** **

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM10-Q**

 
| **(Mark  One)**                                             |
|-------------------------------------------------------------|
| **ý**                                                  | ** ** | **QUARTERLY  REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
| ** **                                                  | ** ** | ** ** |
| **For  the Quarterly Period Ended December 31, 2005.** |
|                                                        |   |   |
| **OR**                                                      |
|                                                        |   |   |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For thetransition period from                                    to                                     .**

 

**CommissionFile Number 0-15935**

 

**SPESCOMSOFTWARE INC.**

(Exact name of registrantas specified in its charter)

 
| **CALIFORNIA**                                              | ** ** | **95-3634089**       |
|-------------------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                            |       | (I.R.S. Employer     |
| incorporation or  organization)                             |       | Identification  No.) |
|                                                        |       |                 |
| **10052  MESA RIDGE COURT, SUITE 100, SAN DIEGO, CA 92121** |
| (Address of  principal executive offices and zip code)      |
|                                                        |       |                 |
| **(858)  625-3000**                                         |
| (Registrants  telephone number, including area code)        |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

YES         ý            NO          o

 

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

 

Large Accelerated Filer o                  AcceleratedFiler o             Non-AcceleratedFiler ý

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 126-2 of theExchange Act).

 

YES         o            NO          ý

 

Number of shares ofCommon Stock outstanding at February 14, 2006:  36,818,528

 

Number of SequentiallyNumbered Pages: 23

 

 

----

 

**ITEM1.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**SPESCOMSOFTWARE INC.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                    | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2005**         | ** ** | **2005**          | ** ** |
|                                                                                                                                                          |       | **(Unaudited)**  |       |              |       |
| **ASSETS**                                                                                                                                                    |       |             |       |              |       |
| Current assets:                                                                                                                                               |       |             |       |              |       |
| Cash and cash  equivalents                                                                                                                                    |       | $                | 396,000    |              | $          | 285,000 |   |
| Receivables, net                                                                                                                                              |       | 575,000          |       | 613,000           |       |
| Other current  assets                                                                                                                                         |       | 187,000          |       | 72,000            |       |
| Total current  assets                                                                                                                                         |       | 1,158,000        |       | 970,000           |       |
|                                                                                                                                                          |       |             |       |              |       |
| Property and  equipment, net                                                                                                                                  |       | 153,000          |       | 168,000           |       |
| Computer  software, net                                                                                                                                       |       | 503,000          |       | 477,000           |       |
| Other assets                                                                                                                                                  |       | 30,000           |       | 30,000            |       |
| Total assets                                                                                                                                                  |       | $                | 1,844,000  |              | $          | 1,645,000 |   |
|                                                                                                                                                          |       |             |       |              |       |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIT**                                                                                                                |       |             |       |              |       |
| Current liabilities:                                                                                                                                          |       |             |       |              |       |
| Accounts payable                                                                                                                                              |       | $                | 531,000    |              | $          | 374,000 |   |
| Payable to  Spescom Ltd.                                                                                                                                      |       | 282,000          |       | 213,000           |       |
| Preferred stock  dividend payable to Spescom Ltd.                                                                                                             |       | 645,000          |       | 568,000           |       |
| Accrued  liabilities                                                                                                                                          |       | 1,160,000        |       | 1,407,000         |       |
| Lease  obligations– current portion                                                                                                                      |       | 43,000           |       | 41,000            |       |
| Notes and  accrued interest payable to Spescom Ltd.                                                                                                           |       | 994,000          |       | —            |       |
| Deferred revenue                                                                                                                                              |       | 2,806,000        |       | 3,026,000         |       |
| Total current  liabilities                                                                                                                                    |       | 6,461,000        |       | 5,629,000         |       |
|                                                                                                                                                          |       |             |       |              |       |
| Notes and  accrued interest payable to Spescom Ltd.                                                                                                           |       | —           |       | 917,000           |       |
| Lease  obligations                                                                                                                                            |       | 46,000           |       | 59,000            |       |
| Total  liabilities                                                                                                                                            |       | 6,507,000        |       | 6,605,000         |       |
|                                                                                                                                                          |       |             |       |              |       |
| Series H  redeemable preferred stock, par value $0.01 per share, 2,450 remaining shares  authorized; 1,950 shares issued and outstanding at December 31, 2005 |       | 1,950,000        |       | —            |       |
|                                                                                                                                                          |       |             |       |              |       |
| Shareholders’  deficit:                                                                                                                                  |       |             |       |              |       |
| Convertible  preferred stock, 243,239 remaining shares authorized                                                                                             |       |             |       |              |       |
| Series F - par  value $1.00 per share; 5,291 shares authorized, issued and outstanding at December  31, 2005 and September 30, 2005                           |       | 6,790,000        |       | 6,790,000         |       |
| Series G - par  value $0.01 per share; 1,670 remaining shares authorized; 1450 shares issued  and outstanding at September 30, 2005                           |       | —           |       | 1,450,000         |       |
| Common stock, no  par value, 100,000,000 shares authorized; 36,818,528 shares issued and  outstanding at December 31, 2005 and September 30, 2005             |       | 76,207,000       |       | 75,938,000        |       |
| Common stock  warrants                                                                                                                                        |       | 1,678,000        |       | 1,506,000         |       |
| Accumulated  other comprehensive loss                                                                                                                         |       | (318,000         | )          | (353,000          | )          |
| Accumulated  deficit                                                                                                                                          |       | (90,970,000      | )          | (90,291,000       | )          |
| Total  shareholders’ deficit                                                                                                                             |       | (6,613,000       | )          | (4,960,000        | )          |
|                                                                                                                                                          |       |             |       |              |       |
| Total  liabilities and shareholders’ deficit                                                                                                             |       | $                | 1,844,000  |              | $          | 1,645,000 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

2

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**SPESCOMSOFTWARE INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                          | ** ** | **For the three months ended  December 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| Revenues:                                           |       |                                         |       |   |   |
| Licenses                                            |       | $                                            | 564,000    |   | $ | 268,000 |   |
| Services and  other                                 |       | 1,268,000                                    |       | 1,385,000 |   |
| Total revenues                                      |       | 1,832,000                                    |       | 1,653,000 |   |
|                                                |       |                                         |       |   |   |
| Cost of  revenues:                                  |       |                                         |       |   |   |
| Licenses                                            |       | 122,000                                      |       | 44,000 |   |
| Services and  other                                 |       | 540,000                                      |       | 614,000 |   |
| Total cost of  revenues                             |       | 662,000                                      |       | 658,000 |   |
|                                                |       |                                         |       |   |   |
| Gross profit                                        |       | 1,170,000                                    |       | 995,000 |   |
|                                                |       |                                         |       |   |   |
| Operating expenses:                                 |       |                                         |       |   |   |
| Research and  development                           |       | 203,000                                      |       | 346,000 |   |
| Marketing and  sales                                |       | 653,000                                      |       | 824,000 |   |
| General and  administrative                         |       | 441,000                                      |       | 399,000 |   |
|                                                |       | 1,297,000                                    |       | 1,569,000 |   |
|                                                |       |                                         |       |   |   |
| Loss from  operations                               |       | (127,000                                     | )          | (574,000 | ) |
|                                                |       |                                         |       |   |   |
| Interest expense                                    |       | (52,000                                      | )          | (30,000 | ) |
| Net loss                                            |       | (179,000                                     | )          | (604,000 | ) |
|                                                |       |                                         |       |   |   |
| Deemed preferred  dividend                          |       | (500,000                                     | )          | (2,200,000 | ) |
| Net loss  available after deemed preferred dividend |       | (679,000                                     | )          | (2,804,000 | ) |
|                                                |       |                                         |       |   |   |
| Cumulative  preferred dividends                     |       | (88,000                                      | )          | (74,000 | ) |
| Net loss  available to common shareholders          |       | $                                            | (767,000   | ) | $ | (2,878,000 | ) |
|                                                |       |                                         |       |   |   |
| Earnings (loss)  per share:                         |       |                                         |       |   |   |
| Basic and  diluted                                  |       | $                                            | (0.02      | ) | $ | (0.08 | ) |
| Weighted average  shares outstanding:               |       |                                         |       |   |   |
| Basic and  diluted                                  |       | 36,819,000                                   |       | 34,159,000 |   |
|                                                |       |                                         |       |   |   |
| **Statement  of Comprehensive Loss**                |       |                                         |       |   |   |
| Net loss                                            |       | $                                            | (179,000   | ) | $ | (604,000 | ) |
| Other  Comprehensive income (loss):                 |       |                                         |       |   |   |
| Foreign currency  translation adjustment            |       | 34,000                                       |       | (49,000 | ) |
| Comprehensive  loss                                 |       | $                                            | (145,000   | ) | $ | (653,000 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

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** **

**SPESCOMSOFTWARE INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the three months ended  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                                         |       |   |   |
| Net loss                                                                     |       | $                                            | (179,000   | ) | $ | (604,000 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                         |       |   |   |
|                                                                         |       |                                         |       |   |   |
| Depreciation and  amortization                                               |       | 25,000                                       |       | 26,000 |   |
| Unpaid interest  on notes payable                                            |       | 48,000                                       |       | 31,000 |   |
| Share-based  compensation                                                    |       | 54,000                                       |       | — |   |
| Deferred payment  of professional services by Spescom Ltd.                   |       | 33,000                                       |       | — |   |
| Compensation for  warrants issued to consultants                             |       | 4,000                                        |       | — |   |
| Changes in  assets and liabilities:                                          |       |                                         |       |   |   |
| Receivables, net                                                             |       | 31,000                                       |       | 127,000 |   |
| Other current  assets                                                        |       | (91,000                                      | )          | 4,000 |   |
| Accounts payable                                                             |       | 165,000                                      |       | (28,000 | ) |
| Payable to  Spescom Ltd.                                                     |       | 95,000                                       |       | 5,000 |   |
| Accrued  liabilities                                                         |       | (268,000                                     | )          | (249,000 | ) |
| Deferred revenue                                                             |       | (192,000                                     | )          | (344,000 | ) |
| Net cash used in  operating activities                                       |       | (275,000                                     | )          | (1,032,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Cash flows from  investing activities:                                       |       |                                         |       |   |   |
| Purchases of  property and equipment                                         |       | (1,000                                       | )          | (2,000 | ) |
| Capitalization  of development costs                                         |       | (35,000                                      | )          | — |   |
| Purchases of  software                                                       |       | (2,000                                       | )          | (30,000 | ) |
| Net cash used in  investing activities                                       |       | (38,000                                      | )          | (32,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Cash flows from  financing activities:                                       |       |                                         |       |   |   |
| Proceeds from  exercise of stock options                                     |       | —                                       |       | 2,000 |   |
| Net proceeds  from private placement                                         |       | 436,000                                      |       | 1,782,000 |   |
| Payments on  capital lease obligations                                       |       | (11,000                                      | )          | (6,000 | ) |
| Net cash  provided by financing activities                                   |       | 425,000                                      |       | 1,778,000 |   |
|                                                                         |       |                                         |       |   |   |
| Effect of  exchange rate changes on cash                                     |       | (1,000                                       | )          | (11,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Net increase in  cash and cash equivalents                                   |       | 111,000                                      |       | 703,000 |   |
| Cash and cash  equivalents at beginning of period                            |       | 285,000                                      |       | 109,000 |   |
|                                                                         |       |                                         |       |   |   |
| Cash and cash  equivalents at end of period                                  |       | $                                            | 396,000    |   | $ | 812,000 |   |

 

See Note 2 forsupplemental cash flow information.

