**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 

**(MarkOne)**
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | **QUARTERLY REPORT UNDER SECTION 13  OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **For the Quarterly Period Ended March 31, 2004.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **For the transition period from                                           to                                         .** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **Commission File Number 0-15935**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

**SPESCOMSOFTWARE INC.**

(Exact name of registrant as specified 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**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

 

YES    ý         NO    o

 

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

 

YES    o         NO    ý

 

Number of shares of CommonStock outstanding at April 13, 2004:  34,068,278

 

Number of Sequentially NumberedPages: 27

 

 

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**SPESCOM SOFTWARE, INC.**

 

**INDEX**

 

 
| PART I.                                                                                             | FINANCIAL INFORMATION                                     |   |
|-----------------------------------------------------------------------------------------------------|-----------------------------------------------------------|--------|
|                                                                                                |                                                      |   |
| Item 1. Financial Statements and  Supplementary Data                                                |                                                      |
|                                                                                                |                                                      |   |
|                                                                                                | Consolidated Balance Sheets                               |   |
|                                                                                                |                                                      |   |
|                                                                                                | Consolidated Statements of Operations                     |   |
|                                                                                                |                                                      |   |
|                                                                                                | Consolidated Statements of Cash Flows                     |   |
|                                                                                                |                                                      |   |
|                                                                                                | Condensed Notes to the Consolidated  Financial Statements |   |
|                                                                                                |                                                      |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations |                                                      |
|                                                                                                |                                                      |   |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                 |                                                      |
|                                                                                                |                                                      |   |
| Item 4. Controls and Procedures                                                                     |                                                      |
|                                                                                                |                                                      |   |
| PART II.                                                                                            | OTHER INFORMATION                                         |   |
|                                                                                                |                                                      |   |
| Item 1. Legal Proceedings                                                                           |                                                      |
|                                                                                                |                                                      |   |
| Item 4. Submission of Matters to a Vote of  Security Holders                                        |                                                      |
|                                                                                                |                                                      |   |
| Item 6. Exhibits and Reports on Form 8-K                                                            |                                                      |

 

2

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**PART I****.  FINANCIAL INFORMATION**

 

**ITEM 1****.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**SPESCOM SOFTWARE INC.**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                                            |   | **March 31,  2004** |      | **September 30,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|------------------------------|--------|
|                                                                                                                                            |   | **(Unaudited)**     |      |                         |   |
| **ASSETS**                                                                                                                                      |   |                |      |                         |   |
| Current assets:                                                                                                                                 |   |                |      |                         |   |
| Cash and cash equivalents                                                                                                                       |   | $                   | 220,000   |                         | $      | 333,000 |   |
| Receivables, net of allowance for doubtful  accounts of $84,000 and $78,000 respectively                                                        |   | 652,000             |      | 423,000                      |   |
| Other current assets                                                                                                                            |   | 145,000             |      | 169,000                      |   |
| Total current assets                                                                                                                            |   | 1,017,000           |      | 925,000                      |   |
|                                                                                                                                            |   |                |      |                         |   |
| Property and equipment, net                                                                                                                     |   | 138,000             |      | 213,000                      |   |
| Computer software, net                                                                                                                          |   | 24,000              |      | 63,000                       |   |
| Other assets                                                                                                                                    |   | 28,000              |      | 29,000                       |   |
| Total assets                                                                                                                                    |   | $                   | 1,207,000 |                         | $      | 1,230,000 |   |
|                                                                                                                                            |   |                |      |                         |   |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIT**                                                                                                  |   |                |      |                         |   |
| Current liabilities:                                                                                                                            |   |                |      |                         |   |
| Accounts payable                                                                                                                                |   | $                   | 540,000   |                         | $      | 405,000 |   |
| Payable to Spescom Ltd.                                                                                                                         |   | 50,000              |      | 46,000                       |   |
| Preferred stock dividend payable to Spescom  Ltd.                                                                                               |   | 132,000             |      | —                       |   |
| Accrued liabilities                                                                                                                             |   | 995,000             |      | 1,080,000                    |   |
| Note and accrued interest payable to  Spescom Ltd.                                                                                              |   | 803,000             |      | —                       |   |
| Lease obligations – current portion                                                                                                        |   | 22,000              |      | 23,000                       |   |
| Deferred revenue                                                                                                                                |   | 2,361,000           |      | 2,018,000                    |   |
| Fair value of equity instruments redeemable  for common stock                                                                                   |   | —              |      | 1,233,000                    |   |
| Total current liabilities                                                                                                                       |   | 4,903,000           |      | 4,805,000                    |   |
|                                                                                                                                            |   |                |      |                         |   |
| Notes and accrued interest payable to  Spescom Ltd.                                                                                             |   | —              |      | 504,000                      |   |
| Lease obligations                                                                                                                               |   | 52,000              |      | 62,000                       |   |
| Total liabilities                                                                                                                               |   | 4,955,000           |      | 5,371,000                    |   |
|                                                                                                                                            |   |                |      |                         |   |
| Shareholders’ deficit:                                                                                                                     |   |                |      |                         |   |
| Convertible preferred stock, $1,000 stated  value per share, 1,000,000 shares Authorized; 5,291 shares issued and  outstanding in 2004 and 2003 |   | 6,790,000           |      | 6,790,000                    |   |
| Common stock, no par value, 100,000,000  shares authorized; 34,068,278 and 33,929,278 issued and outstanding in 2004  and 2003                  |   | 74,830,000          |      | 73,676,000                   |   |
| Common stock warrants                                                                                                                           |   | 278,000             |      | 278,000                      |   |
| Accumulated other comprehensive loss                                                                                                            |   | (493,000            | )         | (294,000                     | )      |
| Accumulated deficit                                                                                                                             |   | (85,153,000         | )         | (84,591,000                  | )      |
| Total shareholders’ deficit                                                                                                                |   | (3,748,000          | )         | (4,141,000                   | )      |
|                                                                                                                                            |   |                |      |                         |   |
| Total liabilities and shareholders’ deficit                                                                                                |   | $                   | 1,207,000 |                         | $      | 1,230,000 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

3

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**SPESCOM SOFTWARE INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                  |   | **For the  three months  ended March 31,** |     | **For the  six months  ended March 31,** |   |
|-----------------------------------------------------------------------|--------|--------------------------------------------|----------|------------------------------------------|--------|
|                                                                  |   | **2004**                                   |     | **2003**                                 |   | **2004** |   | **2003** |   |
| Revenues:                                                             |   |                                       |     |                                     |   |   |   |   |   |
| Licenses                                                              |   | $                                          | 359,000  |                                     | $      | 367,000 |   | $ | 1,478,000 |   | $ | 1,288,000 |   |
| Services and other                                                    |   | 1,242,000                                  |     | 1,448,000                                |   | 2,248,000 |   | 2,816,000 |   |
| Total revenues                                                        |   | 1,601,000                                  |     | 1,815,000                                |   | 3,726,000 |   | 4,104,000 |   |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Cost of revenues:                                                     |   |                                       |     |                                     |   |   |   |   |   |
| Licenses                                                              |   | 53,000                                     |     | 125,000                                  |   | 141,000 |   | 400,000 |   |
| Services and other                                                    |   | 541,000                                    |     | 500,000                                  |   | 1,107,000 |   | 1,094,000 |   |
| Total cost of revenues                                                |   | 594,000                                    |     | 625,000                                  |   | 1,248,000 |   | 1,494,000 |   |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Gross profit                                                          |   | 1,007,000                                  |     | 1,190,000                                |   | 2,478,000 |   | 2,610,000 |   |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Operating expenses:                                                   |   |                                       |     |                                     |   |   |   |   |   |
| Research and development                                              |   | 336,000                                    |     | 414,000                                  |   | 668,000 |   | 737,000 |   |
| Marketing and sales                                                   |   | 726,000                                    |     | 657,000                                  |   | 1,331,000 |   | 1,283,000 |   |
| General and administrative                                            |   | 482,000                                    |     | 363,000                                  |   | 989,000 |   | 771,000 |   |
|                                                                  |   | 1,544,000                                  |     | 1,434,000                                |   | 2,988,000 |   | 2,791,000 |   |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Loss from operations                                                  |   | (537,000                                   | )        | (244,000                                 | )      | (510,000 | ) | (181,000 | ) |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Interest and other income                                             |   | 1,000                                      |     | —                                   |   | 6,000 |   | — |   |
| Interest and other expense                                            |   | (37,000                                    | )        | (134,000                                 | )      | (58,000 | ) | (259,000 | ) |
| Net loss                                                              |   | (573,000                                   | )        | (378,000                                 | )      | (562,000 | ) | (440,000 | ) |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Cummulative preferred dividends                                       |   | (66,000                                    | )        | —                                   |   | (132,000 | ) | — |   |
| Net loss available to common shareholders                             |   | $                                          | (639,000 | )                                        | $      | (378,000 | ) | $ | (694,000 | ) | $ | (440,000 | ) |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Basic and diluted net loss per common share                           |   | $                                          | (0.02    | )                                        | $      | (0.01 | ) | $ | (0.02 | ) | $ | (0.01 | ) |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| Shares used in computing basic and diluted  net loss per common share |   | 33,979,000                                 |     | 30,847,000                               |   | 33,954,000 |   | 30,844,000 |   |
|                                                                  |   |                                       |     |                                     |   |   |   |   |   |
| **Statement of Comprehensive Income**                                 |   |                                       |     |                                     |   |   |   |   |   |
| Net loss                                                              |   | (573,000                                   | )        | (378,000                                 | )      | (562,000 | ) | (440,000 | ) |
| Other Comprehensive income (loss):                                    |   |                                       |     |                                     |   |   |   |   |   |
| Foreign currency translation adjustment                               |   | (151,000                                   | )        | 30,000                                   |   | (199,000 | ) | (18,000 | ) |
| Comprehensive Income                                                  |   | $                                          | (724,000 | )                                        | $      | (348,000 | ) | $ | (761,000 | ) | $ | (458,000 | ) |

 

The accompanying condensednotes are an integral part of these consolidated financial statements.

