**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

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** **

**FORM10-Q**

** **
| **ý**                                                | **Quarterly report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.**  | ** ** |
|-----------------------------------------------------------|------------------------------------------------------------------------------------------------|------------|
| ** **                                                |
| **For the quarterly  period ended September 30, 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**

** **

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** **

**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 92630**                          |
| **Address of principal executive offices**                                |
| ** **                                                                |
| **Registrant’s telephone number including area code**(949)  598-6000 |

 

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Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.   Yes  ý  No o

 

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

Yes o  No ý

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). oYes ý No

 

The aggregate market value of the common stock held by non-affiliatesof the registrant, based upon the last sale price of the Common Stock reportedon the National Association of Securities Dealers Automated Quotation NationalMarket System on November 14, 2005 was $464,245.         

 

The number of shares of common stock issued, outstanding and subscribedas of November 14, 2005 was 57,847,862.

 

 

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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,  2004 (a)**      | ** **   | **As of September  30, 2005** | ** ** |
|                                                                                                              |         |                                  |         |   |   |
| **ASSETS  (note 5)**                                                                                              |         |                                  |         |   |   |
|                                                                                                              |         |                                  |         |   |   |
| Current assets:                                                                                                   |         |                                  |         |   |   |
| Cash                                                                                                              |         | $                                     | 195          |   | $ | 429 |   |
| Receivables,  less allowance for doubtful accounts of $321 in 2004 and $302 in 2005,  respectively                |         | 2,171                                 |         | 2,581 |   |
| Inventories                                                                                                       |         | 71                                    |         | 205 |   |
| Prepaids and  other assets                                                                                        |         | 748                                   |         | 862 |   |
|                                                                                                              |         |                                  |         |   |   |
| Total current  assets                                                                                             |         | 3,185                                 |         | 4,077 |   |
|                                                                                                              |         |                                  |         |   |   |
| Furniture,  fixtures and equipment, net                                                                           |         | 629                                   |         | 558 |   |
| Intangibles, net                                                                                                  |         | 7,470                                 |         | 6,800 |   |
| Goodwill                                                                                                          |         | 4,622                                 |         | 4,622 |   |
| Other assets                                                                                                      |         | 15                                    |         | 14 |   |
|                                                                                                              |         |                                  |         |   |   |
| Total assets                                                                                                      |         | $                                     | 15,921       |   | $ | 16,071 |   |
|                                                                                                              |         |                                  |         |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIENCY**                                                                |         |                                  |         |   |   |
|                                                                                                              |         |                                  |         |   |   |
| Current  liabilities:                                                                                             |         |                                  |         |   |   |
| Current portion  of long-term debt                                                                                |         | $                                     | 1,003        |   | $ | 1,138 |   |
| Accounts payable                                                                                                  |         | 1,077                                 |         | 637 |   |
| Customer  deposits                                                                                                |         | 2,181                                 |         | 3,236 |   |
| Accrued  liabilities                                                                                              |         | 2,901                                 |         | 2,540 |   |
| Income taxes  payable                                                                                             |         | 103                                   |         | 92 |   |
| Unearned revenue                                                                                                  |         | 3,456                                 |         | 4,125 |   |
|                                                                                                              |         |                                  |         |   |   |
| Total current  liabilities                                                                                        |         | 10,721                                |         | 11,768 |   |
|                                                                                                              |         |                                  |         |   |   |
| Long-term debt                                                                                                    |         | 6,649                                 |         | 5,751 |   |
| Other  liabilities                                                                                                |         | 764                                   |         | 637 |   |
|                                                                                                              |         |                                  |         |   |   |
| Total  liabilities                                                                                                |         | 18,134                                |         | 18,156 |   |
|                                                                                                              |         |                                  |         |   |   |
| 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 |         | 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                                   | )            | (59 | ) |
| Accumulated  deficit                                                                                              |         | (49,334                               | )            | (49,216 | ) |
|                                                                                                              |         |                                  |         |   |   |
| Total  stockholders’ deficiency                                                                              |         | (2,213                                | )            | (2,085 | ) |
|                                                                                                              |         |                                  |         |   |   |
| Total  liabilities and stockholders’ deficiency                                                              |         | $                                     | 15,921       |   | $ | 16,071 |   |

 

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

 

**The accompanying notes are anintegral part of these condensed consolidated financial statements.**

 

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**MAI SYSTEMS CORPORATION**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

 
| ** **                                                                   | ** **   | **(Unaudited)**                              | ** **   | **(Unaudited)**                             | ** **   |
|------------------------------------------------------------------------------|--------------|----------------------------------------------|--------------|---------------------------------------------|--------------|
| ** **                                                                   | *** *** | **For the Three Months Ended September 30,** | *** *** | **For the Nine Months Ended September 30,** | *** *** |
| ** **                                                                   | *** *** | **(in thousands, except per share data)**    | *** *** | **(in thousands, except per share data)**   | *** *** |
| ** **                                                                   | ** **   | **2004**                                     | ** **   | **2005**                                    | ** **   | **2004** | ** ** | **2005** | ** ** |
| Revenue:                                                                     |         |                                         |         |                                        |         |   |   |   |   |
| Software                                                                     |         | $                                            | 842          |                                        | $            | 1,103 |   | $ | 2,945 |   | $ | 3,641 |   |
| Network and  computer equipment                                              |         | 118                                          |         | 169                                         |         | 329 |   | 448 |   |
| Services                                                                     |         | 3,923                                        |         | 4,357                                       |         | 11,683 |   | 12,297 |   |
| Total revenue                                                                |         | 4,883                                        |         | 5,629                                       |         | 14,957 |   | 16,386 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Direct costs:                                                                |         |                                         |         |                                        |         |   |   |   |   |
| Software                                                                     |         | 40                                           |         | 197                                         |         | 369 |   | 706 |   |
| Network and  computer equipment                                              |         | 103                                          |         | 122                                         |         | 272 |   | 365 |   |
| Services                                                                     |         | 1,264                                        |         | 1,306                                       |         | 3,446 |   | 4,027 |   |
| Total direct  costs                                                          |         | 1,407                                        |         | 1,625                                       |         | 4,087 |   | 5,098 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Gross profit                                                                 |         | 3,476                                        |         | 4,004                                       |         | 10,870 |   | 11,288 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Selling, general  and administrative expenses                                |         | 2,200                                        |         | 2,272                                       |         | 6,900 |   | 6,822 |   |
| Research and  development costs                                              |         | 956                                          |         | 1,032                                       |         | 2,756 |   | 3,296 |   |
| Amortization of  intangibles                                                 |         | —                                       |         | 126                                         |         | — |   | 364 |   |
| Other operating  expense (income)                                            |         | 48                                           |         | (23                                         | )            | 67 |   | 48 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Operating income                                                             |         | 272                                          |         | 597                                         |         | 1,147 |   | 758 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Interest  expense, net                                                       |         | (303                                         | )            | (229                                        | )            | (881 | ) | (630 | ) |
| Other  non-operating expense, net                                            |         | (22                                          | )            | —                                      |         | (60 | ) | — |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Income (loss)  before income taxes                                           |         | (53                                          | )            | 368                                         |         | 206 |   | 128 |   |
| Income tax  expense                                                          |         | (5                                           | )            | (1                                          | )            | (15 | ) | (10 | ) |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Net income  (loss)                                                           |         | $                                            | (58          | )                                           | $            | 367 |   | $ | 191 |   | $ | 118 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Income (loss)  per share:                                                    |         |                                         |         |                                        |         |   |   |   |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Net income  (loss) per share:                                                |         |                                         |         |                                        |         |   |   |   |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Basic income  (loss) per share                                               |         | $                                            | 0.00         |                                        | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Diluted income  (loss) per share                                             |         | $                                            | 0.00         |                                        | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Weighted average  common shares used in determining income (loss) per share: |         |                                         |         |                                        |         |   |   |   |   |
|                                                                         |         |                                         |         |                                        |         |   |   |   |   |
| Basic                                                                        |         | 14,676                                       |         | 57,848                                      |         | 14,676 |   | 57,848 |   |
| Diluted                                                                      |         | 14,676                                       |         | 57,848                                      |         | 14,676 |   | 57,848 |   |

