SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from                                      to                                     .

Commission File Number 0-15935

SPESCOM SOFTWARE INC.

(Exact name of registrant as specified in its charter)

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 12-b-2 of the Exchange Act).

YES    o          NO    ý

ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

SPESCOM SOFTWARE INC.

CONSOLIDATED BALANCE SHEETS

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

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SPESCOM SOFTWARE INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

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SPESCOM SOFTWARE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See Note 2 for supplemental cash flow information.

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

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SPESCOM SOFTWARE INC.

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 — Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2005 and for the three and six months ended March 31, 2005 and 2004 are unaudited. The consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles applicable to interim periods.  In the opinion of management, the consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial position, operating results and cash flows for the periods presented.

The information contained in the following Condensed Notes to the Consolidated Financial Statements is condensed from that which would appear in the annual consolidated financial statements; accordingly, the consolidated financial statements included herein should be reviewed in conjunction with the consolidated financial statements and related notes thereto contained in the Company’s Annual Report on Form 10-K/A for the year ended September 30, 2004.  It should be understood that the accounting measurements at an interim date inherently involve greater reliance on estimates than at year-end.  The results of operations for the interim periods presented are not necessarily indicative of the results expected for the entire year.

Note 2 — Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements are prepared using accounting principles generally accepted in the United States of America and include the accounts of the Company and its wholly-owned United Kingdom subsidiary, Spescom Software, Ltd. All significant intercompany balances and transactions have been eliminated.

Foreign Currency

The functional currency of the Company’s United Kingdom subsidiary is the pound sterling. Assets and liabilities are translated into U.S. dollars at end-of-period exchange rates. Revenues and expenses are translated at average exchange rates in effect for the period. Net currency exchange gains or losses resulting from such translations are excluded from net income and are accumulated in a separate component of shareholders’ deficit as accumulated other comprehensive income (loss). Gains and losses resulting from foreign currency transactions, which are not significant, are included in the consolidated statements of operations.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and also requires disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include revenue recognition estimates, the viability of recognizing deferred income tax assets, capitalized software costs and the valuation of equity instruments, and the allowance for doubtful accounts.  Significant changes in these estimates may have a material impact on the financial statements.

Revenue Recognition

The Company’s revenues are derived from sales of its document and configuration management systems that are primarily composed of software and services, including maintenance, training and consulting services, and third party software and hardware. The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition” and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions” and Staff Accounting Bulletin (“SAB”) No. 101, updated by SAB’s 103 and 104 “Update of Codification of Staff Accounting Bulletins.”

Software license and third party product revenues are recognized upon shipment of the product if no significant vendor obligations remain and collection is probable. In cases where a significant vendor obligation exists, revenue recognition is delayed until such obligation has been satisfied. For new software products where a historical record has not yet been demonstrated that acceptance is perfunctory, the Company defers recognition of revenue until acceptance has occurred.   If an undelivered element of the arrangement exists under the license arrangement, a portion of revenue is deferred based on vendor-specific objective evidence (VSOE) of the fair value of the undelivered element until delivery occurs.  If VSOE does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered.  Annual maintenance revenues, which consist of ongoing support

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and product updates, are recognized on a straight-line basis over the term of the contract. Payments received in advance of performance of the related service for maintenance contracts are recorded as deferred revenue. Revenues from training and consulting services are recognized when the services are performed and adequate evidence of providing such services is available. Contract revenues for long-term contracts or programs requiring specialized systems are recognized using the percentage-of-completion method of accounting, primarily based on contract labor hours incurred to date compared with total estimated labor hours at completion. Provisions for anticipated contract losses are recognized at the time they become known.

Contracts are billed based on the terms of the contract. There are no retentions in billed contract receivables. Unbilled contract receivables relate to revenues earned but not billed at the end of the period.

The Company considers many factors when applying accounting principles generally accepted in the United States of America related to revenue recognition.  These factors include, but are not limited to:

•                                          The actual contractual terms, such as payment terms, delivery dates, and pricing of the various product and service elements of a contract

•           Availability of products to be delivered

•           Time period over which services are to be performed

•           Creditworthiness of the customer

•           The complexity of customizations to the Company’s software required by service contracts

•           The sales channel through which the sale is made (direct, VAR, distributor, etc.)

•           Discounts given for each element of a contract

•           Any commitments made as to installation or implementation of “go live” dates

Each of the relevant factors is analyzed to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer.  Management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards.  Any misjudgment or error by management in its evaluation of the factors and the application of the standards, especially with respect to complex or new types of transactions, could have a material adverse effect on the Company’s future operating results.

Fair Value of Financial Instruments

Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value of Financial Instruments”, requires management to disclose the estimated fair value of certain assets and liabilities defined by SFAS No. 107 as cash or a contractual obligation that both conveys to one entity a right to receive cash or other financial instruments from another entity, and imposes on the other entity the obligation to deliver cash or other financial instruments to the first entity. At March 31, 2005 and September 30, 2004, management believes that the carrying amounts of cash and cash equivalents, short-term investments, accounts receivable and accounts payable, and accrued expenses approximate fair value because of the short maturity of these financial instruments. The Company believes that the carrying value of its loans approximate their fair values based on current market rates of interest.