 

4

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**SPESCOM SOFTWARE INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                       |   | **For the six  months  ended March 31,** |     |
|--------------------------------------------------------------------------------------------|--------|------------------------------------------|----------|
|                                                                                       |   | **2004**                                 |     | **2003** |   |
| Cash flows from operating activities:                                                      |   |                                     |     |   |   |
| Net loss                                                                                   |   | $                                        | (562,000 | ) | $ | (440,000 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |                                     |     |   |   |
| Depreciation and amortization                                                              |   | 122,000                                  |     | 235,000 |   |
| Unpaid interest on notes payable                                                           |   | 22,000                                   |     | 224,000 |   |
| Gain on derivative revaluation                                                             |   | (6,000                                   | )        |   |   |
| Value of stock options issued to consultant                                                |   | 46,000                                   |     | — |   |
| Changes in assets and liabilities, net :                                                   |   |                                     |     |   |   |
| Receivables, net                                                                           |   | (213,000                                 | )        | 317,000 |   |
| Other assets                                                                               |   | 45,000                                   |     | 178,000 |   |
| Accounts payable                                                                           |   | 80,000                                   |     | (310,000 |   |
| Accrued liabilities                                                                        |   | (206,000                                 | )        | (397,000 | ) |
| Deferred revenue                                                                           |   | 272,000                                  |     | 344,000 |   |
| Net cash provided by (used in) operating  activities                                       |   | (400,000                                 | )        | 151,000 |   |
|                                                                                       |   |                                     |     |   |   |
| Cash flows from investing activities:                                                      |   |                                     |     |   |   |
| Purchases of property and equipment                                                        |   | (2,000                                   | )        | (27,000 | ) |
| Purchases of software                                                                      |   | —                                   |     | (4,000 | ) |
| Net cash used in investing activities                                                      |   | (2,000                                   | )        | (31,000 | ) |
|                                                                                       |   |                                     |     |   |   |
| Cash flows from financing activities:                                                      |   |                                     |     |   |   |
| Proceeds from shareholder loan                                                             |   | 600,000                                  |     | — |   |
| Payments on shareholder loan                                                               |   | (305,000                                 | )        | — |   |
| Proceeds from exercise of stock options                                                    |   | 13,000                                   |     | 5,000 |   |
| Payments on capital lease obligations                                                      |   | (11,000                                  | )        | (4,000 | ) |
| Net cash provided by financing activities                                                  |   | 297,000                                  |     | 1,000 |   |
|                                                                                       |   |                                     |     |   |   |
| Effect of exchange rate changes on cash                                                    |   | (8,000                                   | )        | (3,000 | ) |
|                                                                                       |   |                                     |     |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |   | (113,000                                 | )        | 118,000 |   |
|                                                                                       |   |                                     |     |   |   |
| Cash and cash equivalents at beginning of  period                                          |   | 333,000                                  |     | 87,000 |   |
|                                                                                       |   |                                     |     |   |   |
| Cash and cash equivalents at end of period                                                 |   | $                                        | 220,000  |   | $ | 205,000 |   |

 

----

*See Note 1 for supplementalcash flow information.

 

The accompanying condensednotes are an integral part of these consolidated financial statements.

 

5

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**SPESCOMSOFTWARE INC.**

**CONDENSED NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Note1 - Basis of Presentation**

 

The accompanying consolidatedfinancial statements as of March 31, 2004 and for the three and six monthsended March 31, 2004 and 2003 are unaudited. The consolidated financialstatements and related notes have been prepared in accordance with generallyaccepted accounting principles applicable to interim periods.  In theopinion of management, the consolidated financial statements reflect alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the consolidated financial position, operating results andcash flows for the periods presented.

 

The information contained inthe following Condensed Notes to the Consolidated Financial Statements iscondensed from that which would appear in the annual consolidated financialstatements; accordingly, the consolidated financial statements included hereinshould be reviewed in conjunction with the consolidated financial statementsand related notes thereto contained in Spescom Software Inc.’s (the “Company”)Annual Report on Form 10-K for the year ended September 30, 2003.  Itshould be understood that the accounting measurements at an interim dateinherently involve greater reliance on estimates than at year-end.  Theresults of operations for the interim periods presented are not necessarilyindicative of the results expected for the entire year.

 

The Company’s future liquiditydepends on its ability to generate new system sales of its eB product suite inthe near term, which cannot be assured. Failure to generate sufficient systemsales to meet the Company’s cash flow needs can be expected to have a materialadverse effect on the Company’s business, results of operations, and financialcondition.  The Company’s financial position can be a factor in attractingnew customers.  In an effort to strengthen the Company’s financialcondition and provide capital for expanding marketing and sales capabilities,the Company will continue to explore additional equity or debt financing fromthird parties.  There can be no assurance that additional financing willbe available or that the terms of such financing will be acceptable to theCompany.  The Company believes that its current cash and receivables, aswell as additional cash that may be generated from operations, will besufficient to meet its short-term needs for working capital. However, theCompany may not be able to obtain sufficient orders to enable the Company tocontinue on a cash flow break-even level, which would be necessary to continueoperations in the absence of further financing.

 

**Note2 – Summary of Significant Accounting Policies**

 

*Principles of Consolidation*

 

The consolidated financialstatements are prepared using accounting principles generally accepted in theUnited States of America and include the accounts of the Company and itswholly-owned United Kingdom subsidiary, Spescom Software, Ltd. All significantintercompany balances and transactions have been eliminated.

 

*Foreign Currency*

 

The functional currency of theCompany’s United Kingdom subsidiary is the pound sterling. Assets andliabilities are translated into U.S. dollars at end-of-period exchange rates.Revenues and expenses are translated at average exchange rates in effect forthe period. Net currency exchange gains or losses resulting from suchtranslations are excluded from net income and are accumulated in a separatecomponent of shareholders’ deficit as accumulated other comprehensiveincome(loss). Gains and losses resulting from foreign currency transactions,which are not significant, are included in the consolidated statements ofoperations.

 

*Use of Estimates*

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and also requiresdisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. Actual results could differ from those estimates.Significant estimates made by management include revenue recognition estimates,the viability of recognizing deferred income tax assets, capitalized softwarecosts and the valuation of equity instruments, and the allowance for doubtfulaccounts.  Significant changes in these estimates may have a materialimpact on the financial statements.

 

6

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*Revenue Recognition*

 

The Company’s revenues arederived from sales of its document and configuration management systems thatare primarily composed of software and services, including maintenance, trainingand consulting services, and third party software and hardware. The Companyrecognizes revenue in accordance with Statement of Position (“SOP”) 97-2“Software Revenue Recognition” and SOP 98-9, “Modification of SOP 97-2,Software Revenue Recognition with Respect to Certain Transactions” and StaffAccounting Bulletin (“SAB”) No. 101.

 

Software license and thirdparty product revenues are recognized upon shipment of the product if nosignificant vendor obligations remain and collection is probable. In caseswhere a significant vendor obligation exists, revenue recognition is delayeduntil such obligation has been satisfied. For new software products where ahistorical record has not yet been demonstrated that acceptance is perfunctory,the Company defers recognition of revenue until acceptance hasoccurred.   If an undelivered element of the arrangement exists underthe license arrangement, a portion of revenue is deferred based onvendor-specific objective evidence (VSOE) of the fair value of the undeliveredelement until delivery occurs.  If VSOE does not exist for all undeliveredelements, all revenue is deferred until sufficient evidence exists or allelements have been delivered.  Annual maintenance revenues, which consistof ongoing support and product updates, are recognized on a straight-line basisover the term of the contract. Payments received in advance of performance ofthe related 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 onthe terms of the contract. There are no retentions in billed contractreceivables. Unbilled contract receivables relate to revenues earned but notbilled at the end of the period.

 

The Company considers manyfactors when applying accounting principles generally accepted in the UnitedStates of America related to revenue recognition.  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.)

•                                          Discountsgiven for each element of a contract

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

 

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

 

*Fair Value of Financial Instruments*

 

Statement of FinancialAccounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value ofFinancial Instruments”, requires management to disclose the estimated fairvalue of certain assets and liabilities defined by SFAS No. 107 as cash ora contractual obligation that both conveys to one entity a right to receivecash or other financial instruments from another entity, and imposes on theother entity the obligation to deliver cash or other financial instruments tothe first entity. At March 31, 2004 and September 30, 2003, managementbelieves that the carrying amounts of cash and cash equivalents, short-terminvestments, accounts receivable and accounts payable, and accrued expensesapproximate fair value because of the short maturity of these financialinstruments. The Company believes that the carrying value of its loansapproximate their fair values based on current market rates of interest.

