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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the period ended June 30, 2003 or
/__/ 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: 1-9158
MAI SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 22-2554549
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
26110 ENTERPRISE WAY, LAKE FOREST, CA 92630
ADDRESS OF PRINCIPAL EXECUTIVE OFFICES
Registrant's telephone number including area code (949) 598-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
The aggregate market value of the common stock held by non-affiliates of the
registrant, based upon the last sale price of the Common Stock reported on the
National Association of Securities Dealers Automated Quotation National Market
System on August 13, 2003 was $1,785,090.
The number of shares of common stock issued, outstanding and subscribed as of
August 13, 2003 was 14,875,752.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MAI SYSTEMS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share data)
---------------------------
As of December As of June
31, 2002 30, 2003
--------- ---------
ASSETS
Current assets:
Cash $ 545 $ 429
Receivables, less allowance for doubtful accounts of
$336 in 2002 and $323 in 2003 1,834 2,285
Inventories 60 74
Notes receivable 250 --
Prepaids and other assets 628 627
--------- ---------
Total current assets 3,317 3,415
Furniture, fixtures and equipment, net 843 819
Intangibles, net 1,823 2,242
Other assets 194 267
--------- ---------
Total assets $ 6,177 $ 6,743
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Current portion of long-term debt $ 3,289 $ 3,439
Accounts payable 1,077 748
Customer deposits 1,811 1,424
Accrued liabilities 2,007 2,522
Income taxes payable 89 78
Unearned revenue 3,693 4,555
--------- ---------
Total current liabilities 11,966 12,766
Long-term debt 7,234 6,970
Other liabilities 1,759 1,688
--------- ---------
Total liabilities 20,959 21,424
--------- ---------
Commitments and contingencies
Stockholders' deficiency:
Preferred Stock, par value $0.01 per share;
1,000,000 shares authorized, none issued and outstanding -- --
Common Stock, par value $0.01 per share; authorized
24,000,000 shares; 14,675,752 and 14,875,752 shares
issued, outstanding and subscribed at
December 31, 2002 and June 30, 2003, respectively 150 152
Additional paid-in capital 218,251 218,112
Accumulated other comprehensive loss
Minimum pension liability (918) (918)
Foreign currency translation (31) 9
Unearned Compensation (91) (72)
Accumulated deficit (232,143) (231,964)
--------- ---------
Total stockholders' deficiency (14,782) (14,681)
--------- ---------
Total liabilities and stockholders' deficiency $ 6,177 $ 6,743
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
MAI SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) (UNAUDITED)
---------------------------- ----------------------------
For the Three Months Ended June 30, For the Six Months Ended June 30,
(in thousands, except per share data) (in thousands, except per share data)
---------------------------- ----------------------------
2002 2003 2002 2003
-------- -------- -------- --------
Revenue:
Software $ 1,124 $ 1,127 $ 2,391 $ 2,257
Network and computer equipment 134 86 404 235
Services 4,230 3,539 8,425 7,446
-------- -------- -------- --------
Total revenue 5,488 4,752 11,220 9,938
-------- -------- -------- --------
Direct costs:
Software 192 52 349 258
Network and computer equipment 90 74 292 165
Services 1,499 1,100 3,119 2,274
-------- -------- -------- --------
Total direct costs 1,781 1,226 3,760 2,697
-------- -------- -------- --------
Gross profit 3,707 3,526 7,460 7,241
Selling, general and administrative expenses 2,322 2,438 4,382 4,969
Research and development costs 656 658 1,664 1,340
Amortization of intangibles 45 -- 109 --
Other operating (income) loss 6 3 5 (46)
-------- -------- -------- --------
Operating income 678 427 1,300 978
Interest income 1 -- 3 1
Interest expense (388) (292) (775) (642)
Other non-operating expense (14) (212) (27) (212)
-------- -------- -------- --------
Income (loss) from continuing operations before
income taxes 277 (77) 501 125
Income tax benefit (expense) (5) (5) (8) 54
-------- -------- -------- --------
Income (loss) from continuing operations 272 (82) 493 179
Income from discontinued operations 74 -- 180 --
-------- -------- -------- --------
Net income (loss) $ 346 $ (82) $ 673 $ 179
======== ======== ======== ========
Income (loss) per share:
Continuing Operations:
Basic income (loss) per share $ 0.02 $ (0.01) $ 0.04 $ 0.01
======== ======== ======== ========
Diluted income (loss) per share $ 0.02 $ (0.01) $ 0.04 $ 0.01
======== ======== ======== ========
Discontinued Operations:
Basic income per share $ 0.01 $ 0.00 $ 0.01 $ 0.00
======== ======== ======== ========
Diluted income per share $ 0.01 $ 0.00 $ 0.01 $ 0.00
======== ======== ======== ========
Net income per share:
Basic income (loss) per share $ 0.02 $ (0.01) $ 0.05 $ 0.01
======== ======== ======== ========
Diluted income (loss) per share $ 0.02 $ (0.01) $ 0.05 $ 0.01
======== ======== ======== ========
Weighted average common shares used
in determining income (loss) per share:
Basic 13,852 14,426 13,754 14,426
======== ======== ======== ========
Diluted 14,361 14,426 14,223 14,726
======== ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
-2-
MAI SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
June 30,
(in thousands)
--------------------------
2002 2003
------- -------
Net cash provided by operating activities: $ 1,229 $ 399
Cash flows used in investing activities:
Proceeds from note receivable -- 250
Capital Expenditures (117) (195)
Capitalized software development costs (359) (419)
------- -------
Net cash used in investing activities (476) (364)
Cash flows from financing activities:
Net decrease in line of credit (385) --
Repayments on long-term debt (75) (148)
------- -------
Net cash used in financing activities (460) (148)
------- -------
Net cash provided by (used in) continuing operations 293 (113)
Net cash used in discontinued operations (264) --
Effect of exchange rate changes on cash (15) (3)
------- -------
Net change in cash 14 (116)
------- -------
Cash at beginning of period 1,224 545
------- -------
Cash at end of period $ 1,238 $ 429
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
-3-
MAI SYSTEMS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2003
(UNAUDITED)
1. BASIS OF PRESENTATION
Companies for which this report is filed are MAI Systems Corporation and its
wholly owned subsidiaries (the "Company"). The information contained herein is
unaudited, but gives effect to all adjustments (which are normal recurring
accruals) necessary, in the opinion of Company management, to present fairly the
condensed consolidated financial statements for the interim period. All
significant intercompany transactions and accounts have been eliminated in
consolidation.
Although the Company believes that the disclosures in these financial statements
are adequate to make the information presented not misleading, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to the rules
and regulations of the Securities and Exchange Commission (the "SEC"), and these
financial statements should be read in conjunction with the financial statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002, which is on file with the SEC.
2. LIQUIDITY
Although the Company has a net stockholders' deficiency of $14,646,000 and a
working capital deficit of $9,316,000 (which includes subordinated debt due to
CSA of $2,800,000) at June 30, 2003, the Company believes it will continue to
generate sufficient funds from operations and obtain additional financing or
restructure its subordinated note with CSA to meet its operating and capital
requirements. The Company is currently in negotiations with CSA to restructure
the terms of the existing debt, including extending the maturity date. The
Company expects to generate positive cash flow from its continuing operations
during 2003 from shipping out products and services from its current backlog as
of June 30, 2003 as well as new orders. In the event that the Company cannot
generate positive cash flow from its continuing operations during 2003, the
Company can substantially reduce its research and development efforts to
mitigate cash outflow to help sustain its operations. There can be no assurance
that the Company will be able to sustain profitability, generate positive cash
flow from operations or restructure its debt as necessary. These financial
statements have been prepared assuming the Company will continue to operate as a
going concern. If the Company is unsuccessful in the aforementioned efforts, the
Company could be forced to liquidate certain of its assets, reorganize its
capital structure and, if necessary, seek other remedies available to the
Company, including protection under the bankruptcy laws.