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

4

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**SPESCOMSOFTWARE INC.**

**CONDENSEDNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1 -Basis of Presentation**

 

The accompanyingconsolidated financial statements as of December 31, 2005 and for thethree months ended December 31, 2005 and 2004 are unaudited. Theconsolidated financial statements and related notes have been prepared inaccordance with generally accepted accounting principles applicable to interimperiods.  In the opinion of management, the consolidated financialstatements reflect all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the consolidated financialposition, operating results and cash flows for the periods presented.

 

The information containedin the following Condensed Notes to the Consolidated Financial Statements iscondensed from that which would appear in the annual consolidated financialstatements; accordingly, the consolidated financial statements included herein shouldbe reviewed in conjunction with the consolidated financial statements andrelated notes thereto contained in the Company’s Annual Report on Form 10-K/A forthe year ended September 30, 2005.  It should be understood that theaccounting measurements at an interim date inherently involve greater relianceon estimates than at year-end.  The results of operations for the interimperiods presented are not necessarily indicative of the results expected forthe entire year.

 

**Note 2 –Summary of Significant Accounting Policies**

 

*Principlesof Consolidation*

 

The consolidatedfinancial statements are prepared using accounting principles generallyaccepted in the United States of America and include the accounts of theCompany and its wholly-owned United Kingdom subsidiary, Spescom Software, Ltd.All significant intercompany balances and transactions have been eliminated.

 

*ForeignCurrency*

 

The functional currencyof the Company’s United Kingdom subsidiary is the pound sterling. Assets andliabilities are translated into U.S. dollars at end-of-period exchange rates.Revenues and expenses are translated at average exchange rates in effect forthe period. Net currency exchange gains or losses resulting from suchtranslations are excluded from net income and are accumulated in a separatecomponent of shareholders’ deficit as accumulated other comprehensive income (loss).Gains and losses resulting from foreign currency transactions, which are notsignificant, are included in the consolidated statements of operations.

 

*Use ofEstimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andalso requires disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting periods. Actual results could differ from those estimates.Significant estimates made by management include revenue recognition estimates,the viability of recognizing deferred income tax assets, capitalized softwarecosts and the valuation of equity instruments, and the allowance for doubtfulaccounts.  Significant changes in these estimates may have a materialimpact on the financial statements.

 

*RevenueRecognition*

 

The Company’s revenuesare derived from sales of its document and configuration management systemsthat are primarily composed of software and services, including maintenance,training and consulting services, and third party software and hardware. TheCompany recognizes revenue in accordance with Statement of Position (“SOP”)97-2 “Software Revenue Recognition” and SOP 98-9, “Modification of SOP 97-2,Software Revenue Recognition with Respect to Certain Transactions” and StaffAccounting Bulletin (“SAB”) No. 101, updated by SAB’s 103 and 104 “Update ofCodification of Staff Accounting Bulletins.”

 

Software license andthird party product revenues are recognized upon shipment of the product if nosignificant vendor obligations remain and collection is probable. In caseswhere a significant vendor obligation exists, revenue recognition is delayeduntil such obligation has been satisfied. For new software products where ahistorical record has not yet been demonstrated that acceptance is perfunctory,the Company defers recognition of revenue until acceptance hasoccurred.   If an undelivered element of the arrangement exists underthe license arrangement, a portion of revenue is deferred based onvendor-specific objective evidence (VSOE) of the fair value of the undeliveredelement until delivery occurs.  If VSOE does not exist for all undeliveredelements, all revenue is deferred until sufficient evidence exists or allelements have been delivered.  Annual maintenance revenues, which consistof ongoing support

 

5

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and product updates, arerecognized on a straight-line basis over the term of the contract. Paymentsreceived in advance of performance of the related service for maintenancecontracts are recorded as deferred revenue. Revenues from training andconsulting services are recognized when the services are performed and adequateevidence of providing such services is available. Contract revenues forlong-term contracts or programs requiring specialized systems are recognizedusing the percentage-of-completion method of accounting, primarily based oncontract labor hours incurred to date compared with total estimated labor hoursat completion. Provisions for anticipated contract losses are recognized at thetime they become known.

 

Contracts are billedbased on the terms of the contract. There are no retentions in billed contractreceivables. Unbilled contract receivables relate to revenues earned but notbilled at the end of the period.

 

The Company considersmany factors when applying accounting principles generally accepted in theUnited States of America related to revenue recognition.  These factorsinclude, but are not limited to:

 

•                                          Theactual contractual terms, such as payment terms, delivery dates, and pricing ofthe various product and service elements of a contract

•                                          Availabilityof products to be delivered

•                                          Timeperiod over which services are to be performed

•                                          Creditworthinessof the customer

•                                          Thecomplexity of customizations to the Company’s software required by servicecontracts

•                                          Thesales channel through which the sale is made (direct, VAR, distributor, etc.)

•                                          Discountsgiven for each element of a contract

•                                          Anycommitments made as to installation or implementation of “go live” dates

 

Each of the relevantfactors is analyzed to determine its impact, individually and collectively withother factors, on the revenue to be recognized for any particular contract witha customer.  Management is required to make judgments regarding thesignificance of each factor in applying the revenue recognition standards, aswell as whether or not each factor complies with such standards.  Anymisjudgment or error by management in its evaluation of the factors and theapplication of the standards, especially with respect to complex or new typesof transactions, could have a material adverse effect on the Company’s futureoperating results.

 

*FairValue of Financial Instruments*

 

Statement of FinancialAccounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value ofFinancial Instruments”, requires management to disclose the estimated fairvalue of certain assets and liabilities defined by SFAS No. 107 as cash ora contractual obligation that both conveys to one entity a right to receivecash or other financial instruments from another entity, and imposes on theother entity the obligation to deliver cash or other financial instruments tothe first entity. At December 31, 2005 and September 30, 2005,management believes that the carrying amounts of cash and cash equivalents,short-term investments, accounts receivable and accounts payable, and accruedexpenses approximate fair value because of the short maturity of these financialinstruments. The Company believes that the carrying value of its loansapproximate their fair values based on current market rates of interest.

 

*Concentrationof Credit Risk*

 

The Company providesproducts and services to customers in a variety of industries worldwide,including local governments, petrochemicals, utilities, manufacturing andtransportation. Concentration of credit risk with respect to trade receivablesis limited due to the geographic and industry dispersion of the Company’scustomer base. The Company has not experienced significant credit losses on itscustomer accounts. W.H. Smith Ltd., CSC International Systems, Pan AmericanEnergy, and City of Lancaster accounted for 17%, 14%, 13% and 10%, respectively,of trade accounts receivable at December 31, 2005 as compared to W.H. SmithLtd. and Entergy Operations, which accounted for 33% and 28%, respectively, oftrade accounts receivable at September 30, 2005.

 

A small number ofcustomers have typically accounted for a large percentage of the Company’sannual revenues. Florida Power and Light, Constellation Energy Group and W.H.Smith Ltd. accounted for 16%, 13% and 11%, respectively, of revenue for thethree months ended December 31, 2005 while Network Rail and ConstellationEnergy Group accounted for 19% and 11%, respectively, of revenue for the threemonths ended December 31, 2004.  The Company’s reliance on relativelyfew customers could have a material adverse effect on the results of itsoperations on a quarterly basis.

 

*Propertyand Equipment*

 

Property and equipment isrecorded at cost and depreciated using the straight-line method over usefullives of two to seven years. Leasehold improvements are amortized on astraight-line basis over the shorter of their useful life or the term of therelated lease. Expenditures for ordinary repairs and maintenance are expensedas incurred while major additions and improvements are capitalized.

 

6

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*SoftwareDevelopment Costs*

 

Software developmentcosts are capitalized when technological feasibility and marketability of therelated product have been established. Software development costs incurredsolely in connection with a specific contract are charged to cost of revenues.Capitalized software development costs are amortized on a product-by-productbasis, beginning when the product is available for

general release tocustomers. Annual amortization expense is calculated using the greater of theratio of each product’s current gross revenues to the total of current andexpected gross revenues or the straight-line method over the estimated usefullife of three to five years. For the three months ended December 31, 2005software development costs totaling $35,000 were capitalized while amortizationexpense was $9,000. There were no capitalized software development costs oramortization expense for the three months ended December 31, 2004. As ofDecember 31, 2005 and September 30, 2005, the balance of software developmentcapitalized totaled $513,000 and $478,000, respectively, with accumulated amortizationof $10,000 and $1,000, respectively.

