**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549**

 

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**FORM 10-Q**

** **
| **ý**                                                                                                                                                                  | ** ** | **Quarterly report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                  | ** ** | ** **                                                                                                |
| **For the period ended  June 30, 2005 or**                                                                                                                             |
| ** **                                                                                                                                                                  | ** ** | ** **                                                                                                |
| **o**                                                                                                                                                                       | ** ** | **Transition report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.** |
| ** **                                                                                                                                                                  | ** ** | ** **                                                                                                |
| **For the transition  period  from           to           .** |

** **

**Commission file number: 1-9158**

** **

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** **

**MAI Systems Corporation**(Exact name of registrant as specified in its charter)

** **

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

** **

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

**Registrant’stelephone number including area code (949) 598-6000**

** **

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** **

**Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes **ý   No o

** **

**Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes **o   No ý

** **

**The aggregate market value of the common stock held bynon-affiliates of the registrant, based upon the last sale price of the CommonStock reported on the National Association of Securities Dealers AutomatedQuotation National Market System on September 16, 2005 was $510,669. **o

** **

**The number of shares of common stock issued, outstandingand subscribed as of September 16, 2005 was 57,847,862.**

** **

 

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**PART I- FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**MAI SYSTEMS CORPORATION**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

**(Unaudited)**

 
| ** **                                                                                                                                                         | ** ** | **(in thousands, except share data)** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                         | ** ** | **As of December 31,  2004 (a)** | ** ** | **As of June 30,  2005** | ** ** |
|                                                                                                                                                               |       |                                  |       |   |   |
| **ASSETS**                                                                                                                                                         |       |                                  |       |   |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Current assets:                                                                                                                                                    |       |                                  |       |   |   |
| Cash                                                                                                                                                               |       | $                                     | 195        |   | $ | 412 |   |
| Receivables,  less allowance for doubtful accounts of $321 in 2003 and $300 in 2005                                                                                |       | 2,171                                 |       | 3,289 |   |
| Inventories                                                                                                                                                        |       | 71                                    |       | 62 |   |
| Prepaids and  other assets                                                                                                                                         |       | 748                                   |       | 772 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total current  assets                                                                                                                                              |       | 3,185                                 |       | 4,535 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Furniture, fixtures and equipment, net                                                                                                                             |       | 629                                   |       | 575 |   |
| Intangibles, net                                                                                                                                                   |       | 7,470                                 |       | 7,020 |   |
| Goodwill                                                                                                                                                           |       | 4,622                                 |       | 4,622 |   |
| Other assets                                                                                                                                                       |       | 15                                    |       | 14 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total assets                                                                                                                                                       |       | $                                     | 15,921     |   | $ | 16,766 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIENCY**                                                                                                                  |       |                                  |       |   |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Current liabilities:                                                                                                                                               |       |                                  |       |   |   |
| Current portion  of long-term debt                                                                                                                                 |       | $                                     | 1,003      |   | $ | 1,200 |   |
| Accounts payable                                                                                                                                                   |       | 1,077                                 |       | 907 |   |
| Customer  deposits                                                                                                                                                 |       | 2,181                                 |       | 2,481 |   |
| Accrued  liabilities                                                                                                                                               |       | 2,901                                 |       | 2,856 |   |
| Income taxes  payable                                                                                                                                              |       | 103                                   |       | 95 |   |
| Unearned revenue                                                                                                                                                   |       | 3,456                                 |       | 5,003 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total current  liabilities                                                                                                                                         |       | 10,721                                |       | 12,542 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Long-term debt                                                                                                                                                     |       | 6,649                                 |       | 5,984 |   |
| Other liabilities                                                                                                                                                  |       | 764                                   |       | 692 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total  liabilities                                                                                                                                                 |       | 18,134                                |       | 19,218 |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Commitments and contingencies                                                                                                                                      |       |                                  |       |   |   |
|                                                                                                                                                               |       |                                  |       |   |   |
| Stockholders’ deficiency:                                                                                                                                     |       |                                  |       |   |   |
| Preferred Stock,  par value $0.01 per share; 1,000,000 shares authorized, none issued or outstanding                                                               |       | —                                |       | — |   |
| Common Stock,  par value $0.01 per share; authorized 99,000,000 shares; 57,847,862 shares  issued and outstanding at December 31, 2004 and June 30, 2005 |       | 584                                   |       | 584 |   |
| Additional  paid-in capital                                                                                                                                        |       | 47,856                                |       | 47,856 |   |
| Accumulated other comprehensive loss:                                                                                                                              |       |                                  |       |   |   |
| Minimum pension  liability                                                                                                                                         |       | (1,250                                | )          | (1,250 | ) |
| Foreign currency  translation                                                                                                                                      |       | (69                                   | )          | (59 | ) |
| Accumulated deficit                                                                                                                                                |       | (49,334                               | )          | (49,583 | ) |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total  stockholders’ deficiency                                                                                                                               |       | (2,213                                | )          | (2,452 | ) |
|                                                                                                                                                               |       |                                  |       |   |   |
| Total liabilities and stockholders’ deficiency                                                                                                                |       | $                                     | 15,921     |   | $ | 16,766 |   |

 

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(a)          Derivedfrom the December 31, 2004 audited financial statements.

 

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

** **

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**MAI SYSTEMS CORPORATION**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

