** **

**UNITEDSTATES SECURITIES 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 September 30, 2004 or** |
| ** **                                           | ** **                                                                                          |
| **o**                                                | **Transition report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.** |

** **

**Forthe transition period from     to      .**

** **

**Commissionfile number: 1-9158**

** **

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** **

**MAISystems Corporation**

**(Exact name of registrant asspecified 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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** **

**Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes   **ý      Noo

** **

**Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).**

**Yes  **ý      No o

** **

**Theaggregate market value of the common stock held by non-affiliates of theregistrant, based upon the last sale price of the Common Stock reported on theNational Association of Securities Dealers Automated Quotation National MarketSystem on November 18, 2004 was $1,648,000**

** **

**Thenumber of shares of common stock issued, outstanding and subscribed as of  November 18, 2004 was 57,847,862.**

** **

** **

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** **

**PART I - FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**MAI SYSTEMS CORPORATION**

** **

**CONDENSED CONSOLIDATED BALANCE SHEETS**

** **

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                        | ** ** | **(in thousands, except share data)** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                                                                        | ** ** | **As of December  31, 2003**          | ** ** | **As of September  30, 2004** | ** ** |
| ** **                                                                                                                                                                                                        | ** ** | ** **                            | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                                                                        |       |                                  |       |   |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Current  assets:                                                                                                                                                                                                  |       |                                  |       |   |   |
| Cash                                                                                                                                                                                                              |       | $                                     | 664        |   | $ | 555 |   |
| Receivables,  less allowance for doubtful accounts of $335 in 2003 and $311 in 2004                                                                                                                               |       | 1,313                                 |       | 2,130 |   |
| Inventories                                                                                                                                                                                                       |       | 47                                    |       | 74 |   |
| Prepaids  and other assets                                                                                                                                                                                        |       | 814                                   |       | 659 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  current assets                                                                                                                                                                                             |       | 2,838                                 |       | 3,418 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Furniture,  fixtures and equipment, net                                                                                                                                                                           |       | 758                                   |       | 501 |   |
| Intangibles,  net                                                                                                                                                                                                 |       | 2,876                                 |       | 3,697 |   |
| Other  assets                                                                                                                                                                                                     |       | 58                                    |       | 14 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  assets                                                                                                                                                                                                     |       | $                                     | 6,530      |   | $ | 7,630 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                                                                 |       |                                  |       |   |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Current  liabilities:                                                                                                                                                                                             |       |                                  |       |   |   |
| Current  portion of long-term debt                                                                                                                                                                                |       | $                                     | 3,646      |   | $ | 983 |   |
| Accounts  payable                                                                                                                                                                                                 |       | 904                                   |       | 1,078 |   |
| Customer  deposits                                                                                                                                                                                                |       | 2,334                                 |       | 2,243 |   |
| Accrued  liabilities                                                                                                                                                                                              |       | 3,059                                 |       | 2,725 |   |
| Income  taxes payable                                                                                                                                                                                             |       | 85                                    |       | 111 |   |
| Unearned  revenue                                                                                                                                                                                                 |       | 3,209                                 |       | 3,415 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  current liabilities                                                                                                                                                                                        |       | 13,237                                |       | 10,555 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Long-term  debt                                                                                                                                                                                                   |       | 7,135                                 |       | 9,982 |   |
| Other  liabilities                                                                                                                                                                                                |       | 744                                   |       | 505 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  liabilities                                                                                                                                                                                                |       | 21,116                                |       | 21,042 |   |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| 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 99,000,000 shares; 14,875,752  and 14,675,752 shares issued,outstanding and subscribed at December 31,  2003 and September 30, 2004, respectively. |       | 152                                   |       | 152 |   |
| Additional  paid-in capital                                                                                                                                                                                       |       | 218,112                               |       | 218,112 |   |
| Common  stock subscribed                                                                                                                                                                                          |       | —                                |       | 1,000 |   |
| Accumulated  other comprehensive loss                                                                                                                                                                             |       |                                  |       |   |   |
| Minimum  pension liability                                                                                                                                                                                        |       | (1,005                                | )          | (1,005 | ) |
| Foreign  currency translation                                                                                                                                                                                     |       | (2                                    | )          | (47 | ) |
| Unearned  Compensation                                                                                                                                                                                            |       | (53                                   | )          | (25 | ) |
| Accumulated  deficit                                                                                                                                                                                              |       | (231,790                              | )          | (231,599 | ) |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  stockholders’ deficiency                                                                                                                                                                              |       | (14,586                               | )          | (13,412 | ) |
|                                                                                                                                                                                                              |       |                                  |       |   |   |
| Total  liabilities and stockholders’ deficiency                                                                                                                                                              |       | $                                     | 6,530      |   | $ | 7,630 |   |

** **

**The accompanying notes are an integral part of thesecondensed consolidated financial statements.**

** **

**1**

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** **

**MAI SYSTEMS CORPORATION**

** **

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                                   | ** ** | **(Unaudited)  For the Three Months Ended  September 30,** | ** ** | **(Unaudited)  For the Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **(in thousands, except per share data)**                       | ** ** | **(in thousands, except per share data)**                      | ** ** |
| ** **                                                                   | ** ** | **2003**                                                        | ** ** | **2004**                                                       | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue:                                                                     |       |                                                            |       |                                                           |       |   |   |   |   |
| Software                                                                     |       | $                                                               | 842        |                                                           | $          | 842 |   | $ | 3,098 |   | $ | 2,945 |   |
| Network  and computer equipment                                              |       | 104                                                             |       | 118                                                            |       | 339 |   | 329 |   |
| Services                                                                     |       | 3,868                                                           |       | 3,923                                                          |       | 11,315 |   | 11,683 |   |
| Total  revenue                                                               |       | 4,814                                                           |       | 4,883                                                          |       | 14,752 |   | 14,957 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Direct  costs:                                                               |       |                                                            |       |                                                           |       |   |   |   |   |
| Software                                                                     |       | 167                                                             |       | 40                                                             |       | 425 |   | 369 |   |
| Network  and computer equipment                                              |       | 73                                                              |       | 103                                                            |       | 238 |   | 272 |   |
| Services                                                                     |       | 1,109                                                           |       | 1,264                                                          |       | 3,384 |   | 3,446 |   |
| Total  direct costs                                                          |       | 1,349                                                           |       | 1,407                                                          |       | 4,047 |   | 4,087 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Gross  profit                                                                |       | 3,465                                                           |       | 3,476                                                          |       | 10,705 |   | 10,870 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Selling,  general and administrative expenses                                |       | 2,307                                                           |       | 2,200                                                          |       | 7,277 |   | 6,900 |   |
| Research  and development costs                                              |       | 764                                                             |       | 956                                                            |       | 2,104 |   | 2,756 |   |
| Other  expense(income)                                                       |       | (134                                                            | )          | 48                                                             |       | (181 | ) | 67 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Operating  income                                                            |       | 528                                                             |       | 272                                                            |       | 1,505 |   | 1,147 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Interest  income                                                             |       | —                                                          |       | —                                                         |       | 1 |   | 1 |   |
| Interest  expense                                                            |       | (286                                                            | )          | (303                                                           | )          | (928 | ) | (882 | ) |
| Other  non-operating expense                                                 |       | (98                                                             | )          | (22                                                            | )          | (309 | ) | (60 | ) |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Income  (loss) before income taxes                                           |       | 144                                                             |       | (53                                                            | )          | 269 |   | 206 |   |
| Income  tax benefit (expense)                                                |       | (12                                                             | )          | (5                                                             | )          | 41 |   | (15 | ) |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Net  income (loss)                                                           |       | $                                                               | 132        |                                                           | $          | (58 | ) | $ | 310 |   | $ | 191 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Income  (loss) per share:                                                    |       |                                                            |       |                                                           |       |   |   |   |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Net  income (loss) per share:                                                |       |                                                            |       |                                                           |       |   |   |   |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Basic  income (loss) per share                                               |       | $                                                               | 0.01       |                                                           | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Diluted  income (loss) per share                                             |       | $                                                               | 0.01       |                                                           | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Weighted  average common shares used in determining income (loss) per share: |       |                                                            |       |                                                           |       |   |   |   |   |
|                                                                         |       |                                                            |       |                                                           |       |   |   |   |   |
| Basic                                                                        |       | 14,575                                                          |       | 14,676                                                         |       | 14,525 |   | 14,676 |   |
| Diluted                                                                      |       | 14,875                                                          |       | 14,676                                                         |       | 14,825 |   | 14,676 |   |

 

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

 