 

*Long-livedAssets*

 

The Company assessespotential impairments to its long-lived assets when there is evidence thatevents or changes in circumstances have made recovery of the assets’ carryingvalue unlikely. An impairment loss would be recognized when the sum of theexpected future net cash flows is less than the carrying amount of the asset.

 

*Share-BasedPayments*

 

In April 1996, the Company adopted its 1996 Stock Incentive Plan(the “1996 Plan”).  The 1996 Plan is administered by either the Board ofDirectors or a committee designated by the Board to oversee the plan.  Thetotal number of authorized shares under the 1996 plan is 7,425,000.  As ofDecember 31, 2005, options to purchase 5,733,000 shares are outstandingand 1,342,962 shares are available for grant.

 

The option vesting period under the plan is determined by the Board ofDirectors or a Stock Option Committee and usually provides that 25% of theoptions granted can be exercised 90 days from the date of grant, andthereafter, those options vest and become exercisable in additional cumulativeannual installments of 25% commencing on the first anniversary of the date ofgrant. Options granted are generally due to expire upon the sooner of ten yearsfrom date of grant, thirty days after termination of services other than byreason of convenience of the Company, three months after disability, or oneyear after the date of the option holder’s death. The option exercise price isequal to the fair market value of the common stock on the date of grant. Options granted to employees under the 1996 Plan may be either incentive stockoptions or nonqualified options. Only nonqualified options may be granted tononemployee directors.

 

In December 2004,the Financial Accounting Standards Board (FASB) revised Statement of FinancialAccounting Standards No. 123 (FAS 123R), “Share-Based Payment,” whichestablishes accounting for share-based awards exchanged for employee servicesand requires companies to expense the estimated fair value of these awards overthe requisite employee service period. On April 14, 2005, the U.S.Securities and Exchange Commission adopted a new rule amending the effectivedates for FAS 123R. In accordance with the new rule, the accounting provisionsof FAS 123R are effective for the Company beginning in the quarter endedDecember 31, 2005.

 

Under FAS 123R,share-based compensation cost is measured at the grant date, based on theestimated fair value of the award, and is recognized as expense over theemployee’s requisite service period. The Company has no awards with market orperformance conditions. The Company adopted the provisions of FAS 123R onOctober 1, 2005, the first day of the Company’s fiscal year 2006, using amodified prospective application, which provides for certain changes to themethod for valuing share-based compensation. Under the modified prospectiveapplication, prior periods are not revised for comparative purposes. Thevaluation provisions of FAS 123R apply to new awards and to awards that areoutstanding on the effective date and subsequently modified or cancelled.Estimated compensation expense for awards outstanding at the effective datewill be recognized over the remaining service period using the compensationcost calculated for pro forma disclosure purposes under FASB StatementNo. 123, “Accounting for Stock-Based Compensation” (FAS 123).

 

On November 10,2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards.”The Company has elected to adopt the alternative transition method provided inthis FASB Staff Position for calculating the tax effects of share-basedcompensation pursuant to FAS 123R. The alternative transition method includes asimplified method to establish the beginning balance of the additional paid-incapital pool (APIC pool) related to the tax effects of employee share-basedcompensation, which is available to absorb tax deficiencies recognizedsubsequent to the adoption of FAS 123R.

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted average assumptions used forgrants:

 
| ** **               | ** ** | **For the three months ended  December 31, 2005** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|
| Dividend Yield           |       | 0                                                 | %          |
| Expected  Volatility     |       | 213                                               | %          |
| Risk free  interest rate |       | 4.47                                              | %          |
| Expected lives           |       | 10 yrs                                            |       |

 

7

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The weighted –averageestimated fair value of employee stock options granted during the three monthsended December 31, 2005 using the Black-Scholes model were as follows:

 
| ** **                                                   | ** ** | **For the three months ended  December 31, 2005** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------|------------|
| Research and  development                                    |       | $                                                 | 3,000      |   |
| Marketing and  sales                                         |       | 18,000                                            |       |
| General and  administrative                                  |       | 33,000                                            |       |
|                                                         |       |                                              |       |
| Share-based  compensation                                    |       | $                                                 | 54,000     |   |
|                                                         |       |                                              |       |
| Basic and  diluted net loss per share attributable to common |       |                                              |       |
| Basic                                                        |       | $                                                 | —     |   |
| Diluted                                                      |       | $                                                 | —     |   |

 

A summary of optionactivity under the Plan as of December 31, 2005, and changes during the threemonths then ended is presented below:

 
| ** **                                      | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **     | ** ** |
|-------------------------------------------------|------------|------------|------------|---------------|------------|-----------------|------------|----------------|------------|
| ** **                                      | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **     | ** ** |
| ** **                                      | ** ** | ** ** | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregrate** | ** ** |
| ** **                                      | ** ** | ** ** | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic**  | ** ** |
| **Options**                                     | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**      | ** ** |
|                                            |       | **(000)**  |       |          |       |            |       |           |       |
| Outstanding  Options at September 30, 2005 |       | 4,856      |       | $             | 0.30       |            |       |           |       |   |
|                                            |       |       |       |          |       |            |       |           |       |
| Granted                                         |       | 920        |       | $             | 0.11       |            |       |           |       |   |
|                                            |       |       |       |          |       |            |       |           |       |
| Exercised                                       |       | —     |       | —        |       |            |       |           |       |
|                                            |       |       |       |          |       |            |       |           |       |
| Forfeited or  expired                           |       | (43        | )          | $             | 0.45       |            |       |           |       |   |
|                                            |       |       |       |          |       |            |       |           |       |
| Outstanding at  December 31, 2005               |       | 5,733      |       | $             | 0.27       |            | 7.4 yrs    |           | $          | 67,110 |   |
|                                            |       |       |       |          |       |            |       |           |       |
| Exercisable at  December 31, 2005               |       | 4,031      |       | $             | 0.31       |            | 6.8 yrs    |           | $          | 27,960 |   |

 

The weighted average grant-date fair values of options granted duringthe quarter ended December 31, 2005 were $0.11 per share.  There were no options exercised for the threemonths ended December 31, 2005.

 

A summary of the status of our nonvested stock options as of December31, 2005, and changes during the quarter ended December 31, 2005, ispresented below:

 
| ** **                      | ** ** | **Number of  Shares** | ** ** | **Weighted  average  grant-date  fair value per  share** | ** ** |
|---------------------------------|------------|-----------------------|------------|----------------------------------------------------------|------------|
| Nonvested at September 30, 2005 |       | 1,098,000             |       | $                                                        | 0.30       |   |
| Granted                         |       | 920,000               |       | $                                                        | 0.11       |   |
| Vested                          |       | (316,000              | )          | $                                                        | 0.11       |   |
| Nonvested at December 31, 2005  |       | 1,702,000             |       | $                                                        | 0.30       |   |

 

As of December 31,2005 there was $145,000 of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the 1996Plan.  That cost is expected to berecognized over a period of 3 years.  Thetotal fair value of shares vested during the three months ended December 31,2005 was $35,000.

 

*ProForma Information under FAS 123 for Periods Prior to Fiscal 2006*

 

The Company measurescompensation expense for its stock-based employee compensation plans using theintrinsic value method and

provides pro formadisclosures of net loss and basic and diluted net loss per share as if the fairvalue-based method had been applied in measuring compensation expense. TheCompany applies SFAS No.123,*Accounting forStock-Based Compensation* and Accounting Principles Board OpinionNo. 25 and related Interpretations in accounting for its employeestock-based compensation plan.

 

8

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No compensation cost wasrecognized for employee stock option grants during 2005 based upon theintrinsic value method, which were fixed in nature, as the options were grantedat exercise prices equal to fair market value on the date of grant. Hadcompensation cost for the Company’s employee stock-based compensation plan beendetermined based on the fair value at the grant dates the disclosurerequirements of SFAS No. 148, which amends the disclosure requirements of FAS123, would have been as follows:

 
| ** **                                                                                                                | ** ** | **For the three months ended  December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| Net loss used in  computing net loss per share                                                                            |       |                                              |       |
| As reported                                                                                                               |       | $                                                 | (2,878,000 | ) |
| Subtract: Total  stock based employee compensation expense value based method for all awards,  net of related tax effects |       | (58,000                                           | )          |
| Pro forma net  loss                                                                                                       |       | $                                                 | (2,936,000 | ) |
|                                                                                                                      |       |                                              |       |
| Basic and  diluted net loss per share attributable to common                                                              |       |                                              |       |
| As reported                                                                                                               |       | $                                                 | (0.09      | ) |
| Pro forma                                                                                                                 |       | $                                                 | (0.09      | ) |

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted average assumptions used forgrants:

 
| ** **               | ** ** | **For the three months ended   December 31, 2004** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|
| Dividend Yield           |       | 0                                                  | %          |
| Expected  Volatility     |       | 235                                                | %          |
| Risk free  interest rate |       | 4.23                                               | %          |
| Expected lives           |       | 10 yrs                                             |       |

 

*IncomeTaxes*

 

Current income taxexpense is the amount of income taxes expected to be payable for the currentyear. A deferred income tax asset or liability is established for the expectedfuture consequences resulting from the differences in the financial reportingand tax bases of assets and liabilities. Deferred income tax expense (benefit)is the change during the year in the deferred income tax asset or liability.

 

Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be “more likely than not” realized in the future based on the Company’scurrent and expected operating results.

 

*NetIncome (Loss) per Common Share*

 

Basic net income (loss)per common share is computed as net income (loss) divided by the weightedaverage number of common shares outstanding during the year. Diluted net income(loss) per common share is computed as net loss divided by the weighted averagenumber of common shares and potential common shares, using the treasury stockmethod, outstanding during the year and assumes conversion into common stock atthe beginning of each period of all outstanding shares of convertible preferredstock, stock options, warrants and other potential common stock. Computationsof diluted net income (loss) per share do not give effect to individualpotential common stock for any period in which their inclusion would beanti-dilutive.

