**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the transition period from                                    to                                     .**

 

**CommissionFile Number 0-15935**

 

**SPESCOM SOFTWARE INC.**

(Exact name of registrant asspecified in its charter)

 
| **CALIFORNIA**                                                  | ** ** | **95–3634089**                   |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer 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 mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

YES    ý          NO    o

 

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

 

YES    o          NO    ý

 
| Number of shares of Common Stock  outstanding at May 16, 2005:   35,260,028 |
|--------------------------------------------------------------------------------------------|
|                                                                                       |
| Number of Sequentially Numbered Pages: 27                                                  |

 

 

----

 

**ITEM1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**SPESCOMSOFTWARE INC.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                      | ** ** | **March 31, 2005** | ** ** | **September 30, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                      | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                      |       |                    |       |                        |       |
| Current  assets:                                                                                                                                |       |                    |       |                        |       |
| Cash and  cash equivalents                                                                                                                      |       | $                       | 1,031,000  |                        | $          | 109,000 |   |
| Receivables,  net                                                                                                                               |       | 914,000                 |       | 954,000                     |       |
| Other  current assets                                                                                                                           |       | 176,000                 |       | 209,000                     |       |
| Total  current assets                                                                                                                           |       | 2,121,000               |       | 1,272,000                   |       |
|                                                                                                                                            |       |                    |       |                        |       |
| Property and  equipment, net                                                                                                                    |       | 102,000                 |       | 116,000                     |       |
| Computer  software, net                                                                                                                         |       | 249,000                 |       | 15,000                      |       |
| Other assets                                                                                                                                    |       | 28,000                  |       | 27,000                      |       |
| Total assets                                                                                                                                    |       | $                       | 2,500,000  |                        | $          | 1,430,000 |   |
|                                                                                                                                            |       |                    |       |                        |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                           |       |                    |       |                        |       |
| Accounts  payable                                                                                                                               |       | $                       | 442,000    |                        | $          | 440,000 |   |
| Payable to  Spescom Ltd.                                                                                                                        |       | 51,000                  |       | 90,000                      |       |
| Preferred  stock dividend payable to Spescom Ltd.                                                                                               |       | 417,000                 |       | 271,000                     |       |
| Accrued  liabilities                                                                                                                            |       | 1,326,000               |       | 1,226,000                   |       |
| Lease  obligations— current portion                                                                                                        |       | 17,000                  |       | 19,000                      |       |
| Notes and  accrued interest payable to Spescom Ltd.                                                                                             |       | 588,000                 |       | —                      |       |
| Deferred  revenue                                                                                                                               |       | 2,232,000               |       | 1,919,000                   |       |
| Total  current liabilities                                                                                                                      |       | 5,073,000               |       | 3,965,000                   |       |
|                                                                                                                                            |       |                    |       |                        |       |
| Notes and  accrued interest payable to Spescom Ltd.                                                                                             |       | —                  |       | 557,000                     |       |
| Lease  obligations                                                                                                                              |       | 35,000                  |       | 44,000                      |       |
| Total  liabilities                                                                                                                              |       | 5,108,000               |       | 4,566,000                   |       |
|                                                                                                                                            |       |                    |       |                        |       |
| Shareholders’  deficit:                                                                                                                    |       |                    |       |                        |       |
| Series F  Convertible Preferred Stock, $1,000 stated value, 5,291 shares authorized;  5,291 shares issued and outstanding in 2005 and 2004 |       | 6,790,000               |       | 6,790,000                   |       |
| Series G  Convertible Preferred Stock, $1,000 stated value, 2,420 shares authorized;  2,200 shares issued and outstanding in 2005.         |       | 2,200,000               |       | —                      |       |
| Common  stock, no par value, 100,000,000 shares authorized; 34,321,661 and 34,143,278  issued and outstanding in 2005 and 2004                  |       | 75,328,000              |       | 74,726,000                  |       |
| Common stock  warrants                                                                                                                          |       | 1,360,000               |       | 278,000                     |       |
| Accumulated  other comprehensive loss                                                                                                           |       | (431,000                | )          | (387,000                    | )          |
| Accumulated  deficit                                                                                                                            |       | (87,855,000             | )          | (84,543,000                 | )          |
| Total  shareholders’ deficit                                                                                                               |       | (2,608,000              | )          | (3,136,000                  | )          |
|                                                                                                                                            |       |                    |       |                        |       |
| Total  liabilities and shareholders’ deficit                                                                                               |       | $                       | 2,500,000  |                        | $          | 1,430,000 |   |

 

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

 

2

----

 

**SPESCOMSOFTWARE INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                            | ** ** | **For the three months  ended March 31,** | ** ** | **For the six months  ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                             |       |                                           |       |                                         |       |   |   |   |   |
| Licenses                                                              |       | $                                              | 86,000     |                                         | $          | 359,000 |   | $ | 354,000 |   | $ | 1,478,000 |   |
| Services and  other                                                   |       | 1,587,000                                      |       | 1,242,000                                    |       | 2,972,000 |   | 2,248,000 |   |
| Total  revenues                                                       |       | 1,673,000                                      |       | 1,601,000                                    |       | 3,326,000 |   | 3,726,000 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Cost of  revenues:                                                    |       |                                           |       |                                         |       |   |   |   |   |
| Licenses                                                              |       | 64,000                                         |       | 53,000                                       |       | 108,000 |   | 141,000 |   |
| Services and  other                                                   |       | 620,000                                        |       | 541,000                                      |       | 1,234,000 |   | 1,107,000 |   |
| Total cost  of revenues                                               |       | 684,000                                        |       | 594,000                                      |       | 1,342,000 |   | 1,248,000 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Gross profit                                                          |       | 989,000                                        |       | 1,007,000                                    |       | 1,984,000 |   | 2,478,000 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Operating  expenses:                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Research and  development                                             |       | 174,000                                        |       | 336,000                                      |       | 520,000 |   | 668,000 |   |
| Marketing  and sales                                                  |       | 914,000                                        |       | 726,000                                      |       | 1,738,000 |   | 1,331,000 |   |
| General and  administrative                                           |       | 373,000                                        |       | 482,000                                      |       | 772,000 |   | 989,000 |   |
|                                                                  |       | 1,461,000                                      |       | 1,544,000                                    |       | 3,030,000 |   | 2,988,000 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Loss from  operations                                                 |       | (472,000                                       | )          | (537,000                                     | )          | (1,046,000 | ) | (510,000 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Interest and  other income                                            |       | 2,000                                          |       | 1,000                                        |       | 2,000 |   | 6,000 |   |
| Interest and  other expense                                           |       | (38,000                                        | )          | (37,000                                      | )          | (68,000 | ) | (58,000 | ) |
| Net loss                                                              |       | (508,000                                       | )          | (573,000                                     | )          | (1,112,000 | ) | (562,000 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Deemed  Preferred Dividend                                            |       | —                                         |       | —                                       |       | (2,200,000 | ) | — |   |
| Net income  (loss) available after deemed preferred dividend          |       | (508,000                                       | )          | (573,000                                     | )          | (3,312,000 | ) | (562,000 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Cumulative  preferred dividends                                       |       | (86,000                                        | )          | (66,000                                      | )          | (169,000 | ) | (132,000 | ) |
| Net loss  available to common shareholders                            |       | $                                              | (594,000   | )                                            | $          | (639,000 | ) | $ | (3,481,000 | ) | $ | (694,000 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Basic and  diluted net loss per common share                          |       | $                                              | (0.02      | )                                            | $          | (0.02 | ) | $ | (0.10 | ) | $ | (0.02 | ) |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| Shares used  in computing basic and diluted net loss per common share |       | 34,215,000                                     |       | 33,979,000                                   |       | 34,187,000 |   | 33,954,000 |   |
|                                                                  |       |                                           |       |                                         |       |   |   |   |   |
| **Statement  of Comprehensive Income**                                |       |                                           |       |                                         |       |   |   |   |   |
| Net loss                                                              |       | $                                              | (508,000   | )                                            | $          | (573,000 | ) | $ | (1,112,000 | ) | $ | (562,000 | ) |
| Other  Comprehensive income (loss):                                   |       |                                           |       |                                         |       |   |   |   |   |
| Foreign  currency translation adjustment                              |       | 5,000                                          |       | (151,000                                     | )          | (49,000 | ) | (199,000 | ) |
| Comprehensive  Income                                                 |       | $                                              | (503,000   | )                                            | $          | (724,000 | ) | $ | (1,161,000 | ) | $ | (761,000 | ) |

 

The accompanying condensed notes are an integral part of theseconsolidated financial statements.

