UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

ý	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the period ended September 30, 2004 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: 1-9158

 

 

MAI Systems Corporation

(Exact name of registrant as specified in its charter)

 

Delaware		22-2554549
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

 

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   ý      No o

 

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

Yes   ý      No o

 

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 November 18, 2004 was $1,648,000

 

The number of shares of common stock issued, outstanding and subscribed as of  November 18, 2004 was 57,847,862.

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MAI SYSTEMS CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(Unaudited)

 

		(in thousands, except share data)
		As of December 31, 2003			As of September 30, 2004
ASSETS
Current assets:
Cash		$	664		$	555
Receivables, less allowance for doubtful accounts of $335 in 2003 and $311 in 2004		1,313			2,130
Inventories		47			74
Prepaids and other assets		814			659
Total current assets		2,838			3,418
Furniture, fixtures and equipment, net		758			501
Intangibles, net		2,876			3,697
Other assets		58			14
Total assets		$	6,530		$	7,630
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
Current liabilities:
Current portion of long-term debt		$	3,646		$	983
Accounts payable		904			1,078
Customer deposits		2,334			2,243
Accrued liabilities		3,059			2,725
Income taxes payable		85			111
Unearned revenue		3,209			3,415
Total current liabilities		13,237			10,555
Long-term debt		7,135			9,982
Other liabilities		744			505
Total liabilities		21,116			21,042
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 99,000,000 shares; 14,875,752 and 14,675,752 shares issued,outstanding and subscribed at December 31, 2003 and September 30, 2004, respectively.		152			152
Additional paid-in capital		218,112			218,112
Common stock subscribed		—			1,000
Accumulated other comprehensive loss
Minimum pension liability		(1,005		)	(1,005		)
Foreign currency translation		(2		)	(47		)
Unearned Compensation		(53		)	(25		)
Accumulated deficit		(231,790		)	(231,599		)
Total stockholders’ deficiency		(14,586		)	(13,412		)
Total liabilities and stockholders’ deficiency		$	6,530		$	7,630

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MAI SYSTEMS CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		(Unaudited) For the Three Months Ended September 30,						(Unaudited) For the Nine Months Ended September 30,
		(in thousands, except per share data)						(in thousands, except per share data)
		2003			2004			2003			2004
Revenue:
Software		$	842		$	842		$	3,098		$	2,945
Network and computer equipment		104			118			339			329
Services		3,868			3,923			11,315			11,683
Total revenue		4,814			4,883			14,752			14,957
Direct costs:
Software		167			40			425			369
Network and computer equipment		73			103			238			272
Services		1,109			1,264			3,384			3,446
Total direct costs		1,349			1,407			4,047			4,087
Gross profit		3,465			3,476			10,705			10,870
Selling, general and administrative expenses		2,307			2,200			7,277			6,900
Research and development costs		764			956			2,104			2,756
Other expense(income)		(134		)	48			(181		)	67
Operating income		528			272			1,505			1,147
Interest income		—			—			1			1
Interest expense		(286		)	(303		)	(928		)	(882		)
Other non-operating expense		(98		)	(22		)	(309		)	(60		)
Income (loss) before income taxes		144			(53		)	269			206
Income tax benefit (expense)		(12		)	(5		)	41			(15		)
Net income (loss)		$	132		$	(58	)	$	310		$	191
Income (loss) per share:
Net income (loss) per share:
Basic income (loss) per share		$	0.01		$	0.00		$	0.02		$	0.01
Diluted income (loss) per share		$	0.01		$	0.00		$	0.02		$	0.01
Weighted average common shares used in determining income (loss) per share:
Basic		14,575			14,676			14,525			14,676
Diluted		14,875			14,676			14,825			14,676

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MAI Systems Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(Unaudited)

 

		For the Nine Months Ended September 30,
		(in thousands)
		2003			2004
Net cash provided by operating activities:		$	619		$	405
Cash flows used in investing activities:
Proceeds from note receivable		250			—
Capital Expenditures		(240		)	(98		)
Acquisition of unconsolidated subsidiary		(79		)
Capitalized software development costs		(619		)	(821		)
Net cash used in investing activities		(688		)	(919		)
Cash flows used in financing activities:
Proceeds for common stock subscribed		—			1,000
Repayments on long-term debt		(312		)	(594		)
Net cash used in financing activities		(312		)	406
Net cash used in operations		(381		)	(108		)
Effect of exchange rate changes on cash		(3		)	(1		)
Net change in cash		(384		)	(109		)
Cash at beginning of period		545			664
Cash at end of period		$	161		$	555

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MAI Systems Corporation

 

Notes to Condensed Consolidated Financial Statements

 

Three and Nine Months ended September 30, 2004

 

(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, 2003, which is on file with the SEC.