 

*Statementsof Cash Flows*

 

The following tableprovides supplemental cash flow information:

 
| ** **                                    | ** ** | **For the  three months ended  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| Supplemental  cash flow information:          |       |                                          |       |   |   |
| Interest paid                                 |       | $                                             | 4,000      |   | $ | 2,000 |   |
|                                          |       |                                          |       |   |   |
| Non-cash  financing and investing activities: |       |                                          |       |   |   |
| Accrued  preferred stock dividends            |       | $                                             | 88,000     |   | $ | 74,000 |   |
| Warrants issued  for services                 |       | 39,000                                        |       | 30,000 |   |
| Deemed dividend  on private placement         |       | 500,000                                       |       | 2,200,000 |   |
| Expiration of  warrants                       |       | —                                        |       | 133,000 |   |
|                                          |       | $                                             | 627,000    |   | $ | 2,437,000 |   |

 

9

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**Note 3 –Spescom Ltd. Transactions and Related Parties**

 

As of December 31, 2005and September 30, 2005 there were 5,291 shares of Series F Convertible PreferredStock with a stated value of $1,000 per share held by Spescom Ltd., themajority shareholder of the Company. The Series F Convertible Preferred Stock isconvertible into common stock, at a stated conversion price of $0.45 per sharesubject to certain adjustments.  The conversion is at the option ofSpescom Ltd. through September 30, 2008. The outstanding Series FConvertible Preferred Stock is entitled to receive dividends of 5% of thestated value of $1,000 per share per annum, payable on a quarterly basis incash or common stock (valued on the basis of the average per share market valueon the 30 trading days immediately prior to the date on which such dividend isdeclared by the Board of Directors).  Unpaid dividends accrue interest atthe rate of 8% per annum.  As of December 31, 2005, unpaid dividends andaccrued interest amounted to $595,000 and $50,000, respectively. As ofSeptember 30, 2005, unpaid dividends and accrued interest amounted to$529,000 and $39,000, respectively.

 

Related party liabilitiesconsist of the following:

 
| ** **                                                      | ** ** | **December 31,  2005** | ** ** | **September 30,  2005** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                                      | ** ** | ** **             | ** ** | ** **              | ** ** |
| Payable to  Spescom Ltd. UK                                     |       | $                      | 282,000    |                    | $          | 213,000 |   |
|                                                            |       |                   |       |                    |       |
| Payable to  Spescom Ltd.                                        |       | $                      | 363,000    |                    | $          | 302,000 |   |
| Notes and  accrued interest payable on demand - Spescom Ltd. UK |       | 631,000                |       | 615,000                 |       |
|                                                            |       | $                      | 994,000    |                    | $          | 917,000 |   |

 

The Company has twoexisting demand notes payable to Spescom Ltd. UK, a wholly owned subsidiary ofSpescom Ltd.,  for $400,000 and $100,000,each bearing interest rate of 10% per annum.  As of December 31, 2005 andSeptember 30, 2005, the balance owed on the notes including interest was $631,000and $615,000, respectively.Spescom Ltd. has agreed that it will not causeSpescom Ltd. UK to demand repayment under the two notes prior toOctober 1, 2006.  Interest expense on the notes was $16,000 and $14,000for the three months ended December 31, 2005 and 2004, respectively. These notes are collateralized by a security interest in favor of both Spescom Ltd.and Spescom Ltd. UK in respect of all the Company’s assets. In November 2005the Company’s wholly owned subsidiary, Spescom Software Ltd. agreed toguarantee certain loan obligations of Spescom Ltd. totaling $5.4 million as ofDecember 31, 2005.  The proceeds of theseloans had been used by Spescom Ltd. in prior years to provide working capitalto the Company. The guarantee is secured by the assets of Spescom Software Ltd.which totaled $342,000 as of December 31, 2005.

 

Under a royaltyarrangement beginning in fiscal 2004, Spescom Ltd. resells the Company’ssoftware and maintenance services in South Africa.  Royalty revenuerecognized under this agreement for the three months ended December 31, 2005and December 31, 2004 totaled $37,000 and $9,000, respectively.  InSeptember 2005, Spescom Ltd. performed certain marketing and businessdevelopment projects for the company along with assisting in raising workingcapital. Spescom Ltd. had agreed to defer payment for these services untilafter October 1, 2006. However, interest will accrue on the balance owed at arate of 11%. The total expense relating to these services was $302,000 for theyear ended September 30, 2005 and additional expense of $2,000 was recorded forthe three months ended December 31, 2005. As of December 31, 2005, the totalunpaid services and interest amounted to $304,000 and $8,000, respectively. AtDecember 31, 2005 personnel related charges are due to Spescom totaled $51,000.

 

Spescom Ltd. UK providescertain administrative and accounting functions for the Company’s UnitedKingdom subsidiary.  The Company is billed a monthly fee by Spescom Ltd.UK for reimbursement of certain costs in the United Kingdom including theoffice facilities, all accounting and human resources services, and certaincorporate marketing activities.  For the three months ended

December 31, 2005 and 2004,the administrative fees totaled $143,000 and $153,000, respectively.  Theoffice rent for the Company’s United Kingdom operations included in theadministrative fee totaled $84,000 and $90,000 for the three months endedDecember 31, 2005 and 2004, respectively.  At December 31, 2005 andSeptember 30, 2005 the Company had a payable to Spescom Ltd. UK of $282,000 and$213,000, respectively. In 1999, as part of an agreement to sell a 60% interestin its United Kingdom subsidiary to Spescom Ltd., the lease for the UnitedKingdom office facility was to be assigned to Spescom Ltd. UK; however, thelandlord did not

grant its consent to theassignment and as such Spescom Ltd.UK has paid the lease for the entire officedirectly to the landlord.  The lease expires in March 2006 and has anannual rent of $597,000.  A portion of the office has been subleased tothird party tenants for an annual rent of $274,000.  The subleases alsoexpire March 2006.

 

Spescom Ltd. and theCompany have entered into a license agreement pursuant to which Spescom Ltd. haslicensed to the Company the right to use the name “Spescom” and to use atrademark owned by Spescom Ltd. related to certain computer software. TheCompany will not pay any royalties to Spescom Ltd. in connection with thislicense. The license is for an indefinite term, but is

terminable by eitherparty upon 60 days prior written notice. Under the license agreement, SpescomLtd. has agreed to indemnify and hold harmless the Company and its directors,officers, employees and agents against liabilities arising from any claimbrought against the Company that alleges that Spescom Ltd.’s or the Company’suse of the licensed trademark infringes the rights of any third party, providedthat the Company is in material compliance with the provisions of the licenseagreement.

 

10

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**Note 4 –Receivables**

 
| ** **                            | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                            | ** ** | **2005**         | ** ** | **2005**          | ** ** |
| **Receivables consist of:**           |       |             |       |              |       |
| Receivables                           |       | $                | 583,000    |              | $          | 621,000 |   |
| Less: allowance for doubtful accounts |       | (8,000           | )          | (8,000            | )          |
|                                  |       | $                | 575,000    |              | $          | 613,000 |   |

 

**Note 5 –Reconciliation of Net Income (Loss) and Shares Used in Per Share Computations:**

 
| ** **                                 | ** ** | **For three months ended  December 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Net loss available for common shareholders |       | $                                        | (767,000   | ) | $ | (2,878,000 | ) |
|                                       |       |                                     |       |   |   |
| Common stock and common stock equivalents  |       | 36,819,000                               |       | 34,159,000 |   |
|                                            |            |                                          |            |  |  |  |  |

 

Basic net income (loss) per share is computed usingthe weighted average number of common shares outstanding during theperiod.  Contingently issued shares are included in the computation ofbasic net income (loss) per share when the related conditions aresatisfied.  Diluted net income (loss) per share is computed using theweighted average number of common shares and potentially dilutive securitiesoutstanding during the period.  Potentially dilutive securities consist ofcontingently issued shares, the common shares issuable upon conversion ofpreferred stock or convertible debt and shares issuable upon the exercise ofstock options and common stock warrants.  Potentially dilutive securitiesare excluded from the computation if their effect is anti-dilutive.

 

As of December 31, 2005,a total of 5,733,000 stock options, 6,468,428 common stock warrants and, 5,291 and1,950 shares of Series F and H Convertible Preferred Stock, respectively, wereexcluded from the diluted net income (loss) per share calculation, as theireffect would be anti-dilutive. There were no shares of Series G ConvertiblePreferred Stock at December 31, 2005. As of December 31, 2004, a total of 5,393,846stock options, 3,758,335 common stock warrants and, 5,291 and 2,200 shares ofSeries F and Series G Convertible Preferred Stock, respectively, were excludedfrom the diluted net income (loss) per share calculation, as their effect wouldbe anti-dilutive.

 

**Note 6 –Segment and Geographic Information**

 

The Company has onebusiness segment, which consists of the development and sale of a suite ofintegrated document, configuration and records management software product.

 

Revenues by customer locationare as follows:

** **
| ** **                       | ** ** | **For the three months ended  December 31,** | ** ** |
|----------------------------------|------------|----------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| United States                    |       | $                                            | 1,209,000  |   | $ | 917,000 |   |
| Europe, primarily United Kingdom |       | 492,000                                      |       | 722,000 |   |
| Other International              |       | 131,000                                      |       | 14,000 |   |
|                             |       | $                                            | 1,832,000  |   | $ | 1,653,000 |   |

 
|                                            |   | **December  31,** | ** ** | **September  30,** | ** ** |
|-------------------------------------------------|--------|-------------------|------------|--------------------|------------|
|                                            |   | **2005**          | ** ** | **2005**           | ** ** |
| Identifiable assets from continuing operations: |   |              |       |               |       |
| United States                                   |   | $                 | 1,502,000  |               | $          | 1,300,000 |   |
| Europe, United Kingdom                          |   | 342,000           |       | 345,000            |       |
|                                            |   | $                 | 1,844,000  |               | $          | 1,645,000 |   |

 

11

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**Note 7—RedeemablePreferred Stock**

 

**October2005 Private Placement**

 

On October 25, 2005, the Company completed a privateplacement issuing 1,950 shares of Series H Preferred Stock and warrants for thepurchase of 925,926 common shares in exchange for cash of $500,000 and 1,450shares of previously issued Series G Preferred Stock. The common stock warrantshave an exercise price of $0.27 per share and expire October 25, 2008. Inconnection with this transaction, the 1,450 shares of Series G PreferredStock were cancelled by the Company. Expenses relating to the transactiontotaled $64,000 primarily relating to legal and accounting fees. Pursuant tothe terms of the financing, the Company filed a registration statement on January6, 2006 for the common shares issuable under the Series H Preferred Stock andrelated warrants.