2

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**MAI Systems Corporation**

** **

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**(Unaudited)**

** **
| ** **                                  | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                | ** ** |
| ** **                                  | ** ** | **2003**                                          | ** ** | **2004** | ** ** |
|                                        |       |                                              |       |   |   |
| Net  cash provided by operating activities: |       | $                                                 | 619        |   | $ | 405 |   |
|                                        |       |                                              |       |   |   |
| Cash  flows used in investing activities:   |       |                                              |       |   |   |
| Proceeds  from note receivable              |       | 250                                               |       | — |   |
| Capital  Expenditures                       |       | (240                                              | )          | (98 | ) |
| Acquisition  of unconsolidated subsidiary   |       | (79                                               | )          |   |   |
| Capitalized  software development costs     |       | (619                                              | )          | (821 | ) |
| Net  cash used in investing activities      |       | (688                                              | )          | (919 | ) |
|                                        |       |                                              |       |   |   |
| Cash  flows used in financing activities:   |       |                                              |       |   |   |
| Proceeds  for common stock subscribed       |       | —                                            |       | 1,000 |   |
| Repayments  on long-term debt               |       | (312                                              | )          | (594 | ) |
| Net  cash used in financing activities      |       | (312                                              | )          | 406 |   |
|                                        |       |                                              |       |   |   |
| Net  cash used in operations                |       | (381                                              | )          | (108 | ) |
|                                        |       |                                              |       |   |   |
| Effect  of exchange rate changes on cash    |       | (3                                                | )          | (1 | ) |
|                                        |       |                                              |       |   |   |
| Net  change in cash                         |       | (384                                              | )          | (109 | ) |
|                                        |       |                                              |       |   |   |
| Cash  at beginning of period                |       | 545                                               |       | 664 |   |
|                                        |       |                                              |       |   |   |
| Cash  at end of period                      |       | $                                                 | 161        |   | $ | 555 |   |

 

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

 

3

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**MAI Systems Corporation**

** **

**Notes to Condensed Consolidated Financial Statements**

** **

**Three and Nine Months ended September 30, 2004**

** **

**(Unaudited)**

1.                                       **Basis of Presentation**

 

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

 

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 filewith the SEC.

 

2.                                       **Liquidity**

 

Although the Company has a net stockholders’ deficiencyof $13,412,000 and a working capital deficit of $7,137,000 at September 30,2004, the Company expects to generate positive cash flow from its operationsduring 2004 and 2005 from shipping out products and services from its currentbacklog as of September 30, 2004 as well as new orders to meet itsoperating and capital requirements. In the event that the Company cannotgenerate positive cash flow from its operations, the Company can substantiallyreduce its research and development efforts to mitigate cash outflow to helpsustain its operations.  There can be noassurance that the Company will be able to sustain profitability or generatepositive cash flow from operations. These financial statements have been prepared assuming the Company willcontinue to operate as a going concern. If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company, including protection under the bankruptcy laws. Therestructured debt, pursuant to the original inter-creditor agreement betweenCanyon Capital and Coast, which was sold to Wamco on May 15, 2003, containsvarious restrictions and covenants.  Inthe event that the Company were not in compliance with the various restrictionsand covenants and were unable to receive waivers for non-compliance, the termdebt would be immediately due and payable. The Company is in compliance with the amended debt covenants as of andfor the period ended September 30, 2004. There is no guaranty that theCompany 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.

 

**3.****                                      Inventory**

 

Inventories are summarized as follows:

 
| ** **         | ** ** | **(dollars in thousands)**  | ** ** |
|--------------------|------------|-----------------------------|------------|
| ** **         | ** ** | **December 31,  2003** | ** ** | **September 30,  2004** | ** ** |
| Finished  goods    |       | $                           | 39         |   | $ | 67 |   |
| Replacement  parts |       | 8                           |       | 7 |   |
|               |       |                        |       |   |   |
|               |       | $                           | 47         |   | $ | 74 |   |

 

**4.****                                      BusinessAcquisitions**

 

**Hospitality Services &Solutions**

 

On June 23, 2002, the Company acquiredsubstantially all of the assets and assumed certain liabilities of HospitalityServices & Solutions (“HSS”) including a 35% ownership in AMDB – HIS (“AMDB”)pursuant to a stock purchase

 

4

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agreement for 100,000 shares of common stock valued at$32,000 (the quoted market price of the common stock at the time the terms wereagreed), and $75,000 in cash. Additionally, the shareholders of HSS received a 20% minority interestin the Company’s combined operations in Asia. HSS was acquired for the Companyto expand its operations in the Asian marketplace, strengthen its managementteam in the territory and create new opportunities for its new enterprisecapable suite of products.  The netassets acquired from HSS are used in the business of software design,engineering and service relating to hotel information systems.  The net assets also include subsidiaries ofHSS 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 this acquisition had occurred atthe beginning of 2001 and 2002 are not shown because its impact would have beenimmaterial.

 

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,the Company 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 2003 are not shown because its impact would have beenimmaterial.

 

**5.****                                      Long-TermDebt**

 

**Wamco 32 Ltd.**

 

On January 13, 2003, the Company re-negotiatedthe terms of its credit facility with Coast Business Credit (“Coast”) wherebythe outstanding balance of $1,828,000 was converted to a term loan whichaccrues interest at 9.25% per annum and requires monthly payments of $58,000over a 36 months period commencing March 1, 2003.  On February 7, 2003, the Federal DepositInsurance Corporation (“FDIC”) put Coast and its parent company, SouthernPacific Bank, into receivership and held all of Coast’s assets for sale tothird parties.  On May 15, 2003, the loanwas sold to Wamco 32, Ltd. (“Wamco”). This sale of the loan by the FDIC did not change any of the terms of theCompany’s loan agreement.  The Company isrequired to pay Wamco additional principal payments on a quarterly basis basedupon an EBITDA-based formula commencing March 31, 2003.  For the period ended September 30, 2004,there are no additional principal payments required under the EBITDA-basedformula.

 

On April 9, 2004, the Company successfullyre-negotiated the terms of its 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 modify the financial covenants to a minimum quick ratioof  0.20 to 1.00 and a minimum debtcoverage ratio of 0.50 to 1.00 effective for the three month period ended March 31,2004 and for each and every fiscal quarter ending thereafter.  The Company was in compliance with the amendeddebt covenants as of and for the period ending September 30, 2004. Thereis no guaranty that the Company will meet its debt covenants in thefuture.  In the event that the Companywere not in compliance with the various restrictions and covenants and wereunable to receive waivers for non-compliance, the term loan would beimmediately due and payable.  As of December 31,2003 and September 30, 2004, the balance of the term loan was $1,366,000and $907,000, respectively.

 

**Canyon Capital 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 payments of $52,000until the Wamco term loan is paid off in full at which time the note payablewill be converted into a three-year amortizing loan which will accrue interestat 11% per annum and requires equal monthly payments of principal and interestsuch that the subordinated debt will be paid in full at the end of the amendedterm.  Upon the repayment of the Wamcodebt in full, the Company will also be required to pay Canyon additionalprincipal payments on a quarterly basis based upon an EBITDA-based formula.  Additionally, the Company issued to Canyon200,000 shares of its common stock valued at $20,000 (the quoted market priceof the common stock at the time the terms were agreed) and agreed to issue onemillion warrants at an exercise price of $0.40 per share valued at $42,000(using the Black-Scholes option-pricing model with the following weighted-averageassumptions: risk-free interest rate of 6.5%, volatility of 80% and an expectedlife of 5 years).  The $62,000 is beingamortized to interest expense over the term of the modified note.  The principal balance outstanding on thesubordinate notes payable to Canyon was approximately $5,662,000 and $5,660,000respectively at December 31, 2003 and September 30, 2004,respectively.

 

**CSA Private Limited**

 

In connection with a settlement agreement in February 2001with CSA Private Limited (“CSA”), the Company issued

 

5

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$2.8 million of subordinated debt to CSA.  The $2.8 million of debt was secured by allof the Company’s assets, which was subordinate to Wamco and Canyon, accruedinterest at 10% per annum and required payments of $37,500 from March 1,2002 through September 1, 2002 and monthly payments of $107,500 commencingon October 1, 2002 until October 2003 when all remaining unpaidprincipal 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 the subordinatednote would have ceased until a final payment in the amount of $400,000 is paidby February 28, 2003.  If theCompany did not make all of the modified payments to CSA, the subordinated notewould revert back to its original terms. The Company did not make the modified payment and have not made anypayments since September 2002.  CSAdid not formally notify the Company of its default.

 

On April 9, 2004, the Company successfullyamended its agreement with CSA whereby the principal balance and accruedinterest through March 31, 2004, totaling $3,633,000, were converted totwo new notes.  The first note for$500,000 accrues interest at 10% per annum and provides for monthly payments of$10,000 until the Wamco and Canyon debt is paid in full.  Thereafter, the note provides for monthlypayments in an amount equal to the greater of i) $10,000 or ii) the amountrequired to fully amortize all remaining principal and interest in 24 equalmonthly payments.  The second note for$3,133,000 (“Other Note”) also accrues interest at 10% per annum and providesfor monthly payments of $7,500, or such other interest amount, not to exceed$10,000 per month, that Wamco and Canyon will allow.  As of September 30, the Company accruedand unpaid interest relating to the Other Note was $160,000.  Under the terms of the amended subordinationagreement between Wamco, Canyon and CSA, all payments under the new notes aresubordinated to the payment in full of the Wamco and Canyon loan agreements.The Company has not made any payments on the two new notes as of September 30,2004.  The Company is currently indefault of the first note.  The interestrate has been increased to 12.5% in line with the terms of that note until theCompany becomes current on its contractual payments.

