**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM10-Q**

 

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

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

 

**TwoMeridian Crossings, Suite 800**

**Minneapolis,Minnesota 55423**

(Address of principalexecutive offices)

 

**(612) 851-1500**

(Registrant’s telephonenumber, 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 o   NO  ý

 

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

 

The number of shares of the registrant’s common stock outstanding as ofMarch 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 March 31, 2005 and September 30, 2004                             |   |
|       | Consolidated Statements  of Operations for the three and six months ended March 31, 2005 and 2004 |   |
|       | Consolidated  Statements of Cash Flows for the six months ended March 31, 2005 and 2004           |   |
|       | 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.  FINANCIAL INFORMATION**

** **

**ITEM 1.  FINANCIAL STATEMENTS**

 

**SoftBrands, Inc.**

**Consolidated Balance Sheets**

**in thousands, except per sharedata**

**(unaudited)**

 
| ** **                                                                                                                                 | ** ** | **March 31,  2005** | ** ** | **September 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                 | ** ** | ** **               | ** ** | ** **                   | ** ** |
| **Assets**                                                                                                                                 | ** ** | ** **               | ** ** | ** **                   | ** ** |
| Current assets                                                                                                                             |       |                     |       |                         |       |
| Cash and cash  equivalents                                                                                                                 |       | $                        | 9,070      |                         | $          | 9,719 |   |
| Accounts  receivable, net                                                                                                                  |       | 6,498                    |       | 6,289                        |       |
| Prepaid expenses  and other current assets                                                                                                 |       | 1,259                    |       | 1,224                        |       |
| Total current  assets                                                                                                                      |       | 16,827                   |       | 17,232                       |       |
| Furniture,  fixtures and equipment, net                                                                                                    |       | 2,338                    |       | 2,382                        |       |
| Restricted cash                                                                                                                            |       | 750                      |       | 846                          |       |
| Goodwill                                                                                                                                   |       | 22,947                   |       | 22,947                       |       |
| Intangible  assets, net                                                                                                                    |       | 5,809                    |       | 7,917                        |       |
| Other long-term  assets                                                                                                                    |       | 950                      |       | 1,127                        |       |
| Total assets                                                                                                                               |       | $                        | 49,621     |                         | $          | 52,451 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                             |       |                     |       |                         |       |
| Current  liabilities                                                                                                                       |       |                     |       |                         |       |
| Current portion  of long-term debt and capital leases                                                                                      |       | $                        | 2,522      |                         | $          | 547 |   |
| Accounts payable                                                                                                                           |       | 2,090                    |       | 2,169                        |       |
| Accrued expenses                                                                                                                           |       | 5,515                    |       | 6,775                        |       |
| Accrued  restructuring costs                                                                                                               |       | 333                      |       | 1,214                        |       |
| Deferred revenue                                                                                                                           |       | 19,800                   |       | 18,014                       |       |
| Other current  liabilities                                                                                                                 |       | 1,627                    |       | 1,892                        |       |
| Total current  liabilities                                                                                                                 |       | 31,887                   |       | 30,611                       |       |
| Long-term debt  and capital leases                                                                                                         |       | 15,841                   |       | 17,675                       |       |
| Other long-term  liabilities                                                                                                               |       | 410                      |       | 594                          |       |
| Total  liabilities                                                                                                                         |       | 48,138                   |       | 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                                                                                                      |       | (1,673                   | )          | (1,146                       | )          |
| Accumulated  deficit                                                                                                                       |       | (174,809                 | )          | (173,248                     | )          |
| Total  stockholders’ equity                                                                                                           |       | 1,483                    |       | 3,571                        |       |
| Total  liabilities and stockholders’ equity                                                                                           |       | $                        | 49,621     |                         | $          | 52,451 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**SoftBrands, Inc.**

**Consolidated Statements ofOperations**

**in thousands, except per sharedata**

**(unaudited)**

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                         | ** ** | **March 31,**     | ** ** | **March 31,**   | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                         | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                         | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenue**                                                        | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software  licenses                                                 |       | $                      | 2,483      |                 | $          | 2,156 |   | $ | 4,780 |   | $ | 4,308 |   |
| Maintenance                                                        |       | 10,995                 |       | 10,771               |       | 22,128 |   | 21,924 |   |
| Professional  services                                             |       | 3,250                  |       | 3,058                |       | 6,429 |   | 6,465 |   |
| Third-party  software and hardware                                 |       | 658                    |       | 823                  |       | 1,326 |   | 1,526 |   |
| Total revenue                                                      |       | 17,386                 |       | 16,808               |       | 34,663 |   | 34,223 |   |
| **Cost of  revenues**                                              |       |                   |       |                 |       |   |   |   |   |
| Software  licenses                                                 |       | 1,088                  |       | 1,413                |       | 2,208 |   | 2,540 |   |
| Maintenance                                                        |       | 3,478                  |       | 3,661                |       | 7,011 |   | 7,414 |   |
| Professional  services                                             |       | 2,611                  |       | 2,377                |       | 5,197 |   | 5,164 |   |
| Third-party  software and hardware                                 |       | 385                    |       | 707                  |       | 830 |   | 1,265 |   |
| Total cost of  revenues                                            |       | 7,562                  |       | 8,158                |       | 15,246 |   | 16,383 |   |
| Gross profit                                                       |       | 9,824                  |       | 8,650                |       | 19,417 |   | 17,840 |   |
| **Operating  expenses**                                            |       |                   |       |                 |       |   |   |   |   |
| Selling, general  and administrative                               |       | 7,655                  |       | 6,002                |       | 15,082 |   | 13,044 |   |
| Research and  product development                                  |       | 2,027                  |       | 2,260                |       | 4,029 |   | 4,408 |   |
| Restructuring  related                                             |       | (261                   | )          | 365                  |       | (261 | ) | 1,491 |   |
| Total operating  expenses                                          |       | 9,421                  |       | 8,627                |       | 18,850 |   | 18,943 |   |
| Operating income  (loss)                                           |       | 403                    |       | 23                   |       | 567 |   | (1,103 | ) |
| Interest expense                                                   |       | (1,022                 | )          | (1,230               | )          | (2,025 | ) | (2,268 | ) |
| Change in value  of mandatorily redeemable common stock warrant    |       |                   |       | (6,040               | )          |   |   | (6,423 | ) |
| Other income  (expense), net                                       |       | (86                    | )          | (44                  | )          | 187 |   | (18 | ) |
| Loss from  continuing operations before provision for income taxes |       | (705                   | )          | (7,291               | )          | (1,271 | ) | (9,812 | ) |
| Provision for  income taxes                                        |       | 190                    |       | 133                  |       | 290 |   | 143 |   |
| Loss from  continuing operations                                   |       | (895                   | )          | (7,424               | )          | (1,561 | ) | (9,955 | ) |
| **Discontinued  operations**                                       |       |                   |       |                 |       |   |   |   |   |
| Income from  discontinued operations, net of tax                   |       |                   |       | 133                  |       |   |   | 2,339 |   |
| Net loss                                                           |       | $                      | (895       | )                    | $          | (7,291 | ) | $ | (1,561 | ) | $ | (7,616 | ) |
| **Basic  and diluted earnings (loss) per common share**            |       |                   |       |                 |       |   |   |   |   |
| Continuing  operations                                             |       | $                      | (0.02      | )                    | $          | (0.19 | ) | $ | (0.04 | ) | $ | (0.25 | ) |
| Discontinued  operations                                           |       |                   |       |                 |       |   |   | $ | 0.06 |   |
| Net loss                                                           |       | $                      | (0.02      | )                    | $          | (0.18 | ) | $ | (0.04 | ) | $ | (0.19 | ) |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| **Weighted  average basic and diluted shares outstanding**         |       | 40,030                 |       | 40,000               |       | 40,030 |   | 40,000 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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**SoftBrands, Inc.**