Concentration of Credit Risk

The Company provides products and services to customers in a variety of industries worldwide, including local governments, petrochemicals, utilities, manufacturing and transportation. Concentration of credit risk with respect to trade receivables is limited due to the geographic and industry dispersion of the Company’s customer base. The Company has not experienced significant credit losses on its customer accounts.  Computer Science Corporation accounted for 29% of trade accounts receivable at March 31, 2005 as compared to Entergy Operations Inc., Northeast Utilities Service Company and Aker Kvaerner, which accounted for 13%, 12% and 12%, respectively, of trade accounts receivable at September 30, 2004.

A small number of customers have typically accounted for a large percentage of the Company’s annual revenues. Network Rail and Computer Science Corporation accounted for 19% and 12% respectively of revenue for the six months ended March 31, 2005 while Constellation Energy Group accounted for 24% of revenue for the six months ended March 31, 2004.  The Company’s reliance on relatively few customers could have a material adverse effect on the results of its operations on a quarterly basis.

Property and Equipment

Property and equipment is recorded at cost and depreciated using the straight-line method over useful lives of two to seven years. Leasehold improvements are amortized on a straight-line basis over the shorter of their useful life or the term of the related lease. Expenditures for ordinary repairs and maintenance are expensed as incurred while major additions and improvements are capitalized.

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Software Development Costs and Purchased Software

Software development costs and purchased software are capitalized when technological feasibility and marketability of the related product have been established. Software development costs incurred solely in connection with a specific contract are charged to cost of revenues. Capitalized software costs are amortized on a product-by-product basis, beginning when the product is available for general release to customers. Annual amortization expense is calculated using the greater of the ratio of each product’s current gross revenues to the total of current and expected gross revenues or the straight-line method over the estimated useful life of three to five years. The unamortized value of capitalized software costs was $249,000 and $24,000 at March 31, 2005 and 2004, respectively. The related amortization expense was $13,000 and $39,000 for the six months ended March 31, 2005 and 2004, respectively.

Long-lived Assets

The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances have made recovery of the assets’ carrying value unlikely. An impairment loss would be recognized when the sum of the expected future net cash flows is less than the carrying amount of the asset.

Stock-Based Compensation

The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method and provides pro forma disclosures of net loss and basic and diluted net loss per share as if the fair value-based method had been applied in measuring compensation expense. The Company applies SFAS No.123, Accounting for Stock-Based Compensation and Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its employee stock-based compensation plan.

No compensation cost was recognized for employee stock option grants during the three and six months ended March 31, 2005 and 2004 based upon the intrinsic value method, which were fixed in nature, as the options were granted at exercise prices equal to fair market value on the date of grant. Had compensation cost for the Company’s employee stock-based compensation plan been determined based on the fair value at the grant dates, the necessary disclosure pursuant to the requirements of SFAS No. 148, which amends the disclosure requirements of FAS 123, would be as follows:

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants:

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Income Taxes

Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax asset or liability is established for the expected future consequences resulting from the differences in the financial reporting and tax bases of assets and liabilities. Deferred income tax expense (benefit) is the change during the year in the deferred income tax asset or liability. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be “more likely than not” realized in the future based on the Company’s current and expected operating results.

Net Income (Loss) per Common Share

Basic net income (loss) per common share is computed as net income (loss) divided by the weighted average number of common shares outstanding during the year. Diluted net income (loss) per common share is computed as net loss divided by the weighted average number of common shares and potential common shares, using the treasury stock method, outstanding during the year and assumes conversion into common stock at the beginning of each period of all outstanding shares of convertible preferred stock, stock options, warrants and other potential common stock. Computations of diluted net income (loss) per share do not give effect to individual potential common stock for any period in which their inclusion would be anti-dilutive.

Statements of Cash Flows

The following table provides supplemental cash flow information:

Note 3 — Related Party Transactions

As of March 31, 2005 and September 30, 2004 there were 5,291 shares of Series F Convertible Preferred Stock with a stated value of $1,000 per share held by Spescom Ltd., the majority shareholder of the Company.  The Series F Convertible Preferred Stock is convertible into common stock, at a stated conversion price of $0.45 per share subject to certain adjustments.  The conversion is at the option of Spescom Ltd. through September 30, 2008.  The outstanding Series F Convertible Preferred Stock is entitled to receive dividends of 5% of the stated value of $1,000 per share per annum, payable on a quarterly basis in cash or common stock (valued on the basis of the average per share market value on the 30 trading days immediately prior to the date on which such dividend is declared by the Board of Directors).  Unpaid dividends accrue interest at the rate of 8% per annum.  As of March 31, 2005, unpaid dividends and accrued interest amounted to $397,000 and $20,000, respectively as compared to $132,000 and $1,000, respectively for the same periods in 2004.

