** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM10-Q**

 

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| **ý**                                                                                                                                                                                                                                                                                           | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                           | ** ** | ** **                                                                                          |
| **FOR  THE QUARTERLY PERIOD ENDED MARCH 31, 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 ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices)

** **

**(612) 851-1500**

(Registrant’stelephone number, including area code)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.

 
| Large accelerated filer |   | o |   | Accelerated filer |   | o |   | Non-accelerated filer |   | ý |
|-------------------------|--------|---|--------|-------------------|--------|---|--------|-----------------------|--------|--------|

 

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

YES    o    NO    ý

 

The number of shares of the registrant’s common stock outstanding as ofMarch 31, 2006 was 40,160,199.

 

 

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**Index**

 
| Part I.    | Financial Information                                                                             |   |
|------------|---------------------------------------------------------------------------------------------------|--------|
| Item 1.    | Financial Statements                                                                              |   |
|       | Consolidated Balance Sheets at March  31, 2006 and September 30, 2005                             |   |
|       | Consolidated Statements of  Operations for the three and six months ended March 31, 2006 and 2005 |   |
|       | Consolidated Statements of  Cash Flows for the six months ended March 31, 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**

 

**ITEM1. Financial Statements**

 

**SoftBrands, Inc.**

**Consolidated Balance Sheets**

**in thousands, except share and per share data**

**(unaudited)**

 
| ** **                                                                                                                                                                   | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2006**           | ** ** | **2005**               | ** ** |
| ** **                                                                                                                                                                   | ** ** | ** **         | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                   | ** ** | ** **         | ** ** | ** **             | ** ** |
| Current assets                                                                                                                                                               |       |               |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                   |       | $                  | 14,706     |                   | $          | 16,034 |   |
| Accounts  receivable, net                                                                                                                                                    |       | 6,452              |       | 5,363                  |       |
| Prepaid expenses  and other current assets                                                                                                                                   |       | 1,620              |       | 1,134                  |       |
| Total current  assets                                                                                                                                                        |       | 22,778             |       | 22,531                 |       |
| Furniture,  fixtures and equipment, net                                                                                                                                      |       | 1,925              |       | 1,986                  |       |
| Restricted cash                                                                                                                                                              |       | 663                |       | 648                    |       |
| Goodwill                                                                                                                                                                     |       | 23,538             |       | 22,947                 |       |
| Intangible  assets, net                                                                                                                                                      |       | 2,989              |       | 3,783                  |       |
| Other long-term  assets                                                                                                                                                      |       | 20                 |       | 6                      |       |
| Total assets                                                                                                                                                                 |       | $                  | 51,913     |                   | $          | 51,901 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                               |       |               |       |                   |       |
| Current  liabilities                                                                                                                                                         |       |               |       |                   |       |
| Current portion  of long-term debt and capital leases                                                                                                                        |       | $                  | 46         |                   | $          | 260 |   |
| Accounts payable                                                                                                                                                             |       | 1,238              |       | 2,240                  |       |
| Accrued expenses                                                                                                                                                             |       | 4,835              |       | 5,707                  |       |
| Accrued  restructuring costs                                                                                                                                                 |       | 181                |       | 203                    |       |
| Deferred revenue                                                                                                                                                             |       | 18,568             |       | 15,355                 |       |
| Other current  liabilities                                                                                                                                                   |       | 968                |       | 1,352                  |       |
| Total current  liabilities                                                                                                                                                   |       | 25,836             |       | 25,117                 |       |
|                                                                                                                                                                         |       |               |       |                   |       |
| Other long-term  liabilities                                                                                                                                                 |       | 321                |       | 292                    |       |
| Total  liabilities                                                                                                                                                           |       | 26,157             |       | 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; 40,160,199 and 40,030,000  shares issued and outstanding, respectively                                        |       | 402                |       | 400                    |       |
| Additional  paid-in capital                                                                                                                                                  |       | 174,580            |       | 173,756                |       |
| Accumulated  other comprehensive loss                                                                                                                                        |       | (1,858             | )          | (1,893                 | )          |
| Accumulated  deficit                                                                                                                                                         |       | (167,501           | )          | (165,904               | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 25,756             |       | 26,492                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                             |       | $                  | 51,913     |                   | $          | 51,901 |   |

 

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

 

3

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**SoftBrands,Inc.**

**Consolidated Statements of Operations**

**inthousands, except per share data(unaudited)**

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                         | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue**                                                        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software  licenses                                                 |       | $                                | 2,561      |                           | $          | 2,483 |   | $ | 4,918 |   | $ | 4,780 |   |
| Maintenance  & support                                         |       | 10,462                           |       | 10,995                         |       | 20,967 |   | 22,128 |   |
| Professional  services                                             |       | 3,707                            |       | 3,250                          |       | 7,062 |   | 6,429 |   |
| Third-party  software and hardware                                 |       | 646                              |       | 658                            |       | 1,171 |   | 1,326 |   |
| Total revenue                                                      |       | 17,376                           |       | 17,386                         |       | 34,118 |   | 34,663 |   |
| **Cost of  revenues**                                              |       |                             |       |                           |       |   |   |   |   |
| Software  licenses                                                 |       | 933                              |       | 1,088                          |       | 1,916 |   | 2,208 |   |
| Maintenance  & support                                         |       | 3,294                            |       | 3,478                          |       | 6,542 |   | 7,011 |   |
| Professional  services                                             |       | 3,214                            |       | 2,611                          |       | 6,254 |   | 5,197 |   |
| Third-party  software and hardware                                 |       | 433                              |       | 385                            |       | 775 |   | 830 |   |
| Total cost of  revenues                                            |       | 7,874                            |       | 7,562                          |       | 15,487 |   | 15,246 |   |
| Gross profit                                                       |       | 9,502                            |       | 9,824                          |       | 18,631 |   | 19,417 |   |
| **Operating  expenses**                                            |       |                             |       |                           |       |   |   |   |   |
| Selling, general  and administrative                               |       | 8,275                            |       | 7,655                          |       | 15,786 |   | 15,082 |   |
| Research and  product development                                  |       | 2,553                            |       | 2,027                          |       | 4,992 |   | 4,029 |   |
| Restructuring  related                                             |       |                             |       | (261                           | )          |   |   | (261 | ) |
| Total operating  expenses                                          |       | 10,828                           |       | 9,421                          |       | 20,778 |   | 18,850 |   |
| Operating income  (loss)                                           |       | (1,326                           | )          | 403                            |       | (2,147 | ) | 567 |   |
| Interest expense                                                   |       | (2                               | )          | (1,022                         | )          | (6 | ) | (2,025 | ) |
| Other income,  net                                                 |       | 88                               |       | (86                            | )          | 173 |   | 187 |   |
| Loss from  continuing operations before provision for income taxes |       | (1,240                           | )          | (705                           | )          | (1,980 | ) | (1,271 | ) |
| Provision for  income taxes                                        |       | 92                               |       | 190                            |       | 5 |   | 290 |   |
| Loss from continuing  operations                                   |       | (1,332                           | )          | (895                           | )          | (1,985 | ) | (1,561 | ) |
| **Discontinued  operations**                                       |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  from discontinued operations, net of tax            |       | (38                              | )          |                           |       | 388 |   |   |   |
| Net loss                                                           |       | (1,370                           | )          | (895                           | )          | (1,597 | ) | (1,561 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Preferred stock  dividends                                         |       | 273                              |       |                           |       | 546 |   |   |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| **Net  loss applicable to common shareholders**                    |       | $                                | (1,643     | )                              | $          | (895 | ) | $ | (2,143 | ) | $ | (1,561 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| **Basic  and diluted earnings (loss) per common share**            |       |                             |       |                           |       |   |   |   |   |
| Continuing  operations                                             |       | $                                | (0.04      | )                              | $          | (0.02 | ) | $ | (0.06 | ) | $ | (0.04 | ) |
| Discontinued  operations                                           |       | $                                | (0.00      | )                              |       |   | $ | 0.01 |   | $ | — |   |
| Net loss                                                           |       | $                                | (0.04      | )                              | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.04 | ) |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| **Weighted  average basic and diluted shares outstanding**         |       | 40,137                           |       | 40,030                         |       | 40,088 |   | 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**