 
| ** **                                                                   | ** ** | **(Unaudited)  For the Three Months Ended June 30,** | ** ** | **(Unaudited)  For the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **(in thousands, except per share data)**                 | ** ** | **(in thousands, except per share data)**               | ** ** |
| ** **                                                                   | ** ** | **2004**                                                  | ** ** | **2005**                                                | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue:                                                                     |       |                                                      |       |                                                    |       |   |   |   |   |
| Software                                                                     |       | $                                                         | 814        |                                                    | $          | 1,583 |   | $ | 2,103 |   | $ | 2,537 |   |
| Network and  computer equipment                                              |       | 136                                                       |       | 90                                                      |       | 211 |   | 279 |   |
| Services                                                                     |       | 3,951                                                     |       | 4,329                                                   |       | 7,760 |   | 7,941 |   |
| Total revenue                                                                |       | 4,901                                                     |       | 6,002                                                   |       | 10,074 |   | 10,757 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Direct costs:                                                                |       |                                                      |       |                                                    |       |   |   |   |   |
| Software                                                                     |       | 8                                                         |       | 166                                                     |       | 329 |   | 509 |   |
| Network and  computer equipment                                              |       | 109                                                       |       | 64                                                      |       | 169 |   | 243 |   |
| Services                                                                     |       | 1,113                                                     |       | 1,396                                                   |       | 2,182 |   | 2,721 |   |
| Total direct  costs                                                          |       | 1,230                                                     |       | 1,626                                                   |       | 2,680 |   | 3,473 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Gross profit                                                                 |       | 3,671                                                     |       | 4,376                                                   |       | 7,394 |   | 7,284 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Selling, general and administrative expenses                                 |       | 2,351                                                     |       | 2,366                                                   |       | 4,700 |   | 4,550 |   |
| Research and development costs                                               |       | 908                                                       |       | 1,143                                                   |       | 1,800 |   | 2,264 |   |
| Amortization of intangibles                                                  |       | —                                                    |       | 126                                                     |       | — |   | 238 |   |
| Other operating expense                                                      |       | 15                                                        |       | 59                                                      |       | 18 |   | 72 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Operating income                                                             |       | 397                                                       |       | 682                                                     |       | 876 |   | 160 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Interest expense                                                             |       | (288                                                      | )          | (197                                                    | )          | (579 | ) | (400 | ) |
| Other non-operating expense                                                  |       | (23                                                       | )          | —                                                  |       | (39 | ) | — |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Income (loss)  before income taxes                                           |       | 86                                                        |       | 485                                                     |       | 258 |   | (240 | ) |
| Income tax expense                                                           |       | (4                                                        | )          | (5                                                      | )          | (10 | ) | (9 | ) |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Net income  (loss)                                                           |       | $                                                         | 82         |                                                    | $          | 480 |   | $ | 248 |   | $ | (249 | ) |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Income (loss) per share:                                                     |       |                                                      |       |                                                    |       |   |   |   |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Net income  (loss) per share:                                                |       |                                                      |       |                                                    |       |   |   |   |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Basic income  (loss) per share                                               |       | $                                                         | 0.01       |                                                    | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Diluted income  (loss) per share                                             |       | $                                                         | 0.01       |                                                    | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Weighted average  common shares used in determining income (loss) per share: |       |                                                      |       |                                                    |       |   |   |   |   |
|                                                                         |       |                                                      |       |                                                    |       |   |   |   |   |
| Basic                                                                        |       | 14,676                                                    |       | 57,848                                                  |       | 14,676 |   | 57,848 |   |
| Diluted                                                                      |       | 14,676                                                    |       | 57,848                                                  |       | 14,676 |   | 57,848 |   |

 

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

 

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**MAI Systems Corporation**

 

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

 

**(Unaudited)**

 
| ** **                                 | *** *** | **For the Six Months Ended  June 30,** | ** ** |
|--------------------------------------------|--------------|---------------------------------------------|------------|
| ** **                                 | *** *** | **(in thousands)**                          | ** ** |
| ** **                                 | ** **   | **2004**                                    | ** ** | **2005** | ** ** |
|                                       |         |                                        |       |   |   |
| Net cash provided by operating activities: |         | $                                           | 605        |   | $ | 718 |   |
|                                       |         |                                        |       |   |   |
| Cash flows used in investing activities:   |         |                                        |       |   |   |
| Capital  Expenditures                      |         | (110                                        | )          | (27 | ) |
| Capitalized  software development costs    |         | (604                                        | )          | — |   |
| Net cash used in investing activities      |         | (714                                        | )          | (27 | ) |
|                                       |         |                                        |       |   |   |
| Cash flows used in financing activities-   |         |                                        |       |   |   |
| Repayments on  long-term debt              |         | (425                                        | )          | (478 | ) |
|                                       |         |                                        |       |   |   |
| Net cash provided by (used in) operations  |         | (534                                        | )          | 213 |   |
|                                       |         |                                        |       |   |   |
| Effect of exchange rate changes on cash    |         | (1                                          | )          | 4 |   |
|                                       |         |                                        |       |   |   |
| Net increase (decrease) in cash            |         | (535                                        | )          | 217 |   |
|                                       |         |                                        |       |   |   |
| Cash at beginning of period                |         | 664                                         |       | 195 |   |
|                                       |         |                                        |       |   |   |
| Cash at end of period                      |         | $                                           | 129        |   | $ | 412 |   |

 

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

 

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**MAI Systems Corporation**

 

**Notes to Condensed ConsolidatedFinancial Statements**

 

**Three Months ended June 30,2005**

 

**(Unaudited)**

**NOTE 1 - BASIS OF PRESENTATION**

 

Companies for which this report is filed are MAISystems Corporation and its wholly-owned subsidiaries (the “Company”).  The information contained herein isunaudited, but gives effect to all adjustments (which are normal recurringaccruals) necessary, in the opinion of Company management, to present fairlythe condensed consolidated financial statements for the interim period.  All significant intercompany transactions andaccounts have been eliminated in consolidation. The results of operations for the quarter and six month periods endedJune 30, 2005 are not necessarily indicative of the results to be expected forthe entire year or for any future period.

 

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

 

**NOTE 2 - LIQUIDITY**

 

Although the Company has a net stockholders’deficiency of $2,452,000 and a working capital deficit of $8,007,000 at June 30,2005, the Company believes it will generate sufficient funds from operations orobtain additional financing to meet its operating and capital requirements forat least the next 12 months.    TheCompany expects to generate positive cash flow from its continuing operationsduring 2005 from shipping out products and services from its current backlog asof June 30, 2005 as well as new orders. In the event that the Company cannot generate positive cash flow fromits continuing operations during 2005, the Company can substantially reduce itsresearch and development efforts to mitigate cash outflow to help sustain itsoperations.  There can be no assurancethat the Company will be able to sustain profitability or generate positivecash flow from operations or obtain additional financing as necessary.  These financial statements have been preparedassuming the Company will continue to operate as a going concern.  If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company.

 

The restructured debt, pursuant to the originalintercreditor agreement between Canyon and Coast, which was sold to Wamco on May 15,2003, contains various restrictions and covenants, including a minimum quickratio of 0.20 to 1.00 and minimum debt service coverage ratio of 0.50 to1.00.  In the event that we were not incompliance with the various restrictions and covenants and were unable toreceive waivers for non-compliance, the term debt would be immediately due andpayable (see note 5). The Company was in compliance with its covenants as of June 30,2005. There is no guaranty that the Company will meet its debt covenants in thefuture.