On November 18, 2003 the Company issued a note payable to Spescom Ltd. UK, a wholly-owned subsidiary of Spescom Ltd., with a principal balance of $600,000 bearing an interest rate of 5% per annum.  The note was repaid during fiscal 2004.  Interest expense on the note for fiscal 2004 was $9,000.

The Company has two existing demand notes payable to Spescom Ltd. UK for $400,000 and $100,000, each bearing interest rate of 10% per annum.  As of March 31, 2005 and September 30, 2004, the balance owed on the notes including interest was $588,000 and $557,000, respectively.   Spescom Ltd. has agreed that it will not cause Spescom Ltd. UK to demand repayment under the two notes prior to October 1, 2005.  Interest expense on the notes was $14,000 and $28,000 for the three and six months ended March 31, 2005, respectively compared to $15,000 and $33,000 for the same periods in 2004.  These notes are collateralized by a security interest in favor of Spescom Ltd. UK in respect of all the Company’s assets.

Under a royalty arrangement beginning in fiscal 2004, Spescom Ltd. resells the Company’s software and maintenance services in

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South Africa.  Royalty revenue recognized under this agreement for the three and six months ended March 31, 2005 totaled $13,000 and $22,000, respectively.

In December 2004, the Company entered into an arrangement with Spescom Ltd. in which the Company relocated certain engineering personnel to South Africa to work out of Spescom Ltd. facilities.  As part of the agreement Spescom Ltd. bills the Company for wages and an administrative fee that covers office rent and information technology costs on a monthly basis.  For the six months ended March 31, 2005, total expenses under this arrangement was $32,000.

Spescom Ltd. UK provides certain administrative and accounting functions for the Company’s United Kingdom subsidiary.  The Company is billed a monthly fee by Spescom Ltd. UK for reimbursement of certain costs in the United Kingdom including the office facilities, all accounting and human resources services, and certain corporate marketing activities.  For the three and six months ended March 31, 2005 the administrative fees totaled $155,000 and $309,000, respectively as compared to $151,000 and $291,000, respectively, for the same periods in 2004.  The office rent for the Company’s United Kingdom operations included in the administrative fee totaled $91,000 and $180,000 for the three and six months ended March 31, 2005, respectively as compared to $88,000 and $170,000, respectively for the same period in the period in 2004.  At March 31, 2005 and September 30, 2004 the Company had a payable to Spescom Ltd. UK of $51,000 and $90,000, respectfully.  In 1999, as part of an agreement to sell a 60% interest in its United Kingdom subsidiary to Spescom Ltd., the lease for the United Kingdom office facility was to be assigned to Spescom Ltd. UK; however, the landlord did not grant its consent to the assignment and as such Spescom Ltd. UK has paid the lease for the entire office directly to the landlord.  The lease expires in March 2006 and has an annual rent of $638,000.  A portion of the office has been subleased to third party tenants for an annual rent of $297,000.  The subleases also expire March 2006.

Spescom Ltd. and the Company have entered into a license agreement pursuant to which Spescom Ltd. has licensed to the Company the right to use the name “Spescom” and to use a trademark owned by Spescom Ltd. related to certain computer software. The Company will not pay any royalties to Spescom Ltd. in connection with this license. The license is for an indefinite term, but is terminable by either party upon 60 days prior written notice. Under the license agreement, Spescom Ltd. has agreed to indemnify and hold the Company and its directors, officers, employees and agents harmless against liabilities arising from any claim brought against the Company that alleges that Spescom Ltd.’s or the Company’s use of the licensed trademark infringes the rights of any third party, provided that the Company is in material compliance with the provisions of the license agreement.

Note 4 — Receivables

Note 5 — Reconciliation of Net Income (Loss) and Shares Used in Per Share Computations:

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period.  Contingently issued shares are included in the computation of basic net income (loss) per share when the related conditions are satisfied.  Diluted net income (loss) per share is computed using the weighted average number of common shares and potentially dilutive securities outstanding during the period.  Potentially dilutive securities consist of contingently issued shares, the common shares issuable upon conversion of preferred stock or convertible debt and shares issuable upon the exercise of stock options and common stock warrants.  Potentially dilutive securities are excluded from the computation if their effect is anti-dilutive.

As of March 31, 2005, a total of 3,919,860 stock options, 3,758,335 common stock warrants, 5,291 Series F Convertible Preferred Stock, and 2,200 shares of Series G Convertible Preferred Stock, were excluded from the diluted net income (loss) per share calculation, as their effect would be anti-dilutive.  As of March 31, 2004, a total of 2,999,934 stock options, 1,008,335 common stock warrants,  and 5,291 shares of Series F Convertible Preferred Stock were excluded from the diluted net income (loss) per share calculation, as their effect would be anti-dilutive.

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Note 6 — Segment and Geographic Information

The Company has one business segment, which consists of the development and sale of a suite of integrated document, configuration and records management software product.