 

The shares of Series HPreferred Stock issued are convertible into common stock at the conversion ratein effect at the time of conversion.  The conversion price per share of theSeries H Preferred Stock is equal to 85% of the market price (the volumeweighted average price of the Company’s common stock during the 5 immediatelypreceding trading days), provided that in no event shall the conversion priceexceed a ceiling price of $0.40 per share, or be less than a floor price whichvaries with the aggregate gross revenues of the Company during the last fourfiscal quarters for which revenues have been reported by the Company prior tosuch time, but which will not be lower than $0.0725 per share and not higherthan $0.16 per share.

 

Under the terms of theSeries H Preferred Stock, if the Company has not entered into a bindingagreement to consummate a consolidation, merger, reclassification of the stockof the Company (subject to certain exceptions), or disposition of all onsubstantially all of the assets of the Company, on or before April 30, 2006,the holders of Series H Preferred Stock may, by the vote

 

12

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not later than June 30, 2006of at least two-thirds of the then-outstanding shares, elect to have all of theoutstanding shares of Series H Preferred Stock redeemed by the Company. Upon such election, the Company would be obligated to redeem the Series HPreferred Stock at an amount equal to $1,000 per share plus all declared butunpaid dividends.  In the event that the holders of Series H PreferredStock exercise their redemption right but the Company does not have sufficientfunds available to redeem the Series H Preferred Stock in accordance withapplicable law, the holders of Series H Preferred Stock as a class will beentitled to elect the smallest number of directors of the Company constitutinga majority of the authorized number of directors. Due to this conditionalredemption feature the Series H Preferred Stock has been excluded from stockholders’equity and liabilities on the balance sheet until the condition are resolved.

 

The terms of the financing provide for a second closing to haveoccurred no later than January 20, 2006, under which the Company would issue anadditional 500 shares of Series H Preferred Stock and additional warrants forthe purchase of 925,926 common shares in exchange for cash of $500,000. Theobligations of the purchasers to consummate the second closing were subject tocertain conditions, including that the closing price of the Company’s commonstock would be $0.16 or greater for 20 consecutive trading days. This stockprice condition was not satisfied and the second closing was not completed. TheCompany is currently in discussions with the investor regarding revised terms forthe additional $500,000.

 

In accordance with EITF00-27 “Application of issue No 98-5 to Certain Convertible Instruments,” theCompany calculated, using the Black –Scholes method, the intrinsic value of theconvertible instruments issued and determined that there was a deemed preferreddividend equal to the gross proceeds received of $500,000.

 

**Note 8—Equity**

 

**November2004 Private Placement**

 

On November 5, 2004, the Company completed a financingarrangement whereby the Company issued 2,200 shares of our Series G PreferredStock along with 2,750,000 common stock warrants for gross proceeds of $2,200,000.The Series G Preferred Stock was convertible into common stock at a price equalto 85% of the volume weighted average price of the Company’s common stockduring the five trading days immediately preceding the conversion date; however,the conversion price could be no higher than $0.40 per share and no lower than$0.30 per share. The 2,750,000 warrants have an exercise price of $0.44 pershare and expire November 5, 2007. The Company incurred $418,000 in expensesrelated to the transaction and issued 825,000 common stock warrants to aninvestment consulting firm. The 825,000 warrants were comprised of 550,000warrants with an exercise price of $0.40 per share which expire November 5,2009 and 275,000 warrants with an exercise price of $0.44 per share whichexpire on November 5, 2007. In connection with the financing, the Company recordeda beneficial conversion of $2,200,000 on the Series G Preferred Stock as a deemeddividend for the three months ended December 31, 2004. During fiscal 2005, 750shares of the Series G Preferred Stock were converted into 2,428,000 shares ofcommon stock. As part of the private placement in October 2005 the Companyexchanged the 1,450 remaining shares of Series G Preferred Stock for 1,450shares of Series H Preferred Stock. The shares of the Series G PreferredStock have been cancelled by the Company. (See Note 7)

 

**Issuanceof Warrants to Investor Relations Firm**

 

During November 2005, theCompany entered into a six-month engagement with an investment relations firmto develop and implement a marketing program to promote financial market andinvestor awareness for the Company. The investor relations firm will receivewarrants to purchase 50,000 shares of the Company’s common stock per month at anexercise price of $0.10 per share for a total of 300,000 shares over thesix-month contract. The warrants have a three year term from the date ofissuance. In addition the investment relations firm can earn a one timeperformance warrant to purchase 500,000 shares of the Company’s common stock at$0.25 per share if during the term of the agreement the volume weighted averageprice of the Company’s common stock is above $0.50 for five consecutive days. Theinvestment relations firm has also been granted standard piggyback registrationrights with respect to any shares issuable to it by the Company pursuant towarrants received under the agreement. Under EITF 96-19 the fair value of thewarrants to purchase 300,000 and 500,000 shares of common stock was determinedto be $39,000 and will be expensed ratably over the six month term of theservice agreement.

 

**Note 9 - Recent Pronouncements**

 

There have not been any recent accounting pronouncements since theCompany’s last filing that would have a material effect on the financialstatements of the Company.

 

13

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** **

**ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward –LookingStatements**

 

*Thisreport contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934. These forward-looking statements are subjectto certain risks and uncertainties that could cause actual results to differmaterially from historical results or anticipated results, including those setforth under “Certain Factors That May Affect Future Results” below andelsewhere in, or incorporated by reference into, this report.*

 

*In somecases, you can identify forward looking statements by terms such as “may,”“intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,”“anticipate,” “estimate,” “predict,” “potential,” or the negative of theseterms, and similar expressions are intended to identify forward-lookingstatements When used in the following discussion, the words “believes,”“anticipates” and similar expressions are intended to identify forward-lookingstatements. Such statements are subject to certain risks and uncertainties,which could cause actual results to differ materially from those projected.Readers are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date hereof The forward-lookingstatements in this report are based upon management’s current expectations andbelief, which management believes are reasonable.  These statementsrepresent our estimates and assumptions only as of the date of this QuarterlyReport on Form 10-Q, and we undertakes no obligation to publicly release theresult of any revisions to these forward-looking statements, which may be madeto reflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events.*

 

*Thefollowing discussion should be read in conjunction with the SelectedConsolidated Financial Data and the Consolidated Financial Statements,including the Notes thereto.*

 

**OVERVIEW**

 

The Company develops,markets and supports*e*B, itsintegrated suite of collaborative document, configuration and recordsmanagement software solutions. The*e*Bsuite enables organizations in a broad range of industries to create, capture,store, manage, share and distribute critical business information regardingtheir customers, products, assets and processes in an efficient manner. The*e*B suite also enables them to maintaincomplete, up-to-date information about the configuration of their products,assets and infrastructures so that they can achieve operational excellence andcompliance with regulatory requirements.*e*Bprovides the capabilities of an Enterprise Content Management (ECM)/ElectronicDocument Management (EDM) System, but extends these capabilities by alsomanaging the “things’ that the content/documents relate to such as products,assets , functions, processes, requirements, projects, organizations,locations, work orders, etc. As a result, *e*Bcan be used to manage the lifecycle of physical items (e.g. products, equipmentor assets), and the requirements (e.g. functional, safety, performance,environmental, etc.) that govern them. It enables intelligent relationships tobe defined between these items thereby creating an interdependency model. As aresult, the effects of any change on requirements, documents and items can bedetermined and change can be managed to effectively ensure informationintegrity. In particular,*e*Benables organizations with extensive and complex physical infrastructures toefficiently identify, classify, structure, link, and manage documents, physicalitems, and requirements throughout their lifecycles and ensure that conformancebetween these is maintained by means of an automated change process.

 

We develop, market andsupport*e*B, our integrated suiteof collaborative document, configuration and records management softwaresolutions. Our revenues in the three months ended December 31, 2005 increasedby 11% from the same period in the prior fiscal year due to higher licensesales as a result of a large software license sale sold to Florida Power andLight. During the three months ended December 31, 2004 there were no large licensesales. The Company’s license revenue fluctuates from quarter to quarter asreflected by the increase in license sales during the quarter.

 

Our revenues are derivedfrom licenses of our software to our customers, services that we provide undermaintenance support contracts and our non-maintenance services, consistingprimarily of design studies, system implementation and training. Of our totalrevenues for the three months ended December 31, 2005, license revenuesaccounted for 31%, maintenance services revenues accounted for 40% andnon-maintenance services represented 29%.

 

Many of our customers arelocated outside the United States, with foreign-originated revenues accountingfor 34% and 45% of revenues for the three months ended December 31, 2005 and2004, respectively. The decrease in foreign revenues was magnified by a foreigncurrency loss of $37,000 due to  thedeclining value of the British pound to the dollar in the first quarter offiscal 2006 versus the same period fiscal 2005.

 

While revenues increased,our cost of revenues remained relatively unchanged when compared to the sameperiod in the prior fiscal year. Operating expenses decreased by 17% primarilyas a result of a reduction in personnel implemented in the second half offiscal 2005 and lower professional fees during the current period.

 

At December 31, 2005, ourprincipal sources of liquidity consisted of $396,000 of cash and cashequivalents, compared to $285,000 at September 30, 2005. On October 25, 2005,we completed a private placement of preferred stock which resulted in grossproceeds of $500,000.

 

14

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**CRITICALACCOUNTING POLICIES**

 

The consolidatedfinancial statements are prepared in conformity with accounting principlesgenerally accepted in the United States of America. As such, management isrequired to make judgments, estimates and assumptions that affect the reportedamounts of assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. The significant accounting policies which are most criticalto aid in fully understanding and evaluating reported financial results includethe following:

 

*RevenueRecognition*

 

The Company enters intocontractual arrangements with end-users that may include licensing of theCompany’s software products, product support and maintenance services,consulting services or various combinations thereof, including the sale of suchproducts or services separately.  The Company recognizes revenue inaccordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition”and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, withRespect to Certain Transactions” and Staff Accounting Bulletin (“SAB”) No. 101, updated by SAB’s 103 and 104 “Update of Codification of StaffAccounting Bulletins.”

