UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-KSB
ý
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Annual
report pursuant to section 13 or 15(d) of the Securities Exchange Act
of 1934.
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For
the fiscal year ending December 31, 2005
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Or
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o
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Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934.
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For
the transition period from
to .
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Commission
file number
001-32623
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CONVERSION
SERVICES INTERNATIONAL, INC.
(Exact
name of registrant as specified in its charter)
Delaware
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20-0101495
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(State
or other jurisdiction
of
incorporation or organization)
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(IRS
Employer
Identification
number)
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100
Eagle Rock Avenue, East Hanover, NJ
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07936
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(Address
of Principal Executive Offices)
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(Zip
Code)
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973-560-9400
(Registrant’s
Telephone Number, Including Area Code)
Securities
registered pursuant to Section 12(b) of the Act:
Title
of Each Class
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Name
of Each Exchange
On
Which Registered
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Common
Stock, $.001 par value
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American
Stock Exchange
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Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange
Act. Yes མ No x.
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 o
NO ý
Check
if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained,
to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. ý
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
State
issuer’s revenues for its most recent fiscal year: $27.6 million
The
aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $15,240,210 as of March 31, 2006 (based on the
closing price for such stock as of March 31, 2006).
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock:
Class
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Outstanding
at March 31, 2006
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Common
Stock, $.001 par value
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49,997,834
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INDEX
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PART
I
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1
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Item
1.
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Business
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1
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Item
2.
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Description
of Property
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35
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Item
3.
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Legal
Proceedings
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36
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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36
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PART
II
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37
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Item
5.
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Market
for Common Equity and Related Stockholder Matters
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37
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Item
6.
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Management’s
Discussion and Analysis or Plan of Operation
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38
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Item
7.
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Financial
Statements
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61
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Item
8.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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62
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Item
8A.
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Controls
and Procedures
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62
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Item
8B.
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Other
Information
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66
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PART
III
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67
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Item
9.
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Directors,
Executive Officers, Promoters and Control Persons; Compliance With
Section
16(a) of the Exchange Act
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67
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Item
10.
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Executive
Compensation
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72
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Item
11.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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78
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Item
12.
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Certain
Relationships and Related Transactions
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79
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Item
13.
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Exhibits
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80
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Item
14.
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Principal
Accountant Fees and Services
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87
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Signatures
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131 |
PART
I
ITEM
1. BUSINESS
References
in this Form 10-KSB to the “Company,” “CSI,” “we,” “our,” and “us” refer to
Conversion Services International, Inc. and our consolidated subsidiaries.
We
are a technology firm providing professional services to the Global 2000 as
well
as mid-market clientele. Our core competency areas include strategic consulting,
data warehousing, business intelligence and data management consulting. Our
clients are primarily in the financial services, pharmaceutical, healthcare
and
telecommunications industries, although we do have clients in other industries.
Our clients are primarily located in the northeastern United States. We enable
organizations to leverage their corporate information assets by providing
strategy, process, methodology, data warehousing, business intelligence,
enterprise reporting and analytic solutions. Our organization delivers value
to
our clients, utilizing a combination of business acumen, technical proficiency,
experience and a proven set of “best practices” methodologies to deliver cost
effective services through time and material engagements (or on occasion fixed
price engagements). CSI empowers clients to gain insight and intelligence from
corporate data through our combination of business acumen, technical proficiency
and proven methodology. We are committed to being a leader in data warehousing
and business intelligence consulting, allowing us to be a valuable asset and
trusted advisor to our customers.
We
believe that our primary strengths that distinguish us from our competitors
are
our:
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·
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role
as a full life-cycle solution
provider;
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·
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ability
to provide strategic guidance and ensure that business requirements
are
properly supported by technology;
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·
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ability
to provide solutions that integrate people, improve process and integrate
technologies;
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·
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extensive
service offerings as it relates to data warehousing, business
intelligence, strategy and data
quality;
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·
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our
perspective regarding the accuracy of data and our data purification
process;
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·
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best
practices methodology, process and
procedures;
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·
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experience
in architecting, recommending and implementing large and complex
data
warehousing and business intelligence solutions;
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·
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understanding
of data management solutions; and
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·
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ability
to consolidate inefficient environments into robust, scalable, reliable
and manageable enterprise
solutions.
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Our
goal
is to be the premier provider of data warehousing, business intelligence and
related strategic consulting services for organizations seeking to leverage
their corporate information. In support of this goal we intend to:
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·
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enhance
our brand and mindshare;
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·
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continue
growth both organically and via
acquisition;
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·
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increase
our geographic coverage;
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·
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expand
our client relationships;
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·
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introduce
new and creative service offerings;
and
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·
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leverage
our strategic alliances.
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We
are
committed to being a leader in data warehousing and business intelligence
consulting. As a data warehousing and business intelligence specialist, we
approach business intelligence from a strategic perspective, providing
integrated data warehousing and business intelligence strategy and technology
implementation services to clients that are attempting to leverage their
enterprise information. Our matrix of services includes strategy consulting,
data warehousing and business intelligence architecture and implementation
solutions, data quality solutions and data management solutions. We have
developed a methodology which provides a framework for each stage of a client
engagement, from helping the client conceive its strategy, to architecting,
engineering and extending its information. We believe that our integrated
methodology allows us to deliver reliable, robust, scalable, secure and
extensible business intelligence solutions in rapid timeframes based on accurate
information.
We
are a
Delaware corporation formerly named LCS Group, Inc. In January 2004, a
privately-held company named Conversion Services International, Inc. (“Old CSI”)
merged with and into our wholly owned subsidiary, LCS Acquisition Corp. In
connection with such transaction: (i) a 16-year old information technology
business (formed in 1990) became our operating business, (ii) the former
stockholders of Old CSI assumed control of our Board of Directors and were
issued approximately 75.9% of the outstanding shares of our common stock at
that
time (due to subsequent events, that percentage of ownership has decreased),
and
(iii) we changed our name to “Conversion Services International, Inc.” The
acquisition was accounted for as a reverse acquisition.
Please
see Note 1 Accounting Policies of the Notes to Consolidated Financial Statements
for further discussion on this transaction.
On
September 21, 2005, our common stock began trading on the American Stock
Exchange under the symbol “CVN”.
Our
offices are located at 100 Eagle Rock Avenue, East Hanover, New Jersey 07936,
and our telephone number is (973) 560-9400.
Our
Services
As
a full
service strategic consulting, business intelligence, data warehousing and data
management firm, we offer services in the following solution
categories:
Strategic
Consulting: Involves
planning and assessing both process and technology, performing gap analysis,
making recommendations regarding technology and business process improvements
to
help our clients realize their business goals and maximize their investments
in
people and technology.
Business
and Process Consulting
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·
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Information,
Process and Infrastructure (IPI) Diagrams (Claritypath) -
A blueprinting
process and service that facilitates and accelerates the
strategic
planning process.
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·
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Change
Management Consulting - Assist clients with implementing
project
management governance and best practices for large scale
change
initiatives, including consolidations, conversions, integration
of new
business processes and systems
applications.
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·
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Integration
Management, Mergers and Acquisitions - Work with clients to
implement best
practices for mergers and acquisitions. Support all aspects
of the
integration process from initial assessment through implementation
support.
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·
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Acquisition
Readiness - Work with clients to better prepare them for
large scale
acquisitions in the financial services domain. This includes
building best
practices, mapping and gapping and implementing a strategic
roadmap to
integrate multiple companies.
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· |
Process
Improvement (Lean, Six Sigma) - Provide a full array of products
and
services in support of Lean and Six Sigma, including training,
process
improvement, project management and implementation
support.
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· |
Regulatory Compliance (The Health Insurance
Portability
and Accountability Act of 1996, Basel II, Sarbanes-Oxley) -
Work with
clients to analyze, design and implement operational control,
procedures
and business intelligence that will align the organization
to meet new
regulatory requirements. |
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· |
Project
Management (PMO) - Setting up an internal office at a client
location,
staffed with senior/certified project managers that act in
accordance with
the policies and procedures identified in CSI Best Practices
for Project
Management.
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· |
Request
For Proposal Creation and Responses - Gather user and technical
requirements and develop Requests For Proposals (RFP) on
behalf of our
clients. Respond to client RFPs with detailed project plans,
solutions and
cost.
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Technology
Consulting
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·
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Data
Warehousing and Business Intelligence Strategic Planning - Helping
clients
develop a strategic roadmap to align with a data warehouse or business
intelligence implementation. These engagements are focused on six
strategic domains that have been identified and documented by CSI:
Business Case, Program Formulation, Organizational Design, Program
Methodologies, Architecture and Operations and Servicing.
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·
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Business
Technology Alignment - A strategic offering that consists of a series
of
interviews including both the business and technology constituents
to
collect information regarding user satisfaction, user requirements
and
expectations, as well as the technology groups understanding of needs
and
current and future deliverables. The result is a set of recommendations
that will better align the user and technology groups and deliver
more
perceived value.
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·
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Business
Intelligence Strategy - Helping clients develop a roadmap to leverage
a
business intelligence platform throughout the enterprise aligning
the
client with best practices.
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·
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BI/DW
Software Selection - Evaluation, analysis and recommendation of
appropriate software tools for deploying BI/DW solutions. Gather
business
and technical requirements and measure those requirements against
the
capabilities of available tools in the current marketplace. Software
evaluated and recommended include reporting, ad-hoc query, analytics,
extract, transform and load processes (ETL), data profiling, database
and
data modeling.
|
Business
Intelligence: A
category of applications and technologies for gathering, storing, analyzing
and
providing access to data to help enterprise users make better and quicker
business decisions.
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·
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Business
Intelligence, Architecture and Implementation - Develop architecture
plans
and install all tools required to implement a business intelligence
solution, including enterprise reporting, ad-hoc reporting, analytical
views and data mining. Solutions are typically developed using tools
such
as Cognos, Business Objects, MicroStrategy, SAS and Crystal
Reports.
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|
·
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Business
Intelligence Competency Center - Set up an internal office at a client
location, staffed with a mix of senior business intelligence developers
and business intelligence architects that will implement best practices,
policies, procedures, standards and provide training and mentoring
to
further increase the use of the data warehouse and facilitate the
business
owners embracing of the business intelligence
solution.
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·
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Analytics
and Dashboards - Identify and document dashboard requirements. These
requirements are typically driven by Key Performance Indicators (KPIs)
identified by upper management. Architect a supporting database structure
to support the identified hierarchies, drill-downs and slice and
dice
requirements, implement a dashboard tool, provide training and
education.
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|
·
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Business
Performance Management - Leveraging a new or existing business
intelligence implementation to monitor and manage both business process
and IT events through key performance
indicators.
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·
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Data
Mining - Implementing data mining tools that extract implicit, previously
unknown, and potentially useful information from data. These tools
typically use statistical and visualization techniques to discover
and
present knowledge in a form which is easily comprehensible to humans.
Business intelligence tools will answer questions based on information
that has already been captured (history). Data mining tools will
discover
information and project information based on historic
information.
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·
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Proof
of Concepts and Prototypes - Gather requirements, design and implement
a
small scale business intelligence implementation called a Proof of
Concept. The Proof of Concept will validate the technology and/or
business
case, as well as “sell” the concept of business intelligence to
management.
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|
·
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Outsourcing
- Development of new reports offsite/offshore and redeployment of
reports
in new technologies in support of technology
consolidation.