 

On April 9, 2004, an investor group, consistingof Canyon, the Company’s Chairman of the Board, Chief Executive Officer andChief Financial and Operating Officer (“Investor Group”), acquired 2,433,333shares of the Company’s common stock held by CSA and the Other Note for $1million in cash.

 

On September 22, 2004, the Company receivedapproval from its shareholders for the Investor Group  to convert the Company indebtedness acquiredfrom CSA plus any accrued interest through the date of conversion for  shares of the Company’s common stock basedupon a conversion price of $0.10 per share. Additionally, the shareholders also approved for the Investor Group toinvest $1,000,000 of new cash proceeds into the Company, which the Companyreceived on September 24, 2004, in a private placement at $0.10 per share(The Management Equity/Conversion Transaction). As of September 30, 2004, the private placement funds wereclassified as a Common Stock Subscribed in the accompanying condensedconsolidated balance sheet (See Note 13). The Company issued common stock inconnection with the Management Equity/Conversion Transaction on November 1,2004 (See Note 13) and such stock 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.

 

**Tax Claim**

 

On September 30, 2003, the Company entered into asettlement agreement with the United States Internal Revenue Service (the “Service”)on a tax claim which resulted from the Company’s 1993 Chapter 11 proceedingswhereby it agreed to pay $489,000 in equal monthly installments of $7,438 overa period of six (6) years at an interest rate of 6%.  The $489,000 settlement is reflected as debtin the financial statements and resulted in a one-time gain of $262,000 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 December 31,2003 and September 30, 2004, the debt balance was $428,000 and $379,000,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.****                                      RestrictedStock Plan**

 

In May 2001, the Board of Directors adopted the 2001Restricted Stock Plan.  Under the plan,1,250,000 authorized shares of the Company’s Common Stock are reserved forissuance to officers and directors of the Company.  The shares will be issued as “RestrictedStock” within the meaning of Rule 144 of the Securities Act of 1933, asamended.  The

 

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 of theshares of $153,000 was treated as unearned compensation and is being amortizedto expense in proportion to the vesting schedule.  The unamortized balance as of September 30,2004 is $25,000 and is included in accumulated other comprehensive loss in theaccompanying consolidated balance sheet.

 

**7.****                                      PreferredStock**

 

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

 

**8.****                                      IntangibleAssets**

 

Intangible assets consist primarily of goodwill andcapitalized software.  Intangible assetsother than goodwill are amortized on a straight-line basis over their estimateduseful lives.  Prior to 2002, goodwill,representing the excess of the purchase price over the estimated fair value ofthe net assets of the acquired business, was amortized over the period ofexpected benefit of five to seven years. However, effective January 1, 2002, the Company adopted Statementof Financial Accounting Standards No. 142, “Goodwill and Other IntangibleAssets, (“SFAS No. 142”) which requires that the Company cease amortization ofall goodwill and intangible assets having indefinite useful economiclives.  The Company determined that therewas no impairment upon adoption. Such assets are not to be amortized untiltheir lives are determined to be finite. However, a recognized intangible assetwith an indefinite useful life should be tested for impairment annually or onan interim basis if events or circumstances indicate that the fair value of theasset has decreased below its carrying value. At September 30, 2004, the Company evaluated its goodwill anddetermined that fair value had not decreased below carrying value and noadjustment to impair goodwill was necessary in accordance with SFAS No. 142.

 

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

 

| ** **                 | ** ** | **(dollars in thousands)**  | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **December 31,  2003** | ** ** | **September 30,  2004** | ** ** |
|                       |       |                        |       |   |   |
| Goodwill                   |       | $                           | 1,121      |   | $ | 1,121 |   |
| Accumulated  amortization  |       | —                      |       | — |   |
| Goodwill,  net             |       | 1,121                       |       | 1,121 |   |
|                       |       |                        |       |   |   |
| Capitalized  software      |       | 1,755                       |       | 2,576 |   |
| Accumulated  amortization  |       | —                      |       | — |   |
| Capitalized  software, net |       | 1,755                       |       | 2,576 |   |
|                       |       |                        |       |   |   |
| Total                      |       | $                           | 2,876      |   | $ | 3,697 |   |

 

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

 

7

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The Company’s weighted average amortization period forcapitalized software is expected to be three years.  The Company expects that certain of our newproducts will be available for general release during the first quarter of 2005at which time amortization of such costs shall commence.  The following table shows the estimatedamortization expense for these assets for each of the five succeeding years:

 

| **Year  Ending December 31,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| **(in  thousands)**                | ** ** | ** ** | ** ** |
| 2004                               |       | $          | —     |   |
| 2005                               |       | 859        |       |
| 2006                               |       | 859        |       |
| 2007                               |       | 858        |       |
| 2008                               |       | —     |       |
|                               |       | $          | 2,576      |   |

 

**9.****                                      Income(Loss) Per Share**

 

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

 

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

 
| ** **                                                                                                                   | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 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)                                   |       | $                                                  | 132        |                                              | $          | (58 | ) | $ | 310 |   | $ | 191 |   |
|                                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Denominator:                                                                                                                 |       |                                               |       |                                              |       |   |   |   |   |
| Denominator  for basic income (loss) per share– weighted average number of Common shares  outstanding during the period |       | 14,575                                             |       | 14,676                                            |       | 14,525 |   | 14,676 |   |
|                                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Incremental  common shares attributable to exercise of outstanding shares                                                    |       | 300                                                |       | —                                            |       | 300 |   | — |   |
|                                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Denominator  for diluted income (loss) per per share                                                                         |       | 14,875                                             |       | 14,676                                            |       | 14,825 |   | 14,676 |   |
|                                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Basic  earnings (loss)per share                                                                                              |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |
|                                                                                                                         |       |                                               |       |                                              |       |   |   |   |   |
| Diluted  earnings (loss) per share                                                                                           |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |

 

The number of anti-dilutive options and warrants thatwere excluded from the computation of incremental common shares were 3,041,500and 3,104,000 for the nine month period ended September 30, 2003 and 2004,respectively.

 

8

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**10.****                               StockOption 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 stock options is determined based on the excess ofthe market price of the Company’s stock over the exercise price on the date ofgrant, the intrinsic value method, versus the fair value method as providedunder FAS No. 123.

 

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

 

At September 30, 2004, the Company had twostock-based employee compensation plans. The Company accounts for that plan under the recognition and measurementprinciples of APB No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations.  Hadcompensation cost for the Company’s stock option plan been determined based onthe fair value at the grant date for awards for the three-month periods ended September 30,2003 and 2004, consistent with the provisions of FAS No. 123, the Company’snet income and net income per share would have decreased.  The following table represents the effect onnet income and net income per share if the Company had applied the fair valuebased method and recognition provisions of Statement of Financial AccountingStandards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, tostock-based employee compensation.

 
| ** **                                                                                 | ** ** | **For the three-months ended  September 30,** | ** ** | **For the Nine-months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **(in thousands, except per  share data)**         | ** ** | **(in thousands, except per  share data)**        | ** ** |
| ** **                                                                                 | ** ** | **2003**                                           | ** ** | **2004**                                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net  income (loss):                                                                        |       |                                               |       |                                              |       |   |   |   |   |
| As  reported                                                                               |       | $                                                  | 132        |                                              | $          | (58 | ) | $ | 310 |   | $ | 191 |   |
| Add:  Stock-based employee compensation expense recorded                                   |       | —                                             |       | 10                                                |       | — |   | 30 |   |
| Less:  Stock based employee compensation expense determined under fair value  calculations |       | (17                                                | )          | (10                                               | )          | (51 | ) | (30 | ) |
| Pro  forma                                                                                 |       | $                                                  | 115        |                                              | $          | (58 | ) | $ | 259 |   | $ | 191 |   |
|                                                                                       |       |                                               |       |                                              |       |   |   |   |   |
| Basic  income (loss) per share:                                                            |       |                                               |       |                                              |       |   |   |   |   |
| As  reported                                                                               |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.02 |   |
| Add:  Stock-based employee compensation expense recorded                                   |       | —                                             |       | —                                            |       | — |   | — |   |
| Less:  Stock based employee compensation expense determined under fair value  calculations |       | —                                             |       | —                                            |       | — |   | — |   |
| Pro  forma                                                                                 |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.02 |   |
|                                                                                       |       |                                               |       |                                              |       |   |   |   |   |
| Diluted  income (loss) per share:                                                          |       |                                               |       |                                              |       |   |   |   |   |
| As  reported                                                                               |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |
| Add:  Stock-based employee compensation expense recorded                                   |       | —                                             |       | —                                            |       | — |   | — |   |
| Less:  Stock based employee compensation expense determined under fair value  calculations |       | —                                             |       | —                                            |       | — |   | — |   |
| Pro  forma                                                                                 |       | $                                                  | 0.01       |                                              | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |

 

**11.****                               LegalProceedings**

 

*Hotel Information Systems, Inc.*

 

On March 25, 2003, the Company entered into asettlement agreement with Hotel Information Systems (“HIS”) and one

 

9

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of its former corporate officers whereby (i) theparties dismissed all claims, known and unknown, against each other; (ii) theCompany forgave and wrote off a note receivable from the former corporateofficer of HIS in the amount of $66,000 (which was expensed to other expense inthe 2002 consolidated statement of operations); (iii) the Company paid $50,000in cash and issued a non-interest bearing unsecured promissory note whichrequires 35 consecutive monthly payments of $5,000 each commencing April 1,2003; and (iv) the remaining 374,116 shares in the escrow account will bereleased to the Company.  If the Companyis delinquent four times in any twelve-month period during the term of the unsecuredpromissory note in making its $5,000 monthly payments to HIS, and HIS issuesrespective valid default notices, the Company will be subject to a $225,000penalty.  The 374,116 shares have beenreceived by MAI together with the HIS authorization to legally transfer suchshares to MAI.

 

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

### * *

*Logix Development Corporation*

 

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

 

In December 2003, the Company entered intoanother settlement agreement with Logix whereby it (i) issued 200,000 freetrading shares in exchange for the 200,000 restricted Common Shares from theoriginal settlement agreement in July 2002 (ii) required the Company tomake monthly payments totaling $187,500 over a 25 month period and (iii)mutually released each other of all past, present and future claims associatedwith 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.****                               ComprehensiveIncome (Loss)**

 

The following table summarizes components ofcomprehensive income (loss):

 
| ** **                                    | ** ** | **For The Three Months Ended  September 30,** | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                    | ** ** | **2003**                                           | ** ** | **2004**                                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                          |       |                                               |       |                                              |       |   |   |   |   |
| Net  income (loss)                            |       | $                                                  | 132        |                                              | $          | (58 | ) | $ | 310 |   | $ | 191 |   |
| Change  in cumulative translation adjustments |       | (11                                                | )          | 13                                                |       | 28 |   | (46 | ) |
| Comprehensive  income (loss)                  |       | $                                                  | 121        |                                              | $          | (45 | ) | $ | 338 |   | $ | 145 |   |

 

Accumulated other comprehensive income in theaccompanying consolidated balance sheets consists of cumulative translationadjustments and minimum pension liability.

 

**13.**                               ManagementEquity/Conversion Transaction

** **

**OnNovember 1, 2004, the Company converted $3,317,211 of its indebtedness tothe Investor Group on such date, at $0.10 per share, and issued  33,172,110 shares of its common stocktogether with 10,000,000 shares of its commons stock relating to the $1,000,000private placement to the Investor Group.**

** **

**10**

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** **

*Pro Forma Financial InformationShowing Effect of Management Equity/Conversion Transaction*

 

The unaudited pro formaconsolidated balance sheet set forth below give effect to the ManagementEquity/Conversion Transaction as if it had occurred on September 30, 2004.The unaudited pro forma consolidated statements of operations for the three andnine months ended September 30, 2004 give effect to the ManagementEquity/Conversion Transaction as if it had occurred on January 1, 2004.The pro forma financial information does not purport to represent what theCompany’s financial position or what the results of operations would haveactually been had the Management Equity/Conversion Transaction occurred at suchdates or to project the Company’s financial position or results of operationsfor any future date or period. In addition, it does not incorporate anybenefits from anticipated cost savings or revenue growth from the ManagementEquity/Conversion Transaction.

 

The pro forma adjustmentsinclude the effect of to the amortization of any identifiable intangible assetsrecorded in connection with purchase accounting over their respective usefullives estimated at five years which reduces pro forma net income (loss) andincome (loss) per share. The Company has engaged a third party expert toperform a valuation of the intangible and tangible assets.

 

Pursuant to an actiontaken by written consent of the Special Committee of the Board of Directors ofMAI Systems Corporation on October 15, 2003, the Company and an investorgroup consisting of certain members of senior management (Mr. Ressler, Mr.Dolan and Mr. Kretzmer) and certain third parties (the “Investor Group”) agreedto the Management Equity/Conversion Transaction, subject to execution ofdefinitive documents with CSA, shareholder approval and other requirements suchas receipt of a fairness opinion. Subsequent to the approval of the SpecialCommittee of the Board of Directors on October 15, 2003, the InvestorGroup negotiated directly with Computer Sciences Corporation to acquire the MAIshares held by CSA together with a portion of CSA’s indebtedness from MAI. On April 9,2004, Computer Sciences Corporation agreed to terms with the Investor Group toacquire CSA’s equity position and $3,194,156 of Company indebtedness from CSA. OnSeptember 22, 2004, the Company received approval from its shareholdersfor the Investor Group to convert the Company indebtedness acquired from CSAplus any accrued interest through the date of conversion for  33,172,110 shares of its common stock basedupon a conversion price of $0.10 per share. Additionally, the shareholders also approved for the Investor Group toinvest $1,000,000 of new cash proceeds into the Company, which the Companyreceived on September 24, 2004, in a private placement at $0.10 per share

 

As the conversion priceof the acquired indebtedness of $0.10 per share was lower than the fair value(quoted market price) on April 9, 2004 (the date that Computer SciencesCorporation agreed to terms with the Investor Group to acquire CSA’s debt andequity position) (see Note 5) of $0.18 per share, a beneficial conversion righthas been provided to the Investor Group. The value of this beneficialconversion right has been measured for accounting purposes on April 9,2004, as $2.6 million. The Company will record this value as a charge tointerest expense on November 1, 2004, the date of the debt conversion andshares were issued.

 

In addition, the marketprice for the Company’s common stock was $0.14 per share on November 1,2004, the date of issuance of the 10,000,000 shares of the Company’s common stockto the Investor Group.  Accordingly, theCompany will record a $250,000 charge to stock compensation expense sincecertain members of the Company’s management are also members of the InvestorGroup. The amount of the charge is based on the 6,250,000 shares attributableto members of management based on their share in the Investor Group multipliedby the amount that the market price of the Company’s common stock of $0.14 pershare exceeded the $0.10 per share on the date of issuance of such shares.

 

The Company believes thatthe aforementioned transaction permits but does not require it to use new basisor push down accounting since the members of the Investor Group will holdbetween 80% and 94% of the voting shares of the Company upon completion of thetransaction. The Company has elected to apply push down accounting.

 

11

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TheCompany currently has a stockholders’ deficit of approximately $13.4 millionand an accumulated deficit of approximately $232 million. After application ofthe push down accounting, the portion of the historic deficit attributable tothe Investor Group’s new ownership will be eliminated, and stockholders’deficit will be partially reset based on the Investor Group’s new basis in MAIof approximately $2.25 million. Post push down stockholders’ equity(deficiency) will be calculated as follows (in thousands):

 
| Non-Investor  Group:                                               |   |   |    |   |   |
|--------------------------------------------------------------------|--------|--------|---------|--------|--------|
| Historic  stockholders’ deficiency at September 30, 2004 |   | $      | (13,412 | )      |   |   |
| Non-Investor  Group Ownership (100% – 83.37%)                 |   | 16.63  | %       |   |   |
| Non-Investor  Group basis to carry over                            |   |   |    | $      | (2,230 | ) |
|                                                               |   |   |    |   |   |
| Investor  Group:                                                   |   |   |    |   |   |
| New  basis to push down                                            |   |   |    | $      | 2,250  | (a) |
| Original  basis to carry over                                      |   | $      | (13,412 | )      |   |   |
| Investor  Group pre-existing ownership percentage                  |   | 4.53   | %       |   |   |
|                                                               |   |   |    | (608   | )      |
|                                                               |   |   |    |   |   |
| New  stockholders’deficiency                                  |   |   |    | $      | (588   | ) |

** **

----

(a)          $2 million investmentfrom Investor Group used to purchase debt and MAI shares from CSA plus approximately$250,000 stock compensation expense attributable to members of Investor Groupwhich are also members of the Company’s management (See footnote (e) to the proforma financial statements).

 

Based on the balancesheet as of September 30, 2004, and considering the additional equityinvestment and debt conversion by the Investor Group, application of  push down accounting will result in a step-upin basis of the net assets of the Company of approximately $9,531,000calculated as follows (in thousands):

 
| Historical  stockholders’ deficiency at September 30, 2004 |   | $     | (13,412 | ) |
|----------------------------------------------------------------------|--------|-------|---------|---|
| Conversion  of Investor Group debt at book value                     |   | 3,293 |    |
| Step  up in value of net assets                                      |   | 9,531 |    |
| Post  push-down accounting stockholders’ deficiency             |   | $     | (588    | ) |

** **

In accordance with pushdown accounting, the following pro forma statements of operations for theperiods presented do not reflect estimated stock compensation and beneficialconversion charges of $250,000 and $2,635,000, respectively, resulting from theManagement Equity/Conversion Transaction as such amounts will be charged toexpense in the financial statements prior to the application of push downaccounting and will have no impact on the post transaction balance sheet orstatement of operations.