**Consolidated Statements of CashFlows**

**in thousands**

**(unaudited)**

 
| ** **                                                                                                         | ** ** | **Six Months Ended**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                         | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
|                                                                                                               |       |                     |       |   |   |
| **Cash  flow from operating activities**                                                                           | ** ** | ** **               | ** ** | ** ** | ** ** |
| Loss from  continuing operations                                                                                   |       | $                        | (1,561     | ) | $ | (9,955 | ) |
| Adjustments to  reconcile loss from continuing operations to net cash provided by (used in)  continuing operations |       |                     |       |   |   |
| Depreciation and  amortization                                                                                     |       | 2,929                    |       | 3,607 |   |
| Change in value  of mandatorily redeemable common stock warrant                                                    |       |                     |       | 6,423 |   |
| Noncash interest  expense                                                                                          |       | 586                      |       | 792 |   |
| Foreign currency  transaction (gains) losses                                                                       |       | (124                     | )          | 22 |   |
| Restructuring  related                                                                                             |       | (261                     | )          | 1,491 |   |
| Provision for  doubtful accounts                                                                                   |       | 75                       |       | 99 |   |
| Change in  operating assets and liabilities                                                                        |       |                     |       |   |   |
| Accounts  receivable, net                                                                                          |       | (55                      | )          | 395 |   |
| Prepaid expenses  and other current assets                                                                         |       | 10                       |       | 396 |   |
| Accounts payable                                                                                                   |       | (112                     | )          | (2,366 | ) |
| Accrued expenses                                                                                                   |       | (1,359                   | )          | (1,585 | ) |
| Accrued  restructuring costs                                                                                       |       | (689                     | )          | (2,362 | ) |
| Deferred revenue                                                                                                   |       | 1,440                    |       | 2,842 |   |
| Other current  liabilities                                                                                         |       | (270                     | )          | (264 | ) |
| Other long-term  assets and liabilities                                                                            |       | (59                      | )          | 213 |   |
| Net cash  provided by (used in) continuing operations                                                              |       | 550                      |       | (252 | ) |
| Net cash  provided by discontinued operations                                                                      |       |                     |       | 2,915 |   |
| Net cash  provided by operating activities                                                                         |       | 550                      |       | 2,663 |   |
| **Cash  flow from investing activities**                                                                           |       |                     |       |   |   |
| Purchases of  furniture, fixtures and equipment                                                                    |       | (358                     | )          | (499 | ) |
| Capitalized  software development costs                                                                            |       | (191                     | )          |   |   |
| Net cash used in  investing activities                                                                             |       | (549                     | )          | (499 | ) |
| **Cash  flow from financing activities**                                                                           |       |                     |       |   |   |
| Repayment of  long-term debt and capital leases                                                                    |       | (226                     | )          | (693 | ) |
| Capitalized  financing costs                                                                                       |       | —                   |       | (52 | ) |
| Net cash used in  financing activities                                                                             |       | (226                     | )          | (745 | ) |
| Effect of exchange  rates on cash balances                                                                         |       | (424                     | )          | (158 | ) |
| Change in cash  and cash equivalents                                                                               |       | (649                     | )          | 1,261 |   |
| **Cash  and cash equivalents**                                                                                     |       |                     |       |   |   |
| Beginning of  period                                                                                               |       | 9,719                    |       | 8,976 |   |
| End of period                                                                                                      |       | $                        | 9,070      |   | $ | 10,237 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**SoftBrands, Inc.**

**Notes to Consolidated FinancialStatements**

**(unaudited)**

 

**1.             Basisof Presentation**

 

The unaudited consolidated financial statements included herein reflectall adjustments, in the opinion of management, necessary to fairly state the consolidatedfinancial position, results of operations and cash flows ofSoftBrands, Inc. (“the Company”) for the periods presented. Theseadjustments consist of normal, recurring items unless otherwise noted. Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts therein. Due to theinherent uncertainty involved in making estimates, actual results in futureperiods may differ from those estimates. The results of operations for thethree and six months ended March 31, 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 certaininformation included in the Company’s annual financial statements and notes.The accompanying interim consolidated financial statements should be read inconjunction with the financial statements and related notes included in theCompany’s Report on Form 10 as filed with the Securities and ExchangeCommission (“SEC”) on January 14, 2005, and as amended on March 15, 2005 and May6, 2005.

 

**2.             RecentAccounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Boardpublished SFAS No. 123 (revised 2004), *Share-BasedPaymen**t*.  SFAS No. 123(R) revises SFAS No. 123, *Accounting for Stock-Based Compensation*,and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. The revised statement addresses the accounting for share-based paymenttransactions with employees and other third parties, eliminates the ability toaccount for share-based payment transactions using APB Opinion No. 25 andrequires that the compensation costs relating to such transactions berecognized in the consolidated statement of operations based on the grant-datefair value of those instruments. The revised statement is effective for thecompany on October 1, 2005.  The Companyis currently determining what impact the newly issued statement will have onits results of operations and financial position.  See the “Stock-Based Compensation” discussionin Note 3, which includes the pro forma impact of recognizing stock-basedcompensation under SFAS No. 123, on the Company’s net loss and loss percommon share for the three and six months ended March 31, 2005 and 2004.

 

**3.****                                      Stock-BasedCompensation**

 

In accordance with SFAS No. 123, the Company has elected toaccount for stock-based compensation using the intrinsic value methodprescribed in APB Opinion No. 25, and related interpretations.  Accordingly, compensation cost for stockoptions granted to employees is measured as the excess, if any, of the fairvalue of the Company’s common stock at the date of the grant over the amount anemployee must pay to acquire the stock. The Company accounts for stock-based compensation to nonemployees usingthe fair value method prescribed by SFAS No. 123.  The Company has implemented the disclosureprovisions of SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.

 

Pro forma net loss for the three and six months ended March 31, 2005and 2004 was as follows:

 

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| ** **                                                                                            | ** ** | **Three Months Ended**   | ** ** | **Six Months Ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **Thousands**                                                                                         | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
| ** **                                                                                            | ** ** | ** **               | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss, as  reported                                                                                |       | $                        | (895       | )                        | $          | (7,291 | ) | $ | (1,561 | ) | $ | (7,616 | ) |
| Less total stock-based  compensation expense determined under fair value based method for all rewards |       | (1,406                   | )          | (155                     | )          | (1,683 | ) | (278 | ) |
| Pro forma net  loss                                                                                   |       | $                        | (2,301     | )                        | $          | (7,446 | ) | $ | (3,244 | ) | $ | (7,894 | ) |
|                                                                                                  |       |                     |       |                     |       |   |   |   |   |
| Basic and  diluted loss per common share                                                              |       |                     |       |                     |       |   |   |   |   |
| As reported                                                                                           |       | $                        | (0.02      | )                        | $          | (0.18 | ) | $ | (0.04 | ) | $ | (0.19 | ) |
| Pro forma                                                                                             |       | (0.06                    | )          | (0.19                    | )          | (0.08 | ) | (0.20 | ) |

 

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 registration underSection 12(g) of Securities Exchange Act of 1934 became effective.  As a result, the pro forma stock-basedcompensation expense for the three and six months ended March 31, 2005 includes$1,019,000 to record the cumulative effect of the acceleration provisions onprior periods.  As of March 31, 2005, thenumber of shares of the Company’s stock available through the exercise of employeeoptions was approximately 6,002,000, which represents approximately 60% of theCompany’s outstanding options.

 

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

 

Net income (loss) per share is computed under the provisions of SFASNo. 128, *Earning 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 three and six months ended March 31, 2005, 4,332,000 sharesof Series B convertible preferred stock issued in August 2004 were notconsidered in the calculation of basic earnings per share because the Companyhad net losses, and based on the contractual terms, the Series B convertiblepreferred stock does not have the obligation to share in the losses of theCompany.  In accordance withEITF 03-6, *Participating Securities and the Two-ClassMethod under FASB Statement No. 128*, the Company’sSeries B convertible preferred stock is considered in both the basic anddiluted earnings per share calculations in these periods in which the Companyrecords net profits.  During the threeand six months ended March 31, 2005, 4,332,000 shares of Series B convertiblepreferred stock and options and warrants to purchase 14,594,000 shares of theCompany’s common stock were not considered in the calculation of dilutedearnings per share because the Company had net losses and to do so would havebeen antidilutive.  During the three andsix months ended March 31, 2004, options and warrants to purchase 16,986,000shares of the Company’s common stock were not considered in the calculation ofdiluted earnings per share because the Company had net losses and to do sowould have been antidilutive.

 

**5.             DiscontinuedOperations**

 

In December 2003, the Company received a cash distribution of $2.9million from the liquidating trust of AremisSoft Corporation (the “FormerParent”), which was recorded as income from discontinued operations during thefirst quarter ended December 31, 2003. In addition, the Company recorded a $619,000 charge for additionalobligations of the discontinued operations in the quarter ended December 31,2003, and a $153,000 benefit in the quarter ended March 31, 2004.  These amounts were recorded net of $120,000of income tax expense.  The remainingobligations of the Former Parent are included in accrued expenses on theCompany’s balance sheet at March 31, 2005. The liability represents lease commitments and other costs associatedwith the Former Parent’s bankruptcy and clean-up efforts.

 

The details of the Company’s relationship with the Former Parent aremore fully described in the

 

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Company’s Report on Form 10 filed with the SEC on January 14, 2005,as amended on March 15, 2005 and May 6, 2005.

