**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

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| **x**                                                                                                                                                                                                                                                                               | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **                                                                                         |
| **FOR THE  QUARTERLY PERIOD ENDED June 30, 2006**                                                                                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **                                                                                         |
| **Or**                                                                                                                                                                                                                                                                              |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **                                                                                         |
| **o**                                                                                                                                                                                                                                                                               | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **                                                                                         |
| **FOR THE  TRANSITION PERIOD FROM                         TO                  ** |

**Commissionfile number 0-51118**

**SoftBrands, Inc.**

(Exact name of registrant as specified in its charter)

| **DELAWARE**                     |   | **41-2021446**          |
|----------------------------------|--------|-------------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer        |
| incorporation or  organization)  |   | Identification  Number) |

 

**TwoMeridian Crossings, Suite 800Minneapolis, Minnesota 55423**

(Address of principal executive offices)

**(612) 851-1500**

(Registrant’s telephone number, including area code)

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    YES  x    NO  o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.
| Large accelerated  filer | o | Accelerated filer | o | Non-accelerated  filer | x |
|--------------------------|---|-------------------|---|------------------------|---|

Indicate by checkmarkwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

YES    o    NO    x

The number of shares ofthe registrant’s common stock outstanding as of July 31, 2006 was 40,251,499.

 

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**Index**
| Part I     | Financial Information                                                                             |   |
|------------|---------------------------------------------------------------------------------------------------|--------|
| Item 1.    | Financial Statements                                                                              |   |
|       | Consolidated Balance Sheets at June 30, 2006 and  September 30, 2005                              |   |
|       | Consolidated Statements of Operations for the three  and nine months ended June 30, 2006 and 2005 |   |
|       | Consolidated Statements of Cash Flows for the nine  months ended June 30, 2006 and 2005           |   |
|       | Notes to 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 1A.   | Risk Factors                                                                                      |   |
| Item 2.    | Unregistered Sales of Equity Securities and Use of  Proceeds                                      |   |
| Item 3.    | Defaults Upon Senior Securities                                                                   |   |
| Item 4.    | Submission of Matters to a Vote of Security Holders                                               |   |
| Item 5.    | Other Information                                                                                 |   |
| Item 6.    | Exhibits                                                                                          |   |
| Signatures |                                                                                              |

 

2

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**PARTI. FINANCIAL INFORMATION**

**ITEM 1. Financial Statements**

**SoftBrands,Inc.**

**Consolidated Balance Sheets**

**inthousands, except share and per share data**

**(unaudited)**
| ** **                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2006**          | ** ** | **2005**               | ** ** |
| ** **                                                                                                                                                                   | ** ** | ** **        | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                   |       |              |       |                   |       |
| Current assets                                                                                                                                                               |       |              |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                   |       | $                 | 12,717     |                   | $          | 16,034 |   |
| Accounts  receivable, net                                                                                                                                                    |       | 5,992             |       | 5,363                  |       |
| Prepaid expenses  and other current assets                                                                                                                                   |       | 1,541             |       | 1,134                  |       |
| Total current  assets                                                                                                                                                        |       | 20,250            |       | 22,531                 |       |
| Furniture, fixtures and  equipment, net                                                                                                                                      |       | 2,139             |       | 1,986                  |       |
| Restricted cash                                                                                                                                                              |       | 600               |       | 648                    |       |
| Goodwill                                                                                                                                                                     |       | 23,474            |       | 22,947                 |       |
| Intangible assets, net                                                                                                                                                       |       | 2,330             |       | 3,783                  |       |
| Other long-term assets                                                                                                                                                       |       | 19                |       | 6                      |       |
| Total assets                                                                                                                                                                 |       | $                 | 48,812     |                   | $          | 51,901 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                               |       |              |       |                   |       |
| Current liabilities                                                                                                                                                          |       |              |       |                   |       |
| Current portion  of long-term debt and capital leases                                                                                                                        |       | $                 | 23         |                   | $          | 260 |   |
| Accounts payable                                                                                                                                                             |       | 1,390             |       | 2,240                  |       |
| Accrued expenses                                                                                                                                                             |       | 4,798             |       | 5,707                  |       |
| Accrued  restructuring costs                                                                                                                                                 |       | 178               |       | 203                    |       |
| Deferred revenue                                                                                                                                                             |       | 16,970            |       | 15,355                 |       |
| Other current  liabilities                                                                                                                                                   |       | 1,039             |       | 1,352                  |       |
| Total current  liabilities                                                                                                                                                   |       | 24,398            |       | 25,117                 |       |
|                                                                                                                                                                         |       |              |       |                   |       |
| Other long-term  liabilities                                                                                                                                                 |       | 136               |       | 292                    |       |
| Total  liabilities                                                                                                                                                           |       | 24,534            |       | 25,409                 |       |
| Stockholders’ equity                                                                                                                                                    |       |              |       |                   |       |
| Series A  Convertible Preferred Stock, $0.01 par value; 300,000 shares authorized; no  shares issued or outstanding                                                          |       |              |       |                   |       |
| Series B  Convertible Preferred Stock, $0.01 par value; 4,331,540 shares authorized,  issued and outstanding; liquidation value of $4,591                                    |       | 5,068             |       | 5,068                  |       |
| Series C  Convertible Preferred Stock, $0.01 par value; 20,027 shares authorized,  18,000 shares issued and outstanding; liquidation value of $18,000 plus  unpaid dividends |       | 15,065            |       | 15,065                 |       |
| Common stock,  $0.01 par value; 110,000,000 shares authorized; 40,251,499 and 40,030,000  shares issued and outstanding, respectively                                        |       | 403               |       | 400                    |       |
| Additional  paid-in capital                                                                                                                                                  |       | 175,099           |       | 173,756                |       |
| Accumulated other  comprehensive loss                                                                                                                                        |       | (2,122            | )          | (1,893                 | )          |
| Accumulated  deficit                                                                                                                                                         |       | (169,235          | )          | (165,904               | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 24,278            |       | 26,492                 |       |
| Total liabilities and  stockholders’ equity                                                                                                                             |       | $                 | 48,812     |                   | $          | 51,901 |   |

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

3

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**SoftBrands,Inc.**

**Consolidated Statements of Operations**

**in thousands, except per share data(unaudited)**
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                         | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue**                                                        | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                                                  |       | $                                | 1,653      |                            | $          | 3,116 |   | $ | 6,571 |   | $ | 7,896 |   |
| Maintenance &  support                                         |       | 10,480                           |       | 10,923                          |       | 31,447 |   | 33,051 |   |
| Professional services                                              |       | 3,521                            |       | 3,626                           |       | 10,583 |   | 10,055 |   |
| Third-party software  and hardware                                 |       | 473                              |       | 1,330                           |       | 1,644 |   | 2,656 |   |
| Total revenue                                                      |       | 16,127                           |       | 18,995                          |       | 50,245 |   | 53,658 |   |
| **Cost of revenues**                                               | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                                                  |       | 585                              |       | 1,376                           |       | 2,501 |   | 3,584 |   |
| Maintenance &  support                                         |       | 3,349                            |       | 3,574                           |       | 9,891 |   | 10,585 |   |
| Professional services                                              |       | 3,127                            |       | 2,765                           |       | 9,381 |   | 7,962 |   |
| Third-party software  and hardware                                 |       | 351                              |       | 1,157                           |       | 1,126 |   | 1,987 |   |
| Total cost of  revenues                                            |       | 7,412                            |       | 8,872                           |       | 22,899 |   | 24,118 |   |
| Gross profit                                                       |       | 8,715                            |       | 10,123                          |       | 27,346 |   | 29,540 |   |
| **Operating expenses**                                             | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general and  administrative                               |       | 7,962                            |       | 7,300                           |       | 23,748 |   | 22,382 |   |
| Research and product  development                                  |       | 2,670                            |       | 2,213                           |       | 7,662 |   | 6,242 |   |
| Restructuring related                                              |       |                             |       |                            |       |   |   | (261 | ) |
| Total operating  expenses                                          |       | 10,632                           |       | 9,513                           |       | 31,410 |   | 28,363 |   |
| Operating income  (loss)                                           |       | (1,917                           | )          | 610                             |       | (4,064 | ) | 1,177 |   |
| Interest expense                                                   |       | (3                               | )          | (1,021                          | )          | (9 | ) | (3,046 | ) |
| Other income, net                                                  |       | 189                              |       | 111                             |       | 362 |   | 298 |   |
| Loss from  continuing operations before provision for income taxes |       | (1,731                           | )          | (300                            | )          | (3,711 | ) | (1,571 | ) |
| Provision for (benefit  from) income taxes                         |       | 8                                |       | (251                            | )          | 13 |   | 39 |   |
| Loss from  continuing operations                                   |       | (1,739                           | )          | (49                             | )          | (3,724 | ) | (1,610 | ) |
| **Discontinued operations**                                        | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from  discontinued operations, net of tax                   |       | 5                                |       | 12,083                          |       | 393 |   | 12,083 |   |
| Net income  (loss)                                                 |       | (1,734                           | )          | 12,034                          |       | (3,331 | ) | 10,473 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| Preferred stock  dividends                                         |       | 273                              |       |                            |       | 819 |   |   |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| **Net income (loss) applicable to  common shareholders**           |       | $                                | (2,007     | )                               | $          | 12,034 |   | $ | (4,150 | ) | $ | 10,473 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| **Basic and diluted earnings  (loss) per common share**            | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Continuing operations                                              |       | $                                | (0.05      | )                               | $          | — |   | $ | (0.11 | ) | $ | (0.04 | ) |
| Discontinued operations                                            |       | $                                | —     |                            | $          | 0.30 |   | $ | 0.01 |   | $ | 0.30 |   |
| Net income (loss)                                                  |       | $                                | (0.05      | )                               | $          | 0.30 |   | $ | (0.10 | ) | $ | 0.26 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| **Weighted average basic and diluted shares  outstanding**         |       | 40,198                           |       | 40,030                          |       | 40,125 |   | 40,030 |   |

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

4

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**SoftBrands,Inc.**

**Consolidated Statements of Cash Flows**

**in thousands(unaudited)**
| ** **                                                                                               | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                               | ** ** | **June 30,**               | ** ** | **June 30,** | ** ** |
| ** **                                                                                               | ** ** | **2006**                        | ** ** | **2005** | ** ** |
|                                                                                                     |       |                            |       |   |   |
| **Cash flow from operating  activities**                                                                 |       |                            |       |   |   |
| Loss from continuing  operations                                                                         |       | $                               | (3,724     | ) | $ | (1,610 | ) |
| Adjustments to  reconcile loss from continuing operations to net cash provided by continuing  operations |       |                            |       |   |   |
| Depreciation and  amortization                                                                           |       | 3,773                           |       | 4,336 |   |
| Share-based  compensation expense                                                                        |       | 1,593                           |       |   |   |
| Noncash interest  expense                                                                                |       |                            |       | 884 |   |
| Foreign currency  transaction gains                                                                      |       | (116                            | )          | (221 | ) |
| Restructuring related                                                                                    |       |                            |       | (261 | ) |
| Provision for  doubtful accounts                                                                         |       | 48                              |       | 132 |   |
| Noncash income  tax benefit                                                                              |       |                            |       | (322 | ) |
| Change in  operating assets and liabilities, net of effect of acquisitions                               |       |                            |       |   |   |
| Accounts  receivable                                                                                     |       | (738                            | )          | (887 | ) |
| Prepaid expenses  and other current assets                                                               |       | (321                            | )          | (23 | ) |
| Accounts payable                                                                                         |       | (918                            | )          | 337 |   |
| Accrued expenses                                                                                         |       | (336                            | )          | (1,320 | ) |
| Accrued  restructuring costs                                                                             |       | (24                             | )          | (748 | ) |
| Deferred revenue                                                                                         |       | 1,488                           |       | (180 | ) |
| Other current  liabilities                                                                               |       | (330                            | )          | (36 | ) |
| Other long-term  assets and liabilities                                                                  |       | (72                             | )          | (75 | ) |
| Net cash  provided by continuing operations                                                              |       | 323                             |       | 6 |   |
| Net cash  provided by discontinued operations                                                            |       |                            |       | 12,405 |   |
| Net cash  provided by operating activities                                                               |       | 323                             |       | 12,411 |   |
| **Cash flow from investing  activities**                                                                 |       |                            |       |   |   |
| Purchases of furniture,  fixtures and equipment                                                          |       | (928                            | )          | (487 | ) |
| Capitalized software  development costs                                                                  |       |                            |       | (216 | ) |
| Acquisition, net of  cash acquired                                                                       |       | (1,907                          | )          |   |   |
| Decrease in restricted  cash                                                                             |       | 48                              |       |   |   |
| Net cash used in  investing activities                                                                   |       | (2,787                          | )          | (703 | ) |
| **Cash flow from financing  activities**                                                                 |       |                            |       |   |   |
| Repayment of long-term  debt and capital leases                                                          |       | (236                            | )          | (338 | ) |
| Proceeds on issuance of  common stock                                                                    |       | 331                             |       |   |   |
| Preferred stock  dividends paid                                                                          |       | (951                            | )          |   |   |
| Net cash used in  financing activities                                                                   |       | (856                            | )          | (338 | ) |
| Effect of exchange  rates on cash balances                                                               |       | 3                               |       | (631 | ) |
| Change in cash  and cash equivalents                                                                     |       | (3,317                          | )          | 10,739 |   |
| **Cash and cash equivalents**                                                                            |       |                            |       |   |   |
| Beginning of period                                                                                      |       | 16,034                          |       | 9,719 |   |
| End of period                                                                                            |       | $                               | 12,717     |   | $ | 20,458 |   |