 

Software license andthird party product revenues are recognized upon shipment of the product if nosignificant vendor obligations remain and collection is probable. In caseswhere a significant vendor obligation exists, revenue recognition is delayeduntil such obligation has been satisfied. For new software products where ahistorical record has not yet been demonstrated that acceptance is perfunctory,the Company defers recognition of revenue until acceptance has occurred. If anundelivered element of the arrangement exists under the license arrangement, aportion of revenue is deferred based on vendor-specific objective evidence(VSOE) of the fair value of the undelivered element until deliveryoccurs.  If VSOE does not exist for all undelivered elements, all revenueis deferred until sufficient evidence exists or all elements have beendelivered.  Annual maintenance revenues, which consist of ongoing supportand product updates, are recognized on a straight-line basis over the term ofthe contract. Payments received in advance of performance of the relatedservice for maintenance contracts are recorded as deferred revenue. Revenuesfrom training and consulting services are recognized when the services areperformed and adequate evidence of providing such services is available.Contract revenues for long-term contracts or programs requiring specializedsystems are recognized using the percentage-of-completion method of accounting,primarily based on contract labor hours incurred to date compared with total estimatedlabor hours at completion. Provisions for anticipated contract losses arerecognized at the time they become known.

 

Contracts are billedbased on the terms of the contract. There are no retentions in billed contractreceivables. Unbilled contract receivables relate to revenues earned but notbilled at the end of the period.

 

The Company considersmany factors when applying accounting principles generally accepted in theUnited States of America related to revenue recognition.  These factorsinclude, but are not limited to:

 

•                                          Theactual contractual terms, such as payment terms, delivery dates, and pricing ofthe various product and service elements of a contract

•                                          Availabilityof products to be delivered

**•****                                         **Timeperiod over which services are to be performed

•                                          Creditworthinessof the customer

•                                          Thecomplexity of customizations to the Company’s software required by servicecontracts

•                                          Thesales channel through which the sale is made (direct, VAR, distributor, etc.)

•                                          Discountsgiven for each element of a contract

•                                          Anycommitments made as to installation or implementation of “go live” dates

 

Each of the relevantfactors is analyzed to determine its impact, individually and collectively withother factors, on the revenue to be recognized for any particular contract witha customer.  Management is required to make judgments regarding thesignificance of each factor in applying the revenue recognition standards, aswell as whether or not each factor complies with such standards.  Anymisjudgment or error by management in its evaluation of the factors and theapplication of the standards, especially with respect to complex or new typesof transactions, could have a material adverse effect on the Company’s futureoperating results.

 

*SoftwareDevelopment Costs*

 

Software developmentcosts are capitalized when technological feasibility and marketability of therelated product have been established. Software development costs incurredsolely in connection with a specific contract are charged to cost of revenues. Capitalizedsoftware costs are amortized on a product-by-product basis, beginning when theproduct is available for general release to customers.   Annual amortization expense is calculated using the greater of theratio of each product’s current gross revenues to the total of current andexpected gross revenues or the straight-line method over the estimated usefullife of three to five years.

 

15

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*Allowancefor Doubtful Accounts*

 

The Company sells itsproducts directly to end-users, generally requiring a significant up-frontpayment and remaining terms appropriate for the creditworthiness of thecustomer. The Company also sells its products to VARs and other softwaredistributors

generally under termsappropriate for the creditworthiness of the VAR or distributor. The Companyretains no continuing obligations on sales to VARs.  Receivables fromcustomers are generally unsecured. The Company continuously monitors itscustomer account balances and actively pursues collections on past duebalances. The Company maintains an allowance for doubtful accounts which iscomprised of a general reserve based on historical collections performance plusa specific reserve for certain known customer collections issues. If actual baddebts are greater than the reserves calculated based on historical trends andknown customer issues, the Company may be required to book additional bad debtexpense which could have a material adverse effect on our business, results ofoperations and financial condition for the periods in which such additionalexpense occurs.

 

**RESULTSOF OPERATIONS**

 

The following table setsforth the condensed consolidated statement of operations expressed as apercentage of total revenue for the periods indicated:

 
| ** **                                 | ** ** | **For the three months ended  December 31,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| Revenues                                   |       |                                         |       |   |   |
| Licenses                                   |       | 31                                           | %          | 16 | % |
| Services and  other                        |       | 69                                           | %          | 84 | % |
| Total revenues                             |       | 100                                          | %          | 100 | % |
|                                       |       |                                         |       |   |   |
| Cost of revenues                           |       |                                         |       |   |   |
| Licenses                                   |       | 7                                            | %          | 3 | % |
| Services and  other                        |       | 29                                           | %          | 37 | % |
|                                       |       | 36                                           | %          | 40 | % |
|                                       |       |                                         |       |   |   |
| Gross profit                               |       | 64                                           | %          | 60 | % |
|                                       |       |                                         |       |   |   |
| Operating  expenses:                       |       |                                         |       |   |   |
| Research and  development                  |       | 11                                           | %          | 21 | % |
| Marketing and  sales                       |       | 36                                           | %          | 50 | % |
| General and  administrative                |       | 24                                           | %          | 24 | % |
|                                       |       | 71                                           | %          | 95 | % |
|                                       |       |                                         |       |   |   |
| Income (loss)  from operations             |       | (7                                           | )%         | (35 | )% |
|                                       |       |                                         |       |   |   |
| Interest expense                           |       | (3                                           | )%         | (2 | )% |
|                                       |       |                                         |       |   |   |
| Net loss                                   |       | (10                                          | )%         | (37 | )% |
|                                       |       |                                         |       |   |   |
| Deemed dividend                            |       | (27                                          | )%         | (133 | )% |
| Cumulative  preferred dividends            |       | (5                                           | )%         | (4 | )% |
| Net loss  available to common shareholders |       | (42                                          | )%         | (174 | )% |

 

16

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**Revenues**

 

*LicenseRevenues*

(in thousands)

 
| ** **                   | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|------------|------------|----------|------------|
| License revenues             |       | $        | 564        |       | 110        | %        | $          | 268 |   |
| Percentage of total revenues |       | 31       | %          |       |       | 16       | %          |
|                              |            |          |            |            |            |          |            |  |  |

 

License revenues increasedby $296,000, or 110%, to $564,000 from $268,000 for the three months ended December 31,2005 compared to the same period a year ago.  The Company’s licenserevenues fluctuate from quarter to quarter which is reflected by the increasein license sales in the current quarter. In the current quarter, a large saleof licenses to Florida Power and Light amounted to $269,000 while there was no similarsize sales in the prior year.

 

We anticipate that thedemand for our products will increase if overall economic conditions continueto strengthen leading to an increase in overall demand for enterprise document,configuration and records management software solutions.  The Company’slicense revenues can fluctuate from quarter to quarter, based on the timing ofcustomer orders due to the long sales cycle and changes in customers’ internalplans of the rollout of software licenses.

 

Although the Company hashistorically generated the majority of its revenues from its direct salesforce, the Company has also established a network of third-party VARs, systemintegrators and OEMs who build and sell systems (with components or completesystems provided by the Company) that address specific customer needs withinvarious industries, including those targeted directly by the Company. Sales through indirect channels for the three months ended December 31,2005 amounted to $133,000 or 7% compared to $167,000, or 10% for the sameperiod in the prior year. The Company plans to grow their indirect channelbusiness to be a greater percentage of overall revenue of the Company.

 

A small number ofcustomers have typically accounted for a large percentage of the Company’sannual revenues. Florida Power and Light, Constellation Energy Group and W.H.Smith Ltd. accounted for 16%, 13% and 11%, respectively, of revenue for thethree months ended December 31, 2005 while Network Rail and ConstellationEnergy Group accounted for 19% and 11%, respectively, of revenue for the threemonths ended December 31, 2004.  The Company’s reliance on relativelyfew customers could have a material adverse effect on the results of its operationson a quarterly basis.

 

*Servicesand Other Revenues*

(in thousands)

 
| ** **                   | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Services and other revenues  |       | $        | 1,268      |       | (8         | )%       | $          | 1,385 |   |
| Percentage of total revenues |       | 69       | %          |       |       | 84       | %          |
|                              |            |          |            |            |            |          |            |  |  |

 

Services and otherrevenues are comprised of maintenance and non-maintenance services. Non-maintenance services typically relate to business process studies,implementation of systems and training which vary with the level of licenserevenues while maintenance revenue is primarily dependent on customers renewingtheir annual maintenance support contracts.

 

Services and otherrevenue decreased $117,000, or 8%, from $1,385,000 to $1,268,000 for the threemonths ended December 31, 2005 compared to the same period a yearago.  The non-maintenance portion of service revenue decreased $55,000, or9% from $590,000 to $535,000 primarily due to one customer delaying servicesuntil the beginning of their new fiscal year, April 1, 2006.   Alsoin this quarter, maintenance revenue decreased $63,000, or 8% from $795,000 to$732,000. The decrease in maintenance is primarily the result of a customer thatdid not renew their maintenance since they had been acquired by another entity.

 

We anticipate that serviceand other revenue will fluctuate primarily due to sales to new customersbecause they require more services that typically include a business processstudy, integration with other business systems and training.  In addition,service and other revenues will continue to fluctuate from quarter to quarterbased on the timing of customer orders.

 

17

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**Cost ofRevenues**

 

*Cost ofLicense Revenues*

(in thousands)

 
| ** **                   | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Cost of license revenues     |       | $        | 122        |       | 177        | %        | $          | 44 |   |
| Percentage of total revenues |       | 7        | %          |       |       | 3        | %          |
|                              |            |          |            |            |            |          |            |  |  |

 

Cost of licenses revenuesconsists of costs associated with reselling third-party products andamortization of capitalized software development costs.