**inthousands(unaudited)**

 
| ** **                                                                                               | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                               | ** ** | **March 31,**             | ** ** | **March 31,** | ** ** |
| ** **                                                                                               | ** ** | **2006**                       | ** ** | **2005** | ** ** |
|                                                                                                     |       |                           |       |   |   |
| **Cash  flow from operating activities**                                                                 | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Loss from  continuing operations                                                                         |       | $                              | (1,985     | ) | $ | (1,561 | ) |
| Adjustments to  reconcile loss from continuing operations to net cash provided by continuing  operations |       |                           |       |   |   |
| Depreciation and  amortization                                                                           |       | 2,792                          |       | 2,929 |   |
| Share-based  compensation expense                                                                        |       | 935                            |       |   |   |
| Noncash interest  expense                                                                                |       |                           |       | 586 |   |
| Foreign currency  transaction gains                                                                      |       |                           |       | (124 | ) |
| Restructuring  related                                                                                   |       |                           |       | (261 | ) |
| Provision for  (Recoveries of) doubtful accounts                                                         |       | (4                             | )          | 75 |   |
| Change in  operating assets and liabilities, net of effect of acquisitions                               |       |                           |       |   |   |
| Accounts  receivable                                                                                     |       | (984                           | )          | (55 | ) |
| Prepaid expenses  and other current assets                                                               |       | (404                           | )          | 10 |   |
| Accounts payable                                                                                         |       | (1,045                         | )          | (112 | ) |
| Accrued expenses                                                                                         |       | (625                           | )          | (1,359 | ) |
| Accrued  restructuring costs                                                                             |       | (22                            | )          | (689 | ) |
| Deferred revenue                                                                                         |       | 3,298                          |       | 1,440 |   |
| Other current  liabilities                                                                               |       | (306                           | )          | (270 | ) |
| Other long-term  assets and liabilities                                                                  |       | (48                            | )          | (59 | ) |
| Net cash  provided by operating activities                                                               |       | 1,602                          |       | 550 |   |
| **Cash  flow from investing activities**                                                                 |       |                           |       |   |   |
| Purchases of  furniture, fixtures and equipment                                                          |       | (547                           | )          | (358 | ) |
| Capitalized  software development costs                                                                  |       |                           |       | (191 | ) |
| Acquisition, net  of cash acquired                                                                       |       | (1,907                         | )          |   |   |
| Net cash used in  investing activities                                                                   |       | (2,454                         | )          | (549 | ) |
| **Cash  flow from financing activities**                                                                 |       |                           |       |   |   |
| Repayment of  long-term debt and capital leases                                                          |       | (214                           | )          | (226 | ) |
| Proceeds on  issuance of common stock                                                                    |       | 195                            |       |   |   |
| Preferred stock  dividends paid                                                                          |       | (408                           | )          |   |   |
| Net cash used in  financing activities                                                                   |       | (427                           | )          | (226 | ) |
| Effect of  exchange rates on cash balances                                                               |       | (49                            | )          | (424 | ) |
| Change in cash and  cash equivalents                                                                     |       | (1,328                         | )          | (649 | ) |
| **Cash  and cash equivalents**                                                                           |       |                           |       |   |   |
| Beginning of  period                                                                                     |       | 16,034                         |       | 9,719 |   |
| End of period                                                                                            |       | $                              | 14,706     |   | $ | 9,070 |   |

 

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

 

5

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**SoftBrands,Inc.**

**Notes to Consolidated FinancialStatements**

**(unaudited)**

 

**1.****                                      Basisof 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 six months ended March 31, 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**

 

On December 13, 2001, the Company’s Board of Directors andshareholders approved the SoftBrands, Inc. 2001 Stock Incentive Plan,which has a total of 12,400,000 shares of the Company’s common stock reservedfor issuance under options, including incentive stock options (“ISOs”) andother stock options, restricted stock awards, stock appreciation rights,dividend rights and other share-based awards thereunder.  The planprovides that employees, directors and consultants are eligible to receiveawards thereunder, that the Compensation Committee of the Board of Directors isauthorized to establish the terms of such awards, as long as, in the case ofISOs, the term does not exceed ten years from the date of grant and  the exercise price of the options is  not less than fair value on the date ofgrant.  Through March 31, 2006, 7,906,794 of the options granted hadbecome exercisable. 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 October 1, 2005 the Company adopted the fair value method ofaccounting for share-based compensation arrangements in accordance withFinancial Accounting Standards Board (“FASB”) Statement No123R, *Share-Based Payment*(“SFAS No. 123(R)”),using the modified prospective method of transition. Under the provisions of SFASNo. 123(R), the estimated fair value of share based awards granted under the2001 Stock Incentive Plan is recognized as compensation expense over thevesting period. Using the modified prospective method, compensation expense isrecognized beginning with the effective date of adoption of SFAS No. 123(R) forall share based payments (i) granted after the effective date of adoption and(ii) granted prior to the effective date of adoption and that remain unvestedon the date of adoption.

 

Prior to October 1, 2005, the Company accounted for share-basedemployee compensation plans using the intrinsic value method of accounting inaccordance with Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*(“APB25”), and its related interpretations. Under the provisions of APB 25, nocompensation expense was recognized when stock options were granted withexercise prices equal to or greater than market value on the date of grant.

 

The Company recorded $587,000, or $0.01 per share and $935,000, or $0.02per share of total share-based compensation expense for the three and six monthsended March 31, 2006, respectively, as required by the provisions of SFAS No.123(R). The share-based compensation expense is calculated on a straight-linebasis over the vesting periods of the related options, RSUs and SARs. Thischarge had no impact on the Company’s reported cash flows. For the three andsix months ended March 31, 2005, the Company recorded no share-basedcompensation expense pursuant to APB 25. The allocation of the share-basedcompensation expense for the three and six months ended March 31, 2006 was asfollows:

 

6

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| ** **                                    | ** ** | **March 31, 2006** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **Three Months**        | ** ** | **Six Months** | ** ** |
| **Thousands**                                 | ** ** | **Ended**                    | ** ** | **Ended** | ** ** |
| Cost of revenue                               |       | $                            | 67         |   | 90 |   |
| Selling, general  and administrative expenses |       | 445                          |       | 748 |   |
| Research and  Development                     |       | 75                           |       | 97 |   |
| Total                                         |       | $                            | 587        |   | $ | 935 |   |
|                                               |            |                              |            |  |  |  |  |

 

Under the modified prospective method of transition under SFAS No.123(R), the Company is not required to restate its prior period financialstatements to reflect expensing of share-based compensation under SFAS No.123(R). Therefore, the results as of March 31, 2006 are not directly comparableto the same period in the prior year.

 

As required by SFAS No. 123(R), the Company has presented pro formadisclosures of its net loss and net loss per share for the prior year periodassuming the estimated fair value of the options outstanding during the periodended March 31, 2005 was amortized to expense over the option-vesting period asillustrated below.

 
| ** **                                                                                            | ** ** | **March 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                            | ** ** | **Three Months**        | ** ** | **Six Months** | ** ** |
| **Thousands**                                                                                         | ** ** | **Ended**                    | ** ** | **Ended** | ** ** |
| ** **                                                                                            | ** ** | ** **                   | ** ** | ** ** | ** ** |
| Net loss, as  reported                                                                                |       | $                            | (895       | ) | $ | (1,561 | ) |
| Less total  stock-based compensation expense determined under fair value based method for  all awards |       | (1,406                       | )          | (1,683 | ) |
| Pro forma net  loss                                                                                   |       | $                            | (2,301     | ) | $ | (3,244 | ) |
|                                                                                                  |       |                         |       |   |   |
| Basic and  diluted loss per common share                                                              |       |                         |       |   |   |
| As reported                                                                                           |       | $                            | (0.02      | ) | $ | (0.04 | ) |
| Pro forma                                                                                             |       | $                            | (0.06      | ) | $ | (0.08 | ) |

 

The pro forma share-based compensation expense for the three and sixmonth periods ending March 31, 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 market value of each share-based option is estimated on thedate of grant using a Black-Scholes valuation method that uses the assumptionsnoted in the following table. The weighted average option life is a significantassumption as it determines the period for which the risk-free interest rate,volatility, and dividend yield must be applied. The expected life is theestimated average length of time over which the options will be exercised. Inthe fourth quarter of fiscal 2005, the Company changed the expected life ofoptions granted from 10 years to 5 years based on a market study of comparablecompanies and to reflect anticipated increased marketability and trading volumeof SoftBrands, Inc. common stock due to the approved listing and trading on theAmerican Stock Exchange effective December 27, 2005. The risk-free interestrate is based on the five-year Treasury constant maturity interest rate whoseterm is consistent with the expected life of our stock options. An outsidevaluation advisor was used to assist the company in more accurately projectingexpected stock price volatility considering both historical data and observablemarket prices of similar equity instruments.