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

5

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**SoftBrands,Inc.**

**Notes to Consolidated FinancialStatements**

**(unaudited)**

**1.             Basis of Presentation**

The unauditedconsolidated financial statements included herein reflect all adjustments, inthe opinion of management, necessary to fairly state the consolidated financialposition, results of operations and cash flows of SoftBrands, Inc. (the “Company”)for the periods presented. These adjustments consist of normal, recurring itemsunless otherwise noted. The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts therein. Due to the inherent uncertainty involved in making estimates,actual results in future periods may differ from those estimates. The resultsof operations for the three and nine months ended June 30, 2006 are notnecessarily indicative of the results to be expected for any subsequent quarteror for the entire fiscal year ending September 30, 2006. These statementsdo not contain certain information included in the Company’s annual financialstatements and notes. The accompanying interim consolidated financialstatements should be read in conjunction with the financial statements andrelated notes included in the Company’s fiscal 2005 Report on Form 10-K asfiled with the Securities and Exchange Commission (“SEC”) on December 20, 2005.

**2.            ****Share-based Compensation**

OnDecember 13, 2001, the Company’s Board of Directors and shareholdersapproved the SoftBrands, Inc. 2001 Stock Incentive Plan, which has a totalof 13,900,000 shares of the Company’s common stock reserved for issuance underoptions, including incentive stock options (“ISOs”) and other stock options,restricted stock awards, stock appreciation rights, dividend rights and othershare-based awards thereunder.  The plan provides that employees,directors and consultants are eligible to receive awards thereunder, that theCompensation Committee of the Board of Directors is authorized to establish theterms of such awards, as long as, in the case of ISOs, the term does not exceedten years from the date of grant and the exercise price of the options is  not less than fair value on the date ofgrant.  Through June 30, 2006, 7,958,786 of the options granted had becomeexercisable. In the fiscal quarter ended December 31, 2005 the Company’sCompensation Committee for the first time approved equity awards to managementwhich consisted of restricted stock units (“RSUs”) and stock appreciationrights (“SARs”). The Company promptly issues and delivers, out of thereservation created for the plan from its authorized but unissued common stock,shares upon exercise of options or stock appreciation rights, or upon vestingof restricted stock units, and has no current expectation of repurchasingshares to replace the shares so issued.

Effective October1, 2005 the Company adopted the fair value method of accounting for share-basedcompensation arrangements in accordance with Financial Accounting StandardsBoard (“FASB”) Statement No. 123(R), *Share-BasedPayment*(“SFAS No. 123(R)”), using the modified prospective methodof transition. Under the provisions of SFAS No. 123(R), the estimated fairvalue of share-based awards granted under the 2001 Stock Incentive Plan isrecognized as compensation expense over the vesting period. Using the modifiedprospective method, compensation expense is recognized beginning with theeffective date of adoption of SFAS No. 123(R) for all share based payments (i)granted after the effective date of adoption and (ii) granted prior to theeffective date of adoption and that remain unvested on the date of adoption.

Prior to October1, 2005, the Company accounted for share-based employee compensation plansusing the intrinsic value method of accounting in accordance with AccountingPrinciples Board Opinion No. 25,*Accountingfor Stock Issued to Employees*(“APB 25”), and its relatedinterpretations. Under the provisions of APB 25, no compensation expense wasrecognized when stock options were granted with exercise prices equal to orgreater than market value on the date of grant.

The Companyrecorded $658,000, or $0.02 per share and $1,593,000, or $0.04 per share oftotal share-based compensation expense for the three and nine months ended June30, 2006, respectively, as required by the provisions of SFAS No. 123(R). Theshare-based compensation expense is calculated on a straight-line basis overthe vesting periods of the related options, RSUs and SARs. This charge had noimpact on the Company’s reported cash flows. For the three and nine monthsended June 30, 2005, the Company recorded no share-based compensation expensepursuant to APB 25. The allocation of the share-based compensation expense forthe three and nine months ended June 30, 2006 was as follows:

6

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|                                               | ** ** | **June 30, 2006** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **Three Months**       | ** ** | **Nine Months** | ** ** |
| **Thousands**                                 | ** ** | **Ended**                   | ** ** | **Ended** | ** ** |
| Cost of revenue                               |       | $                           | 57         |   | 147 |   |
| Selling, general  and administrative expenses |       | 558                         |       | 1,306 |   |
| Research and  Development                     |       | 43                          |       | 140 |   |
| Total                                         |       | $                           | 658        |   | $ | 1,593 |   |
|                                               |            |                             |            |  |  |  |  |

Under the modified prospective method of transitionunder SFAS No. 123(R), the Company is not required to restate its prior periodfinancial statements to reflect expensing of share-based compensation underSFAS No. 123(R). Therefore, the results as of June 30, 2006 are not directlycomparable to the same period in the prior year.

As required bySFAS No. 123(R), the Company has presented pro forma disclosures of its netincome and net income per share for the prior year periods assuming theestimated fair value of the options outstanding during the periods ended June30, 2005 was amortized to expense over the option-vesting period as illustratedbelow.
|                                                                                                       | ** ** | **June 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                            | ** ** | **Three Months**       | ** ** | **Nine Months** | ** ** |
| **Thousands**                                                                                         | ** ** | **Ended**                   | ** ** | **Ended** | ** ** |
| ** **                                                                                            | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Net income, as  reported                                                                              |       | $                           | 12,034     |   | $ | 10,473 |   |
| Less total  stock-based compensation expense determined under fair value based method for  all awards |       | (392                        | )          | (2,056 | ) |
| Pro forma net  income                                                                                 |       | $                           | 11,642     |   | $ | 8,417 |   |
|                                                                                                  |       |                        |       |   |   |
| Basic and  diluted income per common share                                                            |       |                        |       |   |   |
| As reported                                                                                           |       | $                           | 0.30       |   | $ | 0.26 |   |
| Pro forma                                                                                             |       | $                           | 0.29       |   | $ | 0.21 |   |

The pro forma share-based compensation expense for thenine month periods ending June 30, 2005 includes an additional $1.0 million torecord the effect of the accelerated vesting. Prior to March 15, 2005 when theCompany’s registration under Section 12(g) of the Securities Exchange Act of1934 became effective, options had a seven year cliff vesting period.  Under initial terms of the options, vestingwas accelerated on March 15, 2005 and vesting now occurs overthree-to-four-year terms.

The fair marketvalue of each share-based option is estimated on the date of grant using aBlack-Scholes valuation method that uses the assumptions noted in the followingtable. The weighted average option life is a significant assumption as itdetermines the period for which the risk-free interest rate, volatility, anddividend yield must be applied. The expected life is the estimated averagelength of time over which the options will be exercised.  In the fourth quarter of fiscal 2005, theCompany changed the expected life of options granted from 10 years to 5 yearsbased on a market study of comparable companies and to reflect anticipatedincreased marketability and trading volume of SoftBrands, Inc. common stock dueto the approved listing and trading on the American Stock Exchange effectiveDecember 27, 2005.  The risk-freeinterest rate is based on the five-year Treasury constant maturity interestrate whose term is consistent with the expected life of our stock options.  An outside valuation advisor was used toassist the company in more accurately projecting expected stock pricevolatility considering both historical data and observable market prices ofsimilar equity instruments.
|                  | ** ** | ** **             | ** ** | ** **   | ** ** | ** **     | ** ** | **Weighted-**           | ** ** |
|------------------|------------|------------------------|------------|--------------|------------|----------------|------------|-------------------------|------------|
| ** **       | ** ** | **Risk-Free**          | ** ** | **Dividend** | ** ** | **Volatility** | ** ** | **Average Option** | ** ** |
| ** **       | ** ** | **Interest Rate** | ** ** | **Yield**    | ** ** | **Factor**     | ** ** | **Life (Years)**   | ** ** |
| Fiscal Year 2006 |       | 4.40% – 5.0       | 3%         | 0            | %          | 80             | %          | 5.0                     |       |
| Fiscal Year 2005 |       | 4.00% – 4.4       | 2%         | 0            | %          | 80             | %          | 9.9                     |       |

The Black-Scholes option-pricing model requires theinput of highly subjective assumptions. The Company’s employee stock optionshave characteristics significantly different from those of traded options.Because changes in the subjective input assumptions can materially affect thefair value estimate, management will continue to assess the assumptions andmethodologies used to calculate estimated fair value of share-basedcompensation. Circumstances may change and additional data may become availableover time, which could result in changes to these assumptions andmethodologies, which could materially impact the Company’s fair valuedetermination.

A summary ofoption activity under the 2001 Stock Incentive Plan as of June 30, 2006, andchanges during the three-, six- and nine-month periods then ended are presentedbelow.

7

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| ** **                               | ** ** | ** **         | ** ** | **Weighted-**           | ** ** | **Weighted-Average**           | ** ** | **Aggregate**                      | ** ** |
|------------------------------------------|------------|--------------------|------------|-------------------------|------------|--------------------------------|------------|------------------------------------|------------|
| ** **                               | ** ** | **Number of** | ** ** | **Average**             | ** ** | **Remaining Contractual** | ** ** | **Intrinsic**                      | ** ** |
| ** **                               | ** ** | **Options**        | ** ** | **Exercise Price** | ** ** | **Life (Years)**          | ** ** | **Value (in thousands)** | ** ** |
|                                     |       |               |       |                    |       |                           |       |                               |       |
| Outstanding balance,  September 30, 2005 |       | 10,487,500         |       | $                       | 2.20       |                           |       |                               |       |   |
| Granted                                  |       | 145,500            |       | $                       | 1.88       |                           |       |                               |       |   |
| Exercised                                |       | (41,500            | )          | $                       | 1.50       |                           |       |                               | $          | 17 |   |
| Forfeited                                |       | (252,626           | )          | $                       | 1.51       |                           |       |                               |       |   |
| Outstanding balance,  December 31, 2005  |       | 10,338,874         |       | $                       | 2.21       |                           | 7.0        |                               | $          | 2,602 |   |
| Granted                                  |       | —             |       | —                  |       |                           |       |                               |       |
| Exercised                                |       | (88,699            | )          | $                       | 1.50       |                           |       |                               | $          | 40 |   |
| Forfeited                                |       | (214,627           | )          | $                       | 1.53       |                           |       |                               |       |   |
| Outstanding balance  March 31, 2006      |       | 10,035,548         |       | $                       | 2.22       |                           | 6.8        |                               | —     |   |
| Granted                                  |       | —             |       |                    |       |                           |       |                               |       |
| Exercised                                |       | (90,799            | )          | $                       | 1.50       |                           |       |                               | $          | 21 |   |
| Forfeited                                |       | (52,376            | )          | $                       | 1.53       |                           |       |                               |       |   |
| Outstanding balance  June 30, 2006       |       | 9,892,373          |       | $                       | 2.23       |                           | 6.5        |                               | $          | 1,566 |   |
|                                     |       |               |       |                    |       |                           |       |                               |       |
| Exercisable shares as of June 30, 2006   |       | 7,958,786          |       | $                       | 2.39       |                           | 6.2        |                               | $          | 1,041 |   |

The weighted-average, grant-date fair value of optionsgranted during the nine-month period ended June 30, 2006 and 2005 was $1.28 and$1.24, respectively.