 

2.                                       Liquidity

 

Although the Company has a net stockholders’ deficiency of $13,412,000 and a working capital deficit of $7,137,000 at September 30, 2004, the Company expects to generate positive cash flow from its operations during 2004 and 2005 from shipping out products and services from its current backlog as of September 30, 2004 as well as new orders to meet its operating and capital requirements. In the event that the Company cannot generate positive cash flow from its operations, 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 or generate positive cash flow from operations.  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 is in compliance with the amended debt covenants as of and for the period ended September 30, 2004. There is no guaranty that the Company will meet its debt covenants in the future.  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 loan would be immediately due and payable.

 

3.                                      Inventory

 

Inventories are summarized as follows:

 

		(dollars in thousands)
		December 31, 2003			September 30, 2004
Finished goods		$	39		$	67
Replacement parts		8			7
		$	47		$	74

 

4.                                      Business Acquisitions

 

Hospitality Services & Solutions

 

On June 23, 2002, the Company acquired substantially all of the assets and assumed certain liabilities of Hospitality Services & Solutions (“HSS”) including a 35% ownership in AMDB – HIS (“AMDB”) pursuant to a stock purchase

 

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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 $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.

 

Included in the acquired assets of HSS was a 35% interest in AMDB, an online reservation service, originally purchased by HSS for $66,000.  On February 20, 2003, the Company entered into an agreement whereby it acquired the remaining 65% for $79,000 payable over 6 month installments.  The net liabilities of $15,000 acquired are used to support an online reservation service related to hotel information systems.  The Company recorded $159,000 of goodwill in connection with the acquisition of AMDB.  Pro forma results of operations as if this acquisition had occurred at the beginning of 2003 are not shown because its impact would have been immaterial.

 

5.                                      Long-Term Debt

 

Wamco 32 Ltd.

 

On January 13, 2003, the Company re-negotiated the terms of its credit facility with Coast Business Credit (“Coast”) whereby the outstanding balance of $1,828,000 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.  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 32, Ltd. (“Wamco”).  This sale of the loan by the FDIC did not change any of the terms of the Company’s loan agreement.  The Company is required to pay Wamco additional principal payments on a quarterly basis based upon an EBITDA-based formula commencing March 31, 2003.  For the period ended September 30, 2004, there are no additional principal payments required under the EBITDA-based formula.

 

On April 9, 2004, the Company successfully re-negotiated the terms of its loan whereby the maturity date was extended to February 28, 2006.  In addition, various restrictions and covenants, pursuant to the inter-creditor agreement between Canyon and Wamco, were amended to modify the financial covenants to a minimum quick ratio of  0.20 to 1.00 and a minimum debt coverage ratio of 0.50 to 1.00 effective for the three month period ended March 31, 2004 and for each and every fiscal quarter ending thereafter.  The Company was in compliance with the amended debt covenants as of and for the period ending September 30, 2004. There is no guaranty that the Company will meet its debt covenants in the future.  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 loan would be immediately due and payable.  As of December 31, 2003 and September 30, 2004, the balance of the term loan was $1,366,000 and $907,000, respectively.

 

Canyon Capital Management LP

 

On January 13, 2003, the Company modified its 11% subordinated notes payable agreement with Canyon Capital Management LP (“Canyon”), whereby the Company is required to make monthly interest 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 issued 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 agreed to issue 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.  The principal balance outstanding on the subordinate notes payable to Canyon was approximately $5,662,000 and $5,660,000 respectively at December 31, 2003 and September 30, 2004, respectively.

 

CSA Private Limited

 

In connection with a settlement agreement in February 2001 with CSA Private Limited (“CSA”), the Company issued

 

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$2.8 million of subordinated debt to CSA.  The $2.8 million of debt was secured by all of the Company’s assets, which was subordinate to Wamco and Canyon, accrued interest at 10% per annum and required 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 was to be paid in full.

 

The agreement with CSA was amended whereby the Company was required to make 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 would revert back to its original terms.  The Company did not make the modified payment and have not made any payments since September 2002.  CSA did not formally notify the Company of its default.