 

3

----

 

**SPESCOMSOFTWARE INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **For the six months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| Cash flows  from operating activities:                                       |       |                                         |       |   |   |
| Net income  (loss)                                                           |       | $                                            | (1,112,000 | ) | $ | (562,000 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                                         |       |   |   |
| Depreciation  and amortization                                               |       | 38,000                                       |       | 122,000 |   |
| Unpaid  interest on notes payable                                            |       | 66,000                                       |       | 22,000 |   |
| Gain on  derivative revaluation                                              |       | —                                       |       | (6,000 | ) |
| Stock  options issued to consultant                                          |       | —                                       |       | 46,000 |   |
| Changes in  assets and liabilities:                                          |       |                                         |       |   |   |
| Receivables,  net                                                            |       | 58,000                                       |       | (213,000 | ) |
| Other current  assets                                                        |       | 31,000                                       |       | 45,000 |   |
| Accounts  payable                                                            |       | (1,000                                       | )          | 80,000 |   |
| Payable to  Spescom Ltd.                                                     |       | (7,000                                       | )          | — |   |
| Accrued  liabilities                                                         |       | 52,000                                       |       | (206,000 | ) |
| Deferred  revenue                                                            |       | 287,000                                      |       | 272,000 |   |
| Net cash  used in operating activities                                       |       | (588,000                                     | )          | (400,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Cash flows  from investing activities:                                       |       |                                         |       |   |   |
| Purchases of  property and equipment                                         |       | (13,000                                      | )          | (2,000 | ) |
| Capitalization  of software development costs                                |       | (209,000                                     | )          | — |   |
| Purchases of  software                                                       |       | (37,000                                      | )          | — |   |
| Net cash  used in investing activities                                       |       | (259,000                                     | )          | (2,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Cash flows  from financing activities:                                       |       |                                         |       |   |   |
| Proceeds  from exercise of stock options                                     |       | 2,000                                        |       | 13,000 |   |
| Proceeds  from exercise of warrants                                          |       | 17,000                                       |       | — |   |
| Proceeds  from shareholder loan                                              |       | —                                       |       | 600,000 |   |
| Payments on  shareholder loan                                                |       | —                                       |       | (305,000 | ) |
| Net proceeds  from private placement                                         |       | 1,767,000                                    |       | — |   |
| Payments on  capital lease obligations                                       |       | (11,000                                      | )          | (11,000 | ) |
| Net cash  provided by financing activities                                   |       | 1,775,000                                    |       | 297,000 |   |
|                                                                         |       |                                         |       |   |   |
| Effect of  exchange rate changes on cash                                     |       | (6,000                                       | )          | (8,000 | ) |
|                                                                         |       |                                         |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 923,000                                      |       | (113,000 | ) |
| Cash and  cash equivalents at beginning of period                            |       | 109,000                                      |       | 333,000 |   |
|                                                                         |       |                                         |       |   |   |
| Cash and  cash equivalents at end of period                                  |       | $                                            | 1,031,000  |   | $ | 220,000 |   |

 

See Note 2 for supplemental cash flow information.

 

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

 

4

----

 

**SPESCOM SOFTWARE INC.**

**CONDENSED NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Note 1 — Basis of Presentation**

 

The accompanying consolidated financial statements as of March 31,2005 and for the three and six months ended March 31, 2005 and 2004 areunaudited. The consolidated financial statements and related notes have beenprepared in accordance with generally accepted accounting principles applicableto interim periods.  In the opinion of management, the consolidatedfinancial statements reflect all adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the consolidatedfinancial position, operating results and cash flows for the periods presented.

 

The information contained in the following Condensed Notes to theConsolidated Financial Statements is condensed from that which would appear inthe annual consolidated financial statements; accordingly, the consolidatedfinancial statements included herein should be reviewed in conjunction with theconsolidated financial statements and related notes thereto contained in theCompany’s Annual Report on Form 10-K/A for the year ended September 30,2004.  It should be understood that the accounting measurements at aninterim date inherently involve greater reliance on estimates than atyear-end.  The results of operations for the interim periods presented arenot necessarily indicative of the results expected for the entire year.

 

**Note 2 — Summary of Significant AccountingPolicies**

 

*Principles of Consolidation*

 

The consolidated financial statements are prepared using accountingprinciples generally accepted in the United States of America and include theaccounts of the Company and its wholly-owned United Kingdom subsidiary, SpescomSoftware, Ltd. All significant intercompany balances and transactions have beeneliminated.

 

*Foreign Currency*

 

The functional currency of the Company’s United Kingdom subsidiary isthe pound sterling. Assets and liabilities are translated into U.S. dollars atend-of-period exchange rates. Revenues and expenses are translated at averageexchange rates in effect for the period. Net currency exchange gains or lossesresulting from such translations are excluded from net income and areaccumulated in a separate component of shareholders’ deficit as accumulatedother comprehensive income (loss). Gains and losses resulting from foreigncurrency transactions, which are not significant, are included in theconsolidated statements of operations.

 

*Use of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and also requires disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting periods. Actual results could differfrom those estimates. Significant estimates made by management include revenuerecognition estimates, the viability of recognizing deferred income tax assets,capitalized software costs and the valuation of equity instruments, and theallowance for doubtful accounts.  Significant changes in these estimatesmay have a material impact on the financial statements.

 

*Revenue Recognition*

 

The Company’s revenues are derived from sales of its document andconfiguration management systems that are primarily composed of software andservices, including maintenance, training and consulting services, and thirdparty software and hardware. The Company recognizes revenue in accordance withStatement of Position (“SOP”) 97-2 “Software Revenue Recognition” and SOP 98-9,“Modification of SOP 97-2, Software Revenue Recognition with Respect to CertainTransactions” and Staff Accounting Bulletin (“SAB”) No. 101, updated bySAB’s 103 and 104 “Update of Codification of Staff Accounting Bulletins.”

 

Software license and third party product revenues are recognized uponshipment of the product if no significant vendor obligations remain andcollection is probable. In cases where a significant vendor obligation exists,revenue recognition is delayed until such obligation has been satisfied. Fornew software products where a historical record has not yet been demonstratedthat acceptance is perfunctory, the Company defers recognition of revenue untilacceptance has occurred.   If an undelivered element of thearrangement exists under the license arrangement, a portion of revenue isdeferred based on vendor-specific objective evidence (VSOE) of the fair valueof the undelivered element until delivery occurs.  If VSOE does not existfor all undelivered elements, all revenue is deferred until sufficient evidenceexists or all elements have been delivered.  Annual maintenance revenues,which consist of ongoing support

 

5

----

 

and product updates, are recognized on a straight-line basis over theterm of the contract. Payments received in advance of performance of therelated service for maintenance contracts are recorded as deferred revenue.Revenues from training and consulting services are recognized when the servicesare performed 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 totalestimated labor hours at completion. Provisions for anticipated contract lossesare recognized at the time they become known.

 

Contracts are billed based on the terms of the contract. There are noretentions in billed contract receivables. Unbilled contract receivables relateto revenues earned but not billed at the end of the period.

 

The Company considers many factors when applying accounting principlesgenerally accepted in the United States of America related to revenuerecognition.  These factors include, 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

•           Availability of products to be delivered

•           Time period over which services are to beperformed

•           Creditworthiness of the customer

•           The complexity of customizations to theCompany’s software required by service contracts

•           The sales channel through which the sale ismade (direct, VAR, distributor, etc.)

•           Discounts given for each element of acontract

•           Any commitments made as to installation orimplementation of “go live” dates

 

Each of the relevant factors is analyzed to determine its impact,individually and collectively with other factors, on the revenue to berecognized for any particular contract with a customer.  Management isrequired to make judgments regarding the significance of each factor inapplying the revenue recognition standards, as well as whether or not eachfactor complies with such standards.  Any misjudgment or error bymanagement in its evaluation of the factors and the application of thestandards, especially with respect to complex or new types of transactions,could have a material adverse effect on the Company’s future operating results.

 

*Fair Value of Financial Instruments*

 

Statement of Financial Accounting Standards (“SFAS”) No. 107, “DisclosuresAbout Fair Value of Financial Instruments”, requires management to disclose theestimated fair value of certain assets and liabilities defined by SFAS No. 107as cash or a contractual obligation that both conveys to one entity a right toreceive cash or other financial instruments from another entity, and imposes onthe other entity the obligation to deliver cash or other financial instrumentsto the first entity. At March 31, 2005 and September 30, 2004,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 thesefinancial instruments. The Company believes that the carrying value of itsloans approximate their fair values based on current market rates of interest.

 

*Concentration of Credit Risk*

 

The Company provides products and services to customers in a variety ofindustries worldwide, including local governments, petrochemicals, utilities,manufacturing and transportation. Concentration of credit risk with respect totrade receivables is limited due to the geographic and industry dispersion ofthe Company’s customer base. The Company has not experienced significant creditlosses on its customer accounts.  Computer Science Corporation accountedfor 29% of trade accounts receivable at March 31, 2005 as compared toEntergy Operations Inc., Northeast Utilities Service Company and Aker Kvaerner,which accounted for 13%, 12% and 12%, respectively, of trade accountsreceivable at September 30, 2004.

