** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-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 JUNE 30, 2005** |
| ** **                                            | ** ** | ** **                                                                                                                                                                                                                                                                                                         |
| **Or**                                                |
|                                                  |       |                                                                                                                                                                                                                                                                                                               |
| **o**                                                 | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES   EXCHANGE ACT OF 1934**                                                                                                                                                                                                          |
| ** **                                            | ** ** | ** **                                                                                                                                                                                                                                                                                                         |
| ** **                                            | ** ** | **FOR THE TRANSITION PERIOD FROM                         TO                         ** |
| ** **                                            | ** ** | ** **                                                                                                                                                                                                                                                                                                         |
| **Commission file number 0-51118**                    |

 

**SoftBrands****, Inc.**

(Exact name of registrant as specifiedin its charter)

 

| **DELAWARE**                                                             | ** ** | **41-2021446**                           |
|--------------------------------------------------------------------------|------------|------------------------------------------|
| (State or  other jurisdiction of  incorporation or organization)         |       | (I.R.S. Employer  Identification Number) |
| ** **                                                               | ** ** | ** **                               |
| **Two Meridian Crossings, Suite 800  Minneapolis, Minnesota 55423** |
| (Address of  principal executive offices)                                |
| ** **                                                               | ** ** | ** **                               |
| **(612) 851-1500**                                                  |
| (Registrant’s  telephone number, including area code)               |

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  YES ý  NO o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  YES o  NO ý

 

The number of shares of the registrant’s common stock outstanding as ofAugust 10, 2005 was 40,030,000.

 

 

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**Form 10-Q**

**Index**

 
| Part I. | Financial Information                                                                                              |   |
|--------------|--------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.      | Financial Statements                                                                                               |   |
|         | Consolidated Balance Sheets at June 30,  2005 and September 30, 2004                                     |   |
|         | Consolidated Statements of Operations for  the three and nine months ended June 30, 2005 and 2004  (restated) |   |
|         | Consolidated Statements of Cash Flows for  the nine months ended June 30, 2005 and 2004 (restated)            |   |
|         | 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 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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PART I.   FinancialInformation

 

ITEM 1.  FinancialStatements

 

**SoftBrands****, Inc.**

**Consolidated Balance Sheets**

**inthousands, except per share data**

**(unaudited)**

 
| ** **                                                                                                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                 | ** ** | **2005**          | ** ** | **2004**               | ** ** |
| ** **                                                                                                                                 | ** ** | ** **        | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                 | ** ** | ** **        | ** ** | ** **             | ** ** |
| Current  assets                                                                                                                            |       |              |       |                   |       |
| Cash and  cash equivalents                                                                                                                 |       | $                 | 20,458     |                   | $          | 9,719 |   |
| Accounts  receivable, net                                                                                                                  |       | 7,093             |       | 6,289                  |       |
| Prepaid  expenses and other current assets                                                                                                 |       | 1,275             |       | 1,224                  |       |
| Total  current assets                                                                                                                      |       | 28,826            |       | 17,232                 |       |
|                                                                                                                                       |       |              |       |                   |       |
| Furniture,  fixtures and equipment, net                                                                                                    |       | 2,230             |       | 2,382                  |       |
| Restricted  cash                                                                                                                           |       | 716               |       | 846                    |       |
| Goodwill                                                                                                                                   |       | 22,947            |       | 22,947                 |       |
| Intangible  assets, net                                                                                                                    |       | 4,791             |       | 7,917                  |       |
| Other long-term  assets                                                                                                                    |       | 863               |       | 1,127                  |       |
| Total assets                                                                                                                               |       | $                 | 60,373     |                   | $          | 52,451 |   |
| ** **                                                                                                                                 |       |              |       |                   |       |
| **Liabilities  and Stockholders’ Equity**                                                                                             |       |              |       |                   |       |
| Current  liabilities                                                                                                                       |       |              |       |                   |       |
| Current  portion of long-term debt and capital leases                                                                                      |       | $                 | 2,444      |                   | $          | 547 |   |
| Accounts  payable                                                                                                                          |       | 2,498             |       | 2,169                  |       |
| Accrued  expenses                                                                                                                          |       | 5,530             |       | 6,775                  |       |
| Accrued  restructuring costs                                                                                                               |       | 285               |       | 1,214                  |       |
| Deferred  revenue                                                                                                                          |       | 17,920            |       | 18,014                 |       |
| Other  current liabilities                                                                                                                 |       | 1,885             |       | 1,892                  |       |
| Total  current liabilities                                                                                                                 |       | 30,562            |       | 30,611                 |       |
|                                                                                                                                       |       |              |       |                   |       |
| Long-term  debt and capital leases                                                                                                         |       | 16,013            |       | 17,675                 |       |
| Other  long-term liabilities                                                                                                               |       | 385               |       | 594                    |       |
| Total  liabilities                                                                                                                         |       | 46,960            |       | 48,880                 |       |
|                                                                                                                                       |       |              |       |                   |       |
| Stockholders’  equity                                                                                                                 |       |              |       |                   |       |
| Series A  and undesignated preferred stock, $0.01 par value; 10,668 shares authorized;  no shares issued or outstanding               |       |              |       |                   |       |
| Series B  convertible preferred stock, $0.01 par value; 4,332 shares authorized, issued  and outstanding; liquidation value of $4,591 |       | 5,068             |       | 5,068                  |       |
| Common  stock, $0.01 par value; 110,000 shares authorized; 40,030 shares issued and  outstanding                                           |       | 400               |       | 400                    |       |
| Additional  paid-in capital                                                                                                                |       | 172,497           |       | 172,497                |       |
| Accumulated  other comprehensive loss                                                                                                      |       | (1,777            | )          | (1,146                 | )          |
| Accumulated  deficit                                                                                                                       |       | (162,775          | )          | (173,248               | )          |
| Total  stockholders’ equity                                                                                                           |       | 13,413            |       | 3,571                  |       |
| Total  liabilities and stockholders’ equity                                                                                           |       | $                 | 60,373     |                   | $          | 52,451 |   |

 

The accompanying notes are anintegral 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** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                  | ** ** | **June 30,**      | ** ** | **June 30,**     | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                                  | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                  | ** ** | ** **             | ** ** | **(restated)**        | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| **Revenue**                                                                 | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software  licenses                                                          |       | $                      | 3,116      |                  | $          | 2,766 |   | $ | 7,896 |   | $ | 7,074 |   |
| Maintenance                                                                 |       | 10,923                 |       | 10,979                |       | 33,051 |   | 32,903 |   |
| Professional  services                                                      |       | 3,626                  |       | 2,665                 |       | 10,055 |   | 9,130 |   |
| Third-party  software and hardware                                          |       | 1,330                  |       | 775                   |       | 2,656 |   | 2,301 |   |
| Total  revenue                                                              |       | 18,995                 |       | 17,185                |       | 53,658 |   | 51,408 |   |
| ** **                                                                  |       |                   |       |                  |       |   |   |   |   |
| **Cost of  revenues**                                                       |       |                   |       |                  |       |   |   |   |   |
| Software  licenses                                                          |       | 1,376                  |       | 1,234                 |       | 3,584 |   | 3,774 |   |
| Maintenance                                                                 |       | 3,574                  |       | 3,583                 |       | 10,585 |   | 10,997 |   |
| Professional  services                                                      |       | 2,765                  |       | 2,574                 |       | 7,962 |   | 7,738 |   |
| Third-party  software and hardware                                          |       | 1,157                  |       | 532                   |       | 1,987 |   | 1,797 |   |
| Total cost  of revenues                                                     |       | 8,872                  |       | 7,923                 |       | 24,118 |   | 24,306 |   |
| Gross profit                                                                |       | 10,123                 |       | 9,262                 |       | 29,540 |   | 27,102 |   |
| ** **                                                                  |       |                   |       |                  |       |   |   |   |   |
| **Operating  expenses**                                                     |       |                   |       |                  |       |   |   |   |   |
| Selling,  general and administrative                                        |       | 7,300                  |       | 6,543                 |       | 22,382 |   | 19,587 |   |
| Research and  product development                                           |       | 2,213                  |       | 2,242                 |       | 6,242 |   | 6,650 |   |
| Restructuring  related                                                      |       |                   |       | 220                   |       | (261 | ) | 1,711 |   |
| Total  operating expenses                                                   |       | 9,513                  |       | 9,005                 |       | 28,363 |   | 27,948 |   |
| Operating  income (loss)                                                    |       | 610                    |       | 257                   |       | 1,177 |   | (846 | ) |
|                                                                        |       |                   |       |                  |       |   |   |   |   |
| Interest  expense                                                           |       | (1,021                 | )          | (1,043                | )          | (3,046 | ) | (3,311 | ) |
| Change in  value of mandatorily redeemable common stock  warrant            |       |                   |       | 3,102                 |       |   |   | (3,321 | ) |
| Other income  (expense), net                                                |       | 111                    |       | 77                    |       | 298 |   | 59 |   |
| Income  (loss) from continuing operations before provision for income taxes |       | (300                   | )          | 2,393                 |       | (1,571 | ) | (7,419 | ) |
|                                                                        |       |                   |       |                  |       |   |   |   |   |
| Provision  for (benefit from) income taxes                                  |       | (251                   | )          | (764                  | )     | 39 |   | (711 | ) |
| Income  (loss) from continuing operations                                   |       | (49                    | )          | 3,157                 |       | (1,610 | ) | (6,708 | ) |
| ** **                                                                  |       |                   |       |                  |       |   |   |   |   |
| **Discontinued  operations**                                                |       |                   |       |                  |       |   |   |   |   |
| Income (loss)  from discontinued operations, net of tax                     |       | 12,083                 |       | (881                  | )          | 12,083 |   | 1,355 |   |
| Net income  (loss)                                                          |       | $                      | 12,034     |                  | $          | 2,276 |   | $ | 10,473 |   | $ | (5,353 | ) |
| ** **                                                                  |       |                   |       |                  |       |   |   |   |   |
| **Basic  earnings (loss) per common share**                                 |       |                   |       |                  |       |   |   |   |   |
| Continuing  operations                                                      |       | $                      | —     |                  | $          | 0.08 |   | $ | (0.04 | ) | $ | (0.17 | ) |
| Discontinued  operations                                                    |       | $                      | 0.30       |                  | $          | (0.02 | ) | $ | 0.30 |   | $ | 0.03 |   |
| Net income  (loss)                                                          |       | $                      | 0.30       |                  | $          | 0.06 |   | $ | 0.26 |   | $ | (0.13 | ) |
|                                                                        |       |                   |       |                  |       |   |   |   |   |
| **Diluted  earnings (loss) per common share**                               |       |                   |       |                  |       |   |   |   |   |
| Continuing  operations                                                      |       | $                      | —     |                  | $          | 0.07 |   | $ | (0.04 | ) | $ | (0.17 | ) |
| Discontinued  operations                                                    |       | $                      | 0.30       |                  | $          | (0.02 | ) | $ | 0.30 |   | $ | 0.03 |   |
| Net income  (loss)                                                          |       | $                      | 0.30       |                  | $          | 0.05 |   | $ | 0.26 |   | $ | (0.13 | ) |
|                                                                        |       |                   |       |                  |       |   |   |   |   |
| **Weighted  average basic shares outstanding**                              |       | 40,030                 |       | 40,030                |       | 40,030 |   | 40,010 |   |
|                                                                        |       |                   |       |                  |       |   |   |   |   |
| **Weighted  average diluted shares outstanding**                            |       | 40,030                 |       | 44,608                |       | 40,030 |   | 40,010 |   |

 

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

 