 

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

 

2

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**MAISystems Corporation**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 

**(Unaudited)**

 
| ** **                                          | *** *** | **For the Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|--------------|----------------------------------------------|------------|
| ** **                                          | *** *** | **(in thousands)**                           | ** ** |
| ** **                                          | ** **   | **2004**                                     | ** ** | **2005** | ** ** |
|                                                |         |                                         |       |   |   |
| Net cash provided by operating activities:          |         | $                                            | 405        |   | $ | 1,072 |   |
|                                                |         |                                         |       |   |   |
| Cash flows used in investing activities:            |         |                                         |       |   |   |
| Capital  Expenditures                               |         | (98                                          | )          | (65 | ) |
| Capitalized  software development costs             |         | (821                                         | )          | — |   |
| Net cash used in investing activities               |         | (919                                         | )          | (65 | ) |
|                                                |         |                                         |       |   |   |
| Cash flows used in financing activities-            |         |                                         |       |   |   |
| Proceeds from  common stock subscribed              |         | 1,000                                        |       | — |   |
| Repayments on  long-term debt                       |         | (594                                         | )          | (779 | ) |
| Net cash provided by (used in) financing activities |         | 406                                          |       | (779 | ) |
|                                                |         |                                         |       |   |   |
| Net cash provided by (used in) operations           |         | (108                                         | )          | 228 |   |
|                                                |         |                                         |       |   |   |
| Effect of exchange rate changes on cash             |         | (1                                           | )          | 6 |   |
|                                                |         |                                         |       |   |   |
| Net increase (decrease) in cash                     |         | (109                                         | )          | 234 |   |
|                                                |         |                                         |       |   |   |
| Cash at beginning of period                         |         | 664                                          |       | 195 |   |
|                                                |         |                                         |       |   |   |
| Cash at end of period                               |         | $                                            | 555        |   | $ | 429 |   |

 

**The accompanying notes are anintegral part of these condensed consolidated financial statements.**

 

3

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**MAISystems Corporation**

 

**Notesto Condensed Consolidated Financial Statements**

 

**Threeand Nine Months ended September 30, 2005**

 

**(Unaudited)**

 

**NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

Companies for which this report is filed are MAI Systems Corporationand 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 and nine month periods ended September30, 2005 are not necessarily indicative of the results to be expected for theentire year or for any future period.

 

Although the Company believes that the disclosures in these financialstatements are adequate to make the information presented not misleading,certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to therules and regulations of the Securities and Exchange Commission (the “SEC”), andthese condensed consolidated financial statements should be read in conjunctionwith the financial statements included in the Company’s Annual Report on Form10-K for the year ended December 31, 2004, which is on file with the SEC.

 

**NOTE 2 - LIQUIDITY**

 

Although the Company has a net stockholders’ deficiency of $­2,085,000and a working capital deficit of $7,691,000 at September 30, 2005, the Companybelieves it will generate sufficient funds from operations or obtain additionalfinancing to meet its operating and capital requirements for at least the next12 months.    The Company expects togenerate positive cash flow from its operations during 2005 from shipping outproducts and services from its current backlog as of September 30, 2005 as wellas new orders.  In the event that theCompany cannot generate positive cash flow from its continuing operationsduring 2005 and 2006, the Company can substantially reduce its research anddevelopment efforts 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 or obtain additional financing as necessary.  These condensed consolidated financialstatements have been prepared assuming the Company will continue to operate asa going concern.  If the Company isunsuccessful in the aforementioned efforts, the Company could be forced toliquidate certain of its assets, reorganize its capital structure and, ifnecessary, seek other remedies available to the Company.

 

The restructured debt, pursuant to the original intercreditor agreementbetween the Company, 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 (seenote 5). The Company was in compliance with its covenants as of September 30,2005. There is no guaranty that the Company will meet its debt covenants in thefuture.

 

**NOTE 3 – MANAGEMENT EQUITY/CONVERSION TRANSACTIONAND PRIVATIZATION PLANS**

 

**Management Equity/Conversion Transaction**

 

On April 9, 2004, an investor group, consisting ofCanyon, 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, the Companyreceived approval from its shareholders for the Investor Group to convert theCompany’s secured indebtedness acquired from CSA plus any accrued interestthrough the date of conversion for shares of the Company’s common stock basedupon a conversion price of $0.10 per share. Additionally, the shareholders also approved for the Investor Group toinvest $1,000,000 of new cash proceeds into the Company, which the Companyreceived on September 24, 2004, in a private placement at $0.10 per share (the “ManagementEquity/Conversion Transaction”).    OnNovember 1, 2004, the Company issued 10 million shares of its common stock tothe 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, wasconverted into 33,172,110 shares of the Company’s common stock.