**RestrictedStock Units and Stock Appreciation Rights**

OnDecember 29, 2005, the Company’s Compensation Committee approved equityawards to management employees under the SoftBrands, Inc. 2001 StockIncentive Program.  To better optimize the cost of the Company’s equityincentives under SFAS 123(R), the awards consisted of restricted stock units (“RSUs”)and stock appreciation rights (“SARs”) rather than stock options.

In general, RSUgrants vest and require SoftBrands to issue to the employee 25% of the sharessubject to the grant on the first, second, third and fourth annualanniversaries of the date of grant, provided the employee remains an employeeof the Company or a subsidiary on those dates. The estimated fair value of RSUsis based on the fair market value of the Company’s common stock on the date ofgrant.

A summary of thestatus of the Company’s RSUs as of June 30, 2006, and changes during thethree-, six- and nine- month periods then ended are presented below.
|                                        | ** ** | ** **    | ** ** | **Weighted-Average** | ** ** |
|----------------------------------------|------------|---------------|------------|----------------------|------------|
| ** **                             | ** ** | **Nonvested** | ** ** | **Grant-Date**       | ** ** |
| ** **                             | ** ** | **Shares**    | ** ** | **Fair Value**  | ** ** |
| Nonvested  balance, September 30, 2005 |       | —        |       | —               |       |
| Granted                                |       | 362,000       |       | $                    | 2.08       |   |
| Vested                                 |       |          |       |                 |       |
| Forfeited                              |       |          |       |                 |       |
| Nonvested  balance, December 31, 2005  |       | 362,000       |       | $                    | 2.08       |   |
| Granted                                |       |          |       |                 |       |
| Vested                                 |       |          |       |                 |       |
| Forfeited                              |       | (13,000       | )          | $                    | 2.08       |   |
| Nonvested balance,  March 31, 2006     |       | 349,000       |       | $                    | 2.08       |   |
| Granted                                |       |          |       |                 |       |
| Vested                                 |       |          |       |                 |       |
| Forfeited                              |       | (11,000       | )          | $                    | 2.08       |   |
| Nonvested balance, June  30, 2006      |       | 338,000       |       | $                    | 2.08       |   |

Each of the SAR grants also vest on the first, second,third and fourth anniversaries of the date of grant with respect to 25% of theshares, provided the employee remains employed with the Company or a subsidiaryon that date, and expire on the fifth anniversary of the date of grant. The SARs entitle the employee, once vested and exercised, to receive shares of 

8

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SoftBrands common stock having a value on the date ofexercise equal to the excess of the fair market value of the shares on the dateof exercise over the fair market value of the shares on the date of grant.  Compensation expense is recognized over the vestingperiod of SARs based on estimated fair value at grant date using the Black-Scholesvaluation model.

A summary of thestatus of the Company’s SARs as of June 30, 2006, and changes during thethree-, six- and nine- month periods then ended are presented below.
|                                        | ** ** | ** **  | ** ** | **Weighted-Average** | ** ** |
|----------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                             | ** ** | **Number**  | ** ** | **Grant-Date**       | ** ** |
| ** **                             | ** ** | **of SARs** | ** ** | **Fair Value**  | ** ** |
| Nonvested  balance, September 30, 2005 |       | —      |       |                 |       |
| Granted                                |       | 237,500     |       | $                    | 1.27       |   |
| Vested                                 |       |        |       |                 |       |
| Forfeited                              |       |        |       |                 |       |
| Nonvested  balance, December 31, 2005  |       | 237,500     |       | $                    | 1.27       |   |
| Granted                                |       | 5,000       |       | 1.05                 |       |
| Vested                                 |       |        |       |                 |       |
| Forfeited                              |       | (30,000     | )          | $                    | 1.27       |   |
| Nonvested  balance, March 31, 2006     |       | 212,500     |       | $                    | 1.26       |   |
| Granted                                |       | 436,000     |       | 1.11                 |       |
| Vested                                 |       |        |       |                 |       |
| Forfeited                              |       | (5,000      | )          | $                    | 1.05       |   |
| Nonvested balance, June  30, 2006      |       | 643,500     |       | $                    | 1.16       |   |

As of June 30, 2006, there was $2,921,947, net ofestimated forfeitures, of total unrecognized compensation expense related tostock–based arrangements granted under the 2001 Stock Incentive Plan. Thisexpense is expected to be recognized over a weighted-average period of 1.8years.

**3.             Net Income (Loss) Per Share**

Net income (loss)per share is computed under the provisions of SFAS No. 128, *Earning per Share*. Basic earnings per share is computedusing net income (loss) available to common shareholders and the weightedaverage number of shares outstanding. Income (loss) available to commonshareholders includes the impact of dividends on the Company’s Series CConvertible Preferred Stock which was issued in August 2005. Diluted earningsper share reflects the weighted average number of shares outstanding plus anypotentially dilutive shares outstanding during the period, calculated using the“treasury stock” method. In accordance with EITF 03-6, *Participating Securities and the Two-Class Method under FASB StatementNo. 128*, the Company’s Series B Convertible PreferredStock and Series C Preferred Stock is considered in both the basic and dilutedearnings per share calculations, subject to the applicable antidilutionprovisions.

For the three andnine months ended June 30, 2006, 4,331,540 shares of Series B ConvertiblePreferred Stock and 18,000 shares of Series C Convertible Preferred Stock werenot considered in the calculation of basic or diluted earnings per sharebecause the Company had net losses and based on the contractual terms, holdersof neither the Series B Convertible Preferred Stock nor the Series CConvertible Preferred Stock have the obligation to share in the losses of theCompany. In addition, for the periods ended June 30, 2006, SARs, RSUs, optionsand warrants to purchase 16,952,329 shares of the Company’s common stock werenot considered in the calculation of diluted earnings per share because theimpact would be antidilutive.

For the three andnine months ended June 30, 2005, 4,331,540 shares of Series B ConvertiblePreferred Stock and options and warrants to purchase 14,851,699 shares of theCompany’s common stock were not considered in the calculation of dilutedearnings per share because the Company had net losses from continuing operationsand to do so would have been antidilutive. There were no Series C ConvertiblePreferred Stock shares issued and outstanding at June 30, 2005.

**4.             Discontinued Operations**

In accordance with thebankruptcy and reorganization plan of AremisSoft Corporation, the Company’sformer parent, the Company retained a 10% interest in the net collections bythe Liquidating Trust established to pursue litigation claims and collection ofassets remaining in AremisSoft after bankruptcy.  The Company records any recoveries from theliquidating trust of AremisSoft Corporation and any associated expenses asincome or loss from discontinued operations. In June 2005, the Company received a distribution in the amount of $12.6million from the Liquidating Trust that was recorded net of tax of $558,000 asincome from discontinued operations.

9

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Upon separationfrom the Former Parent, the Company established an accrual related to leaseexpense for premises occupied by the Former Parent in the United Kingdom. Uponre-assignment of the lease to a third party during the first quarter endedDecember 31, 2005, the Company reversed the remaining $655,000 balance of theaccrual. The benefit is recorded as income from discontinued operations and isshown net of income taxes of $262,000.

The details of theCompany’s relationship with the Former Parent are more fully described in theCompany’s Report on Form 10-K filed with the SEC on December 20, 2005.

**5.             Restructuring Related Charges**

The discussion ofthe Company’s restructuring activities included below is organized by theperiod of initiation of the different restructuring plans together with relatedsubsequent activity.

During the yearended September 30, 2004, the Company ceased using two internationalfacilities and recorded restructuring charges of $981,000 for lease costs thatwere to continue. Of this amount, $728,000 was taken during the first quarterof fiscal year 2004. These charges are an extension of the September 2003restructuring program (see below) and reflect the Company’s desire toconsolidate certain of its hospitality and manufacturing operations. Thesecosts were reversed in the second quarter of fiscal year 2005 with the closingof leased space in our Europe, Middle East and Africa (“EMEA”) region. Therewere no more restructuring-based lease commitments as of September 30, 2005.

OnSeptember 30, 2003, the Company announced a restructuring andreorganization plan that primarily affected the Hospitality segment. The plan’snear-term focus was to support current customers’ needs and return the businessto profitability. All product strategies and investment decisions werere-assessed. As a result, certain development projects were deferred orcancelled while other projects were afforded focused efforts to complete. Theplan included the closure or consolidation of several offices in various U.S.and international locations and the elimination of approximately 120 positions.The initial restructuring charges related to this program were taken inSeptember 2003. An additional restructuring charge of $490,000 was taken duringthe year ended September 30, 2004, primarily for additional employeeseverance related to the remaining 30 identified positions and contractterminations. As of September 30, 2005, the remaining balance of this plan was$33,000. During the nine-month period ended June 30, 2006, the Company madecash severance payments of $18,000. At June 30, 2006, the remaining employeeseverance accrual for this program was $15,000, all of which is continuedcarryover from regions outside of the U.S.

InDecember 2001, the Company instituted a restructuring plan to align itscost structure with its business plan. Under the restructuring plan, theCompany reduced its workforce by approximately 20%, or 153 positions throughoutthe organization. In addition to the employee termination costs, charges weretaken related to excess leased space at two of the Company’s facilities. Inconjunction with the restructuring related charges, the Company estimatedfuture sublease income to offset the liability. During the year endedSeptember 30, 2004, due to the Company’s inability to negotiate acceptablesublease terms at one of the facilities, additional restructuring charges of$470,000 were taken. In September 2004, Company management made thestrategic decisions to utilize both of the leased spaces previously consideredexcess, and the remaining restructuring accrual of $991,000 was eliminated anda restructuring benefit was recorded. The most significant portion of thisreversal relates to previously unused space at the Company’s headquarters inthe U.S. Following the initiation of certain key business partnerships and therelated staff increase, the Company chose to utilize the unused space fordevelopment, training and general office space.

In conjunctionwith the acquisition of Fourth Shift Corporation in April 2001, theCompany assumed accrued restructuring liabilities related to employeetermination costs and facility consolidation. At June 30, 2006, $163,000 ofthis restructuring liability was remaining and is required for special one-timeretirement benefits that the Company is obligated to pay for three formeremployees.

The followingtable presents a summary of the Company’s restructuring activities during thenine months ended June 30, 2006 and the year ended September 30, 2005:

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|                                | ** ** | **Employee**           | ** ** | ** **      | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                     | ** ** | **Severance and** | ** ** | ** **      | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Termination**        | ** ** | **Lease**       | ** ** | ** ** | ** ** |
| **Thousands**                  | ** ** | **Costs**              | ** ** | **Commitments** | ** ** | **Total**  | ** ** |
| ** **                     | ** ** | ** **             | ** ** | ** **      | ** ** | ** ** | ** ** |
| Balance at  September 30, 2004 |       | $                      | 466        |            | $          | 748        |       | $ | 1,214 |   |
| Adjustments and  reversals     |       | (81                    | )          | (180            | )          | (261       | )          |
| Cash payments  and other (1)   |       | (182                   | )          | (568            | )          | (750       | )          |
| Balance at  September 30, 2005 |       | 203                    |       |            |       | 203        |       |
| Cash payments  and other (1)   |       | (25                    | )          |            |       | (25        | )          |
|                           |       |                   |       |            |       |       |       |
| Balance at June 30,  2006      |       | $                      | 178        |            | $          | —     |       | $ | 178 |   |

 

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(1)          The impact of foreigncurrency translation is included with cash payments.

**6.             Comprehensive Income (loss)**

Totalcomprehensive income (loss) was $(2.0) million and $11.9 million for thethree months ended June 30, 2006 and 2005, respectively. Total comprehensiveincome (loss) was $(3.6) million and $9.8 million for the nine months endedJune 30, 2006 and 2005, respectively. Comprehensive income (loss) differs fromnet income (loss) due to foreign currency translation adjustments.