4

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**SoftBrands****, Inc.**

**Consolidated Statements of Cash Flows**

**inthousands**

**(unaudited)**

 
| ** **                                                                                               | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                               | ** ** | **June 30,**     | ** ** | **June 30,** | ** ** |
| ** **                                                                                               | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                                                                                     |       |                  |       | **(restated)** |   |
| **Cash  flow from operating activities**                                                                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Loss from  continuing operations                                                                         |       | $                     | (1,610     | ) | $ | (6,708 | ) |
| Adjustments  to reconcile loss from continuing operations to net cash provided by  continuing operations |       |                  |       |   |   |
| Depreciation  and amortization                                                                           |       | 4,336                 |       | 5,393 |   |
| Change in  value of mandatorily redeemable common stock  warrant                                         |       |                  |       | 3,321 |   |
| Noncash interest expense                                                                                 |       | 884                   |       | 1,087 |   |
| Foreign  currency transaction gains (losses)                                                             |       | (221                  | )          | 5 |   |
| Restructuring  related                                                                                   |       | (261                  | )          | 1,711 |   |
| Provision  for doubtful accounts                                                                         |       | 132                   |       | 301 |   |
| Other, net                                                                                               |       |                  |       | 35 |   |
| Change in  operating assets and liabilities                                                              |       |                  |       |   |   |
| Accounts  receivable, net                                                                                |       | (887                  | )          | (372 | ) |
| Prepaid  expenses and other current assets                                                               |       | (23                   | )          | 389 |   |
| Accounts  payable                                                                                        |       | 337                   |       | (2,179 | ) |
| Accrued  expenses                                                                                        |       | (1,320                | )          | (304 | ) |
| Accrued  restructuring costs                                                                             |       | (748                  | )          | (2,831 | ) |
| Deferred  revenue                                                                                        |       | (180                  | )          | 1,212 |   |
| Other  current liabilities                                                                               |       | (36                   | )          | (456 | ) |
| Other  long-term assets and liabilities                                                                  |       | (75                   | )          | (8 | ) |
| Net cash  provided by continuing operations                                                              |       | 328                   |       | 596 |   |
| Net cash  provided by discontinued operations                                                            |       | 12,083                |       | 1,355 |   |
| Net cash  provided by operating activities                                                               |       | 12,411                |       | 1,951 |   |
| **Cash  flow from investing activities**                                                                 |       |                  |       |   |   |
| Purchases of  furniture, fixtures and equipment                                                          |       | (487                  | )          | (691 | ) |
| Capitalized  software development costs                                                                  |       | (216                  | )          |   |   |
| Net cash  used in investing activities                                                                   |       | (703                  | )          | (691 | ) |
| **Cash  flow from financing activities**                                                                 |       |                  |       |   |   |
| Repayment of  long-term debt and capital leases                                                          |       | (338                  | )          | (984 | ) |
| Capitalized  financing costs                                                                             |       |                  |       | (52 | ) |
| Net cash  used in financing activities                                                                   |       | (338                  | )          | (1,036 | ) |
| Effect of  exchange rates on cash balances                                                               |       | (631                  | )          | (132 | ) |
| Change in  cash and cash equivalents                                                                     |       | 10,739                |       | 92 |   |
| **Cash and  cash equivalents**                                                                           |       |                  |       |   |   |
| Beginning of  period                                                                                     |       | 9,719                 |       | 8,976 |   |
| End of  period                                                                                           |       | $                     | 20,458     |   | $ | 9,068 |   |

 

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

 

5

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**SoftBrands****, Inc.**

**Notes to Consolidated Financial Statements**

**(unaudited)**

 

**1.****                                      Basisof Presentation**

 

The unaudited consolidated financialstatements included herein reflect all adjustments, in the opinion ofmanagement, necessary to fairly state the consolidated financial position,results of operations, and cash flows of SoftBrands, Inc.(“the Company”) for the periods presented. These adjustments consist of normal, recurring items unless otherwisenoted.  The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts therein. Due to the inherent uncertainty involved in making estimates, actualresults in future periods may differ from those estimates.  The results of operations for the three andnine months ended June 30, 2005 are not necessarily indicative of theresults to be expected for any subsequent quarter or for the entire fiscal yearending September 30, 2005. These statements do not contain certain information included in theCompany’s annual financial statements and notes.  The accompanying interim consolidatedfinancial statements should be read in conjunction with the financialstatements and related notes included in the Company’s Report on Form 10as filed with the Securities and Exchange Commission (“SEC”) on January 14,2005, and as amended on March 15, 2005, May 6, 2005 and June 24,2005.

 

**2.             Restatement ofConsolidated Financial Statements**

 

SoftBrands has recognized tax benefits inits income from continuing operations in the three- and nine-month periodsended June 30, 2005, and in the nine-month period ended June 30, 2004to the extent that income from discontinued operations has been sheltered bycurrent-period losses from continuing operations.

 

The Company has determined that its accounting for income taxesdescribed in the previous paragraph related to income from discontinuedoperations generated by trust distributions from the AremisSoft LiquidatingTrust in fiscal 2004 and its interim periods included in previous filings withthe Securities and Exchange Commission was incorrect.  The income tax benefit created by the use ofoperating losses to shelter income from discontinued operations as a result oftrust distributions in the nine-month period ended June 30, 2004 was recordednet within income from discontinued operations rather than applied as a taxbenefit to continuing operations as required under SFAS No. 109, *Accounting for Income Taxes*. The consolidated financial statements for the three and nine-monthperiods ended June 30, 2004 discussed and presented herein have been restatedto correct the error resulting in increases of $881,000 and $984,000, respectively,in the income tax benefit in continuing operations. These adjustments areoffset by increases in the income tax provision in discontinued operations asreflected in the table below.  Thisadjustment had no impact on net loss, net cash provided by operating activitiesor total stockholders’ equity as previously reported for the nine month periodended June 30, 2004.

 
| ** **                                                                  | ** ** | **Nine Months Ended**        | ** ** | ** **     | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------|------------|----------------|------------|-----------------------|------------|
| ** **                                                                  | ** ** | **June 30, 2004**            | ** ** | ** **     | ** ** | **June 30, 2004**     | ** ** |
| ** **                                                                  | ** ** | **(as previously reported)** | ** ** | **Adjustment** | ** ** | **(as restated)**     | ** ** |
|                                                                        |       |                         |       |           |       |                  |       |
| Income (loss) from continuing operations  before provision for income taxes |       | $                            | (7,419     | )              |       |                  | $          | (7,419 | ) |
| Provision  for (benefit from) income taxes                                  |       | 273                          |       | $              | (984       | )                     | (711       | ) |
| Income (loss) from continuing operations                                    |       | (7,692                       | )          | 984            |       | (6,708                | )          |
| **Discontinued  operations**                                                |       |                         |       |           |       |                  |       |
| Income from  discontinued operations, net of tax                            |       | 2,339                        |       | (984           | )          | 1,355                 |       |
| Net income (loss)                                                           |       | $                            | (5,353     | )              | $          | —                |       | $ | (5,353 | ) |
| **Basic and diluted earnings (loss) per  common share**                     | ** ** | ** **                   | ** ** | ** **     | ** ** | ** **            | ** ** |
| Continuing operations                                                       |       | $                            | (0.19      | )              | $          | .02                   |       | $ |   | 0.17 |   |
| Discontinued operations                                                     |       | $                            | 0.06       |           | $          | (.03                  | )          | $ | 0.03 |   |
| Net Income (loss)                                                           |       | $                            | 0.13       |           | $          | —                |       | $ | (0.13 | ) |
|                                                                        |       |                         |       |           |       |                  |       |   |   |   |
| **Cash Flow**                                                               |       |                         |       |           |       |                  |       |   |   |   |
| Loss from continuing operations                                             |       | $                            | (7,692     | )              | $          | 984                   |       | $ | (6,708 | ) |
| Net cash provided by (used in) continuing  operations                       |       | $                            | (388       | )              | $          | 984                   |       | $ | 596 |   |
| Net cash provided by discontinued  operations                               |       | $                            | 371        |           | $          | 984                   |       | $ | 1,355 |   |
|                                                                             |            |                              |            |                |            |                       |            |  |  |  |  |

 
| ** **                                                                  | ** ** | **Three Months Ended  June 30, 2004 (as  previously reported)** | ** ** | **Adjustment** | ** ** | **Three Months  Ended June 30,  2004 (as restated)** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | ** **                                                      | ** ** | ** **     | ** ** | ** **                                           | ** ** |
| Income (loss) from continuing operations  before provision for income taxes |       |                                                            | 2,393      |           |       |                                                 | 2,393      |   |
| Provision for (benefit from) income tax                                     |       |                                                            | 130        |           | (894       | )                                                    | (764       | ) |
| Income from continuing operations                                           |       | $                                                               | 2,263      |           | 894        |                                                 | 3,157      |   |
| **Discontinued Operations**                                                 |       |                                                            |       |           |       |                                                 |       |   |
| Income from discontinued operations, net of  tax                            |       | —                                                          |       | (881           | )          | (881                                                 | )          |
| Net Income                                                                  |       | $                                                               | 2,263      |           | $          | 13                                                   |       | $ | 2,276 |   |
|                                                                        |       |                                                            |       |           |       |                                                 |       |
| **Basic earnings per common share**                                         | ** ** | ** **                                                      | ** ** | ** **     | ** ** | ** **                                           | ** ** |
| Continuing  operations                                                      |       | $                                                               | 0.06       |           | $          | .01                                                  |       | $ | .08 |   |
| Discontinued  operations                                                    |       |                                                            |       | $              | (.01       | )                                                    | $          | (.02 | ) |
| Net Income                                                                  |       | $                                                               | 0.06       |           | $          | —                                               |       | $ | 0.06 |   |
|                                                                        |       |                                                            |       |           |       |                                                 |       |
| **Diluted earnings (loss) per common share**                                |       |                                                            |       |           |       |                                                 |       |
| Continuing  operations                                                      |       | $                                                               | 0.05       |           | $          | 0.02                                                 |       | $ | 0.07 |   |
| Discontinued  operations                                                    |       |                                                            |       | $              | (0.02      | )                                                    | $          | (0.02 | ) |
| Net Income  (loss)                                                          |       | $                                                               | 0.05       |           | —     |                                                 | $          | 0.05 |   |

 

**3.****                                      RecentAccounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Boardpublished SFAS No. 123 (revised 2004), *Share-Based Paymen**t*.  SFAS No. 123(R)revises SFAS No. 123, *Accounting for Stock-Based Compensation*, and supersedes APBOpinion No. 25, *Accounting for StockIssued to Employees*.  Therevised statement addresses the accounting for share-based payment transactionswith employees and other third parties, eliminates the ability to account forshare-based payment transactions using APB Opinion No. 25, and requiresthat the compensation costs relating to such transactions be recognized in theconsolidated statement of operations based on the grant-date fair value ofthose instruments.  The revised statementwill be effective for the Company on October 1, 2005.  The Company is currently determining whatimpact the newly issued statement will have on its results of operations andfinancial position.  See the “Stock-BasedCompensation” discussion in Note 4, which includes the pro forma impact ofrecognizing stock-based compensation under SFAS No. 123on the Company’s net income (loss) and income (loss) per common share for thethree and nine months ended June 30, 2005 and 2004.

 

**4.****                                      Stock-BasedCompensation**

 

In accordance with SFAS No. 123, theCompany has elected to account for employee stock-based compensation using theintrinsic value method prescribed in APB Opinion No. 25 and relatedinterpretations.  Accordingly,compensation cost for stock options granted to employees is measured as the excess,if any, of the fair value of the Company’s common stock at the date of thegrant over the amount an employee must pay to acquire the stock.  The Company accounts for stock-basedcompensation to non-employees using the fair value method prescribed by SFAS No. 123. The Company has implemented the disclosure provisions of SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.

 

Pro forma net income (loss) for the three and nine months ended June 30,2005 and 2004 was as follows:

 

6

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| ** **                                                                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                            | ** ** | **June 30,**      | ** ** | **June 30,**     | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| **Thousands**                                                                                         | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                            | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  (loss), as reported                                                                       |       | $                      | 12,034     |                  | $          | 2,276 |   | $ | 10,473 |   | $ | (5,353 | ) |
| Less total  stock-based compensation expense determined under fair value based method for  all awards |       | (392                   | )          | (210                  | )          | (2,056 | ) | (488 | ) |
| Pro forma  net income (loss)                                                                          |       | $                      | 11,642     |                  | $          | 2,066 |   | $ | 8,417 |   | $ | (5,841 | ) |
|                                                                                                  |       |                   |       |                  |       |   |   |   |   |
| Basic income  (loss) per common share                                                                 |       |                   |       |                  |       |   |   |   |   |
| As reported                                                                                           |       | $                      | 0.30       |                  | $          | 0.06 |   | $ | 0.26 |   | $ | (0.13 | ) |
| Pro forma                                                                                             |       | 0.29                   |       | 0.05                  |       | 0.21 |   | (0.15 | ) |
|                                                                                                  |       |                   |       |                  |       |   |   |   |   |
| Diluted  income (loss) per common share                                                               |       |                   |       |                  |       |   |   |   |   |
| As reported                                                                                           |       | $                      | 0.27       |                  | $          | 0.05 |   | $ | 0.26 |   | $ | (0.13 | ) |
| Pro forma                                                                                             |       | 0.26                   |       | 0.05                  |       | 0.21 |   | (0.15 | ) |

 

Options granted to employees under the 2001 Stock Incentive Plan (theonly form of award granted) now vest over a three- to four-year term from thedate of grant.  Vesting of outstandingoptions was accelerated in accordance with the terms of each option agreementto this schedule on March 15, 2005, when the Company’s registrationunder Section 12(g) of Securities Exchange Act of 1934 becameeffective.  As a result, the pro formastock-based compensation expense for the nine months ended June 30, 2005includes an additional $1,019,000 taken in the quarter ended March 31,2005, to record the effect of the acceleration provisions.  As of June 30, 2005, the number ofshares of the Company’s exercisable stock options was 5,995,528.