 

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

 

**Management Equity/Conversion Transaction**

 

On April 9, 2004, an investor group, consistingof Canyon, the Company’s Chairman of the Board, Chief Executive Officer &President and Chief Financial & Operating Officer (“Investor Group”),acquired 2,433,333 shares of the Company’s common stock held by CSA and$3,133,344 of secured indebtedness owed to CSA for $1 million in cash (see note8).  On September 22, 2004, theCompany received approval from its shareholders for the Investor Group toconvert the Company’s secured indebtedness acquired from CSA plus any accruedinterest through the date of conversion for shares of the Company’s commonstock based upon a conversion price of $0.10 per share.  Additionally, the shareholders also approvedfor the Investor Group to invest $1,000,000 of new cash proceeds into theCompany, which the Company received on September 24, 2004, in a privateplacement at $0.10 per share (the “Management Equity/Conversion Transaction”).    On November 1, 2004, the Companyissued 10 million shares of its common stock to the Investor Group in exchangefor the $1,000,000 of cash proceeds and the $3,133,344 secured note, togetherwith $183,867 of accrued interest, was converted into 33,172,110 shares of theCompany’s common stock.

 

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

 

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

 

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

 

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

 

The following reflectsthe unaudited pro forma effect of the Management Equity/Conversion Transactionon continuing operations for the three and six -month periods ended June 30,2004 (in thousands):

 

| ** **           | ** ** | **For the Three -  Months Ended  June 30, 2004** | ** ** | **For the Six -  Months Ended  June 30, 2004** | ** ** |
|----------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
|                 |       |                                                  |       |                                                |       |
| Revenue              |       | $                                                     | 4,901      |                                                | $          | 10,074 |   |
| Operating income     |       | 258                                                   |       | 597                                                 |       |
| Net income           |       | 26                                                    |       | 135                                                 |       |
| Net income per share |       | $                                                     | 0.00       |                                                | $          | 0.01 |   |

 

# **The unaudited pro formainformation provided above has been prepared by adjusting historical amountsfor the three and six month periods ended June 30, 2004 to give effect tothe Management Equity/Conversion Transaction as if it had occurred on January 1,2004.  The pro forma adjustments to thehistorical results of operations for the three and six month periods ended June 30,2004 include the pro forma impact of the push down accounting resulting in thereduction of depreciation expense of $76,000 and $152,000, respectively, and anincrease of amortization of identifiable intangible assets of $215,000 and $431,000,respectively. The pro forma adjustments to the historical results of operationsfor the three month and six month periods ended June 30, 2004 include thepro forma impact of the debt conversion resulting in the reduction of interestexpense of $83,000 and $166,000, respectively.**

 

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**Privatization Plans**

 

Our Board of Directors and the Investor Group are in the process offurnishing an information statement to all holders of record of the issued andoutstanding shares of our common stock, $0.01 par value, in connection with aproposed Amendment to the Company’s Amendedand Restated Certificate of Incorporation (“Amendment”) to effectuate a 1-for-150reverse stock split. If consummated, the reverse stock split would enable theCompany to terminate its periodic reporting obligations under Sections 13 and15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”),the registration of our common stock under Section 12(g) of theExchange Act and the quotation of our common stock on the OTC Bulletin Boardand become a “private” company.

 

**NOTE 4 - INVENTORY**

 

Inventories are summarized as follows:

 

| ** **        | ** ** | **(dollars in thousands)**  | ** ** |
|-------------------|------------|-----------------------------|------------|
| ** **        | ** ** | **December 31,  2004** | ** ** | **June 30,  2005** | ** ** |
|              |       |                        |       |   |   |
| Finished goods    |       | $                           | 65         |   | $ | 54 |   |
| Replacement parts |       | 6                           |       | 8 |   |
|              |       | $                           | 71         |   | $ | 62 |   |

 

**NOTE 5 - LONG TERM DEBT**

 

**Wamco 32 Ltd.**

 

On January 13, 2003, the Company re-negotiatedthe terms of its credit facility with Coast Business Credit (“Coast”) wherebythe outstanding balance of $1,828,000 was converted to a secured term loanwhich accrues interest at 9.25% per annum and requires monthly payments of$58,000 over a 36 months period commencing March 1, 2003.  The loan is secured by all the tangible andintangible assets for the Company, including intellectual property.  On February 7, 2003, the Federal 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, theloan was sold to Wamco 32, Ltd. (“Wamco”). This sale of the loan by the FDIC did not change any of the terms of theCompany’s loan agreement.

 

The loan matures on February 28, 2006, at whichtime all remaining principal and accrued interest is due and payable.  The Company will also be required to payWamco additional principal payments on a quarterly basis based upon anEBITDA-based formula commencing March 31, 2003.  For the years ended December 31, 2003and 2004, there were no additional principal payments required under theEBITDA-based formula. As of December 31, 2004 and June 30, 2005, thebalance of the term loan was $774,000 and $402,000, respectively.

 

The loan, pursuant to the original inter-creditoragreement between Canyon Capital and Coast, which was sold to Wamco on May 15,2003, contains various restrictions and covenants, including a minimum quickratio of 0.20 to 1.00 and minimum debt service coverage ratio of 0.50 tol.00.  In the event that the Company werenot in compliance with the various restrictions and covenants and were unableto receive waivers for non-compliance, the term loan would be immediately dueand payable.  The Company was in compliancewith such covenants as of June 30, 2005. There is no guaranty that the Company will meet its debt covenants inthe future.

 

**Canyon Capital Management LP**

 

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

 

6

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subordinate notes payable to Canyon was approximately$108,000 at June 30, 2005. The principal balance outstanding on thesubordinate notes payable to Canyon was approximately $5,660,000 at December 31,2004 and June 30, 2005.

 

**CSA Private Limited**

 

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

 

The agreement with CSA was amended whereby the Companywas required to make payments under the subordinated note unless and until itpaid $1 million by December 31, 2002. Upon payment of the $1 million, contractual payments under 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 accrued interestthrough March 31, 2004, totaling $3,633,000, were converted to two securednew notes.  The first note for $500,000accrues interest at 10% per annum and provides for monthly payments of $10,000until the Wamco and Canyon debt is paid in full.  Thereafter, the note provides for monthlypayments in an amount equal to the greater of i) $10,000 or ii) the amountrequired to fully amortize all remaining principal and interest in 24 equalmonthly payments.  The second note for$3,133,344 (“Other Note”) also accrued interest at 10% per annum and providedfor monthly payments of $7,500, or such other interest amount, not to exceed$10,000 per month, that Wamco and Canyon will allow.  Under the terms of the amended subordinationagreement between Wamco, Canyon and CSA, all payments under the new notes aresubordinated to the payment in full of the Wamco and Canyon loan agreements.The Company has not made any payments on the $500,000 note as of June 30,2005 and is currently in default.  Theinterest rate has been increased to 12.5% in line with the terms of that noteuntil the Company becomes current on its contractual payments.  As of June 30, 2005, the Company’saccrued and unpaid interest relating to the $500,000 secured note was $84,000.