 

7

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*Concentration of Credit Risk*

 

The Company provides productsand services to customers in a variety of industries worldwide, including localgovernments, petrochemicals, utilities, manufacturing and transportation. Concentrationof credit risk with respect to trade receivables is limited due to thegeographic and industry dispersion of the Company’s customer base. The Companyhas not experienced significant credit losses on its customer accounts. AuroraLoan Services, CACI and Sempra Energy accounted for 15% 17% and 11% of tradeaccounts receivable at March 31, 2004 and there were no customers thataccounted for more than 10% of trade accounts receivable at September 30, 2003.

 

A small number of customershave typically accounted for a large percentage of the Company’s annualrevenues. Constellation Energy Group accounted for 24% of revenue for the sixmonths ended March 31, 2004, while Network Rail accounted for 24% of revenuefor six months ended March 31, 20003.  The Company’s reliance onrelatively few customers could have a material adverse effect on the results ofits operations on a quarterly basis.

 

*Property and Equipment*

 

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

 

*Software Development Costs and Purchased Software*

 

Software development costs andpurchased software are capitalized under FAS 86, “Accounting for the Costs ofComputer Software to Be Sold, Leased or Otherwise Marketed,” when technologicalfeasibility and marketability of the related product have been established.Software development costs incurred solely in connection with a specificcontract are charged to cost of revenues. Capitalized software costs are amortizedon a product-by-product basis, beginning when the product is available forgeneral release to customers. Annual amortization expense is calculated usingthe greater of the ratio of each product’s current gross revenues to the totalof current and expected gross revenues or the straight-line method over theestimated useful life of three to four years. Accumulated amortization ofcapitalized software costs was $254,000 and $215,000 at March 31, 2004 andSeptember 30, 2003, respectively. The related amortization expense was $39,000and $193,000 for the six months ended March 31, 2004 and 2003, respectively.

 

*Long-lived Assets*

 

The Company assesses potentialimpairments to its long-lived assets when there is evidence that events orchanges in circumstances have made recovery of the asset’s carrying valueunlikely. An impairment loss would be recognized when the sum of the expectedfuture net cash flows is less than the carrying amount of the asset.  TheCompany concluded in fiscal 2004 that there were no events or changes incircumstances that would indicate that the carrying amounts of long-livedassets were impaired.

 

*Derivatives*

 

Under Emerging Issues TaskForce (EITF) Issue No. 00-19,*Accounting forDerivative Financial Instruments Index to, and Potentially Settle in, aCompany’s Own Stock*, the initial balance sheet classification ofcontracts that require net cash settlement are recorded as assets orliabilities and contracts that require settlement in shares are recorded asequity instruments. At each balance sheet date, the Company reviews contractsand equity instruments that are to be settled in common stock to determine ifsufficient common shares are available to satisfy the maximum number of sharesthat could be required to net-share settle the contracts, among otherconditions.  If sufficient common shares do not exist, then certaincontracts are reclassified as a liability based on their fair value. Changes in fair value are accounted for in the consolidated statements ofoperations.

 

*Stock-Based Compensation*

 

The Company measurescompensation expense for its stock-based employee compensation plans using theintrinsic value method and provides pro forma disclosures of net loss and basicand diluted net loss per share as if the fair value-based method had beenapplied in measuring compensation expense. The Company applies SFAS No.123,*Accounting for Stock-Based Compensation*and Accounting Principles Board Opinion No. 25 and related Interpretationsin accounting for its employee stock-based compensation plan.

 

8

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No compensation cost wasrecognized for employee stock option grants during 2004 and 2003 based upon theintrinsic value method, which were fixed in nature, as the options were grantedat exercise prices equal to fair market value on the date of grant. Hadcompensation cost for the Company’s employee stock-based compensation plan beendetermined based on the fair value at the grant dates the disclosurerequirements of SFAS No. 148, which amends the disclosure requirements of FAS123, would have been as follows:

 
|                                                                              |   | **For the  three months  ended March 31,** |     | **For the  six months  ended March 31,** |   |
|-----------------------------------------------------------------------------------|--------|--------------------------------------------|----------|------------------------------------------|--------|
|                                                                              |   | **2004**                                   |     | **2003**                                 |   | **2004** |   | **2003** |   |
| Net loss used in computing net loss per  share                                    |   |                                       |     |                                     |   |   |   |   |   |
| As reported                                                                       |   | $                                          | (573,000 | )                                        | $      | (378,000 | ) | $ | (562,000 | ) | $ | (440,000 | ) |
| Deduct:                                                                           |   |                                       |     |                                     |   |   |   |   |   |
| Stock-based employee compensation expense  determined under the fair value method |   | (73,000                                    | )        | (23,000                                  | )      | (217,000 | ) | (51,000 | ) |
| Pro forma                                                                         |   | $                                          | (646,000 | )                                        | $      | (401,000 | ) | $ | (779,000 | ) | $ | (491,000 | ) |
|                                                                              |   |                                       |     |                                     |   |   |   |   |   |
| Basic and diluted net loss per share                                              |   |                                       |     |                                     |   |   |   |   |   |
| As reported                                                                       |   | $                                          | (0.02    | )                                        | $      | (0.01 | ) | $ | (0.02 | ) | $ | (0.01 | ) |
| Pro forma                                                                         |   | $                                          | (0.02    | )                                        | $      | (0.01 | ) | $ | (0.02 | ) | $ | (0.02 | ) |

 

Under FAS 123, the fair valueof each option grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted average assumptions used forgrants:

 
|                    |   | **For the  three months  ended March 31,** |   | **For the  six months  ended March 31,** |   |
|-------------------------|--------|--------------------------------------------|--------|------------------------------------------|--------|
|                    |   | **2004**                                   |   | **2003**                                 |   | **2004** |   | **2003** |   |
| Dividend Yield          |   | 0                                          | %      | 0                                        | %      | 0 | % | 0 | % |
| Expected Volatility     |   | 261                                        | %      | 238                                      | %      | 261 | % | 312 | % |
| Risk free interest rate |   | 3.83                                       |   | 4.90                                     |   | 3.83 |   | 4.90 |   |
| Expected lives (years)  |   | 5                                          |   | 5                                        |   | 5 |   | 5 |   |

 

*Income Taxes*

 

Current income tax expense isthe amount of income taxes expected to be payable for the current year. A deferredincome tax asset or liability is established for the expected futureconsequences resulting from the differences in the financial reporting and taxbases of assets and liabilities. Deferred income tax expense (benefit) is thechange during the year in the deferred income tax asset or liability. Valuationallowances are established when necessary to reduce deferred tax assets to theamount expected to be “more likely than not” realized in the future based onthe Company’s current and expected operating results.

 

*Net Income (Loss) per Common Share*

 

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

 

*Statements of Cash Flows*

The following table providessupplemental cash flow information:

 
|                                                                                    |   | **For the  three months  ended March 31,** |      | **For the  six months  ended March 31,** |   |
|-----------------------------------------------------------------------------------------|--------|--------------------------------------------|-----------|------------------------------------------|--------|
|                                                                                    |   | **2004**                                   |      | **2003**                                 |   | **2004** |   | **2003** |   |
| Supplemental cash flow information:                                                     |   |                                       |      |                                     |   |   |   |   |   |
| Interest paid                                                                           |   | $                                          | 4,000     |                                     | $      | 1,000 |   | $ | 6,000 |   | $ | 3,000 |   |
|                                                                                    |   |                                       |      |                                     |   |   |   |   |   |
| Non-cash financing and investing  activities:                                           |   |                                       |      |                                     |   |   |   |   |   |
| Accrued preferred stock dividends                                                       |   | $                                          | 66,000    |                                     | $      | — |   | $ | 132,000 |   | $ | — |   |
| Fair value of equity instruments redeemable  for common stock converted to common stock |   | $                                          | 1,159,000 |                                     | $      | — |   | $ | 1,159,000 |   | $ | — |   |

 

9

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**Note3 – Related Party Transactions**

 

In September 2003$5,291,000 of debt owed to Spescom Ltd. and Spescom UK was converted intopreferred stock.  The debt converted was comprised of the outstandingprincipal balance of promissory notes plus accrued but unpaid interest as wellas accounts payable due to Spescom UK in the amount of $492,000.  OnSeptember 30, 2003, the Company issued 5,291 Series F ConvertiblePreferred Stock to Spescom Ltd. with a stated value of $1,000 per share. The Series F preferred stock are convertible into common stock, beginning 45days from the issuance date subject to availability of sufficient common sharesat a stated conversion price of $0.45 per share subject to certainadjustments.  The conversion is at the option of Spescom Ltd. throughSeptember 30, 2008.

 

Related party liabilitiesconsist of the following:

 
|                                                            |   | **March 31,  2004** |    | **September  30,  2003** |   |
|-----------------------------------------------------------------|--------|--------------------------|---------|--------------------------|--------|
|                                                            |   | **(Unaudited)**          |    |                     |   |
| Related party liabilities:                                      |   |                     |    |                     |   |
| Notes and accrued interest payable on  demand – Spescom UK |   | $                        | 803,000 |                     | $      | 504,000 |   |
|                                                            |   |                     |    |                     |   |
| Total liabilities                                               |   | $                        | 803,000 |                     | $      | 504,000 |   |

 

On November 18, 2003 theCompany issued a note payable to Spescom UK with a principal balance of$600,000 bearing interest rate of 5% per annum, with principal payable in twoinstallments of approximately $300,000 plus interest at January 31, 2004and March 31, 2004.  The first payment of $305,000 was made onJanuary 29, 2004 to Spescom UK and the second payment due date wasextended to May 31, 2004.  TheCompany expects to make the second payment by the May 31, 2004 due date.  Interest expense on the note for the threeand six months ended March 31, 2004 amounted to $5,000 and $7,000,respectively.  This note is collateralized by a security interest in favorof Spescom UK in respect of all the Company’s assets.