The restructured debt, pursuant to the original inter-creditor agreement between
Canyon Capital and Coast, which was sold to Wamco on May 15, 2003, contains
various restrictions and covenants. In the event that the Company were not in
compliance with the various restrictions and covenants and were unable to
receive waivers for non-compliance, the term debt would be immediately due and
payable. The Company was not in compliance with but received waivers for the
covenants as of and for the three month period ended June 30, 2003. (see note 7)
3. INVENTORIES
Inventories are summarized as follows:
(dollars in thousands)
-------------------
December 31, June 30,
2002 2003
---- ----
Finished goods $45 $60
Replacement parts 15 14
--- ---
$60 $74
=== ===
-4-
4. PLAN OF REORGANIZATION
In connection with the Company's Chapter 11 bankruptcy proceedings in 1993,
shares of Common Stock are currently being distributed by the Company to its
former creditors pursuant to the Plan of Reorganization (the "Plan") as approved
by United States Bankruptcy Court. The Company does not anticipate that
additional shares will be issued under the plan. As of June 30, 2003, 6,758,251
shares had been issued pursuant to the Plan.
Notwithstanding the confirmation and effectiveness of its Plan of Reorganization
pursuant to which the Company emerged from a voluntary proceeding under the
bankruptcy laws, the United States Bankruptcy Court continues to have
jurisdiction, among other things, to resolve disputed pre-petition claims
against the Company, to resolve matters related to the assumptions, assignment
or rejection of executory contracts pursuant to the Plan, and to resolve other
matters that may arise in connection with the implementation of the Plan.
5. BUSINESS ACQUISITIONS
HOTEL INFORMATION SYSTEMS, INC.
Effective August 9, 1996, the Company acquired substantially all of the assets
and assumed certain liabilities of Hotel Information Systems, Inc. ("HIS")
pursuant to an asset purchase agreement dated June 30, 1996 (as amended July 10,
1996) for 1,179,000 unregistered shares of the Company's common stock valued at
$10,900,000. The net assets acquired from HIS are used in the business of
software design, engineering and service relating to hotel information systems.
The net assets also included subsidiaries of HIS in Singapore, Hong Kong and
Mexico. The acquisition of HIS has been accounted for by the purchase method of
accounting. The total purchase price for HIS was $21,373,000, which included net
liabilities assumed of HIS of $7,873,000 and acquisition costs of approximately
$2,600,000.
During 1996, the Company entered into arbitration proceedings regarding the
purchase price of HIS. The Company placed approximately 1,100,000 shares of
Common Stock issued in connection with the acquisition of HIS in an escrow
account to be released in whole, or in part, upon final resolution of post
closing adjustments.
In November 1997, the purchase price for the acquisition of HIS was reduced by
$931,000 pursuant to arbitration proceedings. As a result, goodwill was reduced
by $931,000 and approximately 100,650 shares were required to be released from
the escrow account and returned to the Company (this has not occurred as of June
30, 2003). In addition, the Company had further claims against HIS relating to
legal costs and certain disbursements inappropriately made by HIS prior to the
closing estimated at $650,000. The Company was required, as needed, pursuant to
the asset purchase agreement and related documents, to issue additional shares
of Common Stock in order that the recipients ultimately receive shares worth a
fair value of $9.25 per share. This adjustment applied to a maximum of 73,466
shares of Common Stock. As of June 30, 2003, the fair market value of the
Company's common stock was $0.15 per share, which would result in approximately
5,744,316 additional shares being issued. Also, included in the escrow account
at December 31, 2002 are 200,000 shares of the Company's common stock, which do
not have a guarantee of value.
On March 25, 2003, the Company entered into a settlement agreement with HIS and
one of its former corporate officers whereby (i) the parties dismissed all
claims, known and unknown, against each other; (ii) the Company forgave and
wrote off a note receivable from the former corporate officer of HIS in the
amount of $66,000 (which was expensed to other expense in the 2002 consolidated
statement of operations); (iii) the Company paid $50,000 in cash and issued a
non-interest bearing unsecured promissory note which requires 35 consecutive
monthly payments of $5,000 each commencing April 1, 2003; and (iv) the remaining
374,116 shares in the escrow account will be released to the Company. If the
Company is delinquent four times in any twelve month period during the term of
the unsecured promissory note in making its $5,000 monthly payments to HIS, and
HIS issues respective valid default notices, the Company will be subject to a
$225,000 penalty. The 374,116 shares have been received by MAI together with the
HIS authorization to legally transfer such shares to MAI.
Imputing interest at 11%, the present value of the $175,000 promissory note a
the date of the settlement was $149,000. The Company recorded the present value
of this debt issuance and the $50,000 cash payment as a reduction to additional
paid-in capital.
HOSPITALITY SERVICES & SOLUTIONS
On June 23, 2002, the Company acquired substantially all of the assets and
assumed certain liabilities of Hospitality Services & Solutions ("HSS") pursuant
to a stock purchase agreement for 100,000 shares of common stock valued at
$32,000 (the quoted market price of the common stock at the time the terms were
agreed), and $75,000 in cash. Additionally, the shareholders of HSS received a
20% minority interest in the Company's combined operations in Asia. HSS was
acquired for the Company to expand its operations in the Asian marketplace,
strengthen its management team in the territory and create new opportunities for
its new enterprise capable suite of products. The net assets acquired from HSS
are used in the business of software design, engineering and service relating to
hotel information systems. The net assets also include subsidiaries of HSS in
Malaysia, Singapore and Thailand. The Company recorded
-5-
$297,000 of goodwill (deductible for tax purposes) in connection with the
acquisition of HSS. Pro forma results of operations as if this acquisition had
occurred at the beginning of 2001 and 2002 are not shown because its impact
would have been immaterial.
6. BUSINESS DIVESTITURES
GAMING SYSTEMS INTERNATIONAL
On June 19, 1999, the Company sold Gaming Systems International ("GSI") for an
amount in excess of the book value of net assets sold. Assets sold of
approximately $3,749,000 consisted of accounts receivable of $1,514,000,
inventories of $364,000, furniture, fixtures and equipment of $218,000,
intangible assets of $1,573,000 and prepaid expenses of $80,000. Liabilities
assumed by the buyer consisted of accounts payable and accrued liabilities of
$197,000, deposits of $100,000, unearned revenue of $351,000 and long-term debt
of $446,000. The Company received three promissory notes totaling $4,925,000
with face values of $1,100,000, $1,500,000 and $2,325,000, respectively.
Interest was paid monthly at the rate of 10% per annum on both the $1,100,000
and $1,500,000 notes, with the principal due and payable on June 19, 2001 and
June 19, 2003, respectively. A third party guaranteed the $1,100,000 promissory
note. Principal payments and interest, at prime plus 1%, was to commence for the
$2,325,000 promissory note on October 1, 2002 in 48 monthly installments of
approximately $48,000 of principal, plus accrued interest.
Imputing interest at a rate of 10%, the present value of the $2,325,000
promissory note at the date of sale was $1,682,000, which resulted in a combined
carrying value of $4,282,000 for all three promissory notes. The gain on sale of
$1,227,000 had been deferred until collection of the proceeds representing the
gain can be assured. As of December 31, 2000, the Notes were held for sale and
were written down to an amount, which approximated their estimated net
realizable value of $2,700,000.