 

On April 9, 2004, an investor group, consistingof Canyon, the Company’s Chairman of the Board, Chief Executive Officer andChief Financial and Operating Officer (“Investor Group”), acquired 2,433,333shares of the Company’s common stock held by CSA and the Other Note for $1million in cash .  On November 1,2004, the $3,133,344 Other Note, together with $183,867 of accrued interest,was converted into 33,172,110 shares of the Company’s common stock (see note3).

 

**TaxClaims**

 

On September 30, 2003, the Company entered into asettlement agreement with the United States Internal Revenue Service (the “Service”)on a tax claim which resulted from the Company’s 1993 Chapter 11 proceedingswhereby it agreed to pay $489,000 in equal monthly installments of $7,438 overa period of six (6) years at an interest rate of 6%.  The $489,000 settlement is reflected as debtin the financial statements and resulted in a one-time gain of $262,000 whichis included in income tax benefit. In the event that the Company fails to paythe Service any payment, and such payment failure continues for sixty daysafter written notice of such failure, $1,832,100, plus accrued interestthereon, less any payments made by the Company will be immediately due andpayable to the Service.  As of June 30,2005, the Company was current with its payments to the Service and the debtbalance was $328,000.

 

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

 

**NOTE 6 - RESTRICTED STOCK PLAN**

 

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

 

In May 2002, the Company issued 612,500 shares ofrestricted common stock to its members of the board of directors and certain ofits corporate officers which vest equally over a four-year period.  Recipients are not required to provideconsideration to the Company other than rendering the service and have theright to vote the shares.  Under APB 25,

 

7

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compensation cost is recognized for the fair value ofthe restricted stock awarded, which is its quoted market price at the date ofgrant, which was $0.25 per share.  Thetotal market value of the shares of $153,000 was treated as unearnedcompensation and was amortized to expense in proportion to the vestingschedule.  The balance of unearnedcompensation was fully amortized as of June, 2005.

 

**NOTE 7 - PREFERRED STOCK**

 

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

 

**NOTE 8 - INTANGIBLE ASSETS**

 

As of June, 2005, intangible assets consist ofdeveloped technology, software trade names, customer lists and goodwill (whichrepresents the excess of the purchase price over the estimated fair value ofthe net assets of the acquired businesses) and capitalized software.  Identifiable intangible assets other thangoodwill are amortized on a straight-line basis over their estimated usefullives.  Goodwill is not to be amortizeduntil its life is determined to be finite, however, a recognized intangibleasset with an indefinite useful life should be tested for impairment annuallyor on an interim basis if events or circumstances indicate that the fair valueof the asset has decreased below its carrying value.  At June 30, 2005, the Company evaluatedits goodwill and determined that fair value had not decreased below carryingvalue and no adjustment to impair goodwill was necessary.

 

Intangible assets as of December 31, 2004 and June 30,2005 are as follows (in thousands):

 

| ** **                                  | ** ** | **December 31,  2004** | ** ** | **June 30,  2005** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Gross carrying amount of intangible assets: |       |                        |       |                    |       |
| Capitalized  software                       |       | $                           | 2,662      |                    | $          | 2,662 |   |
| Software trade  names                       |       | 2,659                       |       | 2,659                   |       |
| Customer  relationships                     |       | 2,285                       |       | 2,285                   |       |
| Total intangible  assets                    |       | 7,606                       |       | 7,606                   |       |
| Accumulated amortization:                   |       |                        |       |                    |       |
| Capitalized  software                       |       | (39                         | )          | (250                    | )          |
| Software trade  names                       |       | (41                         | )          | (118                    | )          |
| Customer  relationships                     |       | (56                         | )          | (218                    | )          |
| Total  accumulated amortization             |       | (136                        | )          | (586                    | )          |
|                                        |       |                        |       |                    |       |
| Intangible assets, net                      |       | $                           | 7,470      |                    | $          | 7,020 |   |
|                                        |       |                        |       |                    |       |
| Goodwill                                    |       | $                           | 4,622      |                    | $          | 4,622 |   |

# ** **

# **A roll forward of goodwillfor the year ended December 31, 2004 is as follows (in thousands):**

# ** **

| Goodwill at  December 31, 2003                        |   | $      | 1,121  |   |
|------------------------------------------------------------|--------|--------|--------|--------|
| Goodwill from Management Equity/Conversion  Transaction    |   | 5,251  |   |
| Private placement by Investor Group (note 2)               |   | (1,000 | )      |
| Year end adjustment to minimum pension liability           |   | (750   | )      |
| Impairment identified in 2004                              |   | — |   |
|                                                       |   |   |   |
| Goodwill at December 31, 2004 and June 30,  2005 |   | $      | 4,622  |   |

 

8

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

 

| **Year Ending December 31,** | *** *** |
|-----------------------------------|--------------|
| **(in thousands)**                | ** **   |
| 2005                              |         | $ | 431 |   |
| 2006                              |         | 861 |   |
| 2007                              |         | 861 |   |
| 2008                              |         | 861 |   |
| 2009                              |         | 861 |   |
| Thereafter                        |         | 3,731 |   |
|                              |         | $ | 7,606 |   |

 

**NOTE 9 - INCOME (LOSS) PER SHARE**

 

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

 