 

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

 

Net income (loss) per share is computed under the provisions of SFAS No. 128, *Earnings per Share*.  Basic earnings per share is computed usingnet income (loss) and the weighted average number of shares outstanding.  Diluted earnings per share reflects theweighted average number of shares outstanding plus any potentially dilutiveshares outstanding during the period, calculated using the “treasury stock”method.

 

During the nine months ended June 30, 2005, 4,332,000 shares of Series Bconvertible preferred stock issued in August 2004 were not considered inthe calculation of basic earnings per share because the Company had net lossesfrom continuing operations, and based on the contractual terms, the Series Bconvertible preferred stock does not have the obligation to share in the lossesof the Company.  In accordance with EITF 03-6, *Participating Securitiesand the Two-Class Method under FASB Statement No. 128*,the Company’s Series B convertible preferred stock is considered in boththe basic and diluted earnings per share calculations, in those periods inwhich the Company reports net income from continuing operations.  During the nine months ended June 30,2005, 4,332,000 shares of Series B convertible preferred stock and optionsand warrants to purchase 14,852,000 shares of the Company’s common stock werenot considered in the calculation of diluted earnings per share because theCompany had net losses from continuing operations and to do so would have been antidilutive.  Duringthe three months ended June 30, 2004, 4,578,000 shares related to options andwarrants were included in the calculation of diluted earnings per share.  During the nine months ended June 30,2004, options and warrants to purchase 16,986,000 shares of the Company’scommon stock were not considered in the calculation of diluted earnings pershare because the Company had net losses from continuing operations and to doso would have been antidilutive.

 

7

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**6.****                                      DiscontinuedOperations (Restated)**

 

In accordance with the bankruptcy and reorganization plan of AremisSoft Corporation, the Company’s former parent, theCompany retained a 10% interest in the net collections by the Liquidating Trustestablished to pursue litigation claims and collection of assets remaining in AremisSoft after bankruptcy.  In December 2003, the Company received acash distribution of $2.9 million from the Liquidating Trust, which wasrecorded as income from discontinued operations during the first quarter ended December 31,2003.  In addition, the Company recordeda $619,000 charge for additional obligations of the discontinued operations inthe quarter ended December 31, 2003, and a $163,000 benefit in the quarterended March 31, 2004.  These amountswere recorded net of $1.1 million of income tax expense.  In June 2005, the Company receivedanother distribution in the amount of $12.6 million from the Liquidating Trustthat was recorded net of tax of $864,000 as income from discontinuedoperations.  The remaining obligations ofthe Former Parent are included in accrued expenses on the Company’s balancesheet at June 30, 2005.  Theliability represents lease commitments and other costs associated with theFormer Parent’s bankruptcy and resolution efforts.

 

The details of the Company’s relationship with the Former Parent aremore fully described in the Company’s Report on Form 10 filed with the SECon January 14, 2005, as amended on March 15, 2005, May 6, 2005and June 24, 2005.

 

**7.****                                      RestructuringRelated Charges**

 

The following table presents a summary of the Company’s restructuringactivities during the nine months ended June 30, 2005 and the year ended September 30,2004:

 
| ** **                          | ** ** | **Employee**      | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **Severance and** | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Termination**   | ** ** | **Lease**       | ** ** | **Other**  | ** ** | ** ** | ** ** |
| **Thousands**                       | ** ** | **Costs**         | ** ** | **Commitments** | ** ** | **Costs**  | ** ** | **Total**  | ** ** |
| ** **                          | ** ** | ** **        | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at September 30,  2003 |       | $                 | 2,375      |            | $          | 968        |       |       |       | $ | 3,343 |   |
| Restructuring  charges              |       | 302               |       | 1,451           |       | $          | 188        |       | 1,941      |   |
| Adjustments  and reversals          |       |              |       | (991            | )          |       |       | (991       | )          |
| Cash  payments and other (1)        |       | (2,211            | )          | (680            | )          | (166       | )          | (3,057     | )          |
| Non-cash  charges used              |       |              |       |            |       | (22        | )          | (22        | )          |
| Balance at September 30,  2004 |       | 466               |       | 748             |       | —     |       | 1,214      |       |
| Adjustments  and reversals          |       | (81               | )          | (180            | )          |       |       | (261       | )          |
| Cash  payments and other (1)        |       | (149              | )          | (519            | )          |       |       | (668       | )          |
|                                |       |              |       |            |       |       |       |       |       |
| Balance at June 30,  2005      |       | $                 | 236        |            | $          | 49         |       | $          | —     |   | $ | 285 |   |

 

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(1)                      The impact of foreign currency translation isincluded with cash payments.

 

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 ceasedusing two international facilities and recorded restructuring charges of$981,000 for ongoing lease obligations. Of this amount, $785,000 was taken during the nine months of fiscal year2004.  These charges are an extension ofthe September 2003 restructuring program (see below) and reflect theCompany’s desire to consolidate certain of its hospitality and manufacturingoperations.  These costs were expected tobe paid in conjunction with the term of the related leases, which expire by April 2007.  In March 2005, the Company negotiatedearly termination of one of the leases, which resulted in a benefit of$180,000.  There has been no otheractivity related to these restructuring expenses other than the normal monthlycash payments due under the leases.

 

8

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On September 30, 2003, the Company announced a restructuring andreorganization plan that primarily affected the hospitality segment.  The plan’s near-term focus was to supportcurrent customers’ needs and return the business to profitability.  All product strategies and investmentdecisions were re-assessed.  As a result,certain development projects were deferred or cancelled while other projectswere afforded focused efforts to complete. The plan included the closure or consolidation of several offices invarious U.S. and international locations and the elimination of approximately120 positions.  The initial restructuringcharges related to this program were taken in September 2003.  An additional restructuring charge of$490,000 was taken during the year ended September 30, 2004, primarily foradditional employee severance related to the remaining 30 identifiedpositions and contract terminations.  Ofthis amount, $456,000 was taken during the first nine months of fiscal year2004.   During the nine months ended June 30,2005, the Company made cash severance payments of $149,000, and reversed$81,000 of the accrual, due to lower than expected severance costs.  At June 30, 2005, the remaining employeeseverance accrual for this program was $60,000, and this balance is expected tobe paid in the Company’s fiscal year 2005.

 

In December 2001, the Company instituted a restructuring plan toalign its cost structure with its business plan.  Under the restructuring plan, the Companyreduced its workforce by approximately 20%, or 153 positions throughout the organization.  In addition to the employee terminationcosts, charges were taken related to excess leased space at two of the Company’sfacilities.  In conjunction with therestructuring- related charges, the Company estimated future sublease income tooffset the liability.  During the fiscalyear ended September 30, 2004, due to the Company’s inability to negotiateacceptable sublease terms at one of the facilities, additional restructuringcharges of $470,000 were taken.  In September 2004,Company management made the strategic decisions to utilize both of the leasedspaces previously considered excess, and the remaining restructuring accrual of$991,000 was eliminated and a restructuring benefit recorded.  The most significant portion of this reversalrelates to previously unused space at the Company’s headquarters in the UnitedStates.  Following the initiation ofcertain key business partnerships and the related staff increase, the Companychose to utilize the unused space for development, training and general officespace.

 

In conjunction with the acquisition of Fourth Shift Corporation in April 2001,the Company assumed accrued restructuring liabilities related to employeetermination costs and facility consolidation. At June 30, 2005, $176,000 of this restructuring liability wasremaining, and is designated for special retirement benefits that the Companyis obligated to pay for three former employees.

 

**8.****                                      ComprehensiveGain/Loss**

 

Total comprehensive income was $11.9 million and $2.1 million for thethree months ended June 30, 2005 and 2004, respectively.  Total comprehensive income was $9.8 millionfor the nine months ended June 30, 2005, and total comprehensive loss was$5.7 million for the nine months ended June 30, 2004.  Comprehensive gain (loss) differs from netincome (loss) due to foreign currency translation adjustments.

 

**9.**                                      **Goodwill and Intangible Assets**

 

The Company assesses goodwill for impairment under the annualrequirement of SFAS No. 142, *Goodwill and Other Intangible Assets,* orwhen impairment indicators arise.  The Company’s September 30, 2004annual assessment resulted in no impairments.

 

Intangible assets, net were comprised of the following at June 30,2005 and September 30, 2004:

 

9

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| ** **                        | ** ** | **June 30, 2005** | ** ** | **September 30, 2004** | ** ** |
|-----------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **Gross**              | ** ** | ** **                  | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                        | ** ** | **Carrying**           | ** ** | **Accumulated**             | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| **Thousands**                     | ** ** | **Amount**             | ** ** | **Amortization**            | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                              |       |                   |       |                        |       |   |   |   |   |   |   |   |   |
| Acquired  technology              |       | $                      | 20,444     |                        | $          | (16,279 | ) | $ | 4,165 |   | $ | 20,484 |   | $ | (13,304 | ) | $ | 7,180 |   |
| Capitalized  software development |       | 1,093                  |       | (519                        | )          | 574 |   | 877 |   | (305 | ) | 572 |   |
| Other                             |       | 505                    |       | (453                        | )          | 52 |   | 508 |   | (343 | ) | 165 |   |
| Intangible  assets                |       | $                      | 22,042     |                        | $          | (17,251 | ) | $ | 4,791 |   | $ | 21,869 |   | $ | (13,952 | ) | $ | 7,917 |   |

 

Total amortization of intangibles was $1.0 million and $1.2 million forthe three months ended June 30, 2005 and 2004, respectively.  Total amortization of intangibles was $3.3million and $3.7 million for the nine months ended June 30, 2005 and 2004,respectively.  Based on the remaining netcarrying amount of intangibles at June 30, 2005, estimated amortizationexpense for each of the next four years is as follows:

 

**YearEnding September 30 (thousands)**

 
| Remainder of  fiscal year 2005 |   | $     | 1,004  |   |
|--------------------------------|--------|-------|--------|--------|
| 2006                           |   | 2,821 |   |
| 2007                           |   | 910   |   |
| 2008                           |   | 56    |   |
|                           |   | $     | 4,791  |   |
|                                |        |       |        |        |  |

 

**10.****                               Segmentand Geographic Information**

 

The Company discloses segments in accordance with SFASNo. 131, *Disclosures about Segments ofan Enterprise and Related Information*, which establishes standardsfor disclosure of financial information related to operating segments of theCompany as well as disclosure requirements for customer and geographicinformation.  SFASNo. 131 defines an operating segment as a component of a company for whichoperating results are reviewed regularly by the chief operating decision-makerto determine resource allocation and assess performance.  The Company has two reportable segments underthe guidelines of SFAS No. 131:  manufacturing and hospitality.  Manufacturing and hospitality derive theirrevenues from licensing proprietary software systems; providing customersupport, training, consulting and installation services related to software;and reselling complementary third-party software licenses and hardware.

 

As part of the restructuring of hospitality operations begun in September 2003,the Company consolidated some of the operational and strategic management ofthe two reportable segments.  Also as aresult of this consolidation, some of the expenses that were previouslyincurred within the operational segments are now classified as part ofcorporate expense.  Prior year segmentinformation is reclassified to conform to this new presentation.

 

Financial information by segment is summarized in the followingtable.  Total assets are not allocated tomanufacturing and hospitality for internal reporting purposes.

