**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 period ended June  30, 2004 or**                                                                                                                             |
|       |   |                                                                                                                                                                   |
| **o**      |   | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.**                                                                        |
|       |   |                                                                                                                                                                   |
|       |   | **For the transition period  from            to           .** |

 

**Commission file number: 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  incorporation or organization)** |   | **(IRS Employer Identification No.)** |

 

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

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

 

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

 

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

**Yes **o   No   ý

 

The aggregate market value ofthe common stock held by non-affiliates of the registrant, based upon the lastsale price of the Common Stock reported on the National Association ofSecurities Dealers Automated Quotation National Market System on August 5, 2004was $2,494,877.84. 

 

The number of shares of commonstock issued, outstanding and subscribed as of August 5, 2004 was 14,675,752. 

 

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**MAISYSTEMS CORPORATION**

** **

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

** **

**(Unaudited)**

** **
|                                                                                                                                                                                                          |   | **(in  thousands, except share data)** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                                                                                                          |   | **As of  December  31, 2003**          |   | **As of  June30,  2004** |   |
| **ASSETS**                                                                                                                                                                                                    |   |                                   |   |   |   |
| Current assets:                                                                                                                                                                                               |   |                                   |   |   |   |
| Cash                                                                                                                                                                                                          |   | $                                      | 664    |   | $ | 129 |   |
| Receivables, less allowance for doubtful  accounts of  $335 in 2003 and $434 in  2004                                                                                                                    |   | 1,313                                  |   | 2,009 |   |
| Inventories                                                                                                                                                                                                   |   | 47                                     |   | 50 |   |
| Prepaids and other assets                                                                                                                                                                                     |   | 814                                    |   | 800 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total current assets                                                                                                                                                                                          |   | 2,838                                  |   | 2,988 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Furniture, fixtures and equipment, net                                                                                                                                                                        |   | 758                                    |   | 623 |   |
| Intangibles, net                                                                                                                                                                                              |   | 2,876                                  |   | 3,480 |   |
| Other assets                                                                                                                                                                                                  |   | 58                                     |   | 140 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total assets                                                                                                                                                                                                  |   | $                                      | 6,530  |   | $ | 7,231 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                                                             |   |                                   |   |   |   |
| Current liabilities:                                                                                                                                                                                          |   |                                   |   |   |   |
| Current portion of long-term debt                                                                                                                                                                             |   | $                                      | 3,646  |   | $ | 914 |   |
| Accounts payable                                                                                                                                                                                              |   | 904                                    |   | 1,157 |   |
| Customer deposits                                                                                                                                                                                             |   | 2,334                                  |   | 1,463 |   |
| Accrued liabilities                                                                                                                                                                                           |   | 3,059                                  |   | 2,422 |   |
| Income taxes payable                                                                                                                                                                                          |   | 85                                     |   | 99 |   |
| Unearned revenue                                                                                                                                                                                              |   | 3,209                                  |   | 4,787 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total current liabilities                                                                                                                                                                                     |   | 13,237                                 |   | 10,842 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Long-term debt                                                                                                                                                                                                |   | 7,135                                  |   | 10,286 |   |
| Other liabilities                                                                                                                                                                                             |   | 744                                    |   | 480 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total liabilities                                                                                                                                                                                             |   | 21,116                                 |   | 21,608 |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Commitments and contingencies                                                                                                                                                                                 |   |                                   |   |   |   |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Stockholders’ deficiency:                                                                                                                                                                                |   |                                   |   |   |   |
| Preferred Stock, par value $0.01 per  share;  1,000,000 shares authorized,  none issued and outstanding                                                                                                  |   | —                                 |   | — |   |
| Common Stock, par value $0.01 per share;  authorized  24,000,000 shares;  14,875,752 and 14,675,752 shares issued,outstanding and subscribed at  December 31, 2003 and June 30, 2004, respectively. |   | 152                                    |   | 152 |   |
| Additional paid-in capital                                                                                                                                                                                    |   | 218,112                                |   | 218,112 |   |
| Accumulated other comprehensive loss                                                                                                                                                                          |   |                                   |   |   |   |
| Minimum pension liability                                                                                                                                                                                     |   | (1,005                                 | )      | (1,005 | ) |
| Foreign currency translation                                                                                                                                                                                  |   | (2                                     | )      | (60 | ) |
| Unearned Compensation                                                                                                                                                                                         |   | (53                                    | )      | (34 | ) |
| Accumulated deficit                                                                                                                                                                                           |   | (231,790                               | )      | (231,542 | ) |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total stockholders’ deficiency                                                                                                                                                                           |   | (14,586                                | )      | (14,377 | ) |
|                                                                                                                                                                                                          |   |                                   |   |   |   |
| Total liabilities and stockholders’  deficiency                                                                                                                                                          |   | $                                      | 6,530  |   | $ | 7,231 |   |

** **

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

 