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

 
| ** **                                                                                                       | ** ** | **For the Three Months Ended June 30,** | ** ** | **For the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2004**                                     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                       | ** ** | **(in thousands except per share data)**     | ** ** | **(in thousands except per share data)**   | ** ** |
| Numerator:                                                                                                       |       |                                         |       |                                       |       |   |   |   |   |
| Numerator for  basic and diluted earnings (loss) per share – net income (loss)                              |       | $                                            | 82         |                                       | $          | 480 |   | $ | 248 |   | $ | (249 | ) |
|                                                                                                             |       |                                         |       |                                       |       |   |   |   |   |
| Denominator:                                                                                                     |       |                                         |       |                                       |       |   |   |   |   |
| Denominator for  basic income (loss) per weighted average number of Common shares outstanding  during the period |       | 14,676                                       |       | 57,848                                     |       | 14,676 |   | 57,848 |   |
|                                                                                                             |       |                                         |       |                                       |       |   |   |   |   |
| Incremental  common shares attributable to exercise of outstanding shares                                        |       | —                                       |       | —                                     |       | — |   | — |   |
|                                                                                                             |       |                                         |       |                                       |       |   |   |   |   |
| Denominator for  diluted income (loss) per per share                                                             |       | 14,676                                       |       | 57,848                                     |       | 14,676 |   | 57,848 |   |
|                                                                                                             |       |                                         |       |                                       |       |   |   |   |   |
| Basic earnings (loss) per share                                                                                  |       | $                                            | 0.01       |                                       | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
|                                                                                                             |       |                                         |       |                                       |       |   |   |   |   |   |   |   |   |
| Diluted earnings (loss) per share                                                                                |       | $                                            | 0.01       |                                       | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |

 

The number ofanti-dilutive options and warrants that were excluded from the computation ofincremental common shares were 3,104,000 and 2,647,750 in 2004 and 2005,respectively.

 

**NOTE10 - STOCK OPTION PLANS**

 

TheCompany accounts for stock-based compensation in accordance with AccountingPrinciples Board, APB, No. 25, “Accounting for Stock Issued to Employees.”The Company has adopted the disclosure-only provisions of FAS No. 123

 

9

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“Accountingfor Stock-Based Compensation.” Under APB No. 25, compensation expenserelating to employee stock options is determined based on the excess of themarket price of the Company’s stock over the exercise price on the date ofgrant, the intrinsic value method, versus the fair value method as providedunder FAS No. 123.

 

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

 

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

 

| ** **                                                                                | ** ** | **For the three-months ended  June 30,** | ** ** | **For the six-months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **(in thousands, except per  share data)**    | ** ** | **(in thousands, except per  share data)**  | ** ** |
| ** **                                                                                | ** ** | **2004**                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income  (loss):                                                                       |       |                                          |       |                                        |       |   |   |   |   |
| As reported                                                                               |       | $                                             | 82         |                                        | $          | 480 |   | $ | 248 |   | $ | (249 | ) |
| Add: Stock-based  employee compensation expense recorded                                  |       | 10                                            |       | 10                                          |       | 20 |   | 20 |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | (10                                           | )          | (10                                         | )          | (20 | ) | (20 | ) |
| Pro forma                                                                                 |       | $                                             | 82         |                                        | $          | 480 |   | $ | 248 |   | $ | (249 | ) |
|                                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Basic income  (loss) per share:                                                           |       |                                          |       |                                        |       |   |   |   |   |
| As reported                                                                               |       | $                                             | 0.01       |                                        | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
| Add: Stock-based  employee compensation expense recorded                                  |       | —                                        |       | —                                      |       | — |   | — |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | —                                        |       | —                                      |       | — |   | — |   |
| Pro forma                                                                                 |       | $                                             | 0.01       |                                        | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
|                                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Diluted income  (loss) per share:                                                         |       |                                          |       |                                        |       |   |   |   |   |
| As reported                                                                               |       | $                                             | 0.01       |                                        | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
| Add: Stock-based  employee compensation expense recorded                                  |       | —                                        |       | —                                      |       | — |   | — |   |
| Less: Stock  based employee compensation expense determined under fair value calculations |       | —                                        |       | —                                      |       | — |   | — |   |
| Pro forma                                                                                 |       | $                                             | 0.01       |                                        | $          | 0.01 |   | $ | 0.02 |   | $ | 0.00 |   |
|                                                                                           |            |                                               |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE11 - LEGAL PROCEEDINGS**

 

*Hotel Information Systems, Inc.*

 

On March 25, 2003, the Company entered into asettlement agreement with Hotel Information Systems (“HIS”) and one of itsformer corporate officers whereby (i) the parties dismissed all claims,known and unknown, against each other; (ii) the Company forgave and wroteoff a note receivable from the former corporate officer of HIS in the amount of$66,000 (which

 

10

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was expensed to other expense in the 2002 consolidatedstatement of operations); (iii) the Company paid $50,000 in cash andissued a non-interest bearing unsecured promissory note which requires 35consecutive monthly payments of $5,000 each commencing April 1, 2003; and (iv) theremaining 374,116 shares in the escrow account will be released to the Company.  If the Company is delinquent four times inany twelve-month period during the term of the unsecured promissory note inmaking its $5,000 monthly payments to HIS, and HIS issues respective validdefault notices, the Company will be subject to a $225,000 penalty.  As of June 30, 2005, the Company wascurrent on its payments to HIS. The 374,116 shares have been received by MAItogether with the HIS authorization to legally transfer such shares to MAI.

 

### *Imputing interest at 11%, the present value of the$175,000 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) issuedLogix 200,000 shares of our Common Stock (ii) required the Company to makevarious cash installment payments totaling $175,000 to be paid within 1 yearand (iii) executed a contract with Logix for a consulting project in theamount of $50,000.  The Company has madeall required payments to Logix under this settlement agreement.

 

In December 2003, the Company entered intoanother settlement agreement with Logix whereby it (i) issued 200,000 freetrading shares in exchange for the 200,000 restricted Common Shares from theoriginal settlement agreement in July 2002 (ii) required the Companyto make monthly payments totaling $187,500 over a 25 month period and (iii) mutuallyreleased each other of all past, present and future claims associated with thelawsuit.  As of June 30, 2005, theCompany was current on its payments to Logix.

 

*Other Litigation*

 

We were also involved in various other legal proceedingsthat are incident to its business. Management believes the ultimate outcome ofthese matters will not have a material adverse effect on our consolidatedfinancial position, results of operations or liquidity.