 

10

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| ** **     | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------|------------|--------------------------------------|------------|
| ** **     | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Thousands**  | ** ** | **Revenue**                          | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating Income  (Loss)** | ** ** |
| ** **     | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing  |       | $                                    | 13,097     |   | $ | 4,113 |   | $ | 12,515 |   | $ | 2,334 |   |
| Hospitality    |       | 5,898                                |       | 336 |   | 4,670 |   | 924 |   |
| Corporate      |       |                                 |       | (3,839 | ) |   |   | (3,001 | ) |
|           |       |                                 |       |   |   |   |   |   |   |
| Total  Company |       | $                                    | 18,995     |   | $ | 610 |   | $ | 17,185 |   | $ | 257 |   |
|                |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **     | ** ** | **Nine Months Ended June 30,** | ** ** |
|----------------|------------|-------------------------------------|------------|
| ** **     | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| **Thousands**  | ** ** | **Revenue**                         | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue** | ** ** | **Operating  Income  (Loss)** | ** ** |
|           |       |                                |       |   |   |   |   |   |   |
| Manufacturing  |       | $                                   | 37,469     |   | $ | 10,481 |   | $ | 37,042 |   | $ | 7,616 |   |
| Hospitality    |       | 16,189                              |       | 2,267 |   | 14,366 |   | 598 |   |
| Corporate      |       |                                |       | (11,571 | ) |   |   | (9,060 | ) |
|           |       |                                |       |   |   |   |   |   |   |
| Total  Company |       | $                                   | 53,658     |   | $ | 1,177 |   | $ | 51,408 |   | $ | (846 | ) |

 

**Revenue by geographic area for periodspresented is as follows:**

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Thousands**                          | ** ** | **Manufacturing**                    | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| **Geography:**                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Americas                               |       | $                                    | 8,035      |   | $ | 1,705 |   | $ | 9,740 |   | $ | 7,728 |   | $ | 1,792 |   | $ | 9,520 |   |
| Europe,  Middle East & Africa |       | 3,305                                |       | 3,612 |   | 6,917 |   | 3,084 |   | 2,251 |   | 5,335 |   |
| Asia Pacific                           |       | 1,757                                |       | 581 |   | 2,338 |   | 1,703 |   | 627 |   | 2,330 |   |
|                                   |       | $                                    | 13,097     |   | $ | 5,898 |   | $ | 18,995 |   | $ | 12,515 |   | $ | 4,670 |   | $ | 17,185 |   |

 
| ** **                             | ** ** | **Nine  Months Ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Thousands**                          | ** ** | **Manufacturing**                    | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| **Geography:**                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Americas                               |       | $                                    | 22,977     |   | $ | 5,801 |   | $ | 28,778 |   | $ | 22,641 |   | $ | 5,789 |   | $ | 28,430 |   |
| Europe,  Middle East & Africa |       | 9,437                                |       | 8,502 |   | 17,939 |   | 9,698 |   | 6,698 |   | 16,396 |   |
| Asia Pacific                           |       | 5,055                                |       | 1,886 |   | 6,941 |   | 4,703 |   | 1,879 |   | 6,582 |   |
|                                   |       | $                                    | 37,469     |   | $ | 16,189 |   | $ | 53,658 |   | $ | 37,042 |   | $ | 14,366 |   | $ | 51,408 |   |

 

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**11.****                               SubsequentEvents**

 

On August 4, 2005, SoftBrandsand Capital Resource Partners IV, L.P. (“CRP”) executed Amendment No. 4 tothe Senior Subordinated Secured Note and Warrant Purchase Agreement dated November 26,2002 ( as amended, the “Agreement”), the agreement pursuant to which SoftBrands borrowed $20.0 million represented by a SeniorSubordinated Secured Note Due 2008 (the “Note”).  In accordance with Amendment No. 4, SoftBrands prepaid $8.0 million principal amount, plusaccrued interest, on the Note, plus a redemption premium of $190,000.  The remaining principal balance of the Note wastherefore $12.0 million.  Amendment No. 4also (1) adjusted the remaining principal payments so that they would haveoccurred $3.0 million on December 31, 2006, $4.0 million on December 31,2007 and $5 million on December 31, 2008; (2) added as events thatrequire SoftBrands to prepay the principal amountsoutstanding under the Note, any debt financing that generates more than $7.0million, and any equity financing (other than for benefit plans oracquisitions) that generates more than $100,000 of gross proceeds; (3) requiredSoftBrands to pay a redemption premium of $390,000 forprepaying the Note prior to September 30, 2006; (4) reduced to $7.2million the EBITDA requirement for rolling 12-monthperiods ending with each fiscal quarter end; and (5) reduced to 1.0  the fixed charge coverage ratio for each such12-month period (except the 12 months ending June 30, 2006, which wasreduced to 0.50).

 

On August 17, 2005, the Company sold to ABRYMezzanine Partners, L.P. and Capital Resource Partners IV, L.P., 18,000 Sharesof Series C Convertible Preferred Stock (the “Series C PreferredStock”) and warrants to purchase 1,200,000 shares of common stock (the “Warrants”)for a total of $18 million.  Each share of Series C Preferred Stock

 

•      hasa nominal face value of $1,000;

•      carriesa mandatory dividend, whether or not earned or declared, of 6% of its facevalue per annum (paid in two semi-annual installments, commencing December 31,2005);

•      hasa preference in payments upon liquidation over common stock and on a par withthe Series B Preferred Stock equal to its face value plus accrued andunpaid dividends;

•      isconvertible into common stock at any time at $2.01 per share, subject to priceanti-dilution protection on a weighted average basis for new issuances by theCompany below the conversion price or below 80% of market price; and

•      maybe redeemed by the Company at par plus accrued dividends, or automatically convertedinto common stock, commencing on August 17, 2007, subject to satisfactionof a number of conditions, including market price conditions.

 

The holders of the Series C Preferred Stock also have the right toelect, by 75% vote, one director of the Company and the right to approve thecreation of classes of senior stock, the payment of dividends on, or redemptionof, other classes of stock, and amendments to the Company’s articles and bylawsthat effect the rights of the Series C Preferred Stock.  The SeriesC Preferred Stock otherwise votes on an as converted basis with commonstock.  The Warrants are exercisable at$2.11 per share, subject to the same price anti-dilution provisions, containcash-less exercise rights and expire on August 17, 2015.  The associatedpurchase agreement contains a number of affirmative and negative covenants,including a covenant not to sell the Company during the first three yearsunless the sale generates proceeds to the investors in the Series CPreferred Stock of 175% of their purchase price and a covenant not to incurdebt over specified levels.  The purchase agreement also provides theinvestors with information and access rights, and a right of first refusal onprivate issuances of the Company’s securities (subject to exceptions).Violation of some of the covenants creates a right of the purchasers to causethe Company to consider a sale process. The investors received registrationrights under a separate investor rights agreement.  Proceeds, net oftransaction cost of Series C Preferred Stock will be recorded as anincrease to the Company’s equity.

 

On August 4, 2005, the Company restructured its debt agreementwith CRP and retired $8.0 million of its outstanding $20.0 million ofdebt.  On August 17, 2005, in conjunction with sale of Series CPreferred Stock and Warrants described above, the Company retired the balanceof the $20.0 million of debt owed to CRP.  As a result, the Companyexpects to record a charge of approximately $2.7 million from the acceleratedamortization of previously capitalized financing costs and original issue debtdiscount related to the CRP debt, as well as consent fees, prepayment fees andfinancing fees of approximately $800,000.

 

12

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**ITEM 2.**

 

**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 contains forward-looking statements based upon currentexpectations that involve risks and uncertainties.  Our actual results may differ materially fromthose anticipated in these forward-looking statements as a result of variousfactors, including those set forth in more detail in the “Forward-LookingStatements” section below.  Weundertake no obligation to update any information in our forward-lookingstatements.*

 

**Business Overview**

 

We provide enterprise software and supportsolutions to over 4,000 customers in more than 60 countries.  We areorganized into two reportable segments:  manufacturing andhospitality.  Our manufacturing businessdesigns, develops and sells enterprise resource planning software and servicesto small- to mid-sized manufacturing concerns.  Our principal products inthis segment include***Fourth Shift*,** our core manufacturing enterprise softwaresolution aimed at small- to mid-sized manufacturers;***evolution***, asoftware system designed to serve niche manufacturing markets that isparticularly suitable for ‘converter’ manufacturers;***Demand Stream***, alean enterprise automation software system that was introduced in 2003; and***Fourth Shift Edition for SAPBusiness One***, our newest product, in which Fourth Shift isintegrated with SAP’s Business One product suite for sale by SoftBrands and SAP’sbusiness partners to mid-sized manufacturers.

 

Our hospitality business designs, develops andsells software and services that support the enterprise information managementneeds of hotels and resorts.  Principal products in the hospitalitysegment include***Medallion***, a Windows-based property management system designedprimarily for medium-service independent hotels and hotel chains;***PORTfolio***, a comprehensiveclient/server hotel system for both the front- and back-office operations ofsingle-site and multi-property hotels; and***RIO***, a leisure management system thatsupports the activities of spas, health clubs and resorts.

 

We derive revenue in both of our reportablesegments by selling licenses to use our software products and providingservices required to maintain, install, implement, and in some cases tocustomize our products.  On occasion, we also sell hardware products ofthird-party vendors on a distribution basis and sell licenses to third-partysoftware programs for the convenience of our customers.  Our softwarelicense revenue is heavily influenced by the timing of customer purchases andinstallations and the terms under which we sell software licenses.  Oursoftware maintenance revenue, which currently constitutes the majority of ourrevenue, is derived primarily from one-year contracts that require payment atthe beginning of the contract term and under which we recognize revenue ratablyover the one-year contract period.  Our other services revenue is normallyrecognized over the time services are performed.

 

We have successfully established low-costdevelopment and support operations in India and China to help maintain ourcompetitive position in the marketplace.  We employ 67 people in India at June 30,2005 who directly support product development and customer service.  This includes 20 who support manufacturing,29 who support hospitality, and 18 who occupy development roles.  We have 31 employees in China to supportmanufacturing development.

 

Both the timing of new product introductions and savings fromorganizational restructurings completed in 2004 benefited our operations duringthe three- and nine- month periods ended June 30, 2005.  We introduced Medallion 6.0; the newestversion of what we expect will be our leading hospitality software product, on January 24,2005.  We have witnessed an increasing interest in this product beginningin late January and total revenue from new Medallion license salesincreased in both the quarter ended March 31, 2005 and the quarter ended June 30,2005.  We expect this trend tocontinue.  Today there are more than

 

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750 Medallion systems installed around theworld. We also released Fourth Shift Edition for SAP Business One, which weexpect to be our leading manufacturing product, on April 29, 2005. As of June 30, 2005, we had signed contracts with 12 customers fordelivery of Fourth Shift Edition and had been able to recognize more than $560,000of total revenue related to this product.

 

**Restatement of Consolidated Financial Statements**

 

SoftBrands has recognized tax benefits in its income from continuingoperations in the three- and nine-month periods ended June 30, 2005, andin the nine-month period ended June 30, 2004 to the extent that incomefrom discontinued operations has been sheltered by current-period losses fromcontinuing operations.

 

As further described in Note2 to the Consolidated Financial Statements of this Form 10-Q, we havedetermined that our accounting for income taxes described in the previousparagraph related to income from discontinued operations generated by trustdistributions in fiscal 2004 and our interim periods included in previousfilings with the Securities and Exchange Commission was incorrect.  The income tax benefit created by the use ofoperating losses to shelter income from discontinued operations as a result oftrust distributions in the nine month period ended June 30, 2004 was recordednet within income from discontinued operations rather than applied as a taxbenefit to continuing operations as required under SFAS No. 109, *Accounting for Income Taxes*. The consolidated financial statements for three and nine-month periodsended June 30, 2004 discussed and presented herein have been restated to correctthe error resulting in increases of $881,000 and $984,000, respectively, in theincome tax benefit in continuing operations and offsetting increases in theincome tax provision in discontinued operations.  This adjustment had no impact on net loss,net cash provided by operating activities or total stockholders’ equity as previouslyreported for the nine month period ended June 30, 2004. Our nine-month loss pershare for fiscal 2004 from continuing operations was improved by $0.03 pershare as a result of this correction, while earnings per share fromdiscontinued operations decreased by a similar amount.