 

A small number of customers have typically accounted for a largepercentage of the Company’s annual revenues. Network Rail and Computer ScienceCorporation accounted for 19% and 12% respectively of revenue for the sixmonths ended March 31, 2005 while Constellation Energy Group accounted for24% of revenue for the six months ended March 31, 2004.  The Company’sreliance on relatively few customers could have a material adverse effect onthe results of its operations on a quarterly basis.

 

*Property and Equipment*

 

Property and equipment is recorded at cost and depreciated using thestraight-line method over useful lives of two to seven years. Leaseholdimprovements are amortized on a straight-line basis over the shorter of theiruseful life or the term of the related lease. Expenditures for ordinary repairsand maintenance are expensed as incurred while major additions and improvementsare capitalized.

 

6

----

 

*Software Development Costs and PurchasedSoftware*

 

Software development costs and purchased software are capitalized whentechnological feasibility and marketability of the related product have beenestablished. Software development costs incurred solely in connection with aspecific contract are charged to cost of revenues. Capitalized software costsare amortized on a product-by-product basis, beginning when the product isavailable for general release to customers. Annual amortization expense iscalculated using the greater of the ratio of each product’s current grossrevenues to the total of current and expected gross revenues or thestraight-line method over the estimated useful life of three to five years. Theunamortized value of capitalized software costs was $249,000 and $24,000 at March 31,2005 and 2004, respectively. The related amortization expense was $13,000 and$39,000 for the six months ended March 31, 2005 and 2004, respectively.

 

*Long-lived Assets*

 

The Company assesses potential impairments to its long-lived assetswhen there is evidence that events or changes in circumstances have maderecovery of the assets’ carrying value unlikely. An impairment loss would berecognized when the sum of the expected future net cash flows is less than thecarrying amount of the asset.

 

*Stock-Based Compensation*

 

The Company measures compensation expense for its stock-based employeecompensation plans using the intrinsic 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 Opinion No. 25and related Interpretations in accounting for its employee stock-basedcompensation plan.

 

No compensation cost was recognized for employee stock option grantsduring the three and six months ended March 31, 2005 and 2004 based uponthe intrinsic value method, which were fixed in nature, as the options weregranted at 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 necessary disclosurepursuant to the requirements of SFAS No. 148, which amends the disclosurerequirements of FAS 123, would be as follows:

 
| ** **                                                                        | ** ** | **For the three months  ended March 31,** | ** ** | **For the six months  ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  available to common shareholders                                        |       |                                           |       |                                         |       |   |   |   |   |
| As reported                                                                       |       | $                                              | (594,000   | )                                            | $          | (639,000 | ) | $ | (3,481,000 | ) | $ | (694,000 | ) |
| Deduct:                                                                           |       |                                           |       |                                         |       |   |   |   |   |
| Stock-based  employee compensation expense determined under the fair value method |       | (56,000                                        | )          | (73,000                                      | )          | (114,000 | ) | (217,000 | ) |
| Pro forma                                                                         |       | $                                              | (650,000   | )                                            | $          | (712,000 | ) | $ | (3,595,000 | ) | $ | (911,000 | ) |
|                                                                              |       |                                           |       |                                         |       |   |   |   |   |
| Basic and  diluted net loss per share                                             |       |                                           |       |                                         |       |   |   |   |   |
| As reported                                                                       |       | $                                              | (0.02      | )                                            | $          | (0.02 | ) | $ | (0.10 | ) | $ | (0.02 | ) |
| Pro forma                                                                         |       | $                                              | (0.02      | )                                            | $          | (0.02 | ) | $ | (0.10 | ) | $ | (0.03 | ) |

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option-pricing model with the following weightedaverage assumptions used for grants:

 
| ** **               | ** ** | **For the three months  ended March 31,** | ** ** | **For the six months  ended March 31,** | ** ** |
|--------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **               | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Dividend  Yield          |       | 0                                              | %          | 0                                            | %          | 0 | % | 0 | % |
| Expected  Volatility     |       | 261                                            | %          | 261                                          | %          | 261 | % | 261 | % |
| Risk free  interest rate |       | 4.50                                           |       | 3.83                                         |       | 4.50 |   | 3.83 |   |
| Expected  lives (years)  |       | 10                                             |       | 10                                           |       | 10 |   | 10 |   |

 

7

----

 

*Income Taxes*

 

Current income tax expense is the amount of income taxes expected to bepayable for the current year. A deferred income tax asset or liability isestablished for the expected future consequences resulting from the differencesin the financial reporting and tax bases of assets and liabilities. Deferredincome tax expense (benefit) is the change during the year in the deferredincome tax asset or liability. Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be “morelikely than not” realized in the future based on the Company’s current andexpected operating results.

 

*Net Income (Loss) per Common Share*

 

Basic net income (loss) per common share is computed as net income(loss) divided by the weighted average number of common shares outstandingduring the year. Diluted net income (loss) per common share is computed as netloss divided by the weighted average number of common shares and potentialcommon shares, using the treasury stock method, outstanding during the year andassumes conversion into common stock at the beginning of each period of alloutstanding shares of convertible preferred stock, stock options, warrants andother potential common stock. Computations of diluted net income (loss) pershare do not give effect to individual potential common stock for any period inwhich their inclusion would be anti-dilutive.

 

*Statements of Cash Flows*

The following table provides supplemental cash flow information:

 
| ** **                                                                              | ** ** | **For the six months  ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| Supplemental  cash flow information:                                                    |       |                                         |       |   |   |
| Interest  paid                                                                          |       | $                                            | 4,000      |   | $ | 6,000 |   |
|                                                                                    |       |                                         |       |   |   |
| Non-cash  financing and investing activities:                                           |       |                                         |       |   |   |
| Warrants  issued for services                                                           |       | $                                            | 30,000     |   | $ | — |   |
| Deemed  dividend on private placement                                                   |       | $                                            | 2,200,000  |   | $ | — |   |
| Expiration  of warrants                                                                 |       | $                                            | 133,000    |   | $ | — |   |
| Accrued  preferred stock dividends                                                      |       | $                                            | 132,000    |   | $ | 132,000 |   |
| Fair value  of equity instruments redeemable for common stock converted to common stock |       | $                                            | —     |   | $ | 1,159,000 |   |

 

**Note 3 — Related Party Transactions**

 

As of March 31, 2005 and September 30, 2004 there were 5,291shares of Series F Convertible Preferred Stock with a stated value of$1,000 per share held by Spescom Ltd., the majority shareholder of theCompany.  The Series F Convertible Preferred Stock is convertibleinto common stock, at a stated conversion price of $0.45 per share subject tocertain adjustments.  The conversion is at the option of Spescom 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 March 31, 2005, unpaid dividends andaccrued interest amounted to $397,000 and $20,000, respectively as compared to$132,000 and $1,000, respectively for the same periods in 2004.

 

On November 18, 2003 the Company issued a note payable to SpescomLtd. UK, a wholly-owned subsidiary of Spescom Ltd., with a principal balance of$600,000 bearing an interest rate of 5% per annum.  The note was repaidduring fiscal 2004.  Interest expense on the note for fiscal 2004 was$9,000.

 

The Company has two existing demand notes payable to Spescom Ltd. UKfor $400,000 and $100,000, each bearing interest rate of 10% per annum. As of March 31, 2005 and September 30, 2004, the balance owed on thenotes including interest was $588,000 and $557,000, respectively.  Spescom Ltd. has agreed that it will not cause Spescom Ltd. UK to demandrepayment under the two notes prior to October 1, 2005.  Interestexpense on the notes was $14,000 and $28,000 for the three and six months endedMarch 31, 2005, respectively compared to $15,000 and $33,000 for the sameperiods in 2004.  These notes are collateralized by a security interest infavor of Spescom Ltd. UK in respect of all the Company’s assets.

 

Under a royalty arrangement beginning in fiscal 2004, Spescom Ltd.resells the Company’s software and maintenance services in

 

8

----

 

South Africa.  Royalty revenue recognized under this agreement forthe three and six months ended March 31, 2005 totaled $13,000 and $22,000,respectively.

 

In December 2004, the Company entered into an arrangement withSpescom Ltd. in which the Company relocated certain engineering personnel toSouth Africa to work out of Spescom Ltd. facilities.  As part of the agreement Spescom Ltd. billsthe Company for wages and an administrative fee that covers office rent andinformation technology costs on a monthly basis.  For the six months ended March 31, 2005,total expenses under this arrangement was $32,000.