 

In addition, the Company hadtwo existing demand notes payable to Spescom UK for $400,000 and $100,000, eachbearing interest rate of 10% per annum.  Spescom Ltd. has agreed that itwill not cause Spescom UK to demand repayment under the two notes prior toOctober 1, 2004.  Interest expense on the notes was $18,000 and$33,000 for the three and six months ended March 31, 2004, respectivelycompared to $24,000 and $48,000 for the same period in 2003, respectively.  These notes are collateralized by a securityinterest in favor of Spescom UK in respect of all the Company’s assets.

 

Spescom UK provides certainadministrative and accounting functions for the Company’s United Kingdomsubsidiary.  The Company is billed a monthly fee by Spescom UK forreimbursement of certain costs in the United Kingdom including the officefacilities, all accounting and human resources services, and certain corporatemarketing activities.  For the three and six months ended March 31, 2004the administrative fees totaled $150,000 and $291,000, respectively, comparedto $153,000 and $305,000 for the three and six month period ended March 31,2003.  The office rent for the Company’s United Kingdom operationsincluded in the administrative fee totaled $88,000 and $170,000,respectively for the three and six months ended March 31, 2004 compared to$69,000 and $136,000, respectively for the three and six months ended March 31,2003.   At March 31, 2004 and September 2003 the Company had apayable to Spescom UK of $50,000 and $46,000, respectively.  In 1999, aspart of an agreement to sell the 60% interest in its United Kingdom subsidiaryto Spescom UK, the lease for the United Kingdom office facility was to beassigned to Spescom Ltd.; however, the landlord did not grant its consent tothe assignment.  Since 1999, Spescom Ltd. has paid the lease for theentire office directly to the landlord.  The lease expires inMarch 2006 and has an annual rent of $530,000.  A portion of theoffice has been subleased to third party tenants for an annual rent of$252,000.  The sublease also expires March 2006.

 

Spescom Ltd. and the Companyhave entered into a license agreement pursuant to which Spescom Ltd. haslicensed to the Company the right to use the name “Spescom” and to use atrademark owned by Spescom Ltd. related to certain computer software. TheCompany will not pay any royalties to Spescom Ltd. in connection with thislicense. The license is for an indefinite term, but is terminable by eitherparty upon 60 days prior written notice. Under the license agreement, SpescomLtd. has agreed to indemnify and hold harmless the Company and its directors,officers, employees and agents against liabilities arising from any claimbrought against the Company that alleges that Spescom Ltd.’s or the Company’suse of the licensed trademark infringes the rights of any third party, providedthat the Company is in material compliance with the provisions of the licenseagreement.

 

10

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**Note4 – Receivables** 

 
|                                        |   | **March 31,  2004** |    | **September 30,  2003** |   |
|---------------------------------------------|--------|---------------------|---------|------------------------------|--------|
|                                        |   | **(Unaudited)**     |    |                         |   |
| Receivables consist of:                     |   |                |    |                         |   |
| Receivables                                 |   | $                   | 736,000 |                         | $      | 501,000 |   |
| Less:  allowance for doubtful accounts |   | (84,000             | )       | (78,000                      | )      |
|                                        |   | $                   | 652,000 |                         | $      | 423,000 |   |

 

**Note5 – Reconciliation of Net Income (Loss) and Shares Used in Per ShareComputations:**

 
|                                                                                                      |   | **For the  three months ended  March 31,** |     | **For the  six months ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|----------|------------------------------------------|--------|
|                                                                                                      |   | **2004**                                   |     | **2003**                                 |   | **2004** |   | **2003** |   |
| Net loss                                                                                                  |   | $                                          | (573,000 | )                                        | $      | (378,000 | ) | $ | (562,000 | ) | $ | (440,000 | ) |
| Weighted average common shares outstanding  used in computing basic and diluted net loss per common share |   | 33,979,000                                 |     | 30,847,000                               |   | 33,954,000 |   | 30,844,000 |   |
|                                                                                                           |        |                                            |          |                                          |        |  |  |  |  |  |  |  |  |

 

Employee stock options toacquire 1,640,000 and 101,000 shares of common stock were outstanding at March31, 2004 and 2003, respectively.  The shares were not included in thecomputation of diluted earnings per share because their effect was antidilutive.

 

In September 2003, theCompany issued an option to purchase 2,500,000 shares of common stock to aninvestment consulting firm involved in a private placement and the Companyissued 5,291 shares of Series F Preferred Stock with a stated value of $1,000per share which are convertible into the Company’s common stock at a statedconversion price of $0.45 per share representing a total of 11,757,778 sharesof common stock.  In addition in September 2003, the Company issuedwarrants to participating investors of the private placement to purchase1,008,335 shares of the Company’s common stock.  The stock options,warrants and convertible preferred stock were excluded from calculations of pershare amounts, because their effect would be antidilutive.

 

**Note6 – Segment and Geographic Information**

 

The Company has one businesssegment, which consists of the development and sale of a suite of integrateddocument, configuration and records management software product.

 

Revenues for the three and sixmonth periods ended March 31, 2004 and 2003 by customer location are asfollows:

 
|                             |   | **For the  three months ended  March 31,** |      | **For the  six months ended  March 31,** |   |
|----------------------------------|--------|--------------------------------------------|-----------|------------------------------------------|--------|
|                             |   | **2004**                                   |      | **2003**                                 |   | **2004** |   | **2003** |   |
| Net sales:                       |   |                                       |      |                                     |   |   |   |   |   |
| United States                    |   | $                                          | 938,000   |                                     | $      | 929,000 |   | $ | 2,346,000 |   | $ | 2,243,000 |   |
| Europe, primarily United Kingdom |   | 637,000                                    |      | 823,000                                  |   | 1,166,000 |   | 1,774,000 |   |
| Other International              |   | 26,000                                     |      | 63,000                                   |   | 214,000 |   | 87,000 |   |
|                             |   | $                                          | 1,601,000 |                                     | $      | 1,815,000 |   | $ | 3,726,000 |   | $ | 4,104,000 |   |

 
|                                             |   | **March 31,  2004** |      | **September  30,  2003** |   |
|--------------------------------------------------|--------|---------------------|-----------|--------------------------|--------|
|                                             |   | **(Unaudited)**     |      |                     |   |
| Identifiable assets from continuing  operations: |   |                |      |                     |   |
| United States                                    |   | $                   | 540,000   |                     | $      | 941,000 |   |
| Europe, United Kingdom                           |   | 667,000             |      | 289,000                  |   |
|                                             |   | $                   | 1,207,000 |                     | $      | 1,230,000 |   |

 

**Note7 - Recent Accounting Pronouncements**

 

In November 2002, the FASBissued FASB Interpretation No. 45 (FIN No. 45),*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*.FIN No. 45 expands on the accounting guidance of FASB StatementsNo. 5, 57, and 107 and incorporates without change the provisions of FASBInterpretation No. 34, which is being superseded. FIN No. 45 willaffect leasing transactions involving residual guarantees, vendor andmanufacturer guarantees, and tax and environmental indemnities. All suchguarantees will need to be disclosed in the notes to the financial statementsstarting with the period ending after December 15, 2002. Existingguarantees will be grandfathered and will not be recognized on the balancesheet. The provisions related to recognizing a liability at inception of theguarantee do not apply to product warranties, indemnification provisions in oursoftware license arrangements or to guarantees accounted for as derivatives.The initial recognition and measurement provision are effective prospectivelyfor

 

11

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guarantees issued or modifiedon or after December 31, 2002 and the disclosure requirements apply toguarantees outstanding as of December 31, 2002.  This interpretationdid not have a material effect on our consolidated financial position orresults of operations as we currently do not have any guarantees or obligationsfalling under the scope of Interpretation No. 45.

 

In December 2002, the FASBissued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure,” an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  In addition, SFAS No. 148amends the disclosure requirements of SFAS No. 123 to require more prominentand more frequent disclosures in financial statements about the effects ofstock-based compensation.  Thisstatement is effective for financial statements for fiscal years ending afterDecember 15, 2002. We are currently evaluating which method of transitionto fair value accounting we will elect.

 

In January 2003, theEmerging Issues Task Force (EITF) issued No. 00-21,*Accounting for Revenue Arrangements with Multiple Deliverables*.This EITF establishes the criteria for recognizing revenue in arrangements whenseveral items are bundled into one agreement. EITF 00-21 does not allow revenuerecognition unless the fair value of the undelivered element(s) is available andthe element has stand-alone value to the customer. EITF 00-21 also providesguidance on allocating the total contract revenue to the individual elementsbased upon the available fair value of each deliverable. This interpretation isnot expected to have a material effect on our consolidated financial positionor consolidated results of operations.