 

4

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We believe that the aforementioned transaction permitted but did notrequire us to use new basis or push down accounting since the members of theInvestor Group hold between 80% and 94% of the voting shares of the Companyupon completion of the transaction. Applicationof push-down accounting requires that the acquiring parent or control groupobtain at least an 80% ownership interest, either in a single transaction, orthough a series of transactions. The Investor Group has acquired 78.84%, andthe members of the Investor Group previously personally held 17.85% ownership,not within the Investor Group. The 17.85% personal ownership of the membersoutside of the Investor Group was reduced to 4.53% after the Investor Group’sacquisition of 78.84% of the Company’s common stock.  The basis for considering the members as partof a control group is due to the fact that the group’s intent was tomutually promote the acquisition and to collaborate on the subsequent controlof the Company and, as such, should be viewed effectively as oneinvestor/group.  The 78.84%interest held by the Investor Group effectively ties the four members togetherinto a control group, and that the remaining outside holdings of 4.53%(totaling 83.37%) should also be treated as held by the control group forpurposes of applying push-down accounting (therefore the Investor Groupcontrols 83.37% of the Company’s common stock). Accordingly, the Company has elected to apply push downaccounting in the accompanying financial statements, 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 the date ofthe transaction.

 

In connection with the Management Equity/Conversion Transaction, theCompany assigned a new useful life for furniture, fixtures and equipmenteffective as of November 1, 2004. Following is our allocation of the purchase price at estimated fairvalues and amortization periods (useful lives) for the groups of assetsaffected:

 

| ** **                        | ** ** | **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 |                                    |       |   |

 

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*   Reviewed annually for impairment, notamortized, as goodwill has an indefinite life (in accordance with SFAS No.142).

 

The following reflects the unaudited pro forma effect of the ManagementEquity/Conversion Transaction on continuing operations for the three and nine -monthperiods ended September 30, 2004 (in thousands):

 

| ** **           | ** ** | **For the Three -  Months Ended  September 30,  2004** | ** ** | **For the Nine -  Months Ended  September 30,  2004** | ** ** |
|----------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
|                 |       |                                                   |       |                                                  |       |
| Revenue              |       | $                                                      | 4,883      |                                                  | $          | 14,957 |   |
| Operating income     |       | 145                                                    |       | 741                                                   |       |
| Net income (loss)    |       | (102                                                   | )          | 34                                                    |       |
| Net income per share |       | $                                                      | (0.01      | )                                                     | $          | 0.00 |   |

 

The unaudited pro forma information provided above has been prepared byadjusting historical amounts for the three and nine month periods ended September30, 2004 to give effect to the Management Equity/Conversion Transaction as ifit had occurred on January 1, 2004.  Thepro forma adjustments to the historical results of operations for the three andnine month periods ended September 30, 2004 include the pro forma impact of thepush down accounting resulting in the reduction of depreciation expense of $88,000and $240,000, respectively, and an increase of amortization of identifiableintangible assets of $215,000 and $646,000, respectively. The pro formaadjustments to the historical results of operations for the three month and ninemonth periods ended September 30, 2004 include the pro forma impact of the debtconversion resulting in the reduction of interest expense of $83,000 and $249,000,respectively.

 

5

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**Privatization Plans**

 

Our Board of Directors and theInvestor Group are in the process of furnishing an information statement toall holders of record of the issued and outstanding shares of our common stock,$0.01 par value, in connection with aproposed Amendment to theCompany’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, as amended(“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 aresummarized as follows:

 

| *** ***      | *** *** | **(dollars in thousands)** | ** ** |
|-------------------|--------------|----------------------------|------------|
| ** **        | ** **   | **December 31,  2004**     | ** ** | **September 30,  2005** | ** ** |
|              |         |                       |       |   |   |
| Finished goods    |         | $                          | 65         |   | $ | 200 |   |
| Replacement parts |         | 6                          |       | 5 |   |
|              |         |                       |       |   |   |
|              |         | $                          | 71         |   | $ | 205 |   |

 

**NOTE 5 - LONG TERM DEBT**

 

**Wamco 32 Ltd.**

 

On January 13, 2003, the Company re-negotiated theterms of its credit facility with Coast Business Credit (“Coast”) whereby theoutstanding balance of $1,828,000 was converted to a secured term loan whichaccrues interest at 9.25% per annum and requires monthly payments of $58,000over 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 DepositInsurance Corporation (“FDIC”) put Coast and its parent company, SouthernPacific Bank, into receivership and held all of Coast’s assets for sale tothird parties.  On May 15, 2003, the loanwas 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 loan matures on February 28, 2006, at which timeall 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, 2003 and 2004, there were no additionalprincipal payments required under the EBITDA-based formula. As of December 31,2004 and September 30, 2005, the balance of the term loan was $774,000 and $237,000,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 in compliancewith such covenants as of September 30, 2005. There is no guaranty that the Company will meet its debt covenants inthe future.

 

**Canyon Capital Management LP**

 

On January 13, 2003, the Company modified its 11% securedsubordinated notes payable agreement with Canyon Capital Management LP (“Canyon”),whereby the Company is required to make monthly interest payments of $52,000until the Wamco term loan is paid off in full at which time the note payablewill be converted into a three-year amortizing loan which will accrue interestat 11% per annum and requires equal monthly payments of principal and interest ofapproximately $190,000 such that the subordinated debt will be paid in full atthe end of the amended term.  Effective September 30, 2005, the Company againmodified its 11% secured subordinated notes payable agreement with Canyon, whereas the Company shallcontinue to make monthly interest payments of $52,000 until March 31, 2006, atwhich time the debt shall be amortized over a four and a half year period, suchthat monthly principal and interest payments will be reduced to approximately$130,000.  The Canyon debt will stillmature at the end of the three-year period in March 2009 at which time allremaining principal and interest shall be due and payable.  In addition, from and after March 31,2006, the Company will also be required to pay Canyon additional principalpayments on a quarterly basis based upon an EBITDA-based formula.  In connection with the January 13, 2003modification, the Company issued to Canyon 200,000 shares of its common stockvalued at $20,000 (the quoted market price of the common stock at the time theterms were agreed) and

 

6

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agreed to issue one million warrants at an exerciseprice of $0.40 per share valued at $42,000 (using the Black-Scholesoption-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 intellectualproperty, which lien is junior to the lien granted to Wamco. Accrued and unpaidinterest outstanding on the subordinate notes payable to Canyon wasapproximately $216,000 and $24,000 at December 31, 2004 and September 30, 2005,respectively. The principal balance outstanding on the subordinate notespayable to Canyon was approximately $5,660,000 at December 31, 2004 and September30, 2005.

 

**CSA Private Limited**

 

In connection with a settlement agreement in February2001 with CSA Private Limited (“CSA”) a subsidiary of Computer SciencesCorporation (“CSC”), the Company issued $2.8 million of subordinated debt toCSA.  The $2.8 million of debt wassecured by all the tangible and intangible assets for the Company, includingintellectual property, 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.

