearned revenueof $4,889,000, working capital deficiency at March 31, 2004 was $2,309,000.  Excluding unearned revenue of $3,209,000,the Company’s working capital deficiency at December 31, 2003 was$7,190,000.  Excluding unearned revenue,the decrease in the working capital deficiency of $4,881,000 was primarilyattributable to increases in receivables of $1,227,000 and decreases in currentportion of long term debt of $2,768,000, customer deposits of $509,000, accruedliabilities of $787,000 offset by decrease in cash of $154,000 and increase inaccounts payable of $314,000.

 

Net cash used ininvesting activities for the period ended March 31, 2004 totaled $387,000,which is comprised of capital expenditures of $66,000 and capitalized softwareof $321,000.

 

Net cash used infinancing activities for the period ended March 31, 2004 totaled $230,000,which represents repayments on long-term debt. On March 31, 2004, the Company successfully re-negotiated the terms ofits Wamco loan whereby the maturity date was extended to February 28,2006.  In addition, various restrictionsand covenants, pursuant to the inter-creditor agreement between Canyon andWamco, were amended to include a minimum quick ratio of 0.20 to 1.00 and aminimum debt coverage ratio of 0.50 to 1.00 which commence as of and for thethree month period ended March 31, 2004 and for each and every fiscal quarterending thereafter.  The Company was incompliance with the amended debt covenants as of and for the period endingMarch 31, 2004.  There is no guarantythat the Company will meet its debt covenants in the future.  In the event that the Company were not incompliance with the various restrictions and covenants and were unable toreceive waivers for non-compliance, the term loan would be immediately due andpayable.

 

Stockholders’deficiency decreased from $14,586,000 at December 31, 2003 to $14,432,000 atMarch 31, 2004, mainly as a result of net income during the period of $166,000.

 

Although theCompany has a net stockholders’ deficiency of $14,432,000 and a working capitaldeficit of $7,198,000 at March 31, 2004, the Company believes it will generatesufficient funds from operations to meet its operating and capitalrequirements.  In the event that theCompany cannot generate positive cash flow from its continuing operationsduring 2004, the Company can substantially reduce its research and developmentefforts to mitigate cash outflow to help sustain its operations.  There can be no assurance that the Companywill be able to sustain profitability or generate positive cash flow fromoperations; however, the Company expects to generate positive cash flow from itscontinuing operations during 2004 from shipping out products and services fromits current backlog as of March 31, 2004 as well as new orders.  In the event that the Company cannotgenerate positive cash flow from its continuing operations during 2004, theCompany can substantially reduce its research and development efforts tomitigate cash outflow to help sustain its operations.  There can be

 

13

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no assurance thatthe Company will be able to sustain profitability or generate positive cashflow from operations.  These financialstatements have been prepared assuming the Company will continue to operate asa going concern.

 

## **Contractual Obligationsand Commercial Commitments**

 

The followingtable summarizes the Company’s obligations and commitments as of March 31,2004:

 
|                             |   | **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                   |   | $                                         | 11,389 |   | $ | 878 |   | $ | 7,811 |   | $ | 2,291 |   | $ | 409 |   |
| Operating Leases                 |   | 1,773                                     |   | 626 |   | 967 |   | 127 |   | 53 |   |
| Consulting Agreements            |   | 60                                        |   | 60 |   | — |   | — |   | — |   |
|                             |   | $                                         | 13,222 |   | $ | 1,564 |   | $ | 8,778 |   | $ | 2,418 |   | $ | 462 |   |

 

14

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**Results of Operations**

 