 

In January 2003, the FASBissued Interpretation 46,*Consolidation ofVariable Interest Entities.* In general, a variable interest entityis a corporation, partnership, trust, or any other legal structure used forbusiness purposes that either (a) do not have equity investors with votingrights or (b) have equity investors that do not provide sufficient financialresources for the entity to support its activities. Interpretation 46 requiresa variable interest entity to be consolidated by a company if that company issubject to a majority of the risk of loss from the variable interest entity’sactivities or entitled to receive a majority of the entity’s residual returnsor both. The consolidation requirements of Interpretation 46 apply immediatelyto variable interest entities created after January 31, 2003. Theconsolidation requirements apply to older entities in the first fiscal year orinterim period beginning after June 15, 2003. Certain of the disclosurerequirements apply in all financial statements issued after January 31,2003, regardless of when the variable interest entity was established. This interpretation is not expected to have a material effect on ourconsolidated financial position or consolidated results of operations as wecurrently do not have any variable interest entities falling within the scopeof Interpretation 46.

 

In April 2003, the FASBissued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments andHedging Activities.”  SFAS No. 149 amends and clarifies accounting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under SFAS 133, effective for reportingperiods ending after June 30, 2003.  In particular, SFAS No. 149clarifies under what circumstances a contract within an initial net investmentmeets the characteristic of a derivative and when a derivative contains afinancing component that warrants special reporting in the statement of cashflows.  SFAS No. 149 is generally effective for contracts entered into ormodified after June 30, 2003.  The adoption of SFAS 149 had amaterial effect on our consolidated financial position or consolidated resultsof operations.  See Note 9 Derivatives.

 

In May 2003, the FASBissued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity.”  SFAS No. 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity.  Itrequires that an issuer classify a financial instrument that is within itsscope as a liability (or an asset in some circumstances).  Many of thoseinstruments were previously classified as equity.  SFAS No. 150 iseffective for financial instruments entered into or modified after May 31,2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003.  The adoption of SFAS No. 150 did nothave a material effect on our consolidated financial position orconsolidated results of operations as we currently do not have any financialinstruments falling within the scope of SFAS No. 150.

 

**Note8 – Equity**

During the quarter ended, March31, 2004 the company reclassified 5,291 shares of preferred stock valued at$6,790,000 related to the conversion of debt owed to Spescom and Spescom UK toequity from mezzanine equity (see Note 9).  The Company recorded accrued dividends on the preferred stock of$65,000 and interest on unpaid accrued dividends of $1,000.  Finally, the Company issued 90,000 shares ofcommon stock valued at $46,000 to the Company’s investor relations firm forservices rendered.

 

12

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**Note 9—Derivatives**

 

At September 30, 2003, theCompany did not have a sufficient number of authorized shares of its commonstock to satisfy potential exercises of 1,108,335 warrants held by investorsand 1,150,000 options held by non-employees.  As a result, the fair valueof such equity instruments was reclassified from shareholders’ deficit tocurrent liabilities.  The fair value of the warrants and options wasdetermined using the Black-Scholes model at the date of reclassification andtotaled $1,233,000.  As of December 31, 2003 the total options heldby non-employees was reduced by 130,000 options from 1,150,000 to 1,020,000 dueto the exercise of 50,000 options and the expiration of 80,000 options. The Company recognized a gain of $5,000 on the revaluation of the remainingwarrants and options as of December 31, 2003   The AnnualMeeting of Shareholders was held on January 30, 2004.  At themeeting, the shareholders approved a proposal to amend the Company’s Articlesof Incorporation to increase the number of shares of authorized common stockfrom 40,000,000 to 100,000,000 shares.  As a result, the Company hassufficient number of shares of common stock authorized to satisfy potentialexercises of 1,108,335 warrants held by investors and 1,150,000 options held bynon-employees.  The fair value of such equity instruments of $1,159,000was reclassified from current liabilities to equity and a gain of $1,000 wasrecognized on the revaluation of the warrants and options to equity during thequarter ended March 31, 2004.  In addition the preferred stock of$6,790,000 was reclassified to equity from mezzanine equity.

 

**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward– Looking Statements**

 

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

 

*When used in the following discussion, the words “believes,”“anticipates” and similar expressions are intended to identify forward-lookingstatements. Such statements are subject to certain risks and uncertainties,which could cause actual results to differ materially from those projected.Readers are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date hereof. The Company undertakes noobligation to publicly release the result of any revisions to these forward-lookingstatements, which may be made to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events.*

 

*The following discussion should be read in conjunction with theSelected Consolidated Financial Data and the Consolidated Financial Statements,including the Notes thereto.*

 

**CRITICALACCOUNTING POLICIES**

 

The consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States of America. As such, management is required tomake judgments, estimates and assumptions that affect the reported amounts ofassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the reporting period. Thesignificant accounting policies which are most critical to aid in fullyunderstanding and evaluating reported financial results include the following:

 

*Revenue Recognition*

 

The Company enters intocontractual arrangements with end-users that may include licensing of theCompany’s software products, product support and maintenance services,consulting services or various combinations thereof, including the sale of suchproducts or services separately.  The Company recognizes revenue inaccordance with Statement of Position (“SOP”) 97-2 “Software RevenueRecognition” and SOP 98-9, “Modification of SOP 97-2, Software RevenueRecognition, with Respect to Certain Transactions” and Staff AccountingBulletin (“SAB”)  No. 101.

 

Software license and thirdparty product revenues are recognized upon shipment of the product if nosignificant vendor obligations remain and collection is probable. In caseswhere a significant vendor obligation exists, revenue recognition is delayeduntil such obligation has been satisfied. For new software products where ahistorical record has not yet been demonstrated that acceptance is perfunctory,the Company defers recognition of revenue until acceptance has occurred. If anundelivered element of the arrangement exists under the license arrangement, aportion of revenue is deferred based on vendor-specific objective evidence(VSOE) of the fair value of the undelivered element until deliveryoccurs.  If VSOE does not exist for all undelivered elements, all revenueis deferred until sufficient evidence exists or all elements have beendelivered.  Annual maintenance revenues, which consist of ongoing supportand product updates, are recognized on a straight-line basis over the term ofthe contract. Payments received in advance of performance of the relatedservice for maintenance contracts are recorded as deferred revenue. Revenuesfrom training and consulting

 

13

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services are recognized whenthe services are performed and adequate evidence of providing such services isavailable. Contract revenues for long-term contracts or programs requiringspecialized systems are recognized using the percentage-of-completion method ofaccounting, primarily based on contract labor hours incurred to date comparedwith total estimated labor hours at completion. Provisions for anticipatedcontract losses are recognized at the time they become known.

 

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

 

The Company considers manyfactors when applying accounting principles generally accepted in the UnitedStates of America related to revenue recognition.  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.)

•                                          Discountsgiven for each element of a contract

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

 

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

 

*Allowance for Doubtful Accounts*

 

The Company sells its productsdirectly to end-users, generally requiring a significant up-front payment andremaining terms appropriate for the creditworthiness of the customer. TheCompany also sells its products to VARs and other software distributorsgenerally under terms appropriate for the creditworthiness of the VAR ordistributor. The Company retains no continuing obligations on sales toVARs.  Receivables from customers are generally unsecured. The Companycontinuously monitors its customer account balances and actively pursuescollections on past due balances. The Company maintains an allowance fordoubtful accounts which is comprised of a general reserve based on historicalcollections performance plus a specific reserve for certain known customercollections issues. If actual bad debts are greater than the reservescalculated based on historical trends and known customer issues, the Companymay be required to book additional bad debt expense which could have a materialadverse effect on our business, results of operations and financial conditionfor the periods in which such additional expense occurs.

 

14

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**RESULTS OF OPERATIONS**

 

The following table sets forththe condensed consolidated statement of operations expressed as a percentage oftotal revenue for the periods indicated:

 
|                               |   | **For the  three months ended  March 31,** |   | **For the  six months ended  March 31,** |   |
|------------------------------------|--------|-------------------------------------------------|--------|-----------------------------------------------|--------|
|                               |   | **2004**                                        |   | **2003**                                      |   | **2004** |   | **2003** |   |
| Revenues                           |   |                                            |   |                                          |   |   |   |   |   |
| Licenses                           |   | 22                                              | %      | 20                                            | %      | 40 | % | 31 | % |
| Services and other                 |   | 78                                              | %      | 80                                            | %      | 60 | % | 69 | % |
| Total revenues                     |   | 100                                             | %      | 100                                           | %      | 100 | % | 100 | % |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Cost of revenues                   |   |                                            |   |                                          |   |   |   |   |   |
| Licenses                           |   | 3                                               | %      | 7                                             | %      | 4 | % | 10 | % |
| Services and other                 |   | 34                                              | %      | 28                                            | %      | 30 | % | 26 | % |
|                               |   | 37                                              | %      | 34                                            | %      | 34 | % | 36 | % |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Gross profit                       |   | 63                                              | %      | 66                                            | %      | 66 | % | 64 | % |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Operating expenses:                |   |                                            |   |                                          |   |   |   |   |   |
| Research and development           |   | 22                                              | %      | 23                                            | %      | 17 | % | 18 | % |
| Marketing and sales                |   | 45                                              | %      | 36                                            | %      | 36 | % | 31 | % |
| General and administrative         |   | 30                                              | %      | 20                                            | %      | 27 | % | 19 | % |
|                               |   | 97                                              | %      | 79                                            | %      | 80 | % | 68 | % |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Income (loss) from operations      |   | (34                                             | )%     | (13                                           | )%     | (14 | )% | (4 | )% |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Interest income and other income   |   | —                                          |   | —                                        |   | — |   | — |   |
| Interest expense and other expense |   | (2                                              | )%     | (7                                            | )%     | (1 | )% | (7 | )% |
|                               |   |                                            |   |                                          |   |   |   |   |   |
| Net Income (loss)                  |   | (36                                             | )%     | (21                                           | )%     | (15 | )% | (11 | )% |