Revenues by customer location are as follows:

Note 7 — Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R (Revised 2004), Share-Based Payment,which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements based on alternative fair value models. The share-based compensation cost will be measured based on the fair value of the equity or liability instruments issued. We currently disclose pro forma compensation expense quarterly and annually by calculating the stock option grants’ fair value using the Black-Scholes model and disclosing the impact on loss applicable to common stock and the related per share amount in Note 2 to the consolidated financial statements. Upon adoption, pro forma disclosure will no longer be an alternative. See the table under caption “Stock-Based Compensation” in Note 2 for the estimated impact that such a change in accounting treatment would have had if it had been in effect during 2005 and 2004. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow as required under current literature. We will begin to apply SFAS No. 123R as of the first annual reporting period that begins after June 15, 2006, and accordingly, the Company expects to adopt the provisions of this pronouncement in the first quarter of 2007.

In March 2005, the FASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations — an Interpretation of FASB Statement No. 143, Accounting for Asset Retirement Obligations.” This interpretation addresses the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or method of settlement of the obligation are conditional on a future event. The interpretation requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The adoption of this interpretation did not have any impact on our consolidated financial statements.

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Note 8 — Equity

November 2004 Private Placement

On November 5, 2004, the Company completed a financing arrangement whereby the Company issued 2,200 shares of our Series G Convertible Preferred Stock (“Series G Stock”) along with 2,750,000 in common stock warrants for gross proceeds of $2,200,000.  The Series G Stock is convertible into common stock at a price equal to 85% of the volume weighted average price of the Company’s common stock during the five trading days immediately preceding the conversion date; however, the conversion price can be no higher than $0.40 per share and no lower than $0.30 per share.  The 2,750,000 warrants have an exercise price of $0.44 per share and expire November 5, 2007.  The Company incurred $433,000 in expenses related to the transaction and issued 825,000 common stock warrants to an investment consulting firm.  The 825,000 warrants were comprised of 550,000 warrants with an exercise price of $0.40 per share which expire November 5, 2009 and 275,000 warrants which have an exercise price of $0.44 which expire on November 5, 2007. In connection with the financing, the Company recorded a beneficial conversion of $2,200,000 on the Series G Stock as a deemed dividend for the six months ended March 31, 2005.

The Series G Stock is entitled to a liquidation preference equal to $1,000 per share, plus declared but unpaid dividends per share.  Commencing on the date of issuance of the Series G Stock, and continuing until the effective date of the registration statement on Form S-2 pursuant to which the Series G Stock is registered, the Series G Stock is also entitled to receive dividends of 5% of the stated value of $1,000 per share per annum, payable monthly in arrears on the last day of each month based on the number of Series G Stock outstanding as of the first day of such month.  The dividend for the Series G Stock is only payable until the registration statement for the common stock underlying the Series G Stock is declared effective by the Securities and Exchange Commission (“SEC”).  On March 22, 2005 the SEC declared the registration statement effective, thus the Series G Stock is no longer entitled to dividends.  For the three and six months ended March 31, 2005, the Company issued 57,602 and 82,050 shares of common stock with a value of $28,000 and $37,000, respectively, as a dividend on the Series G Stock.

 Warrants for Services

On November 4, 2004, the Company issued to a public relations firm warrants to purchase 1,000,000 shares of its common stock at $0.40 per share, expiring November 3, 2007. The warrants vest and become exercisable as follows: (i) 500,000 warrants vest on the date that the average of the last sale price of the Company’s stock on the OTC Bulletin Board for the ten trading days immediately preceding such date (the “Market Price”) exceeds $0.60 per share, (ii) 250,000 warrants vest on the date that the Market Price exceeds $0.70 per share, and (iii) the remaining 250,000 warrants vest and become exercisable on the date that the Market Price exceeds $0.80 per share.  The fair value of the warrants was determined to be $30,000 is being recognized ratably over the six months of the service agreement.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward — Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under “Certain Factors That May Affect Future Results” below and elsewhere in, or incorporated by reference into, this report.

In some cases, you can identify forward looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,” or the negative of these terms.  These and similar expressions are intended to identify forward-looking statements.   When used in the following discussion, the words “believes,” “anticipates” and similar expressions are intended to identify forward-looking statements.  Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof   The forward-looking statements in this report are based upon management’s current expectations and belief, which management believes are reasonable.  These statements represent our estimates and assumptions only as of the date of this Quarterly Report on Form 10-Q, and we undertakes no obligation to publicly release the result of any revisions to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

The following discussion should be read in conjunction with the Selected Consolidated Financial Data and the Consolidated Financial Statements, including the Notes thereto.