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·
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Training
and Education - Provide formal classroom training for Business Objects
software products. Provide training in data warehousing and business
intelligence methodologies and best practices, as well as technology
tool
training, including business intelligence tools such as Cognos and
MicroStrategy.
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Data
Warehousing: A
consolidated view of high quality enterprise information, making it simpler
and
more efficient to analyze and report on that information.
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·
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Data
Warehousing and Data Mart Design, Development and Implementation
- Design,
development and implementation of custom data warehouse solutions.
These
solutions are based on our methodology and best
practices.
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|
·
|
Proof
of Concepts and Prototypes - Gather requirements, design and implement
a
small scale data warehouse that is called a Proof of Concept. The
Proof of
Concept will validate the technology and/or business case, as well
as
“sell” the concept of data warehousing to
management.
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|
·
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Extract,
Transformation and Loading (ETL) - Design, development and implementation
of data integration solutions with particular expertise and best
practices
for integrating ETL tools with other data warehouse
tools.
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·
|
Enterprise
Information Integration (EII) - Enterprise Information Integration
tools
are used to integrate information by providing a logical view of
data
without moving any data. This is particularly useful when bridging
a
business intelligence tool to multiple data marts or data
warehouses.
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|
·
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Outsourcing
- Implementing and supporting a client data warehouse solution at
a CSI
location.
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Data
Management: Innovative
solutions for managing data (information) throughout an enterprise.
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·
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Enterprise
Information Architecture - Leveraging our Information, Process and
Infrastructure (IPI) Diagrams to create a “snapshot” of the current
information flow and desired information flow throughout the enterprise.
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·
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Metadata
Management - Based on our Data Warehouse Framework, we will build
a
metadata repository that is integrated with all tools used in a data
warehouse implementation and will be leveraged by the business
intelligence environment.
|
|
·
|
Data
Quality Center of Excellence - Set up an internal office at a client
location, staffed with a mix of senior data quality developers and
data
quality architects that will implement best practices, policies,
procedures, standards and provide training and mentoring to further
increase the level of data quality throughout the enterprise and
increase
the awareness and importance of data quality as it pertains to decision
making.
|
|
·
|
Data
Quality/Cleansing/Profiling - Leveraging profiling as an automated
data
analysis process that significantly accelerates the data analysis
process.
Leveraging our best practices to identify data quality concerns and
provide rules to cleanse and purify the
information.
|
|
·
|
Data
Migrations and Conversions - Design, development and implementation
of
custom data migrations. These solutions are based on our methodology
and
best practices.
|
|
·
|
Quality
Assurance Testing (Verification, Validation, Certification) - We
have
developed a quality assurance process referred to as Verification,
Validation, Certification (VVC) of information. This is a repeatable
process that will insure that all data has been validated to be accurate,
consistent and trustworthy.
|
|
·
|
Application
Development - Custom application development or integration to support
data management or data warehouse initiatives. This may include
modification of existing enterprise applications to capture additional
information required in the warehouse or may be a standalone application
developed to facilitate improved integration of existing
information.
|
|
·
|
Infrastructure
Management and Support - An infrastructure must be in place to support
any
data warehouse or data management initiative. This may include servers,
cables, disaster recovery or any process and procedure needed to
support
these types of initiatives.
|
The
following illustrates the percentage of revenues provided by each category
of
services as a percentage of overall revenues:
Category
of Services
|
|
Percentage
of Revenues for the year ended December 31,
|
|
|
|
|
2005
|
|
|
2004
|
|
Strategic
Consulting
|
|
|
40.6
|
%
|
|
35.9
|
%
|
Business
Intelligence
|
|
|
22.4
|
%
|
|
22.7
|
%
|
Data
Warehousing
|
|
|
22.8
|
%
|
|
16.7
|
%
|
Data
Management
|
|
|
13.2
|
%
|
|
23.4
|
%
|
Software
& Support
|
|
|
0.0
|
%
|
|
1.0
|
%
|
Other
|
|
|
1.0
|
%
|
|
0.3
|
%
|
Recent
Acquisitions and Divestiture
We
will
also continue to pursue strategic acquisitions that strengthen our ability
to
compete and extend our ability to provide clients with a core comprehensive
services offering.
In
March
2004, we acquired DeLeeuw Associates, Inc. (“DeLeeuw Associates”), a management
consulting firm in the information technology sector with core competency in
delivering Change Management Consulting, including both Six Sigma and Lean
domain expertise to enhance service delivery, with proven process methodologies
resulting in time to market improvements within the financial services and
banking industries. In connection with the DeLeeuw Associates acquisition,
we:
(i)
paid
Mr. Robert C. DeLeeuw, as the sole stockholder of DeLeeuw Associates, $1.9
million; and (ii) issued 5,333,334
shares
of
our common stock to Mr. DeLeeuw. Please see Note 1 of our Notes To Consolidated
Financial Statements for further discussion on this transaction.
Integration
of DeLeeuw’s Change Management Consulting practices with CSI’s Data Warehousing
and Business Intelligence core competency “The Center for Data Warehousing” was
completed in 2004. The Change Management, Six Sigma and Lean methodology have
been introduced to our clients along with our innovative Information, Process
and Infrastructure (IPI) Diagrams, which provide detailed blueprints of our
client’s information, business processes and infrastructure on a single highly
detailed diagram. These diagrams can be utilized for risk management,
compliance, validation, planning and budgeting requirements. The IPI diagram
offering, launched in the first quarter of 2004, continues to receive favorable
reaction from our clients. In addition, we expanded our Data Warehouse
Assessment, Business Technology Alignment (BTA) and Quality Management Offering
(QMO) related offerings in 2005, which will be the focus of our marketing and
communications programs for 2006. A QMO offering is a combination of
methodologies, best practices and automated techniques leveraged to
establish and enforce standards and procedures as it relates to elevating
the quality of executive information in an efficient and effective
manner. We believe that these offerings will drive greater understanding and
demand for both data warehousing and business intelligence implementations
by
delivering best practices methodologies, tools and techniques to reduce risk,
time to market and total cost of ownership of these engagements. One component
of our business strategy is to continue to enhance and expand our offerings
which include best practices, process improvement, methodologies, advisory
services and implementation expertise.
In
May
2004, CSI acquired 49% of all issued and outstanding shares of common stock
of
Leading Edge Communications Corporation (LEC). The acquisition was completed
through a Stock Purchase Agreement between CSI and the sole stockholder of
LEC.
In connection with the acquisition, CSI (i) repaid a bank loan on behalf of
the
seller in the amount of $35,000; (ii) repaid an LEC bank loan in the amount
of
$38,000; and (iii) satisfied an LEC obligation for $10,000 of prior compensation
to an employee. LEC provides enterprise software and services solutions for
technology infrastructure management. Previously, in November 2003, CSI executed
an Independent Contractor Agreement with LEC, whereby CSI agreed to be a
subcontractor for LEC, and to provide consultants as required to LEC. In return
for these services, CSI receives a fee from LEC based on the hourly rates
established for consultants subcontracted to LEC.
In
June
2004, we acquired substantially all of the assets and assumed substantially
all
of the liabilities of Evoke Software Corporation (“Evoke”), which designed,
developed, marketed and supported software programs for data analysis, data
profiling and database migration applications and provides related support
and
consulting services. In
connection with the Evoke acquisition, we: (i) issued 4,836,264
shares
of
our common stock to Evoke, 476,667 of which were deposited into an escrow
account for a period of one year and were reduced based upon claims for
indemnification that were made pursuant to the asset purchase agreement; (ii)
issued 5% of the outstanding shares of our acquisition subsidiary to Evoke;
(iii) issued 261,273 shares of our common stock to certain executives of Evoke
as a severance payment and to certain employees as retention shares; (iv) paid
approximately $0.5 million in deferred compensation to certain employees of
Evoke; and (v) assumed substantially all of Evoke’s liabilities. Evoke changed
its name to WHRT I Corp. Before
the merger, certain investors of Evoke invested $0.55 million in Evoke, which
investment was converted into approximately 366,667 shares of our common stock
upon effectuation of the merger. On February 2, 2006, we bought back WHRT I
Corp.’s remaining holdings of our common stock, 3,892,355 shares, for
$1,848,868.60, and such shares were placed back into the Company’s treasury. An
additional 253,027 shares of our common stock relating to the escrowed shares
(see above) were placed into treasury as well. Please
see Note 23 of our Notes to Consolidated Financial Statements for further
discussion on this transaction.
In
July
2005, the Company completed the sale of substantially all of the assets of
its
subsidiary Evoke Software Corporation and received an aggregate consideration
of
$645,000 cash, the assumption by Similarity Systems (“Similarity”) and
Similarity Vector Technologies, Ltd. (“SVT”) of certain liabilities, shares of
Similarity which were issuable by Similarity subject to the Company’s
satisfactory completion of certain post-closing obligations, and an earnout
in
an amount equal to 13% of certain Similarity revenues. The maximum earnout
consideration to which the Company was entitled under this agreement was
$1,400,000 and was to be received over a three year period. CSI changed the
name
of its “Evoke Software Corporation” subsidiary to “CSI Sub Corp II (DE)” in
August 2005. On
February 13, 2006, the Company received $2,050,000 from Informatica, SVT and
Similarity Systems related to Informatica’s acquisition of SVT and Similarity as
final payment on all future consideration related to our agreement with SVT
and
Similarity.
In
July
2005, we acquired McKnight Associates, Inc. ("McKnight Associates"). Since
inception, McKnight Associates has focused on successfully designing, developing
and implementing data warehousing and business intelligence solutions for its
clients in numerous industries. In consideration of this merger agreement,
the
Company paid the following consideration to Mr. William McKnight, the sole
stockholder of McKnight Associates: (i) $500,000 in cash, (ii) the commitment
to
pay an additional $250,000 in cash by June 2006 (the Company paid Mr. McKnight
$125,000 in March 2006), (iii) the issuance of 909,091 shares of the Company’s
common stock, and (iv) the assumption of substantially all of the liabilities
of
McKnight Associates. Mr. McKnight joined the Company as Senior Vice President
-
Data Warehousing and is
a
well-known industry leader, frequently
speaks at national trade shows and contributes
to major data management trade publications.
In
July
2005, we acquired Integrated Strategies, Inc. ("ISI"). With offices in New
York
City, ISI is a professional services firm with a solutions-oriented approach
to
complex business and technical challenges. Similar to our wholly owned
subsidiary, DeLeeuw Associates, which is best known for its large-scale merger
integration management and business process change programs for the financial
services markets, ISI also counts many industry leaders in this sector among
its
customers. Because of this shared focus, the operations of ISI were folded
into
DeLeeuw Associates. In consideration of this merger agreement, the Company
paid
the following consideration to Adam Hock and Larry Hock, individual majority
stockholders of ISI: (i) $2,050,000 in cash (reduced by certain amounts), (ii)
the issuance of a promissory note in the amount of $177,937 (which was later
reduced to $76,054), (iii) the issuance by the Company of a subordinated
promissory note in the amount of $165,000, and (iv) the assumption of
substantially all the liabilities of ISI. The agreement also provides for the
commitment, subject to certain revenue and profit thresholds (as described
in
the agreement), to pay additional cash and issue shares of the Company common
stock.