 

**Revenues**

 

*License Revenues*

(in thousands)

 
|                        |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-----------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                        |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| License Revenue             |   | $                                  | 359    |                | $      | 367                              |     | -2                  | %        | $ | 1,478 |   | $ | 1,288 |   | 15 | % |
| Percentage of total revenue |   | 22                                 | %      | 20                  | %      |                             |     | 40                  | %        | 31 | % |   |   |
|                             |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

License revenues decreased by$8,000, or 2%, to $359,000 from $367,000 for the three months ended March 1,2004 as compared to the same period in 2003. The slight decrease for the quarter was due to timing of orders receivedfrom several customers.  Licenserevenues increased by $190,000, or 15%, to $1,478,000 from $1,288,000 for thesix months ended March 31, 2004 as compared to the same period in 2003. Theincrease was due primarily to a sale to a new customer, Constellation EnergyGroup of $750,000 compared to two sales of $369,000 and $250,000 to NetworkRail, formerly Railtrack and Bechtel, respectively during the correspondingperiod in the prior year.  The Company is continuing to see higher salesof the eB product suite as a result of customers expanding their existingsoftware systems and an increase in software orders from new customers inresponse to a higher demand for a comprehensive content management solutionneeded for business process compliance, corporate record keeping and enterprisecollaboration.

 

We anticipate that the demandfor enterprise document, configuration and records management softwaresolutions will continue to increase if overall economic conditions continue tostrengthen.  The Company’s license revenues fluctuate from quarter toquarter, but we have experienced and expect to continue to see increasedlicense revenue opportunities as more users are deployed throughout existingcustomer enterprises and as we make additional sales to new customers.

 

Although the Company hashistorically generated the majority of its revenues from its direct salesforce, the Company has also established a network of third-party VARs, systemintegrators and OEMs who build and sell systems (with components or completesystems provided by the Company) that address specific customer needs withinvarious industries, including those targeted directly by the Company. Sales through indirect channels for the three months ended March 31, 2004amounted to $190,000, or 12% of total revenue compared to $35,000 or 2% oftotal revenue for the same period in 2003.   Sales through indirect channels for the six months ended March 31, 2004amounted to $300,000, or 8% of total revenue compared to $48,000 or 1% of totalrevenue for the same period in 2003.

 

15

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The increase in indirect salesof $155,000 and $252,000 for the three and six months ended March 31, 2004 isdue primarily to increased sales from one distributor in the United Kingdom.

 

A small number of customershave typically accounted for a large percentage of the Company’s annualrevenues. CACI and Constellation Group accounted for 11% and 10%, respectivelyof revenue for the three months ended March 31, 2004 , while Railtrackaccounted for 20% of revenue for three months ended March 31, 2003.  Constellation Energy Group accounted for 24%of revenue for the six months ended March 31, 2004, while Network Railaccounted for 24% of revenue for six months ended March 31, 2003.  TheCompany’s reliance on relatively few customers could have a material adverseeffect on its results of operations on a quarterly basis.

 

*Service and Other Revenues*

(in thousands)

 
|                        |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-----------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                        |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| Service Revenue             |   | $                                  | 1,242  |                | $      | 1,448                            |     | -14                 | %        | $ | 2,248 |   | $ | 2,816 |   | -20 | % |
| Percentage of total revenue |   | 78                                 | %      | 80                  | %      |                             |     | 60                  | %        | 69 | % |   |   |
|                             |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

Services and other revenues arecomprised of maintenance and non-maintenance services.  Non-maintenanceservices typically relate to business process studies, implementation ofsystems and training which vary with the level of license revenues whilemaintenance revenue is primarily dependent on customers renewing their annualmaintenance support contracts.

 

Services and other revenuedecreased in absolute dollars and as a percentage of total revenue for thethree and six months ended March 31, 2004, as compared to the correspondingprior year periods.  The $206,000, or14%, decrease in the three months ended March 31, 2004 as compared to the sameperiods in 2003 was comprised of a $257,000, or 18%, reduction innon-maintenance service revenue which was offset by an increase of $51,000, or4%, in maintenance revenue.  The$568,000, or 20%, decrease in the six months ended March 31, 2004 as comparedto the same period in 2003 consisted of a 20% reduction in non-maintenanceservice revenue and maintenance revenue remained unchanged.  The decrease in overall service revenue inboth periods presented was attributable reduced non-maintenance servicerevenue.  In the three and six monthsended March 31, 2004 the company had one large implementation service contractas compared to two large implementation service contracts for the same periodin 2003.

 

We anticipate that service andother revenue will fluctuate primarily due to fluctuations in sales to newcustomers, which require more services that typically include a businessprocess study, integration with other business systems and training.  Inaddition, we expect that service and other revenues will continue to fluctuatefrom quarter to quarter based on the timing of customer orders.

 

**Costof Revenues**

 

*Cost of License Revenues*

(in thousands)

 
|                          |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-------------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                          |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| Cost of License Revenue       |   | $                                  | 53     |                | $      | 125                              |     | -58                 | %        | $ | 141 |   | $ | 400 |   | -65 | % |
| Percentage of license revenue |   | 15                                 | %      | 34                  | %      |                             |     | 10                  | %        | 31 | % |   |   |
|                               |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

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

 

Cost of license revenuedecreased in absolute dollars and as a percentage of associated license revenuein both the three and six months ended March 31, 2004, as compared to the same periodsin 2003.  In the three months endedMarch 31, 2004as compared to the same period in 2003, there was an overalldecrease of $82,000, or 66%, which was related to reduced amortization expenseof capitalized software costs as a result of the a majority of such costs beingfully amortized in 2003.  The overalldecrease was offset by an increase of $10,000, or 8%, in third-party costs dueto higher sales of third-party products as a percentage of total sales, resultingin a $72,000, or 58%, decrease in cost of license revenue for the three monthsended March 31, 2004, as compared to the same period in 2003.  The overall decrease in cost of licenserevenues resulted in an improvement in gross profit percentage of licenserevenues to 85% for the three months ended March 31, 2004 as compared to 66%for the same period a year ago.

 

The costs of licensed revenuesin the six months ended March 31, 2004 decreased $259,000, or 65% as comparedto the same period in 2003. Approximately $230,000 of this decrease was related to reducedamortization expense of capitalized software as mentioned above.  The remaining decrease of $29,000, was dueto decreased third-party costs due to lower sales of third-party products as apercentage of total sales.  The overalldecrease in cost of license revenues resulted in an improvement in gross profitpercentage of license revenues to 90% for the six months ended March 31, 2004as compared to 70% for the same period a year ago.

 

16

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We expect the cost of licenserevenues to fluctuate based on customer requirements for third-party softwareproducts since these costs have the largest impact on cost of license revenues.

 

*Cost of Services and Other Revenues*

(in thousands)

 
|                                    |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-----------------------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                                    |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| Cost of service and other revenue       |   | $                                  | 541    |                | $      | 500                              |     | 8                   | %        | $ | 1,107 |   | $ | 1,094 |   | 1 | % |
| Percentage of service and other revenue |   | 44                                 | %      | 35                  | %      |                             |     | 49                  | %        | 39 | % |   |   |
|                                         |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

Cost of services and otherrevenues consists primarily of personnel-related costs in providing consultingservices, training to customers and support.  It also includes costsassociated with reselling third-party hardware and maintenance, which includestelephone support costs

 

Cost of services and otherrevenue increased in absolute dollars and as a percentage of associated serviceand other revenue in both the three and six months ended March 31, 2004 ascompared to the same periods in 2003. The $41,000, or 8% and $13,000, or 1%, increase in the three and sixmonths ended March 31, 2004, respectively, as compared to the same periods in2003, was due primarily to increased labor and related costs.  The increase in cost of services and otherrevenue combined with the decrease in service and other revenues resulted in adecrease in gross profit of 56% from services and other revenue for the threemonth period ended March 31, 2004 as compared to 65% for the same period a yearago.    The gross profit from servicesand other revenue as a percentage of services and other revenues decreased to51% for the six months ended March 31, 2004 as compared to 61% for the sameperiod a year ago due to a 20% decrease in service and other revenues whilecost of revenues increased 1% as the personnel dedicated to customer contractsremained relatively unchanged.  Weexpect the cost of service and other revenues to fluctuate in absolute dollaramounts and as a percentage of total revenues as the related service revenuefluctuates.

 

**OperatingExpenses**

 

*Research and Development*

(in thousands)

 
|                              |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-----------------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                              |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| Research and development expenses |   | $                                  | 336    |                | $      | 414                              |     | -19                 | %        | $ | 668 |   | $ | 737 |   | -9 | % |
| Percentage of total revenue       |   | 21                                 | %      | 23                  | %      |                             |     | 17                  | %        | 18 | % |   |   |
|                                   |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

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

 

Research and developmentexpenses decreased in absolute dollars in the three and six months ended March31, 2004, as compared to the same periods in 2003.  The $78,000, or 19%, and $69,000, or 9%, decrease in therespective three and six month periods was due primarily to reduced labor andrelated costs.  In the prior year theCompany was focused its efforts in product improvement which resulted in a newsoftware release.  In addition theCompany reduced facility costs by moving to a smaller facility in the currentyear.