**7.             Acquisition**

Effective October 1, 2005, the Company acquired all of theoutstanding shares of Infra Business Solutions GmbH (“Infra”), a privately heldGerman software company that is a reseller and development partner of SAPBusiness One, for approximately $2.3 million. The purchase price includes cashof approximately $1.9 million (net of cash acquired), warrants to purchase200,000 shares of our common stock valued at $227,000 and closing costs. Theacquisition gives the Company presence in Germany and the ability to use Infra’sestablished channel partners to introduce Fourth Shift Edition for SAP BusinessOne to the German market. As a result of the acquisition of Infra, the Companyacquired $1.4 million of identifiable intangible assets that have estimateduseful lives of three to four years and are being amortized on accelerated andstraight-line methods. The fair market value of the identifiable intangibleassets purchased included Infra’s software product Infra:Net, a productionplanning system sold to small- to medium-sized manufacturers in the German,Swiss and Austrian markets at $676,000, non-contractual customer relationshipsvalued at $282,000, a licensing and royalty agreement valued at $25,000 andemployment contracts valued at $376,000. Goodwill of $585,000 was assigned tothe manufacturing operating segment. The following table summarizes theallocation of the purchase price to the estimated fair values of the assetsacquired and liabilities assumed:
| Current assets                  |   | $         | 413,000   |   |
|---------------------------------|--------|-----------|-----------|--------|
| Furniture and  fixtures         |   | 26,000    |      |
| Other  non-current assets       |   | 15,000    |      |
| Identifiable  intangible assets |   | 1,359,000 |      |
| Goodwill                        |   | 585,000   |      |
| Total assets acquired           |   | 2,398,000 |      |
|                            |   |      |      |
| Current  liabilities            |   | 111,000   |      |
|                            |   |      |      |
| Net assets acquired             |   | $         | 2,287,000 |   |

The results of operations ofInfra have been included in the Company’s consolidated statements of operationssince the date of the acquisition. The pro forma impact of the Infraacquisition was not significant to the results of the Company for the ninemonths ended June 30, 2006 or the three or nine months ended June 30, 2005.

**8.             Goodwill and Intangible Assets**

The Companyassesses goodwill for impairment under the annual requirement of SFAS No. 142, *Goodwill and Other Intangible Assets,* orwhen impairment indicators arise.  The Company’s September 30, 2005 annualassessment resulted in no impairments.

There was anincrease of $527,000 to goodwill during the nine months ended June 30, 2006,which was due entirely to 

11

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goodwill from theInfra acquisition in October 2005, offset by foreign currency translationadjustments.

Net intangibleassets at June 30, 2006 and September 30, 2005, were comprised of thefollowing:
| ** **                        | ** ** | **June 30, 2006** | ** ** | **September 30, 2005** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **Gross**                   | ** ** | ** **                       | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                        | ** ** | **Carrying**                | ** ** | **Accumulated**                  | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| **Thousands**                     | ** ** | **Amount**                  | ** ** | **Amortization**                 | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                              |       |                        |       |                             |       |   |   |   |   |   |   |   |   |
| Acquired technology               |       | $                           | 21,148     |                             | $          | (19,554 | ) | $ | 1,594 |   | $ | 20,436 |   | $ | (17,168 | ) | $ | 3,268 |   |
| Capitalized software  development |       | 1,099                       |       | (882                             | )          | 217 |   | 1,094 |   | (610 | ) | 484 |   |
| Other                             |       | 944                         |       | (425                             | )          | 519 |   | 252 |   | (221 | ) | 31 |   |
| Intangible assets                 |       | $                           | 23,191     |                             | $          | (20,861 | ) | $ | 2,330 |   | $ | 21,782 |   | $ | (17,999 | ) | $ | 3,783 |   |

Total amortization of intangibles was $0.7 million and$1.0 million for the three months ended June 30, 2006 and 2005, respectively.Total amortization of intangibles was $2.9 million and $3.3 million for thenine months ended June 30, 2006 and 2005, respectively. Based on theintangibles at June 30, 2006, estimated amortization expense for each of thenext four years is as follows:
| Year Ending September 30 (thousands) | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|------------|
| Remainder of fiscal  year 2006                           |       | $          | 382        |   |
| 2007                                                     |       | 947        |       |
| 2008                                                     |       | 720        |       |
| 2009                                                     |       | 253        |       |
| 2010                                                     |       | 28         |       |
|                                                     |       | $          | 2,330      |   |

**9.             Segment Information**

The Companydiscloses segments in accordance with SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information*, which established standards for disclosure offinancial information related to operating segments of the Company, as well asdisclosure requirements for customer and geographic information. SFASNo. 131 defines an operating segment as a component of a company for whichoperating results are reviewed regularly by the chief operating decision-makerto determine resource allocation and assess performance. The Company has tworeportable segments under the guidelines of SFAS No. 131:  manufacturing and hospitality. Manufacturingand hospitality derive their revenues from licensing proprietary softwaresystems; providing customer support, training, consulting and installation servicesrelated to software; and through the resale of complementary third-partysoftware licenses and hardware.

Financialinformation by segment is summarized in the following table. Total assets arenot allocated to manufacturing and hospitality for internal reporting purposes.
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------|------------|-----------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Thousands** | ** ** | **Revenue**                                         | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                   | 12,989     |   | $ | 3,358 |   | $ | 13,097 |   | $ | 4,113 |   |
| Hospitality   |       | 3,138                                               |       | (747 | ) | 5,898 |   | 336 |   |
| Corporate     |       |                                                |       | (4,528 | ) |   |   | (3,839 | ) |
|          |       |                                                |       |   |   |   |   |   |   |
| Total Company |       | $                                                   | 16,127     |   | $ | (1,917 | ) | $ | 18,995 |   | $ | 610 |   |

 
| ** **    | ** ** | **Nine Months Ended June 30,** | ** ** |
|---------------|------------|----------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| **Thousands** | ** ** | **Revenue**                                        | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                  | 38,631     |   | $ | 10,764 |   | $ | 37,469 |   | $ | 10,481 |   |
| Hospitality   |       | 11,614                                             |       | 48 |   | 16,189 |   | 2,267 |   |
| Corporate     |       |                                               |       | (14,876 | ) |   |   | (11,571 | ) |
|          |       |                                               |       |   |   |   |   |   |   |
| Total Company |       | $                                                  | 50,245     |   | $ | (4,064 | ) | $ | 53,658 |   | $ | 1,177 |   |

 

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| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Thousands**                     | ** ** | **Manufacturing**                                   | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Geography:**                    | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                          |       | $                                                   | 7,525      |   | $ | 1,385 |   | $ | 8,910 |   | $ | 8,035 |   | $ | 1,705 |   | $ | 9,740 |   |
| Europe, Middle East  & Africa |       | 3,656                                               |       | 1,357 |   | 5,013 |   | 3,305 |   | 3,612 |   | 6,917 |   |
| Asia Pacific                      |       | 1,808                                               |       | 396 |   | 2,204 |   | 1,757 |   | 581 |   | 2,338 |   |
|                              |       | $                                                   | 12,989     |   | $ | 3,138 |   | $ | 16,127 |   | $ | 13,097 |   | $ | 5,898 |   | $ | 18,995 |   |

 
| ** **                        | ** ** | **Nine Months Ended June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| **Thousands**                     | ** ** | **Manufacturing**                                  | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                              |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                    | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                          |       | $                                                  | 22,451     |   | $ | 4,516 |   | $ | 26,967 |   | $ | 22,977 |   | $ | 5,801 |   | $ | 28,778 |   |
| Europe, Middle East  & Africa |       | 10,868                                             |       | 5,507 |   | 16,375 |   | 9,437 |   | 8,502 |   | 17,939 |   |
| Asia Pacific                      |       | 5,312                                              |       | 1,591 |   | 6,903 |   | 5,055 |   | 1,886 |   | 6,941 |   |
|                              |       | $                                                  | 38,631     |   | $ | 11,614 |   | $ | 50,245 |   | $ | 37,469 |   | $ | 16,189 |   | $ | 53,658 |   |

**10.****       Subsequent events**

On August 14, 2006 SoftBrands completed theacquisition of MAI Systems Corporation (“MAI”), the parent company of HotelInformation Systems (“HIS”).  SoftBrandsacquired all of the outstanding stock of MAI and financed the transactionthrough debt and equity.  The transactionincluded a payment to the shareholders of MAI Systems of $15.5 million, arepayment of $6.3 million of MAI Systems indebtedness and other considerationto principal shareholders of MAI Systems of $4.3 million in cash and $1.0million in SoftBrands common stock.

The combination of HIS and SoftBrand expands ourpresence in the property management software (“PMS”) market.  The acquired entity will be merged into thehospitality segment of SoftBrands.  Operations of HIS will be included in the Company’s consolidated resultsfor the periods beginning on August 14, 2006. The purchase price in excess of the fair value of net tangible assets isexpected to include goodwill, significant amortizable intangible assets and thewrite off of purchased research and development costs.  Purchase price allocation includingdetermination of identifiable intangible assets and amortizable lives, goodwilland in-process research and development will be determined upon completion ofan independent business valuation.

OnAugust 14, 2006, SoftBrands executed a Credit Agreement providing $21 millionused to finance the acquisition under a term loan maturing in seven years.  The principal amount of the term loan isrepayable in 78 equal monthly installments commencing March 2007.  The Credit Agreement also provides for arevolving line of credit under which SoftBrands may borrow up to $9 million.  Borrowings bear interest, payable monthly,ranging from 1.0% to 1.75% over the lenders’ prime rate, or from 2.0% to 2.75%over the London interbank rate, depending on the level of earnings beforeinterest, taxes depreciation and amortization for the twelve months precedingthe monthly calculation date.  SoftBrandspaid a $275,000 closing fee in connection with the Credit Agreement, $137,500of which was paid upon execution of a commitment letter on July 28, 2006 andthe remaining $137,500 was paid when the agreement was signed.  The revolving credit facility also carries a0.25% unused line fee, a letter of credit fee equal to 2.5% per annum andservicing fees of $1,000 per month. Borrowings under the Credit Agreement aresecured by all of the assets of SoftBrands

On August 14,2006, SoftBrands closed on the sale of 5,000 shares of its Series D ConvertiblePreferred Stock (“Series D Stock”) and warrants (the “Warrants”) to purchase333,333 shares of common stock for gross sales proceeds of $5,000,000, whichproceeds were used as partial consideration for the MAI acquisition.  An additional 1,667 shares of Series D Stockand warrants to purchase 111,333 shares of common stock for gross proceeds of$1,667,000 may be purchased by certain current shareholders through September4, 2006. The Series D Stock carries an 8% dividend and converts to common at aprice of $1.67 per share.  The warrantsare priced at $1.84 per share. Other terms of the Series D Stock aresubstantially the same as Series C Convertible Preferred Stock (“Series C Stock”).  As a condition to such sale, SoftBrands alsoexchanged 18,000 shares of its Series C Stock

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on a share forshare basis for 18,000 shares of Series C-1 Convertible Preferred Stock (“SeriesC-1 Stock”).  The Series C-1 Stock isidentical to the Series C Stock except with respect to its dividend rate, whichis 8% rather than the 6% payable on the Series C Stock.

**ITEM 2.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

*Thefollowing discussion of our financial condition and results of operationsshould be read together with the financial statements and related notes, whichare included elsewhere in this Form 10-Q. This discussion containsforward-looking statements based upon current expectations that involve risksand uncertainties. Our actual results may differ materially from those anticipatedin these forward-looking statements as a result of various factors, includingthose set forth in more detail in the “Forward-Looking Statements” sectionbelow. We undertake no obligation to update any information in ourforward-looking statements.*

**Business Overview**

SoftBrands,Inc. provides enterprise software and support solutions to approximately 4,000customers in more than 60 countries.  We are organized into two reportablesegments:  manufacturing and hospitality. Our manufacturing business designs,develops and sells enterprise resource planning software and services to smalland medium-sized manufacturing concerns.  Our principal products in thissegment include***FourthShift Edition for SAP Business One,***our newest product that is sold with SAP’s Business One product suiteto small and medium-sized manufacturers and to plants or divisions ofmultinational enterprises; ***FourthShift*****,** ourcore manufacturing enterprise software solution aimed at small-to mid-sizedmanufacturers;***evolution***,a software system designed to serve niche manufacturing markets that isparticularly suitable for ‘converter’ manufacturers; and***Demand Stream***, alean enterprise automation software system. Our hospitality business designs,develops and sells software and services that support the enterpriseinformation management needs of hotels and resorts.  Principal products inthe hospitality segment include***Medallion***, a Windows®-based property management systemdesigned primarily for independent hotels and hotel chains; and***PORTfolio***, acomprehensive client/server hotel system for both the front- and back-officeoperations of single-site and multi-property hotels. Because much of ouradministrative and support staff provides services to both segments, we alsoreport in this Management’s Discussion unallocated corporate expenses as partof a “Corporate” segment.