** **

**Critical Accounting Policies and Estimates**

 

Thepreparation of the financial information contained in this Form 10-Qrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  Weevaluate these estimates on an ongoing basis, including those related torevenue recognition, the valuation allowance for deferred tax assets, thevaluation of our accounts receivable, the valuation of our intangible assets (includinggoodwill), and the recording of restructuring charges.  There have been no material changes to thecritical accounting policies as discussed in greater detail in the Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in our Form 10 as filed with the SEC on January 14, 2005, asamended on March 15, 2005, May 6, 2005 and June 24, 2005.

 

**Resultsof Operations**

 

For the three monthsended June 30, 2005, we reported total revenue of $19.0 million and netincome of $12.0 million, or $0.30 per diluted share, compared to total revenueof $17.2 million and net income of $2.3 million, or $0.05 per diluted share,for the same period in 2004.  The netincome in the 2005 quarter includes net loss of $49,000 from continuingoperations, plus income from discontinued operations of $12.1 million, or $0.30per share, while the net income in the 2004 quarter included the revaluation of$3.1 million related to a mandatorily redeemable common stock warrant.  The income from discontinued operations inthe 2005 quarter reflects a $12.6 million distribution from the AremisSoftLiquidating Trust.  Gross profitincreased 9.3% to $10.1 million for the three months ended June 30, 2005from $9.3 million during the same three months in fiscal 2004, while operatingexpense increased to $9.5 million in 2005 from $9.0 million in 2004, or anincrease of 5.6%.

 

For the nine months endedJune 30, 2005, total revenue was $53.7 million and net income was $10.5million, or $0.26 per diluted share, compared to revenue of $51.4 million and anet loss of $5.4 million, or $0.13 per diluted share, for the same nine monthsin 2004.  Net income for 2005 includes anet loss of $1.6 million, or $0.04 per share, from continuing operations, and incomeof $12.1 million, or $0.30 per share, from discontinued operations, againreflecting the $12.6 million cash distribution from the Liquidating Trust.  The net loss for the nine months ended June 30,2004 includes a net loss of $6.7 million, or $0.17 per share from continuingoperations offset by income from discontinued operations of $1.4 million.  Gross profit increased 9.0% to $29.5 millionin fiscal 2005 from $27.1 million in fiscal 2004, while operating expenseincreased to $28.4 million from $28.0 million, an increase of 1.5%.

 

Thefollowing table summarizes revenue and operating results by reportable segmentfor the three and nine months ended June 30, 2005 and 2004:

 

14

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| ** **     | ** ** | **Three Months Ended June 30,** | ** ** | ** **                   | ** ** | ** **   | ** ** |
|----------------|------------|--------------------------------------|------------|------------------------------|------------|--------------|------------|
| ** **     | ** ** | **2005**                             | ** ** | **2004**                     | ** ** | **% Change** | ** ** |
| **Thousands**  | ** ** | **Revenue**                          | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue**  | ** ** | **Operating Income  (Loss) (1)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **     | ** ** | ** **                           |       |                         |       |         |       |   | ** ** | ** ** |   |   |   |
| Manufacturing  |       | $                                    | 13,097     |                         | $          | 4,113        |       | $ | 12,515 |   | $ | 2,334 |   | 4.7 | % | 76.2 | % |
| Hospitality    |       | 5,898                                |       | 336                          |       | 4,670        |       | 924 |   | 26.3 | % | (63.6 | )% |
| Corporate      |       |                                 |       | (3,839                       | )          |         |       | (3,001 | ) |   |   | 27.9 | % |
|           |       |                                 |       |                         |       |         |       |   |   |   |   |   |   |
| Total  Company |       | $                                    | 18,995     |                         | $          | 610          |       | $ | 17,185 |   | $ | 257 |   | 10.5 | % | 137.4 | % |

 
| ** **     | ** ** | **Nine Months Ended June 30,** | ** ** | ** **                   | ** ** | ** **   | ** ** |
|----------------|------------|-------------------------------------|------------|------------------------------|------------|--------------|------------|
| ** **     | ** ** | **2005**                            | ** ** | **2004**                     | ** ** | **% Change** | ** ** |
| **Thousands**  | ** ** | **Revenue**                         | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue**  | ** ** | **Operating Income  (Loss) (1)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **     | ** ** | ** **                          |       |                         |       |         |       |   |   |   |   |   |   |
| Manufacturing  |       | $                                   | 37,469     |                         | $          | 10,481       |       | $ | 37,042 |   | $ | 7,616 |   | 1.2 | % | 37.6 | % |
| Hospitality    |       | 16,189                              |       | 2,267                        |       | 14,366       |       | 598 |   | 12.7 | % | 279.1 | % |
| Corporate      |       |                                |       | (11,571                      | )          |         |       | (9,060 | ) |   |   | 27.7 | % |
|           |       |                                |       |                         |       |         |       |   |   |   |   |   |   |
| Total  Company |       | $                                   | 53,658     |                         | $          | 1,177        |       | $ | 51,408 |   | $ | (846 | ) | 4.4 | % | (239.1 | )% |

 

----

(1) Certainreclassifications were made to unallocated corporate expenses in fiscal 2004 toconform with the 2005 presentation.

 

Our total revenueincreased $1.8 million, or 10.5%, in the three months ended June 30, 2005compared to the three months ended June 30, 2004, comprising a 4.7%increase in manufacturing revenue and a 26.3% increase in hospitalityrevenue.  Our operating income increased $353,000in the three months ended June 30, 2005.  This increase consisted of a $1.8 million increasein the manufacturing group, offset by a $588,000 decrease in the hospitalitygroup and by increased corporate expenses of $838,000.  The corporate costs include unallocatedshared services charges such as executive management, finance, marketing, IT,legal, and audit expenses, among others. The improvement in manufacturing operating income includes a $745,000increase in gross profit combined with an overall reduction in operatingexpenses.  The hospitality decrease inoperating income is due to increased selling and general and administrativeexpenses as we rebuild this business unit for growth, offset by $116,000 ofincreased gross profits.  Outside costsassociated with our Sarbanes-Oxley internal control project accounted forapproximately $300,000 of the increase in corporate expense in the quarter.  The remainder of the change is due to generalincreases in the cost of shared services and expanded marketing programs, aswell as the costs of being subject to a public reporting requirements.

 

Our total revenueincreased $2.3 million, or 4.4%, in the nine months ended June 30, 2005compared to the nine months ended June 30, 2004, comprising a 1.2%increase in manufacturing revenue and a 12.7% increase in hospitalityrevenue.  Our operating income increasedto $1.2 million in the nine months ended June 2005 from an operating lossof $846,000 in the nine months ended June 30, 2004, reflecting increasesof $2.9 million in operating income from our manufacturing group and $1.7million in operating income from our hospitality group, partially offset by anincrease of $2.5 million in corporate expenses. The increase in manufacturing operating income is due to $1.4 million ofincreased gross profit, the absence of restructuring expenses in the currentperiod, and reduced operating expenses. The hospitality improvement in operating income is attributable to a $1.1million increase in gross margin, a $1.3 million decrease in restructuringexpenses, including $261,000 of restructuring reversals during the secondquarter of 2005, offset by increased operating expenses.  Operating income in the hospitality segmentcontinues to be affected by spending on development and sales of the Medallionproduct in advance of

 

15

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revenue from thatproduct, and decreasing maintenance revenue. The corporate change includes approximately $1.2 million in Sarbanes-Oxleycompliance costs in 2005, increases in shared services, increased marketing andthe costs of being a public reporting company.

 

As part of therestructuring of our hospitality operations begun in September 2003, weconsolidated some of the operational and strategic management of our two operationalsegments.  Also as a result of thisconsolidation, some of the expenses that were previously incurred within ourreportable segments are now classified as part of our corporate group.  When practical, prior year segmentinformation has been reclassified to conform to this new presentation.

 

**Revenue. **The following table summarizes revenue byreportable segment, revenue type and geography for the three and nine months ended June 30,2005 and 2004:

 
| ** **                             | ** ** | **Three  Months Ended June 30,** | ** ** | ** **      | ** ** | ** **    | ** ** | ** **        | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|-----------------|------------|---------------|------------|-------------------|------------|
| ** **                             | ** ** | **2005**                              | ** ** | **2004**        | ** ** | **%  change** | ** ** |
| **Thousands**                          | ** ** | **Manufacturing**                     | ** ** | **Hospitality** | ** ** | **Total**     | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                                   |       |                                  |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue Type:**                      |       |                                  |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software  licenses                     |       | $                                     | 2,169      |            | $          | 947           |       | $                 | 3,116      |   | $ | 2,408 |   | $ | 358 |   | $ | 2,766 |   | (9.9 | )% | 164.5 | % | 12.7 | % |
| Maintenance                            |       | 7,724                                 |       | 3,199           |       | 10,923        |       | 7,520             |       | 3,459 |   | 10,979 |   | 2.7 | % | (7.5 | )% | (0.5 | )% |
| Professional  services                 |       | 2,831                                 |       | 795             |       | 3,626         |       | 2,213             |       | 452 |   | 2,665 |   | 27.9 | % | 75.9 | % | 36.1 | % |
| Third-party  software and hardware     |       | 373                                   |       | 957             |       | 1,330         |       | 374               |       | 401 |   | 775 |   | (0.3 | )% | 138.7 | % | 71.6 | % |
|                                   |       | $                                     | 13,097     |            | $          | 5,898         |       | $                 | 18,995     |   | $ | 12,515 |   | $ | 4,670 |   | $ | 17,185 |   | 4.7 | % | 26.3 | % | 10.5 | % |
|                                   |       |                                  |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                         |       |                                  |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                               |       | $                                     | 8,035      |            | $          | 1,705         |       | $                 | 9,740      |   | $ | 7,728 |   | $ | 1,792 |   | $ | 9,520 |   | 4.0 | % | (4.9 | )% | 2.3 | % |
| Europe,  Middle East & Africa |       | 3,305                                 |       | 3,612           |       | 6,917         |       | 3,084             |       | 2,251 |   | 5,335 |   | 7.2 | % | 60.5 | % | 29.7 | % |
| Asia  Pacific                          |       | 1,757                                 |       | 581             |       | 2,338         |       | 1,703             |       | 627 |   | 2,330 |   | 3.2 | % | (7.3 | )% | 0.3 | % |
|                                   |       | $                                     | 13,097     |            | $          | 5,898         |       | $                 | 18,995     |   | $ | 12,515 |   | $ | 4,670 |   | $ | 17,185 |   | 4.7 | % | 26.3 | % | 10.5 | % |

 
| ** **                             | ** ** | **Nine  Months Ended June 30,** | ** ** | ** **      | ** ** | ** **    | ** ** | ** **        | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|---------------|------------|-------------------|------------|
| ** **                             | ** ** | **2005**                             | ** ** | **2004**        | ** ** | **%  change** | ** ** |
| **Thousands**                          | ** ** | **Manufacturing**                    | ** ** | **Hospitality** | ** ** | **Total**     | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                                   |       |                                 |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue Type:**                      |       |                                 |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software  licenses                     |       | $                                    | 5,609      |            | $          | 2,287         |       | $                 | 7,896      |   | $ | 6,051 |   | $ | 1,023 |   | $ | 7,074 |   | (7.3 | )% | 123.6 | % | 11.6 | % |
| Maintenance                            |       | 22,991                               |       | 10,060          |       | 33,051        |       | 22,168            |       | 10,735 |   | 32,903 |   | 3.7 | % | (6.3 | )% | 0.4 | % |
| Professional  services                 |       | 7,871                                |       | 2,184           |       | 10,055        |       | 7,472             |       | 1,658 |   | 9,130 |   | 5.3 | % | 31.7 | % | 10.1 | % |
| Third-party  software and hardware     |       | 998                                  |       | 1,658           |       | 2,656         |       | 1,351             |       | 950 |   | 2,301 |   | (26.1 | )% | 74.5 | % | 15.4 | % |
|                                   |       | $                                    | 37,469     |            | $          | 16,189        |       | $                 | 53,658     |   | $ | 37,042 |   | $ | 14,366 |   | $ | 51,408 |   | 1.2 | % | 12.7 | % | 4.4 | % |
|                                   |       |                                 |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                         |       |                                 |       |            |       |          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                               |       | $                                    | 22,977     |            | $          | 5,801         |       | $                 | 28,778     |   | $ | 22,641 |   | $ | 5,789 |   | $ | 28,430 |   | 1.5 | % | 0.2 | % | 1.2 | % |
| Europe,  Middle East & Africa |       | 9,437                                |       | 8,502           |       | 17,939        |       | 9,698             |       | 6,698 |   | 16,396 |   | (2.7 | )% | 26.9 | % | 9.4 | % |
| Asia  Pacific                          |       | 5,055                                |       | 1,886           |       | 6,941         |       | 4,703             |       | 1,879 |   | 6,582 |   | 7.5 | % | 0.4 | % | 5.5 | % |
|                                   |       | $                                    | 37,469     |            | $          | 16,189        |       | $                 | 53,658     |   | $ | 37,042 |   | $ | 14,366 |   | $ | 51,408 |   | 1.2 | % | 12.7 | % | 4.4 | % |

 

*Manufacturing Segment*:  Our license revenue from manufacturingsoftware decreased by $239,000, or 9.9% in the three months ended June 30,2005 compared to the three months ended June 30, 2004, and

 

16

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decreased by $442,000, or7.3%, in the nine months ended June 30, 2005 compared to the same periodin 2004.  The decrease was due to anumber of factors, including a $292,000 decrease in the three-month period anda $630,000 decrease in the nine-month period in revenue from licenses of ourFourth Shift product, and a $36,000 decrease in the three-month period and a $202,000decrease in the nine-month period in revenue from our evolution product.  Reduced revenue for Fourth Shift was at leastpartially attributable to increased marketing for our newly-released Fourth ShiftEdition for SAP Business One and the transfer of some of our U.S. sales forcefrom Fourth Shift to Fourth Shift Edition. We deferred all revenue for Fourth Shift Edition until after its generalrelease in April 2005.  Consistentwith this release and the shipment of product, we recorded $340,000 in license revenuefrom Fourth Shift Edition in the third quarter of fiscal 2005.  Also for the quarter ended June 30,2005, license revenue from the sale of Demand Stream decreased by $263,000compared to the same period in 2004, but is showing a slight increase in year-over-yearcomparison.