 
| ** **       | ** ** | ** **        | ** ** | ** **   | ** ** | ** **     | ** ** | **Weighted-**      | ** ** |
|------------------|------------|-------------------|------------|--------------|------------|----------------|------------|--------------------|------------|
| ** **       | ** ** | **Risk-Free**     | ** ** | **Dividend** | ** ** | **Volatility** | ** ** | **Average Option** | ** ** |
| ** **       | ** ** | **Interest Rate** | ** ** | **Yield**    | ** ** | **Factor**     | ** ** | **Life (Years)**   | ** ** |
| Fiscal Year 2006 |       | 4.41              | %          | 0            | %          | 80             | %          | 5                  |       |
| Fiscal Year 2005 |       | 4.09              | %          | 0            | %          | 80             | %          | 9.5                |       |

 

The Black-Scholes option-pricing model requires the input of highlysubjective assumptions. The Company’s employee stock

 

7

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options have characteristics significantly different from those oftraded options. Because changes in the subjective input assumptions canmaterially affect the fair value estimate, management will continue to assessthe assumptions and methodologies used to calculate estimated fair value ofshare-based compensation. Circumstances may change and additional data maybecome available over time, which could result in changes to these assumptionsand methodologies, which could materially impact the Company’s fair valuedetermination.

 

A summary of option activity under the 2001 Stock Incentive Plan as of March31, 2006, and changes during the three-and six-month periods then ended arepresented below.

 
| ** **                               | ** ** | ** **         | ** ** | **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        |                               | —     |   |
|                                     |       |               |       |                    |       |                           |       |                               |       |
| Exercisable  shares as of March 31, 2006 |       | 7,906,794          |       | $                       | 2.39       |                           | 6.4        |                               | —     |   |

 

The weighted-average, grant-date fair value of options granted duringthe six-month period ended March 31, 2006 and 2005 was $1.23 and $1.75,respectively.

 

**Restricted Stock Units and StockAppreciation Rights**

 

On December 29,2005, the Company’s Compensation Committee approved equity awards to managementemployees under the SoftBrands, Inc. 2001 Stock Incentive Program.  Tobetter optimize the cost of the Company’s equity incentives under SFAS 123(R),the awards consisted of restricted stock units (“RSUs”) and stock appreciationrights (“SARs”) rather than stock options.  In total, the Committeegranted RSUs to acquire 362,000 shares of common stock, and SARs with respectto 237,500 shares of common stock. The SARs were assigned a fair value at $1.27per share using the Black Scholes valuation model using the same assumptionsused for share-based options.

 

In general, RSU grants vestand require SoftBrands to issue to the employee 25% of the shares subject tothe grant on the first, second, third and fourth annual anniversaries of thedate of grant, provided the employee remains an employee of the Company or asubsidiary on those dates. The estimated fair value of RSUs is based on thefair market value of the Company's common stock on the date of grant.

 

A summary of the status of the Company’s unvested shares as of March31, 2006, and changes during the three-and six- month periods then ended arepresented below.

 

8

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| ** **                             | ** ** | ** **    | ** ** | **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       |   |

 

Each of the SAR grantsalso vest on the first, second, third and fourth anniversaries of the date ofgrant with respect to 25% of the shares, provided the employee remains employedwith the Company or a subsidiary on that date, and expire on the fifthanniversary of the date of grant.  The SARs entitle the employee, oncevested and exercised, to receive shares of SoftBrands common stock having a valueon the date of exercise equal to the excess of the fair market value of theshares on the date of exercise over the fair market value of the shares on thedate of grant. During the quarter ending March 31, 2006, an additional 5,000SARs were granted (valued at $1.05 per share) and 30,000 SARs were forfeited. Thetotal outstanding at March 31, 2006 is 212,500.

 

As of March 31, 2006, there was $3,176,053, net of estimatedforfeitures, of total unrecognized compensation expense related to stock–basedarrangements granted under the 2001 Stock Incentive Plan. This expense isexpected to be recognized over a weighted-average period of 2.0 years.

 

**3.****                                      NetIncome (Loss) Per Share**

 

Net income (loss) pershare 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 common shareholdersincludes the impact of dividends on the Company’s Series C ConvertiblePreferred Stock which was issued in August 2005. Diluted earnings per share reflects the weighted average number ofshares outstanding plus any potentially dilutive shares outstanding during theperiod, calculated using the “treasury stock” method. In accordance withEITF 03-6, *Participating Securities and the Two-ClassMethod under FASB Statement No. 128*, the Company’sSeries B Convertible Preferred Stock and Series C Preferred Stock isconsidered in both the basic and diluted earnings per share calculations,subject to the applicable antidilution provisions.

 

For the three and sixmonths ended March 31, 2006, 4,331,540 shares of Series B Convertible PreferredStock and 18,000 shares of Series C Convertible Preferred Stock were not consideredin the calculation of basic or diluted earnings per share because the Companyhad net losses and based on the contractual terms, holders of neither theSeries B Convertible Preferred Stock nor the Series C Convertible PreferredStock have the obligation to share in the losses of the Company. In addition,for the periods ended March 31, 2006, SARs, RSUs, options and warrants topurchase 16,675,504 shares of the Company’s common stock were not considered inthe calculation of diluted earnings per share because the impact would beantidilutive.

 

For the three and sixmonths ended March 31, 2005, 4,331,540 shares of Series B Convertible PreferredStock and options and warrants to purchase 14,594,000 shares of the Company’scommon stock were not considered in the calculation of diluted earnings pershare because the Company had net losses and to do so would have beenantidilutive. There were no Series C Convertible Preferred Stock shares issuedand outstanding at March 31, 2005.

 

**4.****                                      DiscontinuedOperations**

 

The Company records anyrecoveries from the liquidating trust of AremisSoft Corporation (the “FormerParent”) and any associated expenses as income or loss from discontinuedoperations. Upon separation from the Former Parent, the Company established anaccrual related to lease expense for premises occupied by the Former Parent inthe Europe, Middle East and Africa (“EMEA”). Upon re-assignment of the lease toa third party during the first quarter ended December 31, 2005, the Companyreversed the remaining $655,000 balance of the accrual. The benefit is recordedas income from discontinued operations and is shown net of income taxes of $267,000.

 

The details of theCompany’s relationship with the Former Parent are more fully described in theCompany’s Report on

 

9

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Form 10-K filed withthe SEC on December 20, 2005.

 

**5.****                                      RestructuringRelated Charges**

 

The discussion of the Company’s restructuring activities included belowis organized by the period of initiation of the different restructuring planstogether with related subsequent activity.

 

During the year ended September 30, 2004, the Company ceased usingtwo international facilities and recorded restructuring charges of $981,000 forlease costs that were to continue. Of this amount, $728,000 was taken duringthe first quarter of fiscal year 2004. These charges are an extension of theSeptember 2003 restructuring program (see below) and reflect the Company’sdesire to consolidate 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 EMEA region. There were no more restructuring-basedlease commitments as of September 30, 2005.

 

On September 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 six-month period ended March 31, 2006, the Company madecash severance payments of $18,000. At March 31, 2006, the remaining employeeseverance accrual for this program was $15,000, all of which is continuedcarryover from regions outside of the U.S.

 

In December 2001, the Company instituted a restructuring plan toalign its cost structure with its business plan. Under the restructuring plan,the Company reduced its workforce by approximately 20%, or 153 positionsthroughout the organization. In addition to the employee termination costs,charges were taken related to excess leased space at two of the Company’sfacilities. In conjunction with the restructuring related charges, the Companyestimated future 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 conjunction with theacquisition of Fourth Shift Corporation in April 2001, the Company assumedaccrued restructuring liabilities related to employee termination costs andfacility consolidation. At March 31, 2006, $166,000 of this restructuringliability was remaining and is required for special one-time retirementbenefits that the Company is obligated to pay for three former employees.

 

The following tablepresents a summary of the Company’s restructuring activities during the sixmonths ended March 31, 2006 and the year ended September 30, 2005:

 

10

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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)   |       | (22                    | )          |            |       | (22        | )          |
|                           |       |                   |       |            |       |       |       |
| Balance at March  31, 2006     |       | $                      | 181        |            | $          | —     |       | $ | 181 |   |

 

----

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

 

**6.****                                      ComprehensiveIncome (loss)**

 

Total comprehensive loss was$1.3 million and $800,000 for the three months ended March 31, 2006 and 2005,respectively. Total comprehensive loss was $1.6 million and $2.1 million forthe six months ended March 31, 2006 and 2005, respectively. Comprehensive lossdiffers from net loss due to foreign currency translation adjustments.