 

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 successfully amended itsagreement with CSA whereby the principal balance and accrued interest throughMarch 31, 2004, totaling $3,633,000, were converted to two secured newnotes.  The first note for $500,000 (“FirstNote”) accrues interest at 10% per annum and provides for monthly payments 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 had not made any payments on the $500,000 note as of September 28,2005 and was in default.  The interestrate was increased to 12.5% in line with the terms of that note until theCompany becomes current on its contractual payments.

 

On April 9, 2004, an investor group, consisting ofCanyon, the Company’s Chairman of the Board, Chief Executive Officer and ChiefFinancial and Operating Officer (“Investor Group”), acquired 2,433,333 sharesof the Company’s common stock held by CSA and the Other Note for $1 million incash .  The purchase price was negotiatedbased upon arm’s length discussions between members of the Investor Group andsenior management of CSC.  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 note3).

 

Effective September 28, 2005, the Investor Group acquired the FirstNote, plus accrued interest of $96,321, from CSA for a total purchase price of$350,000.  The purchase price wasnegotiated based upon arm’s length discussions between members of the InvestorGroup and senior management of CSC.

 

**Tax Claims**

 

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 September30, 2005, the Company was current with its payments to the Service and the debtbalance was $311,000.

 

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.

 

7

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**NOTE 6 - RESTRICTED STOCK PLAN**

 

In May 2001, the Board of Directors adopted the 2001Restricted Stock Plan.  Under the plan,1,250,000 authorized shares of the Company’s Common Stock are reserved forissuance 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 provideconsideration to the Company other than rendering the service and have theright to vote the shares.  Under APB 25,compensation cost is recognized for the fair value of the restricted stockawarded, which is its quoted market price at the date of grant, which was $0.25per share.  The total market value of theshares of $153,000 was treated as unearned compensation and was amortized toexpense in proportion to the vesting schedule. The balance of unearned compensation was fully amortized as of December31, 2004.

 

**NOTE 7 - PREFERRED STOCK**

 

On May 20, 1997, the Company authorized the issuanceof 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 by theholders of Common Stock.

 

**NOTE 8 - INTANGIBLE ASSETS**

 

As of September 30, 2005, intangible assets consist ofdeveloped technology, software trade names, customer lists and goodwill (whichrepresents the excess of the purchase price over the estimated fair value ofthe 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.  The Company’s amortization periodfor customer relationships is the greater of seven years on a straight linebasis or specific identification.** **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 September30, 2005 are as follows (in thousands):

 

| ** **                                   | ** ** | **December 31,  2004** | ** ** | **September 30,  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                    | )          | (345                    | )          |
| Software trade  names                        |       | (41                    | )          | (162                    | )          |
| Customer  relationships                      |       | (56                    | )          | (299                    | )          |
| Total  accumulated amortization              |       | (136                   | )          | (806                    | )          |
|                                         |       |                   |       |                    |       |
| Intangible  assets, net                      |       | $                      | 7,470      |                    | $          | 6,800 |   |
|                                         |       |                   |       |                    |       |
| Goodwill                                     |       | $                      | 4,622      |                    | $          | 4,622 |   |

 

A roll forward of goodwill 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 September 30, 2005    |   | $      | 4,622  |   |

 

8

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The Company’s amortization period for customer relationships is thegreater of seven years on a straight line basis or specificidentification.  Capitalized software andsoftware trade names are being amortized on a straight line basis over sevenand fifteen years, respectively.  Thefollowing table shows the estimated amortization expense for these assets foreach of the succeeding years:

* *

| **Year Ending December 31,** | ** ** |
|------------------------------|------------|
| **(in thousands)**           | ** ** |
| 2005                         |       | $ | 216 |   |
| 2006                         |       | 861 |   |
| 2007                         |       | 861 |   |
| 2008                         |       | 861 |   |
| 2009                         |       | 861 |   |
| Thereafter                   |       | 3,140 |   |
|                         |       | $ | 6,800 |   |

 

**NOTE 9 - INCOME (LOSS) 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:

 
| ** **                                                                                                              | ** ** | **Three Months Ended September 30,**     | ** ** | **Nine Months Ended September 30,**      | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2004**                                 | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                              | ** ** | **(in thousands except per share data)** | ** ** | **(in thousands except per share data)** | ** ** |
| Numerator:                                                                                                              |       |                                     |       |                                     |       |   |   |   |   |
| Numerator for  basic and diluted earnings (loss) per share – net income (loss)                                     |       | $                                        | (58        | )                                        | $          | 367 |   | $ | 191 |   | $ | 118 |   |
|                                                                                                                    |       |                                     |       |                                     |       |   |   |   |   |
| Denominator:                                                                                                            |       |                                     |       |                                     |       |   |   |   |   |
| Denominator for  basic income (loss) per share- weighted average number of Common shares  outstanding during the period |       | 14,676                                   |       | 57,848                                   |       | 14,676 |   | 57,848 |   |
|                                                                                                                    |       |                                     |       |                                     |       |   |   |   |   |
| Incremental  common shares attributable to exercise of outstanding shares                                               |       | —                                   |       | —                                   |       | — |   | — |   |
|                                                                                                                    |       |                                     |       |                                     |       |   |   |   |   |
| Denominator for  diluted income (loss) per per share                                                                    |       | 14,676                                   |       | 57,848                                   |       | 14,676 |   | 57,848 |   |
|                                                                                                                    |       |                                     |       |                                     |       |   |   |   |   |
| Basic earnings  (loss) per share                                                                                        |       | $                                        | 0.00       |                                     | $          | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
|                                                                                                                    |       |                                     |       |                                     |       |   |   |   |   |
| Diluted earnings  (loss) per share                                                                                      |       | $                                        | 0.00       |                                     | $          | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |

 

Thenumber of anti-dilutive options and warrants that were excluded from thecomputation of incremental common shares were 3,104,000 and 2,647,750 in 2004and 2005, respectively.

 

9

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**NOTE 10 – STOCK OPTION PLANS**

 

The Company accounts for stock-basedcompensation in accordance with Accounting Principles Board, APB, No. 25, “Accountingfor Stock Issued to Employees.” The Company has adopted the disclosure-onlyprovisions of FAS No. 123 “Accounting for Stock-Based Compensation.” Under APBNo. 25, compensation expense relating to employee stock options is determinedbased on the excess of the market price of the Company’s stock over theexercise price on the date of grant, the intrinsic value method, versus thefair value method as provided under FAS No. 123.