 

Spescom Ltd. UK provides certain administrative and accountingfunctions for the Company’s United Kingdom subsidiary.  The Company isbilled a monthly fee by Spescom Ltd. UK for reimbursement of certain costs inthe United Kingdom including the office facilities, all accounting and humanresources services, and certain corporate marketing activities.  For thethree and six months ended March 31, 2005 the administrative fees totaled$155,000 and $309,000, respectively as compared to $151,000 and $291,000,respectively, for the same periods in 2004.  The office rent for theCompany’s United Kingdom operations included in the administrative fee totaled$91,000 and $180,000 for the three and six months ended March 31, 2005,respectively as compared to $88,000 and $170,000, respectively for the sameperiod in the period in 2004.  At March 31, 2005 and September 30,2004 the Company had a payable to Spescom Ltd. UK of $51,000 and $90,000,respectfully.  In 1999, as part of an agreement to sell a 60% interest inits United Kingdom subsidiary to Spescom Ltd., the lease for the United Kingdomoffice facility was to be assigned to Spescom Ltd. UK; however, the landlorddid not grant its consent to the assignment and as such Spescom Ltd. UK haspaid the lease for the entire office directly to the landlord.  The leaseexpires in March 2006 and has an annual rent of $638,000.  A portionof the office has been subleased to third party tenants for an annual rent of$297,000.  The subleases also expire March 2006.

 

Spescom Ltd. and the Company have entered into a license agreementpursuant to which Spescom Ltd. has licensed to the Company the right to use thename “Spescom” and to use a trademark owned by Spescom Ltd. related to certaincomputer software. The Company will not pay any royalties to Spescom Ltd. inconnection with this license. The license is for an indefinite term, but isterminable by either party upon 60 days prior written notice. Under the licenseagreement, Spescom Ltd. has agreed to indemnify and hold the Company and itsdirectors, officers, employees and agents harmless against liabilities arisingfrom any claim brought against the Company that alleges that Spescom Ltd.’s orthe Company’s use of the licensed trademark infringes the rights of any thirdparty, provided that the Company is in material compliance with the provisionsof the license agreement.

 

**Note 4 — Receivables**

 
| ** **                                   | ** ** | **March 31,  2005** | ** ** | **September 30,  2004** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **(Unaudited)**          | ** ** | ** **                   | ** ** |
| **Receivables  consist of:**                 |       |                     |       |                         |       |
| Receivables                                  |       | $                        | 922,000    |                         | $          | 1,037,000 |   |
| Less:   allowance for doubtful accounts |       | (8,000                   | )          | (83,000                      | )          |
|                                         |       | $                        | 914,000    |                         | $          | 954,000 |   |

 

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

 
| ** **                                 | ** ** | **For the three months  ended March 31,** | ** ** | **For the six months  ended March 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  available to common shareholders |       | $                                              | (594,000   | )                                            | $          | (639,000 | ) | $ | (3,481,000 | ) | $ | (694,000 | ) |
|                                       |       |                                           |       |                                         |       |   |   |   |   |
| Common stock  and common stock equivalents |       | 34,215,000                                     |       | 33,979,000                                   |       | 34,187,000 |   | 33,954,000 |   |
|                                            |            |                                                |            |                                              |            |  |  |  |  |  |  |  |  |

 

Basic net income (loss) per share is computed using the weightedaverage number of common shares outstanding during the period. Contingently issued shares are included in the computation of basic net income(loss) per share when the related conditions are satisfied.  Diluted netincome (loss) per share is computed using the weighted average number of commonshares and potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of contingently issued shares, thecommon shares issuable upon conversion of preferred stock or convertible debtand shares issuable upon the exercise of stock options and common stockwarrants.  Potentially dilutive securities are excluded from thecomputation if their effect is anti-dilutive.

 

As of March 31, 2005, a total of 3,919,860 stock options,3,758,335 common stock warrants, 5,291 Series F Convertible PreferredStock, and 2,200 shares of Series G Convertible Preferred Stock, wereexcluded from the diluted net income (loss) per share calculation, as theireffect would be anti-dilutive.  As of March 31, 2004, a total of2,999,934 stock options, 1,008,335 common stock warrants,  and 5,291 shares of Series F ConvertiblePreferred Stock were excluded from the diluted net income (loss) per sharecalculation, as their effect would be anti-dilutive.

 

9

----

 

**Note 6 — Segment and Geographic Information**

 

The Company has one business segment, which consists of the developmentand sale of a suite of integrated document, configuration and recordsmanagement software product.

 

Revenues by customer location are as follows:

 
| ** **                        | ** ** | **For the three months ended  March 31,** | ** ** | **For the six months ended  March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales:                        |       |                                           |       |                                         |       |   |   |   |   |
| United  States                    |       | $                                              | 730,000    |                                         | $          | 938,000 |   | $ | 1,647,000 |   | $ | 2,346,000 |   |
| Europe,  primarily United Kingdom |       | 934,000                                        |       | 637,000                                      |       | 1,657,000 |   | 1,166,000 |   |
| Other  International              |       | 9,000                                          |       | 26,000                                       |       | 22,000 |   | 214,000 |   |
|                              |       | $                                              | 1,673,000  |                                         | $          | 1,601,000 |   | $ | 3,326,000 |   | $ | 3,726,000 |   |

 
| ** **                                       | ** ** | **March 31,  2005** | ** ** | **September 30,  2004** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **(Unaudited)**          | ** ** | ** **                   | ** ** |
| Identifiable  assets from continuing operations: |       |                     |       |                         |       |
| United  States                                   |       | $                        | 1,199,000  |                         | $          | 973,000 |   |
| Europe,  United Kingdom                          |       | 1,301,000                |       | 457,000                      |       |
|                                             |       | $                        | 2,500,000  |                         | $          | 1,430,000 |   |

 

**Note 7 — Recent Accounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Board issuedSFAS No. 123R (Revised 2004), *Share-BasedPayment,*which requires that the compensation cost relating toshare-based payment transactions be recognized in financial statements based onalternative fair value models. The share-based compensation cost will bemeasured based on the fair value of the equity or liability instruments issued.We currently disclose pro forma compensation expense quarterly and annually bycalculating the stock option grants’ fair value using the Black-Scholes modeland disclosing the impact on loss applicable to common stock and the relatedper share amount in Note 2 to the consolidated financial statements. Uponadoption, pro forma disclosure will no longer be an alternative. See the tableunder caption “Stock-Based Compensation” in Note 2 for the estimatedimpact that such a change in accounting treatment would have had if it had beenin effect during 2005 and 2004. SFAS No. 123R also requires the benefitsof tax deductions in excess of recognized compensation cost to be reported as afinancing cash flow rather than as an operating cash flow as required undercurrent literature. We will begin to apply SFAS No. 123R as of the firstannual reporting period that begins after June 15, 2006, and accordingly,the Company expects to adopt the provisions of this pronouncement in the firstquarter of 2007.

 

In March 2005, the FASB issued FIN 47, “Accounting for ConditionalAsset Retirement Obligations — an Interpretation of FASB Statement No. 143,Accounting for Asset Retirement Obligations.” This interpretation addresses thetiming of liability recognition for legal obligations associated with theretirement of a tangible long-lived asset when the timing and/or method ofsettlement of the obligation are conditional on a future event. Theinterpretation requires an entity to recognize a liability for the fair valueof a conditional asset retirement obligation when incurred if the liability’sfair value can be reasonably estimated. The adoption of this interpretation didnot have any impact on our consolidated financial statements.

 

10

----

 

**Note 8 — Equity**

 

**November 2004 Private Placement**

 

On November 5, 2004, the Company completed a financing arrangementwhereby the Company issued 2,200 shares of our Series G ConvertiblePreferred Stock (“Series G Stock”) along with 2,750,000 in common stockwarrants for gross proceeds of $2,200,000.  The Series G Stock isconvertible into common stock at a price equal to 85% of the volume weightedaverage price of the Company’s common stock during the five trading daysimmediately preceding the conversion date; however, the conversion price can beno higher than $0.40 per share and no lower than $0.30 per share.  The2,750,000 warrants have an exercise price of $0.44 per share and expire November 5,2007.  The Company incurred $433,000 in expenses related to thetransaction and issued 825,000 common stock warrants to an investmentconsulting firm.  The 825,000 warrants were comprised of 550,000 warrantswith an exercise price of $0.40 per share which expire November 5, 2009and 275,000 warrants which have an exercise price of $0.44 which expire on November 5,2007. In connection with the financing, the Company recorded a beneficialconversion of $2,200,000 on the Series G Stock as a deemed dividend forthe six months ended March 31, 2005.

 

The Series G Stock is entitled to a liquidation preference equalto $1,000 per share, plus declared but unpaid dividends per share. Commencing on the date of issuance of the Series G Stock, and continuinguntil the effective date of the registration statement on Form S-2pursuant to which the Series G Stock is registered, the Series GStock is also entitled to receive dividends of 5% 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 G Stock outstanding as of the first day ofsuch month.  The dividend for the Series G Stock is only payableuntil the registration statement for the common stock underlying the Series GStock is declared effective by the Securities and Exchange Commission (“SEC”).  On March 22, 2005 the SEC declared theregistration statement effective, thus the Series G Stock is no longerentitled to dividends.  For the three andsix months ended March 31, 2005, the Company issued 57,602 and 82,050shares of common stock with a value of $28,000 and $37,000, respectively, as adividend on the Series G Stock.