We deriverevenue in both of our manufacturing and hospitality segments through sale oflicenses to use our software products and through providing services required tomaintain our products, to install and implement our products, and in some casesto customize or create extensions for our products.  On occasion we alsosell hardware products of third-party vendors on a distribution basis for theconvenience of our customers and sell licenses to third-party softwareprograms.  Our software license revenue is heavily influenced by thetiming of customer purchases and installations and the terms under which wesell software licenses.  Our software maintenance revenue, which currentlyconstitutes a majority of our revenue, is derived primarily from one-yearcontracts that require payment at the beginning of the contract term and underwhich we recognize revenue ratably over the one-year contract period.  Ourother services revenue is normally recognized over the time services areperformed.

**Infra Acquisition**

Effective October 1, 2005, we acquired all of theoutstanding shares of Infra Business Solutions GmbH, a privately held Germansoftware company that is a reseller and development partner of SAP BusinessOne, for approximately $2.3 million. The purchase price consisted of cash pluswarrants to purchase 200,000 shares of our common stock. We assigned $343,000of the purchase price to the value of net tangible assets acquired, $1.4million to identifiable intangible assets, and $585,000 to goodwill. The fairmarket value of the identifiable intangible assets purchased included Infra’ssoftware product Infra:Net, a production planning system sold to small- tomedium-sized manufacturers in the German, Swiss and Austrian markets valued at$676,000, non-contractual customer relationships valued at $282,000, alicensing and royalty agreement valued at $25,000 and employment contractsvalued at $376,000.

**Sub****sequentevents**

As a result of theunacceptable trends with our current hospitality product line, not includingHIS, we reassessed the cost structure and took actions in July 2006 with theeffective reduction of 10% of the work force spread between sales, support anddevelopment.  These reductions areexpected to reduce annual operating expenses by approximately $1.7million.  Severance expenses ofapproximately $200,000 will be recorded in the quarter ending September 30,2006.

On August 14, 2006 we completed the acquisition of MAISystems Corporation (“MAI”), and its subsidiary Hotel Information Systems, Inc.(“HIS”), a leading provider of property management systems, for approximately $27.1million plus transaction costs.  Asubsidiary of SoftBrands was merged into MAI and all of outstanding capitalstock of MAI was converted into the right to receive cash and an interest in anescrow account.  Through this merger, MAIbecame a wholly-owned subsidiary of Softbrands.  We

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financed the transaction primarily through the issuance ofdebt.  Equity capital was also providedby our existing preferred shareholders.  Webelieve:

·                  HIS brings us new softwaresolutions that are based on .NET and Java technologies. HIS has invested inresearch and development over the last five years, developing products using Internettechnology, which makes them platform neutral, deployable in any geography andhighly scalable.

·                  HIS provides us with asignificant customer base that allows us to leverage our global distribution,professional services, and product support infrastructure.

·                  The addition of HIS productsallows us to serve a wider segment of the hotel market. Today, our Medallionproduct primarily appeals to independent hotels and groups. HIS serves hotelgroups and chains, in addition to large independent hotels.  We believe that moving into the chain andgroup segment will help improve profitability.

·                  HIS products offer amigration path to our hospitality customers with legacy systems. Our customersinterested in migrating from LANmark and IGS now have a better option formigration.

·                  HIS has a strong U.S. andAsian presence, while SoftBrands gets nearly half of its hospitality revenuefrom Europe.

As indicated above, we financed the HIS transaction withthe issuance of debt and equity.  The keyterms are as follows:

Debt – On August 14, 2006, we executed a Credit Agreementproviding $21 million used to finance the HIS acquisition under a term loanmaturing in seven years.  The principalamount of the term loan is repayable in 78 equal monthly installments,commencing March, 2007.  The CreditAgreement also provides for a revolving line of credit under which we mayborrow up to $9 million.  Borrowings bearinterest, payable monthly, ranging from 1.0% to 1.75% over the lenders’ primerate, or from 2.0% to 2.75% over the London interbank rate, depending on thelevel of earnings before interest, taxes depreciation and amortization for thetwelve months preceding the monthly calculation date.  We paid a $275,000 closing fee in connectionwith the Credit Agreement, $137,500 of which was paid upon execution of acommitment letter on July 28, 2006 and the remaining $137,500 was paid when theagreement was signed.  The revolvingcredit facility also carries a 0.25% unused line fee, a letter of credit feeequal to 2.5% per annum and servicing fees of $1,000 per month. Borrowingsunder the Credit Agreement are secured by all of our assets.

Preferred Stock - On August 14, 2006, we closed on the saleof 5,000 shares of its Series D Convertible Preferred Stock (“Series D Stock”)and warrants (the “Warrants”) to purchase 333,333 shares of common stock forgross sales proceeds of $5,000,000, which proceeds were used as partialconsideration for the MAI acquisition.  Anadditional 1,667 shares of Series D Stock and warrants to purchase 111,333shares of common stock for gross proceeds of $1,667,000 may be purchased bycertain current shareholders through September 4, 2006. The Series D Stockcarries an 8% dividend and converts to common at a price of approximately $1.67per share.  The warrants are priced at$1.84 per share. Other terms of the Series D Stock are substantially the sameas Series C Convertible Preferred Stock (“Series C Stock”).  As a condition to such sale, we alsoexchanged 18,000 shares of Series C Stock on a share for share basis for 18,000shares of Series C-1 Convertible Preferred Stock (“Series C-1 Stock”).  The Series C-1 Stock is identical to theSeries C Stock except with respect to its dividend rate, which is 8% rather forthe Series C-1 Stock rather than the 6% payable on the Series C Stock.

**CriticalAccounting Policies and Estimates**

The preparation ofthe financial information contained in this Form 10-Q requires our managementto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. Our management evaluates these estimates on an ongoing basis,including those related to revenue recognition, the valuation allowance fordeferred tax assets, the valuation of our accounts receivable, and thevaluation of our 

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intangible assets,including goodwill and the recording of restructuring charges. Except withrespect to changes in the manner in which we account for share basedcompensation, as discussed below, there have been no material changes to thecritical accounting policies as discussed in greater detail in the Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in our Form 10-K as filed with the SEC on December 20, 2005.

*Share-basedCompensation. During* the first quarter of 2006, we adoptedthe fair value method of accounting for share-based compensation using themodified prospective method of transition as outlined in Financial AccountingStandards Board Statement No. 123(R), *Share-Based Payment*(“SFAS No. 123(R)”). Under SFAS No. 123(R), the estimated fair value ofshare-based compensation, including stock options granted under our 2001 StockIncentive Plan, is recognized as compensation expense. The estimated fair valueof stock options is expensed on a straight-line basis over the vesting period.Prior to October 1, 2005, we accounted for share-based employee compensationplans using the intrinsic value method of accounting in accordance withAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees*(“APB 25”), and its related interpretations.Under the provisions of APB 25, no compensation expense was recognized whenstock options were granted with exercise prices equal to or greater than marketvalue on the date of grant. Under the modified prospective method of transitionthat we adopted, compensation expense is recognized beginning with theeffective date of adoption for all share-based payments (i) granted after theeffective date of adoption and (ii) granted prior to the effective date ofadoption and that remain unvested on the date of adoption. Under the modifiedprospective method of transition, we are not required to restate our priorperiod financial statements to reflect expensing of share-based compensationunder SFAS No. 123(R). Therefore the three and nine month results of June 30,2006 are not directly comparable to the same period in the prior year. UnderSFAS No. 123(R), we use the Black-Scholes pricing model to estimate the fairvalue of the share-based compensation as of the grant date. The Black-Scholesmodel by its design is highly complex, and dependent upon key data inputsestimated by management. The primary data input with the greatest degree ofsubjective judgment are the estimated lives of the share-based awards and theestimated volatility of our stock price. The Black-Scholes model is highlysensitive to changes in these two data inputs. Beginning in the fourth quarterof fiscal 2005, we calculated the 5-year estimated life of stock optionsgranted using the information and guidance from an analysis by an independentcompensation consultant. We based our estimate of expected volatility on dailyhistorical trading data of our common stock. We selected the historical method primarily because we have notidentified a more reliable or appropriate method to predict future volatility.See Note 2, Accounting for Share-based Compensation, to our financialstatements for more information about the adoption of SFAS No. 123(R).

**Resultsof Operations**

For the three monthsended June 30, 2006, we reported total revenue of $16.1 million and a net lossof $1.7 million, or $0.05 per share, compared to total revenue of $19.0 millionand a net income of $12.0 million, or $0.30 per share, for the same period in2005. Results for the quarter ended June 30, 2005 include the recognition of$1.2 million of one-time revenue, an equal amount of expenses in cost of goodssold and income from discontinued operations of $12.1 million, or $0.30 pershare from a $12.6 million distribution from the AremisSoft Liquidating Trustnet of income taxes.  The results for thequarter ended June 30, 2006 include $658,000 of share-based compensationexpense resulting from the adoption of SFAS No. 123(R) on October 1, 2005.  The decrease in interest expense was from theSenior Notes that were repaid in August 2005.

Forthe nine months ended June 30, 2006, we reported total revenue of $50.2 millionand a net loss of $3.3 million, or $0.10 per share, compared to total revenueof $53.7 million and a net income of $10.5 million, or $0.26 per share, for thesame period in 2005.  Results for thenine months ended June 30, 2005 include the recognition of $1.2 million ofone-time revenue,  an equal amount ofexpenses in cost of goods sold and income from discontinued operations of $12.1million, or $0.30 per share from a $12.6 million distribution from theAremisSoft Liquidating Trust net of income taxes.  Results for the nine months ended June 30,2006 includes $1.6 million of SFAS No. 123(R) share-based compensation expense,$395,000 in severance costs and an expense of $460,000 related to leaseobligations in the United Kingdom, partially offset by a $3.0 million decreasein interest expense.  New lease terms inthe United Kingdom will result in approximately a $480,000, or 49% decrease inannual rent expense for our Reading facility.

The following table summarizes revenue and operating results byreportable segment for the three and nine months ended June 30, 2006 and 2005:
| ** **    | ** ** | ** **                                          | ** ** | ** **             | ** ** |
|---------------|------------|-----------------------------------------------------|------------|------------------------|------------|
| ** **    | ** ** | **Three Months Ended June 30,** | ** ** | **% Change**      | ** ** |
| ** **    | ** ** | **2006**                                            | ** ** | **2005**               | ** ** | ** ** | ** ** | **Operating** | ** ** |
| ** **    | ** ** | ** **                                          | ** ** | **Operating**          | ** ** | ** ** | ** ** | **Operating** | ** ** | ** ** | ** ** | **Income** | ** ** |
| **Thousands** | ** ** | **Revenue**                                         | ** ** | **Income (Loss)** | ** ** | **Revenue** | ** ** | **Income (Loss)** | ** ** | **Revenue** | ** ** | **(Loss)** | ** ** |
| ** **    | ** ** | ** **                                          | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                   | 12,989     |                   | $          | 3,358 |   | $ | 13,097 |   | $ | 4,113 |   | (0.8 | )% | (18.4 | )% |
| Hospitality   |       | 3,138                                               |       | (747                   | )          | 5,898 |   | 336 |   | (46.8 | )% | (322.3 | )% |
| Corporate     |       |                                                |       | (4,528                 | )          |   |   | (3,839 | ) |   |   | 17.9 | % |
|          |       |                                                |       |                   |       |   |   |   |   |   |   |   |   |
| Total Company |       | $                                                   | 16,127     |                   | $          | (1,917 | ) | $ | 18,995 |   | $ | 610 |   | (15.1 | )% | (414.3 | )% |

 

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| ** **    | ** ** | **Nine Months Ended June 30,** | ** ** | ** **                        | ** ** |
|---------------|------------|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **    | ** ** | **2006**                                           | ** ** | **2005**                          | ** ** | **% Change** | ** ** |
| **Thousands** | ** ** | **Revenue**                                        | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                  | 38,631     |                              | $          | 10,764 |   | $ | 37,469 |   | $ | 10,481 |   | 3.1 | % | 2.7 | % |
| Hospitality   |       | 11,614                                             |       | 48                                |       | 16,189 |   | 2,267 |   | (28.3 | )% | (97.9 | )% |
| Corporate     |       |                                               |       | (14,876                           | )          |   |   | (11,571 | ) |   |   | 28.6 | % |
|          |       |                                               |       |                              |       |   |   |   |   |   |   |   |   |
| Total Company |       | $                                                  | 50,245     |                              | $          | (4,064 | ) | $ | 53,658 |   | $ | 1,177 |   | (6.4 | )% | (445.3 | )% |

 

Total revenue forthe three months ended June 30, 2006 was $2.9 million lower as compared to thethree months ended June 30, 2005. This reflects a 0.8% decrease formanufacturing and a 46.8% decrease for hospitality. See below for a moredetailed discussion of changes in revenue by reportable segment, revenue typeand geography. Operating income in the manufacturing group decreased by 18.4%in the three months ended June 30, 2006 compared to the 2005 period, primarilydue to additional development, marketing and sales efforts of Fourth ShiftEdition for SAP Business One.  Operatingincome in the hospitality group decreased significantly in the three monthsended June 30, 2006 compared to the prior year, primarily because of lowerrevenue combined with higher development costs to enhance productfunctionality.  The corporate group lossincreased by 17.9% in the three months ended June 30, 2006, due in large partto share based compensation expenses and increased marketing efforts.