We
believe that as new opportunities are created, Global 2000 companies will
continue the trend of expanding the utilization of external consulting expertise
to support corporate initiatives focused on maximizing Return On Investment
(ROI), leveraging existing technology infrastructure through optimizations
and
best practices and will continue to leverage and derive value from corporate
information assets such as data warehousing, business intelligence and
analytics. We believe that we are positioned to expand our client base by
delivering business value resulting from our 16 years of domain expertise,
proven best practices, methodologies, processes and automation within data
warehousing architecture and implementation. Our ability to apply Six Sigma
and
Lean core competency to client processes and implementation strategies further
strengthens our competitive standing. CSI is well positioned to support the
increasing industry emphasis on data quality and the use of automation to reduce
the costs associated with data warehouse and business intelligence projects,
data migrations and conversions, as well as packaged application implementations
such as Enterprise Resource Planning (ERP), Customer Relationship Management
(CRM) and Supply Chain Management (SCM) by leveraging the automation and
validation gained by the use of data profiling technology.
Recent
External Financings
Taurus
In
May
2004, pursuant to the complete conversion of a $2.0 million unsecured
convertible line of credit note issued in October 2003 at $1.80 per share,
certain investors represented by Taurus Advisory Group, LLC (“Taurus”) received
1,111,111 shares of our common stock, plus interest paid in cash. Because we
failed to perform a private investment in public equity transaction by September
1, 2004, the conversion price on the October 2003 note was adjusted to a fixed
conversion price of $1.575 per share, and 158,730 additional shares of common
stock were issued to Taurus. No additional proceeds were received by us. In
addition, Taurus received a warrant to purchase 277,778 shares of our common
stock, which has an exercise price of $1.575 per share. This warrant expires
in
June 2009. Further in May 2004, we raised an additional $2.0 million pursuant
to
a new five-year unsecured promissory note with Taurus. In June 2004, we replaced
the May 2004 note by issuing a five-year $2.0 million unsecured convertible
line
of credit note with Taurus. The
note
accrues interest at an annual rate of 7%, and the conversion price of the shares
of common stock issuable under the note is equal to $1.575 per
share.
In
July
2005, the Company obtained two $250,000 short term loans from certain investors
represented by Taurus. Both notes bear interest at 8% per annum. The first
note
is dated July 6, 2005 and initially matured on September 6, 2005. The maturity
date for this note has been extended to May 6, 2006. The second note is dated
July 22, 2005 and originally matured on September 22, 2005. The maturity date
for this note has been extended to April 22, 2006. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
In
December 2005, the Company obtained a $1,000,000 short term loan from certain
investors represented by Taurus. This note bears interest at 8% per annum.
The
note is dated December 19, 2005 and initially matured on January 31, 2006.
The
maturity date for this note has been extended to June 1, 2006. In conjunction
with this note, these investors received a warrant to purchase 277,777 shares
of
our common stock with an exercise price of $0.675 per share in December 2005,
a
warrant to purchase 277,777 shares of our common stock with an exercise price
of
$0.75 per share in February 2006 and a warrant to purchase 554,000 shares of
our
common stock with an exercise price of $1.30 per share in March 2006. These
warrants expire in December 2008, January 2009 and February 2009, respectively.
As of December 31, 2005, the Company had borrowed $500,000 under this note.
The
remaining $500,000 was borrowed by the Company in January 2006, and the entire
$1,000,000 remains outstanding. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
On
February 2, 2006, the Company entered into a Securities Purchase Agreement
with
Taurus, pursuant to which the Company issued 19,000 shares of the Company’s
newly created Series A Convertible Preferred Stock, $.001 par value (the “Series
A Preferred”). Each share of Series A Preferred has a stated value of $100.00.
The Company utilized the proceeds ($1,900,000) to repurchase shares of its
common stock from WHRT I Corp. (see above “Recent Acquisitions and
Divestiture”). The Series A Preferred has a cumulative annual dividend equal to
five percent (5%), which is payable semi-annually in cash or common stock,
at the election of the Company, and is convertible into shares of the Company’s
common stock at any time at a price equal to $0.50 per share (subject to adjustments
related to stock splits, reclassifications, combinations, dividends, change
of
control or the issuance of pari passu securities). In addition, the
Series A Preferred has no voting rights, but has liquidation preferences and
certain other privileges. All shares of Series A Preferred not previously
converted shall be redeemed by the Company, in cash or common stock, at the
election of Taurus, on February 1, 2011. Pursuant to the Securities Purchase
Agreement, Taurus was also granted a warrant to purchase 1,900,000 shares of
the
Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
related to stock splits, reclassifications, combinations, dividends, change
of
control or the issuance of pari passu securities), exercisable for a
period of five years.
See
chart
on page 58 in Liquidity and Capital Resources.
Laurus
In
August
2004, we replaced our $3.0
million line of credit with North Fork Bank with a revolving line of credit
with
Laurus Master Fund, Ltd. (“Laurus”), whereby we had access to borrow up to $6.0
million based upon eligible accounts receivable. A portion of Laurus’s revolving
line of credit was used to pay off all outstanding borrowings from North Fork
Bank. This revolving line, effectuated through a $2.0 million convertible
minimum borrowing note and a $4.0 million revolving note, provided for advances
at an advance rate of 90% against eligible accounts receivable, with an annual
interest rate of prime rate (as reported in the Wall Street Journal) plus 1%,
and matured in three years. We had no obligation to meet financial covenants
under the $2.0 million convertible minimum borrowing note or the $4.0 million
revolving note. This line of credit is secured by substantially all the
corporate assets. Both the $2.0 million convertible minimum borrowing note
and
the $4.0 million revolving note provided for conversion at the option of the
holder of the amounts outstanding into our common stock at a fixed conversion
price of $2.10 per share.
Additionally,
in exchange for a $5,000,000 secured convertible term note bearing interest
at
prime rate (as reported in the Wall Street Journal) plus 1%, Laurus had
established a $5.0 million account to be used only for acquisition targets
identified by us that were approved by Laurus in Laurus’ sole discretion. We had
no obligation to meet financial covenants under the $5.0 million secured
convertible term note. This note was convertible into our common stock at a
fixed conversion price of $2.10 per share. This note was to mature in three
years. We issued Laurus a common stock purchase warrant that provided Laurus
with the right to purchase 800,000 shares of our common stock. The exercise
price for the first 400,000 shares acquired under the warrant is $4.35 per
share, the exercise price for the next 200,000 shares acquired under the warrant
is $4.65 per share, and the exercise price for the final 200,000 shares acquired
under the warrant is $5.25 per share. The common stock purchase warrant expires
on August 15, 2011. We paid $0.75 million in brokerage and transaction closing
related costs. These costs were deducted from the $5.0 million restricted cash
balance being provided to us by Laurus.
In
May
2005, Laurus elected to convert $1,000,000 of debt underlying the minimum
borrowing note into the Company’s common stock. As a result of this conversion,
the Company obtained $1,000,000 of additional borrowing capacity under its
revolving line of credit and in return, issued 476,191 shares
of
Company common stock to Laurus.
In
July
2005, the Company entered into amendments of the notes dated August 16, 2004
between the Company and Laurus. Pursuant to the amendment, the Company released
$4,327,295 (the “Funds”) to Laurus, which was being held in the Restricted
Account (which was available to the Company for acquisitions) and issued an
amended and restated convertible note in the principal amount of $749,000.
In
satisfaction of the balance of the accrued interest and any liquidated damages
to which it was entitled pursuant the Registration Rights Agreement entered
into
in August 2004, the Company issued an option to purchase 333,334 shares of
the
Company’s common stock at a purchase price of $0.015 per share. Laurus fully
exercised this option to purchase Company stock on August 1, 2005. Laurus also
agreed to extend the required filing date and effective date of the Registration
Statement. For accounting purposes, the Company recorded this transaction as
an
early extinguishment of debt and recorded the remaining discount and liability
on gain or loss on the early extinguishment of debt.
The
Company also issued an amended and restated convertible secured revolving note
in the principal amount of $4.5 million in favor of Laurus which amended the
$4
million Revolving Note executed in August 2004. In connection with this note,
the Company and Laurus entered into an Overadvance Letter Agreement, pursuant
to
which Laurus made a loan to the Company in excess of the amount available using
the Company accounts receivable as collateral in the principal amount of $2.7
million. The Company utilized the $2.7 million which was advanced to it by
Laurus to acquire McKnight Associates, Inc., Integrated Strategies, Inc. and
ISI
Consulting, LLC. Except as noted above, all terms of the August 2004 agreements
continued to remain in effect.
On
November 30, 2005, the Company (i) amended and restated the convertible
term note in the principal amount of $749,000 by reducing the conversion rate
of
such note from $2.10 to $1.00, (ii) amended and restated the secured
revolving convertible note by increasing the principal amount available from
$4,500,000 to $5,500,000 and reducing the conversion rate from $2.10 to $1.00,
and (iii) amended and restated the secured convertible minimum borrowing
note in the principal amount of $2,000,000 by reducing the fixed conversion
price from $2.10 to $0.65.
On
February 1, 2006, the Company restructured its financing with Laurus again
by
entering into financing agreements with Laurus, pursuant to which it, among
other things, (a) issued a secured non-convertible term note in the principal
amount of $1,000,000 to Laurus (the “Term Note”), (b) issued a secured
non-convertible revolving note in the principal amount of $10,000,000 to Laurus
(the “Revolving Note”, collectively with the Term Note, the “Notes”), and (c)
issued an option to purchase up to 3,080,000 shares of the Company's common
stock to Laurus (the “Option”) at an exercise price of $.001 per share. The
proceeds from the issuance of the Notes were used to refinance the Company’s
outstanding obligations under the existing facility with Laurus (originally
entered into in August 2004 and subsequently amended in July 2005) at a 5%
premium. The Notes bear an annual interest rate of prime (as reported in the
Wall Street Journal, which was 7.25% as of January 31, 2006) plus 1.0%, with
a
floor of 5.0%. Payments of interest will be made in equal monthly amounts until
maturity of the Notes on December 31, 2007, at which time the 5% premium will
also be due. In addition, payments of principal on the Term Note will be made
in
equal monthly amounts until maturity of the Notes on December 31,
2007.
In
connection with the Notes, the Company and Laurus entered into an Overadvance
Letter Agreement, pursuant to which Laurus exercised its discretion granted
to
it pursuant to the Security Agreement entered into in August 2004 to make a
loan
to the Company in excess of the “Formula Amount” (as defined therein). The
Company also entered into a Stock Pledge Agreement and Security Agreement
securing its obligations to Laurus, both prior to and including the Notes,
as
well as a Registration Rights Agreement pursuant to which the Company agreed
to
file a registration statement to register the shares of the Company’s common
stock underlying the Option, as well as the shares of the Company’s common stock
and the shares of the Company’s common stock underlying the warrants held by
Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
809,525 shares of the Company’s common stock, an option to purchase up to
3,080,000 shares of the Company's common stock at an exercise price of $.001
per
share and warrants to purchase 400,000 shares of the Company’s common stock at
$4.35 per share, 200,000 shares of the Company’s common stock at $4.65 per share
and 200,000 shares of the Company’s common stock at $5.25 per share. Please see
Risk Factors for more information related to certain events of default related
to the Laurus transaction.
See
chart
on page 58 in Liquidity and Capital Resources.