 

In December 2002, the FASB issued FAS No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure”, which amended FASNo. 123, “Accounting for Stock-Based Compensation.” The new standard providesalternative methods of transition for a voluntary change to the fair marketvalue based method for accounting for stock-based employee compensation.Additionally, the statement amends the disclosure requirements of FAS No. 123to require prominent disclosures in both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method used on reported results. This statement iseffective for financial statements for the year ended December 31, 2002.  In compliance with FAS No. 148, the Companyhas elected to continue to follow the intrinsic value method in accounting forits stock-based employee compensation plan as defined by APB No. 25.

 

At September 30, 2005, the Company had two stock-basedemployee compensation plans.  The Companyaccounts for these plans under the recognition and measurement principles ofAPB No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. Accordingly, no stock-based employee compensation cost is reflectedin net income (loss), as all options granted under the plan had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.  Had compensation cost for theCompany’s stock option plan been determined based on the fair value at thegrant date for awards for the three and nine month periods ended September 2004and 2005, consistent with the provisions of FAS No. 123, the Company’s netincome (loss) and net income (loss) per share would have decreased.  The following table represents the effect onnet income and net income per share if the Company had applied the fair valuebased method and recognition provisions of Statement of Financial AccountingStandards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, tostock-based employee compensation.

 
| ** **                                                                                | ** ** | **For the three-months ended  September 30,** | *** *** | **For the nine-months ended  September 30,** | *** *** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------|--------------|----------------------------------------------|--------------|
| ** **                                                                                | ** ** | **(in thousands, except per  share data)**    | ** **   | **(in thousands, except per  share data)**   | ** **   |
| ** **                                                                                | ** ** | **2004**                                      | ** **   | **2005**                                     | ** **   | **2004** | ** ** | **2005** | ** ** |
| Net income  (loss):                                                                       |       |                                          |         |                                         |         |   |   |   |   |
| As reported                                                                               |       | $                                             | (58          | )                                            | $            | 367 |   | $ | 191 |   | $ | 118 |   |
| Add: Stock-based  employee compensation expense recorded                                  |       | 10                                            |         | 10                                           |         | 30 |   | 30 |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | (10                                           | )            | (10                                          | )            | ­(30 | ) | ­(30 | ) |
| Pro forma                                                                                 |       | $                                             | (58          | )                                            | $            | 367 |   | $ | 191 |   | $ | 118 |   |
|                                                                                      |       |                                          |         |                                         |         |   |   |   |   |
| Basic income  (loss) per share:                                                           |       |                                          |         |                                         |         |   |   |   |   |
| As reported                                                                               |       | $                                             | 0.00         |                                         | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
| Add: Stock-based  employee compensation expense recorded                                  |       | —                                        |         | —                                       |         | — |   | — |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | —                                        |         | —                                       |         | — |   | — |   |
| Pro forma                                                                                 |       | $                                             | 0.00         |                                         | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
|                                                                                      |       |                                          |         |                                         |         |   |   |   |   |
| Diluted income  (loss) per share:                                                         |       |                                          |         |                                         |         |   |   |   |   |
| As reported                                                                               |       | $                                             | 0.00         |                                         | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
| Add: Stock-based  employee compensation expense recorded                                  |       | —                                        |         | —                                       |         | — |   | — |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | —                                        |         | —                                       |         | — |   | — |   |
| Pro forma                                                                                 |       | $                                             | 0.00         |                                         | $            | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |

 

10

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**NOTE 11 - LEGAL PROCEEDINGS**

 

*Hotel Information 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, knownand unknown, against each other; (ii) the Company forgave and wrote off a notereceivable from the former corporate officer of HIS in the amount of $66,000(which was expensed to other expense in the 2002 consolidated statement ofoperations); (iii) the Company paid $50,000 in cash and issued a non-interestbearing unsecured promissory note which requires 35 consecutive monthlypayments of $5,000 each commencing April 1, 2003; and (iv) the remaining374,116 shares in the escrow account will be released to the Company.  If the Company is delinquent four times inany twelve-month period during the term of the unsecured promissory note inmaking its $5,000 monthly payments to HIS, and HIS issues respective validdefault notices, the Company will be subject to a $225,000 penalty.  As of September 30, 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.

 

Imputing interest at 11%, the present value of the $175,000 promissorynote 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 Company entered into a settlement agreement with Logix DevelopmentCorporation (“Logix”) in July of 2002 whereby we (i) issued Logix 200,000shares of our Common Stock (ii) required the Company to make various cashinstallment payments totaling $175,000 to be paid within 1 year and (iii)executed a contract with Logix for a consulting project in the amount of$50,000.  The Company has made allrequired payments to Logix under this settlement agreement.

 

In December 2003, the Company entered into anothersettlement agreement with Logix whereby it (i) issued 200,000 free tradingshares in exchange for the 200,000 restricted Common Shares from the originalsettlement agreement in July 2002 (ii) required the Company to make monthlypayments totaling $187,500 over a 25 month period and (iii) mutually releasedeach other of all past, present and future claims associated with thelawsuit.  As of September 30, 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  September 30,** | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                      | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income (loss)                            |       | $                                             | (58        | )                                            | $          | 367 |   | $ | 191 |   | $ | 118 |   |
|                                         |       |                                          |       |                                         |       |   |   |   |   |
| Change in cumulative translation adjustments |       | 13                                            |       | —                                       |       | (46 | ) | 10 |   |
|                                         |       |                                          |       |                                         |       |   |   |   |   |
| Comprehensive income (loss)                  |       | $                                             | (45        | )                                            | $          | 367 |   | $ | 145 |   | $ | 128 |   |

 

**Inaccordance with SFAS No. 130, “Reporting Comprehensive Income,” the Companyreports accumulated other comprehensive income (loss) in its ConsolidatedBalance Sheets.  Comprehensive income(loss) includes net income (loss), minimum pension liability and othercomprehensive income (loss), which includes current period foreign currencytranslation adjustments and amortization of unearned compensation.**

 

11

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

 

**Critical Accounting Policies and Estimates**

 

The discussion and analysis of our financial conditionand results of operations are based upon our condensed consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires us to make estimates and judgments that affect our reportedassets, liabilities, revenues and expenses. On an on-going basis, we evaluateour estimates, 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:

 

Software Development 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 $821,000 of softwaredevelopment costs during the nine month period ended September 30, 2004relating to its N-Tier, Internet-native corporate application suite of productswritten in java.  The modules to thissuite of applications became available for general release in the first quarterof 2005 at which time amortization of such costs commenced.  We believe that these new products willproduce new sales adequate to recover amounts capitalized.