Total revenuedecreased 6.4% in the nine months ended June 30, 2006 compared to the ninemonths ended June 30, 2005. This reflects a 3.1% increase in manufacturinggroup revenue offset by a 28.3% decrease in hospitality group revenue. Seebelow for a more detailed discussion of changes in revenue by reportablesegment, revenue type and geography. Operating income in the nine months endedJune 30, 2006 in the manufacturing group increased by 2.7%, primarily throughthe revenue increase. Operating income in the hospitality group decreased 97.9%in the nine months ended June 30, 2006 primarily because of decliningmaintenance revenue. As indicated above, headcount reductions were takensubsequent to the quarter ended June 30, 2006 to reduce operating losses.  In addition, the acquisition of HIS on August14, 2006 will provide additional volume and new growth opportunities.  The corporate group loss increased by 28.6%,due in large part to share based compensation expenses, severance charges andincreased marketing efforts.

**Revenue.**The following table summarizes revenue by reportable segment, revenuetype and geography for the threeand nine months ended June 30, 2006 and 2005:
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|-----------------|------------|-------------------|------------|-------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**                                   | ** ** | **Hospitality** | ** ** | **Total**         | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                                |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 | ** ** | ** **                                          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                  |       | $                                                   | 1,418      |            | $          | 235               |       | $                 | 1,653      |   | $ | 2,169 |   | $ | 947 |   | $ | 3,116 |   | (34.6 | )% | (75.2 | )% | (47.0 | )% |
| Maintenance and  support           |       | 8,075                                               |       | 2,405           |       | 10,480            |       | 7,724             |       | 3,199 |   | 10,923 |   | 4.5 | % | (24.8 | )% | (4.1 | )% |
| Professional  services             |       | 3,023                                               |       | 498             |       | 3,521             |       | 2,831             |       | 795 |   | 3,626 |   | 6.8 | % | (37.4 | )% | (2.9 | )% |
| Third-party  software and hardware |       | 473                                                 |       |            |       | 473               |       | 373               |       | 957 |   | 1,330 |   | 26.8 | % | (100.0 | )% | (64.4 | )% |
|                               |       | $                                                   | 12,989     |            | $          | 3,138             |       | $                 | 16,127     |   | $ | 13,097 |   | $ | 5,898 |   | $ | 18,995 |   | (0.8 | )% | (46.8 | )% | (15.1 | )% |
|                               |       |                                                |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     | ** ** | ** **                                          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                           |       | $                                                   | 7,525      |            | $          | 1,385             |       | $                 | 8,910      |   | $ | 8,035 |   | $ | 1,705 |   | $ | 9,740 |   | (6.3 | )% | (18.8 | )% | (8.5 | )% |
| Europe, Middle  East & Africa  |       | 3,656                                               |       | 1,357           |       | 5,013             |       | 3,305             |       | 3,612 |   | 6,917 |   | 10.6 | % | (62.4 | )% | (27.5 | )% |
| Asia Pacific                       |       | 1,808                                               |       | 396             |       | 2,204             |       | 1,757             |       | 581 |   | 2,338 |   | 2.9 | % | (31.8 | )% | (5.7 | )% |
|                               |       | $                                                   | 12,989     |            | $          | 3,138             |       | $                 | 16,127     |   | $ | 13,097 |   | $ | 5,898 |   | $ | 18,995 |   | (0.8 | )% | (46.8 | )% | (15.1 | )% |

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| ** **                         | ** ** | **Nine Months Ended June 30,** | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|-----------------|------------|-------------------|------------|-------------------|------------|
| ** **                         | ** ** | **2006**                                           | ** ** | **2005**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**                                  | ** ** | **Hospitality** | ** ** | **Total**         | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                               |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 | ** ** | ** **                                         | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                  |       | $                                                  | 5,123      |            | $          | 1,448             |       | $                 | 6,571      |   | $ | 5,609 |   | $ | 2,287 |   | $ | 7,896 |   | (8.7 | )% | (36.7 | )% | (16.8 | )% |
| Maintenance and  support           |       | 23,756                                             |       | 7,691           |       | 31,447            |       | 22,991            |       | 10,060 |   | 33,051 |   | 3.3 | % | (23.5 | )% | (4.9 | )% |
| Professional  services             |       | 8,730                                              |       | 1,853           |       | 10,583            |       | 7,871             |       | 2,184 |   | 10,055 |   | 10.9 | % | (15.2 | )% | 5.3 | % |
| Third-party  software and hardware |       | 1,022                                              |       | 622             |       | 1,644             |       | 998               |       | 1,658 |   | 2,656 |   | 2.4 | % | (62.5 | )% | (38.1 | )% |
|                               |       | $                                                  | 38,631     |            | $          | 11,614            |       | $                 | 50,245     |   | $ | 37,469 |   | $ | 16,189 |   | $ | 53,658 |   | 3.1 | % | (28.3 | )% | (6.4 | )% |
|                               |       |                                               |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     | ** ** | ** **                                         | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                           |       | $                                                  | 22,451     |            | $          | 4,516             |       | $                 | 26,967     |   | $ | 22,977 |   | $ | 5,801 |   | $ | 28,778 |   | (2.3 | )% | (22.2 | )% | (6.3 | )% |
| Europe, Middle  East & Africa  |       | 10,868                                             |       | 5,507           |       | 16,375            |       | 9,437             |       | 8,502 |   | 17,939 |   | 15.2 | % | (35.2 | )% | (8.7 | )% |
| Asia Pacific                       |       | 5,312                                              |       | 1,591           |       | 6,903             |       | 5,055             |       | 1,886 |   | 6,941 |   | 5.1 | % | (15.6 | )% | (0.5 | )% |
|                               |       | $                                                  | 38,631     |            | $          | 11,614            |       | $                 | 50,245     |   | $ | 37,469 |   | $ | 16,189 |   | $ | 53,658 |   | 3.1 | % | (28.3 | )% | (6.4 | )% |

*Manufacturing segment:*  Total manufacturing revenue decreased by$0.1 million or 0.8% for the three months ended June 30, 2006 compared tothe three months ended June 30, 2005, and increased $1.2 million or 3.1% in thenine months ended June 30, 2006 compared to the same period in 2005. License revenuedecreased 34.6% in the three months ended and 8.7% in the nine months endedJune 30, 2006 in manufacturing as a result of a number of factors includinglower sales of Fourth Shift and the prior year recognition of initial sales ofFourth Shift Edition for SAP Business One upon the general release in April2005.  Maintenance revenues inmanufacturing increased 4.5 % in the quarter and 3.3% in the nine months endedJune 30, 2006 as we continue to experience high retention rates on maintenancerenewals and the generation of support revenue from additional serviceofferings. These services include remote system administration, and businessprocess management. Professional services revenue increased 6.8% during thequarter and 10.9% during the nine months ended June 30, 2006, primarily due toincreased consultant utilization strong performance in the business processmanagement services and new revenue from our October 2005 acquisition of Infrain Germany.

Geographically, wegenerated organic license and maintenance growth and increased revenue fromevolution sales in Europe, Middle East & Africa (“EMEA”) region and fromthe Infra acquisition. Our license and maintenance revenue from the AsiaPacific region increased as the strength of the Chinese economy continues andour customers demand increased for product and services. The Americas regionwas aided during the second quarter by the strong maintenance and supportrevenue offset by lower Fourth Shift license revenue.

Operationally, we havebeen positioning the manufacturing business for growth with our SAP-centricproduct while maintaining our Fourth Shift customer base.  There are three pillars of our strategy inmanufacturing; the SAP channel, the B1 Large business and our base Fourth Shiftbusiness.  We continue the transition ofFSE sales from a direct sales to a channel sales model. Over time, thisstrategy is expected to enable greater volume for FSE sales to small andmedium-sized businesses.  At June 30,2006 we had 12 partners in the U.S. selling Fourth Shift Edition in themanufacturing space.  We are now workingon enabling these partners.  Oneparticularly noteworthy event is that RSM McGladrey (“RSMI”) added Fourth ShiftEdition for SAP Business One to its Technology Consulting product line.  RSMI will represent Fourth Shift Edition asits manufacturing ERP system of choice for manufacturing clients in themid-market.  For larger accounts, we havebeen in discussions with several large SAP customers to serve as theirmanufacturing plant solution in their distributed geographic regions. We callthis our B1 Large strategy.  In July2006, we signed a global, multi-year agreement with a multinational foodcompany to supply the Fourth Shift Edition for SAP Business One solution to plantswithin its many operating divisions. The majority of the license revenue impactfrom this agreement will likely occur in fiscal 2007 and beyond, although we doexpect some license revenue impact in the fourth quarter of this fiscal year.  We are currently implementing the first sitefor this customer. Our expectation is to roll out between 50 to 100manufacturing sites for this division over the next three to four years.  This global agreement has potential to serveother divisions of this customer. Additionally, we announced that we had formedan alliance with The Information Management Group — or IMG — Americas — to sellFourth Shift Edition for SAP Business One to large SAP accounts. IMG is astrategic systems integrator for SAP B1 large and is known for being the “go to”for global SAP Business One implementations. We expect the partnership to help drive international sales andimplementations of Fourth Shift Edition.

*Hospitalitysegment:*  Totalhospitality segment revenue decreased by $2.8 million or 46.8% in the threemonths ended June 30, 2006, compared to the prior year and decreased $4.6million or 28.3% in the nine-month period. The revenue decrease was driven byreduced maintenance revenue and because the fiscal 2005 period includes $502,000combined license and professional services revenue from a large customdevelopment project that did not recur in the fiscal 2006 period. Licenserevenue decreased $712,000 or 75.2% in the three months ended June 30, 2006over June 30, 2005 and $839,000 or 36.7% in the nine months ended June 30, 2006over the same period in 2005. License revenue was higher in the priornine-month

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period in partbecause of $275,000 recorded from the custom project mentioned above.  The average site license revenue is lowerthan historically realized due to a high mix of sales to smaller hotels. Ourdeal volume was much higher but the average size was less due to sales tosmaller hotels.  The 23.5% decrease inhospitality maintenance revenue was primarily due to continued attritionrelated to legacy systems that are being phased out by customers. Although weplan to partially offset this attrition with revenue from maintenance of newlysold Medallion and Portfolio products, our installed base of those products isnot to the level necessary to compensate for the attrition. Provided we aresuccessful in meeting our new account sales objectives, we expect relativelyflat hospitality maintenance revenue for the remainder of the year.  Third party hardware and software revenue isunusually small due to revenue recognition and delays in customerimplementation schedules.

Geographically, weprovide maintenance services on legacy products primarily in the EMEA andAmericas regions, and our operations in those regions have thereforeexperienced the largest decreases in hospitality maintenance revenue.

As highlighted earlier,we acquired Hotel Information Systems in August 2006.  This acquisition provides added products innew markets and an opportunity to more efficiently utilize our customer supportcenters.  With this acquisition weanticipate a revitalized hospitality business that is focused on two distinctareas: serving group and chain hotels with the new epitome and core products;and serving independent hotels with our existing Medallion product. 