Laidlaw/Sands
In
September 2004, we issued to Sands Brothers Venture Capital LLC, Sands Brothers
Venture Capital III LLC and Sands Brothers Venture Capital IV LLC (collectively,
“Sands”) three subordinated secured convertible promissory notes equaling $1.0
million (the “Notes”), each with an annual interest rate of 8% expiring
September 22, 2005. The Notes were secured by substantially all corporate
assets, subordinate to Laurus. The Notes are convertible into shares of our
common stock at the election of Sands at any time following the consummation
of
a convertible debt or equity financing with gross proceeds of $5.0 million
or
greater (a “Qualified Financing”). The conversion price of the shares of our
common stock issuable upon conversion of the Notes shall be equal to a price
per
share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. Since no Qualified
Financing had been consummated by September 8, 2005, Sands is entitled to elect
to convert the Notes at a fixed conversion price of $2.10 per share. In the
event that we issue stock or derivatives convertible into our stock for a price
less than the aforementioned fixed conversion price, then the fixed conversion
price is reset using a weighted average dilution calculation. We also issued
Sands three common stock purchase warrants (the “Warrants”) providing Sands with
the right to purchase 400,000 shares of our common stock. The exercise price
of
the shares of our common stock issuable upon exercise of the Warrants shall
be
equal to $2.10 or in the event of a Qualified Financing, a price per share
of
common stock equal to forty percent (40%) of the price of the securities issued
pursuant to such Qualified Financing. The latest that the Warrants may expire
is
September 8, 2008.
On
September 22, 2005, upon maturity of the September 2004 notes, the Company
issued to Sands three amended subordinated secured convertible promissory notes
equaling $1.08 million, each with an annual interest rate of 12% expiring on
January 1, 2007. The Company also issued Sands three common stock purchase
warrants (the “Additional Warrants”) providing Sands with the right to purchase
400,000 shares of the Company’s common stock. The exercise price of the shares
of the Company’s common stock issuable upon exercise of the Additional Warrants
shall be equal to a price per share of common stock equal to one hundred twenty
percent (120%) of the price of the securities issued pursuant to a Qualified
Financing. If no Qualified Financing has been consummated by December 15, 2006,
then Sands may elect to exercise the Additional Warrants at a fixed conversion
price of $2.10 per share. The latest that the Warrants may expire is December
15, 2009.
Other
On
November 8, 2004, we entered into a Stock Purchase Agreement (the “Agreement”)
with a private investor, CMKX-treme, Inc. Pursuant to the Agreement,
CMKX-treme, Inc. agreed to purchase 833,333 shares of common stock for a
purchase price of $1.75 million. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 238,095 shares of common stock for $0.5
million, and it was required to purchase the remaining 595,238 shares of Common
Stock for $1.25 million by December 31, 2004. As of March 17, 2005, CMKX-treme,
Inc. remitted final payment for the remaining 595,238 shares.
Clients
For
16
years, we have helped our clients develop strategies and implement technology
solutions to help them leverage corporate information.
Our
clients are primarily in the financial services, pharmaceutical, healthcare
and
telecommunications industries and are primarily located in the northeastern
United States. During the year ended December 31, 2005, two of our clients,
Leading Edge Communications Corporation, a related party, (13.4%) and Bank
of
America (27.2%), accounted collectively for approximately 40.6% of total
revenues. During the year ended December 31, 2004, two of our clients, Leading
Edge Communications Corporation, a related party, (16.1%) and Bank of America
(16.7%), accounted collectively for approximately 32.8% of total revenues.
As we
continue to pursue and consummate acquisitions, our dependence on these
customers should be less significant. We do not have long-term contracts with
any of these customers. The loss of any of our largest customers could have
a
material adverse effect on our business. We have not had any collections
problems with any of these customers to date.
Marketing
We
currently market our services through our internal marketing group, our external
public relations firm, and our sales force comprised of 14 employees. We also
receive new business opportunities through referrals from current clients,
strategic partners, independent industry analysts and industry associations.
We
are engaging in the following specific sales related programs and activities
to
expand our brand awareness and generate sales leads:
|
·
|
Advertising
and Sponsorships:
Through advertising and sponsorship programs within the leading industry
publications, we obtain new business leads and further increase our
brand
awareness. Throughout the year, we sponsor publications and newsletters
published by DM Review, The Business Intelligence Network, The Data
Warehousing Institute and iSix Sigma. Most of these sponsorships
include
web banner advertising and registration vehicles to promote CSI white
papers and best practices research.
|
|
·
|
Web
Site Promotion:
Our website (www.csiwhq.com)
provides a comprehensive view of our service offerings and promotes
our
subject matter expertise via white papers, articles and industry
presentations. We are currently promoting our website through internet
search engine advertising, direct marketing and through reciprocity
from
partner sites.
|
|
·
|
Trade
Show and Conference Participation:
Our participation in trade shows and conferences has further solidified
our position in our industry. There are a number of trade shows and
conferences within our target industry that provide significant exposure
to prospective customers, business and trade media and industry analysts,
as well as collaborative networking with technology partners. As
with most
trade show events, the higher the level of sponsorship, the greater
exposure and benefits received, such as the location of our booth,
banner
and advertising space, and position on the conference agenda. We
participated at the Shared Insights/DCI Data Warehousing and Business
Intelligence Conference with a sponsorship, exhibit and keynote
presentations (in San Diego in April 2005, Orlando in September 2005
and
in Chicago in February 2006). We are a partner member of The Data
Warehouse Institute (TDWI) and we sponsor and provide speakers for
several
of the conferences TDWI holds each year (in Baltimore in May 2005,
in
Orlando in October 2005 and upcoming in Chicago in May
2006).
|
|
·
|
Web
Seminars:
Participation in web seminars provides exposure to new sales prospects
and
affords us the opportunity to demonstrate our subject matter expertise.
We
sponsor approximately three web seminars annually, in addition to
participating as guest presenters at partner and vendor sponsored
web
seminars.
|
|
·
|
Thought
Leadership: We
continually demonstrate our thought leadership by writing and promoting
our white papers via our web site, the TDWI web site and through
direct
mail. Monthly articles by our consultants are published in DM Review,
on
The Business Intelligence Network Pharmaceutical Channel and the
iSix
Sigma financial services channel. We intend to continue and expand
all our
publishing activities, including blogs, by-line articles and expert
web
channels where our experts respond to end-user questions (searchCRM
and
searchDataManagement.com).
|
|
·
|
Sponsorships
of Vendor Marketing Activities:
We expect that joint marketing activities with leading software vendors
should also stimulate new business prospect generation. This
participation also enhances the market perception of CSI as experts
in
individual product areas by co-sponsoring and participating in vendor
marketing activities. We are invited to write white papers and articles
for vendors such as Microsoft, Teradata and Dataflux. We sponsor
and
present at the Annual User Conferences for Business Objects and Teradata,
as well as new product launch seminars with Business Objects and
Cognos.
|
|
·
|
Vendor
Relations:
We are continually identifying key vendor relationships. With the
ability
to leverage our 16 year history, we intend to continue to forge and
maintain relationships with technical, service and industry vendors.
We
have solidified and continue to develop strategic relationships with
technology vendors in the data warehousing and business intelligence
arena. These relationships designate our status as a systems integration
and/or reseller which authorizes us to provide consulting services
and to
resell select vendor software. We employ certified consultants in
our
vendor partner technology platforms. We maintain vendor independence
by
consistently evaluating the respective vendors’ technologies in our lab
located at our headquarters in East Hanover, New Jersey. We
regularly attend vendor partnership events, including partner summits
and
user group meetings, in support of our partnership programs. We currently
maintain relationships with the
following:
|
Database
Vendors:
|
IBM
- |
We
are an Indirect Passport Advantage Reseller Partner which enables
us to
resell IBM software products. We also employ consulting staff trained
and
certified in IBM technology.
|
|
Oracle
- |
We
are part of the Oracle Partner Program (OPP) as a Certified Solution
Provider (CSP). We also employ certified Oracle professionals and
our
partnership allows us to utilize Oracle support channels for technical
advisement.
|
|
Microsoft
-
|
We
are a Microsoft Certified Solution Provider. We maintain the required
number of Microsoft certified professionals to hold this
designation.
|
|
Sybase
- |
We
have a Systems Integration Agreement and employ professionals trained
in
the vendor’s technology.
|
Business
Intelligence Vendors:
|
Busines
Objects - |
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s technology. In
addition, we are a Certified Onsite Education Partner, which allows
us to
directly market and provide a certified training partner, which enables
us
to provide onsite training classes in the respective vendor
technology.
|
|
Cognos
- |
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
|
|
MicroStrategy
- |
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
|
|
Spotfire
- |
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
|
Data
Warehousing Vendors:
|
Informatica
- |
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
|
|
Ascential
Software
-
|
We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
|
|
Computer
Associates |
We
are an affiliate partner. We employ and maintain a staff of professionals
that are certified in the vendor’s technology.
|
|
·
|
Expanded
Direct Sales Activities:
We are continually updating and increasing our direct contact programs
for
lead generation, cross selling and up-selling. We conduct direct
sales
activities, such as e-mail and direct mail campaigns, telemarketing,
networking and attending partnership functions to generate leads
for
direct sales opportunities. In addition, we have developed a number
of
best practices service offerings which encompass selection, deployment,
implementation, maintenance and knowledge transfer. In some cases,
these
service offerings include methodologies and best practices for integrating
several vendor technology platforms resulting in cross selling and
up
selling opportunities when applicable.
|
Protection
Against Disclosure of Client Information
As
our
core business relates to the storage and use of client information, which is
often confidential, we have implemented policies to prevent client information
from being disclosed to unauthorized parties or used inappropriately. Our
employee handbook, of which every employee receives and acknowledges, mandates
that it is strictly prohibited for employees to disclose client information
to
third parties. Our handbook further mandates that disciplinary action be taken
against those who violate such policy, including possible termination. Our
outside consultants sign non-disclosure agreements prohibiting disclosure of
client information to third parties, among other things, and we perform
background checks on employees and outside consultants.
Intellectual
Property
The
trademarks “TECH SMART BUSINESS WISE”, “QUALITY MANAGEMENT OFFICE”, “QMO” and
DQXPRESS have been registered with the United States Patent and Trademark Office
(“USPTO”). Our trademark registration application for the mark DQROI is
presently pending before the USPTO. We use non-disclosure agreements with our
employees, independent contractors and clients to protect information which
we
believe are proprietary or constitute trade secrets.
Competition
To
our
knowledge, there are no publicly-traded competitors that focus solely on data
warehousing and business intelligence consulting and strategy. However, we
have
several competitors in the general marketplace, including data warehouse and
business intelligence practices within large international, national and
regional consulting and implementation firms, as well as smaller boutique
technology firms. Many
of
our competitors are large companies that have substantially greater market
presence, longer operating histories, more significant client bases, and
financial, technical, facilities, marketing, capital and other resources than
we
have. We
believe that we compete with these firms on the basis of the quality of our
services, industry reputation and price. We
believe our competitors include firms such as:
|
·
|
Cap
Gemini Ernst & Young
|
As
of
December 31, 2005, we had 37 outside consultants, 118 consultants on the payroll
and 44 non-consultant employees. Outside consultants are not our employees,
and
as such, do not receive benefits or have taxes withheld. These
consultants are members or employees of separate corporations, they are
responsible for providing us with a current certificate of insurance and they
are responsible for filing and payment of their own taxes. We maintain
relationships with these consultants and their status is updated in a
proprietary data base application that we have built. Consultants on the payroll
are our employees, billable to clients, and they have taxes withheld similar
to
other employees.