 

We believe that continuedinvestment in research and development is a critical factor in maintaining ourcompetitive position and we expect research and development costs to remain atthe current levels in absolute dollar amounts in the next several quarters.

 

*Marketing and Sales*

(in thousands)

 
|                         |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|------------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                         |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| Marketing and sales expenses |   | $                                  | 726    |                | $      | 657                              |     | 11                  | %        | $ | 1,331 |   | $ | 1,283 |   | 4 | % |
| Percentage of total revenue  |   | 45                                 | %      | 36                  | %      |                             |     | 36                  | %        | 31 | % |   |   |
|                              |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

Marketing and sales expensesconsist of salaries, cost of benefits, sales commissions and other expensesrelated to the direct sales force, as well as allocation of overall corporateexpenses, calculated on the basis of headcount, related to items such ascorporate insurance, facilities, telephone and other.

 

17

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Marketing and sales expensesincreased in absolute dollars and as a percentage of total revenue for thethree and six months ended March 31, 2004, as compared to the same periods in2003.  The increase of $69,000, or 11%,for the three months ended March 31, 2004 was due to increased marketing costsof $49,000 including tradeshows, user conferences, travel and advertising.  In addition, commissions earned increased by$20,000 from the prior year.

 

The increase of $48,000, or 4%,for the six months ended March 31, 2004 as compared to the same period in 2003was due to increased marketing costs of $116,000 relating to tradeshows, userconferences, travel and advertising which was partially offset by a reductionin outside consultants of $43,000 due to our bringing certain marketing andsales services in-house and reduced occupancy costs of $23,000 due to ourmoving the corporate offices into a smaller facility.

 

We expect marketing and salesexpense to increase in absolute dollar amounts and as a percentage of totalrevenue as a result of the planned expansion of our sales and marketing effortsin the next several quarters.

 

*General and Administrative*

(in thousands

 
|                                |   | **Three  Months Ended  March 31,** |   | **Percent  Change** |   | **Six Months  Ended  March 31,** |     | **Percent  Change** |     |
|-------------------------------------|--------|------------------------------------|--------|---------------------|--------|----------------------------------|----------|---------------------|----------|
|                                |   | **2004**                           |   | **2003**            |   |                             | **2004** |                | **2003** |   |   |
| General and administrative expenses |   | $                                  | 482    |                | $      | 363                              |     | 33                  | %        | $ | 989 |   | $ | 771 |   | 28 | % |
| Percentage of total revenue         |   | 30                                 | %      | 20                  | %      |                             |     | 27                  | %        | 19 | % |   |   |
|                                     |        |                                    |        |                     |        |                                  |          |                     |          |  |  |  |  |  |  |  |  |

 

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

 

General and administrativeexpenses increased in absolute dollars and as a percentage of total revenue forthe three and six months ended March 31, 2004, as compared to the same periodin 2003.  The 33%, or $119,000 increasein the three months ended March 31, 2004 as compared to the same period in 2003,was primarily due to increased accounting and legal fees of $45,000 relating toseveral registration statement filings, increased costs associated with theannual shareholder meeting of $30,000 and increased investor relations costs of$27,000 relating to a new public relations firm engaged in September 2003.

 

The 28%, or $218,000 increasein the six months ended March 31, 2004 as compared to the same period in 2003was due primarily to an increase in accounting and legal fees of $132,000relating to routine SEC review of the Company’s Annual Report on Form 10-K forthe year ended September 30, 2002 and several registration filings.  In addition, the Company incurred additionalexpenses of $56,000 relating to a new public relations firm engaged in September,2003,  and increased costs of $30,000associated with the annual shareholder meeting held in January, 2004.

 

We expect that general andadministrative expenses will fluctuate in absolute dollars based on the timingof accounting and legal matters such as the Company’s recent registrationstatement filings.

 

**INTERESTEXPENSE**

Interest expense consistsprimarily of fixed interest obligations on our outstanding debt to Spescom Ltd.as well as interest paid on capital lease obligations.  Interest expensewas $37,000 and $58,000 for the three and six months ended March 31, 2004,respectively, as compared to $134,000 and $259,000 for the comparable periodsin 2003.  The decrease is due to decreased debt balances owed to SpescomUK due to the conversion of debt to convertible preferred stock inSeptember 2003.

 

**LIQUIDITYAND CAPITAL RESOURCES**

At March 31, 2004, theCompany’s cash and cash equivalents totaled $220,000 as compared to $333,000 atMarch 31, 2003.  Its current ratio(current assets divided by current liabilities) was .21 at March 31, 2004.

 

For the six months ended March31, 2004, cash provided by financing activities totaled $297,000, primarilyfrom a short-term note payable issued to Spescom Ltd.. Cash used in operatingactivities totaled $400,000 and primarily relates to the decrease inreceivables which resulted from the collection of a large receivable during thequarter.

 

The Company has received loansfrom Spescom Ltd. in the past to meet its obligations.  The outstandingbalance of its loans from Spescom increased to $803,000 at March 31, 2004 from$504,000 at September 30, 2003 due to the issuance of a $600,000short-term note payable to Spescom UK.  Such loans are secured by all ofthe assets of the Company.  The short-term note payable was due in twopayments of approximately $300,000 in January 31, 2004 and March 31,2004.  The first payment of $305,000 was made on January 29, 2004 andthe second payment has been extended to May 31, 2004. The remaining notes aredue in October 2004.

 

In fiscal year 2003, SpescomLtd. supported the Company’s operations by extending the due dates of notespayable and by converting $5.3 million in debt and other obligations owed toSpescom Ltd. to preferred stock.  The preferred stock is entitled toreceive dividends of 5% of the stated value per share per annum, payable on aquarterly basis in cash or common stock.  The Company shall pay intereston all accrued but unpaid dividends at 8% per anum compounded annually from thedate of accrual until paid.  The Companyhas recorded accrued dividends on the preferred stock of $131,000 and interestof $1,000 as of March 31, 2004.  Spescom Ltd. has stated that it has theability and will continue to fund the Company’s operations throughOctober 1, 2004, if necessary.

 

18

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However, the funding ofsuch loans may be delayed or prevented by currency exchange regulations of theRepublic of South Africa, under which Spescom is required to apply for andobtain the approval of the South African Reserve Bank before providing anyfunds to the Company. Spescom Ltd. is presently unaware of any reason why suchReserve Bank approval should not be given.

 

The Company’s future liquiditydepends on its ability to generate new system sales of its eB product suite inthe near term, which cannot be assured. Failure to generate sufficient systemsales to meet the Company’s cash flow needs can be expected to have a materialadverse effect on the Company’s business, results of operations, and financialcondition.  The Company’s financial position can be a factor in attractingnew customers.  In an effort to strengthen the Company’s financialcondition and provide capital for expanding marketing and sales capabilities,the Company will continue to explore additional equity or debt financing fromthird parties.  There can be no assurance that additional financing willbe available or that the terms of such financing will be acceptable to theCompany.  The Company believes that its current cash and receivables, aswell as additional cash that may be generated from operations, will besufficient to meet its short-term needs for working capital. However, theCompany may not be able to obtain sufficient orders to enable the Company tocontinue on a cash flow break-even level, which would be necessary to continueoperations in the absence of further financing.

 

**CONTRACTUALOBLIGATIONS AND COMMERCIAL COMMITMENTS**

 

The following summarizes ourcontractual obligations and other commitments at March 31, 2004, and the effectsuch obligations could have on our liquidity and cash flow in futureperiods: 

 
|                                  |   | **Amount of  Commitment Expiring by Period** |      |
|---------------------------------------|--------|----------------------------------------------|-----------|
|                                  |   | **Less  Than  1 Year**                       |      | **1-3  Years** |   | **4-5  Years** |   | **Over 5  Years** |   | **Total** |   |
| Notes and Accounts Payable to Spescom |   | $                                            | 803,000   |   | $ | — |   | $ | — |   | — |   | $ | 803,000 |   |
| Capital Lease Obligations             |   | 22,000                                       |      | 50,000 |   | 2,000 |   |   |   | 74,000 |   |
| Operating Lease Obligations           |   | 237,000                                      |      | 749,000 |   | 371,000 |   | — |   | 1,357,000 |   |
| Total                                 |   | $                                            | 1,062,000 |   | $ | 799,000 |   | $ | 373,000 |   | — |   | $ | 2,234,000 |   |

 

The notes and accounts payable to Spescomincreased $300,000 from September 30, 2003 to March 31, 2004.  This increase is due to a $600,000 shortterm note payable issued by the Company to Spescom UK.  The Company paid the first payment of$305,000 of principal and interest on January 29, 2004 and the remainingbalance of $300,000 plus accrued interest is due on May 31, 2004.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

At March 31, 2004 andSeptember 30, 2003, we did not have any other relationships withunconsolidated entities or financial partnerships, including entities oftenreferred to as structured finance or special purpose entities that would havebeen established for the purpose of facilitating off-balance sheet arrangementsor other contractually narrow or limited purposes.  Therefore, we are notmaterially exposed to any financing, liquidity, market or credit risk thatcould arise if we were engaged in such relationships.