OVERVIEW

The Company develops, markets and supports eB, its integrated suite of collaborative document, configuration and records management software solutions.  The eB suite enables organizations in a broad range of industries to create, capture, store, manage, share and distribute critical business information regarding their customers, products, assets and processes in an efficient manner.  The eB suite also enables them to maintain complete, up-to-date information about the configuration of their products, assets and infrastructures so that they can achieve operational excellence and compliance with regulatory requirements.  eB provides the capabilities of an Enterprise Content Management (ECM)/Electronic Document Management (EDM) System, but extends these capabilities by also managing the “things’ that the content/documents relate to such as products, assets , functions, processes, requirements, projects, organizations, locations, work orders, etc.  As a result, eB can be used to manage the lifecycle of physical items (e.g. products, equipment or assets), and the requirements (e.g. functional, safety, performance, environmental, etc.) that govern them.  It enables intelligent relationships to be defined between these items thereby creating an interdependency model.  As a result, the effects of any change on requirements, documents and items can be determined and change can be managed to effectively ensure information integrity.  In particular, eB enables organizations with extensive and complex physical infrastructures to efficiently identify, classify, structure, link, and manage documents, physical items, and requirements throughout their lifecycles and ensure that conformance between these is maintained by means of an automated change process.

We develop, market and support eB, our integrated suite of collaborative document, configuration and records management software solutions.  Our revenues in the three months ended March 31, 2005 increased by 4% from the same period in the prior fiscal year due to higher services revenue.  For the six months ended March 31, 2005 our revenues decreased by 11% from the same period in the prior fiscal year due to the fact that the Company in the prior year had a large license sale to a new customer, while there was no  similarly large sale in the current year.  The Company’s license revenue fluctuates from quarter to quarter as reflected by the decrease in license sales during the quarter.

Our revenues are derived from licenses of our software to our customers, services that we provide under maintenance support contracts and our non-maintenance services, consisting primarily of design studies, system implementation and training.  Of our total revenues for the three months ended March 31, 2005, license revenues accounted for 5%, maintenance services revenues accounted for 47% and non-maintenance services revenues represented 48%.  For the six months ended March 31, 2005, license revenues accounted for 11%, maintenance services revenues accounted for 47% and non-maintenance services revenues represented 42%.

Many of our customers are located outside the United States, with foreign-originated revenues accounting for 57% and 43% of revenues for the three months ended March 31, 2005 and 2004, respectively and 50% and 50% of revenues for the six months ended March 31, 2005 and 2004.  Our revenue for the three and six months ending March 31, 2005 reflected a foreign currency gain of $11,000 and a loss of $62,000 as compared to last year, due to the declining value of the dollar during the year.

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Our cost of revenues increased slightly during the three and six months ended March 31, 2005 which resulted in a decrease in our gross profit from 63% to 59% of revenues and 66% to 60% of revenues, respectively.  Operating expenses remained relatively unchanged.

At March 31, 2005, our principal sources of liquidity consisted of $1,031,000 of cash and cash equivalents, compared to $109,000 at September 30, 2004.  On November 5, 2004, we completed a private placement of preferred stock which resulted in gross proceeds of $2,200,000.

CRITICAL ACCOUNTING POLICIES

The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America.  As such, management is required to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  The significant accounting policies which are most critical to aid in fully understanding and evaluating reported financial results include the following:

Revenue Recognition

The Company enters into contractual arrangements with end-users that may include licensing of the Company’s software products, product support and maintenance services, consulting services or various combinations thereof, including the sale of such products or services separately.  The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition” and SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions” and Staff Accounting Bulletin (“SAB”)  No. 101, updated by SAB’s 103 and 104 “Update of Codification of Staff Accounting Bulletins.”

 Software license and third party product revenues are recognized upon shipment of the product if no significant vendor obligations remain and collection is probable.  In cases where a significant vendor obligation exists, revenue recognition is delayed until such obligation has been satisfied.  For new software products where a historical record has not yet been demonstrated that acceptance is perfunctory, the Company defers recognition of revenue until acceptance has occurred.  If an undelivered element of the arrangement exists under the license arrangement, a portion of revenue is deferred based on vendor-specific objective evidence (VSOE) of the fair value of the undelivered element until delivery occurs.  If VSOE does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered.  Annual maintenance revenues, which consist of ongoing support and product updates, are recognized on a straight-line basis over the term of the contract.  Payments received in advance of performance of the related service for maintenance contracts are recorded as deferred revenue.  Revenues from training and consulting services are recognized when the services are performed and adequate evidence of providing such services is available.  Contract revenues for long-term contracts or programs requiring specialized systems are recognized using the percentage-of-completion method of accounting, primarily based on contract labor hours incurred to date compared with total estimated labor hours at completion.   Provisions for anticipated contract losses are recognized at the time they become known.

Contracts are billed based on the terms of the contract.  There are no retentions in billed contract receivables.  Unbilled contract receivables relate to revenues earned but not billed at the end of the period.

The Company considers many factors when applying accounting principles generally accepted in the United States of America related to revenue recognition.  These factors include, but are not limited to:

•                                          The actual contractual terms, such as payment terms, delivery dates, and pricing of the various product and service elements of a contract

•                                          Availability of products to be delivered

•                                          Time period over which services are to be performed

•                                          Creditworthiness of the customer

•                                          The complexity of customizations to the Company’s software required by service contracts

•                                          The sales channel through which the sale is made (direct, VAR, distributor, etc.)