None
of
our employees are represented by a labor union or subject to a collective
bargaining agreement. We have never experienced a work stoppage and we believe
that our relations with employees are good.
Available
Information
We
file
annual, quarterly and current reports, proxy statements and other information
with the Securities and Exchange Commission (the “Commission”). You may read and
copy any document we file with the Commission at the Commission's public
reference rooms at 450 Fifth Street, N.W., Washington, D.C. 20549, 233 Broadway,
New York, New York 10279, and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Please call the Commission at 1-800-SEC-0330
for further information on the public reference rooms. Our Commission filings
are also available to the public from the Commission's Website at
"http://www.sec.gov." We make available free of charge our annual, quarterly
and
current reports, proxy statements and other information upon request. To request
such materials, please send a written request to Mitchell Peipert, our Chief
Financial Officer, at our address as set forth above or at (973)
560-9400.
We
maintain a Website at www.csiwhq.com (this is not a hyperlink, you must visit
this website through an internet browser). Our Website and the information
contained therein or connected thereto are not incorporated into this Annual
Report on Form 10-KSB.
SPECIAL
NOTE ON FORWARD LOOKING STATEMENTS
In
addition to historical information, this Annual Report on Form 10-KSB contains
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The forward-looking statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from those reflected in such forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in the sections entitled “Business”, “Risk Factors”, and
“Management’s Discussion and Analysis or Plan of Operation.” Readers are
cautioned not to place undue reliance on these forward-looking statements,
which
reflect management’s opinions only as of the date thereof. We undertake no
obligation to revise or publicly release the results of any revision of these
forward-looking statements. Readers should carefully review the risk
factors described in this Annual Report and in other documents that we file
from
time to time with the Securities and Exchange Commission.
In
some cases, you can identify forward-looking statements by terminology such
as
“may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,”
“estimates,” “predicts,” “potential,” “proposed,” “intended,” or “continue” or
the negative of these terms or other comparable terminology. You should read
statements that contain these words carefully, because they discuss our
expectations about our future operating results or our future financial
condition or state other “forward-looking” information. There may be events in
the future that we are not able to accurately predict or control. You should
be
aware that the occurrence of any of the events described in these risk factors
and elsewhere in this Annual Report could substantially harm our business,
results of operations and financial condition, and that upon the occurrence
of
any of these events, the trading price of our securities could decline. Although
we believe that the expectations reflected in the forward-looking statements
are
reasonable, we cannot guarantee future results, growth rates, levels of
activity, performance or achievements.
Except
as required by applicable law, including the securities laws of the United
States, we do not intend to update any of the forward-looking statements to
conform these statements to actual results. The following discussion should
be
read in conjunction with our financial statements and the related notes that
appear elsewhere in this report.
We
cannot give any guarantee that these plans, intentions or expectations will
be
achieved. All forward-looking statements involve risks and uncertainties, and
actual results may differ materially from those discussed in the forward-looking
statements as a result of various factors, including those factors described
in
the “Risk Factors” section of this Annual Report. Listed below and discussed
elsewhere in this Annual Report are some important risks, uncertainties and
contingencies that could cause our actual results, performances or achievements
to be materially different from the forward-looking statements included in
this
Annual Report. These risks, uncertainties and contingencies include, but are
not
limited to, the following:
|
·
|
our
ability to finance our operations on acceptable terms, either through
the
raising of capital, the incurrence of convertible or other indebtedness
or
through strategic financing
partnerships;
|
|
·
|
our ability to maintain the continued listing
standards of the American Stock
Exchange; |
|
·
|
our
ability to retain members of our management team and our
employees;
|
|
·
|
our
ability to retain existing clients or attract new
clients;
|
|
·
|
our
ability to adapt to the rapid technological change constantly occurring
in
the areas in which we provide
services
|
|
·
|
our
ability to offer pricing for services which is acceptable to clients;
|
|
·
|
the
competition that may arise in the future;
and
|
|
·
|
identifying
suitable acquisition candidates and integrating new
acquisitions.
|
The
foregoing does not represent an exhaustive list of risks. Please see “Risk
Factors” below for additional risks which could adversely impact our business
and financial performance. Moreover, new risks emerge from time to time and
it
is not possible for our management to predict all risks, nor can we assess
the
impact of all risks on our business or the extent to which any risk, or
combination of risks, may cause actual results to differ from those contained
in
any forward-looking statements. All forward-looking statements included in
this
Report are based on information available to us on the date of this Report.
Except to the extent required by applicable laws or rules, we undertake no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future events or otherwise. All subsequent
written and oral forward-looking statements attributable to us or persons acting
on our behalf are expressly qualified in their entirety by the cautionary
statements contained throughout this Report.
RISK
FACTORS
The
following factors should be considered carefully in evaluating the Company
and
its business:
Risks
Relating to Our Business
Because
we depend on a small number of key clients, non-recurring revenue and contracts
terminable on short notice, our business could be adversely affected if we
fail
to retain these clients and/or obtain new clients at a level sufficient to
support our operations and/or broaden our client base.
During
the year ended December 31, 2005, two of the Company’s clients, Leading Edge
Communications Corporation (LEC), a related party, and Bank of America,
accounted for approximately 13.4% and 27.2%, respectively, of total revenues.
During the year ended December 31, 2004, two of our clients, LEC and Bank of
America, accounted for approximately 16.1% and 16.7% of total revenues. Further,
the majority of our current assets consist of accounts receivable, and as of
December 31, 2005, one customer, LEC, accounted for 14% of our accounts
receivable balance. With the recent acquisition of new businesses and our
objective of acquiring more over the next year, we believe that our reliance
on
these clients will continue to decline in the future. The
loss
of any of our largest clients could have a material adverse effect on our
business. In addition, our contracts provide that our services are terminable
upon short notice, typically not more than 30 days. Non-renewal or termination
of contracts with these or other clients without adequate replacements could
have a material and adverse effect upon our business. In addition, a large
portion of our revenues are derived from information technology consulting
services that are generally non-recurring in nature. There can be no assurance
that we will:
|
·
|
obtain
additional contracts for projects similar in scope to those previously
obtained from our clients;
|
|
· |
be
able to retain existing clients or attract new
clients;
|
|
· |
provide
services in a manner acceptable to
clients;
|
|
· |
offer
pricing for services which is acceptable to clients;
or
|
|
·
|
broaden
our client base so that we will not remain largely dependent upon
a
limited number of clients that
will continue to account for a substantial portion of our
revenues.
|
Our
internal controls and procedures have been materially deficient, and we are
in
the process of correcting internal control deficiencies.
In
the
first quarter of 2005, resulting from comments related to the Company’s
Registration Statement on Form SB-2/A, the Company and its independent
registered public accounting firm recognized that our internal controls had
material weaknesses. In April 2005, we restated our results of operations for
the Company's quarterly results for the quarters ended March 31, 2004, June
30,
2004 and September 30, 2004 related primarily to our purchase accounting for
two
acquisitions completed in 2004. In November 2005, resulting from discussions
with the Staff of the SEC, we restated our results of operations for the
Company's quarterly results for the quarters ended June 30, 2004, September
30,
2004 and March 31, 2005, and for the year ended December 31, 2004 primarily
as a
result of revised accounting treatment related to the our issuance of financial
instruments in 2004 and to properly record the loss resulting from the fair
value adjustment of the financial instruments. Finally, with this filing,
resulting from discussions with the Staff of the SEC, we restated the
manner in which we recorded and accounted for the beneficial conversion feature
associated with convertible notes issued in 2004 in our
results of operations for the Company's quarterly results for the quarters
ended
September 30, 2004, March 31, 2005, June 30, 2005 and September 30, 2005, and
for the year ended December 31, 2004. As
a
result of this latest restatement, we were unable to file this Form 10-KSB
in a
timely fashion. Further restatements could cause us to miss our filing deadlines
in the future, which could bring us out of compliance
with the continued listing standards of the American Stock Exchange and/or
cause
us to default on certain of our financing arrangements, which would have a
material adverse effect on our business.
If
we
cannot rectify these material weaknesses through remedial measures and
improvements to our systems and procedures, management may encounter
difficulties in timely assessing business performance and identifying incipient
strategic and oversight issues. Management is currently focused on remedying
internal control deficiencies, and this focus will require management from
time
to time to devote its attention away from other planning, oversight and
performance functions.
We
cannot
provide assurances as to the timing of the completion of these efforts. We
cannot be certain that the measures we take will ensure that we implement and
maintain adequate internal controls in the future. Any failure to implement
required new or improved controls, or difficulties encountered in their
implementation, could harm our operating results or cause us to fail to meet
our
reporting obligations.
The
Company may have liability in connection with its recent securities
offerings.
We
have
completed various financings through the issuance of our common stock, as well
as the issuance of notes and warrants convertible into our common stock, while
a
Registration Statement on Form SB-2 was on file with the SEC but had not yet
been declared effective (those transactions were with certain investors of
Taurus Advisory Group, LLC, Laurus Master Fund, Ltd. and three entities
affiliated with Sands Brothers International Limited). We also issued our common
stock in connection with the acquisition of substantially all the assets of
Evoke Software Corporation during this time (we subsequently sold such assets
in
July 2005). Even though all stockholders, noteholders and warrantholders have
been advised of their rights to rescind those financing transactions and they
each have waived their rights to rescind those transactions, there is a remote
possibility that each of those transactions could be reversed and the
consideration received by us may have to be repaid. In such an event, our
business could be adversely affected and we may have an obligation to fund
such
rescissions.
Certain
client-related complications may materially adversely affect our
business.
We
may be
subject to additional risks relating to our clients that could materially
adversely affect our business, such as delays in clients paying their
outstanding invoices, lengthy client review processes for awarding contracts,
delay, termination, reduction or modification of contracts in the event of
changes in client policies or as a result of budgetary constraints, and/or
increased or unexpected costs resulting in losses under fixed-fee contracts,
which factors could also adversely affect our business.
We
have a history of losses and we could incur losses in the
future.
During
the fiscal years ended December 31, 2005 and December 31, 2004, we sustained
operating losses and cannot be sure that we will operate profitably in the
future. During the fiscal year ended December 31, 2005, we reported a net loss
in the approximate amount of ($4.5 million). The Company recorded a ($6.1
million) loss from operating activities for the fiscal year ended December
31,
2005. During the fiscal year ended December 31, 2004, we sustained a net loss
in
the approximate amount of ($35.3 million). The Company recorded a ($17.0
million) loss from operating activities for the fiscal year ended December
31,
2004, of which $12.2 million of the loss resulted from impairment of goodwill
and intangibles for the year ended December 31, 2004. If we do not become
profitable, we could have difficulty obtaining funds to continue our operations.
We have incurred net losses since our merger with LCS Group, Inc. We may
continue to generate losses from the ongoing business prior to returning the
Company to profitability.
We
have a significant amount of debt, which, in the event of a default, could
have
material adverse consequences upon us.
Our
total
debt as of March 31, 2006 is approximately $15.0 million. The degree to which
we
are leveraged could have important consequences to us, including the
following:
|
· |
A
portion of our cash flow must be used to pay interest on our indebtedness,
and therefore is not available for use in our
business;
|
|
· |
Our
indebtedness increases our vulnerability to changes in general economic
and industry conditions;
|
|
· |
Our
ability to obtain additional financing for working capital, capital
expenditures, general corporate purposes or other purposes could
be
impaired;
|
|
· |
Our
failure to comply with restrictions contained in the terms of our
borrowings could lead to a default which could cause all or a significant
portion of our debt to become immediately payable;
and
|
|
· |
If
we default, the loans will become due and we may not have the funds
to
repay the loans, and we could discontinue our business and investors
could
lose all their money.
|
In
addition, certain terms of such loans require the prior consent of Laurus Master
Fund, Ltd. on many corporate actions including, but not limited to, mergers
and
acquisitions—which is part of our ongoing business strategy.