 

On April 9, 2004, the Company successfully amended its agreement with CSA whereby the principal balance and accrued interest through March 31, 2004, totaling $3,633,000, were converted to two new notes.  The first note for $500,000 accrues interest at 10% per annum and provides for monthly payments of $10,000 until the Wamco and Canyon debt is paid in full.  Thereafter, the note provides for monthly payments in an amount equal to the greater of i) $10,000 or ii) the amount required to fully amortize all remaining principal and interest in 24 equal monthly payments.  The second note for $3,133,000 (“Other Note”) also accrues interest at 10% per annum and provides for monthly payments of $7,500, or such other interest amount, not to exceed $10,000 per month, that Wamco and Canyon will allow.  As of September 30, the Company accrued and unpaid interest relating to the Other Note was $160,000.  Under the terms of the amended subordination agreement between Wamco, Canyon and CSA, all payments under the new notes are subordinated to the payment in full of the Wamco and Canyon loan agreements. The Company has not made any payments on the two new notes as of September 30, 2004.  The Company is currently in default of the first note.  The interest rate has been increased to 12.5% in line with the terms of that note until the Company becomes current on its contractual payments.

 

On April 9, 2004, an investor group, consisting of Canyon, the Company’s Chairman of the Board, Chief Executive Officer and Chief Financial and Operating Officer (“Investor Group”), acquired 2,433,333 shares of the Company’s common stock held by CSA and the Other Note for $1 million in cash.

 

On September 22, 2004, the Company received approval from its shareholders for the Investor Group  to convert the Company indebtedness acquired from CSA plus any accrued interest through the date of conversion for  shares of the Company’s common stock based upon a conversion price of $0.10 per share.  Additionally, the shareholders also approved for the Investor Group to invest $1,000,000 of new cash proceeds into the Company, which the Company received on September 24, 2004, in a private placement at $0.10 per share (The Management Equity/Conversion Transaction).  As of September 30, 2004, the private placement funds were classified as a Common Stock Subscribed in the accompanying condensed consolidated balance sheet (See Note 13). The Company issued common stock in connection with the Management Equity/Conversion Transaction on November 1, 2004 (See Note 13) and such stock is subject to certain terms and conditions, including the fact that it will initially be ‘restricted’ stock, not available for sale.  The Company has also received a fairness opinion from Marshall Stevens which concluded that the transaction was fair to the shareholders.

 

Tax Claim

 

On September 30, 2003, the Company entered into a settlement agreement with the United States Internal Revenue Service (the “Service”) on a tax claim which resulted from the Company’s 1993 Chapter 11 proceedings whereby it agreed to pay $489,000 in equal monthly installments of $7,438 over a period of six (6) years at an interest rate of 6%.  The $489,000 settlement is reflected as debt in the financial statements and resulted in a one-time gain of $262,000 which was included in income tax benefit in the fourth quarter of 2003.  In the event that the Company fails to pay the Service any payment, and such payment failure continues for sixty days after written notice of such failure, $1,832,100, plus accrued interest thereon, less any payments made by the Company will be immediately due and payable to the Service.  As of December 31, 2003 and September 30, 2004, the debt balance was $428,000 and $379,000, respectively.

 

In connection with the settlement agreement with the Service, the Company’s 1993 Chapter 11 proceedings were officially closed pursuant to Court order effective as of September 30, 2003.

 

6.                                      Restricted Stock Plan

 

In May 2001, the Board of Directors adopted the 2001 Restricted Stock Plan.  Under the plan, 1,250,000 authorized shares of the Company’s Common Stock are reserved for issuance to officers and directors of the Company.  The shares will be issued as “Restricted Stock” within the meaning of Rule 144 of the Securities Act of 1933, as amended.  The

 

6

 

Compensation Committee of the Board of Directors shall have the discretion to determine what terms and conditions shall apply, including the imposition of a vesting schedule.

 

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 which vest equally over a four-year period.  Recipients are not required to provide consideration to the Company other than rendering the service and have the right to vote the shares.  Under APB 25, compensation cost is recognized for the fair value of the restricted stock awarded, which is its quoted market price at the date of grant, which was $0.25 per share.  The total market value of the shares of $153,000 was treated as unearned compensation and is being amortized to expense in proportion to the vesting schedule.  The unamortized balance as of September 30, 2004 is $25,000 and is included in accumulated other comprehensive loss in the accompanying consolidated balance sheet.

 

7.                                      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.