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**MAISYSTEMS CORPORATION**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
|                                                                         |   | **(Unaudited)**                            |   | **(Unaudited)**                            |   |
|------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|                                                                         |   | **For the  Three Months Ended June 30,**   |   | **For the  Six Months Ended June 30,**     |   |
|                                                                         |   | **2003**                                   |   | **2004**                                   |   | **2003** |   | **2004** |   |
|                                                                         |   | **(in  thousands, except per share data)** |   | **(in  thousands, except per share data)** |   |
| Revenue:                                                                     |   |                                       |   |                                       |   |   |   |   |   |
| Software                                                                     |   | $                                          | 1,127  |                                       | $      | 814 |   | $ | 2,257 |   | $ | 2,103 |   |
| Network and computer equipment                                               |   | 86                                         |   | 136                                        |   | 235 |   | 211 |   |
| Services                                                                     |   | 3,539                                      |   | 3,951                                      |   | 7,446 |   | 7,760 |   |
| Total revenue                                                                |   | 4,752                                      |   | 4,901                                      |   | 9,938 |   | 10,074 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Direct costs:                                                                |   |                                       |   |                                       |   |   |   |   |   |
| Software                                                                     |   | 52                                         |   | 8                                          |   | 258 |   | 329 |   |
| Network and computer equipment                                               |   | 74                                         |   | 109                                        |   | 165 |   | 169 |   |
| Services                                                                     |   | 1,100                                      |   | 1,113                                      |   | 2,274 |   | 2,182 |   |
| Total direct costs                                                           |   | 1, 226                                     |   | 1,230                                      |   | 2,697 |   | 2,680 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Gross profit                                                                 |   | 3,526                                      |   | 3,671                                      |   | 7,241 |   | 7,394 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Selling, general and administrative  expenses                                |   | 2,438                                      |   | 2,351                                      |   | 4,969 |   | 4,700 |   |
| Research and development costs                                               |   | 658                                        |   | 908                                        |   | 1,340 |   | 1,800 |   |
| Other operating (income) loss                                                |   | 3                                          |   | 15                                         |   | (46 | ) | 18 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Operating income                                                             |   | 427                                        |   | 397                                        |   | 978 |   | 876 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Interest income                                                              |   | —                                     |   | —                                     |   | 1 |   | — |   |
| Interest expense                                                             |   | (292                                       | )      | (288                                       | )      | (642 | ) | (579 | ) |
| Other non-operating expense                                                  |   | (212                                       | )      | (23                                        | )      | (212 | ) | (39 | ) |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Income (loss) before income taxes                                            |   | (77                                        | )      | 86                                         |   | 125 |   | 258 |   |
| Income tax benefit (expense)                                                 |   | (5                                         | )      | (4                                         | )      | 54 |   | (10 | ) |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Net income (loss)                                                            |   | $                                          | (82    | )                                          | $      | 82 |   | $ | 179 |   | $ | 248 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Income (loss) per share:                                                     |   |                                       |   |                                       |   |   |   |   |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Net income per share:                                                        |   |                                       |   |                                       |   |   |   |   |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Basic income (loss) per share                                                |   | $                                          | (0.01  | )                                          | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Diluted income (loss) per share                                              |   | $                                          | (0.01  | )                                          | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Weighted average common shares used in  determining income (loss) per share: |   |                                       |   |                                       |   |   |   |   |   |
|                                                                         |   |                                       |   |                                       |   |   |   |   |   |
| Basic                                                                        |   | 14,426                                     |   | 14,676                                     |   | 14,426 |   | 14,676 |   |
| Diluted                                                                      |   | 14,426                                     |   | 14,676                                     |   | 14,726 |   | 14,676 |   |

 

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

 

2

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**MAISystems Corporation**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**(Unaudited)**

** **
|                                       |   | **For the  Six Months Ended  June 30,** |   |
|--------------------------------------------|--------|-----------------------------------------|--------|
|                                       |   | **2003**                                |   | **2004** |   |
|                                       |   | **(in thousands)**                      |   |
| Net cash provided by operating activities: |   | $                                       | 399    |   | $ | 605 |   |
|                                       |   |                                    |   |   |   |
| Cash flows used in investing activities:   |   |                                    |   |   |   |
| Proceeds from note receivable              |   | 250                                     |   | — |   |
| Capital Expenditures                       |   | (195                                    | )      | (110 | ) |
| Capitalized software development costs     |   | (419                                    | )      | (604 | ) |
| Net cash used in investing activities      |   | (364                                    | )      | (714 | ) |
|                                       |   |                                    |   |   |   |
| Cash flows used in financing activities:   |   |                                    |   |   |   |
| Repayments on long-term debt               |   | (148                                    | )      | (425 | ) |
|                                       |   |                                    |   |   |   |
| Net cash used in operations                |   | (113                                    | )      | (534 | ) |
|                                       |   |                                    |   |   |   |
| Effect of exchange rate changes on cash    |   | (3                                      | )      | (1 | ) |
|                                       |   |                                    |   |   |   |
| Net change in cash                         |   | (116                                    | )      | (535 | ) |
|                                       |   |                                    |   |   |   |
| Cash at beginning of period                |   | 545                                     |   | 664 |   |
|                                       |   |                                    |   |   |   |
| Cash at end of period                      |   | $                                       | 429    |   | $ | 129 |   |

 

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

 

3

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**MAI Systems Corporation**

** **

**Notesto Condensed Consolidated Financial Statements**

** **

**ThreeMonths ended June 30, 2004**

** **

**(Unaudited)**

**1.**             Basis ofPresentation

** **

Companies for which this report is filed are MAISystems Corporation and its wholly owned subsidiaries (the “Company”).  The information contained herein isunaudited, but gives effect to all adjustments (which are normal recurringaccruals) necessary, in the opinion of Company management, to present fairlythe condensed consolidated financial statements for the interim period.  All significant intercompany transactionsand accounts have been eliminated in consolidation.

 

Although the Company believes that the disclosures inthese financial statements are adequate to make the information presented notmisleading, certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to the rules and regulations of the Securities and ExchangeCommission (the “SEC”), and these financial statements should be read inconjunction with the financial statements included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003, which is on file withthe SEC.

 

**2.**             Liquidity

** **

Although the Company has a netstockholders’ deficiency of $14,377,000 and a working capital deficit of$7,854,000 at June 30, 2004, the Company expects to generate positive cash flowfrom its operations during 2004 from shipping out products and services fromits current backlog as of June 30, 2004 as well as new orders and through itsproposed private placement of $1 million from an Investor Group to meet itsoperating and capital requirements (see Note 5). In the event that the Companycannot generate positive cash flow from its operations during 2004, the Companycan substantially reduce its research and development efforts to mitigate cashoutflow to help sustain its operations. There can be no assurance that the Company will be able to sustainprofitability, generate positive cash flow from operations or restructure itsdebt as necessary.  These financialstatements have been prepared assuming the Company will continue to operate asa going concern. If the Company is unsuccessful in the aforementioned efforts,the Company could be forced to liquidate certain of its assets, reorganize itscapital structure and, if necessary, seek other remedies available to theCompany, including protection under the bankruptcy laws.The restructured debt,pursuant to the original inter-creditor agreement between Canyon Capital andCoast, which was sold to Wamco on May 15, 2003, contains various restrictionsand covenants.  In the event that theCompany were not in compliance with the various restrictions and covenants andwere unable to receive waivers for non-compliance, the term debt would beimmediately due and payable.  TheCompany is not in compliance with the amended debt covenants as of and for theperiod ending June 30, 2004. There is no guaranty that the Company will meetits debt covenants in the future.  Inthe event that the Company were not in compliance with the various restrictionsand covenants and were unable to receive waivers for non-compliance, the termloan would be immediately due and payable.