 

 **Warrants for Services**

 

On November 4, 2004, the Company issued to a public relations firmwarrants to purchase 1,000,000 shares of its common stock at $0.40 per share,expiring November 3, 2007. The warrants vest and become exercisable asfollows: (i) 500,000 warrants vest on the date that the average of the lastsale price of the Company’s stock on the OTC Bulletin Board for the ten tradingdays immediately preceding such date (the “Market Price”) exceeds $0.60 pershare, (ii) 250,000 warrants vest on the date that the Market Priceexceeds $0.70 per share, and (iii) the remaining 250,000 warrants vest andbecome exercisable on the date that the Market Price exceeds $0.80 pershare.  The fair value of the warrants was determined to be $30,000 isbeing recognized ratably over the six months of the service agreement.

 

11

----

 

**ITEM 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward — Looking Statements**

 

*This report contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities 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 some cases, you can identify forwardlooking statements by terms such as “may,” “intend,” “might,” “will,” “should,”“could,” “would,” “expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,”or the negative of these terms.  Theseand similar expressions are intended to identify forward-lookingstatements.   When used in the followingdiscussion, the words “believes,” “anticipates” and similar expressions areintended to identify forward-looking statements.  Such statements are subject to certain risksand uncertainties, which could cause actual results to differ materially fromthose projected.  Readers are cautionednot to place undue reliance on these forward-looking statements, which speakonly as of the date hereof   Theforward-looking statements in this report are based upon management’s currentexpectations and belief, which management believes are reasonable.  Thesestatements represent our estimates and assumptions only as of the date of thisQuarterly Report on Form 10-Q, and we undertakes no obligation to publiclyrelease the result of any revisions to these forward-looking statements, whichmay be made to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated events.*

 

*The following discussion should be read inconjunction with the Selected Consolidated Financial Data and the ConsolidatedFinancial Statements, including the Notes thereto.*

 

**OVERVIEW**

 

The Company develops, markets and supports*eB*, its integrated suite of collaborative document,configuration and records management software solutions.  The*eB*suite 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*eB*suite also enables them to maintain complete, up-to-date information about theconfiguration of their products, assets and infrastructures so that they canachieve operational excellence and compliance with regulatory requirements.*  eB*provides 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 aresult, *eB* can be used to managethe lifecycle of physical items (e.g. products, equipment or assets), and therequirements (e.g. functional, safety, performance, environmental, etc.) thatgovern them.  It enables intelligent relationshipsto be defined between these items thereby creating an interdependencymodel.  As a result, the effects of anychange on requirements, documents and items can be determined and change can bemanaged to effectively ensure information integrity.  In particular,*eB* enables organizations with extensive and complexphysical infrastructures to efficiently identify, classify, structure, link,and manage documents, physical items, and requirements throughout theirlifecycles and ensure that conformance between these is maintained by means ofan automated change process.

 

We develop, market and support*eB*,our integrated suite of collaborative document, configuration and recordsmanagement software solutions.  Ourrevenues in the three months ended March 31, 2005 increased by 4% from thesame period in the prior fiscal year due to higher services revenue.  Forthe six months ended March 31, 2005 our revenues decreased by 11% from thesame period in the prior fiscal year due to the fact that the Company in the prioryear had a large license sale to a new customer, while there was no  similarly large sale in the currentyear.  The Company’s license revenue fluctuates from quarter to quarter asreflected by the decrease in license sales during the quarter.

 

Our revenues are derived from licenses of our software to ourcustomers, services that we provide under maintenance support contracts and ournon-maintenance services, consisting primarily of design studies, systemimplementation and training.  Of our total revenues for the three monthsended March 31, 2005, license revenues accounted for 5%, maintenanceservices revenues accounted for 47% and non-maintenance services revenuesrepresented 48%.  For the six monthsended March 31, 2005, license revenues accounted for 11%, maintenanceservices revenues accounted for 47% and non-maintenance services revenuesrepresented 42%.

 

Many of our customers are located outside the United States, withforeign-originated revenues accounting for 57% and 43% of revenues for the threemonths ended March 31, 2005 and 2004, respectively and 50% and 50% ofrevenues for the six months ended March 31, 2005 and 2004.  Ourrevenue for the three and six months ending March 31, 2005 reflected aforeign currency gain of $11,000 and a loss of $62,000 as compared to lastyear, due to the declining value of the dollar during the year.

 

12

----

 

Our cost of revenues increased slightly during the three and six monthsended March 31, 2005 which resulted in a decrease in our gross profit from63% to 59% of revenues and 66% to 60% of revenues, respectively. Operating expenses remained relatively unchanged.

 

At March 31, 2005, our principal sources of liquidity consisted of$1,031,000 of cash and cash equivalents, compared to $109,000 at September 30,2004.  On November 5, 2004, we completed a private placement ofpreferred stock which resulted in gross proceeds of $2,200,000.

 

**CRITICAL ACCOUNTING POLICIES**

 

The consolidated financial statements are prepared in conformity withaccounting principles generally accepted in the United States of America.  As such, management is required to makejudgments, estimates and assumptions that affect the reported amounts of assetsand liabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting period.  The significant accounting policies which aremost critical to aid in fully understanding and evaluating reported financialresults include the following:

 

*Revenue Recognition*

 

The Company enters into contractual arrangements with end-users thatmay include licensing of the Company’s software products, product support andmaintenance services, consulting services or various combinations thereof,including the sale of such products or services separately.  The Companyrecognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “SoftwareRevenue Recognition” and SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, with Respect to Certain Transactions” and Staff AccountingBulletin (“SAB”)  No. 101, updated by SAB’s 103 and 104 “Update ofCodification of Staff Accounting Bulletins.”

 

 Software license and third party product revenues are recognizedupon shipment of the product if no significant vendor obligations remain andcollection is probable.  In cases where asignificant vendor obligation exists, revenue recognition is delayed until suchobligation has been satisfied.  For newsoftware products where a historical record has not yet been demonstrated thatacceptance is perfunctory, the Company defers recognition of revenue untilacceptance 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 been delivered. Annual maintenance revenues, which consist of ongoing support and productupdates, are recognized on a straight-line basis over the term of thecontract.  Payments received in advanceof performance of the related service for maintenance contracts are recorded asdeferred revenue.  Revenues from trainingand consulting services are recognized when the services are performed andadequate evidence of providing such services is available.  Contract revenues for long-term contracts orprograms requiring specialized systems are recognized using thepercentage-of-completion method of accounting, primarily based on contractlabor hours incurred to date compared with total estimated labor hours atcompletion.   Provisions for anticipatedcontract losses are recognized at the time they become known.

 

Contracts are billed based on the terms of the contract.  There are no retentions in billed contractreceivables.  Unbilled contractreceivables relate to revenues earned but not billed at the end of the period.

 

The Company considers many factors when applying accounting principlesgenerally accepted in the United States of America related to revenuerecognition.  These factors include, 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.)

•           Discounts given for each element of acontract

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

 

Each of the relevant factors is analyzed to determine its impact,individually and collectively with other factors, on the revenue to berecognized for any particular contract with a customer.  Management isrequired to make judgments regarding the significance of each factor inapplying the revenue recognition standards, as well as whether or not eachfactor complies with such standards.  Any

 

13

----

 

misjudgment or error by management in its evaluation of the factors andthe application of the standards, especially with respect to complex or newtypes of transactions, could have a material adverse effect on the Company’sfuture operating results.

 

*Allowance for Doubtful Accounts*

 

The Company sells its products directly to end-users, generallyrequiring a significant up-front payment and remaining terms appropriate forthe creditworthiness of the customer. The Company also sells its products to VARs and other software distributorsgenerally under terms appropriate for the creditworthiness of the VAR ordistributor.  The Company retains nocontinuing obligations

 

on sales to VARs.  Receivables from customers are generallyunsecured.  The Company continuouslymonitors its customer account balances and actively pursues collections on pastdue balances.  The Company maintains anallowance for doubtful accounts which is comprised of a general reserve basedon historical collections performance plus a specific reserve for certain knowncustomer collections issues.  If actualbad debts are greater than the reserves calculated based on historical trendsand known customer issues, the Company may be required to book additional baddebt expense which could have a material adverse effect on our business,results of operations and financial condition for the periods in which suchadditional expense occurs.