 

8.                                      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 September 30, 2004, 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, 2003 and September 30, 2004 are as follows:

 

 

Net goodwill is comprised of $665,000 on the purchase of Hotel Information Systems Inc. (HIS) in 1996, $297,000 on the purchase of HSS in 2002 and $159,000 on the purchase of AMDB in 2003 (see Note 4).

 

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The Company’s weighted average amortization period for capitalized software is expected to be three years.  The Company expects that certain of our new products will be available for general release during the first quarter of 2005 at which time amortization of such costs shall commence.  The following table shows the estimated amortization expense for these assets for each of the five succeeding years:

 

 

9.                                      Income (Loss) Per Share

 

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 (loss) per share under the provisions of SFAS 128:

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2003			2004			2003			2004
		(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)		$	132		$	(58	)	$	310		$	191
Denominator:
Denominator for basic income (loss) per share– weighted average number of Common shares outstanding during the period		14,575			14,676			14,525			14,676
Incremental common shares attributable to exercise of outstanding shares		300			—			300			—
Denominator for diluted income (loss) per per share		14,875			14,676			14,825			14,676
Basic earnings (loss)per share		$	0.01		$	0.00		$	0.02		$	0.01
Diluted earnings (loss) per share		$	0.01		$	0.00		$	0.02		$	0.01

 

The number of anti-dilutive options and warrants that were excluded from the computation of incremental common shares were 3,041,500 and 3,104,000 for the nine month period ended September 30, 2003 and 2004, respectively.

 

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10.                               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.

 

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.

 

At September 30, 2004, 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.  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 September 30, 2003 and 2004, consistent with the provisions of FAS No. 123, the Company’s net income and net income 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.

 

		For the three-months ended September 30,						For the Nine-months ended September 30,
		(in thousands, except per share data)						(in thousands, except per share data)
		2003			2004			2003			2004
Net income (loss):
As reported		$	132		$	(58	)	$	310		$	191
Add: Stock-based employee compensation expense recorded		—			10			—			30
Less: Stock based employee compensation expense determined under fair value calculations		(17		)	(10		)	(51		)	(30		)
Pro forma		$	115		$	(58	)	$	259		$	191
Basic income (loss) per share:
As reported		$	0.01		$	0.00		$	0.02		$	0.02
Add: Stock-based employee compensation expense recorded		—			—			—			—
Less: Stock based employee compensation expense determined under fair value calculations		—			—			—			—
Pro forma		$	0.01		$	0.00		$	0.02		$	0.02
Diluted income (loss) per share:
As reported		$	0.01		$	0.00		$	0.02		$	0.01
Add: Stock-based employee compensation expense recorded		—			—			—			—
Less: Stock based employee compensation expense determined under fair value calculations		—			—			—			—
Pro forma		$	0.01		$	0.00		$	0.02		$	0.01

 

11.                               Legal Proceedings

 

Hotel Information Systems, Inc.

 

On March 25, 2003, the Company entered into a settlement agreement with Hotel Information Systems (“HIS”) and one

 

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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 at 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.

 

Logix Development Corporation

 

The Company entered into a settlement agreement with Logix Development Corporation (“Logix”) in July of 2002 whereby we (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.  The Company has made all required payments to Logix under this settlement agreement.

 

In December 2003, the Company entered into another settlement agreement with Logix whereby it (i) issued 200,000 free trading shares in exchange for the 200,000 restricted Common Shares from the original settlement agreement in July 2002 (ii) required the Company to make monthly payments totaling $187,500 over a 25 month period and (iii) mutually released each other of all past, present and future claims associated with the lawsuit.

 

Other Litigation

 

We were also involved in various other legal proceedings that are incident to its business. Management believes the ultimate outcome of these matters will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

 

12.                               Comprehensive Income (Loss)

 

The following table summarizes components of comprehensive income (loss):

 

		For The Three Months Ended September 30,						For The Nine Months Ended September 30,
		2003			2004			2003			2004
Net income (loss)		$	132		$	(58	)	$	310		$	191
Change in cumulative translation adjustments		(11		)	13			28			(46		)
Comprehensive income (loss)		$	121		$	(45	)	$	338		$	145

 

Accumulated other comprehensive income in the accompanying consolidated balance sheets consists of cumulative translation adjustments and minimum pension liability.

 

13.                               Management Equity/Conversion Transaction

 

On November 1, 2004, the Company converted $3,317,211 of its indebtedness to the Investor Group on such date, at $0.10 per share, and issued  33,172,110 shares of its common stock together with 10,000,000 shares of its commons stock relating to the $1,000,000 private placement to the Investor Group.