 

**3.**             Inventory

 

Inventories are summarized as follows:

 

|              |   | **(dollars  in thousands)** |   |
|-------------------|--------|-----------------------------|--------|
|              |   | **December  31,  2003**     |   | **June 30,  2004** |   |
| Finished goods    |   | $                           | 39     |   | $ | 43 |   |
| Replacement parts |   | 8                           |   | 7 |   |
|              |   |                        |   |   |   |
|              |   | $                           | 47     |   | $ | 50 |   |

** **

**4.**             BusinessAcquisitions

** **

**HospitalityServices & Solutions**

** **

On June 23, 2002, the Company acquired substantiallyall of the assets and assumed certain liabilities of Hospitality

 

4

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Services & Solutions (“HSS”) including a 35%ownership in AMDB – HIS (“AMDB”) pursuant to a stock purchase agreement for100,000 shares of common stock valued at $32,000 (the quoted market price ofthe common stock at the time the terms were agreed), and $75,000 in cash.  Additionally, the shareholders of HSSreceived a 20% minority interest in the Company’s combined operations in Asia.HSS was acquired for the Company to expand its operations in the Asian marketplace,strengthen its management team in the territory and create new opportunitiesfor its new enterprise capable suite of products.  The net assets acquired from HSS are used in the business ofsoftware design, engineering and service relating to hotel informationsystems.  The net assets also includesubsidiaries of HSS in Malaysia, Singapore and Thailand.  The Company recorded $297,000 of goodwill(deductible for tax purposes) in connection with the acquisition of HSS.  Pro forma results of operations as if thisacquisition had occurred at the beginning of 2001 and 2002 are not shownbecause its impact would have been immaterial.

 

Included in the acquired assets of HSS was a 35%interest in AMDB, an online reservation service, originally purchased by HSSfor $66,000.  On February 20, 2003, theCompany entered into an agreement whereby it acquired the remaining 65% for$79,000 payable over 6 month installments. The net liabilities of $15,000 acquired are used to support an onlinereservation service related to hotel information systems.  The Company recorded $159,000 of goodwill inconnection with the acquisition of AMDB. Pro forma results of operations as if this acquisition had occurred atthe beginning of 2002 and 2003 are not shown because its impact would have beenimmaterial.

 

**5.**             Long-Term Debt

 

**Wamco32 Ltd.**

** **

On January 13, 2003, theCompany re-negotiated the terms of its credit facility with Coast BusinessCredit (“Coast”) whereby the outstanding balance of $1,828,000 was converted toa term loan which accrues interest at 9.25% per annum and requires monthlypayments of $58,000 over a 36 months period commencing March 1, 2003.  On February 7, 2003, the Federal DepositInsurance Corporation (“FDIC”) put Coast and its parent company, Southern PacificBank, into receivership and held all of Coast’s assets for sale to thirdparties.  On May 15, 2003, the loan wassold to Wamco 32, Ltd. (“Wamco”).  Thissale of the loan by the FDIC did not change any of the terms of the Company’sloan agreement.  The Company is requiredto pay Wamco additional principal payments on a quarterly basis based upon anEBITDA-based formula commencing March 31, 2003.  For the period ended June 30, 2004, there are no additionalprincipal payments required under the EBITDA-based formula.

 

On April 9, 2004, theCompany successfully re-negotiated the terms of its loan whereby the maturitydate was extended to February 28, 2006. In addition, various restrictions and covenants, pursuant to theinter-creditor agreement between Canyon and Wamco, were amended to modify thefinancial covenants to a minimum quick ratio of  0.20 to 1.00 and a minimum debt coverage ratio of 0.50 to 1.00effective for the three month period ended March 31, 2004 and for each andevery fiscal quarter ending thereafter. The Company was not in compliance with the amended debt covenants as ofand for the period ending June 30, 2004, but obtained a waiver fornon-compliance.  There is no guarantythat the Company will meet its debt covenants in the future.  In the event that the Company were not incompliance with the various restrictions and covenants and were unable toreceive waivers for non-compliance, the term loan would be immediately due andpayable.  As of December 31, 2003 andJune 30, 2004, the balance of the term loan was $1,366,000 and $1,027,000respectively.

 

**CanyonCapital Management LP**

** **

On January 13, 2003, the Company modified its 11%subordinated notes payable agreement with Canyon Capital Management LP(“Canyon”), whereby the Company is required to make monthly interest paymentsof $52,000 until the Wamco term loan is paid off in full at which time the notepayable will be converted into a three-year amortizing loan which will accrueinterest at 11% per annum and requires equal monthly payments of principal andinterest such that the subordinated debt will be paid in full at the end of theamended term.  Upon the repayment of theWamco debt in full, the Company will also be required to pay Canyon additionalprincipal payments on a quarterly basis based upon an EBITDA-basedformula.  Additionally, the Companyissued to Canyon 200,000 shares of its common stock valued at $20,000 (thequoted market price of the common stock at the time the terms were agreed) andagreed to issue one million warrants at an exercise price of $0.40 per sharevalued at $42,000 (using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions: risk-free interest rate of 6.5%,volatility of 80% and an expected life of 5 years).  The $62,000 is being amortized to interest expense over the termof the modified note.  The principalbalance outstanding on the subordinate notes payable to Canyon wasapproximately $5,662,000 at December 31, 2003 and June 30, 2004.

 

5

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**CSAPrivate Limited**

** **

In connection with a settlement agreement in February2001 with CSA Private Limited (“CSA”), the Company issued $2.8 million ofsubordinated debt to CSA.  The $2.8million of debt was secured by all of the Company’s assets, which wassubordinate to Wamco and Canyon, accrued interest at 10% per annum and requiredpayments of $37,500 from March 1, 2002 through September 1, 2002 and monthlypayments of $107,500 commencing on October 1, 2002 until October 2003 when allremaining unpaid principal and accrued interest was to be paid in full.

 

The agreement with CSA was amended whereby the Companywas required to make payments under the subordinated note unless and until itpaid $1 million by December 31, 2002. Upon payment of the $1 million, contractual payments under thesubordinated note would have ceased until a final payment in the amount of$400,000 is paid by February 28, 2003. If the Company did not make all of the modified payments to CSA, thesubordinated note would revert back to its original terms.  The Company did not make the modifiedpayment and 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 new notes.  The first note for $500,000 accrues interestat 10% per annum and provides for monthly payments of $10,000 until the Wamcoand Canyon debt is paid in full. Thereafter, the note provides for monthly payments in an amount equal tothe greater of i) $10,000 or ii) the amount required to fully amortize allremaining principal and interest in 24 equal monthly payments.  The second note for $3,133,000 (“Othernote”) also accrues interest at 10% per annum and provides for monthly paymentsof $7,500, or such other interest amount, not to exceed $10,000 per month, thatWamco and Canyon will allow.  Under theterms of the amended subordination agreement between Wamco, Canyon and CSA, allpayments under the new notes are subordinated to the payment in full of theWamco and Canyon loan agreements. The company has not made any payments on thetwo new notes as of June 30, 2004.  TheCompany is currently in default of the first note.  The interest rate has been increased to 12.5% in line with theterms of that note until the Company becomes current on its contractualpayments.

 

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.