 

We continue to believeFourth Shift Edition will generate overall license revenue growth for thissegment.  We are seeing increased interestin this new product as our sales effort is refined along with an expanding pipelineof opportunities as we continue to develop new functionality and improveexisting performance. As of June 30, 2005, we had delivered Fourth ShiftEdition to 12 customers, 10 of them in the U.S.

 

Our maintenance revenuefor manufacturing products increased by $204,000, or 2.7%, during the quarterended June 30, 2005 as compared to the quarter ended June 30, 2004and increased by $823,000, or 3.7%, during the nine months ended June 30,2005 compared to the same period in 2004. The growth in manufacturing maintenance revenue resulted from continuedlow attrition rates, an increase in new software sales (and therefore newactive accounts), and customer adoption of new services in our Americas region (suchas our remote system management service) that were not available in the prioryear.  These new services generatedrevenue of $103,000 for the quarter, and a total of $310,000 year-to-date.  Professional services revenue increased 27.9%during the three months ended June 30, 2005 compared to the three monthsended June 30, 2004 and increased 5.3% during the nine months ended June 30,2005 compared to the same period in 2004. The increase in professional services revenue is due to implementationand consulting resources related to the Fourth Shift Edition product.  Third party software and hardware revenue was flatin the three-month period and decreased by $353,000 in the nine-month period comparedto the same period of 2004 due in large part to two specific hardware orders in2004 which did not recur in fiscal 2005. Sales of third party hardware and software products are generally doneas a courtesy to provide a full solution to our customers.  Our revenue and gross profit from third partyproducts will fluctuate based on mix and customer demand.

 

Geographically, the AsiaPacific region is still experiencing consistent growth on both a quarterly andyear-to-date basis, and we expect this to continue as the Chinese economycontinues to expand.  Much of the customerdemand in China comes from existing U.S. Fourth Shift customers with facilitiesin China.  On the quarter comparison, theEurope, Middle East & Africa (“EMEA”) region is reporting an increasein total revenue of $221,000, or 7.2%, over the same quarter in 2004.  This region reported lower revenue in 2005than 2004 year-to-date due to large contracts in 2004. However, there has beenextensive transitioning in its sales strategy and the region is beginning to benefitfrom this change.  We believe this changewill strengthen the region’s long-term performance.  The Americas region reported some reductionin license revenue due to our shift in sales and marketing efforts to newproducts.  The Americas region has beensuccessful, however, in offsetting some of the license revenue declines withrevenue from its remote systems management maintenance support product, and hasstarted to see some positive trends in Americas manufacturing license revenuewith the release of Fourth Shift Edition during this quarter.

 

*Hospitality Segment*:  Total hospitality revenue increased $1.2million, or 26.3%, in the three months ended June 30, 2005 compared to theprior year and increased $1.8 million, or 12.7%, in the nine-month period.  The increase during the three-month periodover the prior year was a result of the recognition of $1.2 million of revenuepreviously deferred due to acceptance provisions of an agreement with acustomer.  The nine-month period includesa large custom development project to add time share capability to ourPORTfolio product, which was completed during the quarter ended March 31,2005.  Overall, there is a generaldecline in the number of new PORTfolio license sales that is being offset bygrowth in Medallion

 

17

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sales.  Revenue in both the three- and nine-monthperiods in 2004 was unusually low because we stopped actively sellinghospitality products in all but the EMEA region in September 2003 andinstead focused on stabilization and enhancement of Medallion for the U.S.market.  Renewed sales efforts in fiscal2005, along with the completion of the already mentioned PORTfolio project, aregenerating positive results.

 

Software license revenue fromour hospitality products increased to $947,000 during the three months ended June 30,2005 from $358,000 during the three months ended June 30, 2004, and to$2.3 million during the nine months ended June 30, 2005 from $1.0 million duringthe nine months ended June 30, 2004. The increase during both periods was attributable to license revenuepreviously deferred due to outstanding development commitments and stabilizationof PORTfolio with the release of Version 3.1. The declines in hospitality maintenance revenue of 7.5% during the threemonths ended June 30, 2005 and 6.3% during the nine months ended June 30,2005 from the comparable periods in 2004 were due to a number of factorsincluding normal attrition and lower replacement from new license revenues.

 

There was a 75.9% increasein professional services revenue during the three months ended June 30,2005 and a 31.7% increase during the nine months ended June 30, 2005 overthe comparable periods in 2004.  This isdue to the completion of large custom development projects along with morebillable projects.

 

Geographically, the smallincrease in hospitality revenue in the Americas region was due to a custom developmentproject.  The increase in revenue in theEMEA region was due primarily to recognition of previously deferred revenue andsales of Medallion throughout the region with the release of Medallion 6.0.  The EMEA region also realized added revenuefrom the migration of existing customers to PORTfolio 3.1, as well as growth inprofessional services revenue.  Theregion is also experiencing strong business partner activity in central Europe.

 

**Gross Margin. **The following table summarizes gross marginpercentages by reportable segment and revenue type for the three and nine months ended June 30,2005 and 2004:

 

18

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| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **Manufacturing**                    | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Software  licenses                 |       | 55.3                                 | %          | 57.0 | % | 55.8 | % | 57.8 | % | 38.8 | % | 55.4 | % |
|                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance                        |       | 77.4                                 | %          | 42.8 | % | 67.3 | % | 74.6 | % | 51.7 | % | 67.4 | % |
|                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Professional  services             |       | 27.7                                 | %          | 9.7 | % | 23.7 | % | 5.3 | % | (5.3 | )% | 3.5 | % |
|                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Third-party  software and hardware |       | 29.8                                 | %          | 6.5 | % | 13.0 | % | 57.0 | % | 7.2 | % | 31.2 | % |
|                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **61.7**                             | **%**      | **34.7** | **%** | **53.3** | **%** | **58.6** | **%** | **41.4** | **%** | **53.9** | **%** |

 
| ** **                         | ** ** | **Nine Months Ended June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                         | ** ** | **Manufacturing**                   | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Software  licenses                 |       | 52.0                                | %          | 60.9 | % | 54.6 | % | 53.0 | % | 9.1 | % | 46.6 | % |
|                               |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance                        |       | 77.1                                | %          | 47.2 | % | 68.0 | % | 74.2 | % | 50.8 | % | 66.6 | % |
|                               |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Professional  services             |       | 22.0                                | %          | 16.7 | % | 20.8 | % | 16.4 | % | 10.0 | % | 15.2 | % |
|                               |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Third-party  software and hardware |       | 28.4                                | %          | 23.3 | % | 25.2 | % | 24.8 | % | 17.8 | % | 21.9 | % |
|                               |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                          | ** ** | **60.4**                            | **%**      | **42.6** | **%** | **55.1** | **%** | **57.3** | **%** | **40.9** | **%** | **52.7** | **%** |

 

*Manufacturing Segment*:  Manufacturing software license gross marginpercentage during the three months ended June 30, 2005 over the comparableperiod in 2004 showed a slight decline due to a decrease in amortization,however it is offset by increased royalty expenses, due to Fourth Shift Editionroyalties due SAP.  Cost of licenserevenue consists of the amortization of acquired software, the amortization ofcapitalized costs for internally developed software, and the cost ofthird-party software, including Fourth Shift Edition for SAP Business One, embeddedin some of our products.  Amortizationhas fluctuated in this fiscal year as some of the older software intangibles arereaching complete amortization while we begin to amortize newer software.  On a year-to-date basis amortization hasdecreased approximately $93,000 over the comparable 2004 period.  Royalty costs to third parties can fluctuatedepending on product mix.  We anticipatea reduction to gross margin in percentage as royalties associated with FourthShift Edition for SAP Business One sales expand.

 

Maintenance gross profitpercentage for our manufacturing products increased in the three months ended June 30,2005 over the comparable period in 2004 and in the year-to-date period overlast year.  This is due to the continueddevelopment of the manufacturing support center in Bangalore, India whichbecame fully operational in late 2004.  Professional services gross margin percentagefor manufacturing improved to 27.7% in the quarter ended June 30, 2005from 5.3 % in the quarter ended June 30, 2004.  There is also a smaller improvement in theyear-over-year periods.  This is due tounusually low margins in the third quarter of 2004.  Third-party software and hardware grossmargin decreased significantly to 29.8% from 57.0% during the three months, andincreased to 28.4% during the nine months ended June 30, 2005 from 24.8% duringthe prior year nine-month period.  Thirdparty sales are generally done as a courtesy to provide full service solutionsto our customers.  Due to the relativelylow revenue amounts the

 

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gross margin percentage ishighly variable due to pricing and product mix changes.  This does not reflect a significant dollarchange in gross margin.

 

*Hospitality Segment*:  Hospitality software license gross marginpercentage was 57.0% during the three months and 60.9% during the nine monthsended June 30, 2005, compared to 38.8% and 9.1% respectively during thesame periods of 2004.  The margins in 2005improved due to an increase in revenue levels combined with a large decrease inamortization expense over the prior fiscal periods as some of the oldersoftware products reached complete amortization.  The nine-month period ended June 30,2004 reflects an unusually low gross margin due to low revenue levels combinedwith fixed amortization charges.

 

Hospitality maintenancegross margin percentage was 42.8% during the three months and 47.2% during thenine months ended June 30, 2005 compared to 51.7% and 50.8% respectivelyduring the same periods of 2004.  Improvementsin hospitality maintenance gross margin percentage are expected as we expandour Bangalore hospitality support center. This project, started late in fiscal 2004, is expected to contribute toour efforts to control costs later in fiscal 2005, although we believe the fullbenefit from this investment will not be realized until fiscal 2006.  As the hospitality center is ramped up, thereare significant costs related to hiring and training, which accounts for theslight decline in both the three month and nine month figures for 2005.  Professional services margins are showingimprovement over 2004.  The servicemargins in 2004 were low because the hospitality professional servicesorganization had not yet realized the benefits of the reorganization announcedin September 2003.  While slightlyimproved for the three months ended June 30, 2005 over the comparableperiod in 2004, the professional services margins are low due to recognition of$502,000 of consulting revenue at no margin on a project in Europe.  The customer had previously paid us for theservice but recognition of the revenue and related cost was deferred untilfinal acceptance and delivery requirements were met in the third quarter offiscal 2005.  The professional servicesgross profit percentage in Europe is also adversely affected by the need toutilize external consulting resources in central Europe.  We expect an improved gross profit percentagein the hospitality sector as the recent releases of the PORTfolio 3.1 andMedallion 6.0 products contribute more to profitability.  In addition, a future release of Medallion forthe European market is anticipated in late fourth quarter 2005, or early infiscal year 2006, which should lead to even greater improvement.