 

Revenue Recognition 

 

The Company earns revenue from sales of hardware,software and professional services and from arrangements involving multipleelements of each of the above. Revenue for multiple element arrangements arerecorded by allocating revenue to the various elements based on theirrespective fair values as evidenced by vendor specific objective evidence. Thefair value in multi-element arrangements is determined based upon the pricecharged when sold separately. Revenue is not recognized until persuasiveevidence of an arrangement exists, delivery has occurred, the fee is fixed ordeterminable and collectibility is probable. Sales of network and computerequipment are recorded when title and risk of loss transfers. Software revenuesare recorded when application software programs are shipped to end users,resellers and distributors, 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.

 

Accounts Receivable

 

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 oftheir ability to make payments, additional allowances may be required whichwould result in an additional general and administrative expense in the periodsuch determination was made. While such credit losses have historically beenwithin our expectations and the provisions established, we cannot guaranteethat we will continue to experience the same credit loss rates that we have inthe past.

 

12

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Intangible and Long-Lived Assets

 

AtDecember 31, 2004 and September 30, 2005, goodwill and other long-livedassets represented 80% and 75%, respectively, of the Company’s total assets.

 

Goodwill must betested at least annually for impairment at a level of reporting referred to asthe reporting unit and more frequently if adverse events or changes incircumstances indicate that the asset may be impaired.   The Company did not record an impairmentcharge 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 

 

The Company reviews its contingentliabilities, which arise primarily from litigation and litigation defensecosts, in accordance with Statement of Financial Accounting StandardsNo. 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

 

Provision forincome taxes is based upon the Company’s estimate of taxable income or loss foreach respective accounting period.  Anasset or liability is recognized for the deferred tax consequences of temporarydifferences between the tax bases of assets and liabilities and their reportedamounts in the financial statements. These temporary differences will result in taxable or deductible amountsin future periods when the reported amounts of assets are recovered orliabilities are settled. The Company regularly reviews its deferred tax assetsto determine the amount that is more likely than not to be realized. When thisamount is less than the deferred tax asset recorded, the Company records avaluation allowance to reduce the asset to its estimated realizable value.  If the Company determined that it was notgoing to be able to fully realize its recorded deferred tax assets, it wouldmake an adjustment to the valuation allowance. This would reduce net income in the period that the Company made itsdetermination.  Similarly, if the Companyrealized that it was going to be able to fully realize a deferred tax asset inexcess of its net recorded value, net income would be increased in the periodthat the Company made its determination.

 

The Company alsoreviews its deferred tax liabilities on a regular basis to determine that theamount recorded is adequate to cover the expected reversal of temporary incometax liabilities.  In the event that theamount recorded was less than adequate, the deferred tax liability would beincreased to its estimated realizable value and net income would be decreasedaccordingly.  In the event that thedeferred tax liability was determined to be overstated, it would be reduced toits estimated realizable value and net income would increase accordingly.

 

The Company generally determines its effective taxrate by considering the statutory federal income tax rate, the statutory stateand local tax rates (net of the federal income tax benefit) and anynondeductible expenses.  This rate couldalso be affected by increases or decreases to deferred tax assets orliabilities as described above.

 

**Liquidity and Capital Resources**

 

At September 30, 2005, our cash balance was $429,000and our working capital deficiency increased from a working capital deficiencyof $7,536,000 at December 31, 2004 to a working capital deficiency of $7,691,000.  Excluding unearned revenue of $4,125,000,working capital deficiency at September 30, 2005 was $3,566,000.  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 $514,000 was primarily attributable toincreases in receivables of $410,000, inventories of $134,000, prepaids andother assets of $114,000 and cash of $234,000 and decreases in accounts payableof $440,000 and accrued liabilities of $361,000 offset by increases in currentportion of long term debt of $135,000 and deposits of $1,055,000.

 

13

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Net cash used in investing activities for the periodended September 30, 2005 totaled $65,000, which is comprised of capitalexpenditures.

 

Net cash used in financing activities for the periodended September 30, 2005 totaled $779,000, which represents repayments onlong-term debt.  On January 13, 2003, theCompany converted its credit facility to a term loan which requires monthlyprincipal and interest payments of $58,000 and matures on February 28, 2006.  In addition, the Company amended itssubordinated note to require monthly interest only payments of $52,000 throughMarch 31, 2006, at which time it will convert to a term loan to be amortizedover a four and one half year period which matures in three years.  The restructured debt, pursuant to theoriginal intercreditor agreement between Canyon and Coast, which was sold toWamco on May 15, 2003, contains various restrictions and covenants, including aminimum quick ratio of 0.20 to 1.00 and minimum debt service coverage ratio of0.50 to 1.00.  In the event that we werenot in compliance with the various restrictions and covenants and were unableto receive waivers for non-compliance, the term debt would be immediately dueand payable. The Company was in compliance with its covenants as of September30, 2005. There is no guaranty that the Company will meet its debt covenants inthe future.

 

Stockholders’ deficiency decreased from $2,213,000 atDecember 31, 2004 to $2,085,000 at September 30, 2005, mainly as a result ofnet income during the period of $118,000.

 

Although the Company has a net stockholders’deficiency of $2,085,000 and a working capital deficit of $7,691,000 at September30, 2005, the Company believes it will generate sufficient funds from operationsor obtain additional financing to meet its operating and capital requirementsfor at least the next 12 months.    TheCompany expects to generate positive cash flow from its operations during 2005from shipping out products and services from its current backlog as of September30, 2005 as well as new orders.  In theevent that the Company cannot generate positive cash flow from its continuingoperations during 2005 and 2006, the Company can substantially reduce itsresearch and development 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 areremoved from backlog.  Orders that areremoved from backlog for non-shipment are restored if they are reinstated bythe customer.  We include in backlogsigned government contracts which have not yet been fully funded that areexpected to commence delivery within the next twelve months.  As of September 30, 2005, we haveapproximately $9.7 million included in backlog relating to the Air Force, ofwhich $1.2 million is expected to be shipped during the next twelve months andthe balance of the contract shipped by December 31, 2008.  Our backlog as of September 30, 2004 and 2005was $2,400,000 and $15,900,000, respectively.

 

Our backlog is not necessarily indicative of futurerevenues.