•           Discounts given for each element of a contract

•                                          Any commitments made as to installation or implementation of “go live” dates

Each of the relevant factors is analyzed to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer.  Management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards.  Any

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misjudgment or error by management in its evaluation of the factors and the application of the standards, especially with respect to complex or new types of transactions, could have a material adverse effect on the Company’s future operating results.

Allowance for Doubtful Accounts

The Company sells its products directly to end-users, generally requiring a significant up-front payment and remaining terms appropriate for the creditworthiness of the customer.  The Company also sells its products to VARs and other software distributors generally under terms appropriate for the creditworthiness of the VAR or distributor.  The Company retains no continuing obligations

on sales to VARs.  Receivables from customers are generally unsecured.  The Company continuously monitors its customer account balances and actively pursues collections on past due balances.  The Company maintains an allowance for doubtful accounts which is comprised of a general reserve based on historical collections performance plus a specific reserve for certain known customer collections issues.  If actual bad debts are greater than the reserves calculated based on historical trends and known customer issues, the Company may be required to book additional bad debt expense which could have a material adverse effect on our business, results of operations and financial condition for the periods in which such additional expense occurs.

RESULTS OF OPERATIONS

The following table sets forth the condensed consolidated statement of operations expressed as a percentage of total revenue for the periods indicated:

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Revenues

License Revenues

(in thousands)

License revenues decreased by $273,000, or 76%, to $86,000 from $359,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The Company’s license revenues fluctuate from quarter to quarter which is reflected by the decrease in license sales in the current quarter.  License revenue decreased $1,124,000, or 76%, to $354,000 from $1,478,000 million for the six months end March 31, 2005 as compared to the same period a year ago.  In the prior year a large sale of licenses to Constellation Energy amounted to $750,000, while there was no similar size sales in the current year.  The length of time it takes to establish new customer relationships typically ranges from 6 to 12 months, and as such the timing of sales can fluctuate significantly from quarter to quarter.

Despite the relatively weak license revenue in the three and six months ended March 31, 2005, we anticipate that the demand for our products will increase if overall economic conditions continue to strengthen leading to an increase in overall demand for enterprise document, configuration and records management software solutions.  The Company’s license revenues can fluctuate from quarter to quarter, based on the timing of customer orders due to the long sales cycle and changes in customers’ internal plans of the rollout of software licenses.

 Although the Company has historically generated the majority of its revenues from its direct sales force, the Company has also established a network of third-party VARs, system integrators and OEMs who build and sell systems (with components or complete systems provided by the Company) that address specific customer needs within various industries, including those targeted directly by the Company.  Sales through indirect channels for the three months ended March 31, 2005 amounted to $65,000 or 4% of total revenue compared to $190,000 or 12% of total revenue for the same period in 2004.  Sales through indirect channels for the six months ended March 31, 2005 amounted to $232,000 or 7% of total revenue compared to $300,000, or 8% of total revenue for the same period in 2004.

A small number of customers have typically accounted for a large percentage of the Company’s annual revenues.  Network Rail and Computer Sciences Corporation each accounted for 19% of revenue for the three months ended March 31, 2005 while CACI and Constellation Group accounted for 11% and 10%, respectively of revenue for the three months ended March 31, 2004.  Network Rail and Computer Sciences Corporation accounted for 19% and 12%, respectively of revenue for the six months ended March 31, 2005 while Constellation Energy Group accounted for 24% of revenue for the six months ended March 31, 2004.

Service and Other Revenues

(in thousands)

Services and other revenues are comprised of maintenance and non-maintenance services.  Non-maintenance services typically relate to business process studies, implementation of systems and training which vary with the level of license revenues while maintenance revenue is primarily dependent on customers renewing their annual maintenance support contracts.

Services and other revenue increased $345,000, or 28%, from $1,242,000 to $1,587,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The increase is primarily due to higher non-maintenance service revenue of $300,000, relating to an increased demand for consulting services relating to customers extending their systems to additional departments and upgrading from older legacy systems to current versions of eB.  Also in this quarter the maintenance revenue increased $45,000, or 6% as compared to the same period a year ago, which reflects support services for the licenses sold in fiscal year 2004.

Services and other revenue increased $724,000, or 32%, from $2,248,000 to $2,972,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The increase is primarily due to higher non-maintenance service revenue of $607,000, relating to an increased demand for consulting services relating to customers expanding the integration of eB into additional departments and to upgrading from older legacy systems to the current versions of eB.  Also for the current fiscal year, maintenance revenue increased $116,000 as compared to the same period a year ago, which reflects support services for licenses sold in fiscal year 2004.

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Fluctuations in license revenue can impact service revenues in future periods as customers implement the software and require maintenance support.  As such, we anticipate service and other revenue will fluctuate primarily due to sales to new customers because they require more services that typically include a business process study, integration with other business systems and training.  In addition, service and other revenues will continue to fluctuate from quarter to quarter based on the timing of customer orders.