 

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**Operating Expenses. **The following table summarizes operating expenses for the three and ninemonths ended June 30, 2005 and 2004:

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | ** **              | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2005**                             | ** ** | **2004**                | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                           | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
|                              |       |                                 |       |                    |       |   |   |   |   |   |   |
| General  and administrative       |       | $                                    | 4,521      |                    | 23.8       | % | $ | 4,316 |   | 25.1 | % | 4.7 | % |
| Selling  and marketing            |       | 2,779                                |       | 14.6                    | %          | 2,227 |   | 13.0 | % | 24.8 | % |
| Research  and product development |       | 2,213                                |       | 11.7                    | %          | 2,242 |   | 13.0 | % | (1.3 | )% |
| Restructuring  related charges    |       | —                               |       | 0.0                     | %          | 220 |   | 1.3 | % | NM |   |
| Total  operating expenses         |       | $                                    | 9,513      |                    | 50.1       | % | $ | 9,005 |   | 52.4 | % | 5.6 | % |

 
| ** **                        | ** ** | **Nine Months Ended June 30,** | ** ** | ** **              | ** ** |
|-----------------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2005**                            | ** ** | **2004**                | ** ** | ** ** | ** ** |
| **Thousands**                     | ** ** | ** **                          | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
|                              |       |                                |       |                    |       |   |   |   |   |   |   |
| General  and administrative       |       | $                                   | 14,434     |                    | 26.9       | % | $ | 13,112 |   | 25.6 | % | 10.1 | % |
| Selling  and marketing            |       | 7,948                               |       | 14.9                    | %          | 6,475 |   | 12.6 | % | 22.7 | % |
| Research  and product development |       | 6,242                               |       | 11.6                    | %          | 6,650 |   | 12.9 | % | (6.1 | )% |
| Restructuring  related charges    |       | (261                                | )          | (0.5                    | )%         | 1,711 |   | 3.3 | % | NM |   |
| Total  operating expenses         |       | $                                   | 28,363     |                    | 52.9       | % | $ | 27,948 |   | 54.4 | % | 1.5 | % |

 

----

NM: Percentage notmeaningful.

 

Operating expenses beforerestructuring costs increased in dollars but decreased as a percentage ofrevenue in both the three-month and year-to-date periods.  The year-to-date increase in general andadministrative expense was due to approximately $1.2 million of externalprofessional fees associated with our Sarbanes-Oxley compliance project, whichbegan in the first quarter of fiscal 2005. We have also expanded our selling and marketing efforts associated withthe manufacturing segment’s Fourth Shift Edition for SAP Business One productline and our corporate re-branding.  Researchand development expenses for manufacturing as a percentage of manufacturingrevenue were 11.5% during the three months ended June 30, 2005 and 11.1% duringthe three months ended June 30, 2004, and were 11.5% for the nine monthsended June 30, 2005 and 11.4% during the nine months ended June 30,2004.  Research and development expensesfor hospitality decreased to 12.0% of hospitality revenue during the threemonths ended June 30, 2005 compared with 12.6% during the three monthsended June 30, 2004.  Research anddevelopment expenses for hospitality were 12.0% of revenue during the ninemonths ended June 30, 2005 compared to 15.2% during the nine months ended June 30,2004. Research and product development expenses were unusually high in thefirst quarter of 2004 due to intensive efforts to improve certain hospitalityproducts.

 

On March 2, 2005,the SEC announced a deferral of implementation of the requirements to certifyand to obtain external attestation of internal controls over financialreporting under The Sarbanes-Oxley Act of 2002 for non-accelerated filers.  Due to the deferral, we were able to postponesome of the work and related expenses that we had originally anticipatedincurring in the third and fourth quarters of fiscal 2005 to implement a COSO-compliantinternal control framework.  Although wewill continue to work on completing the implementation, we will take advantageof the extension by performing the remaining work at a more controlled pace,and we will utilize internal resources to a greater extent.  Some of the costs for testing and attestationservices that were originally anticipated in the second half of fiscal year2005 will be deferred to fiscal 2006.  Weexpect that selling and marketing expense and research and product developmentexpense will continue at levels similar to those experienced in the third quarterwith a possible increase in selling expenses because of the recent release ofFourth Shift Edition for SAP Business One in the U.S. market.

 

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The restructuring chargeof $1.7 million in the nine months ended June 30, 2004 reflects $456,000of additional charges for employee severance expenses and other costs relatedto the ongoing implementation of the September 2003 hospitalityreorganization plan, which resulted in the elimination of 120 positions.  Charges were taken in September 2003covering severance for approximately 90 of the employees and, in the six monthsof fiscal 2004, additional charges related to most of the remaining 30employees were incurred along with other costs. In addition, charges of $785,000 were taken related to two leasedinternational facilities that we ceased using, and a charge of $470,000 was takento increase a lease-related accrual originally established in December 2001.  Our expectations regarding our ability toreduce the lease obligation through subleasing the space were revised andresulted in the additional charge.

 

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

 

Cash payments of $149,000were made during the nine months ended June 30, 2005 related to employeeseverance and $15,000 related to lease commitments.  A balance of $285,000 of accruedrestructuring charges remained at June 30, 2005.  Those costs will not affect our fiscal year2005 operating results but will require the expenditure of cash over time forseverance and, to a lesser extent, for lease termination costs.  Severance payments will continue through theend of fiscal 2005 with the exception of $176,000 of retirement benefits whichwill be paid over a longer period.

 

**Non-Operating Income and Expensesand Discontinued Operations. **The following table summarizes non-operatingincome and expenses for the three and nine months ended June 30, 2005 and2004:

 
| ** **                                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **Thousands**                                                                         | ** ** | **2005**                              | ** ** | **2004 (restated)**                  | ** ** | **2005** | ** ** | **2004 (restated)** | ** ** |
|                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Interest  expense                                                                     |       | $                                     | 1,021      |                                 | $          | 1,043 |   | $ | 3,046 |   | $ | 3,311 |   |
| Income  (expense) from change in value of mandatorily redeemable common stock warrant |       |                                  |       | 3,102                                |       |   |   | (3,321 | ) |
| Other  income (expense) net                                                           |       | 111                                   |       | 77                                   |       | 298 |   | 59 |   |
| Provision  for (benefit from) income tax                                              |       | (251                                  | )          | (764                                 | )          | 39 |   | (711 | ) |
| Income  (loss) from discontinued operations, net of tax                               |       | 12,083                                |       | (881                                 | )          | 12,083 |   | 1,355 |   |
|                                                                                       |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |

 

Interest expense isrelated to our long-term institutional debt incurred in November 2002.  It includes cash interest expense,amortization of capitalized financing costs, and debt accretion of an originalissue discount.  In August 2005, we paidoff this debt.  This will result inaccelerated amortization of related capitalized financing costs and originalissue discount in the quarter ending September 30, 2005.

 

Our statements ofoperations for the three and nine months ended June 30, 2004 includecharges for the change in value of the mandatorily redeemable common stockwarrant we issued as part of the long-term institutional debt financing in November 2002.  During the three months ended June 30,2004, the put warrant fair value decreased by $3.1 million resulting in non-operatingincome during the period.  During the ninemonths ended June 30, 2004, the put warrant fair value appreciated by $3.3million, resulting in non-operating expense during that period.  In August 2004, this put warrant wasexchanged for Series B convertible preferred stock and a new common stockwarrant.  As a result, revaluation ofthis put warrant is no longer required.

 

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Other income (expense),net primarily consists of the effect of changes in foreign exchange rates onintercompany payables denominated in U.S. dollars.  A significant portion of this gain is thedirect result of the change in exchange rates between the British Pound and theU.S. Dollar.  We do not currently utilizeany derivative security instruments or engage in any hedging activities.

 

We have recognized taxbenefits in the three- and nine-month periods ended June 30, 2005, and inthe nine-month period ended June 30, 2004, to the extent that income fromdiscontinued operations has been sheltered by current period losses fromcontinuing operations.  In all periods,such benefits are stated net of amounts for our estimated domestic federal andstate liabilities and international tax liabilities.  For the three and nine months ended June 30,2005, $558,000 of income tax expense was recorded as part of discontinuedoperations.  The income from discontinuedoperations in the nine months ended June 30, 2004 is net of $1.1 millionof income tax expense.  We consider theearnings of our international subsidiaries to be indefinitely invested abroad,and do not foresee the American Jobs Creation Act of 2004 having a materialimpact upon our financial position.

 

In accordance with thebankruptcy and reorganization plan of AremisSoft Corporation, our formerparent, we retained a 10% interest in net collections by the Liquidating Trustestablished to pursue litigation claims and collection of assets remaining inAremisSoft after bankruptcy.  In December 2003we received a cash distribution of $2.9 million from the Liquidating Trust,which was recorded as income from discontinued operations.  In addition, we recorded a $619,000 chargefor additional obligations of the discontinued operations in the quarter ended December 31,2003 and an additional $163,000 benefit in the quarter ended March 31,2004.  These amounts were recorded net ofan income tax expense of $1.1 million.  In June 2005, the Liquidating Trustreached settlement with one of the former officers of AremisSoft, resulting ina cash distribution of $12.6 million to SoftBrands.  Upon cash receipt we recognized thisdistribution as income from discontinued operations net of an income taxprovision of $558,000.  Because neither wenor any of our executives have any affiliation with the trust other than our10% interest in net collections, we cannot predict if there will be any future distributions.

 

# **Liquidity and CapitalResources**

 

# **As of June 30, 2005, we had $20.5 million of cash and cashequivalents.  Our working capital deficit(current assets less current liabilities) decreased to $1.7 million at June 30,2005 from $13.4 million at September 30, 2004.  This decrease in working capital deficit isdue to the receipt of $12.6 million from the Trust settlement in June 2005,offset by the reclassification from long-term to current the $2.0 millionprincipal payment of debt that was due on December 31, 2005 and changes inother working capital balances, most significantly accrued expenses.  The working capital deficit at June 30,2005 includes deferred revenue of $17.9 million.  Deferred maintenance revenues comprise themajority of our deferred revenues and our cost to perform these revenues hasrecently been between 30% and 35% of total maintenance revenue.  Our most significant source of operating cashflows is derived from license, maintenance, and service fees.  Our primary uses of cash from operatingactivities are for employee costs, third-party costs for services, and the costof our facilities.**

 

# **Cash Flows from Operating Activities. **We generated$328,000 of cash from continuing operations in the nine months ended June 30,2005 compared to $596,000 generated in the comparable prior year period.  The most significant changes between the twoperiods include a $5.1 million improvement in 2005 from 2004 in the loss fromcontinuing operations and a $3.3 million change in valuation of mandatorilyredeemable common stock warrant.  Thechange in valuation of the mandatorily redeemable warrant, a non-cash item, wasrecorded in 2004 as an operating expense and is no longer required due to theexchange of this warrant for Series B convertible preferred stock and anew common stock warrant.  In addition,other non-cash charges, excluding the change in valuation of mandatorilyredeemable common stock warrant, decreased by $3.7 million in the nine monthsended June 30, 2005.  We had $4.9million of non-cash expenses in the nine months ended June 30, 2005,including $4.3 million of depreciation and amortization and $884,000 fornon-cash interest charges related to the amortization of financing costs andthe original issue discount on the long-term debt.  This compares to non-cash expenses of $11.9million in the prior year, including $5.4

 

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# **million of depreciation and amortization, $1.1 million for non-cashinterest, and $3.3 million of mandatorily redeemable common stock warrant.**

 

# **Changes in operating assets and liabilities produced a cash usage of $2.9million in the nine months ended June 30, 2005 as compared to a $4.5million usage in the prior year.  Themost significant cash flow changes between the two periods relate to accountspayable and accrued restructuring costs. In the nine months ended June 30, 2005, we used $411,000 for thereduction of these balances compared to $5.0 million in the nine months ended June 30,2004.  The 2004 period includedsignificant cash payments for restructuring related expenses and to bringvendor accounts current.  We used$180,000 reflecting a decrease in deferred revenue during the nine months endedJune 30, 2005, and generated cash of $1.2 million from increased deferredrevenue during the nine months ended June 30, 2004.**

 

# **In December 2003, we received a cash distribution of $2.9 millionfrom the Liquidating Trust established following the AmerisSoft bankruptcy, whichis reflected, net of taxes as cash from discontinued operations.  Subsequently, we have received another cashdistribution of $12.6 million from the trust in June 2005, which is alsoreflected, net of taxes as cash from discontinued operations.**

 

Days sales outstanding(DSO), which is calculated as net receivables at period end divided by revenuefor the quarter times 90 days in the quarter, was 34 and 32 days as of June 30,2005 and September 30, 2004, respectively. DSO has been fairly consistentthroughout this fiscal year.