**Gross Margin.**The following table summarizes gross profit as a percentage of revenue,or gross margin percentages, by reportable segment and revenue type for the three and nine months ended June 30,2006 and 2005:
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Manufacturing**                                   | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | 60.2                                                | %          | 91.5 | % | 64.6 | % | 55.3 | % | 57.0 | % | 55.8 | % |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance and support            |       | 76.2                                                | %          | 40.7 | % | 68.0 | % | 77.4 | % | 42.8 | % | 67.3 | % |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Professional services              |       | 14.3                                                | %          | (7.4 | )% | 11.2 | % | 27.7 | % | 9.7 | % | 23.7 | % |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Third-party software  and hardware |       | 24.5                                                | %          | — |   | 25.8 | % | 29.8 | % | 6.5 | % | 13.0 | % |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **58.1**                                            | **%**      | **37.0** | **%** | **54.0** | **%** | **61.7** | **%** | **34.7** | **%** | **53.3** | **%** |

 
| ** **                         | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Manufacturing**                                  | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | 53.3                                               | %          | 92.5 | % | 61.9 | % | 52.0 | % | 60.9 | % | 54.6 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance and support            |       | 76.4                                               | %          | 44.3 | % | 68.5 | % | 77.1 | % | 47.2 | % | 68.0 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Professional services              |       | 11.2                                               | %          | 12.3 | % | 11.4 | % | 22.0 | % | 16.7 | % | 20.8 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Third-party software  and hardware |       | 21.1                                               | %          | 48.6 | % | 31.5 | % | 28.4 | % | 23.3 | % | 25.2 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **57.1**                                           | **%**      | **45.4** | **%** | **54.4** | **%** | **60.4** | **%** | **42.6** | **%** | **55.1** | **%** |

Overall gross margin percentage increased to 54.0% inthe third quarter of 2006 from 53.3% in the third quarter of 2005 due togreater mix of higher margin manufacturing revenue..

The manufacturingsegment’s software license gross margin percentage improved to 60.2% during thethree months ended June 30, 2006 from 55.3% during the three months ended June30, 2005. Cost of license revenue consists of amortization of acquiredsoftware, the amortization of capitalized costs for internally developedsoftware, and the cost of third-party software embedded in some of ourproducts. The improved margin in the third quarter of 2006 reflects fullamortization of some of the acquired Fourth Shift software asset.  Excluding any effect from new acquisitions,amortization expense will continue to 

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decline as assetsassociated with Fourth Shift become fully amortized.  Decreases in amortization is expected toreduce costs by $267,000 for the three months ending September 30, 2006,compared to the three months ended June 30, 2006. This reduction in expensewill be offset by additional royalty expense as sales of Fourth Shift for SAPBusiness One increase as percentage of overall license revenue. Royalty coststo third parties can fluctuate depending on product mix. 

The manufacturingsegment’s maintenance gross margin percentage also remained stable as we sawless revenue in the Americas region, but an increase in both the EMEA and APACregions. Management changes in our manufacturing professional servicesorganization and low utilization rates resulted in lower professional servicesmargin in both the three and nine month periods ended June 30, 2006 comparedwith comparable periods in 2005. Manufacturing third-party software and hardware gross margins decreasedfor both the three and nine month periods due to a change in product mix.

The decline inhospitality maintenance gross margin percentage is due to a large decline inmaintenance revenue which was not offset by a similar decline in related costs.Although our cost of providing hospitality maintenance has declined since wecompleted the move of hospitality maintenance services to the facility inBangalore, India we had previously established for manufacturing softwaremaintenance, the $403,000 decrease in cost during the three months ended June30, 2006, did not fully compensate for the even larger revenue decline. Thehospitality world-wide support center has grown from 28 people in June 2005 to42 people in June 2006.

**OperatingExpenses.**Thefollowing table summarizes operating expenses for the three and nine monthsended June 30, 2006 and 2005:
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | ** **                        | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2006**                                            | ** ** | **2005**                          | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                                          | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                        | ** ** | ** **                                          | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative       |       | $                                                   | 4,563      |                              | 28.3       | % | $ | 4,521 |   | 23.8 | % | 0.9 | % |
| Selling and  marketing            |       | 3,399                                               |       | 21.1                              | %          | 2,779 |   | 14.6 | % | 22.3 | % |
| Research and  product development |       | 2,670                                               |       | 16.6                              | %          | 2,213 |   | 11.7 | % | 20.7 | % |
| Total operating  expenses         |       | $                                                   | 10,632     |                              | 65.9       | % | $ | 9,513 |   | 50.1 | % | 11.8 | % |

 
| ** **                        | ** ** | **Nine Months Ended June 30,** | ** ** | ** **                        | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2006**                                           | ** ** | **2005**                          | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                                         | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                        | ** ** | ** **                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative       |       | $                                                  | 14,392     |                              | 28.6       | % | $ | 14,434 |   | 26.9 | % | (0.3 | )% |
| Selling and  marketing            |       | 9,356                                              |       | 18.6                              | %          | 7,948 |   | 14.9 | % | 17.7 | % |
| Research and  product development |       | 7,662                                              |       | 15.2                              | %          | 6,242 |   | 11.6 | % | 22.7 | % |
| Restructuring  related charges    |       | —                                             |       | 0.0                               | %          | (261 | ) | (0.5 | )% | (100.0 | )% |
| Total operating  expenses         |       | $                                                  | 31,410     |                              | 62.5       | % | $ | 28,363 |   | 52.9 | % | 10.7 | % |

Operating expenses for the quarter ended June 30, 2006increased $1.1 million or 11.8% compared to the quarter ended June 30, 2005.For the nine-month period ended June 30, 2006, operating expenses increased$3.0 million or 10.7% over the comparable period in the prior year.

In June 2006, weamended the terms of our Executive Chairman agreement terminating his executiveterm.  He remains as Chairman of theBoard.  This change will generate futurenet annual savings in excess of $400,000 in compensation and administrativecosts.  General and administrativeexpenses in the quarter ending June 30, 2006 includes $98,000 of rent accrualand $299,000 for accelerated vesting of stock options related to the revisionof terms with our Executive Chairman. General and administrative expenses inthe nine months ended June 30, 2006 includes approximately $458,000 ofprofessional fees associated with the internal control documentation projectundertaken to comply with Section 404 provisions of the Sarbanes-Oxley Act of2002 compared with approximately $1.2 million incurred in 2005. The provisionsof Section 404 do not currently apply to the Company for fiscal 2006.  General and administrative expenses in thenine months ended June 30, 2006 are higher than expenses in the prior year dueto the inclusion of $1,593,000 of stock compensation expense, $340,000 ofseverance related charges, and $346,000 related to terminating a lease obligationin the U.K. in June 2006.  The new leasein the U.K. will generate savings of approximately $480,000 per year comparedto previous lease terms.

We expanded oursales force, stepped up demand generation activities, increased businessdevelopment efforts to support strategic partnerships, and expanded corporatecommunications in 2006. These factors and the addition of Infra in Germany,resulted in an increase in selling and marketing expense of 22.3% in the threemonths and 17.7% in the nine months ended 

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June 30, 2006. 

Research andproduct development expense was higher in both the three and nine months endedJune 30, 2006, in large part because of expenses from the recently acquiredInfra Business, a proof of concept project in our manufacturing segment, andcontinued efforts to expand functionality of manufacturing and hospitalityproducts.  Research and developmentexpenses for manufacturing were 13.0% of manufacturing revenue for the ninemonths ended June 30, 2006 compared with 11.1% for the same period inFiscal 2005. The increase is primarily due to development of Fourth ShiftEdition for SAP Business One and Infra expenses. Research and developmentexpenses for hospitality were 19.2% of hospitality revenue for the nine monthsended June 30, 2006 compared with 12.0% for the same period in 2005.  The increased spending was for development ofMedallion.

In March 2005, wesuccessfully negotiated an early termination of our lease in Woking, UK.  In exchange for release of all futureobligations on this lease, we made a final payment of approximately$500,000.  Following this payment, wereversed the remaining liability from our accounts, which resulted in a$180,000 credit to restructuring expense. In addition, during the three months ended June 30, 2005, we reversed$81,000 of severance-related restructuring accrual due to lower than expectedseverance costs.

**Non-OperatingItems and other.**Thefollowing table summarizes non-operating income and expenses for the quartersended June 30, 2006 and 2005, as well as our tax provision and discontinuedoperations:
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **June 30,**                | ** ** | **June 30,**               | ** ** |
| **Thousands**                                    | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                 |       | $                                | 3          |                            | $          | 1,021 |   | $ | 9 |   | $ | 3,046 |   |
| Other income,  net                               |       | 189                              |       | 111                             |       | 362 |   | 298 |   |
| Provision for  (benefit from) income taxes       |       | 8                                |       | (251                            | )          | 13 |   | 39 |   |
| Income from  discontinued operations, net of tax |       | 5                                |       | 12,083                          |       | $ | 393 |   | 12,083 |   |
|                                                  |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

Interest expense incurred in 2005 was related tolong-term institutional debt which was repaid in August 2005. It included cashinterest expense, amortization of capitalized financing costs and debtaccretion of an original issue discount.

Other income, net,primarily consists of interest income and the effect of changes in foreignexchange rates on intercompany payables denominated in U.S. dollars. Of the$362,000 of other income, net, reflected on our consolidated statement ofoperations for the nine months ended June 30, 2006; approximately $152,000 wasdue to the impact of the weakening of foreign currencies against the U.S.dollar. We also recorded interest income of $242,000 and other expenses of$32,000. We do not currently utilize any derivative security instruments orengage in any hedging activities.

In accordance withthe bankruptcy and reorganization plan of AremisSoft Corporation, our formerparent, we retained a 10% interest in the net collections by the LiquidatingTrust established to pursue litigation claims and collection of assetsremaining in AremisSoft after bankruptcy. In June 2005, the Company received a distribution in the amount of $12.6million from the Liquidating Trust that was recorded net of tax of $558,000 asincome from discontinued operations. Additionally, after we had separated from the Parent Company, wemaintained an obligation in accrued expenses in our ledger. Reversal of thisaccrual in the first quarter of fiscal 2006 generated income from discontinuedoperations of $393,000, net of income taxes during the nine months ended June30, 2006.  

We recognized atax benefit in continuing operations in the three and nine months ended June30, 2006 to the extent that income from discontinued operations has been offsetby current period losses from continuing operations. The benefit is stated netof amounts for our estimated domestic state and international tax liabilities.Our tax provision fluctuates due to the mix of forecasted results betweendomestic operations and our international subsidiaries. Also, we have notrecorded certain income tax benefits in either of the periods presented due tocontinued uncertainty regarding our ability to realize our deferred tax assets.

# **Liquidityand Capital Resources**

# As of June 30, 2006, we had $12.7 million of cash and cash equivalentsand $600,000 of restricted cash. Our working capital deficit (current assetsless current liabilities), increased to $4.1 million at June 30, 2006 from $2.6million at September 30, 2005. This increase in working capital deficit is dueto a $3.3 million decrease in cash and cash equivalents and a $1.6 millionincrease in deferred revenue Deferred revenue was $17.0 million at June 30,2006, compared with $15.4 million at September 30, 2005. Deferred maintenancerevenues comprise the majority of our deferred revenues and our cost to performthese revenues has recently been between 30% and 35% of total maintenancerevenue. 

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# **Cash Flows fromOperating Activities.** We generated $323,000 of cash fromoperating activities in the nine months ended June 30, 2006 compared to $12.4million for the nine months ended June 30, 2005.  This decrease is primarily due to the trustdistribution included in the 2005 cash provided by discontinuedoperations.  Cash from continuingoperations in the nine month period ended June 30, 2006 increased $317,000 to $323,000from the $6,000 of cash generated in operating activities from the comparableperiod a year ago. This change is primarily due to improved operating incomeafter giving affect for changes in non-cash items, such as share-basedcompensation, and improved collections on maintenance billings.

# We had $5.3 million of non-cash expenses in the nine months ended June30, 2006, which included $3.8 million of depreciation and amortization and $1.6million of share-based compensation. This compares to non-cash expenses of $4.5million in the prior year, including $4.3 million of depreciation andamortization, $884,000 for non-cash interest, and $132,000 from provision fordoubtful accounts with offsets of $221,000 for foreign currency transactiongains, $261,000 for restructuring and $322,000 for income tax benefit.