 

Subject to shareholder approval, the Investor Grouphas agreed to convert the Company indebtedness acquired from CSA plus anyaccrued interest through the date of shareholder approval for approximately32,000,000 shares of the Company’s common stock based upon a conversion price of$0.10 per share, and will invest $1,000,000 of new cash proceeds into theCompany in a private placement at $0.10 per share and receive 10,000,000 sharesof the Company’s common stock.  ThisInvestor Group transaction is subject to certain terms and conditions,including the fact that it will initially be ‘restricted’ stock, not availablefor sale.  The Company has also receiveda fairness opinion from Marshall Stevens which concluded that the transactionwas fair to the shareholders.  TheCompany’s annual shareholders meeting is expected to occur in September 2004.The Investor Group has consented to defer any payments on the other note untilthe annual shareholder meeting at which time, if approved all principals andaccrued interest will be converted to common stock.

 

**TaxClaims**

** **

On September 30, 2003, the Company entered into asettlement agreement with the United States Internal Revenue Service (the“Service”) on a tax claim which resulted from the Company’s 1993 Chapter 11proceedings whereby it agreed to pay $489,000 in equal monthly installments of$7,438 over a 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 whichwas included in income tax benefit in the fourth quarter of 2003.  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 December31, 2003 and June 30, 2004, the debt balance was $428,000 and $396,000,respectively.

 

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.

 

**6.**             Restricted StockPlan

** **

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 “Restricted Stock” within themeaning of Rule 144 of the Securities Act of 1933, as amended.  The

 

6

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Compensation Committee of the Board of Directors shallhave the discretion to determine what terms and conditions 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 ofthe shares of $153,000 was treated as unearned compensation and is beingamortized to expense in proportion to the vesting schedule.  The unamortized balance as of June 30, 2004is $34,000 and is included in accumulated other comprehensive loss in theaccompanying consolidated balance sheet.

 

**7.**             Preferred Stock

** **

On May20, 1997, the Company authorized the issuance of up to 1,000,000 shares of$0.01 par value preferred stock.  TheBoard of Directors has the authority to issue the preferred stock, in one ormore series, and to fix the rights, preferences, privileges and restrictionsthereof without any further vote by the holders of Common Stock.

 

**8.**             Intangible Assets

** **

Intangibleassets consist primarily of goodwill and capitalized software.  Intangible assets other than goodwill areamortized on a straight-line basis over their estimated useful lives.  Prior to 2002, goodwill, representing theexcess of the purchase price over the estimated fair value of the net assets ofthe acquired business, was amortized over the period of expected benefit offive to seven years.  However, effectiveJanuary 1, 2002, the Company adopted Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets, (“SFAS No. 142”) whichrequires that the Company cease amortization of all goodwill and intangibleassets having indefinite useful economic lives.  The Company determined that there was no impairment uponadoption. Such assets are not to be amortized until their lives are determinedto be finite. However, a recognized intangible asset with an indefinite usefullife should be tested for impairment annually or on an interim basis if eventsor circumstances indicate that the fair value of the asset has decreased belowits carrying value.  At June 30, 2004,the Company evaluated its goodwill and determined that fair value had notdecreased below carrying value and no adjustment to impair goodwill wasnecessary in accordance with SFAS No. 142.

 

Goodwill and capitalized software as of December 31,2003 and June 30, 2004 are as follows:

 

|                      |   | **(dollars  in thousands)** |   |
|---------------------------|--------|-----------------------------|--------|
|                      |   | **December  31,  2003**     |   | **June 30,  2004** |   |
|                      |   |                        |   |   |   |   |   |
| Goodwill                  |   | $                           | 1,121  |   | $ | 1,121 |   |
| Accumulated amortization  |   | —                      |   | — |   |
| Goodwill, net             |   | 1,121                       |   | 1,121 |   |
|                      |   |                        |   |   |   |
| Capitalized software      |   | 1,755                       |   | 2,359 |   |
| Accumulated amortization  |   | —                      |   | — |   |
| Capitalized software, net |   | 1,755                       |   | 2,359 |   |
|                      |   |                        |   |   |   |
| Total                     |   | $                           | 2,876  |   | $ | 3,480 |   |

 

Net goodwill is comprised of $665,000 on the purchaseof Hotel Information Systems Inc. (HIS) in 1996,  $297,000 on the purchase of HSS in 2002 and $159,000 on thepurchase of AMDB in 2003 (see Note 4).

 

The Company’s weighted average amortization period forcapitalized software is expected to be three years.  The Company expects that certain of our new products will beavailable for general release during the third quarter of 2004 at which timeamortization of such costs shall commence. The following table shows the estimated amortization expense for theseassets for each of the five succeeding years:

 

7

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| **Year Ending  December 31,** |   |
|-------------------------------|--------|
| ***(in thousands)***          |   |
| 2004                          |   | $ | 393 |   |
| 2005                          |   | 786 |   |
| 2006                          |   | 786 |   |
| 2007                          |   | 394 |   |
| 2008                          |   | –– |   |
|                          |   | $ | 2,359 |   |

 

**9.**             Income (Loss) PerShare

** **

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 per share under the provisions of SFAS 128:

 
|                                                                                                                          |   | **For the  Three Months Ended June 30,** |   | **For the  Six Months Ended June 30,**   |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
|                                                                                                                          |   | **2003**                                 |   | **2004**                                 |   | **2003** |   | **2004** |   |
|                                                                                                                          |   | **(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)                                           |   | $                                        | (82    | )                                        | $      | 82 |   | $ | 179 |   | $ | 248 |   |
|                                                                                                                          |   |                                     |   |                                     |   |   |   |   |   |
| Denominator:                                                                                                                  |   |                                     |   |                                     |   |   |   |   |   |
| Denominator for basic income (loss) per  share – weighted average number of Common shares outstanding during the  period |   | 14,426                                   |   | 14,676                                   |   | 14,426 |   | 14,676 |   |
|                                                                                                                          |   |                                     |   |                                     |   |   |   |   |   |
| Incremental common shares attributable to  exercise of outstanding shares                                                     |   | —                                   |   | —                                   |   | 300 |   | — |   |
|                                                                                                                          |   |                                     |   |                                     |   |   |   |   |   |
| Denominator for diluted income (loss) per  per share                                                                          |   | 14, 426                                  |   | 14,676                                   |   | 14,726 |   | 14,676 |   |
|                                                                                                                          |   |                                     |   |                                     |   |   |   |   |   |
| Basic earnings (loss) per share                                                                                               |   | $                                        | (0.01  | )                                        | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
|                                                                                                                          |   |                                     |   |                                     |   |   |   |   |   |
| Diluted earnings (loss) per share                                                                                             |   | $                                        | (0.01  | )                                        | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |

 

The number of anti-dilutive options and warrants thatwere excluded from the computation of incremental common shares were 3,508,605and 3,104,000 for the six month period ended June 30, 2003 and 2004,respectively.