 

Cost of license revenue increasedby $78,000, or 177%, from $44,000 to $122,000 for the three months endedDecember 31, 2005 compared to the same period a year ago.  The increaseis primarily due to third-party costs associated with the sale in the quarterof a third-party product to one particular customer.  In addition,amortization expense of capitalized software costs increased $9,000 withcompletion and general release of our eB Version 14 software product during thecurrent quarter.  The increase in third-party costs resulted in a decreasein the gross profit percentage of license revenues to 78% for the three monthsended December 31, 2005 as compared to 84% for the same period a yearago.  We expect the cost of license revenues to fluctuate based on fluctuationsin license revenues and in customer requirements for third-party softwareproducts since the cost of meeting these customer requirements have the largestimpact on cost of license revenues.

 

*Cost ofServices and Other Revenues*

(in thousands)

 
| ** **                                | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Cost of services and other revenues       |       | $        | 540        |       | (12        | )%       | $          | 614 |   |
| Percentage of services and other revenues |       | 29       | %          |       |       | 37       | %          |
|                                           |            |          |            |            |            |          |            |  |  |

 

Cost of services andother revenues consists primarily of personnel-related costs in providingconsulting services, training to customers and support.  It also includescosts associated with reselling third-party hardware and maintenance, whichincludes telephone support costs.

 

Cost of services andother revenue decreased $74,000, or 12%, from $614,000 to $540,000 for thethree months ended December 31, 2005 compared to the same period a yearago.  The decrease was primarily due to a reduction of personnel in thefourth quarter of fiscal 2005 and lower travel related costs.  The grossprofit from services and other revenue as a percentage of services and otherrevenues increased slightly to 57% for the three months ended December 31,2005 as compared to 56% for the same period a year ago. We expect the cost ofservice and other revenues to fluctuate in absolute dollar amounts and as apercentage of total revenues as the related service revenue fluctuates.

 

**OperatingExpenses**

 

*Researchand Development*

(inthousands)

 
| ** **                        | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Research and development expenses |       | $        | 203        |       | (41        | )%       | $          | 346 |   |
| Percentage of total revenue       |       | 11       | %          |       |       | 21       | %          |
|                                   |            |          |            |            |            |          |            |  |  |

 

Research and developmentexpenses consist of salaries and benefits for software developers as well as anallocation of corporate expenses, calculated on the basis of headcount, such ascorporate insurance, facilities, telephone and other.

 

Research and developmentexpenses decreased $143,000, or 41%, from $346,000 to $203,000 for the threemonths ended December 31, 2005 compared to the same period a yearago.  The decrease was due primarily to reductions in engineeringpersonnel implemented in June 2005. In addition $35,000 of software developmentcosts were capitalized in the three months ended December 31, 2005 versus nocosts being capitalized in the three months ended December 31, 2004. We believethat continued investment in research and development is a critical factor inmaintaining our competitive position and we expect research and development coststo remain at the current levels in absolute dollar amounts in the next severalquarters. However, our ability to increase research and development spendingmay be adversely impacted by our limited cash flow and liquidity.

 

18

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*Marketingand Sales*

(in thousands)

 
| ** **                     | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Marketing & sales expenses |       | $        | 653        |       | (21        | )%       | $          | 824 |   |
| Percentage of total revenue    |       | 36       | %          |       |       | 50       | %          |
|                                |            |          |            |            |            |          |            |  |  |

 

Marketing and salesexpenses consist of salaries, cost of benefits, sales commissions and otherexpenses related to the direct sales force, as well as allocation of overallcorporate expenses, calculated on the basis of headcount, related to items suchas corporate insurance, facilities, telephone and other.

 

Marketing and sales expensesdecreased $171,000, or 21%, from $824,000 to $653,000 for the three monthsended December 31, 2005 compared to the same period a year ago.  The decreasein marketing and sales expenses is primarily due to decreases of $90,000 inmarketing and sales personnel and their related costs in connection with thestaff reductions the Company implemented in September 2005. The Company alsoreduced marketing costs by $81,000 primarily related to trade shows and travel.

We expect marketing andsales expense to decrease in absolute dollar amounts and as a percentage oftotal revenue in the current fiscal year.

 

*Generaland Administrative*

(in thousands)

 
| ** **                          | ** ** | **2005** | ** ** | **Change** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|------------|------------|----------|------------|
| General and administrative expenses |       | $        | 441        |       | 11         | %        | $          | 399 |   |
| Percentage of total revenue         |       | 24       | %          |       |       | 24       | %          |
|                                     |            |          |            |            |            |          |            |  |  |

 

General andadministrative expenses consist primarily of personnel costs for finance,information technology, human resources and general management, as well asoutside professional services and an allocation of overall corporate expenses,calculated on the basis of headcount, such as corporate insurance, facilities,telephone and other.

 

General andadministrative expenses increased by $42,000, or 11%, from $399,000 to $441,000for the three months ended December 31, 2005 compared to the same period ayear ago.  The overall increase was due primarily to the recognition ofemployee stock option expense of $54,000 as required by SFAS 123R beginningduring the current period.

 

We expect that generaland administrative expenses will increase in absolute dollars in comparison tothe prior year due to the share based compensation expense under the newlyimplemented SFAS 123R.

 

**InterestExpense**

 

Interest expense consistsprimarily of fixed interest obligations on our outstanding debt to Spescom Ltd.as well as interest paid on capital lease obligations.  Interest expensewas $52,000 for the three months ended December 31, 2005 as compared to $30,000for the same period a year ago.  The increase is due primarily to increaseddebt balances owed to Spescom Ltd. on several outstanding notes payable as wellas interest on accrued preferred dividends and certain accounts payable.

 

**DeemedDividends**

 

In October 2005 theCompany completed a financing arrangement whereby the Company issued 1,950shares of our Series H Preferred Stock along with 925,926 common stockwarrants for gross proceeds of $500,000 and the exchange and cancellation of1,450 shares of Series G Convertible Preferred Stock. In accordance withEITF 00-27 “Application of issue No 98-5 to Certain Convertible Instruments,”the Company calculated using the Black –Scholes method the intrinsic value ofthe convertible instruments issued and determined that there was a deemedpreferred dividend equal to the gross proceeds received of $500,000.

 

In the prior year theCompany also had a deemed dividend in connection with a financing arrangementwhereby the Company issued 2,200 shares of Series G Preferred Stock alongwith 2,750,000 common stock warrants for gross proceeds of $2,200,000. TheCompany calculated using the Black –Scholes method the intrinsic value of theconvertible instruments issued and determined that there was a deemed preferreddividend equal to the gross proceeds received of $2,200,000.

 

19

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**CumulativePreferred Dividends**

 

The outstanding Series F ConvertiblePreferred Stock is entitled to receive dividends of 5% of the stated value of$1,000 per share per annum, payable on a quarterly basis in cash or commonstock (valued on the basis of the average per share market value on the 30trading days immediately prior to the date on which such dividend is declaredby the Board of Directors).  Series F cumulative preferred dividendsearned for the three months ended December 31, 2005 and 2004 were $66,000 foreach period. Unpaid dividends accrue interest at the rate of 8% perannum.  As of December 31, 2005, unpaid dividends and accrued interestamounted to $645,000.

 

The outstanding Series H PreferredStock is entitled to receive dividends of 6.75% of the stated value of $1,000per share per annum, payable monthly in arrears on the last day of each monthbased on the number of Series H Preferred Stock outstanding as of the first dayof each such month. For the three months ended December 31, 2005 dividends onthe Series H Preferred Stock totaled $22,000.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

At December 31, 2005, ourprincipal sources of liquidity consisted of $396,000 of cash and cashequivalents compared to $285,000 at September 30, 2005.  Ourliquidity could be negatively impacted by a decrease in demand for ourproducts, which are subject to rapid technological changes, reductions ordelays in capital expenditures by our customers and intense competition, amongother factors.

 

The Company has receivedloans from Spescom Ltd. in the past to meet its obligations.  Theoutstanding balance of our demand notes owed to Spescom Ltd. including interestwas $994,000 at December 31, 2005 as compared to $917,000 at September 30,2005.  Spescom Ltd. has agreed not to call the notes prior toOctober 1, 2006.

 

We used cash in operatingactivities of $275,000 during the three months ended December 31, 2005primarily related to a net loss during the quarter of $179,000 and reductionsin deferred revenue and accrued liabilities of $192,000 and $268,000,respectively. During the three months ended December 31, 2004 we used cash inoperating activities of $1,032,000 primarily related to a net loss for thequarter of $604,000 and reductions in deferred revenues and accrued liabilitiesof $344,000 and $249,000, respectively.

 

Our investing activitiesused $38,000 for three months ended December 31, 2005 primarily relating to thecapitalization of software development costs for our eB Version 14 product.

 

Financing activities providedcash of $425,000 for the three months ended December 31, 2005 primarily from theissuance of preferred stock through a private placement on October 25, 2005. TheCompany intends to use the funds from this private placement to expand itssales and marketing efforts and for liquidity.

 

The Company believes itscapital requirements will continue vary greatly from quarter to quarter,depending on, among other things, capital expenditures, fluctuations in itsoperating results, financing activities, and investments and third partyproducts and receivables management.  The Company’s future liquidity willdepend on its ability to generate new system sales of its*e*B product suite in the near term, whichcannot be assured.  Failure to generate sufficient system sales to meetthe Company’s cash flow needs can be expected to have a material adverse effecton the Company’s business, results of operations, and financialcondition.  Management believes that the Company’s current cash andreceivables, as well as additional cash provided by the financing describedabove and cash that may be generated from operations, will be sufficient tomeet its short-term needs for working capital for at least the next year. However, the Company may not be able to obtain sufficient orders to enable theCompany to continue on a cash flow break-even level, which would be necessaryto continue operations in the absence of further financing.  Future equityfinancings, if available to the Company, would be dilutive to the existingholders of the Company’s common stock.  Future debt financings, ifavailable to the Company, would likely involve restrictive covenants.