 

**6.             RestructuringRelated Charges**

 

The following table presents a summary of the Company’s restructuringactivities during the six months ended March 31, 2005 and the year endedSeptember 30, 2004:

 
| **Thousands**                       | ** ** | **Employee  Severance and  Termination  Costs** | ** ** | **Lease  Commitments** | ** ** | **Other  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)        |       | (105                                            | )          | (515                   | )          |             |       | (620       | )          |
|                                |       |                                            |       |                   |       |             |       |       |       |
| Balance at  March 31, 2005     |       | $                                               | 280        |                   | $          | 53               |       | $          | —     |   | $ | 333 |   |

 

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(1)   The impactof foreign currency translation is included 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 ceased usingtwo international facilities and recorded restructuring charges of $981,000 forlease costs that will continue to be incurred. Of this amount, $785,000 was taken during the six 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 related lease terms, which expire byApril 2007.  In March 2005, theCompany negotiated early termination of one of the leases, which resulted in a$180,000 benefit.

 

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 were taken during the year ended September 30, 2004, primarilyfor additional employee severance related to the remaining 30 identifiedpositions and contract terminations.  Ofthis amount, $506,000 was taken during the first six months of fiscal year2004.   During the six months ended March31, 2005, the Company made cash severance payments of $114,000, and reversed$81,000 of the accrual, due to lower than expected severance costs.  At March 31, 2005, the remaining employeeseverance accrual for this program was $104,000, all of which is expected to bepaid in the Company’s fiscal year 2005.

 

In December 2001, the Company instituted a restructuring plan toalign its cost structure with its business

 

8

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plan.  Under the restructuringplan, the Company reduced its workforce by approximately 20%, or 153 positionsthroughout the organization.  In additionto the employee termination costs, charges were taken related to excess leasedspace at two of the Company’s facilities. In conjunction with the restructuring related charges, the Companyestimated future sublease income to offset the liability.  During the year ended September 30,2004, due to the Company’s inability to negotiate acceptable sublease terms atone of the facilities, additional restructuring charges of $470,000 weretaken.  Of this amount, $200,000 wastaken during the first six months of fiscal year 2004.  In September 2004, Company managementmade the strategic decisions to utilize both of the leased spaces previouslyconsidered excess, and the remaining restructuring accrual of $991,000 waseliminated and a restructuring benefit was 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 inApril 2001, the Company assumed accrued restructuring liabilities relatedto employee termination costs and facility consolidation.  At March 31, 2005, $176,000 of thisrestructuring liability was remaining, and is designated for special  retirement benefits that the Company isobligated to pay for three former employees.

 

**7.             ComprehensiveLoss**

 

Total comprehensive loss was $800,000 and $7.2 million for the threemonths ended March 31, 2005 and 2004, respectively.  Total comprehensive loss was $2.1 million and$7.8 million for the six months ended March 31, 2005 and 2004,respectively.  Comprehensive loss differsfrom net loss due to foreign currency translation adjustments.

 

**8.**             **Goodwill andIntangible Assets**

 

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

 

Intangible assets, net were comprised of the following at March 31,2005 and September 30, 2004:

 
| ** **                        | ** ** | **March 31, 2005**     | ** ** | **September 30, 2004**   | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| **Thousands**                     | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
|                              |       |                        |       |                          |       |   |   |   |   |   |   |   |   |
| Acquired  technology              |       | $                           | 20,512     |                          | $          | (15,422 | ) | $ | 5,090 |   | $ | 20,484 |   | $ | (13,304 | ) | $ | 7,180 |   |
| Capitalized  software development |       | 1,069                       |       | (428                          | )          | 641 |   | 877 |   | (305 | ) | 572 |   |
| Other                             |       | 521                         |       | (443                          | )          | 78 |   | 508 |   | (343 | ) | 165 |   |
| Intangible  assets                |       | $                           | 22,102     |                          | $          | (16,293 | ) | $ | 5,809 |   | $ | 21,869 |   | $ | (13,952 | ) | $ | 7,917 |   |

 

Total amortization of intangibles was $1.2 million and $1.5 million forthe three months ended March 31, 2005 and 2004, respectively.  Total amortization of intangibles was $2.3million and $2.5 million for the six months ended March 31, 2005 and 2004,respectively.  Based on the intangiblesat March 31, 2005, estimated amortization expense for each of the next fiveyears is as follows:

 
| **Year  Ending September 30 (thousands)** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| Remainder of  fiscal year 2005                 |       | $          | 2,017      |   |
| 2006                                           |       | 2,705      |       |
| 2007                                           |       | 547        |       |
| 2008                                           |       | 319        |       |
| 2009                                           |       | 221        |       |
|                                           |       | $          | 5,809      |   |

 

9

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**9.             SegmentInformation**

 

The Company discloses segments in accordance with SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information*, which establishes standards for disclosure offinancial information related to operating segments of the Company, as well asdisclosure requirements for customer and geographic information.  SFAS No. 131 defines an operatingsegment as a component of a company for which operating results are reviewedregularly by the chief operating decision-maker to determine resourceallocation and assess performance.  TheCompany has two reportable segments under the 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 through the resale of complementary third-party software licenses andhardware.

 

As part of the restructuring of our hospitality operations begun inSeptember 2003, we consolidated some of the operational and strategicmanagement of our two reportable segments. Also as a result of this consolidation, some of the expenses that werepreviously incurred within our operational segments are now classified as partof corporate 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.

 
| **Thousands**                               | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------|------------|-------------------|------------|-----------------|------------|---------------|------------|------------------|------------|
| ** **                                  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **    | ** ** | ** **       | ** ** |
| **Three  Months Ended March 31, 2005** |       |              |       |            |       |          |       |             |       |
| Revenue                                     |       | $                 | 11,951     |            | $          | 5,435         |       |             |       | $ | 17,386 |   |
| Operating income  (loss)                    |       | 3,025             |       | 1,472           |       | $             | (4,094     | )                | 403        |   |
| ** **                                  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **    | ** ** | ** **       | ** ** |
| **Three  Months Ended March 31, 2004** |       |              |       |            |       |          |       |             |       |
| Revenue                                     |       | $                 | 12,299     |            | $          | 4,509         |       |             |       | $ | 16,808 |   |
| Operating income  (loss)                    |       | 1,951             |       | 179             |       | $             | (2,107     | )                | 23         |   |
|                                        |       |              |       |            |       |          |       |             |       |
| **Six  Months Ended March 31, 2005**   |       |              |       |            |       |          |       |             |       |
| Revenue                                     |       | $                 | 24,372     |            | $          | 10,291        |       |             |       | $ | 34,663 |   |
| Operating income  (loss)                    |       | 6,368             |       | 1,931           |       | $             | (7,732     | )                | 567        |   |
| ** **                                  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **    | ** ** | ** **       | ** ** |
| **Six  Months Ended March 31, 2004**   |       |              |       |            |       |          |       |             |       |
| Revenue                                     |       | $                 | 24,527     |            | $          | 9,696         |       |             |       | $ | 34,223 |   |
| Operating income  (loss)                    |       | 5,282             |       | (326            | )          | $             | (6,059     | )                | (1,103     | ) |

 

10

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**ITEM2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion of ourfinancial condition and results of operations should be read together with thefinancial statements and related notes, which are included elsewhere in thisForm 10-Q.  This discussion containsforward-looking statements based upon current expectations that involve risksand uncertainties.  Our actual resultsmay differ materially from those anticipated in these forward-lookingstatements as a result of various factors, including those set forth in moredetail in the “Forward-Looking Statements” section below.  We undertake no obligation to update anyinformation in our forward-looking statements.*

 

**Business Overview**

Weprovide enterprise software and support solutions to over 4,000 customers inmore than 60 countries.  We are organized into two reportablesegments:  Manufacturing and Hospitality. Our manufacturing business designs, develops and sells enterpriseresource planning software and services to mid-sized manufacturingconcerns.  Our principal products in this segment include***Fourth Shift*,** ourcore manufacturing enterprise software solution aimed at small- to mid-sizedmanufacturers;***evolution***,a software system designed to serve niche manufacturing markets that isparticularly suitable for ‘converter’ manufacturers;***Demand Stream***, alean enterprise automation software system that was introduced in 2003; and***Fourth Shift Edition for SAPBusiness One***, our newest product, which is integrated with SAP’sBusiness One product suite for sale by SoftBrands, and through SAP’s saleschannels, to medium-sized manufacturers.  Our hospitality businessdesigns, develops and sells software and services that support the enterpriseinformation management needs of hotels and resorts.  Principal products inthe hospitality segment include***Medallion***, a windows-based property management systemdesigned primarily for medium-service independent hotels and hotel chains;***PORTfolio***, acomprehensive client/server hotel system for both the front- and back-officeoperations of single-site and multi-property hotels; and***RIO***, a leisuremanagement system that supports the activities of spas, health clubs andresorts.