 

**10.****          Stock Option Plans**

 

The Company accounts for stock-based compensation in accordance withAccounting Principles Board, APB, No. 25, “Accounting for Stock Issued toEmployees.” The Company has adopted the disclosure-only provisions of FAS No.123 “Accounting for Stock-Based Compensation.” Under APB No. 25, compensationexpense relating to employee

 

8

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stock options is determined based on the excess of the market price ofthe Company’s stock over the exercise price on the date of grant, the intrinsicvalue method, versus the fair value method as provided under FAS No. 123.

 

In December 2002, the FASB issued FAS No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure”, whichamended FAS No. 123, “Accounting for Stock-Based Compensation.” The newstandard provides alternative methods of transition for a voluntary change tothe fair market value based method for accounting for stock-based employeecompensation. Additionally, the statement amends the disclosure requirements ofFAS No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results. Thisstatement is effective for financial statements for the year ended December 31,2002.  In compliance with FAS No. 148,the Company has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation plan as defined by APB No.25.

 

At June 30, 2004, the Company had two stock-basedemployee compensation plans.  TheCompany accounts for that plan under the recognition and measurement principlesof APB No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. Accordingly, no stock-based employee compensation cost isreflected in net income (loss), as all options granted under the plan had anexercise price equal to the market value of the underlying common stock on thedate of grant.  Had compensation costfor the Company’s stock option plan been determined based on the fair value atthe grant date for awards for the three-month periods ended June 30, 2003 and2004, 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  June 30,** |   | **For the  six-months ended  June 30,**   |   |
|--------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                             |   | **2003**                                  |   | **2004**                                  |   | **2003** |   | **2004** |   |
|                                                                                             |   | **(in thousands, except per share data)** |   | **(in thousands, except per share data)** |   |
| Net income (loss):                                                                               |   |                                      |   |                                      |   |   |   |   |   |
| As reported                                                                                      |   | $                                         | (82    | )                                         | $      | 82 |   | $ | 179 |   | $ | 248 |   |
| Add: Stock-based employee compensation  expense recorded                                         |   | 10                                        |   | 10                                        |   | 20 |   | 20 |   |
| Less:   Stock based employee compensation expense determined under fair value  calculations |   | (33                                       | )      | (10                                       | )      | (66 | ) | (20 | ) |
| Pro forma                                                                                        |   | $                                         | (105   | )                                         | $      | 82 |   | $ | 133 |   | $ | 248 |   |
|                                                                                             |   |                                      |   |                                      |   |   |   |   |   |
| Basic income (loss) per share:                                                                   |   |                                      |   |                                      |   |   |   |   |   |
| As reported                                                                                      |   | $                                         | (0.01  | )                                         | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
| Add: Stock-based employee compensation  expense recorded                                         |   | —                                    |   | —                                    |   | — |   | — |   |
| Less:   Stock based employee compensation expense determined under fair value  calculations |   | —                                    |   | —                                    |   | — |   | — |   |
| Pro forma                                                                                        |   | $                                         | (0.01  | )                                         | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
|                                                                                             |   |                                      |   |                                      |   |   |   |   |   |
| Diluted income (loss) per share:                                                                 |   |                                      |   |                                      |   |   |   |   |   |
| As reported                                                                                      |   | $                                         | (0.01  | )                                         | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |
| Add: Stock-based employee compensation  expense recorded                                         |   | —                                    |   | —                                    |   | — |   | — |   |
| Less:   Stock based employee compensation expense determined under fair value  calculations |   | —                                    |   | —                                    |   | — |   | — |   |
| Pro forma                                                                                        |   | $                                         | (0.01  | )                                         | $      | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |

 

**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

 

9

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in cash and issued a non-interest bearing unsecuredpromissory note which requires 35 consecutive monthly payments of $5,000 eachcommencing April 1, 2003; and (iv) the remaining 374,116 shares in the escrowaccount will be released to the Company. If the Company is delinquent four times in any twelve-month periodduring the term of the unsecured promissory note in making its $5,000 monthlypayments to HIS, and HIS issues respective valid default notices, the Companywill be subject to a $225,000 penalty. The 374,116 shares have been received by MAI together with the HISauthorization to legally transfer such shares to MAI.

 

### *Imputinginterest at 11%, the present value of the $175,000 promissory note at the dateof the settlement was $149,000.  TheCompany recorded the present value of this debt issuance and the $50,000 cashpayment as a reduction to additional paid-in capital.*

### * *

***Logix Development Corporation***

** **

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

 

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

 

***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.

 

**12.**          Comprehensive Income

 

The following table summarizes components ofcomprehensive income:

 

 
|                                          |   | **For The  Three Months Ended  June 30,** |   | **For The  Six Months Ended  June 30,** |   |
|-----------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
|                                          |   | **2003**                                  |   | **2004**                                |   | **2003** |   | **2004** |   |
|                                          |   |                                      |   |                                    |   |   |   |   |   |
| Net income (loss)                             |   | $                                         | (82    | )                                       | $      | 82 |   | $ | 179 |   | $ | 248 |   |
|                                          |   |                                      |   |                                    |   |   |   |   |   |
| Change in cumulative translation  adjustments |   | 40                                        |   | (37                                     | )      | 40 |   | (57 | ) |
|                                          |   |                                      |   |                                    |   |   |   |   |   |
| Comprehensive income (loss)                   |   | $                                         | (42    | )                                       | $      | 45 |   | $ | 219 |   | $ | 191 |   |

 

Accumulated other comprehensive income in theaccompanying consolidated balance sheets consists of cumulative translationadjustments.

 

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

** **

**CriticalAccounting Policies and Estimates**

 

The discussion and analysis of our financial conditionand results of operations are based upon our 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, accountsreceivable and intangible assets. We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances. This forms the basis of judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. Actual results may differ from these estimates under differentassumptions or conditions.