On April 6, 2001 the Company entered into an agreement with the maker of the
Notes whereby the maker reconvened 100% of the Common Stock of GSI to the
Company. For the purpose of selling GSI to a third party. In connection with the
agreement, the Company canceled the Notes and entered into a new $1.1 million
secured promissory note with the same party. The maker will be paid a commission
of 30% of cash receipts from the third party, which will be first applied to the
$1.1 million note and paid in cash to the maker thereafter. On July 27, 2001,
the Company entered into an Asset Purchase Agreement ("Agreement") with the
third party for approximately $3.2 million whereby all of the assets of GSI were
acquired and all of the liabilities assumed, except for approximately $300,000
of obligations, which will remain with GSI. The payment terms under the
Agreement required a $1 million non-refundable cash payment to the Company,
which was received on July 27, 2001 and a $1.5 million payment, which was
received in December 2001. The Company also received a secured promissory note
in the amount of $750,000, of which $500,000 was received in December 2002 and
$250,000 in January 2003. The third party was also required to pay an additional
$250,000 subject to a maximum $250,000 reduction pursuant to the resolution of
certain uncertainties as of the date of the Agreement, which, as part of the
settlement, in January 2003 the Company received $46,000. Due to the uncertainty
of collecting the unsecured amount of $250,000, gain recognition on that part of
the proceeds was deferred until collection was assured. The Company recorded a
gain on the sale of GSI of $245,000 in the fourth quarter of 2001.
LEGACY
On October 9, 2001, the Company sold certain rights under customer contracts
together with the related assets and liabilities of its domestic Legacy hardware
maintenance division to the third party currently providing the on-site repair
and warranty service to the Company's Legacy hardware maintenance customers.
Pursuant to the agreement, the Company retained the software maintenance
component of the customer contracts and will continue to provide the software
support services directly to the domestic Legacy customer base. Additionally,
the third party will be required to pay the Company approximately 15% of the
third party's hardware maintenance revenue stream relating to the hardware
maintenance customer contracts subsequent to October 31, 2003. In connection
with the sale, the Company received $328,000 in cash and sold approximately
$157,000 of assets consisting of inventory, spare parts, fixed assets and
certain accounts receivable. The third party also assumed approximately
$1,091,000 of liabilities consisting of accrued liabilities of approximately
$366,000 and deferred revenue of approximately $725,000. The sale resulted in a
gain of approximately $1,262,000 in October 2001.
-6-
MAI CANADA
On December 6, 2002, the Company sold all the assets and certain liabilities of
its Canadian operations, including all legacy divisions, to the management of
this subsidiary pursuant to a stock purchase agreement. In connection with the
sale, the Company also entered into a software distribution agreement whereby
the buyer has a non-exclusive right and license to market and installs the
Company's hospitality products in Canada. The sale resulted in a loss of
approximately $630,000, which is included in the loss on disposal of
discontinued operations. Prior to the sale, the Canadian operations incurred a
net income of $106,000 and $174,000 for the three-month and six-month period
ended June 30, 2002, respectively.
PROCESS MANUFACTURING
On December 6, 2002, the Company entered into an Asset Purchase Agreement
whereby all the assets and certain liabilities of its process manufacturing
software division were sold to a third party for cash of $250,000. The sale
resulted in a loss of approximately $391,000, which is included in the loss on
disposal of discontinued operations. Prior to the sale, Process Manufacturing
operations incurred a net loss of $26,787 and $12,211 for the three-month and
six-month period ended June 30, 2002.
7. LINE OF CREDIT AND BRIDGE LOAN AND LONG TERM DEBT
LINE OF CREDIT & BRIDGE LOAN
On July 28, 1999, the Company obtained a Bridge Loan from Coast Business Credit
("Coast") in the amount of $2,000,000. The Bridge Loan originally bore interest
at prime plus 5% (prime plus 8% when default interest rates apply). Loan
origination fees of $75,000 paid to Coast in connection with the Bridge Loan
were amortized to interest expense over the term of the loan. During the first
quarter of 2001, the remaining balance of the Bridge Loan was repaid in full. In
April 1998, the Company negotiated a $5,000,000 secured revolving credit
facility with Coast. The availability of this facility was based on a
calculation using a rolling average of certain cash collections. The facility is
secured by all assets, including intellectual property of the Company, and bore
interest at prime plus 4.5% and was due to expire on April 30, 2003. The credit
facility was amended to allow for aggregate borrowings on an interest only basis
under the credit facility not to exceed $3,360,000. In connection with the
amendment, the Company agreed to pay Coast a fee of $300,000 ("Loan Fee") in
weekly installments of $35,000 commencing after the Bridge Loan was paid in
full. The Loan Fee was fully paid by April 23, 2001. The Loan Fee of $300,000 is
classified in prepaid and other current assets and was being amortized to
interest expense over the original term of the facility. The loan fee was fully
amortized in the first quarter of 2003.
On January 13, 2003, the Company re-negotiated the terms of the credit facility
whereby the outstanding balance of $1,828,000. As of that date was converted to
a term loan which accrues interest at 9.25% per annum and requires monthly
payments of $58,000 over a 36 months period commencing March 1, 2003. The new
term loan matures on February 28, 2005, at which time all remaining principal
and accrued interest is due and payable. The Company will also be required to
pay Coast additional principal payments on a quarterly basis based upon an
EBITDA-based formula commencing March 31, 2003. For the three-months ended June
30, 2003, there are no additional principal payments required under the
EBITDA-based formula. The consolidated balance sheet as of December 31, 2002 and
June 30, 2003 reflects the re-class of the secured revolving credit facility to
a term loan.
On February 7, 2003, the Federal Deposit Insurance Corporation ("FDIC") put
Coast and its parent company, Southern Pacific Bank, into receivership and held
all of Coast's assets for sale to third parties. On May 15, 2003, the loan was
sold to Wamco 31, Ltd. (Wamco). This sale of the loan by the FDIC did not change
any of the terms of the Company's loan agreement.
The restructured debt, pursuant to the original inter-creditor agreement between
Canyon Capital and Coast, which was sold to Wamco on May 15, 2003, contains
various restrictions and covenants, including a minimum quick ratio of 0.30 to
l.00 and minimum debt service coverage ratio of 0.90 to l.00 which commence as
of and for the three-month period ended March 31, 2003. The minimum quick ratio
increases to 0.31 to 1.00 as of June 30, 2003 and September 30, 2003 and to 0.34
to 1.00 as of December 31, 2003 and for each and every fiscal quarter ending
thereafter. The minimum debt coverage ratio increases to 1.10 to 1.00 for the
three-month period ending June 30, 2003 and to 1.25 to 1.00 for the three-month
period ending September 30, 2003 and for each and every fiscal quarter
thereafter. In the event that the Company were not in compliance with the
various restrictions and covenants and were unable to receive waivers for
non-compliance, the term debt would be immediately due and payable. The Company
was not in compliance with but received waivers for the covenants as of and for
the three month period ended June 30, 2003.
-7-
LONG-TERM DEBT
In March 1997, the Company issued $6,000,000 of 11% subordinated notes payable
due in 2004 to an investment fund managed by Canyon Capital Management LP
("Canyon"). In September 1997, this indebtedness was reduced to $5,250,000
through application of a portion of the proceeds realized from the exercise of
warrants by Canyon. The notes called for semi-annual interest payments.
The Company and Canyon subsequently entered into a forbearance agreement
providing that the Company pays Canyon weekly interest payments of $12,500
effective January 1, 2000. In addition, the Company executed a security
agreement, which provided Canyon with a lien on all of the Company's tangible
and intangible property, which lien is junior to the lien granted to Wamco.