If
an event of default occurs under our notes with Laurus, it could seriously
harm
our operations.
On
February 1, 2006, we issued two separate secured non-convertible term notes
to
Laurus in the amounts of up to $10 million and $1 million respectively. The
note
and related agreements contain several events of default which include:
|
·
|
failure
to pay interest, principal payments or other fees when
due;
|
|
·
|
failure
to pay taxes when due unless such taxes are being contested in good
faith;
|
|
·
|
breach
by us of any material covenant or term or condition of the notes
or any
agreements made in connection
therewith;
|
|
·
|
default
on any indebtedness to which we or our subsidiaries are a
party;
|
|
·
|
breach
by us of any material representation or warranty made in the notes
or in
any agreements made in connection
therewith;
|
|
·
|
attachment
is made or levy upon collateral securing the Laurus debt which is
valued
at more than $150,000 and is not timely
mitigated.
|
|
·
|
any
lien created under the notes and agreements is not valid and perfected
having a first priority interest;
|
|
·
|
assignment
for the benefit of our creditors, or a receiver or trustee is appointed
for us;
|
|
·
|
bankruptcy
or insolvency proceeding instituted by or against us and not dismissed
within 30 days;
|
|
·
|
the
inability to pay debts as they become due or cease business
operations;
|
|
·
|
sale,
assignment, transfer or conveyance of any assets except as
permitted;
|
|
·
|
a
person or group becomes beneficial owner of 35% on fully diluted
basis of
the outstanding voting equity interest or the present directors cease
to
be the majority on the Board of
Directors;
|
|
·
|
indictment
or threatened criminal indictment, or commencement of threatened
commencement of any criminal or civil proceeding against the Company
or
any executive officer; and
|
|
·
|
common
stock suspension for five consecutive days or five days during any
10
consecutive days from a principal market, provided that we are unable
to
cure such suspension within 30 days or list our common stock on another
principal market within 60 days.
|
If
we
default on the notes and the holder demands all payments due and payable, the
cash required to pay such amounts would most likely come out of working capital,
which may not be sufficient to repay the amounts due. The default payment shall
be 115% of the outstanding principal amount of the note, plus accrued but unpaid
interest, all other fees then remaining unpaid, and all other amounts payable
thereunder. In addition, since we rely on our working capital for our day to
day
operations, such a default on the note could materially adversely affect our
business, operating results or financial condition to such extent that we are
forced to restructure, file for bankruptcy, sell assets or cease operations.
Further, our obligations under the notes are secured by substantially all of
our
assets. Failure to fulfill our obligations under the notes and related
agreements could lead to loss of these assets, which would be detrimental to
our
operations.
Our
operating results are difficult to forecast.
We
may
increase our general and administrative expenses in the event that we increase
our business and/or acquire other businesses, while our operating expenses
for
sales and marketing and costs of services for technical personnel to provide
and
support our services also increases. Additionally, although most of our clients
are large, creditworthy entities, at any given point in time, we may have
significant accounts receivable balances with clients that expose us to credit
risks if such clients either delay or elect not to pay or are unable to pay
such
obligations. If we have an unexpected shortfall in revenues in relation to
our
expenses, or significant bad debt experience, our business could be materially
and adversely affected.
Our
profitability, if any, will suffer if we are not able to retain
existing clients or attract new clients. A continuation of current pricing
pressures could result in permanent changes in pricing policies and delivery
capabilities.
Our
gross
profit margin is largely a function of the rates we are able to charge for
our
information technology services. Accordingly, if we are not able to maintain
the
pricing for our services or an appropriate utilization of our professionals
without corresponding cost reductions, our margins will suffer. The rates we
are
able to charge for our services are affected by a number of factors,
including:
|
· |
our
clients’ perceptions of our ability to add value through our
services;
|
|
· |
pricing
policies of our competitors;
|
|
· |
our
ability to accurately estimate, attain and sustain engagement revenues,
margins and cash flows over increasingly longer contract
periods;
|
|
· |
the
use of globally sourced, lower-cost service delivery capabilities
by our
competitors and our clients; and
|
|
· |
general
economic and political conditions.
|
Our
gross
margins are also a function of our ability to control our costs and improve
our
efficiency. If the continuation of current pricing pressures persists it could
result in permanent changes in pricing policies and delivery capabilities and
we
must continuously improve our management of costs.
Unexpected
costs or delays could make our contracts unprofitable.
In
the
future, we may have many types of contracts, including time-and-materials
contracts, fixed-price contracts and contracts with features of both of these
contract types. Any increased or unexpected costs or unanticipated delays in
connection with the performance of these engagements, including delays caused
by
factors outside our control, could make these contracts less profitable or
unprofitable, which would have an adverse effect on all of our margins and
potential net income.
Our
business could be adversely affected if we fail to adapt to emerging and
evolving markets.
The
markets for our services are changing rapidly and evolving and, therefore,
the
ultimate level of demand for our services is subject to substantial uncertainty.
Most of our historic revenue was generated from providing information technology
services only. During the last several years, we have focused our efforts on
providing data warehousing services in particular since we believe that there
is
going to be an increased need in this area. Any significant decline in demand
for programming, applications development, information technology or data
warehousing consulting services could materially and adversely affect our
business and prospects.
Our
ability to achieve growth targets is dependent in part on maintaining existing
clients and continually attracting and retaining new clients to replace those
who have not renewed their contracts. Our ability to achieve market acceptance,
including for data warehousing, will require substantial efforts and
expenditures on our part to create awareness of our services.
If
we should experience rapid growth, such growth could strain our managerial
and
operational resources, which could adversely affect our
business.
Any
rapid
growth that we may experience would most likely place a significant strain
on
our managerial and operational resources. If we continue to acquire other
companies, we will be required to manage multiple relationships with various
clients, strategic partners and other third parties. Further growth (organic
or
by acquisition) or an increase in the number of strategic relationships may
increase this strain on existing managerial and operational resources,
inhibiting our ability to achieve the rapid execution necessary to implement
our
growth strategy without incurring additional corporate expenses.
Lack
of detailed written contracts could impair our ability to collect fees, protect
our intellectual property and protect ourselves from liability to
others.
We
try to
protect ourselves by entering into detailed written contracts with our clients
covering the terms and contingencies of the client engagement. In some cases,
however, consistent with what we believe to be industry practice, work is
performed for clients on the basis of a limited statement of work or verbal
agreements before a detailed written contact can be finalized. To the extent
that we fail to have detailed written contracts in place, our ability to collect
fees, protect our intellectual property and protect ourselves from liability
from others may be impaired.
Failure
to achieve and maintain effective internal controls in accordance with Section
404 of the Sarbanes-Oxley Act could have a material adverse effect on our
business and operating results. In addition, current and potential stockholders
could lose confidence in our financial reporting, which could have a material
adverse effect on our stock price.
Effective
internal controls are necessary for us to provide reliable financial reports
and
effectively prevent fraud. If we cannot provide reliable financial reports
or
prevent fraud, our operating results could be harmed.
Commencing
in July 2007, we will be required to document and test our internal control
procedures in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting and a report
by
our independent registered public accounting firm addressing these assessments.
During the course of our testing, we may identify deficiencies which we may
not
be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley
Act for compliance with the requirements of Section 404. In addition, if we
fail
to maintain the adequacy of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal
control environment could also cause investors to lose confidence in our
reported financial information, which could have a material adverse effect
on
our stock price.
Compliance
with changing regulation of corporate governance and public disclosure may
result in additional expenses.
Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
exchange rules (although not, as of the date of this Annual Report, applicable
to us), are creating uncertainty for companies such as ours. These new or
changed laws, regulations and standards are subject to varying interpretations
in many cases due to their lack of specificity, and as a result, their
application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies, which could result in continuing uncertainty
regarding compliance matters and higher costs necessitated by ongoing revisions
to disclosure and governance practices. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities. In particular, our
efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the
related regulations regarding our required assessment of our internal controls
over financial reporting and our independent registered public accounting firm's
audit of that assessment will require the commitment of significant financial
and managerial resources. Further, our board members, chief executive officer
and chief financial officer could face an increased risk of personal liability
in connection with the performance of their duties. As a result, we may have
difficulty attracting and retaining qualified board members and executive
officers, which could harm our business. If our efforts to comply with new
or
changed laws, regulations and standards differ from the activities intended
by
regulatory or governing bodies due to ambiguities related to practice, our
reputation may be harmed.
We
face intense competition and our failure to meet this competition could
adversely affect our business.
Competition
for our information technology consulting services, including data warehousing,
is significant and we expect that this competition will continue to intensify
due to the low barriers to entry. We may not have the financial resources,
technical expertise, sales and marketing or support capabilities to adequately
meet this competition. We compete against numerous large companies, including,
among others, multi-national and other major consulting firms. These firms
have
substantially greater market presence, longer operating histories, more
significant client bases and greater financial, technical, facilities,
marketing, capital and other resources than we have. If we are unable to compete
against such competitors, our business will be adversely affected.
Our
competitors may respond more quickly than us to new or emerging technologies
and
changes in client requirements. Our competitors may also devote greater
resources than we can to the development, promotion and sales of our services.
If one or more of our competitors develops and implements methodologies that
result in superior productivity and price reductions without adversely affecting
their profit margins, our business could suffer. Competitors may
also:
|
· |
engage
in more extensive research and
development;
|
|
· |
undertake
more extensive marketing campaigns;
|
|
· |
adopt
more aggressive pricing policies;
and
|
|
· |
make
more attractive offers to our existing and potential employees and
strategic partners.
|
In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties that could
be
detrimental to our business.
New
competitors, including large computer hardware, software, professional services
and other technology companies, may enter our markets and rapidly acquire
significant market share. As a result of increased competition and vertical
and
horizontal integration in the industry, we could encounter significant pricing
pressures. These pricing pressures could result in substantially lower average
selling prices for our services. We may not be able to offset the effects of
any
price reductions with an increase in the number of clients, higher revenue
from
consulting services, cost reductions or otherwise. In addition, professional
services businesses are likely to encounter consolidation in the near future,
which could result in decreased pricing and other competition.
If
we fail to adapt to the rapid technological change constantly occurring in
the
areas in which we provide services, including data warehousing, our business
could be adversely affected.
The
market for information technology consulting services and data warehousing
is
rapidly evolving. Significant technological changes could render our existing
services obsolete. We must adapt to this rapidly changing market by continually
improving the responsiveness, functionality and features of our services to
meet
clients’ needs. If we are unable to respond to technological advances and
conform to emerging industry standards in a cost-effective and timely manner,
our business could be materially and adversely affected.
We
depend on our management. If we fail to retain key personnel, our business
could
be adversely affected.
There
is
intense competition for qualified personnel in the areas in which we operate.
The loss of existing personnel or the failure to recruit additional qualified
managerial, technical and sales personnel, as well as expenses in connection
with hiring and retaining personnel, particularly in the emerging area of data
warehousing, could adversely affect our business. We also depend upon the
performance of our executive officers and key employees in particular, Messrs.