 

10

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

 

**Revenue Recognition**

** **

The Company earns revenue from sales of hardware,software and professional services and from arrangements involving multipleelements of each of the above.  Revenuefor multiple element arrangements are recorded by allocating revenue to thevarious elements based on their respective fair values as evidenced by vendorspecific objective evidence.  The fairvalue in multi-element arrangements is determined based upon the price chargedwhen sold separately.  Revenue is notrecognized until persuasive evidence of an arrangement exists, delivery hasoccurred, the fee is fixed or determinable and collectibility is probable.  Sales of network and computer equipment arerecorded when title and risk of loss transfers.  Software revenues are recorded when application software programsare shipped to end users, resellers and distributors, provided the Company isnot required to provide services essential to the functionality of the softwareor 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 maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. The amount of ourreserves is based on historical experience and our analysis of the accountsreceivable balances outstanding. If the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be required which would result in anadditional general and administrative expense in the period such determinationwas made. While such credit losses have historically been within ourexpectations and the provisions established, we cannot guarantee that we willcontinue to experience the same credit loss rates that we have in the past.

 

**Intangible and Long-Lived Assets**

** **

At December 31, 2003 andJune 30, 2004, goodwill and other long-lived assets represented 44% and 45%,respectively, of the Company’s total assets.

 

Goodwill must be tested atleast annually for impairment at a level of reporting referred to as thereporting 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 completion of the initial impairment reviews on January 1, 2002 orupon its annual impairment review at December 31, 2003.

 

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

 

11

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**Provision for Income Taxes**

** **

Provision for income taxes isbased upon the Company’s estimate of taxable income or loss for each respectiveaccounting period.  An asset orliability is recognized for the deferred tax consequences of temporary differencesbetween the tax bases of assets and liabilities and their reported amounts inthe financial statements.  Thesetemporary differences will result in taxable or deductible amounts in futureperiods when the reported amounts of assets are recovered or liabilities aresettled. The Company regularly reviews its deferred tax assets to determine theamount that is more likely than not to be realized. When this amount is lessthan the deferred tax asset recorded, the Company records a valuation allowanceto 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 theCompany realized that it was going to be able to fully realize a deferred taxasset in excess of its net recorded value, net income would be increased in theperiod that the Company made its determination.

 

The Company also reviews itsdeferred tax liabilities on a regular basis to determine that the amountrecorded is adequate to cover the expected reversal of temporary income taxliabilities.  In the event that the amountrecorded was less than adequate, the deferred tax liability would be increasedto 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 any nondeductibleexpenses.  This rate could also beaffected by increases or decreases to deferred tax assets or liabilities asdescribed above.

 

**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 generally amortized over athree-year period.  The Companycontinually assesses the recoverability of software development costs bycomparing the carrying value of individual products to their net realizablevalue.

 

The Company capitalized $419,000 and $604,000 ofsoftware development costs for the period ending June 30, 2003 and 2004respectively, relating to our new N-Tier, Internet-native corporate applicationsuite of products written in java. Although we have not yet sold any of the modules to this suite ofapplications, we believe that these new products will produce new salesadequate to recover amounts capitalized. We expect that certain of our new products will be available for generalrelease during the third quarter of 2004 at which time amortization of suchcosts shall commence.

 

**Liquidityand Capital Resources**

 

At June 30, 2004, ourworking capital deficiency decreased from a working capital deficiency of$10,399,000 at December 31, 2003 to a working capital deficiency of$7,854,000.  Excluding unearned revenueof $4,787,000, working capital deficiency at June 30, 2004 was $3,067,000.  Excluding unearned revenue of $3,209,000,the Company’s working capital deficiency at December 31, 2003 was$7,190,000.  Excluding unearned revenue,the decrease in the working capital deficiency of $4,123,000 was primarilyattributable to increases in receivables of $696,000, and decreases in currentportion of long term debt of $2,732,000, customer deposits of $871,000, accruedliabilities of $637,000 offset by decrease in cash of $535,000 and increase inaccounts payable of $253,000.

 

Net cash used ininvesting activities for the period ended June 30, 2004 totaled $714,000, whichis comprised of capital expenditures of $110,000 and capitalized software of$604,000.

 

Net cash used infinancing activities for the period ended June 30, 2004 totaled $425,000, whichrepresents repayments on long-term debt. On March 31, 2004, the Company successfully re-negotiated the terms ofits Wamco loan whereby the maturity date was extended to February 28,2006.  In addition, various restrictionsand covenants, pursuant to the inter-creditor agreement between Canyon andWamco, were amended to include a minimum quick ratio of 0.20 to 1.00

 

12

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and a minimum debtcoverage ratio of 0.50 to 1.00 which commence as of and for the three monthperiod ended March 31, 2004 and for each and every fiscal quarter endingthereafter.  The Company was not incompliance with the amended debt covenants as of and for the period ending June30, 2004, but obtained a waiver for non-compliance.  There is no guaranty that the Company will meet its debtcovenants in the future.  In the eventthat the Company were not in compliance with the various restrictions andcovenants and were unable to receive waivers for non-compliance, the term loanwould be immediately due and payable.

 

Stockholders’ deficiencydecreased from $14,586,000 at December 31, 2003 to $14,377,000 at June 30, 2004,mainly as a result of net income during the period of $248,000.

 

Although the Company hasa net stockholders’ deficiency of $14,377,000 and a working capital deficit of$7,854,000 at June 30, 2004, the Company believes it will generate sufficientfunds from operations and through its proposed private placement of $1 millionfrom an Investor Group to meet its operating and capital requirements.  In the event that the Company cannotgenerate positive cash flow from its operations during 2004, the Company cansubstantially reduce its research and development efforts to mitigate cashoutflow to help sustain its operations. There can be no assurance that the Company will be able to sustainprofitability or generate positive cash flow from operations; however, theCompany expects to generate positive cash flow from its operations during 2004from shipping out products and services from its current backlog as of June 30,2004 as well as new orders and a private placement of $1 million from anInvestor Group. These financial statements have been prepared assuming theCompany will continue to operate as a 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, including protectionunder the bankruptcy laws.

 

**ContractualObligations and Commercial Commitments**

 

The following table summarizes the Company’sobligations and commitments as of June 30, 2004, excluding interest:

 
|                             |   | **Payments  Due by Period (in thousands)** |   |
|----------------------------------|--------|--------------------------------------------|--------|
| **Contractual Cash Obligations** |   | **Total**                                  |   | **Less Than  1  Year** |   | **1-3 Years** |   | **4-5 Years** |   | **After 5  Years** |   |
|                             |   |                                       |   |   |   |   |   |   |   |   |   |
| Long-Term Debt                   |   | $                                          | 11,200 |   | $ | 914 |   | $ | 8,123 |   | $ | 1,774 |   | $ | 389 |   |
| Operating Leases                 |   | 1,621                                      |   | 514 |   | 927 |   | 127 |   | 53 |   |
| Consulting Agreements            |   | 60                                         |   | 60 |   | — |   | — |   | — |   |
|                             |   | $                                          | 12,881 |   | $ | 1,488 |   | $ | 9,050 |   | $ | 1,901 |   | $ | 442 |   |