 

Wederive revenue in both of our reportable segments through sale of licenses touse our software products, and by providing services required to maintain ourproducts, to install and implement our products, and in some cases to customizeor create extensions for our products.  On occasion we also sell hardwareproducts of third-party vendors on a distribution basis for the convenience ofour customers and sell licenses to third-party software programs.  Oursoftware license revenue is heavily influenced by the timing of customerpurchases and installations, and the terms under which we sell softwarelicenses.  Our software maintenance revenue, which currently constitutes amajority of our revenue, is derived primarily from one-year contracts thatrequire payment at the beginning of the contract term and under which werecognize revenue ratably over the one-year contract period.  Our otherservices revenue is normally recognized over the time services are performed.

 

We have been significantly affected by events thatoccurred in 2002 when our Former Parent incurred significant financial andlegal issues that resulted in disruptions to our operations and large financiallosses.   On August 2, 2002 we were spunoff from our Former Parent.  From thetime of the spin-off to September 30, 2003, our management focused onreorganizing SoftBrands, regaining customer confidence, obtaining acceptablefinancing and emerging as a financially sound business.  At the end of the September 30, 2003 fiscalyear we decided to substantially restructure our operations, particularly inour hospitality business, in order to return to positive cash flow.  We reduced personnel, office locations andcommitments in September 2003, which resulted in significant restructuringcharges.

 

In fiscal year 2004, we capitalized on various strategic steps takenduring 2003 to renew growth in new license sales of the Fourth Shift and othermanufacturing products; and agreed to a significant joint initiative to developsoftware for medium-sized manufacturing concerns as part of the SAP BusinessOne product suite.  In our hospitalityoperations, following the restructuring of September 30, 2003, we completed newversions of our leading software products and obtained renewed customerinterest in our

 

11

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products and services. Additional restructuring charges of $491,000 were recorded in the firstsix months of 2004 for ongoing costs associated with the September 2003restructuring plan and further facilities consolidation.

 

We invested significant time and management effort in fiscal year 2004planning and finalizing our operational structure, and we did not fully operateunder this new structure until the beginning of fiscal 2005.  Although we expect this new structure andseveral of our other initiatives to benefit future operations, we believe ourgrowth in the remainder of fiscal year 2005 and beyond will substantiallydepend on successful introduction of the Fourth Shift Edition for SAP BusinessOne product and our success in generating increased interest in the hospitalityMedallion product.

 

The latest release of Medallion 6.0 was made available to thehospitality market on January 24, 2005.  There has been growinginterest in this product from several target customers as well as a growingnumber of our current customers that are interested in migrating to the newerplatform.  Another significant milestone was the release of Fourth ShiftEdition for SAP Business One, which was released for general availability inthe United States on April 29, 2005.  As of March 31, 2005, wehad already signed contracts with nine customers for delivery of this productwhen available.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of thefinancial information contained in this Form 10-Q requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. We evaluate these estimates on an ongoing basis, includingthose related to revenue recognition, the valuation allowance for deferred taxassets, the valuation of our accounts receivable, the valuation of ourintangible assets, including goodwill, and the recording of restructuringcharges. There have been no material changes to the critical accountingpolicies as discussed in greater detail in the Management’s Discussion andAnalysis of Financial Condition and Results of Operations contained in our Form 10as filed with the SEC on January 14, 2005, as amended on March 15,2005 and May 6, 2005.

 

**Results of Operations**

 

For the three months ended March 31,2005, we reported total revenue of $17.4 million and net loss of $895,000, or$0.02 per share, compared to total revenue of $16.8 million and a net loss of$7.3 million, or $0.18 per share, for the same period in 2004.  The improvement in results reflects a $1.2million increase in gross profit, which was more than offset by a $1.7 millionincrease in selling, general and administrative expenses.  Further, we recorded charges of $6.0 millionduring the 2004 three month period related to our mandatorily redeemable commonstock warrant, and $365,000 of restructuring-related charges.  For the six months ended March 31, 2005,we reported total revenue of $34.7 million and a net loss of $1.6 million, or$0.04 per share, compared to total revenue of $34.2 million and a net loss of$7.6 million, or $0.19 per share, for the same period in 2004.

 

The following table summarizes revenue andoperating results by reportable segment for the three and six months ended March 31,2005 and 2004:

 

12

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| ** **    | ** ** | **Three Months Ended March 31,** | ** ** | ** **                   | ** ** | ** **   | ** ** |
|---------------|------------|----------------------------------|------------|------------------------------|------------|--------------|------------|
| ** **    | ** ** | **2005**                         | ** ** | **2004**                     | ** ** | **% Change** | ** ** |
| **Thousands** | ** ** | **Revenue**                      | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue**  | ** ** | **Operating Income  (Loss) (1)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                                | 11,951     |                         | $          | 3,025        |       | $ | 12,299 |   | $ | 1,951 |   | (2.8 | )% | 55.0 | % |
| Hospitality   |       | 5,435                            |       | 1,472                        |       | 4,509        |       | 179 |   | 20.5 | % | 723.3 | % |
| Corporate     |       |                             |       | (4,094                       | )          |         |       | (2,107 | ) |   |   | 94.3 | % |
|          |       |                             |       |                         |       |         |       |   |   |   |   |   |   |
| Total Company |       | $                                | 17,386     |                         | $          | 403          |       | $ | 16,808 |   | $ | 23 |   | 3.4 | % | 1,652.2 | % |

 
| ** **    | ** ** | **Six Months Ended March 31,** | ** ** | ** **                   | ** ** | ** **   | ** ** |
|---------------|------------|--------------------------------|------------|------------------------------|------------|--------------|------------|
| ** **    | ** ** | **2005**                       | ** ** | **2004**                     | ** ** | **% Change** | ** ** |
| **Thousands** | ** ** | **Revenue**                    | ** ** | **Operating  Income (Loss)** | ** ** | **Revenue**  | ** ** | **Operating Income  (Loss) (1)** | ** ** | **Revenue** | ** ** | **Operating  Income (Loss)** | ** ** |
| ** **    | ** ** | ** **                     | ** ** | ** **                   | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Manufacturing |       | $                              | 24,372     |                         | $          | 6,368        |       | $ | 24,527 |   | $ | 5,282 |   | (0.6 | )% | 20.6 | % |
| Hospitality   |       | 10,291                         |       | 1,931                        |       | 9,696        |       | (326 | ) | 6.1 | % | NM |   |
| Corporate     |       |                           |       | (7,732                       | )          |         |       | (6,059 | ) |   |   | 27.6 | % |
|          |       |                           |       |                         |       |         |       |   |   |   |   |   |   |
| Total Company |       | $                              | 34,663     |                         | $          | 567          |       | $ | 34,223 |   | $ | (1,103 | ) | 1.3 | % | NM |   |

 

NM: Percentage not meaningful.

 

----

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

 

Total revenue increased $578,000, or 3.4%, in the three months ended March 31,2005 compared to the three months ended March 31, 2004, reflecting a 2.8%decrease in manufacturing revenue offset by an increase of 20.5% in hospitalityrevenue.  Our operating income increased$380,000 in the three months ended March 31, 2005, including a $1.1million increase in the manufacturing group and a $1.3 million increase in thehospitality group offset by increased corporate expenses of $2.0 million.  The corporate costs include unallocatedshared services charges such as executive management, finance, marketing, IT,legal and audit among others. Approximately $1.0 million of the increase in corporate expense is dueto outside costs associated with our Sarbanes-Oxley internal controlproject.  The remainder of the change isdue to general increases in the shared services listed above and reflectsrequirements of being a publicly reporting company and expanded marketingprograms.

 

Our total revenue increased $440,000, or 1.3%, in the six months ended March 31,2005 compared to the six months ended March 31, 2004, reflecting a 0.6%decrease in manufacturing revenue offset by an increase of 6.1% in hospitalityrevenue.  Our operating income increased$1.7 million, including a $1.1 million increase in our manufacturing group anda $2.3 million increase in our hospitality group, offset by a $1.7 millionincrease in corporate expenses, including approximately $1.0 million inSarbanes-Oxley compliance costs. Although both reportable segments are showing improvement in operatingprofit, the hospitality improvement is more significant because the fiscal 2005period includes a restructuring benefit of $261,000 while the fiscal 2004period included restructuring charges of $365,000.

 

As part of the restructuring of our hospitality operations begun in September 2003,we consolidated some of the operational and strategic management of our twooperational segments.  Also as a resultof this consolidation, some of the expenses that were previously incurredwithin our reportable segments are now classified as part of our corporate group.  Prior year segment information has beenreclassified to conform to this new presentation.