 

**7.****                                      Acquisition**

 

EffectiveOctober 1, 2005, the Company acquired all of the outstanding shares of InfraBusiness Solutions GmbH (“Infra”), a privately held German software companythat is a reseller and development partner of SAP Business One, for approximately$2.3 million. The purchase price includes cash of approximately $1.9 million(net of cash acquired), warrants to purchase 200,000 shares of our common stockvalued at $227,000 and closing costs. The acquisition gives the Companypresence in Germany and the ability to use Infra’s established channel partnersto introduce Fourth Shift Edition for SAP Business One to the German market. Asa result of the acquisition of Infra, the Company acquired $1.4 million ofidentifiable intangible assets that have estimated useful lives of three tofour years and are being amortized on accelerated and straight-line methods. Thefair market value of the identifiable intangible assets purchased includedInfra’s software product Infra:Net, a production planning system sold to small-to medium-sized manufacturers in the German, Swiss and Austrian markets at$676,000, non-contractual customer relationships valued at $282,000, alicensing and royalty agreement valued at $25,000 and employment contracts valuedat $376,000. Goodwill of $585,000 was assigned to the manufacturing operatingsegment. The following table summarizes the allocation of the purchase price tothe estimated fair values of the assets acquired 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 |   |

 

Theresults of operations of Infra have been included in the Company’s consolidatedstatements of operations since the date of the acquisition. The pro formaimpact of the Infra acquisition was not significant to the results of theCompany for the  six months ended March 31,2006 or the three or six months ended March 31, 2005.

 

11

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**8.****                                      Goodwilland Intangible Assets**

 

The Company assessesgoodwill 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 an increase of$585,000 to goodwill during the six months ended March 31, 2006, which was dueentirely to the Infra acquisition in October 2005.

 

Net intangible assets atMarch 31, 2006 and September 30, 2005, were comprised of the following:

 
| ** **                        | ** ** | **March 31, 2006** | ** ** | **September 30, 2005** | ** ** |
|-----------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **Gross**                    | ** ** | ** **                       | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                        | ** ** | **Carrying**                 | ** ** | **Accumulated**                  | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| **Thousands**                     | ** ** | **Amount**                   | ** ** | **Amortization**                 | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                              |       |                         |       |                             |       |   |   |   |   |   |   |   |   |
| Acquired technology               |       | $                            | 21,103     |                             | $          | (19,001 | ) | $ | 2,102 |   | $ | 20,436 |   | $ | (17,168 | ) | $ | 3,268 |   |
| Capitalized  software development |       | 1,093                        |       | (792                             | )          | 301 |   | 1,094 |   | (610 | ) | 484 |   |
| Other                             |       | 932                          |       | (346                             | )          | 586 |   | 252 |   | (221 | ) | 31 |   |
| Intangible  assets                |       | $                            | 23,128     |                             | $          | (20,139 | ) | $ | 2,989 |   | $ | 21,782 |   | $ | (17,999 | ) | $ | 3,783 |   |

 

Total amortization ofintangibles was $1.1 million and $1.2 million for the three months ended March 31,2006 and 2005, respectively. Total amortization of intangibles was $2.2 millionand $2.3 million for the six months ended March 31, 2006 and 2005,respectively. Based on the intangibles at March 31, 2006, estimatedamortization expense for each of the next four years is as follows:

 
| **Year Ending September 30 (thousands)** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|
| Remainder of  fiscal year 2006                               |       | $          | 1,041      |   |
| 2007                                                         |       | 947        |       |
| 2008                                                         |       | 720        |       |
| 2009                                                         |       | 253        |       |
| 2010                                                         |       | 28         |       |
|                                                         |       | $          | 2,989      |   |

 

**9.****                                      SegmentInformation**

 

The Company disclosessegments in accordance with SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information*, whichestablished standards for disclosure of financial information related tooperating segments of the Company, as well as disclosure requirements forcustomer and geographic information. SFAS No. 131 defines an operatingsegment as a component of a company for which operating results are reviewed regularlyby the chief operating decision-maker to determine resource allocation andassess performance. The Company has two reportable segments under theguidelines of SFAS No. 131:  manufacturingand hospitality. Manufacturing and hospitality derive their revenues fromlicensing proprietary software systems; providing customer support, training,consulting and installation services related to software; and through theresale of complementary third-party software licenses and hardware.

 

Financial information bysegment is summarized in the following table. Total assets are not allocated tomanufacturing and hospitality for internal reporting purposes.

 

12

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| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|------------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| **Thousands** | ** ** | **Revenue**                                          | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                    | 12,962     |   | $ | 3,683 |   | $ | 11,951 |   | $ | 3,394 |   |
| Hospitality   |       | 4,414                                                |       | 549 |   | 5,435 |   | 1,472 |   |
| Corporate     |       |                                                 |       | (5,558 | ) |   |   | (4,463 | ) |
|          |       |                                                 |       |   |   |   |   |   |   |
| Total Company |       | $                                                    | 17,376     |   | $ | (1,326 | ) | $ | 17,386 |   | $ | 403 |   |

 
| ** **    | ** ** | **Six  Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------|------------|
| ** **    | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **Thousands** | ** ** | **Revenue**                     | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                               | 25,642     |   | $ | 7,406 |   | $ | 24,372 |   | $ | 7,052 |   |
| Hospitality   |       | 8,476                           |       | 795 |   | 10,291 |   | 1,931 |   |
| Corporate     |       |                            |       | (10,348 | ) |   |   | (8,416 | ) |
|          |       |                            |       |   |   |   |   |   |   |
| Total Company |       | $                               | 34,118     |   | $ | (2,147 | ) | $ | 34,663 |   | $ | 567 |   |

 

13

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| ** **                        | ** ** | **Three Months Ended March 31,** | ** **   |
|-----------------------------------|------------|------------------------------------------------------|--------------|
| ** **                        | ** ** | **2006**                                             | ** **   | **2005** | ** ** |
| **Thousands**                     | ** ** | **Manufacturing**                                    | ** **   | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| ** **                        |       |                                                 |         |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                    |       |                                                 |         |   |   |   |   |   |   |   |   |   |   |
| Americas                          |       | $                                                    | 7,643        |   | $ | 1,717 |   | $ | 9,360 |   | $ | 7,287 |   | $ | 2,274 |   | $ | 9,561 |   |
| Europe, Middle  East & Africa |       | 3,654                                                |         | 2,227 |   | 5,881 |   | 3,029 |   | 2,516 |   | 5,545 |   |
| Asia Pacific                      |       | 1,665                                                |         | 470 |   | 2,135 |   | 1,635 |   | 645 |   | 2,280 |   |
|                              |       | $                                                    |  12,962 |   | $ |  4,414 |   | $ |  17,376 |   | $ |  11,951 |   | $ |  5,435 |   | $ | 17,386 |   |

 
| ** **                        | ** ** | **Six Months Ended March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| **Thousands**                     | ** ** | **Manufacturing**                                  | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                              |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                    |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Americas                          |       | $                                                  | 14,926     |   | $ | 3,131 |   | $ | 18,057 |   | $ | 14,942 |   | $ | 4,096 |   | $ | 19,038 |   |
| Europe, Middle  East & Africa |       | 7,212                                              |       | 4,150 |   | 11,362 |   | 6,132 |   | 4,890 |   | 11,022 |   |
| Asia Pacific                      |       | 3,504                                              |       | 1,195 |   | 4,699 |   | 3,298 |   | 1,305 |   | 4,603 |   |
|                              |       | $                                                  | 25,642     |   | $ | 8,476 |   | $ | 34,118 |   | $ | 24,372 |   | $ | 10,291 |   | $ | 34,663 |   |

 

**ITEM2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 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 thoseanticipated in these forward-looking statements as a result of various factors,including those set forth in more detail in the “Forward-Looking Statements”section below. 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 businessdesigns, develops and sells enterprise resource planning software and servicesto small and medium-sized manufacturing concerns.  Our principal productsin this segment 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 that was introduced in 2003. Ourhospitality business designs, develops and sells software and services thatsupport the enterprise information management needs of hotels andresorts.  Principal products in the hospitality segment include***Medallion***, a Windows®-basedproperty management system designed primarily for independent hotels and hotelchains;***PORTfolio***,a comprehensive client/server hotel system for both the front- and back-officeoperations of single-site and multi-property hotels; and***RIO***, a leisuremanagement system that supports the activities of spas, health clubs andresorts. Because much of our administrative and support staff provides servicesto both segments, we also report in this Management’s Discussion unallocatedcorporate expenses as part of a “Corporate” segment.