Three Months Ended March 31, 2003 Compared to Three Months Ended March31, 2004

 
|                                         |   | **March 31,  2003** |   | **Percentage  of  Revenue** |   | **March 31,  2004** |   | **Percentage  of  Revenue** |   |
|----------------------------------------------|--------|---------------------|--------|-----------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                         |   |                |   |                        |   |                |   |                        |   |
| Revenue:                                     |   | $                   | 5,186  |                        | 100.0  | %                   | $      | 5,172                       |   | 100.0 | % |
| Gross profit                                 |   | 3,714               |   | 71.6                        | %      | 3,722               |   | 72.0                        | %      |
| Selling, general and administrative expenses |   | 2,531               |   | 48.8                        | %      | 2,348               |   | 45.4                        | %      |
| Research and development costs               |   | 682                 |   | 13.2                        | %      | 892                 |   | 17.1                        | %      |
| Other operating expense (income)             |   | (51                 | )      | (1.0%                       | )      | 3                   |   | 0.0                         | %      |
| Interest expense, net                        |   | 349                 |   | 6.7                         | %      | 291                 |   | 5.6                         | %      |
| Other non-operating expense                  |   | —              |   | —                      |   | 16                  |   | 0.3                         | %      |
| Income tax expense (benefit)                 |   | (59                 | )      | (1.1%                       | )      | 6                   |   | 0.1                         | %      |
| Net income                                   |   | $                   | 262    |                        | 5.1    | %                   | $      | 166                         |   | 3.2 | % |

 

Revenue for 2004was $5,172,000 compared to $5,186,000 in 2003 or a 0.3% decrease.   Revenue decreased slightly in 2004 mainlydue to lackluster capital spending on information technology in 2004 due to theeffects of an overall downturn in the economy.   Many hotels have reduced their operating costs by canceling orreducing contracted services, including support, in a post ‘911’ economy.  Many hotels have requested that theirsuppliers reduce the cost of service or delay any price increases while theyare experiencing reduced guest occupancy and lower average daily rates on theirinventory of rooms.  Certain hotels havealso established their own help desks to further reduce costs.  As a result, the Company has only moderatelyincreased its support prices and agreed, with certain of its clients, toprovide a second line of support versus a first line of support that waspreviously provided to such clients.  Ourcontinuing hospitality business is expected to generate sufficient cash fromoperations to adequately fund its ongoing operating activities.

 

Gross profit for2004 increased to $3,722,000 (72.0%) from $3,714,000 (71.6%) in 2003.  The increase in gross profit is mainly dueto an increase in software revenues during the period in excess of theCompany’s cost reductions.

 

Selling, generaland administrative expenses (“SG&A”) decreased from $2,531,000 in 2003 to$2,348,000 in 2004.  The decrease ismainly due to the Company’s efforts to streamline costs while continuing toactively and aggressively market its newly developed enterprise suite ofapplications and services.

 

Research anddevelopment costs increased from $682,000 in 2003 to $892,000 in 2004.  The increase is mainly due to the Company’scontinued efforts to invest in product development of its new internet nativesuite of applications as well as our core product offerings.

 

Other operatingexpense (income) was ($51,000) in 2003 and $3,000 in 2004. The income in 2003is mainly due to receipt of approximately $46,000 of cash resulting from alegal settlement.  There were no suchsettlement receipts in 2004.

 

Net interestexpense was $349,000 in 2003 compared to $291,000 in 2004.  The decrease is due to lower balances ofinterest bearing debt during 2004 as compared to 2003.

 

Othernon-operating expense of $16,000 in 2004 relates to minority interest expenseassociated with our Asian Operations. There were no such expense recorded in 2003.

 

The income taxbenefit in 2003 is due to the Company recording a domestic income taxreceivable during the period to recover taxes previously paid.  There were no such receivables recorded in2004.

 

**Item 3. Quantitative And Qualitative Disclosures About Market Risk**

** **

***MarketRisk Disclosures***

*** ***

The followingdiscussion about our market risk disclosures contains forward-lookingstatements.  Forward-looking statementsare subject to risks and uncertainties. Actual results could differ materially from those discussed in theforward-looking statements.  We areexposed to market risk related to changes in interest rates and foreigncurrency exchange rates.  We do not havederivative financial instruments for hedging, speculative, or trading purposes.

 

***InterestRate Sensitivity***

*** ***

Of our $11.4million principal amount of indebtedness at March 31, 2004, none bears interestat a variable rate.  However, $5.7million bears interest at a fixed rate of 11%, $3.6 million bears interest at afixed rate of 10%, $1.2 million bears interest

 

15

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at 9.25% and $0.9million bears fixed interest rates ranging from 6% to 17.5%.  Since these debt instruments bear interestat fixed rates, we have no exposure to decreases in interest rates because we stillare required to pay the fixed rate even if current interest rates are lower.