 

13

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**Results of Operations**

 

Three Months Ended June 30, 2003 Compared to Three Months Ended June30, 2004

 
|                                          |   | **June 30,  2003** |   | **Percentage  of  Revenue** |   | **June 30,  2004** |   | **Percentage  of  Revenue** |   |
|-----------------------------------------------|--------|--------------------|--------|-----------------------------|--------|--------------------|--------|-----------------------------|--------|
|                                          |   | **(in thousands)** |   |                        |   | **(in thousands)** |   |                        |   |
| Revenue:                                      |   | $                  | 4,752  |                        | 100.0  | %                  | $      | 4,901                       |   | 100.0 | % |
| Gross profit                                  |   | 3,526              |   | 74.2                        | %      | 3,671              |   | 74.9                        | %      |
| Selling, general and administrative  expenses |   | 2,438              |   | 51.3                        | %      | 2,351              |   | 48.0                        | %      |
| Research and development costs                |   | 658                |   | 13.9                        | %      | 908                |   | 18.5                        | %      |
| Other operating expense                       |   | 3                  |   | 0.1                         | %      | 15                 |   | 0.3                         | %      |
| Interest expense, net                         |   | 292                |   | 6.2                         | %      | 288                |   | 5.9                         | %      |
| Other non-operating expense                   |   | 212                |   | 4.5                         | %      | 23                 |   | 0.5                         | %      |
| Income tax expense                            |   | 5                  |   | 0.1                         | %      | 4                  |   | 0.1                         | %      |
| Net income (loss)                             |   | $                  | (82    | )                           | (1.7   | )%                 | $      | 82                          |   | 1.7 | % |

 

Revenue for 2004 was $4,901,000 compared to $4,752,000in 2003 or a 3.1% increase. Revenue increased $149,000 in 2004, as a result ofincreased software maintenance service.

 

Gross profit for 2004 increased to $3,671,000 from$3,526,000 in 2003.  The increase ingross profit is mainly due to the increase in professional and maintenanceservices revenues from 2003 to 2004.

 

Selling, general and administrative expenses(“SG&A”) decreased from $2,438,000 in 2003 to $2,351,000 in 2004.  The decrease is mainly due to the managementcost control program by reducing vendor costs and consulting services.

 

Research and development costs increased from $658,000in 2003 to $908,000 in 2004. The increase is mainly due to new hires, it’srelated cost and consulting services. The Company capitalized $190,000 and $282,000 of software developmentcosts in 2003 and 2004, respectively, associated with the Company’s productdevelopment of its new internet native suite of applications as well as ourcore product offerings.

 

Net interest expense was $292,000 in 2003 compared to$288,000 in 2004.  The decrease is dueto lower balances of interest bearing debt during 2004 as compared to 2003.

 

Other non-operating expense increased from $212,000 in2003 to $23,000 in 2004.  In 2003non-operating expense relates to pension expense under a defined benefit planfor former employees from our discontinued operations. Other non-operatingexpense of $23,000 in 2004 relates to minority interest expenses associatedwith our Asian Operations. There were no such expense recorded in 2003.

 

The income tax benefit in 2003 is due to the Companyrecording a domestic income tax receivable during the period to recover taxespreviously paid.  There were no suchreceivables recorded in 2004.

 

14

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Six Months Ended June 30, 2003 Compared to Six Months Ended June 30,2004

 
|                                          |   | **June 30,  2003** |   | **Percentage  of  Revenue** |   | **June 30,  2004** |   | **Percentage  of  Revenue** |   |
|-----------------------------------------------|--------|--------------------|--------|-----------------------------|--------|--------------------|--------|-----------------------------|--------|
|                                          |   | **(in thousands)** |   |                        |   | **(in thousands)** |   |                        |   |
| Revenue                                       |   | $                  | 9,938  |                        | 100.0  | %                  | $      | 10,074                      |   | 100.0 | % |
| Gross profit                                  |   | 7,241              |   | 72.9                        | %      | 7,394              |   | 73.4                        | %      |
| Selling, general and administrative  expenses |   | 4,969              |   | 50.0                        | %      | 4,700              |   | 46.7                        | %      |
| Research and development costs                |   | 1,340              |   | 13.5                        | %      | 1,800              |   | 17.9                        | %      |
| Other operating expense (income)              |   | (46                | )      | (0.5                        | )%     | 18                 |   | 0.2                         | %      |
| Interest expense, net                         |   | 641                |   | 6.4                         | %      | 579                |   | 5.8                         | %      |
| Other non-operating expense                   |   | 212                |   | 2.1                         | %      | 39                 |   | 0.4                         | %      |
| Income tax expense (benefit)                  |   | (54                | )      | (0.5                        | )%     | 10                 |   | 0.1                         | %      |
|                                          |   |               |   |                        |   |               |   |                        |   |
| Net income                                    |   | $                  | 179    |                        | 1.8    | %                  | $      | 248                         |   | 2.5 | % |

 

Revenue for 2004 was $10,074,000 compared to$9,938,000 in 2003 or a 1.4% increase. Revenue increased $136,000 in 2004, as aresult of increased professional services revenue as well as maintenanceservice price increases.

 

Gross profit for 2004 increased to $7,394,000 from$7,241,000 in 2003.  The increase ingross profit is mainly due to the increase in professional and maintenanceservices revenues.

 

Selling, general and administrative expenses(“SG&A”) increased from $4,969,000 in 2003 to $4,700,000 in 2004.  The decrease is mainly due to a decrease inheadcount associated with the Company’s focus on reducing costs, such asbuilding rent and consulting services.

 

Research and development costs increased from$1,340,000 in 2003 to $1,800,000 in 2004. The company capitalized $419,000 and $604,000 of software developmentcosts in 2003 and 2004, respectively. The increase is mainly due to the Companycontinued efforts to invest in product development of its new internet nativesuite of applications as well as our core product offerings.

 

Other operating expense (income) was ($46,000) in 2003and $18,000 in 2004.  Other operatingincome in 2003 is due to receipt of approximately $46,000 of cash resultingfrom a legal settlement.

 

Net interest expense was $641,000 in 2003 compared to$579,000 in 2004.  The decrease is dueto lower balances of interest bearing debt during 2004 as compared to 2003.

 

Other non-operating expense increased from $212,000 in2003 to $39,000 in 2004.  In 2003non-operating expense relates to pension expense under a defined benefit planfor former employees from our discontinued operations. Of other non-operatingexpense of $39,000 in 2004, $22,000 relates to minority interest expenseassociated with our Asia Operations. There were no such expense recorded in2003.