 

# **Cash Flows from Investing Activities.* ***We used $703,000 of cash in investing activities during the nine monthsended June 30, 2005 and $691,000 during the nine months ended June 30,2004.  We had limited expenditures foracquired technology or other intangible assets, reflecting our strategyfollowing the September 2003 restructuring plan to focus hospitalitydevelopment efforts on existing products and existing customers.  We have been upgrading and replacing some ofour internal computer hardware and other equipment throughout this year.  We expect investing activities in theremainder of fiscal 2005 to consist primarily of internal technology and systemupgrades.

 

# **Cash Flows from Financing Activities. **We used $338,000of cash in financing activities in the nine months ended June 30, 2005 and$1.0 million in the nine months ended June 30, 2004 primarily related topayments for long-term debt.

 

# **Commitmentsand Capital Adequacy.**  As of June 30, 2005, our primarycommitments are for indebtedness and interest payments under our debt agreementand for leased office space in Minneapolis, Minnesota; Wichita, Kansas; Golden,Colorado; Reading, UK; Tianjin, China; and Sydney, Australia.

 

EffectiveNovember 26, 2002, we borrowed $20.0 million from Capital ResourcePartners IV, L.P. (“CRP”) pursuant to a Senior Subordinated Note and WarrantPurchase Agreement and a Senior Subordinated Note that carried an interest rateof 12.5% per annum.  An amendment in November 2003resulted in an increase in this interest rate to 14%.  The note was collateralized by substantiallyall of our assets, including the stock of our subsidiaries.  As partial consideration for such borrowings,we issued warrants to the lender.  Thesewarrants were subsequently exchanged for convertible preferred stock andwarrants with a higher exercise price.

 

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# **The debt agreement required us to satisfy covenants relating to ourearnings before interest, taxes, depreciation and amortization (“EBITDA”): ourfixed charge coverage ratio; our leasehold expense; and other items.  Although we were in compliance with all ofthe debt covenants at June 30, 2005, the EBITDA ratio would have increasedfrom $7.2 million for the twelve months ended September 30, 2005 quarterlythroughout the term of the Agreement to $16 million at the end of theagreement.  Because of the significantcash we received from the liquidating trust, and in order to both decrease debtservice expense and provide more flexibility in investing in developmentwithout risking violation of the EBITDA covenant, on August 4, 2005 (afterquarter end), we amended the debt agreement and prepaid $8.0 million of the$20.0 million principal amount outstanding. The amendment also (1) required us to pay accrued interest throughthe repayment date, plus a prepayment penalty of $190,000, (2) reduced to$7.2 million the EBITDA requirement for each quarterly 12-month period for theremainder of the term of the agreement, (3) set the fixed charge coverageratio at 1.0 for each 12-month period (except the 12 months ending June 30,2006, which was reduced to 0.50) for the balance of the agreement, (4) adjustedthe remaining $12 million of principal payments so that they would have occurred$3.0 million on December 31, 2006, $4.0 million on December 31, 2007and $5.0 million on December 31, 2008; (5) added as events thatrequired us to prepay the principal amounts outstanding under the Note, anydebt financing that generated more than $7.0 million, and any equity financing(other than for benefit plans or acquisitions) that generated more than$100,000 of gross proceeds; and (6) required us to pay a redemptionpremium of $390,000 for prepaying the Note prior to September 30, 2006.**

 

On August 17, 2005, wesold to ABRY Mezzanine Partners, L.P. and Capital Resource Partners IV, L.P.18,000 Shares of Series C Convertible Preferred Stock (“the Series C PreferredStock”) and warrants to purchase 1,200,000 shares of common stock (“theWarrants”) for a total of $18.0 million. Each share of Series C Preferred Stock has a nominal face value of$1,000; carries a mandatory dividend, whether or not earned or declared, of 6%of its face value per annum (paid in two semi-annual installments, commencingDecember 31, 2005); has a liquidation preference over common stock and on a parwith the Series B Preferred Stock equal to its face value plus accrued andunpaid dividends; is convertible into common stock at any time at $2.01 pershare, subject to price anti-dilution protection on a weighted average basisfor new issuances by us below the conversion price or below 80% of market price;and may be redeemed by us at par plus accrued dividends, or automaticallyconverted into common stock, commencing August 17, 2007, subject tosatisfaction of a number of conditions, including market price conditions.  The Warrants are exercisable at $2.11 pershare, subject to the same price anti-dilution provisions, contain cash-lessexercise rights and expire on August 17, 2015. Proceeds of approximately $16.4 million, net of transaction cost, fromthe sale of the Series C Preferred Stock and Warrants will be recorded as anincrease to equity.

 

On August 4, 2005, werestructured our debt agreement with CRP and retired $8.0 million ofoutstanding debt.  On August 17, 2005, inconjunction with CRP’s participation in the ABRY financing transactiondescribed above, we retired the remaining $12.0 million balance of the $20.0million of debt owed to CRP.  We expectto record a charge of approximately $2.7 million from the acceleratedamortization of previously capitalized financing costs and original issue debtdiscount related to the CRP debt, as well as consent fees, prepayment fees andfinancing fees of approximately $800,000.

 

Webelieve that cash flows from operations,  together with our existing cash and cashequivalents, will be sufficient to meet our commitments and our cashrequirements for at least the next twelve months.  We also believe the restructuring programsimplemented in September 2003 should continue to improve our cash flowsfrom operations over time.

 

**Contractual Obligations. **A table summarizing oursignificant contractual obligations is included in our Form 10 as filedwith the SEC on January 14, 2005, as amended on March 15, 2005, May 6,2005 and June 24, 2005.  There havebeen no significant changes to our contractual obligations during the ninemonths ended June 30, 2005.

 

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**RecentAccounting Pronouncements**

 

In December 2004,the Financial Accounting Standards Board published SFAS No. 123 (revised2004), *Share-Based Paymen**t*.  SFAS No. 123(R)revises SFAS No. 123, *Accounting forStock-Based Compensation*, and supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*.  The revised statement addresses theaccounting for share-based payment transactions with employees and other thirdparties, eliminates the ability to account for share-based payment transactionsusing APB Opinion No. 25, and requires that the compensation costsrelating to such transactions be recognized in the consolidated statement ofoperations based on the grant-date fair value of those instruments.  The revised statement is effective for us on October 1,2005.  We are currently determining whatimpact the newly issued statement will have on our results of operations andfinancial position.  See the “Stock-BasedCompensation” discussion in Note 3 to the Consolidated Financial Statements,which includes the pro forma impact of recognizing stock-based compensationunder SFAS No. 123, on our net loss and loss per common share for thethree and nine months ended June 30, 2005 and 2004.

 

**Forward-LookingStatements**

 

OurForm 10-Q contains a number of statements about our futureoperations.  We make statements regardinganticipated product introductions, changes in markets, customers and customerorder rates, expenditures in research and development, growth in revenue,taxation levels, the effects of pricing, and the growth in our foreignoperations, all of which represent our expectations and beliefs about futureevents.  In some cases, you canidentify forward-looking statements 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 maycause our or our industry’s actual results, level of activity, performance, orachievements to be materially different from those expressed or implied bythese forward-looking statements.  Thefactors that may cause our operations to vary materially from thosecontemplated by our forward-looking statements are described in detail in our Form 10as filed with the SEC on January 14, 2005, as amended on March 15,2005, May 6, 2005, and June 24, 2005 and include:

 

•                  Economicand market conditions.

 

•                  Downturnsin the hospitality or manufacturing markets.

 

•                  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 October 1, 2005, in accounting for stockoptions and other stock based benefits on our reported operating results.

 

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•                  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.

 

•                  Oursusceptibility to declarations of default under, and renegotiation of, our debtagreement with our principal lender.

 

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

 

**ITEM 3.QUALITATIVE AND QUANTITATIVE 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 as filed withthe SEC on January 14, 2005, as amended on March 15, 2005, May 6,2005 and June 24, 2005 for a discussion of market risk for the Company.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.* As required by Rule 13a-15(b) underthe Securities Exchange Act of 1934, as amended, we conducted an evaluationunder the supervision and with the participation of our management, includingthe Chief Executive Officer and the Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures as of the end of theperiod covered by this report.  Based onthat evaluation, and because of the material weakness in internal control overfinancial reporting discussed below, the Chief Executive Officer and the ChiefFinancial Officer concluded that our disclosure controls and procedures are 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 SEC rules andforms and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,in a manner that allows timely decisions regarding required disclosure.

 

*InternalControl over Financial Reporting. *Therewere no changes in our internal control over financial reporting that occurredduring the quarter ended June 30, 2005 that materially affected, or thatare reasonably likely to materially affect, our internal control over financialreporting.

 

Although we have not yet been required to assess andreport on the effectiveness of our internal control over financial reporting,we have concluded that we did not maintain effective internal control overfinancial reporting as related to accounting for income taxes required underSFAS 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 controldeficiency will result in the restatement of our interim and annualconsolidated financial statements for the year ended September 30, 2004,and the interim consolidated financial statements during fiscal year 2005 (thequarters ended December 31, 2004 and March 31, 2005).  The restatement had no impact on net loss,net cash provided by operating activities and total stockholders’ equity as previouslyreported for the fiscal year ended September 30, 2004.  Additionally, this control deficiency couldresult in a misstatement to the tax provision and related tax accounts anddisclosures that would result in a material misstatement in the annual orinterim financial statements that would not be prevented or detected.Accordingly, management determined that this control deficiency was a materialweakness in internal control over financial reporting as of September 30,2004 and through June 30, 2005.

 

Management intends to remediate this material weaknessin internal control over financial reporting during 2005 and will report on itsstatus when it files its Form 10-K for the year ending September 30,2005.  In particular, we intend to

 

•      Strengthen our internal knowledge base with expandedtraining and education.

•      Expand our review procedures related to unique andspecialized transactions.

•      Review unique and specialized transactions on acontemporaneous basis.

•      Increase consultations with external experts in thefield of accounting, to augment our internal knowledge and experience base.

 

By implementing internal control improvements, weexpect to remediate this material weakness in internal control over financialreporting before September 30, 2006, which is the date with respect towhich our management, and our independent registered public accounting firm,must first report on the effectiveness of our internal control over financialreporting under the Section 404 provisions of the Sarbanes-Oxley Act.

 

All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation. We will continue to improve the designand effectiveness of our disclosure controls and procedures to the extentnecessary in the future to provide our senior management with timely access tosuch material information, and to correct any deficiencies that we may discoverin the future.

 

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**PART II. OTHER INFORMATION**

 

**Item 1—Legal Proceedings**

 

We are periodically engagedin litigation in the ordinary course of business, including litigation seekingreturn of software licensing and servicing fees.  We do not believe that any of such litigationis material to our ongoing operations.

 

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

 

Not applicable.

 

**Item3—Default on Senior Securities**

 

Not applicable.

 

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

 

Not applicable.

 

**Item 5—Other Information**

 

Not applicable.

 

**Item 6—Exhibits**

 
| 31.1   | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act –  George H. Ellis. |
|--------|-----------------------------------------------------------------------------------------------|
|   |                                                                                          |
| 31.2   | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act –  David G. Latzke. |
|   |                                                                                          |
| 32.0   | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act.                         |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Date: August 19,  2005 |                  |
|-----------------------------|-----------------------|
|                        |                  |
|                        | SoftBrands, Inc. |
|                        |                  |   |
|                        | By:                   | /s/ DAVID G. LATZKE |
|                        |                  | David G. Latzke*Senior Vice President  and Chief Financial Officer*(principal financial and accounting officer) |

 

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**EXHIBIT INDEX**

 
| **EXHIBIT  NUMBER** | ** ** | **DESCRIPTION OF DOCUMENTS**                                                                  |
|---------------------|------------|-----------------------------------------------------------------------------------------------|
|                |       |                                                                                          |
| 31.1                |       | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act –  George H. Ellis. |
|                |       |                                                                                          |
| 31.2                |       | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act –  David G. Latzke. |
|                |       |                                                                                          |
| 32.0                |       | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                 |

 

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