On April 13, 2000, the Company entered into an agreement with Canyon, waiving
all existing events of default, accelerated the maturity date to March 3, 2003
and provided for continued weekly interest payments of $12,500. On January 31,
2001, the Company entered into an agreement with Canyon whereby the specified
accrued interest of $431,000 was added to the principal balance of the
subordinated notes payable. As part of this agreement, the Company also agreed
to pay Canyon an additional $79,000 loan fee, of which $29,000 was added to
principal. The principal balance outstanding on the subordinate notes payable to
Canyon was approximately $5,662,000 at December 31, 2002 and June 30, 2003.
On January 13, 2003, the Company modified the terms of its agreement with
Canyon, whereby the Company is required to make monthly payments of $52,000
until the Wamco term loan is paid off in full at which time the note payable
will be converted into a three-year amortizing loan which will accrue interest
at 11% per annum and requires equal monthly payments of principal and interest
such that the subordinated debt will be paid in full at the end of the amended
term. Upon the repayment of the Wamco debt in full, the Company will also be
required to pay Canyon additional principal payments on a quarterly basis based
upon an EBITDA-based formula. Additionally, the Company will issue to Canyon
200,000 shares of its common stock valued at $20,000 (the quoted market price of
the common stock at the time the terms were agreed) and one million warrants at
an exercise price of $0.40 per share valued at $ 42,000 (using the Black-Scholes
option-pricing model with the following weighted-average assumptions: risk-free
interest rate of 6.5%, volatility of 80% and an expected life of 5 years). The
$62,000 is being amortized to interest expense over the term of the modified
note.
In connection with a settlement agreement with CSA, the Company issued $2.8
million of subordinated debt to CSA. The $2.8 million of debt is secured by all
of the Company's assets, which is subordinate to Wamco and Canyon, accrues
interest at 10% per annum and requires payments of $37,500 from March 1, 2002
through September 1, 2002 and monthly payments of $107,500 commencing on October
1, 2002 until October 2003 when all remaining unpaid principal and accrued
interest is to be paid in full. The balance outstanding on the subordinate debt
to CSA was $2,800,000 at December 31, 2002 and June 30, 2003.
The agreement with CSA was amended whereby the Company shall be required to pay
the required payments under the subordinated note unless and until it paid $1
million by December 31, 2002. Upon payment of the $1 million, contractual
payments under the subordinated note would have ceased until a final payment in
the amount of $400,000 is paid by February 28, 2003. If the Company did not make
all of the modified payments to CSA, the subordinated note will revert back to
its original terms. The Company did not make the modified payment and have not
made any payments since September 2002. Under the terms of the subordination
agreement between Wamco, Canyon and CSA, the Company is not allowed to make any
principal or interest payments to CSA until the Wamco and Canyon debt, including
any accrued interest, is repaid in full or the CSA debt is restructured and
approved by Wamco and Canyon. The Company is currently in negotiations with CSA
to restructure the terms of the subordinated notes including extending its
maturity date. There can be no assurance that CSA and MAI will come to terms on
a restructuring or that Wamco and Canyon will ultimately approve the terms of
the restructuring. In the event that the Company is unable to meet the required
payments to its primary lenders or meet its payment obligations to its other
secured creditors, they are entitled to exercise certain rights under the
respective agreements the Company has with them, including but not limited to,
foreclosing on all of the Company's tangible and intangible assets. Such action
would have a substantial adverse effect on our ability to continue as a going
concern. The CSA debt is shown as current.
CSA has not formally notified the Company of its default. As of December 31,
2002 and June 30, 2003, accrued interest relating to the CSA subordinated debt
was $408,000 and $572,000 respectively, and is included in accrued liabilities
in the accompanying consolidated balance sheets.
8. COMMON STOCK
In January and February of 2001, the Company entered into agreements with
several creditors to retire approximately $2.1 million of Company obligations in
exchange for 798,000 shares of Common Stock and $470,000 of cash. This resulted
in a gain of $1,377,000. To fulfill its performance under the agreement, the
Company issued the 798,000 shares of its Common Stock and registered the shares
with the SEC. The Company must also pay the $470,000 to the
-8-
creditors as prescribed in the respective agreements. All payments required
under the agreements were made in 2001 and the first quarter of 2002.
In May 2002, the Company issued 612,500 shares of restricted common stock to its
members of the board of directors and certain of its corporate officers.
Recipients are not required to provide consideration to the Company other than
rendering the service and have the right to vote the shares.
Under SFAS No. 123, compensation cost is recognized for the fair value of the
restricted stock awarded, which is its fair market value without restrictions at
the date of grant, which was $0.25 per share. The total market value of the
shares of $153,125 was treated as unearned compensation and is being amortized
to expense in proportion to the vesting schedule through March 2005. The
unamortized balance as of June 30, 2003 is $72,000.
9. PREFERRED STOCK
On May 20, 1997, the Company authorized the issuance of up to 1,000,000 shares
of $0.01 par value preferred stock. The Board of Directors has the authority to
issue the preferred stock, in one or more series, and to fix the rights,
preferences, privileges and restrictions thereof without any further vote by the
holders of Common Stock.
10. INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill and capitalized software.
Intangible assets other than goodwill are amortized on a straight-line basis
over their estimated useful lives. Prior to 2002, goodwill, representing the
excess of the purchase price over the estimated fair value of the net assets of
the acquired business, was amortized over the period of expected benefit of five
to seven years. However, effective January 1, 2002, the Company adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets, ("SFAS No. 142") which requires that the Company cease
amortization of all goodwill and intangible assets having indefinite useful
economic lives. The Company determined that there was no impairment upon
adoption. Such assets are not to be amortized until their lives are determined
to be finite. However, a recognized intangible asset with an indefinite useful
life should be tested for impairment annually or on an interim basis if events
or circumstances indicate that the fair value of the asset has decreased below
its carrying value. At June 30, 2003, the Company evaluated its goodwill and
determined that fair value had not decreased below carrying value and no
adjustment to impair goodwill was necessary in accordance with SFAS No. 142.
Goodwill and capitalized software as of December 31, 2002 and June 30, 2003 are
as follows:
(dollars in thousands)
-----------------------
December 31, June 30,
2002 2003
------ ------
Goodwill $ 962 $ 962
Accumulated amortization -- --
------ ------
Goodwill, net 962 962
------ ------
Capitalized software 861 1,280
Accumulated amortization -- --
------ ------
Capitalized software, net 861 1,280
------ ------
Total $1,823 $2,242
====== ======
The Company's weighted average amortization period for capitalized software is
expected to be three years. The following table shows the estimated amortization
expense for these assets for each of the five succeeding years:
Year Ending December 31,
------------------------
(in thousands)
2003 $ --
2004 427
2005 427
2006 426
2007 --
2008 --
------
$1,280
======
-9-
11. INCOME (LOSS) PER SHARE OF COMMON STOCK
Basic and diluted income or loss per share is computed using the weighted
average shares of common stock outstanding during the period. Consideration is
also given in the diluted income per share calculation for the dilutive effect
of stock options and warrants.