 

**RESULTS OF OPERATIONS**

 

The following table sets forth the condensed consolidated statement ofoperations expressed as a percentage of total revenue for the periods indicated:

 
| ** **                          | ** ** | **For the three months ended  March 31,** | ** ** | **For the six months ended  March 31,** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                       | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                            |       |                                           |       |                                         |       |   |   |   |   |
| Licenses                            |       | 5                                              | %          | 22                                           | %          | 11 | % | 40 | % |
| Services and  other                 |       | 95                                             | %          | 78                                           | %          | 89 | % | 60 | % |
| Total  revenues                     |       | 100                                            | %          | 100                                          | %          | 100 | % | 100 | % |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Cost of  revenues                   |       |                                           |       |                                         |       |   |   |   |   |
| Licenses                            |       | 4                                              | %          | 3                                            | %          | 3 | % | 4 | % |
| Services and  other                 |       | 37                                             | %          | 34                                           | %          | 37 | % | 30 | % |
|                                |       | 41                                             | %          | 37                                           | %          | 40 | % | 34 | % |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Gross profit                        |       | 59                                             | %          | 63                                           | %          | 60 | % | 66 | % |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Operating  expenses:                |       |                                           |       |                                         |       |   |   |   |   |
| Research and  development           |       | 10                                             | %          | 22                                           | %          | 16 | % | 17 | % |
| Marketing  and sales                |       | 55                                             | %          | 45                                           | %          | 52 | % | 36 | % |
| General and  administrative         |       | 22                                             | %          | 30                                           | %          | 23 | % | 27 | % |
|                                |       | 87                                             | %          | 97                                           | %          | 91 | % | 80 | % |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Income  (loss) from operations      |       | (28                                            | )%         | (34                                          | )%         | (31 | )% | (14 | )% |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Interest  income and other income   |       | —                                         |       | —                                       |       | — |   | — |   |
| Interest  expense and other expense |       | (2                                             | )%         | (2                                           | )%         | (2 | )% | (1 | )% |
|                                |       |                                           |       |                                         |       |   |   |   |   |
| Net Income  (loss)                  |       | (30                                            | )%         | (36                                          | )%         | (33 | )% | (15 | )% |

 

14

----

 

**Revenues**

 

*License Revenues*

(in thousands)

 
| ** **                   | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                   | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| License  Revenue             |       | $                                      | 86         |        | $          | 359                                  |       | -76         | %          | $ | 354 |   | $ | 1,478 |   | -76 | % |
| Percentage  of total revenue |       | 5                                      | %          | 22          | %          |                                 |       | 11          | %          | 40 | % |   |   |
|                              |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

License revenues decreased by $273,000, or 76%, to $86,000 from$359,000 for the three months ended March 31, 2005 compared to the sameperiod a year ago.  The Company’s license revenues fluctuate from quarterto quarter which is reflected by the decrease in license sales in the currentquarter.  License revenue decreased $1,124,000, or 76%, to $354,000 from$1,478,000 million for the six months end March 31, 2005 as compared tothe same period a year ago.  In the prioryear a large sale of licenses to Constellation Energy amounted to $750,000,while there was no similar size sales in the current year.  The length oftime it takes to establish new customer relationships typically ranges from 6to 12 months, and as such the timing of sales can fluctuate significantly fromquarter to quarter.

 

Despite the relatively weak license revenue in the three and six monthsended March 31, 2005, we anticipate that the demand for our products willincrease if overall economic conditions continue to strengthen leading to anincrease in overall demand for enterprise document, configuration and recordsmanagement software solutions.  The Company’s license revenues canfluctuate from quarter to quarter, based on the timing of customer orders dueto the long sales cycle and changes in customers’ internal plans of the rolloutof software licenses.

 

 Although the Company has historically generated the majority ofits revenues from its direct sales force, the Company has also established anetwork of third-party VARs, system integrators and OEMs who build and sellsystems (with components or complete systems provided by the Company) thataddress specific customer needs within various industries, including thosetargeted directly by the Company.  Sales through indirect channels for thethree months ended March 31, 2005 amounted to $65,000 or 4% of totalrevenue compared to $190,000 or 12% of total revenue for the same period in2004.  Sales through indirect channelsfor the six months ended March 31, 2005 amounted to $232,000 or 7% oftotal revenue compared to $300,000, or 8% of total revenue for the same periodin 2004.

 

A small number of customers have typically accounted for a largepercentage of the Company’s annual revenues. Network Rail and Computer Sciences Corporation each accounted for 19% ofrevenue for the three months ended March 31, 2005 while CACI andConstellation Group accounted for 11% and 10%, respectively of revenue for thethree months ended March 31, 2004. Network Rail and Computer Sciences Corporation accounted for 19% and12%, respectively of revenue for the six months ended March 31, 2005 whileConstellation Energy Group accounted for 24% of revenue for the six monthsended March 31, 2004.

 

*Service and Other Revenues*

(in thousands)

 
| ** **                   | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                   | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Service  Revenue             |       | $                                      | 1,587      |        | $          | 1,242                                |       | 28          | %          | $ | 2,972 |   | $ | 2,248 |   | 32 | % |
| Percentage  of total revenue |       | 95                                     | %          | 78          | %          |                                 |       | 89          | %          | 60 | % |   |   |
|                              |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

Services and other revenues are comprised of maintenance andnon-maintenance services.  Non-maintenance services typically relate tobusiness process studies, implementation of systems and training which varywith the level of license revenues while maintenance revenue is primarilydependent on customers renewing their annual maintenance support contracts.

 

Services and other revenue increased $345,000, or 28%, from $1,242,000to $1,587,000 for the three months ended March 31, 2005 compared to thesame period a year ago.  The increase isprimarily due to higher non-maintenance service revenue of $300,000, relatingto an increased demand for consulting services relating to customers extendingtheir systems to additional departments and upgrading from older legacy systemsto current versions of *eB*. Also in this quarter the maintenance revenue increased $45,000, or 6% ascompared to the same period a year ago, which reflects support services for thelicenses sold in fiscal year 2004.

 

Services and other revenue increased $724,000, or 32%, from $2,248,000to $2,972,000 for the six months ended March 31, 2005 compared to the sameperiod a year ago.  The increase isprimarily due to higher non-maintenance service revenue of $607,000, relatingto an increased demand for consulting services relating to customers expandingthe integration of *e*B intoadditional departments and to upgrading from older legacy systems to thecurrent versions of *e*B.  Also for the current fiscal year, maintenancerevenue increased $116,000 as compared to the same period a year ago, whichreflects support services for licenses sold in fiscal year 2004.

 

15

----

 

Fluctuations in license revenue can impact service revenues in futureperiods as customers implement the software and require maintenancesupport.  As such, we anticipate 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.

 

**Cost of Revenues**

 

*Cost of License Revenues*

(in thousands) 

 
| ** **                     | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                     | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Cost of  License Revenue       |       | $                                      | 64         |        | $          | 53                                   |       | 21          | %          | $ | 108 |   | $ | 141 |   | -23 | % |
| Percentage  of license revenue |       | 74                                     | %          | 15          | %          |                                 |       | 31          | %          | 10 | % |   |   |
|                                |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

Cost of licenses revenues consists of costs associated with resellingthird-party products and amortization of capitalized software developmentcosts.

 

Cost of license revenue increased by $11,000, or 21%, from $53,000 to$64,000 for the three months ended March 31, 2005 compared to the sameperiod a year ago.  The increase is due primarily to $24,000 in higherthird-party costs as the Company experienced an increase in sales ofthird-party products during the quarter which was partially offset by adecrease of $13,000 in amortization expense of software costs as a result of amajority of such costs being fully amortized in fiscal 2004.  The 76%decrease in license revenue resulted in a reduced gross profit percentage oflicense revenues to 26% for the three months ended March 31, 2005 as comparedto 85% for the same period a year ago. Also contributing to the decrease was the proportional increase in thirdparty products which typically have a lower margin than the sale of the Company’sproprietary software products.

 

Cost of license revenue decreased by $33,000, or 23%, from $141,000 to$108,000 for the six months ended March 31, 2005 compared to the sameperiod a year ago.  The decrease was primarily due to the reducedamortization expense of capitalized software as mention above.  The 76% decrease combined with costsdecreasing 23% in license revenue resulted in a reduced gross profit percentageof license revenues to 69% for the six months ended March 31, 2005 ascompared to 90% for the same period a year ago.

 

We expect the cost of license revenues to fluctuate based onfluctuations in license revenues and in customer requirements for third-partysoftware products since the cost of meeting these customer requirements havethe largest impact on cost of license revenues.

 

*Cost of Services and Other Revenues*

(in thousands)

 
| ** **                               | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                               | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Cost of  service and other revenue       |       | $                                      | 620        |        | $          | 541                                  |       | 15          | %          | $ | 1,234 |   | $ | 1,107 |   | 11 | % |
| Percentage  of service and other revenue |       | 39                                     | %          | 44          | %          |                                 |       | 42          | %          | 49 | % |   |   |
|                                          |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

Cost of services and other revenues consists primarily ofpersonnel-related costs in providing consulting services, training to customersand support.  It also includes costs associated with reselling third-partyhardware and maintenance, which includes telephone support costs.

 

Cost of services and other revenue increased $79,000, or 15%, from$541,000 to $620,000 for the three months ended March 31, 2005 compared tothe same period a year ago.  The increase was primarily due to an increaseof $73,000 in personnel-related costs in connection with the additionalrequirements as a result of the increase in service revenue.  The grossprofit from services and other revenue as a percentage of services and other revenuesincreased to 61% for the three months ended March 31, 2005 as compared to56% for the same period a year ago.  The improvement in gross profitpercentages is due to the 28% increase in service and other revenues while costof revenues increased only 15%.