 

14

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Wederive revenue in both of our manufacturing and hospitality segments throughsale of licenses to use our software products and through providing servicesrequired to maintain our products, to install and implement our products, andin some cases to customize or create extensions for our products.  Onoccasion we also sell hardware products of third-party vendors on adistribution basis for the convenience of our customers and sell licenses tothird-party software programs.  Our software license revenue is heavilyinfluenced by the timing of customer purchases and installations and the termsunder which we sell software licenses.  Our software maintenance revenue,which currently constitutes a majority of our revenue, is derived primarilyfrom one-year contracts that require payment at the beginning of the contractterm and under which we recognize revenue ratably over the one-year contractperiod.  Our other services revenue is normally recognized over the timeservices are performed.

 

**InfraAcquisition**

 

EffectiveOctober 1, 2005, we acquired all of the outstanding shares of Infra BusinessSolutions GmbH, a privately held German software company that is a reseller anddevelopment partner of SAP Business One, for approximately $2.3 million. Thepurchase price consisted of cash plus warrants to purchase 200,000 shares ofour common stock. We assigned $343,000 of the purchase price to the value of nettangible assets acquired, $1.4 million to identifiable intangible assets, and $585,000to goodwill. The fair market value of the identifiable intangible assetspurchased included Infra’s software product Infra:Net, a production planningsystem sold to small- to medium-sized manufacturers in the German, Swiss andAustrian markets valued at $676,000, non-contractual customer relationshipsvalued at $282,000, a licensing and royalty agreement valued at $25,000and  employment contracts valued at $376,000.

 

**Critical Accounting Policies and Estimates**

 

The preparation of thefinancial information contained in this Form 10-Q requires our management tomake 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, the valuation ofour intangible assets, including goodwill and the recording of restructuringcharges. Except with respect to changes in the manner in which we account forshare based compensation, as discussed below, there have been no materialchanges to the critical accounting policies as discussed in greater detail inthe Management’s Discussion and Analysis of Financial Condition and Results ofOperations contained in our Form 10-K as filed with the SEC on December 20,2005.

 

*Share-based Compensation. During*the first quarter of 2006, we adopted the fair value method of accounting for share-basedcompensation using the modified prospective method of transition as outlined inFinancial Accounting Standards Board Statement No. 123R, *Share-BasedPayment* (“SFAS No. 123R”). Under SFAS No. 123R, the estimated fairvalue of share-based compensation, including stock options granted under our2001 Stock Incentive Plan, is recognized as compensation expense. The estimatedfair value of stock options is expensed on a straight-line basis over the vestingperiod. Prior to October 1, 2005, we accounted for share-based employeecompensation plans using the intrinsic value method of accounting in accordancewith Accounting Principles 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. Under the modified prospectivemethod of transition that we adopted, compensation expense is recognizedbeginning with the effective date of adoption 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.Under the modified prospective method of transition, we are not required torestate our prior period financial statements to reflect expensing of share-basedcompensation under SFAS No. 123R. Therefore the three and six month results of March31, 2006 are not directly comparable to the same period in the prior year. UnderSFAS No. 123R, 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 quarter offiscal 2005, we calculated the 5-year estimated life of stock options grantedusing the information and guidance from an analysis by an independent compensationconsultant. We based our estimate of expected volatility for fiscal year 2006on daily historical trading data of our common stock. For fiscal year 2005, webased our volatility estimate under the same method as fiscal year 2006. Weselected the historical method primarily because we have not identified a morereliable or appropriate method to predict future volatility. See Note 2,Accounting for Share-based Compensation, to our financial statements for moreinformation about the adoption of SFAS No. 123(R).

 

15

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**Resultsof Operations**

 

Forthe three months ended March 31, 2006, we reported total revenue of $17.4million and a net loss of $1.4 million, or $0.04 per share, compared to totalrevenue of $17.4 million and a net loss of $895,000, or $0.02 per share, forthe same period in 2005. The results for the quarter ended March 31, 2006, include$587,000 of share-based compensation resulting from the adoption of SFAS No.123(R) on October 1, 2005, $395,000 in severance costs and an expense of $460,000related to lease obligations in the United Kingdom, partially offset by a $1.0million decrease in interest expense. The new lease terms in the U.K. willresult in approximately a $480,000, or 49% decrease in annual rent expense forthe Reading facility. The decrease in interest expense was from the SeniorNotes that were repaid in August 2005.

 

Forthe six months ended March 31, 2006, we reported total revenue of $34.1 millionand a net loss of $1.6 million, or $0.05 per share, compared to total revenueof $34.7 million and a net loss of $1.6 million, or $0.04 per share, for thesame period in 2005. Loss from continuing operations was $2.0 million for the sixmonths ended March 31, 2006 compared to $1.6 million for the six months ended March31, 2005. The change in the loss from continuing operations includes $935,000of  SFAS No. 123(R) share-basedcompensation expense, $395,000in severance costs and an expense of $460,000 related to lease obligations inthe United Kingdom, partially offset by a $2.0 million decrease in interestexpense.

 

Thefollowing table summarizes revenue and operating results by reportable segmentfor the three and six months ended March 31, 2006 and 2005: 

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** | ** **                   | ** ** |
|---------------|------------|------------------------------------------------------|------------|------------------------------|------------|
| ** **    | ** ** | **2006**                                             | ** ** | **2005**                     | ** ** | **% Change** | ** ** |
| **Thousands** | ** ** | **Revenue**                                          | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                           | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                    | 12,962     |                         | $          | 3,683 |   | $ | 11,951 |   | $ | 3,394 |   | 8.5 | % | 8.5 | % |
| Hospitality   |       | 4,414                                                |       | 549                          |       | 5,435 |   | 1,472 |   | (18.8 | )% | (62.7 | )% |
| Corporate     |       |                                                 |       | (5,558                       | )          |   |   | (4,463 | ) |   |   | 24.5 | % |
|          |       |                                                 |       |                         |       |   |   |   |   |   |   |   |   |
| Total Company |       | $                                                    | 17,376     |                         | $          | (1,326 | ) | $ | 17,386 |   | $ | 403 |   | 0.1 | % | NM | * |

 
| ** **    | ** ** | **Six Months Ended March 31,** | ** ** | ** **                        | ** ** |
|---------------|------------|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **    | ** ** | **2006**                                           | ** ** | **2005**                          | ** ** | **% Change** | ** ** |
| **Thousands** | ** ** | **Revenue**                                        | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                                  | 25,642     |                              | $          | 7,406 |   | $ | 24,372 |   | $ | 7,052 |   | 5.2 | % | 5.0 | % |
| Hospitality   |       | 8,476                                              |       | 795                               |       | 10,291 |   | 1,931 |   | (17.6 | )% | (58.8 | )% |
| Corporate     |       |                                               |       | (10,348                           | )          |   |   | (8,416 | ) |   |   | 23.0 | % |
|          |       |                                               |       |                              |       |   |   |   |   |   |   |   |   |
| Total Company |       | $                                                  | 34,118     |                              | $          | (2,147 | ) | $ | 34,663 |   | $ | 567 |   | (1.6 | )% | NM | * |

 

----

*NM: Percentage not meaningful

 

16

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Total revenue was relativelyunchanged in the three months ended March 31, 2006 compared to the three monthsended March 31, 2005. This reflects an 8.5% increase for manufacturing offsetby an 18.8% decrease for hospitality. See below for a more detailed discussionof changes in revenue by reportable segment, revenue type and geography. Operatingincome in the manufacturing group increased by 8.5% in the three months endedMarch 31, 2006 compared to the 2005 period, primarily because of increasedrevenue. Operating income in the hospitality group decreased 62.7% in the threemonths ended March 31, 2006, primarily because of declining maintenance revenue.The corporate group loss increased by 24.5% in the three months ended March 31,2006, due in large part to share based compensation expenses, U.K. leaseobligations, severance charges and increased marketing efforts.

 

Total revenue decreased 1.6%in the six months ended March 31, 2006 compared to the six months ended March31, 2005. This reflects a 5.2% increase in manufacturing group revenue offsetby a 17.6% decrease in hospitality group revenue. See below for a more detaileddiscussion of changes in revenue by reportable segment, revenue type andgeography. Operating income in the six months ended March 31, 2006 in themanufacturing group increased by 5.0%, primarily through the revenue increase. Operatingincome in the hospitality group decreased 58.8% in the six months ended March31, 2006 primarily because of declining maintenance revenue. The corporategroup loss increased by 23.0%, due in large part to share based compensationexpenses, severance charges and increased marketing efforts.