The following table illustrates the computation of basic and diluted earnings
per share under the provisions of SFAS 128:
For the Three Months Ended June 30, For the Six Months Ended June 30,
------------------------------ -------------------------
2002 2003 2002 2003
------- ------------ ------- -------
(in thousands except per share data) (in thousands except per share data)
Numerator:
Numerator for basic and diluted earnings
(loss) per share - net income (loss) $ 346 $ (82) $ 673 $ 179
======= ============ ======= =======
Denominator:
Denominator for basic earnings (loss) per share-
weighted average number of Common
shares outstanding during the period 13,852 14,426 13,754 14,426
Incremental common shares attributable to
exercise of outstanding shares 509 -- 469 300
------- ------------ ------- -------
Denominator for diluted earnings (loss) per
per share 14,361 14,426 14,223 14,726
======= ============ ======= =======
Basic earnings (loss) per share $ 0.02 $ (0.01) $ 0.05 $ 0.01
======= ============ ======= =======
Diluted earnings (loss) per share $ 0.02 $ (0.01) $ 0.05 $ 0.01
======= ============ ======= =======
The number of anti-dilutive options and warrants that were excluded from the
computation of incremental common shares were 1,975,772 and 3,508,605 for the
six month period ended June 30, 2002 and 2003, respectively.
12. STOCK OPTION PLANS
The Company accounts for stock-based compensation in accordance with Accounting
Principles Board, APB, No. 25, "Accounting for Stock Issued to Employees." The
Company has adopted the disclosure-only provisions of FAS No. 123 "Accounting
for Stock-Based Compensation." Under APB No. 25, compensation expense relating
to employee stock options is determined based on the excess of the market price
of the Company's stock over the exercise price on the date of grant, the
intrinsic value method, versus the fair value method as provided under FAS No.
123.
At June 30, 2003, the Company had two stock-based employee compensation plans.
The Company accounts for that plan under the recognition and measurement
principles of APB No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no stock-based employee compensation cost
is reflected in net income (loss), as all options granted under the plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. Had compensation cost for the Company's stock option plan been
determined based on the fair value at the grant date for awards for the
three-month periods ended June 30, 2002 and 2003, consistent with the provisions
of FAS No. 123, the Company's net income (loss) and net income (loss) per share
would have decreased. The following table represents the effect on net income
and net income per share if the Company had applied the fair value based method
and recognition provisions of Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock-Based Compensation", to stock-based employee
compensation.
In December 2002, the FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure", which amended FAS No. 123,
"Accounting for Stock-Based Compensation." The new standard provides alternative
methods of transition for a voluntary change to the fair market value based
method for accounting for stock-based employee compensation. Additionally, the
statement amends the disclosure requirements of FAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for the year ended December 31, 2002. In compliance with FAS No. 148, the
Company has elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation plan as defined by APB No.
25.
-10-
For the three-months For the six-months
ended June 30, ended June 30,
----------------------- -----------------------
(in thousands, except per (in thousands, except
share data) per share data)
2002 2003 2002 2003
------- ------- ------- -------
Net income (loss):
As reported $ 346 $ (82) $ 673 $ 179
Add: Stock-based employee compensation expense recorded -- -- -- --
Less: Stock based employee compensation expense
determined under fair value calculations (33) (33) (66) (66)
------- ------- ------- -------
Pro forma $ 313 $ (115) $ 607 $ 113
======= ======= ======= =======
Basic income (loss) per share:
As reported $ 0.02 $ (0.01) $ 0.05 $ 0.01
Add: Stock-based employee compensation expense recorded -- -- -- --
Less: Stock based employee compensation expense
determined under fair value calculations -- -- -- --
------- ------- ------- -------
Pro forma $ 0.02 $ (0.01) $ 0.05 $ 0.01
======= ======= ======= =======
Diluted income (loss) per share:
As reported $ 0.02 $ (0.01) $ 0.05 $ 0.01
Add: Stock-based employee compensation expense recorded -- -- -- --
Less: Stock based employee compensation expense
determined under fair value calculations -- -- -- --
------- ------- ------- -------
Pro forma $ 0.02 $ (0.01) $ 0.05 $ 0.01
======= ======= ======= =======
13. LEGAL PROCEEDINGS
Chapter 11 Bankruptcy Proceedings
At June 30, 2003, there was only one material claim to be settled regarding the
Company's Chapter 11 proceedings, a tax claim with the United States Internal
Revenue Service (the "Service"). The amount of this claim is in dispute. The
Company has reserved $712,000 for settlement of this claim, which it is
anticipated would be payable to the Service in equal monthly installments over a
period of six (6) years from the settlement date at an interest rate of 6%.
CSA Private Limited
CSA is a MAI shareholder. On August 9, 1996, MAI acquired from Hotel Information
Systems, Inc. ("HIS") substantially all their assets and certain of their
liabilities (the "HIS Acquisition"). At the time of MAI's acquisition of HIS in
1996, CSA was a shareholder of HIS and, in connection with the purchase, MAI
agreed to issue to CSA shares of its Common Stock worth approximately $4.8
million in August 1996, which amount had increased to approximately $6.8 million
as of December 31, 2000, pursuant to the agreement. The Company entered into a
settlement agreement with CSA in February, 2001 whereby it (i) issued CSA
1,916,014 additional shares of our Common Stock to bring CSA's total share
ownership to 2,433,333 shares; (ii) filed a registration statement for all of
CSA's shares of our Common Stock which has been declared effective by the SEC so
that such shares are now freely tradable; and (iii) executed a secured debt
instrument in favor of CSA in the principal sum of $2,800,000 which is
subordinate only to the Company's present group of two (2) senior secured
leaders and required cash installment payments to commence in March 2002.
In connection with the settlement agreement with CSA, the Company recorded the
$2.8 million debt issuance as a reduction in paid in capital and the 1,916,014
additional shares at par as an addition to Common Stock and a reduction to
additional paid in capital.
-11-
Cher-Ae Heights Indian Community
A lawsuit was filed by Cher-Ae Heights Indian Community ("Cher-Ae Heights")
against Logix Development Corporation (Logix). Now known as MAI Development
Corporation, as a co-defendant for a breach of contract by the Company's
formerly owned gaming subsidiary along with the new owners, Monaco Informatiques
Systemes ("MIS"), who acquired the assets and certain liabilities of the gaming
subsidiary on July 27, 2001. Based upon this suit, MIS informed the Company that
it did not intend to pay the next $500,000 due to the Company under a promissory
note and security agreement. On October 24, 2002, the Company entered into a
global settlement agreement between the parties whereby all claims, known and
unknown, between the parties were dismissed and the Company received $796,000.
Logix Development Corporation
The Company entered into a settlement agreement with Logix in July of 2002
whereby it (i) issued Logix 200,000 shares of our Common Stock (ii) required the
Company to make various cash installment payments totaling $175,000 to be paid
within 1 year and (iii) executed a contract with Logix for a consulting project
in the amount of $50,000.
Other Litigation
The Company is also involved in various other legal proceedings and claims that
are incident to its business. Management believes the ultimate outcome of these
matters will not have a material adverse effect on the consolidated financial
position, results of operations or liquidity of the Company.
14. COMPREHENSIVE INCOME
The following table summarizes components of comprehensive income:
For The Three Months Ended For The Six Months Ended
June 30, June 30,
------------------- -------------------
2002 2003 2002 2003
----- ----- ----- -----
Net income (loss) $ 346 $ (82) $ 673 $ 179
Change in cumulative translation adjustments (92) 40 (90) 39
----- ----- ----- -----
Comprehensive income (loss) $ 254 $ (42) $ 583 $ 218
===== ===== ===== =====
Accumulated other comprehensive income in the accompanying consolidated balance
sheets consists of cumulative translation adjustments.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect our reported assets, liabilities, revenues
and expenses. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, accounts receivable and intangible assets. We
base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances. This forms the basis
of judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies and the related judgments
and estimates affect the preparation of our consolidated financial statements:
Revenue Recognition
The Company earns revenue from sales of hardware, software and professional
services and from arrangements involving multiple elements of each of the above.