 

**NOTE12 – COMPREHENSIVE INCOME**

 

The following table summarizes components ofcomprehensive income:

 

| ** **                                   | ** ** | **For The Three Months Ended** | ** ** | **For The Six Months Ended** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **June 30,**              | ** ** | **June 30,**            | ** ** |
| ** **                                   | ** ** | **2004**                       | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                         |       |                           |       |                         |       |   |   |   |   |
| Net income (loss)                            |       | $                              | 82         |                         | $          | 480 |   | $ | 248 |   | $ | (249 | ) |
|                                         |       |                           |       |                         |       |   |   |   |   |
| Change in cumulative translation adjustments |       | (37                            | )          | (5                           | )          | (57 | ) | 10 |   |
|                                         |       |                           |       |                         |       |   |   |   |   |
| Comprehensive income (loss)                  |       | $                              | 45         |                         | $          | 475 |   | $ | 191 |   | $ | (239 | ) |
|                                              |            |                                |            |                              |            |  |  |  |  |  |  |  |  |  |

 

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

** **

**11**

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** **

**Item 2.   Management’s Discussion And Analysis OfFinancial Condition And Results Of Operations**

** **

## **CriticalAccounting Policies and Estimates**

 

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

 

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

 

**Software Development Costs**

 

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

 

The Company capitalized $604,000 of software developmentcosts during the six month period ended June 30, 2004 respectively, relatingto its new N-Tier, Internet-native corporate application suite of productswritten in java.  The modules to thissuite of applications became available for general release in the first quarterof 2005 at which time amortization of such costs shall commence.  We believe that these new products willproduce new sales adequate to recover amounts capitalized.

 

**Revenue Recognition**

 

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

 

**Accounts Receivable**

 

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

 

**Intangible and Long-Lived Assets**

 

At December 31, 2004 and June 30, 2005,goodwill and other long-lived assets represented 80% and 73%, respectively, ofthe Company’s total assets.

 

12

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

 

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

 

**Accrued Expenses**

 

TheCompany reviews its contingent liabilities, which arise primarily fromlitigation and litigation defense costs, in accordance with Statement ofFinancial Accounting Standards No. 5 (SFAS 5), “Accounting forContingencies”.  Contingent liabilitiesare recorded as liabilities when it is probable that a liability has beenincurred and the amount of the loss is reasonably estimable.  Contingent liabilities are often resolvedover long periods.  Estimating probablelosses requires judgments about both the amount of liability, which may or maynot be readily determinable, and the likelihood of liability, which involvesranges of probability that can at times be broad and depend on the potentialactions of third parties.

 

**Income Taxes**

 

Income taxes are accounted for under the asset andliability method.  Deferred tax assetsand liabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating losscarryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to be recoveredor settled.  The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date. The realizability of the deferred tax asset is assessed throughout theyear and a valuation allowance is established accordingly.

 

## **Liquidity andCapital Resources**

 

At June 30, 2005, our working capital deficiencyincreased from a working capital deficiency of $7,536,000 at December 31,2004 to a working capital deficiency of $8,007,000.  Excluding unearned revenue of $5,003,000,working capital deficiency at June 30, 2005 was $3,004,000.  Excluding unearned revenue of $3,456,000, theCompany’s working capital deficiency at December 31, 2004 was$4,080,000.  Excluding unearned revenue,the decrease in the working capital deficiency of $1,076,000 was primarilyattributable to increases in receivables of $1,118,000 and cash of $217,000 anddecreases in accounts payable of $107 and accrued liabilities of $45,000 offsetby increases in current portion of long term debt of $197,000 and deposits of$300,000.

 

Net cash used in investing activities for the periodended June 30, 2005 totaled $27,000, which is comprised of capitalexpenditures.

 

Net cash used in financing activities for the periodended June 30, 2005 totaled $478,000, which represents repayments onlong-term debt.  On January 13,2003, the Company converted its credit facility to a term loan which requiresmonthly principal and interest payments of $58,000 and matures on February 28,2006.  In addition, the Company amendedits subordinated note to require monthly interest only payments of $52,000through February 28, 2006, at which time it will convert to a term loan tobe amortized over a three years period. The restructured debt, pursuant to the original intercreditor agreementbetween Canyon and Coast, which was sold to Wamco on May 15, 2003,contains various restrictions and covenants, including a minimum quick ratio of0.20 to 1.00 and minimum debt service coverage ratio of 0.50 to 1.00.  In the event that we were not in compliancewith the various restrictions and covenants and were unable to receive waiversfor non-compliance, the term debt would be immediately due and payable. TheCompany was in compliance with its covenants as of June 30, 2005. There isno guaranty that the Company will meet its debt covenants in the future.

 

Stockholders’ deficiency increased from $2,213,000 at December 31,2004 to $2,452,000 at June 30, 2005, mainly as a result of net loss duringthe period of $249,000.

 

Although the Company has a net stockholders’deficiency of $2,452,000 and a working capital deficit of $8,007,000 at

 

13

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June 30, 2005, the Company believes it willgenerate sufficient funds from operations or obtain additional financing tomeet its operating and capital requirements for at least the next 12months.    The Company expects togenerate positive cash flow from its continuing operations during 2005 fromshipping out products and services from its current backlog as of June 30,2005 as well as new orders.  In the eventthat the Company cannot generate positive cash flow from its continuingoperations during 2005, the Company can substantially reduce its research anddevelopment efforts to mitigate cash outflow to help sustain itsoperations.  There can be no assurancethat the Company will be able to sustain profitability or generate positivecash flow from operations or obtain additional financing as necessary.  These financial statements have been preparedassuming the Company will continue to operate as a going concern.  If the Company is unsuccessful in theaforementioned efforts, the Company could be forced to liquidate certain of itsassets, reorganize its capital structure and, if necessary, seek other remediesavailable to the Company.

 

# **Order,Shipment and Backlog**

# ** **

We record and enter into backlog a purchase order forequipment and software when we receives a customer’s written order requestingdelivery within twelve months, and systems configuration and contractprovisions are verified.  Orders that arecanceled by the customer and orders that are not shipped within one year areremoved from backlog.  Orders that areremoved from backlog for non-shipment are restored if they are reinstated bythe customer.  We include in backlogsigned government contracts which have not yet been fully funded that areexpected to commence delivery within the next twelve months.  As of June, 2005, we have approximately $9.7million included in backlog relating to the Air Force, of which $1.2 million isexpected to be shipped within fiscal 2005 and the balance of the contractshipped by December 31, 2008.  Ourbacklog as of June 30, 2004 and 2005 was $2,400,000 and $14,900,000,respectively.

 

Our backlog is not necessarily indicative of futurerevenues.