 

12

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**PRO FORMA CONSOLIDATED BALANCE SHEET**

**As of September 30, 2004**

**(UNAUDITED)**

** **
| ** **                                                       | ** ** | **Historical** | ** ** | **Pro Forma  Adjustments** | ** ** | **Footnotes** | ** ** | **Pro Forma** | ** ** |
|------------------------------------------------------------------|------------|----------------|------------|----------------------------|------------|---------------|------------|---------------|------------|
|                                                             |       |           |       |                       |       |          |       |          |       |
| **ASSETS**                                                       |       |           |       |                       |       |          |       |          |       |
| Current  assets:                                                 |       |           |       |                       |       |          |       |          |       |
| Cash                                                             |       | $              | 555        |                       | $          | —        |       |          |       | $ | 555 |   |
| Receivables,  less allowance for doubtful accounts               |       | 2,130          |       | —                     |       |          |       | 2,130         |       |
| Inventories,  net                                                |       | 74             |       | —                     |       |          |       | 74            |       |
| Prepaids  and other assets                                       |       | 659            |       | —                     |       |          |       | 659           |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Total  current assets                                            |       | 3,418          |       | —                     |       |          |       | 3,418         |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Furniture,  fixtures and equipment, net                          |       | 501            |       | —                     |       |          |       | 501           |       |
| Intangibles,  net                                                |       | 3,697          |       | —                     |       |          |       | 3,697         |       |
| Intangible  assets from Management Equity/Conversion Transaction |       | —         |       | 9,531                      |       | (b)           |       | 9,531         |       |
| Other  assets                                                    |       | 14             |       | —                     |       |          |       | 14            |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Total  assets                                                    |       | $              | 7,630      |                       | $          | 9,531         |       |          |       | $ | 17,161 |   |
|                                                             |       |           |       |                       |       |          |       |          |       |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                |       |           |       |                       |       |          |       |          |       |
| Current  liabilities:                                            |       |           |       |                       |       |          |       |          |       |
| Current  portion of long-term debt                               |       | $              | 983        |                       | —     |          |       |          | $          | 983 |   |
| Accounts  payable                                                |       | 1,078          |       | —                     |       |          |       | 1,078         |       |
| Customer  deposits                                               |       | 2,243          |       | —                     |       |          |       | 2,243         |       |
| Accrued  liabilities                                             |       | 2,725          |       | (160                       | )          | (c)           |       | 2,565         |       |
| Income  taxes payable                                            |       | 111            |       | —                     |       |          |       | 111           |       |
| Unearned  revenue                                                |       | 3,415          |       | —                     |       |          |       | 3,415         |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Total  current liabilities                                       |       | 10,555         |       | (160                       | )          |          |       | 10,395        |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Long-term  debt                                                  |       | 9,982          |       | (3,133                     | )          | (c)           |       | 6,849         |       |
| Other  liabilities                                               |       | 505            |       | —                     |       |          |       | 505           |       |
| Total  liabilities                                               |       | 21,042         |       | (3,293                     | )          |          |       | 17,749        |       |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Stockholders’  deficiency:                                  |       |           |       |                       |       |          |       |          |       |
| Preferred  Stock                                                 |       | —         |       | —                     |       |          |       |          |       |
| Common  Stock                                                    |       | 152            |       | 424                        |       | (d)           |       | 576           |       |
| Additional  paid-in capital                                      |       | 218,112        |       | (169,431                   | )          | (d)           |       | 48,681        |       |
| Common  stock subsribed                                          |       | 1,000          |       | (1,000                     | )          | (a)           |       | —        |       |
| Accumulated  other comprehensive income:                         |       |           |       |                       |       |          |       |          |       |
| Minimum  pension liability                                       |       | (1,005         | )          | 792                        |       | (d)           |       | (213          | )          |
| Foreign  currency translation                                    |       | (47            | )          | 37                         |       | (d)           |       | (10           | )          |
| Unearned  compensation                                           |       | (25            | )          | 20                         |       | (d)           |       | (5            | )          |
| Accumulated  deficit                                             |       | (231,599       | )          | 181,982                    |       | (d) (e)       |       | (49,617       | )          |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Total  stockholders’ deficiency                             |       | (13,412        | )          | 12,824                     |       |          |       | (588          | )          |
|                                                             |       |           |       |                       |       |          |       |          |       |
| Total  liabilities and stockholders’ deficiency             |       | $              | 7,630      |                       | $          | 9,531         |       |          |       | $ | 17,161 |   |

 

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** **

**PRO FORMA CONSOLIDATEDSTATEMENT OF OPERATIONSFor the three months ended September 30, 2004(UNAUDITED)(In thousands, except per share data)**

** **
| ** **                                                                   | ** ** | **Historical** | ** ** | **Pro Forma  Adjustments** | ** ** | **Footnotes** | ** ** | **Pro Forma** | ** ** |
|------------------------------------------------------------------------------|------------|----------------|------------|----------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                   | ** ** | ** **     | ** ** | ** **                 | ** ** | ** **    | ** ** | ** **    | ** ** |
| Revenue:                                                                     |       |           |       |                       |       |          |       |          |       |
| Software                                                                     |       | $              | 842        |                       | —     |          |       |          | $          | 842 |   |
| Network and  computer equipment                                              |       | 118            |       | —                     |       |          |       | 118           |       |
| Services                                                                     |       | 3,923          |       | —                     |       |          |       | 3,923         |       |
| Total  revenue                                                               |       | 4,883          |       | 4,883                      |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Direct  costs:                                                               |       |           |       |                       |       |          |       |          |       |
| Software                                                                     |       | 40             |       | 477                        |       | (b)           |       | 517           |       |
| Network and  computer equipment                                              |       | 103            |       | —                     |       |          |       | 103           |       |
| Services                                                                     |       | 1,264          |       | —                     |       |          |       | 1,264         |       |
| Total direct  costs                                                          |       | 1,407          |       | 477                        |       |          |       | 1,884         |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Gross profit                                                                 |       | 3,476          |       | (477                       | )          |          |       | 2,999         |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Selling,  general and administrative expenses                                |       | 2,200          |       | —                     |       |          |       | 2,200         |       |
| Research and  development costs                                              |       | 956            |       | —                     |       |          |       | 956           |       |
| Other  operating expense                                                     |       | 48             |       | —                     |       |          |       | 48            |       |
| Operating  income (loss)                                                     |       | 272            |       | (477                       | )          |          |       | (205          | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Interest  income                                                             |       | —         |       | —                     |       |          |       | —        |       |
| Interest  expense                                                            |       | (303           | )          | 80                         |       | (f)           |       | (223          | )          |
| Other  non-operating expense                                                 |       | (22            | )          | —                     |       |          |       | (22           | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Income  (loss) before income tax benefit                                     |       | 53             |       | (397                       | )          |          |       | (450          | )          |
| Income taxes  expense                                                        |       | (5             | )          | —                     |       |          |       | (5            | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Net income  (loss)                                                           |       | $              | (58        | )                          | $          | (397          | )          |          |       | $ | (455 | ) |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Income  (loss) per share:                                                    |       |           |       |                       |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Basic income  (loss) per share                                               |       | $              | 0.00       |                       | $          | (0.01         | )          |          |       | $ | (0.01 | ) |
| Diluted  income (loss) per share                                             |       | $              | 0.00       |                       | $          | (0.01         | )          |          |       | $ | (0.01 | ) |
| Weighted  average common shares used in determining income (loss) per share: |       |           |       |                       |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Basic                                                                        |       | 14,676         |       | 42,933                     |       |          |       | 57,609        |       |
| Diluted                                                                      |       | 14,676         |       | 42,933                     |       |          |       | 57,609        |       |