 

**Revenue. **The following table summarizes revenue byreportable segment, revenue type and geography for the three and six months ended March 31,2005 and 2004:

 

13

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| ** **                         | ** ** | **Three  Months Ended March 31,** | ** ** | ** **      | ** ** | ** **   | ** ** | ** **        | ** ** |
|------------------------------------|------------|-----------------------------------|------------|-----------------|------------|--------------|------------|-------------------|------------|
| ** **                         | ** ** | **2005**                          | ** ** | **2004**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**                 | ** ** | **Hospitality** | ** ** | **Total**    | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                              |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 |       |                              |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | $                                 | 1,632      |            | $          | 851          |       | $                 | 2,483      |   | $ | 1,863 |   | $ | 293 |   | $ | 2,156 |   | (12.4 | )% | 190.4 | % | 15.2 | % |
| Maintenance                        |       | 7,680                             |       | 3,315           |       | 10,995       |       | 7,426             |       | 3,345 |   | 10,771 |   | 3.4 | % | (0.9 | )% | 2.1 | % |
| Professional  services             |       | 2,381                             |       | 869             |       | 3,250        |       | 2,459             |       | 599 |   | 3,058 |   | (3.2 | )% | 45.1 | % | 6.3 | % |
| Third-party  software and hardware |       | 258                               |       | 400             |       | 658          |       | 551               |       | 272 |   | 823 |   | (53.2 | )% | 47.1 | % | (20.0 | )% |
|                               |       | $                                 | 11,951     |            | $          | 5,435        |       | $                 | 17,386     |   | $ | 12,299 |   | $ | 4,509 |   | $ | 16,808 |   | (2.8 | )% | 20.5 | % | 3.4 | % |
|                               |       |                              |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     |       |                              |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                           |       | $                                 | 7,287      |            | $          | 2,274        |       | $                 | 9,561      |   | $ | 7,421 |   | $ | 1,620 |   | $ | 9,041 |   | (1.8 | )% | 40.4 | % | 5.8 | % |
| Europe, Middle  East & Africa  |       | 3,029                             |       | 2,516           |       | 5,545        |       | 3,454             |       | 2,170 |   | 5,624 |   | (12.3 | )% | 15.9 | % | (1.4 | )% |
| Asia Pacific                       |       | 1,635                             |       | 645             |       | 2,280        |       | 1,424             |       | 719 |   | 2,143 |   | 14.8 | % | (10.3 | )% | 6.4 | % |
|                               |       | $                                 | 11,951     |            | $          | 5,435        |       | $                 | 17,386     |   | $ | 12,299 |   | $ | 4,509 |   | $ | 16,808 |   | (2.8 | )% | 20.5 | % | 3.4 | % |

 

 
| ** **                         | ** ** | **Six  Months Ended March 31,** | ** ** | ** **      | ** ** | ** **   | ** ** | ** **        | ** ** |
|------------------------------------|------------|---------------------------------|------------|-----------------|------------|--------------|------------|-------------------|------------|
| ** **                         | ** ** | **2005**                        | ** ** | **2004**        | ** ** | **% change** | ** ** |
| **Thousands**                      | ** ** | **Manufacturing**               | ** ** | **Hospitality** | ** ** | **Total**    | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
|                               |       |                            |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Revenue  Type:**                 |       |                            |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Software licenses                  |       | $                               | 3,440      |            | $          | 1,340        |       | $                 | 4,780      |   | $ | 3,643 |   | $ | 665 |   | $ | 4,308 |   | (5.6 | )% | 101.5 | % | 11.0 | % |
| Maintenance                        |       | 15,267                          |       | 6,861           |       | 22,128       |       | 14,648            |       | 7,276 |   | 21,924 |   | 4.2 | % | (5.7 | )% | 0.9 | % |
| Professional  services             |       | 5,040                           |       | 1,389           |       | 6,429        |       | 5,259             |       | 1,206 |   | 6,465 |   | (4.2 | )% | 15.2 | % | (0.6 | )% |
| Third-party  software and hardware |       | 625                             |       | 701             |       | 1,326        |       | 977               |       | 549 |   | 1,526 |   | (36.0 | )% | 27.7 | % | (13.1 | )% |
|                               |       | $                               | 24,372     |            | $          | 10,291       |       | $                 | 34,663     |   | $ | 24,527 |   | $ | 9,696 |   | $ | 34,223 |   | (0.6 | )% | 6.1 | % | 1.3 | % |
|                               |       |                            |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Geography:**                     |       |                            |       |            |       |         |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Americas                           |       | $                               | 14,942     |            | $          | 4,096        |       | $                 | 19,038     |   | $ | 14,913 |   | $ | 3,997 |   | $ | 18,910 |   | 0.2 | % | 2.5 | % | 0.7 | % |
| Europe, Middle  East & Africa  |       | 6,132                           |       | 4,890           |       | 11,022       |       | 6,614             |       | 4,447 |   | 11,061 |   | (7.3 | )% | 10.0 | % | (0.4 | )% |
| Asia Pacific                       |       | 3,298                           |       | 1,305           |       | 4,603        |       | 3,000             |       | 1,252 |   | 4,252 |   | 9.9 | % | 4.2 | % | 8.3 | % |
|                               |       | $                               | 24,372     |            | $          | 10,291       |       | $                 | 34,663     |   | $ | 24,527 |   | $ | 9,696 |   | $ | 34,223 |   | (0.6 | )% | 6.1 | % | 1.3 | % |

 

Manufacturing Segment:

 

Our license revenue from manufacturing software decreased by $231,000,or 12.4% in the three months ended March 31, 2005 compared to the threemonths ended March 31, 2004, and decreased by $203,000, or 5.6%, in thesix months ended March 31, 2005 compared to the same period in 2004.  The decrease was due to a number of factors,including a $90,000 decrease in the three month period and a $254,000 decreasein the six month period in revenue from licenses of our Fourth Shift product,and a $412,000 decrease in the three month period and a $344,000 decrease inthe six month period in revenue from evolution.   Reduced revenue for Fourth Shift was atleast partially attributable to increased marketing for Fourth Shift Editionfor SAP Business One, and the transfer of some of our U.S. sales force fromFourth Shift to Fourth Shift Edition.  Wehave deferred all revenue for Fourth Shift Edition until after its generalrelease, which occurred in April 2005. Consistent with this release and the shipment of product, we recordedapproximately $340,000 in revenue from Fourth Shift Edition in the thirdquarter of fiscal 2005 for contracts signed prior to March 31, 2005.

 

Our maintenance revenue for manufacturing products increased by$254,000, or 3.4%, during the quarter ended March 31, 2005 as compared tothe quarter ended March 31, 2004, and increased by $619,000, or 4.2%,during the six months ended March 31, 2005, compared to the same period in2004.  The growth in manufacturingmaintenance revenue was derived from continued low attrition rates, an increasein new software sales, and therefore new active accounts, during the year endedSeptember 30, 2004, and customer adoption of new services in our Americasregion, such as our remote system management service, which were not availablein the prior year.  Professional servicesrevenue decreased 3.2% during the three months ended March 31, 2005compared to the three months ended March 31, 2004 and decreased 4.2%during the six months ended March 31, 2005 compared to the same period in2004.  The decline in professionalservices revenue is primarily due to directing some of the Americasimplementation and consulting resources to the Fourth Shift Editionproduct.  In addition, we had a largeDemandStream consulting project in 2004 for which we recognized professionalservices revenue of $262,000 that was not replicated in 2005.  Third party software and hardware revenuedecreased by $293,000 in the three month period and by $352,000 in the sixmonths ended March 31, 2005 compared to the same periods of 2004, due inlarge part to two specific hardware orders in 2004.   Sales of third party hardware and softwareproducts is generally done as a courtesy to provide a full solution to ourcustomers.  Our revenue and gross profitfrom third party products will fluctuate based on mix and customer demand.

 

14

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Geographically, we experienced strong growth in China, and we expectthis to continue as the Chinese economy continues to expand.  Much of the customer demand in China comesfrom existing U.S. and UK customers with offshore facilities there.  Our EMEA region reported lower revenue in2005 than 2004 due to large deals in 2004 that did not recur.  Additionally the EMEA region is transitioningits sales strategy and the region has not yet benefited from this change whichwe believe will strengthen the long-term performance.  The Americas region has had some reduction inlicense revenue due to our shift in sales and marketing efforts to newproducts.  We have been successful,however, in offsetting some of the license revenue fallout with revenue fromour RSA maintenance support product, and expect some recovery in Americasmanufacturing license revenue with the release of Fourth Shift Edition in thethird quarter of fiscal 2005.