Scott Newman, Glenn Peipert and Robert C. DeLeeuw. Although we have entered
into
employment agreements with Messrs. Newman, Peipert and DeLeeuw, the loss of
any
of these individuals could have a material adverse effect upon us. In addition,
we have not obtained “key man” life insurance on the lives of Messrs. Newman,
Peipert or DeLeeuw.
We
will
need to attract, train and retain more employees for management, engineering,
programming, sales and marketing, and client service and support positions.
As
noted above, competition for qualified employees, particularly engineers,
programmers and consultants, continues to be intense. Consequently, we may
not
be able to attract, train and retain the personnel we need to continue to offer
solutions and services to current and future clients in a cost effective manner,
if at all.
If
we fail to raise capital that we may need to support and increase our
operations, our business could be adversely affected.
Our
future capital uses and requirements will depend on several factors,
including:
|
· |
the
extent to which our solutions and services gain market
acceptance;
|
|
· |
the
level of revenues from current and future solutions and
services;
|
|
· |
the
expansion of operations;
|
|
·
|
the
costs and timing of product and service developments and sales and
marketing activities;
|
|
· |
the
costs related to acquisitions of technology or businesses;
and
|
|
· |
competitive
developments.
|
We
may
require additional capital in order to continue to support and increase our
sales and marketing efforts, continue to expand and enhance the solutions and
services we are able to offer to current and future clients and fund potential
acquisitions. This capital may not be available on terms acceptable to us,
if at
all. In addition, we may be required to spend greater-than-anticipated funds
if
unforeseen difficulties arise in the course of these or other aspects of our
business. As a consequence, we will be required to raise additional capital
through public or private equity or debt financings, collaborative
relationships, bank facilities or other arrangements. We cannot assure you
that
such additional capital will be available on terms acceptable to us, if at
all.
Further, if we raise capital though an equity or debt financing at reduced
exercise or conversion price, it could trigger certain anti-dilution provisions
with other investors. Any additional equity financing is expected to be dilutive
to our stockholders, and debt financing, if available, may involve restrictive
covenants and increased interest costs. Our inability to obtain sufficient
financing may require us to delay, scale back or eliminate some or all of our
expansion programs or to limit the marketing of our services. This could have
a
material and adverse effect on our business.
We
could have potential liability for
intellectual property infringement, personal injury, property damage or breach
of contract to our clients that could adversely affect our
business.
Our
services involve development and implementation of computer systems and computer
software that are critical to the operations of our clients’ businesses. If we
fail or are unable to satisfy a client’s expectations in the performance of our
services, our business reputation could be harmed or we could be subject to
a
claim for substantial damages, regardless of our responsibility for such failure
or inability. In addition, in the course of performing services, our personnel
often gain access to technologies and content which include confidential or
proprietary client information.
Although
we have implemented policies to prevent such client information from being
disclosed to unauthorized parties or used inappropriately, any such unauthorized
disclosure or use could result in a claim for substantial damages. Our business
could be adversely affected if one or more large claims are asserted against
us
that are uninsured, exceed available insurance coverage or result in changes
to
our insurance policies, including premium increases or the imposition of large
deductible or co-insurance requirements. Although we maintain general liability
insurance coverage, including coverage for errors and omissions, there can
be no
assurance that such coverage will continue to be available on reasonable terms
or will be available in sufficient amounts to cover one or more large
claims.
We
do not intend to pay dividends on shares of our common stock in the foreseeable
future.
We
have
never paid cash dividends on our common stock other than distributions resulting
from our past tax status as a Subchapter S corporation. Our current Board of
Directors does not anticipate that we will pay cash dividends in the foreseeable
future. Instead, we intend to retain future earnings for reinvestment in our
business and/or to fund future acquisitions. In addition, the security agreement
with Laurus Master Fund, Ltd. requires that we obtain their consent prior to
paying any dividends on our common stock.
Our
management group owns or controls a significant number of the outstanding shares
of our common stock and will continue to have significant ownership of our
voting securities for the foreseeable future.
Scott
Newman and Glenn Peipert, our principal stockholders and our executive officers
and two of our directors, beneficially own approximately 39.2% and 18.7%,
respectively, of our outstanding common stock. Robert C. DeLeeuw, our Senior
Vice President and President of our wholly owned subsidiary, DeLeeuw Associates,
LLC, owns approximately 10.7% of our outstanding common stock. As a result,
these persons will have the ability, acting as a group, to effectively control
our affairs and business, including the election of directors and subject to
certain limitations, approval or preclusion of fundamental corporate
transactions. This concentration of ownership of our common stock
may:
|
· |
delay
or prevent a change in the control;
|
|
·
|
impede
a merger, consolidation, takeover or other transaction involving
us;
or
|
|
·
|
discourage
a potential acquirer from making a tender offer or otherwise attempting
to
obtain control of us.
|
The
authorization and issuance of “blank check” preferred stock could have an
anti-takeover effect detrimental to the interests of our
stockholders.
Our
certificate of incorporation allows the Board of Directors to issue 20,000,000
shares of preferred stock with rights and preferences set by our board without
further stockholder approval. The issuance of shares of this “blank check
preferred” under particular circumstances could have an anti-takeover effect.
For example, in the event of a hostile takeover attempt, it may be possible
for
management and the board to endeavor to impede the attempt by issuing shares
of
blank check preferred, thereby diluting or impairing the voting power of the
other outstanding shares of common stock and increasing the potential costs
to
acquire control of us. Our Board of Directors has the right to issue blank
check
preferred without first offering them to holders of our common stock, as the
holders of our common stock have no preemptive rights. To date, the Company
has
issued 19,000 shares of Series A Convertible Preferred Stock to Taurus Advisory
Group, LLC.
Our
services or solutions may infringe upon the intellectual property rights of
others.
We
cannot
be sure that our services and solutions, or the solutions of others that we
offer to our clients, do not infringe on the intellectual property rights of
third parties, and we may have infringement claims asserted against us or
against our clients. These claims may harm our reputation, cost us money and
prevent us from offering some services or solutions. In some instances, the
amount of these expenses may be greater than the revenues we receive from the
client. Any claims or litigation in this area, whether we ultimately win or
lose, could be time-consuming and costly, injure our reputation or require
us to
enter into royalty or licensing arrangements. We may not be able to enter into
these royalty or licensing arrangements on acceptable terms. To the best of
our
knowledge, we have never infringed upon the intellectual property rights of
another individual or entity.
We
could be subject to systems failures that could adversely affect our
business.
Our
business depends on the efficient and uninterrupted operation of our computer
and communications hardware systems and infrastructure. We currently maintain
our computer systems in our facilities at our offices in New Jersey and
elsewhere. We
do not
have complete
redundancy in our systems and therefore any damage or destruction to our systems
would significantly harm our business.
Although
we have taken precautions against systems failure, interruptions could result
from natural disasters as well as power losses, telecommunications failures
and
similar events. Our
systems are also subject to human error, security breaches, computer viruses,
break-ins, “denial of service” attacks, sabotage, intentional acts of vandalism
and tampering designed to disrupt our computer systems. We
also
lease telecommunications lines from local and regional carriers, whose service
may be interrupted. Any damage or failure that interrupts or delays network
operations could materially and adversely affect our business.
Our
business could be adversely affected if we fail to adequately address security
issues.
We
have
taken measures to protect the integrity of our technology infrastructure and
the
privacy of confidential information. Nonetheless, our technology infrastructure
is potentially vulnerable to physical or electronic break-ins, viruses or
similar problems. If a person or entity circumvents its security measures,
they
could jeopardize the security of confidential information stored on our systems,
misappropriate proprietary information or cause interruptions in our operations.
We may be required to make substantial additional investments and efforts to
protect against or remedy security breaches. Security breaches that result
in
access to confidential information could damage our reputation and expose us
to
a risk of loss or liability.
Risks
Relating To Acquisitions
We
face intense competition for acquisition candidates, and we may have limited
cash available for such acquisitions.
There
is
a high degree of competition among companies seeking to acquire interests in
information technology service companies such as those we may target for
acquisition. We are expected to continue to be an active participant in the
business of seeking business relationships with, and acquisitions of interests
in, such companies. A large number of established and well-financed entities,
including venture capital firms, are active in acquiring interests in companies
that we may find to be desirable acquisition candidates. Many of these
investment-oriented entities have significantly greater financial resources,
technical expertise and managerial capabilities than we do. Consequently, we
may
be at a competitive disadvantage in negotiating and executing possible
investments in these entities as many competitors generally have easier access
to capital, on which entrepreneur-founders of privately-held information
technology service companies generally place greater emphasis than obtaining
the
management skills and networking services that we can provide. Even if we are
able to compete with these venture capital entities, this competition may affect
the terms and conditions of potential acquisitions and, as a result, we may
pay
more than expected for targeted acquisitions. If we cannot acquire interests
in
attractive companies on reasonable terms, our strategy to build our business
through acquisitions may be inhibited.
We
will encounter difficulties in identifying suitable acquisition candidates
and
integrating new acquisitions.
A
key
element of our expansion strategy is to grow through acquisitions. If we
identify suitable candidates, we may not be able to make investments or
acquisitions on commercially acceptable terms. Acquisitions may cause a
disruption in our ongoing business, distract management, require other resources
and make it difficult to maintain our standards, controls and procedures. We
may
not be able to retain key employees of the acquired companies or maintain good
relations with their clients or suppliers. We may be required to incur
additional debt and to issue equity securities, which may be dilutive to
existing stockholders, to effect and/or fund acquisitions.
We
cannot assure you that any acquisitions we make will enhance our
business.
We
cannot
assure you that any completed acquisition will enhance our business. Since
we
anticipate that acquisitions could be made with both cash and our common stock,
if we consummate one or more significant acquisitions, the potential impacts
are:
|
· |
a
substantial portion of our available cash could be used to consummate
the
acquisitions and/or we could incur or assume significant amounts
of
indebtedness;
|
|
· |
losses
resulting from the on-going operations of these acquisitions could
adversely affect our cash flow; and
|
|
· |
our
stockholders could suffer significant dilution of their interest
in our
common stock.
|
Also,
we
are required to account for acquisitions under the purchase method, which would
likely result in our recording significant amounts of goodwill. The inability
of
a subsidiary to sustain profitability may result in an impairment loss in the
value of long-lived assets, principally goodwill and other tangible and
intangible assets, which would adversely affect our financial statements.
Additionally, we could choose to divest any acquisition that is not
profitable.
Risks
Relating To Our Common Stock
Our
relationship with our majority stockholders presents potential conflicts
of
interest, which may result in decisions that favor them over our other
stockholders.
Our
principal beneficial owners, Scott Newman, Glenn Peipert and Robert C. DeLeeuw,
provide management and financial assistance to us. When their personal
investment interests diverge from our interests, they and their affiliates
may
exercise their influence in their own best interests. Some decisions concerning
our operations or finances may present conflicts of interest between us and
these stockholders and their affiliated entities.
The
limited prior public market and trading market may cause possible volatility
in
our stock price.
There
has
only been a limited public market for our securities and there can be no
assurance that an active trading market in our securities will be maintained.