 

## **ContractualObligations and Commercial Commitments**

 

The following table summarizes the Company’sobligations and commitments as of June 30, 2005:

 
| ** **                       | ** ** | **Payments Due by Period (in thousands)** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Cash Obligations** | ** ** | **Total**                                 | ** ** | **Less Than 1  Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** |
|                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                   |       | $                                         | 7,184      |   | $ | 1,200 |   | $ | 3,876 |   | $ | 1,523 |   | $ | 585 |   |
| Operating Leases                 |       | 3,237                                     |       | 583 |   | 905 |   | 917 |   | 832 |   |
| Consulting  Agreements           |       | 24                                        |       | 24 |   | — |   | — |   | — |   |
|                             |       | $                                         | 10,445     |   | $ | 1,807 |   | $ | 4,781 |   | $ | 2,440 |   | $ | 1,417 |   |

 

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**Results of Operations**

 

Three Months Ended June 30, 2004 Compared to ThreeMonths Ended June 30, 2005

 
| ** **                                   | ** ** | **June 30, 2004** | ** ** | **Percentage of  Revenue** | ** ** | **June 30, 2005** | ** ** | **Percentage of  Revenue** | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**     | ** ** | ** **                 | ** ** | **(in thousands)**     | ** ** | ** **                 | ** ** |
| Revenue                                      |       | $                      | 4,901      |                       | 100.0      | %                      | $          | 6,002                      |       | 100.0 | % |
| Gross profit                                 |       | 3,671                  |       | 74.9                       | %          | 4,376                  |       | 72.9                       | %          |
| Selling, general and administrative expenses |       | 2,351                  |       | 48.0                       | %          | 2,366                  |       | 39.4                       | %          |
| Research and development costs               |       | 908                    |       | 18.5                       | %          | 1,143                  |       | 19.0                       | %          |
| Amortization of intangibles                  |       | —                 |       | —                     |       | 126                    |       | 2.1                        | %          |
| Other operating expense                      |       | 15                     |       | 0.3                        | %          | 59                     |       | 1.0                        | %          |
| Interest expense, net                        |       | 288                    |       | 5.9                        | %          | 197                    |       | 3.2                        | %          |
| Other non-operating expense                  |       | 23                     |       | 0.5                        | %          | —                 |       | —                     |       |
| Income tax expense                           |       | 4                      |       | 0.1                        | %          | 5                      |       | 0.1                        | %          |
| Net income                                   |       | $                      | 82         |                       | 1.7        | %                      | $          | 480                        |       | 8.0 | % |

 

The increase in revenuein 2005 was mainly attributable to an increase in the volume of software sales,which resulted in an increase of approximately $1,101,000.  The general health of the hospitalityindustry continues to improve from the detrimental effects of “9/11” thatseverely affected the hospitality and travel industries.  During the three month period ended June 30,2005, the Company shipped certain orders it expected to ship from its backlogduring the three month period ended March 31, 2005 resulting in increasein revenue from the comparable period of 2004. Revenue for 2005 was $6,002,000 compared to $4,901,000 in 2004 or a 23.9%increase. The increase mainly related to an increase from 2004 to 2005 insoftware and professional services sales in Asia of approximately $631,000 and$209,000, respectively, as well as an increase in professional services salesof approximately $138,000 in the United States. Our continuing hospitality business is expected to generate sufficientcash from operations to adequately fund its ongoing operating activities.

 

Gross profit for 2005 increasedto $4,376,000 from $3,671,000 in 2004. The increase in gross profit is mainly due to the increase in softwaresales which has a gross margin in excess of ninety percent.  The increase in gross profit is also due toan increase in professional and support service sales, which have lower grossmargins. The Company’s professional and support services costs increased from2004.  The increase in professional andsupport services costs was mainly attributable to an increase in globalheadcount combined with salary increases from 2004 to 2005.

 

Selling, general andadministrative expenses (“SG&A”) increased slightly from $2,351,000 in 2004to $2,366,000 in 2005.  The Companycontinues to manage these expenses through it management cost control programresulting in comparable costs in 2004 as compared to 2005.

 

Research and developmentcosts increased from $908,000 in 2004 to $1,143,000 in 2005.  The company capitalized $283,000 of softwaredevelopment costs in 2004. As of January 1, 2005, the Company released itsnew N-Tier, Internet-native corporate application suite of products written injava and ceased capitalizing costs relating to the modules associated with thissuite of applications. After considering the amount capitalized in 2004, grossresearch and development costs decreased from 2004 to 2005 by approximately $48,000due to a decrease in engineers and quality assurance personnel in the UnitedStates which were replaced with less expensive resources in the Company’sMalaysia operations.

 

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

 

Net interest expense was$288,000 in 2004 compared to $197,000 in 2005. The decrease is due to lower balances of interest bearing debt during2005 as compared to 2004 mainly due to the conversion of approximately $3.3million of indebtedness by the Investor Group to the Company’s common stock on November 1,2004.

 

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Six Months Ended June 30, 2004 Compared to Six MonthsEnded June 30, 2005

 
| ** **                                   | ** ** | **June 30, 2004** | ** ** | **Percentage of  Revenue** | ** ** | **June 30, 2005** | ** ** | **Percentage of  Revenue** | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**     | ** ** | ** **                 | ** ** | **(in thousands)**     | ** ** | ** **                 | ** ** |
| Revenue                                      |       | $                      | 10,074     |                       | 100.0      | %                      | $          | 10,757                     |       | 100.0 | % |
| Gross profit                                 |       | 7,394                  |       | 73.4                       | %          | 7,284                  |       | 67.7                       | %          |
| Selling, general and administrative expenses |       | 4,700                  |       | 46.7                       | %          | 4,550                  |       | 42.3                       | %          |
| Research and development costs               |       | 1,800                  |       | 17.9                       | %          | 2,264                  |       | 21.0                       | %          |
| Amortization of intangibles                  |       | —                 |       | —                     |       | 238                    |       | 2.2                        | %          |
| Other operating expense                      |       | 18                     |       | 0.2                        | %          | 72                     |       | 0.7                        | %          |
| Interest expense, net                        |       | 579                    |       | 5.8                        | %          | 400                    |       | 3.7                        | %          |
| Other non-operating expense                  |       | 39                     |       | 0.4                        | %          | —                 |       | —                     |       |
| Income tax expense                           |       | 10                     |       | 0.1                        | %          | 9                      |       | 0.1                        | %          |
|                                         |       |                   |       |                       |       |                   |       |                       |       |
| Net income                                   |       | $                      | 248        |                       | 2.5        | %                      | $          | (249                       | )          | (2.3 | )% |

 

The increase in revenuein 2005 was mainly attributable to an increase in the volume of software sales,which resulted in an increase of approximately $683,000.  The general health of the hospitalityindustry continues to improve from the detrimental effects of “9/11” thatseverely affected the hospitality and travel industries.  Revenue for 2005 was $10,757,000 compared to$10,074,000 in 2004 or a 6.8% increase. The increase mainly related to anincrease from 2004 to 2005 in software and professional services sales in Asiaof approximately $687,000 and $314,000, respectively.  This increase in Asia revenue was offset bydecreases in software sales, professional services and support revenue ofapproximately $296,000, $155,000 and $199,000, respectively in the UnitedStates.  The decrease in revenue in theUnited States was due to the Company not shipping certain orders it expected toship from its backlog during the three month period ended March 31, 2005,which commenced shipment during the three month period ended June 30,2005.  Our continuing hospitalitybusiness is expected to generate sufficient cash from operations to adequatelyfund its ongoing operating activities.