 

Hospitality Segment:

 

Total hospitality revenue increased $926,000 or 20.5% in the threemonths ended March 31, 2005 compared to the prior year and increased $595,000or 6.1% in the six month period.  Theincrease during the three month period over the prior year was primarily due tothe completion of a large custom development project to add time sharecapability to PORTfolio, our flagship hospitality product.  This project generated approximately $500,000combined license and professional services revenue.  Revenue in both the three and six monthperiods in 2004 was unusually low because, in September 2003, we stoppedactively selling hospitality products in all but the EMEA region, and insteadfocused hospitality resources on stabilization of and enhancement of Medallionfor the U.S. market.   Renewed salesefforts in fiscal 2005 are generating positive results.

 

Software license revenue increased from $293,000 during the threemonths ended March 31, 2004 to $851,000 during the three months ended March 31,2005, and from $665,000 during the six months ended March 31, 2004 to $1.3million during the six months ended March 31, 2005   The increase during both periods wasattributable to license revenue previously deferred due to outstandingdevelopment commitments and stabilization of the hospitality products withreleases of Medallion 6.0 and PORTfolio 3.1. The 0.9% decline in hospitality maintenance revenue during the threemonths ended March 31, 2005 and the 5.7% decline during the six monthsended March 31, 2005, from the comparable periods in 2004 were due to anumber of factors including: normal attrition, lower than typical replacement fromnew license revenues and discounted renewal maintenance rates offered formulti-year commitments.  There was a45.1% increase in professional services revenue during the three months ended March 31,2005 and a 15.2% increase during the six months ended March 31, 2005, overthe comparable periods in 2004, due to the completion of a large customdevelopment project.

 

The small increase in hospitality revenue in the Americas region wasdue to the aforementioned custom development project.  The increase in revenue in the hospitalityEMEA region was due primarily to sales of Medallion throughout the region withthe release of Medallion 6.0.  The EMEAregion also realized added revenue from the migration of existing customers toPORTfolio 3.1.  We are experiencingstrong business partner activity in central Europe and are optimistic thatMedallion 6.0 will continue to provide a revenue stream.

 

**Gross Margin. **The following table summarizes gross marginpercentages by reportable segment and revenue type for the three and six months ended March 31,2005 and 2004:

 

15

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| ** **                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **Manufacturing**                | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                 |       | 48.2                             | %          | 71.4 | % | 56.2 | % | 52.5 | % | (80.5 | )% | 34.5 | % |
|                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance                       |       | 76.2                             | %          | 50.2 | % | 68.4 | % | 74.5 | % | 47.1 | % | 66.0 | % |
|                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Professional services             |       | 15.2                             | %          | 31.9 | % | 19.7 | % | 15.1 | % | 51.8 | % | 22.3 | % |
|                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Third-party software and hardware |       | 31.0                             | %          | 48.3 | % | 41.5 | % | (3.6 | )% | 50.0 | % | 14.1 | % |
|                              |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                         | ** ** | **59.3**                         | **%**      | **50.5** | **%** | **56.5** | **%** | **55.8** | **%** | **39.6** | **%** | **51.5** | **%** |

 
| ** **                        | ** ** | **Six Months Ended March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **Manufacturing**              | ** ** | **Hospitality** | ** ** | **Total** | ** ** | **Manufacturing** | ** ** | **Hospitality** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Software licenses                 |       | 50.0                           | %          | 63.7 | % | 53.8 | % | 49.8 | % | (6.9 | )% | 41.1 | % |
|                              |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance                       |       | 76.9                           | %          | 49.3 | % | 68.3 | % | 74.0 | % | 50.4 | % | 66.2 | % |
|                              |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Professional services             |       | 18.8                           | %          | 20.7 | % | 19.2 | % | 21.1 | % | 15.8 | % | 20.1 | % |
|                              |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Third-party software and hardware |       | 27.5                           | %          | 46.2 | % | 37.4 | % | 12.5 | % | 25.5 | % | 17.2 | % |
|                              |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| **Total**                         | ** ** | **59.8**                       | **%**      | **47.1** | **%** | **56.0** | **%** | **56.6** | **%** | **40.7** | **%** | **52.1** | **%** |

 

Manufacturing Segment:

 

The slight decrease in manufacturing software license gross margin percentageduring the three months ended March 31, 2005 over the comparable period in2004 period is due to a decrease in revenues while product amortization remainsrelatively fixed.  Cost of licenserevenue consists of amortization of acquired software, the amortization ofcapitalized costs for internally developed software, and the cost ofthird-party software embedded in some of our products.  Amortization is relatively fixed whileroyalty costs to third parties can fluctuate depending on product mix.  We expect some recovery in Americasmanufacturing license revenue and gross margin with the release of Fourth ShiftEdition in the third quarter of fiscal 2005.

 

The slight improvement in maintenance gross profit percentage in boththe three and six months ended March 31, 2005 over the comparable periodsin 2004 is due both to an increase in related revenue and to cost savings, asthe incremental revenue generated by the new offerings in the Americas regiondid not result in significant additional costs. In addition, we achieved cost savings resulting from our support centerin Bangalore, India, which, having grown from five people in December 2003to 22 people in March 2005, became fully operational in late 2004.  Third-party software and hardware grossmargin improved substantially to 31.0% during the three months and 27.5% duringthe six months ended March 31, 2005 from a slight negative margin in thecomparable prior year three month period and a 12.5% margin during the prioryear six month period.  The improvementis due to mix.

 

Hospitality Segment:

 

Hospitality software license gross margin percentage was 71.4% duringthe three months, and 63.7% during the six months ended March 31, 2005,compared to negative gross margins during the same periods

 

16

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of 2004.  The negative margins in2004 were due to low revenue levels combined with fixed amortization expense.

 

Improvements in hospitality maintenance gross margin percentage areexpected as we move closer to bringing our Bangalore hospitality support centerinto operation.  This project, startedlate in fiscal 2004, is expected to contribute to our efforts to control costslater in fiscal 2005, although we believe full benefits from this investmentwill be realized in fiscal 2006.   In thefirst quarter of fiscal 2004, the hospitality segment’s professional servicesorganization had not yet realized the benefits of the reorganization announcedin September 2003.  The improvementyear-over-year is due largely to the steps taken during the first quarter of2004 that did not have a significant impact until subsequent quarters. However,delayed delivery of hospitality product upgrades limited our ability to provideexpected upgrade services to customers, and resulted in a low professionalservices gross profit percentage of 1.9% for the first quarter of 2005.  This improved to 31.9% in the second quarterof 2005.   In our European operations,the professional services gross profit percentage was also adversely affectedby the requirement to utilize consulting resource in non-billable productupgrade testing activities.  We expect animproved gross profit percentage in the hospitality sector as the recentreleases of the PORTfolio 3.1 and Medallion 6.0 products contribute more torevenue.

 

**Operating Expenses. **The following table summarizes operatingexpenses for the three and six months ended March 31, 2005 and 2004:

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** | ** **              | ** ** |
|----------------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **2005**                         | ** ** | **2004**                | ** ** | ** ** | ** ** |
| **Thousands**                    | ** ** | ** **                       | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                       | ** ** | ** **                       | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative       |       | $                                | 5,076      |                    | 29.2       | % | $ | 4,005 |   | 23.8 | % | 26.7 | % |
| Selling and marketing            |       | 2,579                            |       | 14.8                    | %          | 1,997 |   | 11.9 | % | 29.1 | % |
| Research and product development |       | 2,027                            |       | 11.7                    | %          | 2,260 |   | 13.4 | % | (10.3 | )% |
| Restructuring related charges    |       | (261                             | )          | (1.5                    | )%         | 365 |   | 2.2 | % | NM |   |
| Total operating expenses         |       | $                                | 9,421      |                    | 54.2       | % | $ | 8,627 |   | 51.3 | % | 9.2 | % |

 
| ** **                       | ** ** | **Six Months Ended March 31,** | ** ** | ** **              | ** ** |
|----------------------------------|------------|--------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **2005**                       | ** ** | **2004**                | ** ** | ** ** | ** ** |
| **Thousands**                    | ** ** | ** **                     | ** ** | **% of Total  Revenue** | ** ** | ** ** | ** ** | **% of Total  Revenue** | ** ** | **% Change** | ** ** |
| ** **                       | ** ** | ** **                     | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and administrative       |       | $                              | 9,913      |                    | 28.6       | % | $ | 8,796 |   | 25.7 | % | 12.7 | % |
| Selling and marketing            |       | 5,169                          |       | 14.9                    | %          | 4,248 |   | 12.4 | % | 21.7 | % |
| Research and product development |       | 4,029                          |       | 11.6                    | %          | 4,408 |   | 12.9 | % | (8.6 | )% |
| Restructuring related charges    |       | (261                           | )          | (0.8                    | )%         | 1,491 |   | 4.4 | % | NM |   |
| Total operating expenses         |       | $                              | 18,850     |                    | 54.4       | % | $ | 18,943 |   | 55.4 | % | (0.5 | )% |