** **

**14**

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**PRO FORMA CONSOLIDATEDSTATEMENT OF OPERATIONSFor the nine months ended September 30, 2004(UNAUDITED)(In thousands, except per share data)**

 
| ** **                                                                   | ** ** | **Historical** | ** ** | **Pro Forma  Adjustments** | ** ** | **Footnotes** | ** ** | **Pro Forma** | ** ** |
|------------------------------------------------------------------------------|------------|----------------|------------|----------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                   | ** ** | ** **     | ** ** | ** **                 | ** ** | ** **    | ** ** | ** **    | ** ** |
| Revenue:                                                                     |       |           |       |                       |       |          |       |          |       |
| Software                                                                     |       | $              | 2,945      |                       | —     |          |       |          | $          | 2,945 |   |
| Network and  computer equipment                                              |       | 329            |       | —                     |       |          |       | 329           |       |
| Services                                                                     |       | 11,683         |       | —                     |       |          |       | 11,683        |       |
| Total  revenue                                                               |       | 14,957         |       | 14,957                     |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Direct  costs:                                                               |       |           |       |                       |       |          |       |          |       |
| Software                                                                     |       | 369            |       | 1,430                      |       | (b)(e)        |       | 1799          |       |
| Network and  computer equipment                                              |       | 272            |       | —                     |       |          |       | 272           |       |
| Services                                                                     |       | 3,446          |       | —                     |       |          |       | 3,446         |       |
| Total direct  costs                                                          |       | 4,087          |       | 1,430                      |       |          |       | 5,517         |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Gross profit                                                                 |       | 10,870         |       | (1,430                     | )          |          |       | 9,440         |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Selling,  general and administrative expenses                                |       | 6,900          |       | —                     |       |          |       | 6,900         |       |
| Research and  development costs                                              |       | 2,756          |       | —                     |       |          |       | 2,756         |       |
| Other  operating expense                                                     |       | 67             |       | —                     |       |          |       | 67            |       |
| Operating  income (loss)                                                     |       | 1,147          |       | (1,430                     | )          |          |       | (283          | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Interest  income                                                             |       | 1              |       | —                     |       |          |       | 1             |       |
| Interest  expense                                                            |       | (882           | )          | 240                        |       | (f)           |       | (642          | )          |
| Other  non-operating expense                                                 |       | (60            | )          | —                     |       |          |       | (60           | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Income  (loss) before income tax expense                                     |       | 206            |       | (1,190                     | )          |          |       | (984          | )          |
| Income taxes  expense                                                        |       | (15            | )          | —                     |       |          |       | (15           | )          |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Net income  (loss)                                                           |       | $              | 191        |                       | $          | (673          | )          |          |       | $ | (999 | ) |
| Income  (loss) per share:                                                    |       |           |       |                       |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Basic income  (loss) per share                                               |       | $              | 0.01       |                       | $          | (0.03         | )          |          |       | $ | (0.02 | ) |
| Diluted  income (loss) per share                                             |       | $              | 0.01       |                       | $          | (0.03         | )          |          |       | $ | (0.02 | ) |
| Weighted average  common shares used in determining income (loss) per share: |       |           |       |                       |       |          |       |          |       |
|                                                                         |       |           |       |                       |       |          |       |          |       |
| Basic                                                                        |       | 14,676         |       | 42,933                     |       |          |       | 57,609        |       |
| Diluted                                                                      |       | 14,676         |       | 42,933                     |       |          |       | 57,609        |       |

 

----

Footnotes:

(a)                                  $1,000,000private placement from Investor Group in September 2004 and is classifiedas Common Stock Subscribed in the accompanying pro forma balance sheet.

(b)                                 Preliminaryestimate of definite life intangible assets to be recorded from ManagementEquity/Conversion Transaction using purchase accounting. Intangible assets willbe amortized over a five-year life. For purposes of the pro forma financialstatements, no amounts have been allocated to goodwill.

(c)                                  $3,133,000of secured debt and $160,000 of accrued interest dueto Investor Group and converted to equity.

(d)                                 Purchaseaccounting adjustments to common stock, additional paid-in capital, accumulatedother comprehensive income and accumulated deficit relating to the $250,000compensation charge (see footnote (e) below), $2,635,000 beneficial conversionfeature (see footnote (f) below) and $3,133,000 of secured debt and $160,000 ofaccrued interest converted to equity (see (c) above). Accumulated deficit andother comprehensive income are adjusted to equal minority interest’s share(16.63%) plus Investor Group share from pre-existing ownership (4.53%) of pretransaction amounts. Common stock and additional paid-in capital adjustmentsequals the balance necessary to force net equity change toequal the $9,531,000 step up in book value.

(e)                                  Proforma adjustments do not include a $250,000 non cash stock compensation expenseto be recorded prior to the application of push down accounting in connectionwith the Investor Group private placement. This expense will be recorded uponissuance of the 10,000,000 shares of MAI stock on November 1, 2004, basedon the pro rata portion of shares being issued that are attributable to membersof the Company’s management of 62.5%

 

15

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(Mr. Ressler,Mr. Dolan and Mr. Kretzmer) multiplied by the excess of the market value of theCompany’s common stock on date of issuance of $0.14 per share over the $0.10per share purchase price.

(f)                                    Reductionof interest expense as a result of approximately $3.3 million of debt convertedto equity. Does not include the charge to interest expense to be recorded priorto the application of push down accounting for the beneficial conversion rightprovided to the Investor Group of $2,635,000 (32,933,120 shares to be issuedupon conversion of the outstanding debt as of September 30, 2004 times thedifference between the closing price of MAI’s stock at April 9, 2004 of$0.18 per share and the conversion price of $0.10 per share), which shall becharged to interest expense in the period the conversion occurs.

 

**16**

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**Item 2.**  Management’sDiscussion And Analysis Of Financial Condition And Results OfOperations

 

## **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 historical experienceand on various other assumptions that are believed to be reasonable under thecircumstances. This forms the basis of judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

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 programs areshipped to end users, resellers and distributors, provided the Company is notrequired to provide services essential to the functionality of the software orsignificantly modify, customize or produce the software.  Professional services fees for softwaredevelopment, training and installation are recognized as the services areprovided. Maintenance revenues are recorded evenly over the related contractperiod.

 

**Accounts Receivable**

 

We maintain allowances for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments. The amount of our reserves is based on historicalexperience and our analysis of the accounts receivable balances outstanding. Ifthe financial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired which would result in an additional general and administrative expensein the period such determination was made. While such credit losses havehistorically been within our expectations and the provisions established, wecannot guarantee that we will continue to experience the same credit loss ratesthat we have in the past.

 

**Intangible and Long-Lived Assets**

 

At December 31, 2003 and September 30, 2004, intangible andother long-lived assets represented 56% and 55%, respectively, of the Company’stotal assets.

 

Goodwill must be tested at least annually for impairment at a level ofreporting referred to as the reporting unit and more frequently if adverseevents or changes in circumstances indicate that the asset may beimpaired.   The Company did not record animpairment charge upon completion of the initial impairment reviews on January 1,2002 or upon 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.

 

17

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**AccruedExpenses**

 

The Company reviews its contingentliabilities, which arise primarily from litigation and litigation defensecosts, in accordance with Statement of Financial Accounting StandardsNo. 5 (SFAS 5), “Accounting for Contingencies”.  Contingent liabilities are recorded as liabilitieswhen it is probable that a liability has been incurred and the amount of theloss is reasonably estimable.  Contingentliabilities are often resolved over long periods.  Estimating probable losses requires judgmentsabout both the amount of liability, which may or may not be readilydeterminable, and the likelihood of liability, which involves ranges ofprobability that can at times be broad and depend on the potential actions ofthird parties.

 

**Provisionfor Income Taxes**

 

Provision for income taxes is based upon the Company’s estimate oftaxable income or loss for each respective accounting period.  An asset or liability is recognized for thedeferred tax consequences of temporary differences between the tax bases ofassets and liabilities and their reported amounts in the financialstatements.  These temporary differenceswill result in taxable or deductible amounts in future periods when thereported amounts of assets are recovered or liabilities are settled. TheCompany regularly reviews its deferred tax assets to determine the amount thatis more likely than not to be realized. When this amount is less than thedeferred tax asset recorded, the Company records a valuation allowance toreduce the asset to its estimated realizable value.  If the Company determined that it was notgoing to be able to fully realize its recorded deferred tax assets, it wouldmake an adjustment to the valuation allowance. This would reduce net income in the period that the Company made itsdetermination.  Similarly, if the Companyrealized that it was going to be able to fully realize a deferred tax asset inexcess of its net recorded value, net income would be increased in the periodthat the Company made its determination.

 

The Company also reviews its deferred tax liabilities on a regularbasis to determine that the amount recorded is adequate to cover the expectedreversal of temporary income tax liabilities. In the event that the amount recorded was less than adequate, the deferredtax liability would be increased to its estimated realizable value and netincome would be decreased accordingly. In the event that the deferred tax liability was determined to beoverstated, it would be reduced to its estimated realizable value and netincome would increase accordingly.

 

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

 

**SoftwareDevelopment Costs**

 

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

 

The Company capitalized $619,000 and $821,000 ofsoftware development costs for the period ending September 30, 2003 and2004 respectively, relating to our new N-Tier, Internet-native corporateapplication suite of products written in java. We believe that these new products will produce new sales adequate torecover amounts capitalized.  We expectthat certain of our new products will be available for general release duringthe first quarter of 2005 at which time amortization of such costs shallcommence. There can be no assurance that the company will be able to generate sufficientcash flow to continue to fund its research and development activities relatedto the N-Tier product.