Revenue for multiple element arrangements are recorded by allocating revenue to
the various elements based on their respective fair values as evidenced by
vendor specific objective evidence. The fair value in multi-element arrangements
is determined based upon the price charged when sold separately. Revenue is not
recognized until persuasive evidence of an arrangement exists, delivery has
occurred,
-12-
the fee is fixed or determinable and collectibility is probable. Sales of
network and computer equipment are recorded when title and risk of loss
transfers. Software revenues are recorded when application software programs are
shipped to end users, resellers and distributors, provided the Company is not
required to provide services essential to the functionality of the software or
significantly modify, customize or produce the software. Professional services
fees for software development, training and installation are recognized as the
services are provided. Maintenance revenues are recorded evenly over the related
contract period.
Allowance for Doubtful Accounts
The Company records an allowance for doubtful accounts based on specifically
identified amounts that it believes is uncollectible. The Company also records
additional allowances based upon certain percentages of our aged receivables,
which are determined based on historical experience and or assessment of the
general financial conditions affecting our customer base. If the Company's
actual collection experience changes, revisions to its allowance may be
required. Any unanticipated change in the Company's customer's credit worthiness
or other matters affecting the collectibility of amounts due from such
customers, could have a material affect on its results of operations in the
period in which such changes or events occur. After all attempts to collect a
receivable have failed, the receivable is written off against the allowance.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" provides a single accounting
model for long-lived assets to be disposed of. SFAS No. 144 also changes the
criteria for classifying an asset as held for sale, and broadens the scope of
businesses to be disposed of that qualify for reporting as discontinued
operations and changes the timing of recognizing losses on such operations.
The Company adopted SFAS No. 144 on January 1, 2001. The adoption of SFAS No.144
did not affect the Company's financial statements. In accordance with SFAS No.
144, long-lived assets, such as furniture, fixtures and equipment are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to estimated undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated future cash
flows, and impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Assets to be disposed
of would be separately presented in the balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet.
Prior to the adoption of SFAS No. 144, the Company accounted for long-lived
assets to be disposed of in accordance with SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
Goodwill
Prior to 2002, goodwill, representing the excess of the purchase price over the
estimated fair value of the net assets of the acquired business, was amortized
over the period of expected benefit of five to seven years. Long-lived assets
and certain identifiable intangibles to be held and used by the Company were
reviewed for impairment whenever events or changes in circumstances indicated
that the carrying amount of the asset may not be recoverable. Recoverability of
assets to be held and used was assessed by a comparison of the carrying amount
of an asset to future undiscounted net cash flows expected to be generated by
the asset. If such assets were considered to be impaired, the impairment
recognized was measured by the amount by which the carrying amount of the assets
exceeded the fair value of the assets. Assets that were to be disposed of were
reported at the lower of the carrying amount or fair value less cost to sell.
However, effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets," ("SFAS No.
142") which requires that the Company cease amortization of goodwill and all
intangible assets having indefinite useful economic lives. Such assets are not
to be amortized until their lives are determined to be finite. However, a
recognized intangible asset with an indefinite useful life should be tested for
impairment annually or on an interim basis if events or circumstances indicate
that the fair value of the asset has decreased below its carrying value. At
December 31, 2002, the Company evaluated its goodwill and determined that fair
value had not decreased below carrying value and no adjustment to impair
goodwill was necessary in accordance with SFAS No. 142.
-13-
Software Development Costs
The Company capitalizes costs related to the development of certain software
products. Capitalization of costs begins when technological feasibility is
established and ends when the product is available for general release to
customers. Technological feasibility is reached upon the earlier of completion
of a detailed program design or working model.
Amortization is computed on an individual product basis and is recognized over
the greater of the remaining economic lives of each product or the ratio that
current gross revenues for a product bear to the total of current and
anticipated revenues for that product, commencing when the products become
available for general release to customers. Software development costs are
generally being amortized over a three-year period. The Company continually
assesses the recoverability of software development costs by comparing the
carrying value of individual products to their net realizable value.
The Company capitalized $359,000 and $419,000 for the six-month period ended
June 30, 2002 and 2003, respectively for software development costs relating to
its new N-Tier, Internet-native corporate application suite of products written
in java. Although the Company has not yet sold any of the modules to this suite
of applications, the Company believes that its new product will produce new
sales adequate to recover amounts capitalized.
Reclassifications
Certain prior year amounts have been reclassed to conform with the 2003
presentation.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, working capital decreased from a working capital deficiency of
$8,649,000 at December 31, 2002 to a working capital deficiency of $9,316,000.
Excluding unearned revenue of $4,555,000, the Company's working capital
deficiency at June 30, 2003 would be $4,796,000. Excluding unearned revenue of
$3,693,000, the Company's working capital deficiency at December 31, 2002 would
be $4,956,000. Excluding unearned revenue, the decrease in the working capital
deficiency of $160,000 was primarily attributable to increase in net accounts
receivable of $451,000 and decreases in accounts payable of $329,000, customer
deposits of $387,000 offset by decreases in cash of $116,000, note receivable of
$250,000 and increases in current portion of long term debt of $150,000 and
accrued liabilities of $515,000.
Net cash used in investing activities for the period ended June 30, 2003 totaled
$364,000, which is comprised of capital expenditures of $195,000 and capitalized
software of $419,000 offset by proceeds from note receivable of $250,000.
Net cash used in financing activities for the period ended June 30, 2003 totaled
$148,000, which represents repayments on long-term debt. On January 13, 2003,
the Company converted its credit facility to a term loan which requires monthly
principal and interest payments of $58,000 and matures on February 28, 2005. In
addition, the Company amended its subordinated note to require monthly interest
only payments of $52,000 through February 28, 2005, at which time it will
convert to a term loan to be amortized over a three years period. The
restructured debt, pursuant to the original intercreditor agreement between
Canyon and Coast, which was sold to Wamco on May 15, 2003, contains various
restrictions and covenants, including a minimum quick ratio of 0.30 to l.00 and
minimum debt service coverage ratio of 0.90 to l.00 which commence as of and for
the three-month period ended June 30, 2003. The minimum quick ratio increases to
0.31 to 1.00 as of June 30, 2003 and September 30, 2003 and to 0.34 to 1.00 as
of December 31, 2003 and for each and every fiscal quarter ending thereafter.
The minimum debt coverage ratio increases to 1.10 to 1.00 for the three-month
period ending June 30, 2003 and to 1.25 to 1.00 for the three-month period
ending September 30, 2003 and for each and every fiscal quarter thereafter. In
the event that we were not in compliance with the various restrictions and
covenants and were unable to receive waivers for non-compliance, the term debt
would be immediately due and payable. The Company was not in compliance with but
received waivers for the covenants as of and for the three month period ended
June 30, 2003.
Stockholders' deficiency decreased from $14,782,000 at December 31, 2002 to
$14,646,000 at June 30, 2003, mainly as a result of net income of $214,000, the
issuance of common stock and warrants to Canyon Capital valued at $62,000, and
amortization of unearned compensation of $20,000 offset by a reduction in
additional paid-in capital of $199,000 relating to the issuance of $149,000 of
debt and $50,000 of cash to satisfy a legal settlement (see note 5).
Although the Company has a net stockholders' deficiency of $14,646,000 and a
working capital deficit of $9,316,000. (which includes subordinated debt due to
CSA of $2,800,000) at June 30, 2003, the Company believes it will generate
sufficient funds from operations and obtain additional financing or restructure
its subordinated note with CSA to meet its operating and capital requirements.