Cost of Revenues

Cost of License Revenues

(in thousands) 

Cost of licenses revenues consists of costs associated with reselling third-party products and amortization of capitalized software development costs.

Cost of license revenue increased by $11,000, or 21%, from $53,000 to $64,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The increase is due primarily to $24,000 in higher third-party costs as the Company experienced an increase in sales of third-party products during the quarter which was partially offset by a decrease of $13,000 in amortization expense of software costs as a result of a majority of such costs being fully amortized in fiscal 2004.  The 76% decrease in license revenue resulted in a reduced gross profit percentage of license revenues to 26% for the three months ended March 31, 2005 as compared to 85% for the same period a year ago.  Also contributing to the decrease was the proportional increase in third party products which typically have a lower margin than the sale of the Company’s proprietary software products.

Cost of license revenue decreased by $33,000, or 23%, from $141,000 to $108,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The decrease was primarily due to the reduced amortization expense of capitalized software as mention above.  The 76% decrease combined with costs decreasing 23% in license revenue resulted in a reduced gross profit percentage of license revenues to 69% for the six months ended March 31, 2005 as compared to 90% for the same period a year ago.

We expect the cost of license revenues to fluctuate based on fluctuations in license revenues and in customer requirements for third-party software products since the cost of meeting these customer requirements have the largest impact on cost of license revenues.

Cost of Services and Other Revenues

(in thousands)

Cost of services and other revenues consists primarily of personnel-related costs in providing consulting services, training to customers and support.  It also includes costs associated with reselling third-party hardware and maintenance, which includes telephone support costs.

Cost of services and other revenue increased $79,000, or 15%, from $541,000 to $620,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The increase was primarily due to an increase of $73,000 in personnel-related costs in connection with the additional requirements as a result of the increase in service revenue.  The gross profit from services and other revenue as a percentage of services and other revenues increased to 61% for the three months ended March 31, 2005 as compared to 56% for the same period a year ago.  The improvement in gross profit percentages is due to the 28% increase in service and other revenues while cost of revenues increased only 15%.

Cost of services and other revenue increased $127,000, or 11%, from $1,107,000 to $1,234,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The increase was primarily due to an increase of $117,000 in personnel-related costs.  These increases were associated with the additional service requirements as a result of the increase in services and other revenues.  The gross profit from services and other revenue as a percentage of services and other revenues increased to 58% for the six months ended March 31, 2005 as compared to 51% for the same period a year ago.  The improvement in gross profit percentages is due to the 32% increase in service and other revenues while cost of revenues increased only 11%.

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We expect the cost of service and other revenues to fluctuate in absolute dollar amounts and as a percentage of total revenues as the related service revenue fluctuates.

Operating Expenses

Research and Development

(in thousands)

Research and development expenses consist of salaries and benefits for software developers as well as an allocation of corporate expenses, calculated on the basis of headcount, such as corporate insurance, facilities, telephone and other.

Research and development expenses decreased $162,000, or 48%, from $336,000 to $174,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The decrease was due primarily to the capitalization of $209,000 in costs directly associated with the development of a new architecture for the eB platform.  The decrease was partially offset by an increase of $30,000 in compensation and related benefits associated with increased headcount during the last half of fiscal 2004.

Research and development expenses decreased $148,000, or 22%, from $668,000 to $520,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The decrease was due primarily to the capitalization of $209,000 in costs directly associated with the development of a new architecture for the eB platform.  The decrease was partially offset by an increase of $46,000 in compensation and related benefits associated with increased headcount during the last half of fiscal 2004 and the costs of the relocation of certain employees to the Spescom Ltd. facilities in South Africa.

We believe that continued investment in research and development is a critical factor in maintaining our competitive position and we expect research and development costs to remain at the current levels in absolute dollar amounts in the next several quarters.

Marketing and Sales

(in thousands)

Marketing and sales expenses consist of salaries, cost of benefits, sales commissions and other expenses related to the direct sales force, as well as allocation of overall corporate expenses, calculated on the basis of headcount, related to items such as corporate insurance, facilities, telephone and other.

Marketing and sales expenses increased $188,000, or 26%, from $726,000 to $914,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The increase in marketing and sales expenses is primarily due to increases of $160,000 in additional marketing and sales personnel and their related costs, $65,000 in marketing costs primarily related to trade shows and travel.  The increase was partially offset by a decrease in commissions of $44,000 relating to lower sales during the quarter as compared to the same period a year ago.

Marketing and sales expenses increased $407,000, or 31%, from $1,331,000 to $1,738,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The increase in marketing and sales expenses is primarily due to increases of $305,000 in additional marketing and sales personnel and their related costs, $180,000 in marketing costs primarily related to trade shows and travel and increased costs associated with a public relations campaign of $40,000.  The increase was partially offset by a decrease in commissions of $136,000 relating to lower sales during fiscal 2005 as compared to the same period a year ago.