 

**Revenue.**The following table summarizes revenue by reportable segment, revenuetype and geography for the threeand six months ended March 31, 2006 and 2005:

 
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------|------------|-------------------|------------|-------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **2005**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**                                    | ** ** | **Hospitality** | ** ** | **Total**         | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                                 |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 |       |                                                 |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | $                                                    | 1,946      |            | $          | 615               |       | $                 | 2,561      |   | $ | 1,632 |   | $ | 851 |   | $ | 2,483 |   | 19.2 | % | (27.7 | )% | 3.1 | % |
| Maintenance and support            |       | 7,819                                                |       | 2,643           |       | 10,462            |       | 7,680             |       | 3,315 |   | 10,995 |   | 1.8 | % | (20.3 | )% | (4.8 | )% |
| Professional  services             |       | 2,917                                                |       | 790             |       | 3,707             |       | 2,381             |       | 869 |   | 3,250 |   | 22.5 | % | (9.1 | )% | 14.1 | % |
| Third-party  software and hardware |       | 280                                                  |       | 366             |       | 646               |       | 258               |       | 400 |   | 658 |   | 8.5 | % | (8.5 | )% | (1.8 | )% |
|                               |       | $                                                    | 12,962     |            | $          | 4,414             |       | $                 | 17,376     |   | $ | 11,951 |   | $ | 5,435 |   | $ | 17,386 |   | 8.5 | % | (18.8 | )% | NM | * |
|                               |       |                                                 |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     |       |                                                 |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                           |       | $                                                    | 7,643      |            | $          | 1,717             |       | $                 | 9,360      |   | $ | 7,287 |   | $ | 2,274 |   | $ | 9,561 |   | 4.9 | % | (24.5 | )% | (2.1 | )% |
| Europe, Middle  East & Africa  |       | 3,654                                                |       | 2,227           |       | 5,881             |       | 3,029             |       | 2,516 |   | 5,545 |   | 20.6 | % | (11.5 | )% | 6.1 | % |
| Asia Pacific                       |       | 1,665                                                |       | 470             |       | 2,135             |       | 1,635             |       | 645 |   | 2,280 |   | 1.8 | % | (27.1 | )% | (6.4 | )% |
|                               |       | $                                                    | 12,962     |            | $          | 4,414             |       | $                 | 17,376     |   | $ | 11,951 |   | $ | 5,435 |   | $ | 17,386 |   | 8.5 | % | (18.8 | )% | NM | * |

 
| ** **                         | ** ** | **Six  Months Ended March 31,** | ** ** | ** **      | ** ** | ** **        | ** ** | ** **        | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|-----------------|------------|-------------------|------------|-------------------|------------|
| ** **                         | ** ** | **2006**                                       | ** ** | **2005**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**                              | ** ** | **Hospitality** | ** ** | **Total**         | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                           |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 |       |                                           |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | $                                              | 3,705      |            | $          | 1,213             |       | $                 | 4,918      |   | $ | 3,440 |   | $ | 1,340 |   | $ | 4,780 |   | 7.7 | % | (9.5 | )% | 2.9 | % |
| Maintenance and support            |       | 15,681                                         |       | 5,286           |       | 20,967            |       | 15,267            |       | 6,861 |   | 22,128 |   | 2.7 | % | (23.0 | )% | (5.2 | )% |
| Professional  services             |       | 5,707                                          |       | 1,355           |       | 7,062             |       | 5,040             |       | 1,389 |   | 6,429 |   | 13.2 | % | (2.4 | )% | 9.8 | % |
| Third-party  software and hardware |       | 549                                            |       | 622             |       | 1,171             |       | 625               |       | 701 |   | 1,326 |   | (12.2 | )% | (11.3 | )% | (11.7 | )% |
|                               |       | $                                              | 25,642     |            | $          | 8,476             |       | $                 | 34,118     |   | $ | 24,372 |   | $ | 10,291 |   | $ | 34,663 |   | 5.2 | % | (17.6 | )% | (1.6 | )% |
|                               |       |                                           |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     |       |                                           |       |            |       |              |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                           |       | $                                              | 14,926     |            | $          | 3,131             |       | $                 | 18,057     |   | $ | 14,942 |   | $ | 4,096 |   | $ | 19,038 |   | (0.1 | )% | (23.6 | )% | (5.2 | )% |
| Europe, Middle  East & Africa  |       | 7,212                                          |       | 4,150           |       | 11,362            |       | 6,132             |       | 4,890 |   | 11,022 |   | 17.6 | % | (15.1 | )% | 3.1 | % |
| Asia Pacific                       |       | 3,504                                          |       | 1,195           |       | 4,699             |       | 3,298             |       | 1,305 |   | 4,603 |   | 6.2 | % | (8.4 | )% | 2.1 | % |
|                               |       | $                                              | 25,642     |            | $          | 8,476             |       | $                 | 34,118     |   | $ | 24,372 |   | $ | 10,291 |   | $ | 34,663 |   | 5.2 | % | (17.6 | )% | (1.6 | )% |

 

----

*NM: Percentage not meaningful

 

17

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*Manufacturing segment:*  Total manufacturing revenue increased by $1.0 millionor 8.5% for the three months ended March 31, 2006 compared to the three monthsended March 31, 2005, and increased $1.3 million or 5.2% in the six monthsended March 31, 2006 compared to the same period in 2005. License revenue increased19.2% in the three months ended and 7.7% in the six months ended March 31, 2006in manufacturing as a result of a number of factors including strongperformance from Fourth Shift sales in Americas and Evolution sales in Europeduring the March quarter. Maintenance revenues in manufacturing increased 1.8 %in the quarter and 2.7% in the six months ended March 31, 2006 as we continueto experience high retention rates on maintenance renewals and the generation ofsupport revenue from additional service offerings. These services includeremote system administration, and business process management. Professionalservices revenue increased 22.5% during the quarter and 13.2% during the sixmonths ended March 31, 2006, primarily due to strong performance in thebusiness process management services and new revenue from our October 2005 acquisitionin Germany.

 

Geographically, we generated organic license and maintenance growth andincreased revenue from evolution sales in Europe, Middle East & Africa(EMEA) region and from the Infra acquisition. Our license and maintenancerevenue from the Asia 

 

18

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Pacific region increased as the strength of the Chinese economycontinues and our customers demand increased product and services. The Americasregion was aided during the second quarter by the strong sales of Fourth Shift.

 

*Hospitality segment:*  Total hospitality segment revenue decreasedby $1.0 million or 18.8% in the three months ended March 31, 2006, compared tothe prior year and decreased $1.8 million or 17.6% in the six-month period. Therevenue decrease was driven by reduced maintenance revenue and because thefiscal 2005 period includes $503,000 combined license and professional servicesrevenue from a large custom development project that did not recur in thefiscal 2006 period. License revenue decreased $236,000 or 27.7% in the threemonths ended March 31, 2006 over March 31, 2005 and $127,000 or 9.5% in the sixmonths ended March 31, 2006 over the same period in 2005. License revenue washigher in the prior three month period in part because of $257,000 recordedfrom the custom project mentioned above. Sales volume and license revenue from Medallionincreased from the three months ended March 31, 2005 to the three months endedMarch 31, 2006. The average site license revenue is lower than historicallyrealized due to a high mix of sales to smaller hotels. The 23.0% 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 yet 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.

 

Geographically, we provide maintenance services on legacy productsprimarily in the EMEA and Americas regions, and our operations in those regionshave therefore experienced the largest decreases in hospitality maintenancerevenue.