The Company is currently in negotiations with CSA to restructure the terms of
the existing debt, including extending the maturity date. The Company expects to
generate positive cash flow from its continuing operations during 2003 from
shipping out products and services from its current backlog as of June 30, 2003
-14-
as well as new orders. In the event that the Company cannot generate positive
cash flow from its continuing operations during 2003, the Company can
substantially reduce its research and development efforts to mitigate cash
outflow to help sustain its operations. There can be no assurance that the
Company will be able to sustain profitability, generate positive cash flow from
operations or restructure its debt as necessary. These financial statements have
been prepared assuming the Company will continue to operate as a going concern.
If the Company is unsuccessful in the aforementioned efforts, the Company could
be forced to liquidate certain of its assets, reorganize its capital structure
and, if necessary, seek other remedies available to the Company, including
protection under the bankruptcy laws.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table summarizes the Company's obligations and commitments as of
June 30, 2003:
Payments Due by Period (in thousands)
---------------------------------------------------------------------------------------
Less Than
Contractual Cash Obligations Total 1 Year 1-3 Years 4-5 Years After 5 Years
------- ------- ------- ------- -------
Long-Term Debt $10,409 $ 3,439 $ 3,425 $ 3,293 $ 252
Operating Leases 2,028 622 982 331 93
Consulting Agreements 336 336 -- -- --
------- ------- ------- ------- -------
$12,773 $ 4,397 $ 4,407 $ 3,624 $ 345
======= ======= ======= ======= =======
-15-
RESULTS OF OPERATIONS
Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2003
Percentage of Percentage of
June 30, 2002 Revenue June 30, 2003 Revenue
------------- ------- ------------- -------
(in thousands) (in thousands)
Revenue: $ 5,488 100.0% $ 4,752 100.0%
Gross profit 3,707 67.5% 3,526 74.2%
Selling, general and administrative expenses 2,322 42.3% 2,438 51.3%
Research and development costs 656 12.0% 658 13.9%
Amortization of intangibles 45 0.8% -- --
Other operating expense 6 0.1% 3 0.1%
Interest expense, net 387 7.1% 292 6.2%
Other non-operating expense 14 0.3% 212 4.5%
Income tax expense 5 0.1% 5 0.1%
Income from discontinued operations 74 1.3% -- --
Net income (loss) $ 346 6.3% $ (82) (1.7)%
Revenue for 2003 was $ 4,752,000 compared to $5,488,000 in 2002 or a 13%
decrease. Revenue decreased $736,000 in 2003, as a result of decreased
professional services and maintenance services mainly due to decreased capital
spending on information technology in 2003 mainly due to the effects of the
September 11, 2001 terrorist attacks on the hospitality industry.
The decrease in revenue in 2003 was mainly attributable to a decrease in service
volume and rates as many hotels have reduced their operating costs by canceling
or reducing contracted services, including support, in a post September 11, 2001
economy. Many hotels have requested that their suppliers reduce the cost of
service or delay any price increases while they are experiencing reduced guest
occupancy and lower average daily rates on their inventory of rooms. Certain
hotels have also established their own help desks to further reduce costs. As a
result, the Company postponed increasing its support prices until the first
quarter of 2003 and agreed, with certain of its clients, to provide a second
line of support versus a first line of support that was previously provided to
such clients. Our continuing hospitality business is expected to generate
sufficient cash from operations to adequately fund its ongoing operating
activities.
Gross profit for 2003 decreased to $3,526,000 from $3,707,000 in 2002. The
decrease in gross profit is mainly due to the decrease in software and
maintenance services revenues which was offset by the Company's cost reductions
during the period.
Selling, general and administrative expenses ("SG&A") increased from $2,322,000
in 2002 to $2,438,000 in 2003. The increase is mainly due to an increase in
selling and marketing expenses for trade shows, advertisement and travel as the
Company continues to actively and aggressively market its newly developed
enterprise suite of applications and services.
Research and development costs increased from $656,000 in 2002 to $658,000 in
2003. The Company capitalized $359,000 and $190,000 of software development
costs in 2002 and 2003, respectively, associated with the Company's product
development of its new internet native suite of applications.
The decrease in amortization of intangibles in 2003 versus the comparable period
of 2002 is due to the fact that the Company amortized $ 45,000 of software
development costs in 2002 relating to costs capitalized in 1999. These costs
were fully amortized during 2002.
Net interest expense was $387,000 in 2002 compared to $292,000 in 2003. The
decrease is due to lower balances of interest bearing debt during 2003 as
compared to 2002
Other non-operating expense increased from $14,000 in 2002 to $212,000 in 2003.
Non-operating expense relates to pension expense under a defined benefit plan
for former employees from our discontinued operations.
Results from discontinued operations were $74,000 in 2002. Results from
discontinued operations in 2003 were $0 as all entities held for sale were sold
in the fourth quarter of 2002.
-16-
Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2003
Percentage of Percentage of
June 30, 2002 Revenue June 30, 2003 Revenue
------------- ------- ------------- -------
(in thousands) (in thousands)
Revenue $11,220 100.0% $ 9,938 100.0%
Gross profit 7,460 66.5% 7,241 72.9%
Selling, general and administrative expenses 4,382 39.1% 4,969 50.0%
Research and development costs 1,664 14.8% 1,340 13.5%
Amortization of intangibles 109 1.0% -- --
Other operating expense (income) 5 0.1% (46) (0.5)%
Interest expense, net 772 6.9% 641 6.4%
Other non-operating expense 27 0.2% 212 2.1%
Income tax expense (benefit) 8 0.1% (54) (0.5)%
Income from discontinued operations 180 1.6% -- --
Net income $ 673 6.0% $ 179 1.8%
Revenue for 2003 was $9,938,000 compared to $11,220,000 in 2002 or a 11.4%
decrease. Revenue decreased $1,282,000 in 2003, as a result of decreased
professional services and maintenance services mainly due to decreased capital
spending on information technology in 2003 due to the effects of the September
11, 2001 terrorist attacks on the hospitality industry.
The decrease in revenue in 2003 was mainly attributable to a decrease in service
volume and rates as many hotels have reduced their operating costs by canceling
or reducing contracted services, including support, in a post September 11, 2001
economy. Many hotels have requested that their suppliers reduce the cost of
service or delay any price increases while they are experiencing reduced guest
occupancy and lower average daily rates on their inventory of rooms. Certain
hotels have also established their own help desks to further reduce costs. As a
result, the Company postponed increasing its support prices until the first
quarter of 2003 and agreed, with certain of its clients, to provide a second
line of support versus a first line of support that was previously provided to
such clients. Our continuing hospitality business is expected to generate
sufficient cash from operations to adequately fund its ongoing operating
activities.
Revenue in our Asian operations increased from $1,031,000 in 2002 to $1,348,000
in 2003 as a result of its acquisition of HSS in June 2002 (see note 5) which
allowed the Company to expand its operations in the Asian marketplace,
strengthen its management team in the territory and create new opportunities for
its new enterprise capable suite of products.
Gross profit for 2003 decreased to $7,241,000 from $7,460,000 in 2002. The
decrease in gross profit is mainly due to the decrease in software and
maintenance services revenues which was offset by the Company's cost reductions
during the period.
Selling, general and administrative expenses ("SG&A") increased from $4,382,000
in 2002 to $4,969,000 in 2003. The increase is mainly due to an increase in
selling and marketing expenses for trade shows, advertisement and travel as the
Company continues to actively and aggressively market its newly developed
enterprise suite of applications and services.