 

**Contractual Obligations and Commercial Commitments**

 

The following table summarizes the Company’sobligations and commitments as of September 30, 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*                  |       | $                                         | 6,889      |   | $ | 1,138 |   | $ | 2,484 |   | $ | 2,943 |   | $ | 324 |   |
| Operating Leases                 |       | 2,896                                     |       | 552 |   | 897 |   | 889 |   | 558 |   |
|                             |       | $                                         | 9,785      |   | $ | 1,690 |   | $ | 3,381 |   | $ | 3,832 |   | $ | 882 |   |

 

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*                 Excludinginterest

 

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**Resultsof Operations**

 

Three Months Ended September30, 2004 Compared to Three Months Ended September 30, 2005

 
| ** **                                   | ** **   | **September 30,  2004** | ** ** | **Percentage of  Revenue** | ** **   | **September 30,  2005** | ** **   | **Percentage of  Revenue** | ** **   |
|----------------------------------------------|--------------|-------------------------|------------|----------------------------|--------------|-------------------------|--------------|----------------------------|--------------|
| *** ***                                 | *** *** | **(in thousands)**      | ** ** | ** **                 | *** *** | **(in thousands)**      | *** *** | *** ***               | *** *** |
| Revenue                                      |         | $                       | 4,883      |                       | 100.0        | %                       | $            | 5,629                      |         | 100.0 | % |
| Gross profit                                 |         | 3,476                   |       | 71.2                       | %            | 4,004                   |         | 71.1                       | %            |
| Selling, general and administrative expenses |         | 2,200                   |       | 45.1                       | %            | 2,272                   |         | 40.4                       | %            |
| Research and development costs               |         | 956                     |       | 19.6                       | %            | 1,032                   |         | 18.3                       | %            |
| Amortization of intangibles                  |         | —                  |       | —                     |         | 126                     |         | 2.2                        | %            |
| Other operating expense (income)             |         | 48                      |       | 1.0                        | %            | (23                     | )            | 0.4                        | %            |
| Interest expense, net                        |         | 303                     |       | 6.2                        | %            | 229                     |         | 4.1                        | %            |
| Other non-operating expense                  |         | 22                      |       | 0.5                        | %            | —                  |         | —                     |         |
| Income tax expense                           |         | 5                       |       | 0.1                        | %            | 1                       |         | —                     |         |
| Net income                                   |         | $                       | (58        | )                          | 1.2          | %                       | $            | 367                        |         | 6.5 | % |

 

Theincrease in revenue in 2005 was mainly attributable to an increase in thevolume of software sales, which resulted in an increase of approximately $746,000.  The general health of the hospitalityindustry continues to improve from the detrimental effects of “9/11” thatseverely affected the hospitality and travel industries.  During the three month period ended September30, 2005, the Company shipped certain orders from its growing backlog in theUnited States to new multi-property chain hotels resulting in increase inrevenue from the comparable period of 2004. Revenue for 2005 was $5,629,000 compared to $4,883,000 in 2004 or a 15.3%increase. The increase mainly related to an increase in United States revenue from2004 to 2005 relating to software sales of approximately $170,000, professionalservices of approximately $390,000 and support of approximately $360,000.  The increase in United States revenue wasoffset by a decrease in revenue from our operations in Asia of approximately $190,000resulting from a decrease level of sales to new customers from 2004 to 2005.  Our continuing hospitality business isexpected to generate sufficient cash from operations to adequately fund itsongoing operating activities.

 

Grossprofit for 2005 increased to $4,004,000 from $3,476,000 in 2004.  The increase in gross profit is mainly due toan increase in professional and support service sales in the United States. TheCompany effectively increased its employee utilization of professional andsupport services personnel resulting comparable costs in 2005 compared to 2004while increasing revenue during the period.

 

Selling,general and administrative expenses (“SG&A”) increased slightly from $2,200,000in 2004 to $2,272,000 in 2005.  The Companycontinues to manage these expenses through it management cost control programresulting in comparable costs in 2004 as compared to 2005.

 

Researchand development costs increased from $956,000 in 2004 to $1,032,000 in2005.  The company capitalized $217,000of software development costs in 2004. As of January 1, 2005, the Companyreleased its new N-Tier, Internet-native corporate application suite ofproducts written in java and ceased capitalizing costs relating to the modulesassociated with this suite of applications. After considering the amountcapitalized in 2004, gross research and development costs decreased from 2004to 2005 by approximately $141,000 due to a decrease in engineers and qualityassurance personnel in the United States which were replaced with lessexpensive resources in the Company’s Malaysia operations.

 

Amortizationof intangibles was $126,000 in 2005 as a result of the Company recordingapproximately $10 million of intangible assets in connection with theManagement Equity/Conversion Transaction on November 1, 2004, of whichapproximately $4,786,000 related to identifiable intangible assets whichcommenced amortization in November 2004 over their estimated useful lives ofseven to fifteen years.

 

Netinterest expense was $303,000 in 2004 compared to $229,000 in 2005.  The decrease is due to lower balances ofinterest bearing debt during 2005 as compared to 2004 mainly due to theconversion of approximately $3.3 million of indebtedness by the Investor Groupto the Company’s common stock on November 1, 2004.

 

15

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Nine Months Ended September30, 2004 Compared to Nine Months Ended September 30, 2005

 
| ** **                                   | ** **   | **September 30,  2004** | ** ** | **Percentage of  Revenue** | ** **   | **September 30,  2005** | ** **   | **Percentage of  Revenue** | ** **   |
|----------------------------------------------|--------------|-------------------------|------------|----------------------------|--------------|-------------------------|--------------|----------------------------|--------------|
| *** ***                                 | *** *** | **(in thousands)**      | ** ** | ** **                 | *** *** | **(in thousands)**      | *** *** | *** ***               | *** *** |
| Revenue                                      |         | $                       | 14,957     |                       | 100.0        | %                       | $            | 16,386                     |         | 100.0 | % |
| Gross profit                                 |         | 10,870                  |       | 72.7                       | %            | 11,288                  |         | 68.9                       | %            |
| Selling, general and administrative expenses |         | 6,900                   |       | 46.1                       | %            | 6,822                   |         | 41.6                       | %            |
| Research and development costs               |         | 2,756                   |       | 18.4                       | %            | 3,296                   |         | 20.1                       | %            |
| Amortization of intangibles                  |         | —                  |       | —                     |         | 364                     |         | 2.2                        | %            |
| Other operating expense                      |         | 67                      |       | 0.4                        | %            | 48                      |         | 0.3                        | %            |
| Interest expense, net                        |         | 881                     |       | 5.9                        | %            | 630                     |         | 3.8                        | %            |
| Other non-operating expense                  |         | 60                      |       | 0.4                        | %            | —                  |         | —                     |         |
| Income tax expense                           |         | 15                      |       | 0.1                        | %            | 10                      |         | 0.1                        | %            |
|                                         |         |                    |       |                       |         |                    |         |                       |         |
| Net income                                   |         | $                       | 191        |                       | 1.3          | %                       | $            | 118                        |         | 0.7 | % |

 

The increase in revenue in 2005 was mainlyattributable to an increase in the volume of software sales, which resulted inan increase of approximately $1,429,000. The general health of the hospitality industry continues to improve fromthe detrimental effects of “9/11” that severely affected the hospitality andtravel industries.  Revenue for 2005 was$16,386,000 compared to $14,957,000 in 2004 or a 9.6% increase. The increasemainly related to an increase from 2004 to 2005 in software, professionalservices and support revenues in Asia of approximately $660,000 and $110,000,respectively, which was mainly related to the implementation of the Company’ssoftware to a large hotel chain in Thailand in the second quarter of 2005.  The increase was also related to an increasein United States revenue from 2004 to 2005 relating to sales of professionalservices of approximately $550,000 and support of approximately $175,000 to newmulti-property chain hotels during 2005. Our continuing hospitality business is expected to generate sufficientcash from operations to adequately fund its ongoing operating activities.