 

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Pro Forma Financial Information Showing Effect of Management Equity/Conversion Transaction

 

The unaudited pro forma consolidated balance sheet set forth below give effect to the Management Equity/Conversion Transaction as if it had occurred on September 30, 2004. The unaudited pro forma consolidated statements of operations for the three and nine months ended September 30, 2004 give effect to the Management Equity/Conversion Transaction as if it had occurred on January 1, 2004. The pro forma financial information does not purport to represent what the Company’s financial position or what the results of operations would have actually been had the Management Equity/Conversion Transaction occurred at such dates or to project the Company’s financial position or results of operations for any future date or period. In addition, it does not incorporate any benefits from anticipated cost savings or revenue growth from the Management Equity/Conversion Transaction.

 

The pro forma adjustments include the effect of to the amortization of any identifiable intangible assets recorded in connection with purchase accounting over their respective useful lives estimated at five years which reduces pro forma net income (loss) and income (loss) per share. The Company has engaged a third party expert to perform a valuation of the intangible and tangible assets.

 

Pursuant to an action taken by written consent of the Special Committee of the Board of Directors of MAI Systems Corporation on October 15, 2003, the Company and an investor group consisting of certain members of senior management (Mr. Ressler, Mr. Dolan and Mr. Kretzmer) and certain third parties (the “Investor Group”) agreed to the Management Equity/Conversion Transaction, subject to execution of definitive documents with CSA, shareholder approval and other requirements such as receipt of a fairness opinion. Subsequent to the approval of the Special Committee of the Board of Directors on October 15, 2003, the Investor Group negotiated directly with Computer Sciences Corporation to acquire the MAI shares held by CSA together with a portion of CSA’s indebtedness from MAI. On April 9, 2004, Computer Sciences Corporation agreed to terms with the Investor Group to acquire CSA’s equity position and $3,194,156 of Company indebtedness from CSA. On September 22, 2004, the Company received approval from its shareholders for the Investor Group to convert the Company indebtedness acquired from CSA plus any accrued interest through the date of conversion for  33,172,110 shares of its common stock based upon a conversion price of $0.10 per share.  Additionally, the shareholders also approved for the Investor Group to invest $1,000,000 of new cash proceeds into the Company, which the Company received on September 24, 2004, in a private placement at $0.10 per share

 

As the conversion price of the acquired indebtedness of $0.10 per share was lower than the fair value (quoted market price) on April 9, 2004 (the date that Computer Sciences Corporation agreed to terms with the Investor Group to acquire CSA’s debt and equity position) (see Note 5) of $0.18 per share, a beneficial conversion right has been provided to the Investor Group. The value of this beneficial conversion right has been measured for accounting purposes on April 9, 2004, as $2.6 million. The Company will record this value as a charge to interest expense on November 1, 2004, the date of the debt conversion and shares were issued.

 

In addition, the market price for the Company’s common stock was $0.14 per share on November 1, 2004, the date of issuance of the 10,000,000 shares of the Company’s common stock to the Investor Group.  Accordingly, the Company will record a $250,000 charge to stock compensation expense since certain members of the Company’s management are also members of the Investor Group. The amount of the charge is based on the 6,250,000 shares attributable to members of management based on their share in the Investor Group multiplied by the amount that the market price of the Company’s common stock of $0.14 per share exceeded the $0.10 per share on the date of issuance of such shares.

 

The Company believes that the aforementioned transaction permits but does not require it to use new basis or push down accounting since the members of the Investor Group will hold between 80% and 94% of the voting shares of the Company upon completion of the transaction. The Company has elected to apply push down accounting.

 

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The Company currently has a stockholders’ deficit of approximately $13.4 million and an accumulated deficit of approximately $232 million. After application of the push down accounting, the portion of the historic deficit attributable to the Investor Group’s new ownership will be eliminated, and stockholders’ deficit will be partially reset based on the Investor Group’s new basis in MAI of approximately $2.25 million. Post push down stockholders’ equity (deficiency) will be calculated as follows (in thousands):

 

Non-Investor Group:
Historic stockholders’ deficiency at September 30, 2004		$	(13,412	)
Non-Investor Group Ownership (100% – 83.37%)		16.63		%
Non-Investor Group basis to carry over					$	(2,230	)
Investor Group:
New basis to push down					$	2,250	(a)
Original basis to carry over		$	(13,412	)
Investor Group pre-existing ownership percentage		4.53		%
					(608		)
New stockholders’deficiency					$	(588	)

 

(a)          $2 million investment from Investor Group used to purchase debt and MAI shares from CSA plus approximately $250,000 stock compensation expense attributable to members of Investor Group which are also members of the Company’s management (See footnote (e) to the pro forma financial statements).