 

**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 six months ended March 31,2006 and 2005:

 
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Manufacturing**                                    | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Software  licenses                 |       | 53.1                                                 | %          | 96.6 | % | 63.6 | % | 48.2 | % | 71.4 | % | 56.2 | % |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance and support            |       | 75.8                                                 | %          | 46.9 | % | 68.5 | % | 76.2 | % | 50.2 | % | 68.4 | % |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Professional  services             |       | 8.3                                                  | %          | 31.9 | % | 13.3 | % | 15.2 | % | 31.9 | % | 19.7 | % |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Third-party  software and hardware |       | 18.2                                                 | %          | 44.3 | % | 33.0 | % | 31.0 | % | 48.3 | % | 41.5 | % |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **56.0**                                             | **%**      | **50.9** | **%** | **54.7** | **%** | **59.3** | **%** | **50.5** | **%** | **56.5** | **%** |

 
| ** **                         | ** ** | **Six Months Ended March 31,** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Manufacturing**                                  | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | 50.7                                               | %          | 92.7 | % | 61.0 | % | 50.0 | % | 63.7 | % | 53.8 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance and  support           |       | 76.5                                               | %          | 45.9 | % | 68.8 | % | 76.9 | % | 49.3 | % | 68.3 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Professional  services             |       | 9.5                                                | %          | 19.6 | % | 11.4 | % | 18.8 | % | 20.7 | % | 19.2 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Third-party  software and hardware |       | 18.2                                               | %          | 47.6 | % | 33.8 | % | 27.5 | % | 46.2 | % | 37.4 | % |
|                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **56.6**                                           | **%**      | **48.5** | **%** | **54.6** | **%** | **59.8** | **%** | **47.1** | **%** | **56.0** | **%** |

 

19

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Overall gross marginpercentage decreased to 54.7% in the second quarter of 2006 from 56.5% in the secondquarter of 2005. The manufacturing segment’s software license gross marginpercentage improved to 53.1% during the three months ended March 31, 2006 from 48.2%during the three months ended March 31, 2005. Cost of license revenue consistsof amortization of acquired software, the amortization of capitalized costs forinternally developed software, and the cost of third-party software embedded insome of our products. The improved margin in the second quarter of 2006 reflectsfull amortization of some of the acquired Fourth Shift software asset, offset inpart by increased royalty rates on SAP Business One. Amortization has beenrelatively fixed and, excluding any effect from new acquisitions, will begin todecline as assets associated with Fourth Shift become fully amortized. As aresult, reduced amortization is expected to reduce cost by $344,000 and$611,000 for the three months ending June 30, 2006 and September 30, 2006,respectively, compared to the three months ended March 31, 2006. This reductionin expense will be decreased by additional royalty expense as sales of FourthShift for SAP Business One increase as percentage of overall license revenue. Royaltycosts to third parties can fluctuate depending on product mix. 

 

The manufacturing segment’smaintenance gross profit percentage also remained stable as we saw less revenuein the Americas region, but an increase in both the EMEA and APAC regions. Managementchanges in our manufacturing professional services organization and lowutilization rates resulted in lower professional services margin in both thethree and six month periods ended March 31, 2006 compared with comparableperiods in 2005. Manufacturing third-party software and hardware gross marginsdecreased for both the three and six month periods due to a change in productmix.

 

The decline in hospitality maintenance gross margin percentage is dueto a large decline in maintenance revenue which was not yet offset by a similardecline in related costs. Although our cost of providing hospitality maintenancehas declined since we completed the move of hospitality maintenance services tothe facility in Bangalore, India we had previously established formanufacturing software maintenance, the $247,000 decrease in cost during thethree months ended March 31, 2006, did not fully compensate for the even largerrevenue decline. The hospitality world-wide support center has grown from 17people in March 2005 to 40 people in March 2006  As a result of cost savingsmeasures our average cost per incident has declined 32%.

 

**Operating Expenses.**The following table summarizes operatingexpenses for the three and six months ended March 31, 2006 and 2005:

 
| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** | ** **                        | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2006**                                             | ** ** | **2005**                          | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                                           | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                        | ** ** | ** **                                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative       |       | $                                                    | 5,106      |                              | 29.4       | % | $ | 5,076 |   | 29.2 | % | 0.6 | % |
| Selling and  marketing            |       | 3,169                                                |       | 18.2                              | %          | 2,579 |   | 14.8 | % | 22.9 | % |
| Research and  product development |       | 2,553                                                |       | 14.7                              | %          | 2,027 |   | 11.7 | % | 25.9 | % |
| Restructuring  related charges    |       | —                                               |       | 0.0                               | %          | (261 | ) | (1.5 | )% | (100.0 | )% |
| Total operating  expenses         |       | $                                                    | 10,828     |                              | 62.3       | % | $ | 9,421 |   | 54.2 | % | 14.9 | % |

 
| ** **                        | ** ** | **Six Months Ended March 31,** | ** ** | ** **                        | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2006**                                      | ** ** | **2005**                          | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                                    | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                        | ** ** | ** **                                    | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative       |       | $                                             | 9,829      |                              | 28.8       | % | $ | 9,913 |   | 28.6 | % | (0.8 | )% |
| Selling and  marketing            |       | 5,957                                         |       | 17.5                              | %          | 5,169 |   | 14.9 | % | 15.2 | % |
| Research and  product development |       | 4,992                                         |       | 14.6                              | %          | 4,029 |   | 11.6 | % | 23.9 | % |
| Restructuring  related charges    |       | —                                        |       | 0.0                               | %          | (261 | ) | (0.8 | )% | (100.0 | )% |
| Total operating  expenses         |       | $                                             | 20,778     |                              | 60.9       | % | $ | 18,850 |   | 54.4 | % | 10.2 | % |

 

NM: Percentage not meaningful.

 

Operating expenses forthe quarter ended March 31, 2006 increased $1.4 million or 14.9% compared tothe quarter ended March 31, 2005. For the six-month period ended March 31,2006, operating expenses increased $1.9 million or 10.2% over the comparableperiod in the prior year. The six months ended March 31, 2006 includesapproximately $426,000 of

 

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professional feesassociated with the internal control documentation project undertaken to complywith Section 404 provisions of the Sarbanes-Oxley Act of 2002 compared withapproximately $1.0 million incurred in 2005. General and administrativeexpenses in the six months ended March 31, 2006 are also higher than expensesin the prior year due to the inclusion of $707,000 of stock compensationexpense, $340,000 of severance related charges, and $346,000 related toterminating a lease obligation in the U.K. We will vacate existing premises inthe fourth quarter of this fiscal year and move into less expensive spacesaving approximately $480,000 per year compared to existing lease terms.

 

We expanded our salesforce, stepped up demand generation activities, increased business developmentefforts 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 22.9% in the threemonths and 15.2% in the six months ended March 31, 2006. 

 

Research and productdevelopment expense was higher in both the three and six months ended March 31,2006, in large part because of expenses from the recently acquired Infra BusinessSolutions, GmbH, a proof of concept project in our manufacturing segment, andcontinued efforts to expand functionality of manufacturing and hospitalityproducts.  Research and developmentexpenses for manufacturing were 12.7% of manufacturing revenue for the sixmonths ended March 31, 2006 compared with 11.4% for the same period inFiscal 2005. The increase is primarily due to development of Fourth Shift Editionfor SAP Business One and Infra expenses. Research and development expenses forhospitality were 17.7% of hospitality revenue for the six months endedMarch 31, 2006 compared with 12.1% for the same period in 2005.  The increased spending was for development ofMedallion.

 

**Non-Operating Items and other.**The following table summarizes non-operatingincome and expenses for the quarters ended March 31, 2006 and 2005, as well asour tax provision and discontinued operations:

 
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **March 31,**               | ** ** | **March 31,**             | ** ** |
| **Thousands**                                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                              | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                        |       | $                                | 2          |                           | $          | 1,022 |   | $ | 6 |   | $ | 2,025 |   |
| Other expense  (income), net                            |       | (88                              | )          | 86                             |       | 173 |   | (187 | ) |
| Provision for  income taxes                             |       | 92                               |       | 190                            |       | 5 |   | 290 |   |
| Income (loss)  from discontinued operations, net of tax |       | (38                              | )          | —                         |       | $ | 388 |   | — |   |
|                                                         |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

Interest expense incurredin 2005 was related to long-term institutional debt which was repaid in August2005. It included cash interest expense, amortization of capitalized financingcosts and debt accretion 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 $173,000of other income, net reflected on our consolidated statement of operations forthe six months ended March 31, 2006; approximately $43,000 was due to theimpact of the weakening of foreign currencies against the U.S. dollar. We alsorecorded interest income of $107,000. We do not currently utilize anyderivative security instruments or engage in any hedging activities.

 

After we had separatedfrom the Parent Company, we maintained an obligation in accrued expenses in ourledger. Reversal of this accrual in the first quarter of fiscal 2005 generatedincome from discontinued operations of $388,000, net of income taxes during thesix months ended March 31, 2006.