 

Cost of services and other revenue increased $127,000, or 11%, from$1,107,000 to $1,234,000 for the six months ended March 31, 2005 comparedto the same period a year ago.  The increase was primarily due to anincrease of $117,000 in personnel-related costs.  These increases wereassociated with the additional service requirements as a result of the increasein services and other revenues.  The gross profit from services and otherrevenue as a percentage of services and other revenues increased to 58% for thesix months ended March 31, 2005 as compared to 51% for the same period ayear ago.  The improvement in gross profit percentages is due to the 32%increase in service and other revenues while cost of revenues increased only11%.

 

16

----

 

We expect the cost of service and other revenues to fluctuate inabsolute dollar amounts and as a percentage of total revenues as the relatedservice revenue fluctuates.

 

**Operating Expenses**

 

*Research and Development*

(in thousands)

 
| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                         | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Research and  development expenses |       | $                                      | 174        |        | $          | 336                                  |       | -48         | %          | $ | 520 |   | $ | 668 |   | -22 | % |
| Percentage  of total revenue       |       | 10                                     | %          | 21          | %          |                                 |       | 16          | %          | 18 | % |   |   |
|                                    |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

Research and development expenses consist of salaries and benefits forsoftware developers as well as an allocation of corporate expenses, calculatedon the basis of headcount, such as corporate insurance, facilities, telephoneand other.

 

Research and development expenses decreased $162,000, or 48%, from$336,000 to $174,000 for the three months ended March 31, 2005 compared tothe same period a year ago.  The decrease was due primarily to thecapitalization of $209,000 in costs directly associated with the development ofa new architecture for the *e*Bplatform.  The decrease was partiallyoffset by an increase of $30,000 in compensation and related benefitsassociated with increased headcount during the last half of fiscal 2004.

 

Research and development expenses decreased $148,000, or 22%, from$668,000 to $520,000 for the six months ended March 31, 2005 compared tothe same period a year ago.  The decrease was due primarily to thecapitalization of $209,000 in costs directly associated with the development ofa new architecture for the *e*Bplatform.  The decrease was partiallyoffset by an increase of $46,000 in compensation and related benefitsassociated with increased headcount during the last half of fiscal 2004 and thecosts of the relocation of certain employees to the Spescom Ltd. facilities inSouth Africa.

 

We believe that continued investment in research and development is acritical factor in maintaining our competitive position and we expect researchand development costs to remain at the current levels in absolute dollaramounts in the next several quarters.

 

*Marketing and Sales*

(in thousands)

 
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                    | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Marketing  and sales expenses |       | $                                      | 914        |        | $          | 726                                  |       | 26          | %          | $ | 1,738 |   | $ | 1,331 |   | 31 | % |
| Percentage  of total revenue  |       | 55                                     | %          | 45          | %          |                                 |       | 52          | %          | 36 | % |   |   |
|                               |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

Marketing and sales expenses consist of salaries, cost of benefits,sales commissions and other expenses related to the direct sales force, as wellas allocation of overall corporate expenses, calculated on the basis ofheadcount, related to items such as corporate insurance, facilities, telephoneand other.

 

Marketing and sales expenses increased $188,000, or 26%, from $726,000to $914,000 for the three months ended March 31, 2005 compared to the sameperiod a year ago.  The increase in marketing and sales expenses isprimarily due to increases of $160,000 in additional marketing and salespersonnel and their related costs, $65,000 in marketing costs primarily relatedto trade shows and travel.  The increase was partially offset by adecrease in commissions of $44,000 relating to lower sales during the quarteras compared to the same period a year ago.

 

Marketing and sales expenses increased $407,000, or 31%, from$1,331,000 to $1,738,000 for the six months ended March 31, 2005 comparedto the same period a year ago.  The increase in marketing and salesexpenses is primarily due to increases of $305,000 in additional marketing andsales personnel and their related costs, $180,000 in marketing costs primarilyrelated to trade shows and travel and increased costs associated with a publicrelations campaign of $40,000.  The increase was partially offset by adecrease in commissions of $136,000 relating to lower sales during fiscal 2005as compared to the same period a year ago.

 

We expect marketing and sales expense to increase in absolute dollaramounts and as a percentage of total revenue as a result of the plannedexpansion of our sales and marketing efforts in the next several quarters.

 

17

----

 

*General and Administrative*

(in thousands)

 
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** | **Percent** | ** ** | **Six Months Ended  March 31,** | ** ** | **Percent** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|-------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                           | ** ** | **2005**                               | ** ** | **2004**    | ** ** | **Change**                           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
| General and  administrative expenses |       | $                                      | 373        |        | $          | 482                                  |       | -23         | %          | $ | 772 |   | $ | 989 |   | -22 | % |
| Percentage  of total revenue         |       | 22                                     | %          | 30          | %          |                                 |       | 23          | %          | 27 | % |   |   |
|                                      |            |                                        |            |             |            |                                      |            |             |            |  |  |  |  |  |  |  |  |

 

General and administrative expenses consist primarily of personnelcosts for finance, information technology, human resources and generalmanagement, as well as outside professional services and an allocation ofoverall corporate expenses, calculated on the basis of headcount, such ascorporate insurance, facilities, telephone and other.

 

General and administrative expenses decreased by $109,000, or 23%, from$482,000 to $373,000 for the three months ended March 31, 2005 compared tothe same period a year ago.  The overall decrease was due primarily todecreases of $78,000 in the allowance for uncollectible accounts, $44,000 ininvestor relations expenses related to the expiration of a contract with aninvestor relations firm, $37,000 in legal fees as during the prior year,additional work was required for a routine SEC review of the Company’s AnnualReport on Form 10-K for the year ended September 30, 2002.  These decreases were partially offset by theincrease of $60,000 in costs incurred for consultants and increased accountingfees associated with the Company’s compliance efforts of the Sarbanes-OxleyAct.

 

General and administrative expenses decreased by $217,000, or 22%, from$989,000 to $772,000 for the six months ended March 31, 2005 compared tothe same period a year ago.  The overall decrease was due primarily todecreases of $100,000 in investor relations expenses related to the expirationof a contract with an investor relations firm, $97,000 in legal and SEC filingfees as during the prior year additional work was required for a routine SECreview of the Company’s Annual Report on Form 10-K for the yearended September 30, 2002 and $78,000 reduction in the allowance foruncollectible accounts.  These decreaseswere partially offset by an increase of $75,000 in costs incurred forconsultants and increased accounting fees associated with the Company’scompliance efforts under the Sarbanes-Oxley Act.

 

We expect general and administrative expenses will stay at currentlevels in the next several quarters in absolute dollar amounts due to thecontinued benefits of cost oversight keeping general and administrative expensesin line with current revenues.

 

**Interest Expense**

 

Interest expense consists primarily of fixed interest obligations onour outstanding debt to Spescom Ltd. as well as interest paid on capital leaseobligations.  Interest expense was $38,000 and $68,000 for the three andsix months ended March 31, 2005, respectively, as compared to $37,000 and$58,000 for the same periods in 2004.  The increase is due primarily toincreased debt balances owed to Spescom Ltd. on several outstanding notespayable as well as interest on accrued preferred dividends.

 

**Preferred Dividends**

 

The outstanding Series F Convertible Preferred Stock is entitledto receive dividends of 5% of the stated value of $1,000 per share per annum,payable on a quarterly basis in cash or common stock (valued on the basis ofthe average per share market value on the 30 trading days immediately prior tothe date on which such dividend is declared by the Board of Directors). Unpaid dividends accrue interest at the rate of 8% per annum.  As of March 31,2005, unpaid dividends and accrued interest amounted to $397,000 and $20,000,respectively.

 

The outstanding Series G Stock is entitled to receive dividends of5% of the stated value of $1,000 per share per annum, payable monthly inarrears on the last day of each month based on the number of Series GStock outstanding as of the first day of each such month.  For the threeand six months ended March 31, 2005, the Company issued 57,602 and 82,050shares of common stock with a value of $28,000 and $37,000, respectively, as adividend on the Series G Stock.  In connection with the Series GStock financing, the Company recorded a beneficial conversion of $2,200,000 asa deemed dividend for the six months ended March 31, 2005.  The dividend for the Series G Stock isonly payable until the registration statement for the common stock underlyingthe Series G Stock is declared effective by the Securities and ExchangeCommission (“SEC”).  On March 22,2005 the SEC declared the registration statement effective, thus the Series GStock is no longer entitled to dividends.

 

18

----

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

At March 31, 2005, our principal sources of liquidity consisted of$1,031,000 of cash and cash equivalents compared to $109,000 at September 30,2004.  Our liquidity could be negatively impacted by a decrease in demandfor our products, which are subject to rapid technological changes, reductionsin capital expenditures by our customers and intense competition, among otherfactors.