 

Operating expenses before restructuring costs increasedquarter-over-quarter in dollars and as a percentage of revenue.  The increase in general and administrativeexpense was due to approximately $1.0 million of external professional feesassociated with our Sarbanes-Oxley compliance project, which began in the firstquarter of 2005.  In addition, weexpanded our selling and marketing efforts associated with the manufacturingsegment’s Fourth Shift Edition for SAP Business One product line and ourcorporate re-branding.  Research anddevelopment expenses for manufacturing as a percentage of manufacturing revenuewas 11.6% during the three months ended March 31, 2005 and 12.4% duringthe three months ended March 31, 2004, and was 11.4% for the six monthsended March 31, 2005 and 12.8% during the six months ended March 31,2004.  Research and product developmentexpense was unusually high in the first quarter of 2004 due to intensiveefforts to improve certain hospitality products.  Research and development expenses forhospitality decreased to 11.8% of hospitality revenue during the three monthsended March 31, 2005 compared with 16.3% during the three months ended March 31,2004.  Research and development expensesfor hospitality was 12.1% of revenue during the six months ended March 31,2005 compared to 13.1% during the six months ended March 31, 2004.  On March 2, 2005 the SEC announced adeferral of certain provisions of the Sarbanes-Oxley act for non-acceleratedfilers.  Due to the deferral, we wereable to

 

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postpone some of the work and related expenses that we had originallyanticipated incurring in the third and fourth quarters of fiscal 2005.  Although we will continue to work on meetingthe requirements of the Sarbanes-Oxley Act, we will take advantage of theextension by performing the remaining work at a more controlled pace and we willutilize internal resources to a greater extent. Some of the costs for testing and attestation services that wereoriginally anticipated in the second half of fiscal year 2005 will be deferredto 2006.  We expect that selling andmarketing expense, and research and product development expense will continueat levels similar to those in the first quarter, with a possible increase inselling expenses concurrent with the release of Fourth Shift Edition for SAPBusiness One for the U.S. market.

 

The restructuring charge of $1.5 million in the six months ended March 31,2004 reflects $506,000 of additional charges for employee severance expensesand other costs related to the ongoing implementation of the September 2003hospitality reorganization plan, which resulted in the elimination of 120positions.  Charges were taken in September 2003covering severance for approximately 90 of the employees, and in the six monthsof fiscal 2004, additional charges related to the majority of the remaining 30employees were incurred, along with other costs.  In addition, charges of $785,000 were takenrelated to two leased international facilities that we ceased using, and acharge of $200,000 was taken to increase a lease-related accrual originallyestablished in December 2001.  Ourexpectations regarding our ability to reduce the lease obligation throughsubleasing the space were revised and resulted in the additional charge.

 

In March 2005, we successfully negotiated an early termination ofour lease in Woking, UK.  In exchange forrelease of all future obligations on this lease, we made a final payment ofapproximately $500,000.  Following thispayment, we reversed the remaining liability from our accounts, which resultedin a $180,000 credit to restructuring expense. In addition, during the three months ended March 31, 2005, wereversed $81,000 of severance-related restructuring accrual, due to lower thanexpected severance costs.

 

Cash payments of $105,000 were made during the six months ended March 31,2005 related to employee severance and $515,000 related to leasecommitments.  A balance of $333,000 ofaccrued restructuring charges remained at March 31, 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 Expenses. **Thefollowing table summarizes non-operating income and expenses for the three andsix months ended March 31, 2005 and 2004:

 
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **March 31,**          | ** ** | **March 31,**        | ** ** |
| **Thousands**                                                                | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                                             |       | $                      | 1,022      |                 | $          | 1,230 |   | $ | 2,025 |   | $ | 2,268 |   |
| Expense from change in value of mandatorily  redeemable common stock warrant |       |                   |       | 6,040                |       |   |   | 6,423 |   |
| Other expense (income), net                                                  |       | 86                     |       | 44                   |       | (187 | ) | 18 |   |
| Provision for income tax                                                     |       | 190                    |       | 133                  |       | 290 |   | 143 |   |
| Income from discontinued operations, net of  tax                             |       |                   |       | (133                 | )          |   |   | (2,339 | ) |
|                                                                              |            |                        |            |                      |            |  |  |  |  |  |  |  |  |

 

Interest expense is related to our long-term institutional debtincurred in November 2002.  Itincludes cash interest expense, amortization of capitalized financing costs anddebt accretion of an original issue discount.

 

Our statements of operations for the three and six months ended March 31,2004 include charges for the change in value of the mandatorily redeemablecommon stock warrant we issued as part of the long-term institutional debtfinancing in November 2002.  Duringthe three months ended March 31, 2004, the put warrant fair valueappreciated by $6.0 million, resulting in non-operating expense during theperiod.  During the six months ended March 31,2004, the put warrant fair value appreciated by $6.4 million.  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.

 

18

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Other expense (income), net, primarily consists of the effect ofchanges in foreign exchange rates on intercompany payables denominated in U.S.dollars.  A significant portion of thistransaction gain is the direct result of the change in exchange rates betweenthe British Pound and the U.S. Dollar. We do not currently utilize any derivative security instruments orengage in any hedging activities.

 

Our tax provision for all periods consists of amounts for our estimateddomestic federal and state liabilities and international tax liabilities.  Our tax provision fluctuates due to the mixof forecasted results between domestic operations and our internationalsubsidiaries.  In addition, for the threeand six months ended March 31, 2004, $30,000 and $120,000 of income taxexpense, respectively, was recorded as part of discontinued operations.  Finally, we have not recorded certain incometax benefits in either of the periods presented due to continued uncertaintyregarding our ability to realize our deferred tax assets.  We consider the earnings of our internationalsubsidiaries to be indefinitely invested abroad, and do not foresee theAmerican Jobs Creation Act of 2004 having a material impact upon our financialposition.

 

In accordance with the bankruptcy and reorganization plan of AremisSoftCorporation, our former parent, we retained a 10% interest in net collectionsby the liquidating trust established to pursue litigation claims and collectionof assets remaining in AremisSoft after bankruptcy.  In December 2003, we received a cashdistribution of $2.9 million from the liquidating trust, which was recorded asincome from discontinued operations.  Inaddition, we recorded a $619,000 charge for additional obligations of the discontinuedoperations in the quarter ended December 31, 2003, and a $153,000 benefitin the quarter ended March 31, 2004. These amounts were recorded net of an income tax provision of$120,000.  We have been advised that the liquidating trust has reached settlement inone of the actions it is pursuing and anticipates, in accordance with thatsettlement, a substantial collection within the next several months.  We have not been advised as to the preciseamount of the anticipated collection, the exact timing of the collection, orwhether the liquidating trust will make an immediate distribution to itsbeneficiaries and SoftBrands.  If adistribution occurs, we intend to recognize any such distribution upon cashreceipt and reflect this as income from discontinued operations.

 

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# **Liquidity and Capital Resources**

 

As of March 31, 2005, wehad $9.1 million of cash and cash equivalents. Our working capital deficit (current assets less current liabilities),increased from $13.4 million at September 30, 2004 to $15.1 million at March 31,2005.  This increase in working capitaldeficit is due to the reclassification from long-term to current of the $2.0million principal payment of debt that is due on December 31, 2005, offsetby improvements in other working capital balances, most significantly, accruedexpenses.  The working capital deficit atMarch 31, 2005 includes deferred revenue of $19.8 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 operatingcash flows 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 Flowsfrom Operating Activities. **We generated $550,000 of cash from operatingactivities in the six months ended March 31, 2005, compared to cash usedof $252,000 in the comparable prior year period.  The two most significant changes between thetwo periods are an $8.4 million reduction from 2004 to 2005 in the loss fromcontinuing operations, and the $6.4 million change in valuation of mandatorilyredeemable common stock.  This non-cashitem was recorded in 2004 as an operating expense and is no longer required dueto the exchange of this put warrant for Series B convertible preferredstock and a new common stock warrant.  Additionally, other non-cash charges decreased by $2.8 million.   We had $3.2 million of non-cash expenses inthe six months ended March 31, 2005, including $2.9 million ofdepreciation and amortization and $586,000 for non-cash interest charges.  This compares to other non-cash expenses of$6.0 million in the prior year, including $3.6 million of depreciation andamortization, $1.5 million of restructuring charges and $792,000 for non-cashinterest.