 

**Off-BalanceSheet Arrangements**

 

At December 31, 2005 andSeptember 30, 2005, we did not have any relationships with unconsolidatedentities or financial partnerships, including entities often referred to asstructured finance or special purpose entities that would have been establishedfor the purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes.  Therefore, we are notmaterially exposed to any financing, liquidity, market or credit risk thatcould arise if we were engaged in such relationships.

 

20

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**Inflation**

 

The Company believes thatinflation has not had a material effect on its operations to date. Although theCompany enters into fixed-price contracts, management does not believe thatinflation will have an adverse material impact on its operations for theforeseeable future, as the Company takes into account expected inflation in itscontract proposals and is generally able to project its costs based onforecasted contract requirements.

 

**ContractualObligations and Commercial Commitments**

 

The following summarizesour contractual obligations and other commitments at December 31, 2005, and theeffect such obligations could have on our liquidity and cash flow in futureperiods:

 
| ** **                                  | ** ** | **Amount of Commitment Expiring by Period** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | ** **                                  | ** ** | **Less** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **                                  | ** ** | **Than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **Over 5** | ** ** |
| ** **                                  | ** ** | **Total**                                   | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** |
|                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Notes and  Accounts Payable to Spescom Ltd. |       | $                                           | 1,276,000  |   | $ | 1,276,000 |   | — |   | — |   | — |   |
| Lease  commitments – Operating Leases  |       | $                                           | 961,000    |   | $ | 249,000 |   | $ | 515,000 |   | $ | 197,000 |   | — |   |
| Lease  commitments – Capital Leases    |       | $                                           | 103,000    |   | $ | 51,000 |   | $ | 52,000 |   | — |   | — |   |
| Total                                       |       | $                                           | 2,340,000  |   | $ | 1,576,000 |   | $ | 567,000 |   | $ | 197,000 |   | — |   |

 

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**InterestRate Risk**

 

The Company’s exposure tomarket rate risk for changes in interest rates relates primarily to the Company’sinvestment portfolio.  The Company does not use derivative financialinstruments in its investment portfolio. The Company places its investment withhigh quality issuers and follows internally developed guidelines to limit theamount of credit exposure to any one issuer. Additionally, in an attempt tolimit interest rate risk, the Company follows guidelines to limit the averageand longest single maturity dates. The Company is adverse to principal loss andensures the safety and preservation of its invested funds by limiting default,market and reinvestment risk. As of December 30, 2005 and September 30,2005, the Company did not have any investments in money market accounts.

 

**ForeignCurrency Exchange Risk**

 

The Company’s geographicmarkets are primarily in the United States and Europe, with some sales in otherparts of the world. For the three months ended December 31, 2005, revenuesrecorded in the United States were 66% of total revenues, and revenues fromEurope and other locations were 34% of total revenues. This compares to 55% and45% for the same period a year ago.

 

Revenues from our UnitedKingdom subsidiary can fluctuate from quarter to quarter based on the timing ofcustomer orders.  The decrease in revenue for the three months endedDecember 31, 2005 versus the same period in the prior year was magnified by aforeign currency loss of $37,000 due to a weakened dollar value compared to thepound sterling.  Changes in foreign currency rates, the condition of localeconomies, and the general volatility of software markets may result in ahigher or lower proportion of foreign revenues in the future. Although theCompany’s operating and pricing strategies take into account changes inexchange rates over time, future fluctuations in the value of foreigncurrencies may have a material adverse effect on the Company’s business,operating results and financial condition.

 

**ITEM4.    CONTROLS AND PROCEDURES**

 

The Company carried outan evaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures as of December 31, 2005 pursuant to ExchangeAct Rule 15d-15. Based upon that evaluation, we have concluded that as ofDecember 31, 2005, the Company’s disclosure controls and procedures areeffective in recording, processing, summarizing and reporting within the timeperiods specified in the SEC’s rules and forms material information relating tothe Company (including its consolidated subsidiaries) required to be includedin the Company’s periodic SEC filings.

 

During the last fiscalquarter, there was no change in the Company’s internal control over financialreporting that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PARTII.   OTHER INFORMATION**

 

**ITEM1 – LEGAL PROCEEDINGS**

 

The Company is involvedfrom time to time in litigation arising in the normal course of business.Management believes that any liability with respect to such routine litigation,individually or in the aggregate, is not likely to be material to the Company’sconsolidated financial position or results of operations.

 

**ITEM 2 – UNREGISTERED SALES OF EQUITYSECURITIES**

 

On November 15, 2005, the Company entered into an agreement withLiolios Group, Inc. (“Liolios”), a public relations firm for the provision ofpublic relations services to the Company. As part of the compensation dueLiolios, the Company agreed to issue to it, every month the agreement iseffective, a warrant to purchase up to 50,000 shares of the Company’s common stockat an exercise price of $0.10 per share. The Company also agreed to issue toLiolios, as part of the compensation due it, a one-time performance warrant topurchase 500,000 shares of the Company’s common stock at $0.25 per share, whichshall vest if during the term of the agreement the volume weighted averageprice of the Company’s common stock is above $0.50 for five consecutive days.The agreement provides for a term of six months and for continuation of theengagement thereafter on a month-to-month basis under identical monthlycompensation until termination in accordance with the provisions of theagreement. The Company believes that the issuance of warrants to Liolios underthe agreement is exempt from the registration requirements of the SecuritiesAct by virtue of Section 4(2) thereof and/or Regulation D promulgatedthereunder.

 

**ITEM 5 – OTHER INFORMATION**

 

(a)   On November 15, 2005, the Company enteredinto an agreement with Liolios Group, Inc. (“Liolios”), a public relations firmfor the provision of public relations services to the Company. As part of thecompensation due Liolios, the Company agreed to issue to it, every month theagreement is effective, a warrant to purchase up to 50,000 shares of theCompany’s common stock at an exercise price of $0.10 per share. The Companyalso agreed to issue to Liolios, as part of the compensation due it, a one-timeperformance warrant to purchase 500,000 shares of the Company’s common stock at$0.25 per share, which shall vest if during the term of the agreement thevolume weighted average price of the Company’s common stock is above $0.50 forfive consecutive days. The agreement provides for a term of six months and forcontinuation of the engagement thereafter on a month-to-month basis underidentical monthly compensation until termination in accordance with theprovisions of the agreement. The Company believes that the issuance of warrantsto Liolios under the agreement is exempt from the registration requirements ofthe Securities Act by virtue of Section 4(2) thereof and/or Regulation Dpromulgated thereunder.

 

**ITEM 6 –EXHIBITS**

 
| **(a)(3)** | ** ** | **Exhibits**                                                                                                                                                                                                                                    |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                            |
| 4.1 (1)    |       | Certificate of  Determination of Series H Convertible Preferred Stock of Spescom  Software Inc., dated October 25, 2005.                                                                                                              |
|       |       |                                                                                                                                                                                                                                            |
| 10.1 (2)   |       | Registration Rights  Agreement by and among the Company, Monarch Pointe Fund, Ltd. and M.A.G.  Capital, LLC, dated October 25, 2005.                                                                                                       |
|       |       |                                                                                                                                                                                                                                            |
| 10.2 (3)   |       | Warrant to Purchase  Common Stock issued to M.A.G. Capital, LLC, dated October 25, 2005.                                                                                                                                                   |
|       |       |                                                                                                                                                                                                                                            |
| 10.3 (4)   |       | Warrant to Purchase Common  Stock issued to Monarch Pointe Fund, Ltd., dated October 25, 2005.                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                            |
| 10.4 (5)   |       | Public Relations  Agreement Between Liolios Group, Inc. and the Company dated  November 15, 2005.                                                                                                                                     |
|       |       |                                                                                                                                                                                                                                            |
| 10.5 (6)   |       | Subscription Agreement  by and among the Company, Monarch Pointe Fund, Ltd. and M.A.G. Capital, LLC,  dated October 25, 2005 and associated Form of Registration Rights  Agreement and Form of Warrant to Purchase Common Stock. |
|       |       |                                                                                                                                                                                                                                            |
| 10.6 (7)   |       | Letter of guarantee  between Spescom Software Limited and Absa Bank Limited, dated  November 9, 2005                                                                                                                                       |
|       |       |                                                                                                                                                                                                                                            |
| 31.1       |       | Section 302  Certification by Keith Stentiford, Chief Executive Officer                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                            |
| 31.2       |       | Section 302  Certification by John W. Low, Chief Financial Officer                                                                                                                                                                         |
|       |       |                                                                                                                                                                                                                                            |
| 32.1       |       | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of  the Sarbanes-Oxley Act of 2002.                                                                                                             |

 

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(1)          Incorporated by reference toExhibit 3.1 to the Form 8-K filed on October 31, 2005.

(2)          Incorporated by reference toExhibit 10.2 to the Form 8-K filed on October 31, 2005.

(3)          Incorporated by reference toExhibit 10.4 to the Form 8-K filed on October 31, 2005.

(4)          Incorporated by reference toExhibit 10.5 to the Form 8-K filed on October 31, 2005.

(5)          Incorporated by reference toExhibit 4.17 to the Form 10-K filed on January 4, 2006.

(6)          Incorporated by reference to Exhibits10.1, 10.3 and 10.6 to the Form 8-K filed on October 31, 2005.

(7)          Incorporated by reference toExhibit 10.14 to the Form 10-K filed on January 4, 2006.

 

22

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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.

 
| **Signature**        | ** ** | **Title**                          | ** **                                        | **Date**               | ** ** |
|----------------------|------------|------------------------------------|---------------------------------------------------|------------------------|------------|
| ** **           | ** ** | ** **                         | ** **                                        | ** **             | ** ** |
| /s/ Keith Stentiford |       |                               | Director and Chief  Executive Officer (Principal  |                   |       |   |
| Keith Stentiford     |       | Executive Officer)                 |                                              | February 14, 2006 |       |
|                 |       |                               |                                              |                   |       |
|                 |       |                               |                                              |                   |       |
| /s/ John W. Low      |       |                               | Chief Financial Officer  and Secretary (Principal |                   |       |   |
| John W. Low          |       | Financial and  Accounting Officer) |                                              | February 14, 2006 |       |

 

23

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