 

The income tax benefit in 2003 is due to the Companyrecording a domestic income tax receivable during the period to recover taxespreviously paid. There were no such receivables recorded in 2004.

 

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

** **

***MarketRisk Disclosures***

*** ***

The following discussion about our market riskdisclosures contains forward-looking statements.  Forward-looking statements are subject to risks anduncertainties.  Actual results coulddiffer materially from those 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.

 

***InterestRate Sensitivity***

*** ***

Of our $11.2 million principal amount of indebtednessat June 30, 2004, none bears interest at a variable rate.  However, $5.7 million bears interest at afixed rate of 11%, $3.6 million bears interest at a fixed rate of 10%, $1.0million bears interest at 9.25% and $0.9 million bears fixed interest ratesranging from 6% to 17.5%. Since these debt instruments bear interest at fixedrates, we have no exposure to decreases in interest rates because we still arerequired to pay the fixed rate even if current interest rates are lower.

 

15

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***ForeignCurrency Risk***

*** ***

We believe that our exposure to currency exchangefluctuation risk is reduced because our transactions with international vendorsand customers are generally transacted in US dollars. The currency exchangeimpact on intercompany transactions was immaterial for the quarter ended June30, 2004.

 

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

** **

#### ***(a)***   Evaluation of disclosurecontrols and procedures

#### *** ***

We evaluated the design andoperation of our disclosure controls and procedures to determine whether theyare effective in ensuring that we disclose the required information in a timelymanner and in accordance with the Securities Exchange Act of 1934, as amended,or the Exchange Act, and the rules and forms of the Securities and ExchangeCommission. Management, including our principal executive officer and principalfinancial officer, supervised and participated in the evaluation. Theevaluation was completed as of June 30, 2004. The principal executive officerand principal financial officer concluded, based on their review, that ourdisclosure controls and procedures, as defined by Exchange Act Rules 13a-14(c)and 15d-14(c), are effective and ensure that we disclose the requiredinformation in reports that we file under the Exchange Act and that the filingsare recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms. No significantchanges were made to our internal controls or other factors that couldsignificantly affect these controls subsequent to the date of their evaluation.

 

A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. Because of theinherent limitations in all control systems no evaluation of controls canprovide absolute assurance that all control issues if any, within a companyhave been detected.

 

On August 20, 2004, theCompany’s independent auditors orally notified the Company’s Audit Committeethat they had identified significant deficiencies regarding the Company’sinternal controls. The deficiencies noted were (a) the lack of segregation ofduties, (b) the lack of adequate account analysis and reconciliations, and (c)insufficient supervision of the Company’s accounting personnel. TheCompany believes such deficiencies were primarily attributable to changes inpersonnel within the accounting department combined with a lack of adequateresources.

 

Based on the investigation bythe Company’s Audit Committee and additional procedures performed bymanagement, the Company has concluded that, except as noted above, and subjectto the inherent limitations in all control systems, the Company’s currentdisclosure controls and procedures are sufficient to timely alert the Company’smanagement to material information relating to the Company that is required tobe included in our periodic Securities and Exchange Committee filings, and thatthe internal controls are sufficient to provide reasonable assurance that theconsolidated financial statements are fairly presented in conformity withgenerally accepted accounting principles.

 

#### ***(b)***   Changes in internal controls

 

There were no significant changes in our internalcontrols or to our knowledge, in other factors that could significantly affectour disclosure controls and procedures subsequent to the Evaluation Date.

 

**PARTII - OTHER INFORMATION**

 

**Item1.**    LegalProceedings

** **

***Hotel InformationSystems, 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

 

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$5,000 each commencing April 1, 2003; and (iv) theremaining 374,116 shares in the escrow account will be released to theCompany.  If the Company is delinquentfour times in any twelve-month period during the term of the unsecuredpromissory note in making its $5,000 monthly payments to HIS, and HIS issuesrespective valid default notices, the Company will be subject to a $225,000penalty.  The 374,116 shares have beenreceived by MAI together with the HIS authorization to legally transfer suchshares to MAI.

 

Imputing interest at 11%, thepresent value of the $175,000 promissory note at the date of the settlement was$149,000.  The Company recorded thepresent value of this debt issuance and the $50,000 cash payment as a reductionto additional paid-in capital.

 

***Logix DevelopmentCorporation***

** **

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

 

### *OtherLitigation*

### * *

The Company is also involved in various other legalproceedings and claims that are incidental to its business. Management believesthe ultimate outcome of these matters will not have a material adverse effecton the consolidated financial position, results of operations or liquidity ofthe Company.

 

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

** **

(a)           None.

 

(b)           None.

 

(c)           None

 

(d)           None.

 

**Item3.  Defaults Upon Senior Securities**

** **

(a)           None

 

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

** **

(a)           None

 

(b)           None

 

(c)           None

 

(d)           None

 

**Item5.  Other Information**

** **

(a)           None.

 

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**Item6.  Exhibits and Reports on Form 8-K**

** **
| **(a)** |   | **Exhibits**                                                                                                           |
|---------|--------|------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                   |
| 31.1    |   | Certification of Chief Executive Officer, W. Brian  Kretzmer, as required by Section 3.02 of Sarbane-Oxley Act of 2002 |
|    |   |                                                                                                                   |
| 31.2    |   | Certification of Chief Financial Officer, James W.  Dolan, as required by Section 3.02 of Sarbane-Oxley Act of 2002    |
|    |   |                                                                                                                   |
| 32.1    |   | Certification of Chief Executive Officer, W. Brian  Kretzmer, as required by Section 9.06 of Sarbane-Oxley Act of 2002 |
|    |   |                                                                                                                   |
| 32.2    |   | Certification of Chief Financial Officer, James W.  Dolan, as required by Section 9.06 of Sarbane-Oxley Act of 2002    |
|    |   |                                                                                                                   |
| (b)     |   | Reports on Form 8-K                                                                                                    |
|    |   |                                                                                                                   |
|    |   | Filed April 1, 2004                                                                                                    |
|    |   |                                                                                                                   |
|    |   | Filed April 12, 2004                                                                                                   |

 

 

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**SIGNATURES**

** **

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

 

 
|                  |   | MAI SYSTEMS CORPORATION                               |
|-----------------------|--------|-------------------------------------------------------|
|                  |   | (Registrant)                                          |
|                  |   |                                                  |
|                  |   |                                                  |
| Date: August 23, 2004 | By:    |   /s/James W. Dolan                         |   |
|                  |   |   James  W. Dolan                           |
|                  |   |   Chief  Financial and Operating Officer    |
|                  |   |   (Chief  Financial and Accounting Officer) |

 

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