 

## **Liquidity and CapitalResources**

 

At September 30,2004, our working capital deficiency decreased from a working capitaldeficiency of $10,399,000 at December 31, 2003 to a working capitaldeficiency of $7,137,000.  Excludingunearned revenue of $3,415,000, working capital deficiency at September 30,2004 was $3,722,000.  Excluding unearnedrevenue of $3,209,000, the Company’s working capital deficiency at December 31,2003 was $7,190,000.  Excluding unearnedrevenue, the

 

18

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decreasein the working capital deficiency of $3,468,000 was primarily attributable toincreases in receivables of $817,000 and decreases in current portion of longterm debt of $2,663,000, customer deposits of $90,000, accrued liabilities of$334,000 offset by decrease in cash of $109,000 and increase in accountspayable of $174,000.

 

Net cash used ininvesting activities for the period ended September 30, 2004 totaled$919,000, which is comprised of capital expenditures of $98,000 and capitalizedsoftware of $821,000.

 

Net provided byfinancing activities for the period ended September 30, 2004 totaled$406,000, which represents a $1,000,000 private placement of cash by anInvestor Group offset by $594,000 of repayments on long-term debt.  On March 31, 2004, the Companysuccessfully re-negotiated the terms of its Wamco 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 include aminimum quick ratio of 0.20 to 1.00 and a minimum debt coverage ratio of 0.50to 1.00 which commence as of and for the three month period ended March 31,2004 and for each and every fiscal quarter ending thereafter.  The Company was in compliance with theamended debt covenants as of and for the period ending September 30, 2004.There is no guaranty that the Company will meet its debt covenants in thefuture.  In the event that the Companywere not in compliance with the various restrictions and covenants and wereunable to receive waivers for non-compliance, the term loan would beimmediately due and payable.

 

Stockholders’deficiency decreased from $14,586,000 at December 31, 2003 to $13,412,000at September 30, 2004, mainly as a result of a $1,000,000 privateplacement of cash for subscribed common stock and net income during the periodof $191,000.

 

Although theCompany has a net stockholders’ deficiency of $13,412,000 and a working capitaldeficit of $7,137,000 at September 30, 2004, the Company believes it willgenerate sufficient funds from operations to meet its operating and capitalrequirements.  In the event that theCompany cannot generate positive cash flow from its operations during 2004 and2005, the Company can substantially reduce its research and development effortsto mitigate cash outflow to help sustain its operations.  There can be no assurance that the Companywill be able to sustain profitability or generate positive cash flow fromoperations; however, the Company expects to generate positive cash flow fromits operations during 2004 and 2005 from shipping out products and servicesfrom its current backlog as of September 30, 2004 as well as new orders.These financial statements have been prepared assuming the Company willcontinue to operate as a going concern. If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company, including protection under the bankruptcy laws.

 

## **ContractualObligations and Commercial Commitments**

 

The following table summarizes the Company’sobligations and commitments as of September 30, 2004, excluding interestand original issue discount:

 
| ** **                       | ** ** | **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                  |       | $                                          | 11,045     |   | $ | 983 |   | $ | 6,452 |   | $ | 3,278 |   | $ | 332 |   |
| Operating  Leases                |       | 1,321                                      |       | 479 |   | 842 |   | — |   | — |   |
| Consulting  Agreements           |       | 30                                         |       | 30 |   | — |   | — |   | — |   |
|                             |       | $                                          | 12,396     |   | $ | 1,492 |   | $ | 7,293 |   | $ | 3,278 |   | $ | 332 |   |

 

19

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**Results ofOperations**

 

Three MonthsEnded September 30, 2003 Compared to Three Months Ended September 30,2004

 
| ** **                                    | ** ** | **September 30,  2003** | ** ** | **Percentage of  Revenue** | ** ** | **September 30,  2004** | ** ** | **Percentage of  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|----------------------------|------------|------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **(in thousands)**           | ** ** | ** **                 | ** ** | **(in thousands)**           | ** ** | ** **                 | ** ** |
| Revenue:                                      | ** ** | $                            | 4,814      |                       | 100.0      | %                            | $          | 4,883                      |       | 100.0 | % |
| Gross profit                                  |       | 3,465                        |       | 71.9                       | %          | 3,476                        |       | 71.2                       | %          |
| Selling,  general and administrative expenses |       | 2,307                        |       | 47.9                       | %          | 2,200                        |       | 45.1                       | %          |
| Research and  development costs               |       | 764                          |       | 15.9                       | %          | 956                          |       | 19.6                       | %          |
| Other  operating expense                      |       | (134                         | )          | (2.8                       | )%         | 48                           |       | 1.0                        | %          |
| Interest  expense, net                        |       | 286                          |       | 5.9                        | %          | 303                          |       | 6.2                        | %          |
| Other  non-operating expense                  |       | 98                           |       | 2.0                        | %          | 22                           |       | 0.5                        | %          |
| Income tax  expense                           |       | 12                           |       | 0.2                        | %          | 5                            |       | 0.1                        | %          |
| Net income  (loss)                            |       | $                            | 132        |                       | 2.7        | %                            | $          | (58                        | )          | 1.2 | % |

 

Revenue for 2004 was $4,883,000 compared to $4,814,000in 2003 or a 1.4% increase. Revenue increased $69,000 in 2004, as a result ofincreased software support service.

 

Gross profit for 2004 increased to $3,476,000 from$3,465,000 in 2003.  The slight increasein gross profit is mainly due to the decreased software costs from 2003 to2004.

 

Selling, general and administrative expenses (“SG&A”)decreased from $2,307,000 in 2003 to $2,200,000 in 2004.  The decrease is mainly due to closing theCompany’s Mexico office in January, 2004 and the ongoing effects of themanagement cost control program resulting in reduced vendor costs andconsulting services.

 

Research and development costs increased from $764,000in 2003 to $956,000 in 2004. The increase is mainly due to the addition of severaldevelopers in the Company’s Malaysia operations, including associated overheadcosts and  otherconsulting services.  The Companycapitalized $200,000 and $217,000 of software development costs in 2003 and2004, respectively, associated with the Company’s product development of itsnew internet native suite of applications as well as our core productofferings.

 

Net interest expense was $286,000 in 2003 compared to$303,000 in 2004.

 

Other non-operating expense decreased from $98,000 in2003 to $22,000 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 $22,000 in 2004 mainly relates to minority interest expensesassociated with our Asian Operations. There were nomaterial defined benefit expenses recorded in 2004.

 

20

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Nine Months Ended September 30, 2003 Compared to Nine Months EndedSeptember 30, 2004

 
| ** **                                    | ** ** | **September 30,  2003** | ** ** | **Percentage of  Revenue** | ** ** | **September 30,  2004** | ** ** | **Percentage of  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|----------------------------|------------|------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **(in thousands)**           | ** ** | ** **                 | ** ** | **(in thousands)**           | ** ** | ** **                 | ** ** |
| Revenue                                       |       | $                            | 14,752     |                       | 100.0      | %                            | $          | 14,957                     |       | 100.0 | % |
| Gross profit                                  |       | 10,705                       |       | 72.6                       | %          | 10,870                       |       | 72.7                       | %          |
| Selling,  general and administrative expenses |       | 7,277                        |       | 49.3                       | %          | 6,900                        |       | 46.1                       | %          |
| Research and  development costs               |       | 2,104                        |       | 14.3                       | %          | 2,756                        |       | 18.4                       | %          |
| Other  operating expense (income)             |       | (181                         | )          | (1.2                       | )%         | 67                           |       | 0.4                        | %          |
| Interest  expense, net                        |       | 928                          |       | 6.3                        | %          | 882                          |       | 5.9                        | %          |
| Other  non-operating expense                  |       | 309                          |       | 2.1                        | %          | 60                           |       | 0.4                        | %          |
| Income tax  expense (benefit)                 |       | (41                          | )          | (0.3                       | )%         | 15                           |       | 0.1                        | %          |
|                                          |       |                         |       |                       |       |                         |       |                       |       |
| Net income                                    |       | $                            | 310        |                       | 2.1        | %                            | $          | 191                        |       | 1.3 | % |

 

Revenue for 2004 was $14,957,000 compared to$14,752,000 in 2003 or a 1.0% increase. Revenue increased $205,000 in 2004, asa result of increased software support services driven by slight priceincreases.

 

Gross profit for 2004 increased to $10,870,000 from$10,705,000 in 2003.  The increase ingross profit is mainly due to the increase in professional and support servicesrevenues.

 

Selling, general and administrative expenses (“SG&A”)decreased from $7,277,000 in 2003 to $6,900,000 in 2004.  The decrease is mainly due to the closing ofthe Company’s Mexico office in January, 2004 and the ongoing effects of  the managementcost control program resulting in reduced, building rent and consultingservices.