 

Gross profit for 2005 increased to $11,288,000 from$10,870,000 in 2004.  The increase ingross profit is mainly due to an increase in software gross profit in Asia ofapproximately $210,000 and professional services gross profit in the UnitedStates of approximately $310,000. Although revenue increased from 2004, theCompany’s professional and support services costs increased approximately $617,000from 2004 to 2005.  The increase inprofessional and support services costs was mainly attributable to an increasein global headcount combined with salary increases from 2004 to 2005 resultingin an increase in costs of approximately $455,000 and $190,000 in the UnitedStates and Asia, respectively. Additionally, the Company amortized approximately $306,000 of developedtechnology intangible assets to software cost of sales during 2005.  There was no such amortization charges during2004.

 

Selling, general and administrative expenses (“SG&A”)decrease from $6,900,000 in 2004 to $6,822,000 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 $2,756,000in 2004 to $3,296,000 in 2005.  Thecompany capitalized $821,000 of software development costs in 2004. As ofJanuary 1, 2005, the Company released its new N-Tier, Internet-native corporateapplication suite of products written in java and ceased capitalizing costsrelating to the modules associated with this suite of applications. Afterconsidering the amount capitalized in 2004, gross research and developmentcosts decreased from 2004 to 2005 by approximately $281,000 due to a decreasein engineers and quality assurance personnel in the United States which werereplaced with less expensive resources in the Company’s Malaysia operations.

 

Amortization of intangibles was $364,000 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 $881,000 in 2004 compared to$630,000 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.

 

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

 

***Market Risk Disclosures***

 

The following discussion about our market risk disclosures containsforward-looking statements. Forward-looking statements are subject to risks and uncertainties.  Actual results could differ materially fromthose discussed in the forward-looking statements.  We are exposed to market risk related tochanges in interest rates and foreign currency exchange rates.  We do not have derivative financialinstruments for hedging, speculative, or trading purposes.

 

***Interest Rate Sensitivity***

 

Of our $6.9 million principal amount of indebtedness at September 30,2005, none bears interest at a variable rate. However, $5.7 million bears interest at a fixed rate of 11%, $0.5million bears interest at a fixed rate of 12.5%, $0.2 million bears interest at9.25% and $0.5 million bears fixed interest rates ranging from zero to 6%.Since these debt instruments bear interest at fixed rates, we have exposure todecreases in interest rates because we still are required to pay the fixed rateeven if current interest rates are lower.

 

***Foreign Currency Risk***

 

We believe that our exposure to currency exchange fluctuation risk isreduced because our transactions with international vendors and customers aregenerally transacted in US dollars. The currency exchange impact onintercompany transactions was immaterial for the quarter ended September 30,2005.

 

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

 

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

 

We evaluated the design and operation of our disclosure controls andprocedures to determine whether they are effective in ensuring that we disclosethe required information in a timely manner and in accordance with theSecurities Exchange Act of 1934, as amended, or the Exchange Act, and the rulesand forms of the Securities and Exchange Commission. Management, including ourprincipal executive officer and principal financial officer, supervised andparticipated in the evaluation. The evaluation was completed within 90 days ofthe filing of this report. The principal executive officer and principalfinancial officer concluded, based on their review, that our disclosurecontrols and procedures, as defined by Exchange Act Rules 13a-14(c) and15d-14(c), are effective and ensure that we disclose the required informationin reports that we file under the Exchange Act and that the filings arerecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms. No significant changeswere made to our internal controls or other factors that could significantly affectthese controls subsequent to the date of their evaluation.

 

A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met. Because of the inherent limitationsin all control systems no evaluation of controls can provide absolute assurancethat all control issues if any, within a company have been detected.

 

On November 17, 2004, the Company’s independent auditors orallynotified the Company’s Audit Committee that they had identified significantdeficiencies regarding the Company’s internal controls. The deficiencies notedwere mainly (a) the lack of segregation of duties and (b) the lack of adequateaccount analysis and reconciliations, and (c) insufficient supervision of theCompany’s accounting personnel.  The Company believes such deficiencieswere primarily attributable to changes in personnel within the accountingdepartment combined 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 facilitatesegregation of duties and supervision. Additionally, the Company has implemented procedures for timely andcomplete account analysis and reconciliations. We have implemented new accounting software during the first quarter of2005, which we believe mitigates certain weaknesses in our systems to ensureour financial statements are fairly presented in accordance with United StatesGenerally Accepted Accounting Principles.

 

Based on the investigation by the Company’s Audit Committee andadditional procedures performed by management, the principal executive officer and principal financial officer haveconcluded that our disclosure controls and procedures are effective and willtimely alert the Company’s management to material information relating to theCompany that is required

 

17

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to be included in our periodic Securities and Exchange Committeefilings, and that the internal controls are sufficient to provide reasonableassurance that the consolidated financial statements are fairly presented inconformity with generally accepted accounting principles.

 

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

 

There were no significant changes in our internal controls or to ourknowledge, in other factors that could significantly affect our disclosure controlsand procedures subsequent to the Evaluation Date.

 

**PART II - OTHER INFORMATION**

 

**Item 1.****           LegalProceedings**

 

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 Security Holders**

 

(a)                                  None

 

(b)                                 None

 

(c)                                  None

 

(d)                                 None

 

**Item 5. Other Information**

 

(a)                                  None.

 

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**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                                                                                               |
|    |                                                                                                                    |
|    | Filed September 29,  2005                                                                                               |
|    |                                                                                                                    |
|    | Filed October 28, 2005                                                                                                  |

 

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**SIGNATURES**

 

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

 
|                    |   |   MAI SYSTEMS CORPORATION                  |
|-------------------------|--------|------------------------------------------------------|
|                    |   |   (Registrant)                             |
|                    |   |                                                 |
|                    |   |                                                 |
| Date: November 18, 2005 | By:    |   /s/James W. Dolan                        |
|                    |   |   James W. Dolan                           |
|                    |   |   Chief Financial and Operating Officer    |
|                    |   |   (Chief Financial and Accounting Officer) |

 

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