Research and development costs decreased from $1,664,000 in 2002 to $1,340,000
in 2003. The decrease is due to the capitalization of $359,000 and $419,000 of
software development costs in 2002 and 2003, respectively, associated with the
Company's product development of its new internet native suite of applications.
The decrease is also due to a decrease in headcount associated with the
Company's focus on reducing costs.
Other operating expense (income) was $5,000 in 2002 and ($46,000) in 2003. Other
operating income in 2003 is due to receipt of approximately $46,000 of cash
resulting from a legal settlement.
The decrease in amortization of intangibles in 2003 versus the comparable period
of 2002 is due to the fact that the Company amortized $109,000 of software
development costs in 2002 relating to costs capitalized in 1999. These costs
were fully amortized during 2002.
Net interest expense was $772,000 in 2002 compared to $641,000 in 2003. The
decrease is due to lower balances of interest bearing debt during 2003 as
compared to 2002
Other non-operating expense increased from $27,000 in 2002 to $212,000 in 2003.
Non-operating expense relates to pension expense under a defined benefit plan
for former employees from our discontinued operations.
The income tax provision (benefit) only reflects a tax provision for our foreign
operations and alternative minimum taxes for domestic operations due to the
utilization for net operating loss carry forward. The income tax benefit in 2003
is due to the Company recording a domestic income tax receivable during the
period to recover taxes previously paid.
Results from discontinued operations was $180,000 in 2002. Results from
discontinued operations in 2003 was $0 as all entities held for sale were sold
in the fourth quarter of 2002.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK DISCLOSURES
The following discussion about our market risk disclosures contains
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements. We are exposed to market risk related to changes
in interest rates and foreign currency exchange rates. We do not have derivative
financial instruments for hedging, speculative, or trading purposes.
INTEREST RATE SENSITIVITY
Of our $10.4 million principal amount of indebtedness at June 30, 2003, none
bears interest at a variable rate. However, $5.7 million bears interest at a
fixed rate of 11%, $2.8 million bears interest at a fixed rate of 10%, $1.6
million bears interest at 9.25% and $0.3 million bears fixed interest rates
ranging from 6% to 17.5%. Since these debt instruments bear interest at fixed
rates, we have no exposure to decreases in interest rates because we still are
required to pay the fixed rate even if current interest rates are lower.
FOREIGN CURRENCY RISK
We believe that our exposure to currency exchange fluctuation risk is reduced
because our transactions with international vendors and customers are generally
transacted in US dollars. The currency exchange impact on intercompany
transactions was immaterial for the quarter ended June 30, 2003.
ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our chief executive officer and our chief financial officer, after evaluating
the effectiveness of the Company's "disclosure controls and procedures" (as
defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c))
as of a date ("Evaluation Date") within 90 days before the filing date of this
quarterly report, have concluded that as of the Evaluation Date, our disclosure
controls and procedures were adequate and designed to ensure that material
information relating to us and our consolidated subsidiaries would be made known
to them by others within those entities.
(B) CHANGES IN INTERNAL CONTROLS
There were no significant changes in our internal controls or to our knowledge,
in other factors that could significantly affect our disclosure controls and
procedures subsequent to the Evaluation Date.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Chapter 11 Bankruptcy Proceedings
At June 30, 2003, there was only one material claim to be settled regarding the
Company's Chapter 11 proceedings, a tax claim with the United States Internal
Revenue Service (the "Service"). The amount of this claim is in dispute. The
Company has reserved $712,000 for settlement of this claim, which it is
anticipated would be payable to the Service in
CSA Private Limited
CSA is a MAI shareholder. On August 9, 1996, MAI acquired from Hotel Information
Systems, Inc. ("HIS") substantially all their assets and certain of their
liabilities (the "HIS Acquisition"). At the time of MAI's acquisition of
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HIS in 1996, CSA was a shareholder of HIS and, in connection with the purchase,
MAI agreed to issue to CSA shares of its Common Stock worth approximately $4.8
million in August 1996, which amount had increased to approximately $6.8 million
as of December 31, 2000, pursuant to the agreement. The Company entered into a
settlement agreement with CSA in February, 2001 whereby it (i) issued CSA
1,916,014 additional shares of our Common Stock to bring CSA's total share
ownership to 2,433,333 shares; (ii) filed a registration statement for all of
CSA's shares of our Common Stock which has been declared effective by the SEC so
that such shares are now freely tradable; and (iii) executed a secured debt
instrument in favor of CSA in the principal sum of $2,800,000 which is
subordinate only to the Company's present group of two (2) senior secured
leaders and required cash installment payments to commence in March 2002 (see
note 6).
In connection with the settlement agreement with CSA, the Company recorded the
$2.8 million debt issuance as a reduction in paid in capital and the 1,916,014
additional shares at par as an addition to Common Stock and a reduction to
additional paid in capital.
Cher-Ae Heights Indian Community
A lawsuit was filed by Cher-Ae Heights Indian Community ("Cher-Ae Heights")
against Logix Development Corporation (Logix), now known as MAI Development
Corporation, as a co-defendant for a breach of contract by the Company's
formerly owned gaming subsidiary along with the new owners, Monaco Informatiques
Systemes ("MIS"), who acquired the assets and certain liabilities of the gaming
subsidiary on July 27, 2001. Based upon this suit, MIS informed the Company that
it did not intend to pay the next $500,000 due to the Company under a promissory
note and security agreement. On October 24, 2002, the Company entered into a
global settlement agreement between the parties whereby all claims, known and
unknown, between the parties were dismissed and the Company received $796,000
(see note 5)
Logix Development Corporation
The Company entered into a settlement agreement with Logix in July of 2002
whereby it (i) issued Logix 200,000 shares of our Common Stock (ii) required the
Company to make various cash installment payments totaling $175,000 to be paid
within 1 year and (iii) executed a contract with Logix for a consulting project
in the amount of $50,000.
Other Litigation
The Company is also involved in various other legal proceedings and claims that
are incident to its business. Management believes the ultimate outcome of these
matters will not have a material adverse effect on the consolidated financial
position, results of operations or liquidity of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) None
(d) None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) None
(b) None
(c) None
(d) None
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ITEM 5. OTHER INFORMATION
(a) None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer, W. Brian Kretzmer, as
required by Section 3.02 of Sarbane-Oxley Act of 2002
31.2 Certification of Chief Financial Officer, James W. Dolan, as
required by Section 3.02 of Sarbane-Oxley Act of 2002
32.1 Certification of Chief Executive Officer, W. Brian Kretzmer, as
required by Section 9.06 of Sarbane-Oxley Act of 2002
32.2 Certification of Chief Financial Officer, James W. Dolan, as
required by Section 9.06 of Sarbane-Oxley Act of 2002
(b) Reports on Form 8K
Filed May 2, 2003
Filed April 30, 2003
Filed April 24, 2003
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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 the
undersigned thereunto duly authorized.
MAI SYSTEMS CORPORATION
(Registrant)
Date: August 14, 2003 By: /s/James W. Dolan
------------------------------------------
James W. Dolan
Chief Financial and Operating Officer
(Chief Financial and Accounting Officer)
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EXHIBIT INDEX
31.1 Certification of Chief Executive Officer, W. Brian Kretzmer, as required
by Section 3.02 of Sarbane-Oxley Act of 2002
31.2 Certification of Chief Financial Officer, James W. Dolan, as required by
Section 3.02 of Sarbane-Oxley Act of 2002
32.1 Certification of Chief Executive Officer, W. Brian Kretzmer, as required
by Section 9.06 of Sarbane-Oxley Act of 2002
32.2 Certification of Chief Financial Officer, James W. Dolan, as required by
Section 9.06 of Sarbane-Oxley Act of 2002
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