# ** **

# **Changes in operating assets and liabilitiesproduced a cash usage of $1.1 million in the six months ended March 31, 2005as compared to a $2.7 million usagein the prior year. The most significant cashflow changes between the two periods relate to accounts payable and accruedrestructuring costs.  In the six monthsended March 31, 2004, we used $4.7 million for the reduction of thesebalances compared to $801,000 in the six months ended March 31, 2005.  The 2004 period included significant cashpayments for restructuring related expenses and to bring vendor accountscurrent.  We generated cash of $1.4million and $2.8 million from increased deferred revenue during the six monthsended March 31, 2005 and 2004, respectively.**

# ** **

# **In December 2003, we received a cashdistribution of $2.9 million from the liquidating trust established followingthe AmerisSoft bankruptcy, which is reflected as cash from discontinuedoperations.**

# ** **

# **We believe that increased profitability andeffective working capital management will yield cash generation from operatingactivities in the remainder of fiscal 2005.**

# ** **

# **Cash Flowsfrom Investing Activities.****We used $549,000 of cash in investing activities during the six monthsended March 31, 2005 and $499,000 during the six months ended March 31,2004.  We had limited expenditures foracquired technology or other intangible assets, reflecting our strategy followingthe September 2003 restructuring plan to focus hospitality developmentefforts on existing products and existing customers.  We did have expenditures to upgrade andreplace some of our internal computer hardware and other equipment.  We expect investing activities in theremainder of fiscal 2005 to consist primarily of internal technology and systemupgrades.

# ** **

# **Cash Flowsfrom Financing Activities. **We used $226,000 of cash in financingactivities in the six months ended March 31, 2005 and $745,000 in the sixmonths ended March 31, 2004, primarily related to payments for debtincurred in connection with acquisitions.

# ** **

# **Commitments and Capital Adequacy.**  As of March 31, 2005, ourprimary commitments are for indebtedness and interest payments under our debtagreement and for leased office space in Minneapolis, Minnesota; Wichita,Kansas; Golden, Colorado; Reading, UK; Tianjin, China; and Sydney, Australiaand payments on the long-term debt and lease obligations.

 

20

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Effective November 26, 2002, we borrowed$20.0 million from Capital Resource Partners IV, L.P. (“CRP”) pursuant to aSenior Subordinated Note and Warrant Purchase Agreement and a SeniorSubordinated Note that carried an interest rate of 12.5% per annum.  An amendment in November 2003 resultedin an increase in this interest rate to 14%. The note is collateralized by substantially all of our assets, includingthe stock of our subsidiaries.  Aspartial consideration for such borrowings, we issued warrants to thelender.  These warrants were subsequentlyexchanged for convertible preferred stock and warrants with a higher exerciseprice.

 

# **The debt agreement requires us to satisfycovenants relating to our EBITDA, our fixed charge coverage ratio, our leaseholdexpense and other items.  If we violatethese covenants, the debt agreement provides that CRP may accelerate andrequire us to immediately repay the indebtedness.   Although we are currently in compliance withall of the covenants in that agreement and expect that we will continue tocomply with the covenants during the coming twelve months, we were required torenegotiate the debt agreement in the past when we expected that our operationswould not satisfy the covenants.  Wecannot be certain that, if we were to violate the debt agreement, CRP would beagreeable to renegotiation in the future, and it if it were not, we would berequired to find alternative financing to repay the debt, or risk that CRPwould seek to dispose of some or all of our assets to repay the debt.  We currently do not have arrangements foralternative financing, and if we were forced to obtain financing in a shortperiod of time to avoid default, the terms of that financing might be very disadvantageousto us and to our stockholders.  Webelieve it is probable we will meet our covenants with CRP for the next twelvemonths and therefore the portion of our CRP debt with scheduled payments beyondMarch 31, 2006 is classified as long-term.**

# ** **

If we were to choose to raise additional capital through the sale ofdebt, unless we simultaneously repaid our indebtedness to CRP, we would berequired to obtain their consent to incur amounts which in the aggregate exceedapproximately $6 million of additional indebtedness.  If we were to choose to raise additionalcapital through the sale of preferred stock, unless we simultaneously redeemedour Series B convertible preferred stock, we would be required to obtainCRP’s consent to issue preferred stock having a dividend or liquidationpreference senior to our Series B convertible preferred stock.

 

Subject to remaining in compliance with ourdebt agreement, we believe that cash flows from operations, expected to improvein the remainder of fiscal 2005, together with our cash and cash equivalents, willbe sufficient to meet our commitments and our cash requirements for at leastthe next twelve months.  We also believethe restructuring programs implemented in September 2003 should improveour cash flows from operations over time. Finally, as more fully described in the Non-Operating Income and Expensesection,  there is a possibility that ourcash position will be further enhanced by a distribution from the liquidatingtrust.

 

**Contractual Obligations. **Atable summarizing our significant contractual obligations is included in our Form 10as filed with the SEC on January 14, 2005, as amended on March 15,2005 and May 6, 2005.  There were nosignificant changes to our contractual obligations during the six months ended March 31,2005.

 

**Recent Accounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Boardpublished SFAS No. 123 (revised 2004), *Share-BasedPaymen**t*.  SFAS No. 123(R) revises SFAS No. 123,*Accounting for Stock-Based Compensation*,and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. The revised statement addresses the accounting for share-based paymenttransactions with employees and other third parties, eliminates the ability toaccount for share-based payment transactions using APB Opinion No. 25 andrequires that the compensation costs relating to such transactions berecognized in the consolidated statement of operations based on the grant-datefair 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

 

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the three and six months ended March 31, 2005 and 2004.

 

**Forward-Looking Statements**

 

Our Form 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 can identifyforward-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 may causeour or our industry’s actual results, level of activity, performance orachievements to be materially different from those expressed or implied bythese forward-looking statements.  Thefactors that may cause our operations to vary materially from thosecontemplated by our forward-looking statements are described in detail in ourForm 10 as filed with the SEC on January 14, 2005, as amended on March 15, 2005and May 6, 2005, and include:

 

•                  Economic andmarket conditions.

 

•                  Downturns in thehospitality or manufacturing markets.

 

•                  The difficultyencountered in generating significant new software license sales in maturemarkets.

 

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

 

•                  The risksrelated to our substantial international operations and sales.

 

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

 

•                  The need tocontinue to develop new products and enhance our current products in responseto technological changes and competing products.

 

•                  The dependenceof our revenue on renewal of maintenance agreements by our customers.

 

•                  The possibilitythat we may not be able to recognize revenue when we deliver products.

 

•                  The effect ofour anti-takeover defenses on possible acquisition proposals.

 

•                  The greater sizeand brand recognition of a number of our competitors.

 

•                  The effect of achange, effective for the first annual period beginning after June 15,2005, in accounting for stock options and other stock based benefits on ourreported operating results.

 

•                  Our dependenceon third-party vendors for some of the software technology used in ourproducts.

 

•                  Our potentialexposure to intellectual property disputes.

 

•                  Our dependenceon current management.

 

•                  Our previousstatus and association as a subsidiary of AremisSoft Corporation.

 

•                  Our ability tomaintain an effective system of internal controls.

 

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

 

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•                  Our ability toraise capital with acceptable pricing and terms should we choose to do so.

 

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

 

There were no material changesin market risk for the Company in the period covered by this report. See theCompany’s Form 10 as filed with the SEC on January 14, 2005, asamended on March 15, 2005 and May 6, 2005, for a discussion of marketrisk for the Company.

 

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

 

As required by Rule 13a-15(b) under the Securities ExchangeAct of 1934, as amended, we conducted an evaluation under the supervision andwith the participation of our management, including the Chief Executive Officerand the Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based on that evaluation, the Chief Executive Officer and the Chief FinancialOfficer concluded that our current disclosure controls and procedures areeffective 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.

 

There were no changes in our internal control over financial reportingthat occurred during the quarter ended March 31, 2005 that materiallyaffected, or that are reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II.OTHER INFORMATION**

 

**Item1—Legal Proceedings**

 

We are periodically engaged in litigation in the ordinary course ofbusiness, including litigation seeking return of software licensing andservicing fees.  We do not believe thatany of such litigation is material to our ongoing operations.

 

**Item 2—Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Not applicable.

 

**Item 3—Defaults on Senior Securities**

 

Not applicable.

 

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

 

Not applicable.

 

**Item5—Other Information**

 

Not applicable.

 

**Item 6—Exhibits**

 

31.1                           Certification Pursuant to Section 302 ofthe Sarbanes-Oxley Act – George H. Ellis.

 

31.2                           Certification Pursuant to Section 302 ofthe Sarbanes-Oxley Act – David G. Latzke.

 

32.0         CertificationPursuant to Section 906 of the Sarbanes-Oxley Act.

 

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**SIGNATURES**

 

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

 

 
| Date: May 16, 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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