 

We recognized a taxbenefit in continuing operations in the three and six months ended March 31,2006 to the extent that income from discontinued operations has been offset bycurrent period losses from continuing operations. The benefit is stated net ofamounts for our estimated domestic state and international tax liabilities. Ourtax provision fluctuates due to the mix of forecasted results between domesticoperations and our international subsidiaries. Also, we have not recordedcertain income tax benefits in either of the periods presented due to continueduncertainty regarding our ability to realize our deferred tax assets.

 

# **Liquidity and Capital Resources**

# ** **

# **As of March 31, 2006, we had $14.7 million of cash and cash equivalentsand $663,000 of restricted cash. Our working capital deficit (current assetsless current liabilities), increased to $3.1 million at March 31, 2006 from $2.6million at September 30, 2005. This increase in working capital deficit is dueto the $3.2 million increase in deferred revenue. It is common to see ourdeferred revenue increase significantly during the first quarter and secondquarters, as annual**

 

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# **maintenance contracts are renewed. Deferred revenue was $18.6 millionat March 31, 2006, compared with $15.4 million at September 30, 2005. Deferredmaintenance revenues comprise the majority of our deferred revenues and ourcost to perform these revenues has recently been between 30% and 35% of totalmaintenance revenue.**

# ** **

# **Cash Flows from Operating Activities.**We generated $1.6 million of cash from operating activities in the sixmonths ended March 31, 2006, an increase of $1.0 million from the $550,000 ofcash generated in operating activities from the comparable period a year ago. Thischange is primarily due to improved operating income after giving affect forchanges in non-cash items, such as share-based compensation, and improvedcollections on maintenance billings.

# ** **

# **We had $3.7 million of non-cash expenses in the six months ended March 31,2006, which included $2.8 million of depreciation and amortization and $935,000of share-based compensation. This compares to non-cash expenses of $3.2 millionin the prior year, including $2.9 million of depreciation and amortization,$586,000 for non-cash interest, $124,000 for foreign currency transaction gains,and $75,000 from provision for doubtful accounts.**

# ** **

# **We used $136,000 of cash in the six months ended March 31, 2006 ascompared to a $1.1 million use in the prior year to fund changes in operatingassets and liabilities. The most significant cash flow changes in the currentyear’s quarter relate to the $3.3 million in cash we generated in the sixmonths ended March 31, 2006 from deferred revenue, compared with $1.4 millionin cash generated from deferred revenue in the six months ended March 31, 2005.Strong collection of annual maintenance contracts is common in the first sixmonths of the calendar year. We had particularly strong collections in EMEAduring the second quarter of fiscal 2005. We used $1.7 million of cash toreduce accounts payable and accrued expenses in the six months ended March 31, 2006,as compared to a usage of $1.5 million in the same period of the previousyear.**

# ** **

# **Cash Flows from Investing Activities.****We used $2.5 million of cash ininvesting activities during the six months ended March 31, 2006 and $549,000for the six months ended March 31, 2005. We paid approximately $1.9 million foran acquisition and approximately $547,000 to upgrade and replace some of ourinternal computer hardware and other equipment during the six months endedMarch 31, 2006. We expect investing activities in the remainder of fiscal 2006to consist primarily of internal technology and system upgrades.

# ** **

# **Cash Flows from Financing Activities.**We used $427,000 of cash in financing activities in the six months ended March31, 2006 and $226,000 in the six months ended March 31, 2005. The cash that wasapplied during the six months ended March 31, 2006, primarily related topayments for debt incurred in connection with acquisitions, as well as $408,000in payments of preferred stock dividends, offset by $195,000 of proceeds onissuance of common stock.

# ** **

# **Commitmentsand Capital Adequacy.**As of March31, 2006, our primary commitments 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**

 

OurForm 10-Q contains a number of statements about our future operations. We makestatements regarding anticipated product introductions, changes in markets,customers and customer order rates, expenditures in research and development,growth in revenue, taxation levels, the effects of pricing, and the growth inour foreign operations, all of which represent our expectations and beliefsabout future events. In some cases, you can identify forward-lookingstatements by terminology 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.

 

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•                  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.

 

•                  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. QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There were no materialchanges in market risk for the Company in the period covered by this report.See the Company’s Form 10-K as filed with the SEC on December 20, 2005, for adiscussion of market risk for the Company.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controlsand 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 in thisForm 10-Q fairly present in all material respects the Company’s financialposition, results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles.

 

*Changes in Internal Control overFinancial Reporting.*  Except as noted below, there wereno changes in our internal control over financial reporting that occurredduring the quarter ended March 31, 2006 that materially affected, or that arereasonably likely to materially affect, our internal control over financialreporting.

 

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Although we have not yet been required to assess and report on theeffectiveness of our internal control over financial reporting, we haveconcluded that we did not maintain effective internal controls over accountingfor income taxes required under SFAS No. 109.  Specifically, we didnot maintain effective controls to ensure that the tax accounting wasaccurately presented for unique transactions and situations or that the relatedtax accounting was appropriately reviewed to ensure compliance with generallyaccepted accounting principles.  This control deficiency resulted in therestatement of our interim and annual consolidated financial 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 March 31, 2006.

 

We did not maintain effective controls over the period-end andfinancial reporting process to ensure that our June 30, 2005Form 10-Q was originally filed accurately.  Specifically, in ourrushed attempt to correct the income tax accounting for 2004 by the filingdeadline in the context of the aforementioned control deficiency we filed ourJune 30, 2005 Form 10-Q prior to completion of the usual reviewcontrols and procedures.  The Form 10-Q as originally filed containederrors in the cash flow statement, the restatement footnote and MD&Asections regarding the restatement.  This control deficiency resulted inthe need to amend our June 30, 2005 Form 10-Q.  This controldeficiency could result in a misstatement to the aforementioned 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 March 31, 2006.

 

The tax accounting restatement and restatement of the June 30,2005 Form 10-Q had no impact on net loss, net cash provided by operatingactivities and total stockholders’ equity as previously reported for the fiscalyears ended September 30, 2004 or 2005.

 

*Plans for 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:****

 

•                  conduct additional research

 

•                  increase our internal knowledge base with expanded trainingand education

 

•                  review unique and specialized transactions on acontemporaneous basis

 

•                  add an additional level of management personnel to thereview process

 

•                  establish a formal technical accounting review process. The review process gives specific consideration to accounting and income taximplications of significant discrete period non-routine transactions, such as,but not limited to, acquisitions of businesses or assets or dispositions ofbusinesses or assets. 

 

By implementing these internal controlimprovements, we fully expect to remediate our material weaknesses in internalcontrol over financial reporting by the end of our fiscal year 2006.  

 

Internal control over financial reporting, no matter how well designed,has inherent limitations.  Therefore, even those systems determined to beeffective can provide only reasonable assurance with respect to financialstatement preparation and presentation.  We will continue to improve thedesign and effectiveness of our disclosure controls and procedures and internalcontrol over financial reporting to the extent necessary in the future toprovide our senior management with timely access to such material information,and to correct any deficiencies that we may discover in the future.

 

**PARTII. OTHER INFORMATION**

 

**Item1—Legal Proceedings**

 

We are periodicallyengaged in litigation in the ordinary course of business, including litigationseeking return of software licensing and servicing fees. We do not believe thatany of such litigation is material to our ongoing operations.

 

**Item 1A –Risk Factors**

 

Reference is made to thefactors set forth under the caption “Forward Looking Statements” on pages 3 to6 of our Annual Report on Form 10-K and to the summary of those factors setforth under the sub caption “Forward Looking Statements” of Part 1, Item 2 ofthis Form 10-Q, which are incorporated herein by reference.

 

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**Item2—Unregistered Sales of Equity Securities and Use of Proceeds**.

 

Not applicable.

 

**Item3—Default Upon Senior Securities**

 

Not applicable.

 

**Item4—Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item5—Other Information**

 

Not applicable.

 

**Item 6—Exhibits**

 

31.1                           Certification Pursuant to Section 302 of theSarbanes-Oxley Act – Randal B. Tofteland.

 

31.2                           Certification Pursuant to Section 302 of theSarbanes-Oxley Act – David G. Latzke.

 

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: May 12, 2006 |             |                                                  |
|--------------------|------------------|-------------------------------------------------------|
|               |             |                                                  |
|               | SoftBrands, Inc. |
|               |             |                                                  |
|               | By:              | /s/ DAVID G. LATZKE                                   |   |
|               |             | David G. Latzke                                       |
|               |             | *Senior  Vice President and  Chief Financial Officer* |
|               |             | (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 – David  G. Latzke.     |
|                |       |                                                                                         |
| 32                  |       | Certification  Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                    |

 

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