 

***ForeignCurrency Risk***

*** ***

We believe thatour exposure to currency exchange fluctuation risk is reduced because ourtransactions with international vendors and customers are generally transactedin US dollars. The currency exchange impact on intercompany transactions wasimmaterial for the quarter ended March 31, 2004.

 

**Item 4. Evaluation of Disclosure Controls and Procedures**

** **

#### ***(a)           Evaluation of disclosure controls andprocedures***

#### *** ***

The Company maintainsdisclosure controls and procedures designed to ensure that material informationrelated to the Company, including our consolidated subsidiaries, is recorded,processed, summarized and reported within the time periods specified in the SECrules and forms.  As of the end of theperiod covered by this report, we carried out an evaluation under thesupervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934).  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded, as of the date of suchevaluation, that the design and operation of such disclosure controls andprocedures were effective.

 

#### ***(b)           Changes in internal controls andLimitations 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.  Our management,including our Chief Executive Officer and Chief Financial Officer, does not expectthat our disclosure controls or internal controls over financial reporting willprevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met.  Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within our company have beendetected.  These inherent limitationsinclude the realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls.  The design of any system of controls isbased in part upon certain assumptions about the likelihood of future events,and any design may not succeed in achieving its stated goals under allpotential future conditions.  Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.  Because of the inherent limitation of acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**PARTII - OTHER INFORMATION**

** **

**Item1.    Legal Proceedings**

** **

*Hotel Information Systems, Inc.*

 

On March 25, 2003,the Company entered into a settlement agreement with Hotel Information Systems(“HIS”) and one of its former corporate officers whereby (i) the partiesdismissed all claims, known and unknown, against each other; (ii) the Companyforgave and wrote off a note receivable from the former corporate officer ofHIS in the amount of $66,000 (which was expensed to other expense in the 2002consolidated statement of operations); (iii) the Company paid $50,000 in cashand issued a non-interest bearing unsecured promissory note which requires 35consecutive monthly payments of $5,000 each commencing April 1, 2003; and (iv)the remaining 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 unsecuredpromissory note in making

 

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its $5,000 monthlypayments to HIS, and HIS issues respective valid default notices, the Companywill be subject to a $225,000 penalty. The 374,116 shares have been received by MAI together with the HISauthorization to legally transfer such shares to MAI.

 

### *Imputing interest at 11%, the present value of the $175,000promissory 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.*

### * *

*Logix Development Corporation*

 

The Companyentered into a settlement agreement with Logix Development Corporation(“Logix”) in July of 2002 whereby we (i) issued Logix 200,000 shares of ourCommon Stock (ii) required the Company to make various cash installmentpayments totaling $175,000 to be paid within 1 year and (iii) executed acontract with Logix for a consulting project in the amount of $50,000.  The Company has made all required paymentsto Logix under this settlement agreement.

 

In December 2003,the Company entered into another settlement agreement with Logix whereby it (i)issued 200,000 free trading shares in exchange for the 200,000 restrictedCommon Shares from the original settlement agreement in July 2002 (ii) requiredthe Company to make monthly payments totaling $187,500 over a 25 month period and(iii) mutually released each other of all past, present and future claimsassociated with the lawsuit.

 

*Other Litigation*

 

We were alsoinvolved in various other legal proceedings that are incident to its business.Management believes the ultimate outcome of these matters will not have amaterial adverse effect on our consolidated financial position, results ofoperations or liquidity.

 

**Item2.  Changes in Securities and Use ofProceeds**

** **

(a)           None.

 

(b)           None.

 

(c)           None

 

(d)           None.

 

**Item3.  Defaults Upon Senior Securities**

** **

(a)           None

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

** **

(a)           None

 

(b)           None

 

(c)           None

 

(d)           None

 

**Item5.  Other Information**

** **

(a)           None.

 

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**Item6.  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  April 1, 2004                                                                                                    |
|   |   |                                                                                                                    |
|   |   | Filed  April 12, 2004                                                                                                   |

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|               | MAI SYSTEMS CORPORATION                  |
|--------------------|------------------------------------------|
|               | (Registrant)                             |
|               |                                     |
|               |                                     |
| Date: May 14, 2004 | By:                                      | /s/ James W. Dolan |
|               | James W. Dolan                           |
|               | Chief Financial and Operating Officer    |
|               | (Chief Financial and Accounting Officer) |
|                    |                                          |  |

 

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