 

Research and development costs increased from$2,104,000 in 2003 to $2,756,000 in 2004. The company capitalized $619,000 and $821,000 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 primarily incurredas a result of the addition of several developers in the Company’s Malaysiaoperations, including associated overhead costs and  other consulting services

 

Other operating expense (income) was ($181,000) in2003 and $67,000 in 2004.  Otheroperating income in 2003 is due to receipt of approximately $46,000 of cashresulting from a legal settlement on a tax claim with the United StatedInternal Revenue Service that resulted in a one-time gain of $262,000.  There was no such gain in 2004.

 

Net interest expense was $928,000 in 2003 compared to$882,000 in 2004.  The decrease is due tolower balances of interest bearing debt during 2004 as compared to 2003.

 

Other non-operating expense decreased from $309,000 in2003 to $60,000 in 2004.  In 2003non-operating expense relates to pension expense under a defined benefit planfor former employees from our discontinued operations.  In 2004 $35,000 relates to minority interestexpense associated with our Asia Operations. There were nomaterial defined benefit expense recorded in 2004.

 

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.**  QuantitativeAnd Qualitative Disclosures About Market Risk

*** ***

***Market Risk Disclosures***

 

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

 

***Interest Rate Sensitivity***

 

Of our $11.0 million principal amount of indebtednessat September 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 afixed rate of 10%, $1.0 million bears interest at 9.25% and $0.7 million bearsfixed interest rates ranging from 6% to 17.5%. Since these debt instrumentsbear interest at fixed rates, we have no exposure to decreases in interestrates because we still are required

 

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topay the fixed rate even if current interest rates are lower.

 

***Foreign Currency 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 September 30,2004.

 

**Item 4.**  Evaluationof Disclosure Controls and Procedures

** **

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

 

We evaluated the design and operation ofour disclosure controls and procedures to determine whether they are effectivein ensuring that we disclose the required information in a timely manner and inaccordance with the Securities Exchange Act of 1934, as amended, or theExchange Act, and the rules and forms of the Securities and ExchangeCommission. Management, including our principal executive officer and principalfinancial officer, supervised and participated in the evaluation. Theevaluation was completed as of September 30, 2004. The principal executiveofficer and principal financial officer concluded, based on their review, thatour disclosure controls and procedures, as defined by Exchange Act Rules13a-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 how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met. Because of the inherentlimitations in all control systems no evaluation of controls can provideabsolute assurance that all control issues if any, within a company have beendetected.

 

On November 17, 2004, the Company’s independentauditors orally notified the Company’s Audit Committee that they had identifiedsignificant deficiencies regarding the Company’s internal controls. Thedeficiencies noted were mainly (a) the lack of segregation of duties and (b)the lack of adequate account analysis and reconciliations, and (c) insufficientsupervision of the Company’s accounting personnel.  The Company believessuch deficiencies were primarily attributable to changes in personnel withinthe accounting department combined with the lack of adequate resources giventhe size of the Company.  However, the 

Company has taken steps to improve theseinternal control weaknesses

 

Based on the investigation by the Company’sAudit Committee and additional procedures performed by management, the Companyhas concluded that, except as noted above, and subject to the inherentlimitations in all control systems, the Company’s current disclosure controlsand procedures are sufficient to timely alert the Company’s management tomaterial information relating to the Company that is required to be included inour periodic Securities and Exchange Committee filings, and that the internalcontrols are sufficient to provide reasonable assurance that the consolidatedfinancial statements are fairly presented in conformity with generally acceptedaccounting principles.

 

#### ***(b)***         Changes in internalcontrols

 

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

 

**PART II - OTHERINFORMATION**

** **

**Item 1.**  LegalProceedings

 

*Hotel Information Systems, Inc.*

 

On March 25, 2003, the Company entered into asettlement agreement with Hotel Information Systems (“HIS”) and one

 

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of its former corporate officers whereby (i) theparties dismissed all claims, known and unknown, against each other; (ii) theCompany forgave and wrote off a note receivable from the former corporateofficer of HIS in the amount of $66,000 (which was expensed to other expense inthe 2002 consolidated statement of operations); (iii) the Company paid $50,000in cash and issued a non-interest bearing unsecured promissory note whichrequires 35 consecutive monthly payments of $5,000 each commencing April 1,2003; and (iv) the remaining 374,116 shares in the escrow account will bereleased to the Company.  If the Companyis delinquent four times in any twelve-month period during the term of theunsecured promissory note in making its $5,000 monthly payments to HIS, and HISissues respective valid default notices, the Company will be subject to a$225,000 penalty.  The 374,116 shareshave been received by MAI together with the HIS authorization to legallytransfer 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)issued Logix 200,000 shares of our Common Stock (ii) required the Company tomake various cash installment payments totaling $175,000 to be paid within 1year and (iii) executed a contract with Logix for a consulting project in theamount of $50,000.  The Company has madeall required payments to Logix under this settlement agreement.

 

In December 2003, the Company entered intoanother settlement agreement with Logix whereby it (i) issued 200,000 freetrading shares in exchange for the 200,000 restricted Common Shares from theoriginal settlement agreement in July 2002 (ii) required the Company tomake monthly payments totaling $187,500 over a 25 month period and (iii)mutually released each other of all past, present and future claims associatedwith the lawsuit.

 

### *Other Litigation*

 

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.

** **

**Item 2.**  Changesin Securities and Use of Proceeds

 

(a)                                  None.

 

(b)                                 None.

 

(c)                                  None

 

(d)                                 None.

 

**Item 3.**  DefaultsUpon Senior Securities

 

(a)                                  None

 

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

(a) TheCompany held its Annual Meeting of Stockholders on September 22, 2004 at theHollywood Roosevelt Hotel, 7000 Hollywood Boulevard, Los Angeles, California. 

 

(b) ElectedDirectors of Registrant. The following persons were elected to serve asdirectors of the Company: Richard S. Ressler, Zohar Loshitzer, Stephen Ross andSteven F. Mayer.

 

 (c) Items Voted Upon by Stockholders of theRegistrant. The following matters were voted upon and approved by thestockholders of the Company. The number of votes cast for andagainst are set forth below (as well as the applicable number ofabstentions and broker non-votes):

 
| **Subject**                                                                                         | ** ** | **Votes For** | ** ** | **Votes Against Or Withheld** | ** ** | **Abstentions** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------|------------|-------------------------------|------------|-----------------|------------|
|                                                                                                |       |          |       |                          |       |            |       |
| ELECTION OF DIRECTORS:                                                                              |       |          |       |                          |       |            |       |
|                                                                                                |       |          |       |                          |       |            |       |
| Richard S. Ressler                                                                                  |       | 14.937.000    |       | 143,423                       |       | -               |       |
|                                                                                                |       |          |       |                          |       |            |       |
| Zohar Loshitzer                                                                                     |       | 14,942,553    |       | 137,870                       |       | -               |       |
|                                                                                                |       |          |       |                          |       |            |       |
| Stephen Ross                                                                                        |       | 14,972,360    |       | 108,063                       |       | -               |       |
| Steven F. Mayer                                                                                     |       |          |       |                          |       |            |       |
|                                                                                                |       |          |       |                          |       |            |       |
| APPROVAL OF THE MANAGEMENT CONVERSION/EQUITY  TRANSACTION                                           |       | 7,755,960     |       | 1,230,483                     |       | 4,721           |       |
|                                                                                                |       |          |       |                          |       |            |
|                                                                                                |       |          |       |                          |       |            |       |
| APPROVAL OF AMENDMENT TO COMPANY’S ARTICLES  OF INCORPORATION                                  |       | 7,795,582     |       | 1,192,348                     |       | 3,234           |       |
|                                                                                                |       |          |       |                          |       |            |
|                                                                                                |       |          |       |                          |       |            |       |
| APPROVAL OF AMENDMENT TO 2001 RESTRICTED STOCK  PLAN                                                |       | 7,823,733     |       | 1,163,731                     |       | 3,700           |       |
|                                                                                                |       |          |       |                          |       |            |       |
| RATIFICATION OF THE COMPANY'S SELECTION OF  BDO SEIDMAN LLP AS INDEPENDENT AUDITORS FOR THE COMPANY |       | 14,188,674    |       | 1,163,731                     |       | 3,700           |       |
|                                                                                                |       |          |       |                          |       |            |

 

        (d)           None

 

**Item 5.**  OtherInformation

 

(a)                                  None.

 

**Item 6.**  Exhibitsand 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)    |   | Report on Form 8-K                                                                                                          |
|   |   |                                                                                                                        |
|   |   | Filed August 25, 2004                                                                                                  |
|   |   |                                                                                                                        |
|   |   | Filed September 28, 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 signed onits behalf by the undersigned thereunto duly authorized.

 
|                          | MAI  SYSTEMS CORPORATION                 |
|-------------------------------|------------------------------------------|
|                          | (Registrant)                             |
|                          |                                     |
|                          |                                     |
| Date:  November 18, 2004 |                                     |
| By:                           | /s/James  W. Dolan                       |
|                          | James W. Dolan                           |
|                          | Chief Financial and Operating Officer    |
|                          | (Chief Financial and Accounting Officer) |

 

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