 

The Company has received loans from Spescom Ltd. in the past to meetits obligations.  The outstanding balance of our demand notes owed toSpescom Ltd. including interest was $588,000 at March 31, 2005 as comparedto $557,000 at September 30, 2004.  Spescom Ltd. has agreed not tocall the notes prior to October 1, 2005.

 

We used cash in operating activities of $588,000 during the six monthsended March 31, 2005 primarily related to a net loss during the quarter of$1,112,000 which was offset by increases in deferred revenue and accruedliabilities of $287,000 and $52,000, respectively.  During the six monthsended March 31, 2004 we used cash in operating activities of $400,000primarily related to a net loss of $562,000 and an increase in deferred revenueof reduction in receivables of $272,000 which was partially offset bydepreciation of $122,000.

 

Our investing activities used $259,000 for six months ended March 31,2005 primarily for the acquisition of computer software and equipment. There were no capital asset purchases in the six months ended March 31,2004.

 

Financing activities provided cash of $1.8 million for the three monthsended March 31, 2005 primarily from the issuance of preferred stockthrough a private placement on November 5, 2004.  The Company intendsto use the funds from this private placement to expand its sales and marketingefforts and improve its liquidity.  In connection with the privateplacement, the Company issued 2,200 shares of Series G ConvertiblePreferred Stock, and warrants, expiring November 5, 2007, to purchase2,750,000 shares of common stock at $0.44 per share.  The preferred stockis convertible into up to 7,333,334 shares of common stock.  The netproceeds from the private placement totaled $1,767,000.  Cash provided byfinancing activities for the six  months ended March 31, 2004 of$297,000 was primarily the proceeds from a loan received from  Spescom Ltd. UK.

 

The Company’s future liquidity depends on its ability to generate newsystem sales of its *e*B productsuite in the near term, which cannot be assured. Failure to generate sufficientsystem sales to meet the Company’s cash flow needs can be expected to have amaterial adverse effect on the Company’s business, results of operations, andfinancial condition.  The Company’s financial position can be a factor inattracting new customers.  In an effort to strengthen the Company’sfinancial condition and provide capital for expanding marketing and salescapabilities, the Company will continue to explore additional equity or debtfinancing from third parties.  There can be no assurance that additionalfinancing will be available or that the terms of such financing will beacceptable to the Company.  The Company believes that its current cash andreceivables, as well as additional cash that may be generated from operations,will be sufficient to meet its short-term needs for working capital. However,the Company may not be able to obtain sufficient orders to enable the Companyto continue on a cash flow break-even level, which would be necessary tocontinue operations in the absence of further financing.

 

**Off-Balance Sheet Arrangements**

 

At March 31, 2005 and September 30, 2004, we did not have anyrelationships with unconsolidated entities or financial partnerships, includingentities often referred to as structured finance or special purpose entitiesthat would have been established for the purpose of facilitating off-balancesheet arrangements or other contractually narrow or limited purposes. Therefore, we are not materially exposed to any financing, liquidity,market or credit risk that could arise if we were engaged in suchrelationships.

 

**Inflation**

 

The Company believes that inflation has not had a material effect onits operations to date.  Although the Companyenters into fixed-price contracts, management does not believe that inflationwill have an adverse material impact on its operations for the foreseeablefuture, as the Company takes into account expected inflation in its contractproposals and is generally able to project its costs based on forecastedcontract requirements.

 

19

----

 

**Contractual Obligations and CommercialCommitments**

 

The following summarizes our contractual obligations and othercommitments at March 31, 2004, and the effect such obligations could haveon our liquidity and cash flow in future periods:

 
| ** **                                  | ** ** | **Amount of Commitment Expiring  by Period** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                  | ** ** | **Total**                                    | ** ** | **Less Than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **Over 5 Years** | ** ** |
| Notes and  Accounts Payable to Spescom Ltd. |       | $                                            | 588,000    |   | $ | 588,000 |   | $ | — |   | $ | — |   | $ | — |   |
| Lease  commitments — Operating Leases  |       | 1,106,000                                    |       | 241,000 |   | 756,000 |   | 109,000 |   | — |   |
| Lease  commitments — Capital Leases    |       | 63,000                                       |       | 24,000 |   | 39,000 |   | — |   | — |   |
| Total                                       |       | $                                            | 1,757,000  |   | $ | 853,000 |   | $ | 795,000 |   | $ | 109,000 |   | $ | — |   |

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

**Interest Rate Risk**

 

The Company’s exposure to market rate risk for changes in interestrates relates primarily to the Company’s investment portfolio.  TheCompany does not use derivative financial instruments in its investmentportfolio. The Company places its investments with high quality issuers andfollows internally developed guidelines to limit the amount of credit exposureto any one issuer. Additionally, in an attempt to limit interest rate risk, theCompany follows guidelines to limit the average and longest single maturitydates. The Company is adverse to principal loss and ensures the safety andpreservation of its invested funds by limiting default, market and reinvestmentrisk.  The Company’s investments includedmoney market accounts as of March 31, 2005.

 

**Foreign Currency Exchange Risk**

 

The Company’s geographic markets are primarily in the United States andEurope, with some sales in other parts of the world. For the three months endedMarch 31, 2005, revenues recorded in the United States were 43% of totalrevenues, and revenues from Europe and other locations were 57% of totalrevenues.  This compares to 57% and 43% for the same period a year ago.

 

For the six months ended March 31, 2005, revenues recorded in theUnited States were 50% of total revenues, and revenues from Europe and otherlocations were 50% of total revenues.  This compares to 65% and 35% forthe same period a year ago.

 

Revenues from our United Kingdom subsidiary can fluctuate from quarterto quarter based on the timing of customer orders.  The increased revenuein fiscal 2004 was improved by a foreign currency loss of $62,000 due to aweakened dollar value compared to the pound sterling.  Changes in foreigncurrency rates, the condition of local economies, and the general volatility ofsoftware markets may result in a higher or lower proportion of foreign revenuesin the future. Although the Company’s operating and pricing strategies take intoaccount changes in exchange rates over time, future fluctuations in the valueof foreign currencies may have a material adverse effect on the Company’sbusiness, operating results and financial condition.

 

**ITEM 4.    CONTROLS ANDPROCEDURES**

 

The Company carried out an evaluation under the supervision and withthe participation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures as of March 31,2005 pursuant to Exchange Act Rule 13a-14. Based upon thatevaluation, we have concluded that as of March 31, 2005, the Company’sdisclosure controls and procedures are effective in recording, processing,summarizing and reporting within the time periods specified in the SEC’s rules andforms material information relating to the Company (including its consolidatedsubsidiaries) required to be included in the Company’s periodic SEC filings.

 

During the last fiscal quarter, there was no change in the Company’sinternal control over financial reporting that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

20

----

 

**PART II.  OTHER INFORMATION**

 

**ITEM 1 — LEGAL PROCEEDINGS**

 

The Company is involved from time to time in litigation arising in thenormal course of business. Management believes that any liability with respectto such routine litigation, individually or in the aggregate, is not likely tobe material to the Company’s consolidated financial position or results ofoperations.

 

**ITEM 6 — EXHIBITS**

 
| ** ** | ** ** | **Exhibits**                                                                                                                       |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                         |
| 4.9 (1)    |       | Warrant to Purchase Common Stock issued to  Cappello Capital Corp., dated January 28, 2005.                                   |
|       |       |                                                                                                                               |
| 4.10 (2)   |       | Warrant to Purchase Common Stock issued to  Cappello Capital Corp., dated January 28, 2005.                                   |
|       |       |                                                                                                                               |
| 10.13      |       | Services agreement between Spescom Software  Inc. and Spescom Datavoice Ltd. executed February 28, 2005.                      |
|       |       |                                                                                                                               |
| 10.17      |       | Non-Employee Director Compensation                                                                                                 |
|       |       |                                                                                                                               |
| 10.18      |       | Executive Officer Compensation                                                                                                     |
|       |       |                                                                                                                               |
| 31.1       |       | Section 302 Certification by Carl  Mostert, 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. |

 

----

(1)                                  Incorporatedby reference to Exhibit 10.1 to the Form 8-K filed on January 28,2005.

(2)                                  Incorporatedby reference to Exhibit 10.2 to the Form 8-K filed on January 28,2005.

 

21

----

 

**SIGNATURES**

 

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

 
| May 16, 2005 | **SPESCOM SOFTWARE INC.**                                                            |
|-------------------|--------------------------------------------------------------------------------------|
|              |                                                                                 |
|              |                                                                                 |
|              | /s/ Carl Mostert                                                                     |   |
|              | Carl Mostert                                                                         |
|              | Director and Chief Executive Officer  (Principal Executive Officer)                  |
|              |                                                                                 |
|              | /s/ John Low                                                                         |   |
|              | John Low                                                                             |
|              | Chief Financial Officer and Secretary  (Principal Financial and  Accounting Officer) |

 

22

----