We expect marketing and sales expense to increase in absolute dollar amounts and as a percentage of total revenue as a result of the planned expansion of our sales and marketing efforts in the next several quarters.

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General and Administrative

(in thousands)

General and administrative expenses consist primarily of personnel costs for finance, information technology, human resources and general management, as well as outside professional services and an allocation of overall corporate expenses, calculated on the basis of headcount, such as corporate insurance, facilities, telephone and other.

General and administrative expenses decreased by $109,000, or 23%, from $482,000 to $373,000 for the three months ended March 31, 2005 compared to the same period a year ago.  The overall decrease was due primarily to decreases of $78,000 in the allowance for uncollectible accounts, $44,000 in investor relations expenses related to the expiration of a contract with an investor relations firm, $37,000 in legal fees as during the prior year, additional work was required for a routine SEC review of the Company’s Annual Report on Form 10-K for the year ended September 30, 2002.  These decreases were partially offset by the increase of $60,000 in costs incurred for consultants and increased accounting fees associated with the Company’s compliance efforts of the Sarbanes-Oxley Act.

General and administrative expenses decreased by $217,000, or 22%, from $989,000 to $772,000 for the six months ended March 31, 2005 compared to the same period a year ago.  The overall decrease was due primarily to decreases of $100,000 in investor relations expenses related to the expiration of a contract with an investor relations firm, $97,000 in legal and SEC filing fees as during the prior year additional work was required for a routine SEC review of the Company’s Annual Report on Form 10-K for the year ended September 30, 2002 and $78,000 reduction in the allowance for uncollectible accounts.  These decreases were partially offset by an increase of $75,000 in costs incurred for consultants and increased accounting fees associated with the Company’s compliance efforts under the Sarbanes-Oxley Act.

We expect general and administrative expenses will stay at current levels in the next several quarters in absolute dollar amounts due to the continued benefits of cost oversight keeping general and administrative expenses in line with current revenues.

Interest Expense

Interest expense consists primarily of fixed interest obligations on our outstanding debt to Spescom Ltd. as well as interest paid on capital lease obligations.  Interest expense was $38,000 and $68,000 for the three and six months ended March 31, 2005, respectively, as compared to $37,000 and $58,000 for the same periods in 2004.  The increase is due primarily to increased debt balances owed to Spescom Ltd. on several outstanding notes payable as well as interest on accrued preferred dividends.

Preferred Dividends

The outstanding Series F Convertible Preferred Stock is entitled to receive dividends of 5% of the stated value of $1,000 per share per annum, payable on a quarterly basis in cash or common stock (valued on the basis of the average per share market value on the 30 trading days immediately prior to the date on which such dividend is declared by the Board of Directors).  Unpaid dividends accrue interest at the rate of 8% per annum.  As of March 31, 2005, unpaid dividends and accrued interest amounted to $397,000 and $20,000, respectively.

The outstanding Series G Stock is entitled to receive dividends of 5% of the stated value of $1,000 per share per annum, payable monthly in arrears on the last day of each month based on the number of Series G Stock outstanding as of the first day of each such month.  For the three and six months ended March 31, 2005, the Company issued 57,602 and 82,050 shares of common stock with a value of $28,000 and $37,000, respectively, as a dividend on the Series G Stock.  In connection with the Series G Stock financing, the Company recorded a beneficial conversion of $2,200,000 as a deemed dividend for the six months ended March 31, 2005.  The dividend for the Series G Stock is only payable until the registration statement for the common stock underlying the Series G Stock is declared effective by the Securities and Exchange Commission (“SEC”).  On March 22, 2005 the SEC declared the registration statement effective, thus the Series G Stock is no longer entitled to dividends.

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LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2005, our principal sources of liquidity consisted of $1,031,000 of cash and cash equivalents compared to $109,000 at September 30, 2004.  Our liquidity could be negatively impacted by a decrease in demand for our products, which are subject to rapid technological changes, reductions in capital expenditures by our customers and intense competition, among other factors.

The Company has received loans from Spescom Ltd. in the past to meet its obligations.  The outstanding balance of our demand notes owed to Spescom Ltd. including interest was $588,000 at March 31, 2005 as compared to $557,000 at September 30, 2004.  Spescom Ltd. has agreed not to call the notes prior to October 1, 2005.

We used cash in operating activities of $588,000 during the six months ended March 31, 2005 primarily related to a net loss during the quarter of $1,112,000 which was offset by increases in deferred revenue and accrued liabilities of $287,000 and $52,000, respectively.  During the six months ended March 31, 2004 we used cash in operating activities of $400,000 primarily related to a net loss of $562,000 and an increase in deferred revenue of reduction in receivables of $272,000 which was partially offset by depreciation of $122,000.

Our investing activities used $259,000 for six months ended March 31, 2005 primarily for the acquisition of computer software and equipment.  There were no capital asset purchases in the six months ended March 31, 2004.