 

**CERTAINFACTORS THAT MAY AFFECT FUTURE RESULTS**

 

*Foreign Currency*

 

The Company’s geographicmarkets are primarily in the United States and Europe, with some sales in otherparts of the world. For the six months ended March 31, 2004, revenues from theUnited States were 64% of total revenues, and revenues from Europe and otherlocations were 36% of total revenues.  This compares to 52% and 48%respectively for the same period a year ago. Revenues from our United Kingdomsubsidiary can fluctuate from quarter to quarter based on the timing ofcustomer orders.  The reduced revenue in the current quarter was partiallyoffset by a foreign currency gain of $84,000 due to a weakened dollar valuecompared to the sterling pound.  Changes in foreign currency rates, thecondition of local economies, and the general volatility of software marketsmay result in a higher or lower proportion of foreign revenues in the future.Although the Company’s operating and pricing strategies take into accountchanges in exchange rates over time, future fluctuations in the value offoreign currencies may have a material adverse effect on the Company’sbusiness, operating results and financial condition.

 

*Inflation*

 

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

 

19

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**ITEM 3****. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

**InterestRate Risk**

 

The Company’s exposure tomarket rate risk for changes in interest rates relates primarily to theCompany’s investment portfolio. As of March 31, 2004 the Company hadinvestments in money market accounts totaling $180,000.  The Company does not use derivativefinancial instruments in its investment portfolio. The Company places itsinvestment with high quality issuers and follows internally developedguidelines to limit the amount of credit exposure to any one issuer.Additionally, in an attempt to limit interest rate risk, the Company followsguidelines to limit the average and longest single maturity dates. The Company isadverse to principal loss and ensures the safety and preservation of itsinvested funds by limiting default, market and reinvestment risk. The Company’sinvestments include money market accounts, as of March 31, 2004.

 

**ITEM 4****. CONTROLS AND PROCEDURES**

 

The Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Exchange Act Rule 13a-14.Based upon that evaluation, we have concluded that, as of March 31, 2004, theCompany’s disclosure controls and procedures are effective in recording,processing, summarizing and reporting within the time periods specified in theSEC’s rules and forms material information relating to the Company (includingits consolidated subsidiaries) required to be included in the Company’speriodic SEC filings.

 

During the last fiscal quarter,there were no significant changes in the Company’s internal control overfinancial reporting or in other factors that materially affected, or arereasonably likely to materially affect, the Company’s internal controls overfinancial reporting.

 

20

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**PARTII****.  OTHER INFORMATION**

 

**ITEM 1 – LEGAL PROCEEDINGS**

 

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

 

**ITEM4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The Annual Meeting ofShareholders was held on January 30, 2004.  At the meeting, theshareholders approved three proposals. The shareholders approved a proposal toamend the Company’s 1996 Stock Incentive Plan to increase the aggregate numberof shares of common stock reserved for issuance from 2,425,000 to 5,425,000shares.  The proposal was approved with 22,231,632 voting for, 683,033voting against and 156,208 abstaining.  The shareholders also approved aproposal to amend the Company’s Articles of Incorporation to increase thenumber of shares of authorized common stock from 40,000,000 to 100,000,000shares.  The proposal was approved with 29,930,478 voting for, 652,144voting against and 126,944 abstaining.  The shareholders also approved aproposal to amend the Company’s Articles of Incorporation to change the name ofthe Company to Spescom Software Inc. from Altris Software Inc.   Theproposal was approved with 30,464,823 voting for, 155,225 voting against and89,518 abstaining.

 

In addition, at the meeting,the shareholders approved the election of the following individuals asdirectors who will hold office until the next annual meeting:  CarlMostert, D. Ross Hamilton, Hilton Issacman, Johann Leitner, James P. Myers andLarry D. Unruh.

 

**ITEM6 – EXHIBITS AND REPORTS ON FORM 8-K:**

 
| (a)      | Exhibits                                                                                                                                                                                                                    |
|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |                                                                                                                                                                                                                        |
| 3.1*     | Registrant’s  Articles of Incorporation, as amended.                                                                                                                                                                   |
|     |                                                                                                                                                                                                                        |
| 3.2*     | Registrant’s  Bylaws, as amended.                                                                                                                                                                                      |
|     |                                                                                                                                                                                                                        |
| 10.1 (1) | Lease  between The Irvine Company and Spescom Software Inc., dated February 25,  2001.                                                                                                                                 |
|     |                                                                                                                                                                                                                        |
| 10.2 (2) | 10.0%  promissory note due October 15, 2003 in principal amount of $1,235,076  issued by Spescom Software Inc. to Spescom Ltd. South Africa on  February 15, 2002.                                                |
|     |                                                                                                                                                                                                                        |
| 10.3 (3) | 10.0%  promissory note due October 15, 2003 in principal amount of $1,810,383  issued by Spescom Software Inc. to Spescom Ltd., a United Kingdom  corporation, on February 15, 2002.                              |
|     |                                                                                                                                                                                                                        |
| 10.4 (4) | Security  agreement between Spescom Software Inc. and Spescom Limited, a United Kingdom  corporation and Spescom Limited,  a South African corporation and  collectively with Spescom UK dated February 15, 2002. |
|     |                                                                                                                                                                                                                        |
| 10.5 (5) | 10%  promissory note due upon demand in principal amount of $400,000 issued by  Spescom Software Inc. to Spescom Ltd., a United Kingdom corporation, on  March 15, 2002.                                               |
|     |                                                                                                                                                                                                                        |
| 10.6 (6) | Security  agreement dated March 15, 2002 between Spescom Software Inc., a  California corporation and Spescom Ltd., a United Kingdom corporation.                                                                      |
|     |                                                                                                                                                                                                                        |
| 10.7 (7) | Pledge  agreement executed March 15, 2002 by and between Spescom Software Inc.,  a California corporation, Spescom Ltd., a United Kingdom corporation, and  Solomon Ward Seidenwurm & Smith, LLP.                  |
|     |                                                                                                                                                                                                                        |
| 10.8 (8) | 10.0%  promissory note due upon demand in principal amount of $500,000 issued by  Spescom Software Inc. to Spescom Ltd., a United Kingdom corporation, on  April 19, 2002.                                             |

 

21

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| 10.9 (9)   | 10.0%  promissory note due upon demand in principal amount of $700,000 issued by  Spescom Software Inc. to Spescom Ltd., a United Kingdom corporation, on  May 31, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10 (10) | 5.0%  promissory note due in two payments of $300,000 in principal and accrued  interest on January 31, 2004 and March 31, 2004, respectively  issued by Spescom Software Inc. to Spescom Ltd., a United Kingdom  corporation, on November 18, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 32.2       | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (b)        | Reports on  Form 8-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|       | We furnished  the SEC a report on Form 8-K dated February 2, 2004 that announced the  approval from the Company’s shareholders an amendment to the Articles of  Incorporation to change the name from Altris Software Inc. to Spescom  Software Inc.  We furnished to the SEC two reports on Form 8-K dated April 21, 2004.  The first 8-K announced the dismissal of  Grant Thornton, LLP as the principal independent accountants of the  Company.  In addition, the Company  announced the appointment of Singer, Lewak, Greenbaum and Goldstein, LLP as  the new principal independent accountants.  The Second 8-K announced the appointment of Michael Silverman to the Board of  Directors of the Company.  We furnished the SEC a report on Form 8-K dated April 26, 2004 that announced  preliminary results for the Company’s second fiscal quarter ended March 31,  2004.  Revenues were approximately $1.6  million with an estimated loss of approximately $573,000 or $0.02 per share. |

 

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| (1)  | Incorporated  by reference to Exhibit 10.27 to the Form 10-K filed on November 23,  2001.             |
|------|------------------------------------------------------------------------------------------------------------|
| (2)  | Incorporated  by reference to Exhibit 10.28 to the Form 10-Q filed on May 15, 2002.                   |
| (3)  | Incorporated  by reference to Exhibit 10.29 to the Form 10-Q filed on May 15, 2002.                   |
| (4)  | Incorporated  by reference to Exhibit 10.30 to the Form 10-Q filed on May 15, 2002.                   |
| (5)  | Incorporated  by reference to Exhibit 10.31 to the Form 10-Q filed on May 15, 2002.                   |
| (6)  | Incorporated  by reference to Exhibit 10.32 to the Form 10-Q filed on May 15, 2002.                   |
| (7)  | Incorporated  by reference to Exhibit 10.33 to the Form 10-Q filed on May 15, 2002.                   |
| (8)  | Incorporated  by reference to Exhibit 10.34 to the Form 10-Q filed on August 14, 2002.                |
| (9)  | Incorporated  by reference to Exhibit 10.35 to the Form 10-Q filed on August 14, 2002.                |
| (10) | Incorporated  by reference to Exhibit 10.10 to the Form 10-Q filed on February 13,  2004.             |
| *    | Incorporated  herein by this reference from previous filings with the Securities and  Exchange Commission. |

 

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**SIGNATURES**

 

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

 
| **Signature**     |   | **Title** |                                                                                | **Date** |
|-------------------|--------|-----------|-------------------------------------------------------------------------------------|----------|
|              |   |      |                                                                                |     |
| /s/ Carl  Mostert |   |      | Director and  Chief Executive Officer (Principal Executive Officer)                 |     | May 14, 2004 |
| Carl Mostert      |   |      |                                                                                |     |
|              |   |      |                                                                                |     |
| /s/ John W.  Low  |   |      | Chief  Financial Officer and Secretary (Principal Financial and Accounting Officer) |     | May 14, 2004 |
| John W. Low       |   |      |                                                                                |     |

 

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