 

Based on the balance sheet as of September 30, 2004, and considering the additional equity investment and debt conversion by the Investor Group, application of  push down accounting will result in a step-up in basis of the net assets of the Company of approximately $9,531,000 calculated as follows (in thousands):

 

Historical stockholders’ deficiency at September 30, 2004		$	(13,412	)
Conversion of Investor Group debt at book value		3,293
Step up in value of net assets		9,531
Post push-down accounting stockholders’ deficiency		$	(588	)

 

In accordance with push down accounting, the following pro forma statements of operations for the periods presented do not reflect estimated stock compensation and beneficial conversion charges of $250,000 and $2,635,000, respectively, resulting from the Management Equity/Conversion Transaction as such amounts will be charged to expense in the financial statements prior to the application of push down accounting and will have no impact on the post transaction balance sheet or statement of operations.

 

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PRO FORMA CONSOLIDATED BALANCE SHEET

As of September 30, 2004

(UNAUDITED)

 

		Historical			Pro Forma Adjustments			Footnotes		Pro Forma
ASSETS
Current assets:
Cash		$	555		$	—				$	555
Receivables, less allowance for doubtful accounts		2,130			—					2,130
Inventories, net		74			—					74
Prepaids and other assets		659			—					659
Total current assets		3,418			—					3,418
Furniture, fixtures and equipment, net		501			—					501
Intangibles, net		3,697			—					3,697
Intangible assets from Management Equity/Conversion Transaction		—			9,531			(b)		9,531
Other assets		14			—					14
Total assets		$	7,630		$	9,531				$	17,161
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
Current liabilities:
Current portion of long-term debt		$	983		—					$	983
Accounts payable		1,078			—					1,078
Customer deposits		2,243			—					2,243
Accrued liabilities		2,725			(160		)	(c)		2,565
Income taxes payable		111			—					111
Unearned revenue		3,415			—					3,415
Total current liabilities		10,555			(160		)			10,395
Long-term debt		9,982			(3,133		)	(c)		6,849
Other liabilities		505			—					505
Total liabilities		21,042			(3,293		)			17,749
Stockholders’ deficiency:
Preferred Stock		—			—
Common Stock		152			424			(d)		576
Additional paid-in capital		218,112			(169,431		)	(d)		48,681
Common stock subsribed		1,000			(1,000		)	(a)		—
Accumulated other comprehensive income:
Minimum pension liability		(1,005		)	792			(d)		(213		)
Foreign currency translation		(47		)	37			(d)		(10		)
Unearned compensation		(25		)	20			(d)		(5		)
Accumulated deficit		(231,599		)	181,982			(d) (e)		(49,617		)
Total stockholders’ deficiency		(13,412		)	12,824					(588		)
Total liabilities and stockholders’ deficiency		$	7,630		$	9,531				$	17,161

 

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PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the three months ended September 30, 2004
(UNAUDITED)
(In thousands, except per share data)

 

		Historical			Pro Forma Adjustments			Footnotes		Pro Forma
Revenue:
Software		$	842		—					$	842
Network and computer equipment		118			—					118
Services		3,923			—					3,923
Total revenue		4,883			4,883
Direct costs:
Software		40			477			(b)		517
Network and computer equipment		103			—					103
Services		1,264			—					1,264
Total direct costs		1,407			477					1,884
Gross profit		3,476			(477		)			2,999
Selling, general and administrative expenses		2,200			—					2,200
Research and development costs		956			—					956
Other operating expense		48			—					48
Operating income (loss)		272			(477		)			(205		)
Interest income		—			—					—
Interest expense		(303		)	80			(f)		(223		)
Other non-operating expense		(22		)	—					(22		)
Income (loss) before income tax benefit		53			(397		)			(450		)
Income taxes expense		(5		)	—					(5		)
Net income (loss)		$	(58	)	$	(397	)			$	(455	)
Income (loss) per share:
Basic income (loss) per share		$	0.00		$	(0.01	)			$	(0.01	)
Diluted income (loss) per share		$	0.00		$	(0.01	)			$	(0.01	)
Weighted average common shares used in determining income (loss) per share:
Basic		14,676			42,933					57,609
Diluted		14,676			42,933					57,609

 

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