 

Gross profit for 2005 decreasedto $7,284,000 from $7,394,000 in 2004. Although revenue increased from 2004, the slight decrease in grossprofit in 2005 as compared to 2004 is mainly due to an increase in professionaland support service costs. The Company’s professional and support servicescosts increased approximately $539,000 from 2004 to 2005.  The increase in professional and supportservices costs was mainly attributable to an increase in global headcountcombined with salary increases from 2004 to 2005 resulting in an increase incosts of approximately $403,000 and $160,000 in the United States and Asia,respectively.  Additionally, the Companyamortized approximately $211,000 of developed technology intangible assets tosoftware cost of sales during 2005. There was no such amortization charges during 2004.

 

Selling, general andadministrative expenses (“SG&A”) decrease from $4,700,000 in 2004 to $4,550,000in 2005.  The decrease is mainly due tothe closing of the Company’s Mexico office in January, 2004 and the ongoingeffects of the management cost control program resulting in reduced, buildingrent and consulting services.

 

Research and developmentcosts increased from $1,800,000 in 2004 to $2,264,000 in 2005.  The company capitalized $604,000 of softwaredevelopment costs in 2004. As of January 1, 2005, the Company released itsnew N-Tier, Internet-native corporate application suite of products written injava and ceased capitalizing costs relating to the modules associated with thissuite of applications. After considering the amount capitalized in 2004, grossresearch and development costs decreased from 2004 to 2005 by approximately $140,000due to a decrease in engineers and quality assurance personnel in the UnitedStates which were replaced with less expensive resources in the Company’sMalaysia operations.

 

Amortization ofintangibles was $238,000 in 2005 as a result of the Company recordingapproximately $10 million of intangible assets in connection with theManagement Equity/Conversion Transaction on November 1, 2004, of whichapproximately $4,786,000 related to identifiable intangible assets whichcommenced amortization in November 2004 over their estimated useful livesof seven to fifteen years.

 

Net interest expense was$579,000 in 2004 compared to $400,000 in 2005. The decrease is due to lower balances of interest bearing debt during2005 as compared to 2004 mainly due to the conversion of approximately $3.3million of indebtedness by the Investor Group to the Company’s common stock on November 1,2004.

 

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

** **

***Market RiskDisclosures***

*** ***

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

 

***Interest RateSensitivity***

*** ***

Of our $7.2 millionprincipal amount of indebtedness at June 30, 2005, none bears interest ata variable rate.  However, $5.7 millionbears interest at a fixed rate of 11%, $0.5 million bears interest at a fixedrate of 12.5%, $0.4 million bears interest at 9.25% and $0.6 million bearsfixed interest rates ranging from zero to 6%. Since these debt instruments bearinterest at fixed rates, we have exposure to decreases in interest ratesbecause we still are required to pay the fixed rate even if current interestrates are lower.

 

***Foreign CurrencyRisk***

*** ***

We believe that our exposure to currency exchangefluctuation risk is reduced because our transactions with international vendorsand customers are generally transacted in US dollars. The currency exchangeimpact on intercompany transactions was immaterial for the quarter ended June 30,2005.

 

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

** **

#### ***(a)***                                 Evaluationof disclosure controls 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 within 90 days of the filing of this report. Theprincipal executive officer and principal financial officer concluded, based ontheir review, that our disclosure controls and procedures, as defined byExchange Act Rules 13a-14(c) and 15d-14(c), are effective and ensurethat we disclose the required information in reports that we file under theExchange Act and that the filings are recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms. No significant changes were made to ourinternal controls or other factors that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

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

 

On November 17, 2004, the Company’sindependent auditors orally notified the Company’s Audit Committee that theyhad identified significant deficiencies regarding the Company’s internalcontrols. The deficiencies noted were mainly (a) the lack of segregationof duties and (b) the lack of adequate account analysis andreconciliations, and (c) insufficient supervision of the Company’saccounting personnel.  The Company believes such deficiencies wereprimarily attributable to changes in personnel within the accounting departmentcombined with the lack of adequate resources given the size of theCompany.  However, the Company has takensteps to improve these internal control weaknesses such as hiring of additionalaccounting personnel and the reallocation of duties to better facilitatesegregation of duties and supervision. Additionally, the Company has implemented procedures for timely andcomplete account analysis and reconciliations. We have implemented new accounting software during the first quarter of2005, which we believe mitigates certain weaknesses in our systems to ensureour financial statements are fairly presented in accordance with United StatesGenerally Accepted Accounting Principles.

 

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

 

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

#### *** ***

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

 

**PART II -OTHER INFORMATION**

** **

**Item 1.**           LegalProceedings

** **

None

 

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

** **

(a)                                  None.

 

(b)                                 None.

 

(c)                                  None

 

(d)                                 None.

 

**Item 3.  Defaults Upon Senior Securities**

** **

(a)                                  None

 

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

** **

(a)                                  None

 

(b)                                 None

 

(c)                                  None

 

(d)                                 None

 

**Item 5.  Other Information**

** **

(a)                                  None.

 

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

** **

(a)                                  Exhibits

** **

31.1         Certificationof Chief Executive Officer, W. Brian Kretzmer, as required by Section 3.02of Sarbane-Oxley Act of 2002

 

31.2         Certificationof Chief Financial Officer, James W. Dolan, as required by Section 3.02 ofSarbane-Oxley Act of 2002

 

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32.1         Certificationof Chief Executive Officer, W. Brian Kretzmer, as required by Section 9.06of Sarbane-Oxley Act of 2002

 

32.2         Certificationof Chief Financial Officer, James W. Dolan, as required by Section 9.06 ofSarbane-Oxley Act of 2002

 

(b)                                 Reportson Form 8-K:

 

Filed March 1, 2005

 

Filed September 22, 2005

 

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**SIGNATURES**

** **

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

 

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

 

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