# We used $1.3 million of cash in the nine months ended June 30, 2006 ascompared to a $2.9 million use in the prior year to fund changes in operatingassets and liabilities. The most significant cash flow changes in the currentyear to the $1.5 million in cash we generated in the nine months ended June 30,2006 from deferred revenue, compared with $180,000 in cash used in deferredrevenue in the nine months ended June 30, 2005. We used $1.3 million ofcash to reduce accounts payable and accrued expenses in the nine months endedJune 30, 2006, as compared to a usage of $1.0 million in the same periodof the previous year.

# **Cash Flows fromInvesting Activities.****We used $2.8million of cash in investing activities during the nine months ended June 30,2006 and $703,000 for the nine months ended June 30, 2005. We paidapproximately $1.9 million for an acquisition and approximately $928,000 toupgrade and replace some of our internal computer hardware and other equipmentduring the nine months ended June 30, 2006. We expect investing activities inthe remainder of fiscal 2006 to consist primarily of internal technology andsystem upgrades.

# **Cash Flows fromFinancing Activities.** We used $856,000 of cash in financingactivities in the nine months ended June 30, 2006 and $338,000 in the ninemonths ended June 30, 2005. The cash that was applied during the nine monthsended June 30, 2006, primarily related to payments for debt incurred inconnection with acquisitions, as well as $951,000 in payments of preferredstock dividends, offset by $331,000 of proceeds on issuance of common stock.

# **Commitments and Capital Adequacy.** As of June 30, 2006, our primarycommitments are for leased office space in Minneapolis, Minnesota; Wichita,Kansas; Reading, England; Tianjin, China; and Sydney, Australia.

# We believe that cash flows from operations, expected to improve with2006 results, together with our cash and cash equivalents, will be sufficientto meet our commitments and our cash requirements for at least the next twelvemonths.

**Forward-LookingStatements**

Our Form 10-Q contains anumber of statements about our future operations. We make statements regardinganticipated product introductions, changes in markets, customers and customerorder rates, expenditures in research and development, growth in revenue,taxation levels, the effects of pricing, and the growth in our foreignoperations, all of which represent our expectations and beliefs about futureevents. In some cases, you can identify forward-looking statements byterminology such as “may,” “will,” “should,” “could,” “expect,” “intend,”“plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue”or similar words and expressions. These statements are only predictions andinvolve known and unknown risks, uncertainties and other factors that may causeour or our industry’s actual results, level of activity, performance orachievements to be materially different from those expressed or implied bythese forward-looking statements. The factors that may cause our operations tovary materially from those contemplated by our forward-looking statements aredescribed in detail in our Form 10-K dated December 20, 2005, and include:

·                  Economicand market conditions.

·                  Downturnsin the hospitality or manufacturing markets.

·                  Ourincreasing dependence upon our relationship with SAP.

·                  Thedifficulty encountered in generating significant new software license sales inmature markets.

·                  Increasingdependence on products that are not currently widely accepted and that wecannot be certain will be widely accepted.

22

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·                  Therisks related to our substantial international operations and sales.

·                  Theunpredictability of our operating results because of the sales cycle of ourproducts.

·                  Theneed to continue to develop new products and enhance our current products inresponse to technological changes and competing products.

·                  Thedependence of our revenue on renewal of maintenance agreements by ourcustomers.

·                  Thepossibility that we may not be able to recognize revenue when we deliverproducts.

·                  Theeffect of our anti-takeover defenses on possible acquisition proposals.

·                  Thegreater size and brand recognition of a number of our competitors.

·                  Theeffect of a change, effective for periods beginning after October 1, 2005, inaccounting for stock options and other share based benefits on our reportedoperating results.

·                  Ourdependence on third-party vendors for some of the software technology used inour products.

·                  Ourpotential exposure to intellectual property disputes.

·                  Ourdependence on current management.

·                  Ourprevious status and association as a subsidiary of AremisSoft Corporation.

·                  Ourability to maintain an effective system of internal controls.

·                  Ourability to raise capital with acceptable pricing and terms should we choose todo so.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

There were nomaterial changes in market risk for the Company in the period covered by thisreport. See the Company’s Form 10-K as filed with the SEC on December 20, 2005,for a discussion of market risk for the Company.

**ITEM 4. CONTROLS AND PROCEDURES**

*Evaluationof Disclosure Controls and Procedures.*  As required byRule 13a-15(b) under the Securities Exchange Act of 1934, as amended,we conducted an evaluation under the supervision and with the participation ofour management, including the Chief Executive Officer and the Chief FinancialOfficer, of the effectiveness of our disclosure controls and procedures as ofthe end of the period covered by this report.  Based on that evaluationand because of the material weaknesses in internal control over financialreporting discussed below, the Chief Executive Officer and the Chief FinancialOfficer concluded that our disclosure controls and procedures were noteffective in ensuring that all information required to be disclosed in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SECrules and forms and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, in a manner that allows timely decisions regarding requireddisclosure.  Notwithstanding the material weaknesses discussed below, theCompany’s management has concluded that the financial statements included inthis Form 10-Q fairly present in all material respects the Company’sfinancial position, results of operations and cash flows for the periodspresented in conformity with generally accepted accounting principles.

*Changesin Internal Control over Financial Reporting.*  Except asnoted below, there were no changes in our internal control over financialreporting that occurred during the quarter ended June 30, 2006 that materiallyaffected, or that are reasonably likely to materially affect, our internalcontrol over financial reporting. 

Although we havenot yet been required to assess and report on the effectiveness of our internalcontrol over financial reporting, we have concluded that we did not maintaineffective internal controls over accounting for income taxes required underSFAS No. 109.  Specifically, we did not maintain effective controlsto ensure that the tax accounting was accurately presented for unique transactionsand situations or that the related tax accounting was appropriately reviewed toensure compliance with generally accepted accounting principles.  Thiscontrol deficiency resulted in the restatement of our interim and annualconsolidated financial 

23

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statements for theyear ended September 30, 2004, and the interim consolidated financialstatements during fiscal year 2005 (the quarters ended December 31, 2004and March 31, 2005).  This control deficiency could result in amisstatement to the tax provision and related tax accounts and disclosures inthe financial statements that would result in a material misstatement in theannual or interim financial statements that would not be prevented ordetected.  Accordingly, management determined that this control deficiencyrepresents a material weakness in internal control over financial reporting asof June 30, 2006.

We did notmaintain effective controls over the period-end and financial reporting processto ensure that our June 30, 2005 Form 10-Q was originally filed accurately. Specifically, in our rushed attempt to correct the income tax accounting for2004 by the filing deadline in the context of the aforementioned controldeficiency we filed our June 30, 2005 Form 10-Q prior to completionof the usual review controls and procedures.  The Form 10-Q asoriginally filed contained errors in the cash flow statement, the restatementfootnote and MD&A sections regarding the restatement.  This controldeficiency resulted in the need to amend our June 30, 2005Form 10-Q.  This control deficiency could result in a misstatement tothe aforementioned disclosures in the financial statements that would result ina material misstatement in the annual or interim financial statements thatwould not be prevented or detected.  Accordingly, management determinedthat this control deficiency represents a material weakness in internal controlover financial reporting as of June 30, 2006.

The tax accountingrestatement and restatement of the June 30, 2005 Form 10-Q had noimpact on net loss, net cash provided by operating activities and totalstockholders’ equity as previously reported for the fiscal years endedSeptember 30, 2004 or 2005.

*Plansfor Remediation.*  In response, we implemented a morein-depth and comprehensive process to account for income taxes and brought inexternal resources with greater taxation expertise in order to remediate thematerial weakness discussed above. To further improve our internal control overfinancial reporting; we continue to:****

·                  conductadditional research

·                  increaseour internal knowledge base with expanded training and education

·                  reviewunique and specialized transactions on a contemporaneous basis

·                  addan additional level of management personnel to the review process

·                  establisha formal technical accounting review process.  The review process givesspecific consideration to accounting and income tax implications of significantdiscrete period non-routine transactions, such as, but not limited to,acquisitions of businesses or assets or dispositions of businesses or assets. 

By implementingthese internal control improvements, we fully expect to remediate our materialweaknesses in internal control over financial reporting by the end of ourfiscal year 2006.  

Internal controlover financial reporting, no matter how well designed, has inherentlimitations.  Therefore, even those systems determined to be effective canprovide only reasonable assurance with respect to financial statementpreparation and presentation.  We will continue to improve the design andeffectiveness of our disclosure controls and procedures and internal controlover financial reporting to the extent necessary in the future to provide oursenior management with timely access to such material information, and tocorrect any deficiencies that we may discover in the future.

**PART II. OTHER INFORMATION**

**Item 1—Legal Proceedings**

We areperiodically engaged in litigation in the ordinary course of business,including litigation seeking return of software licensing and servicing fees.We do not believe that any of such litigation is material to our ongoingoperations.

**Item 1A—RiskFactors**

Reference is made to the factors set forth under the caption “ForwardLooking Statements” on pages 3 to 6 of our Annual Report on Form 10-K and tothe summary of those factors set forth under the sub caption “Forward LookingStatements” of Part 1, Item 2 of this Form 10-Q, which are incorporated hereinby reference.

**Item 2—Unregistered Sales of Equity Securities and Use ofProceeds**.

Not applicable.

**Item 3—Default Upon Senior Securities**

24

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Not applicable.

**Item 4—Submission of Matters to a Vote of Security Holders**

We held our annualmeeting of stockholders at 3:00 p.m. on Thursday, May 4, 2006. Stockholdersholding 48,066,517 shares, or approximately 89.93% of the outstanding stockentitled to vote, were represented at the meeting by proxy or in person. Although we originally solicited proxies for three matters to be considered bystockholders at the annual meeting, we withdrew one matter (consideration of anevergreen feature for our 2001 Stock Incentive Plan) prior to the date of themeeting. Two matters were submitted for consideration by stockholders at themeeting: (1) the election of two Class I directors to hold office until theannual meeting in 2009; and (2) a proposal to amend the SoftBrands, Inc. 2001Stock Incentive Plan to increase the number of shares of common stock reservedfor issuance under the plan by 1,500,000 shares.

1. Election of Class IDirectors. The following nominees were elected as members of the Board ofDirectors as Class III Directors until the annual meeting of shareholders in2008 or until such time as a successor may be elected:
| Name                 | ** ** | **Shares Voted For** | ** ** | **Authority Withheld** | ** ** |
|----------------------|------------|--------------------------------|------------|-----------------------------|------------|
| Randal B.  Tofteland |       | 47,446,258                     |       | 620,259                     |       |
|                 |       |                           |       |                        |       |
| Elaine Wetmore       |       | 47,276,547                     |       | 789,970                     |       |

 

2. Amendment to IncreaseShares under 2001 Incentive Stock Plan. Our stockholders approved an amendmentto our 2001 Stock Incentive Plan to increase the number of shares of commonstock available for issuance under that plan by a vote of 20,740,080 shares infavor, 10,693,125 shares against, 13,333 shares abstaining, and 16,619,979broker non-votes.

**Item 5—Other Information**

Not applicable.

**Item6—Exhibits**

31.1                           Certification Pursuant to Section 302 of the Sarbanes-OxleyAct – Randal B. Tofteland.

31.2                           Certification Pursuant to Section 302 of theSarbanes-Oxley Act – Gregg A Waldon.

32                                    CertificationPursuant to Section 906 of the Sarbanes-OxleyAct of 2002

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| Date: August 14 , 2006 |             |                                                            |   |
|------------------------|------------------|-----------------------------------------------------------------|--------|
|                   |             |                                                            |   |
|                   | SoftBrands, Inc. |                                                            |   |
|                   |             |                                                            |   |
|                   | By:              | /s/ Gregg A. Waldon                                             |   |   |   |
|                   |             | Gregg A. Waldon                                                 |   |   |
|                   |             | *Senior Vice President, Chief Financial  Officer and secretary* |   |   |
|                   |             | (principal financial and accounting officer)                    |   |   |
|                        |                  |                                                                 |        |  |  |

 

**EXHIBIT INDEX**
| **EXHIBIT  NUMBER** | ** ** | **DESCRIPTION  OF DOCUMENTS**                                                               |
|---------------------|------------|---------------------------------------------------------------------------------------------|
|                |       |                                                                                        |
| 31.1                |       | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act – Randal B. Tofteland |
|                |       |                                                                                        |
| 31.2                |       | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act – Gregg A. Waldon     |
|                |       |                                                                                        |
| 32                  |       | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                     |

 

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