In
addition, the overall market for securities in recent years has experienced
extreme price and volume fluctuations that have particularly affected the market
prices of many smaller companies. The trading price of our common stock is
expected to be subject to significant fluctuations including, but not limited
to, the following:
|
·
|
quarterly
variations in operating results and achievement of key business
metrics;
|
|
· |
changes
in earnings estimates by securities analysts, if
any;
|
|
·
|
any
differences between reported results and securities analysts’ published or
unpublished expectations;
|
|
·
|
announcements
of new contracts or service offerings by us or our
competitors;
|
|
·
|
market
reaction to any acquisitions, divestitures, joint ventures or strategic
investments announced by us or our
competitors;
|
|
· |
demand
for our services and products;
|
|
· |
shares
being sold pursuant to Rule 144 or upon exercise of warrants;
and
|
|
· |
general
economic or stock market conditions unrelated to our operating
performance.
|
These
fluctuations, as well as general economic and market conditions, may have a
material or adverse effect on the market price of our common stock.
We
may be de-listed from the AMEX if we do not meet continued listing
requirements.
Our
common stock commenced trading on the AMEX on September 21, 2005. The AMEX
(Part
10, Section 1003) requires stockholders’ equity (for continued listing) of at
least $2.0 million if a listed company has sustained net losses in its five
most
recent fiscal years. As of December 31, 2005, our stockholders’ equity was
approximately $2.3 million. However, Section 1003 includes an exception to
such
requirement. Specifically, AMEX will not normally consider suspending a listed
company if the company (i) has a total market capitalization of at least $50
million; or total assets and revenue of $50 million each in its last fiscal
year, or in two of its last three fiscal years; and (ii) the Company has at
least 1.1 million shares publicly held, a market value of publicly held shares
of at least $15 million and 400 round lot stockholders. The Company currently
meets such exception as well, however there can be no assurance that it will
continue to do so, nor that AMEX will not consider the commencement of
suspending or removing the Company’s listing on the AMEX.
As
a
result of failing to file this Form 10-KSB in a timely fashion, the Company
failed to meet the continued listing requirements of the American Stock Exchange
from its due date on April 17, 2006 until the date of this filing. In the
future, if we fail to timely file our required reports, we could be subject
to
delisting.
If
our
common stock is de-listed by the AMEX, trading of our common stock would
thereafter likely be conducted on the OTC Bulletin Board. In such case, the
market liquidity for our common stock would likely be negatively affected,
which
may make it more difficult for holders of our common stock to sell their
securities in the open market and we could face difficulty raising capital
necessary for our continued operations.
Additional
authorized shares of our common stock and preferred stock available for issuance
may adversely affect the market.
We
are
authorized to issue 85 million shares of our common stock. As of March
31,
2006,
there were 49,997,834
shares
of
common stock issued and outstanding. However, the total number of shares of
our
common stock issued and outstanding does not include shares reserved in
anticipation of the conversion of notes or the exercise of options or warrants.
As of March
31,
2006,
we had 1,784,127
shares
of
common stock underlying convertible notes, and we have reserved shares of our
common stock for issuance in connection with the potential conversion thereof.
As of March
31,
2006,
we had outstanding stock options and warrants to purchase approximately
10,507,113
shares
of
our common stock, the exercise price of which range between $0.46 and $5.25
per
share, and we have reserved shares of our common stock for issuance in
connection with the potential exercise thereof. Of the reserved shares, a total
of 6,666,667
shares
are currently reserved for issuance in connection with our 2003 Incentive Plan,
of which options to purchase approximately 5,619,781 shares
have been issued under the plan as of March 31, 2006. A significant number
of
such options and warrants contain provisions for broker-assisted exercise.
To
the extent such options or warrants are exercised, the holders of our common
stock will experience further dilution. In addition, in the event that any
future financing should be in the form of, be convertible into or exchangeable
for, equity securities, and upon the exercise of options and warrants, investors
may experience additional dilution.
The
exercise of the outstanding convertible securities will reduce the percentage
of
common stock held by our stockholders. Further, the terms on which we could
obtain additional capital during the life of the convertible securities may
be
adversely affected, and it should be expected that the holders of the
convertible securities would exercise them at a time when we would be able
to
obtain equity capital on terms more favorable than those provided for by such
convertible securities. As a result, any issuance of additional shares of common
stock may cause our current stockholders to suffer significant dilution which
may adversely affect the market.
In
addition to the above-referenced shares of common stock which may be issued
without stockholder approval, we have 20
million shares
of
authorized preferred stock, the terms of which may be fixed by our Board of
Directors. To
date,
the Company has issued 19,000 shares of Series A Convertible Preferred Stock
to
Taurus Advisory Group LLC. While we
presently have no present plans to issue any more additional shares of preferred
stock, our Board of Directors has the authority, without stockholder approval,
to create and issue one or more series of such preferred stock and to determine
the voting, dividend and other rights of holders of such preferred stock. The
issuance of any of such series of preferred stock may have an adverse effect
on
the holders of common stock.
Shares
eligible for future sale may adversely affect the market.
From
time
to time, certain of our stockholders may be eligible to sell all or some of
their shares of common stock by means of ordinary brokerage transactions in
the
open market pursuant to Rule 144, promulgated under the Securities Act of 1933
(Securities Act), subject to certain limitations. In general, pursuant to Rule
144, a stockholder (or stockholders whose shares are aggregated) who has
satisfied a one-year holding period may, under certain circumstances, sell
within any three-month period a number of securities which does not exceed
the
greater of 1% of the then outstanding shares of common stock or the average
weekly trading volume of the class during the four calendar weeks prior to
such
sale. Rule 144 also permits, under certain circumstances, the sale of
securities, without any limitation, by our stockholders that are non-affiliates
that have satisfied a two-year holding period. Any substantial sale of our
common stock pursuant to Rule 144 or pursuant to any resale prospectus may
have
material adverse effect on the market price of our securities.
Director
and officer liability is limited.
As
permitted by Delaware law, our certificate of incorporation limits the liability
of our directors for monetary damages for breach of a director's fiduciary
duty
except for liability in certain instances. As a result of our charter provision
and Delaware law, stockholders may have limited rights to recover against
directors for breach of fiduciary duty. In addition, our certificate of
incorporation provides that we shall indemnify our directors and officers to
the
fullest extent permitted by law.
ITEM
2. DESCRIPTION
OF PROPERTY
The
Company's corporate headquarters are located at 100 Eagle Rock Avenue, East
Hanover, New Jersey 07936, where it operates under an amended lease agreement
expiring December 31, 2010. In addition to minimum rentals, the Company is
liable for its proportionate share of real estate taxes and operating expenses,
as defined. DeLeeuw Associates, LLC has an office at Suite 1460, Charlotte
Plaza, 201 South College Street, Charlotte, North Carolina 28244. DeLeeuw leases
this space which has a stated expiration date of December 31, 2010. The Company
also leases office space at 11 Penn Plaza, New York, NY 10001. The current
lease
expiration date is March 31, 2007.
The
Company is committed under several operating leases for automobiles that expire
during 2007.
See
Note
20 to the Notes to Consolidated Financial Statements.
ITEM
3. LEGAL
PROCEEDINGS
On
August
1, 2005, Sridhar Bhupatiraju and Scosys, Inc. commenced legal action against
the
Company in the Superior Court of New Jersey. The complaint alleges, among other
things, the Company’s failure to make certain payments pursuant to an asset
purchase agreement with Scosys, Inc. and the Company’s failure to make certain
payments to Sridhar Bhupatiraju in accordance with his employment agreement
with
the Company. The plaintiffs are seeking unspecified compensatory damages,
punitive damages, fees and other costs. On September 30, 2005, the Company
filed
its answer to complaint and third-party complaint against Scorpio Systems,
alleging that Mr. Bhupatiraju embarked on a scheme to circumvent his contractual
obligations under the asset purchase agreement, his non-compete agreement with
the Company, and in violation of his duties of loyalty and fidelity to his
employer (the Company) via Scorpio Systems, among other things Notwithstanding
Mr. Bhupatiraju’s contractual obligations, the Company alleges that he sold the
assets of Scosys while at the same time operating and/or owning a competing
business, Scorpio Systems. Management believes the suit against the Company
to
be without merit and intends to vigorously defend the Company against this
action and pursue its countersuit.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE TO SECURITY HOLDERS
No
matters were submitted to a vote of security holders during the fourth quarter
of the fiscal year ended December 31, 2005.
PART
II
ITEM
5. MARKET
FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market
Information.
Our
common stock traded on the OTC Bulletin Board, except as indicated below, and/or
the Pink Sheets LLC under the symbol “LCSI” from July 16, 2003 through February
2, 2004. From February 3, 2004 through September 20, 2005, our common stock
traded on the OTC Bulletin Board under the symbol “CSII.” On September 21, 2005,
our common stock began trading on the American Stock Exchange under the symbol
“CVN.”
The
following chart sets forth the high and low sales prices for each quarter
from January 1, 2004 through September 20, 2005 and the closing
high and low sales prices of the Company’s common stock as reported by the
American Stock Exchange for
each
quarter from September 20, 2005 through March 31, 2006. All numbers give effect
to a 1 for 15 reverse stock split effected on September 20, 2005.
|
|
High
|
|
Low
|
|
|
|
|
|
|
|
2004
by Quarter
|
|
|
|
|
|
January
1 - March 31
|
|
$
|
3.75
|
|
$
|
1.80
|
|
April
1 - June 30
|
|
$
|
3.975
|
|
$
|
1.65
|
|
July
1 - September 30
|
|
$
|
4.65
|
|
$
|
2.70
|
|
October
1 - December 31
|
|
$
|
3.75
|
|
$
|
2.40
|
|
|
|
|
|
|
|
|
|
2005
by Quarter
|
|
|
|
|
|
|
|
January
1 - March 31
|
|
$
|
3.825
|
|
$
|
2.175
|
|
April
1 - June 30
|
|
$
|
4.20
|
|
$
|
1.67
|
|
July
1 - September 30
|
|
$
|
2.33
|
|
$
|
1.28
|
|
October
1 - December 31
|
|
$
|
2.01
|
|
$
|
0.40
|
|
|
|
|
|
|
|
|
|
2006
by Quarter
|
|
|
|
|
|
|
|
January
1 - March 31
|
|
$
|
1.49
|
|
$
|
0.41
|
|
|
|
|
|
|
|
|
|
Our
Common stock is listed on the American Stock Exchange. On March 31, 2006, the
closing price for shares of our common stock, as reported by the American Stock
Exchange, was $1.03.
No
prediction can be made as to the effect, if any, that future sales of shares
of
our common stock or the availability of our common stock for future sale will
have on the market price of our common stock prevailing from time-to-time.
The
additional registration of our common stock and the sale of substantial amounts
of our common stock in the public market could adversely affect the prevailing
market price of our common stock.
(b) Record
Holders.
As of
March 31, 2006, there were 475 registered holders of our common stock, including
shares held in street name. As of March 31, 2006, there were 49,997,834 shares
of common stock issued and outstanding.
(c) Dividends.
We have
not paid dividends on our common stock in the past and do not anticipate doing
so in the foreseeable future. We currently intend to retain future earnings,
if
any, to fund the development and growth of our business. In addition, the
security agreement with Laurus Master Fund, Ltd. requires that we obtain their
consent prior to paying any dividends on our common stock.
(d) Sales
of Unregistered Securities
During
the period covered by this Annual Report, we did not issue any securities that
were not registered under the Securities Act of 1933, as amended, except as
previously included in a quarterly report on Form 10-QSB or a current report
on
Form 8-K.
ITEM
6. MANAGEMENT’S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Overview
of our Business
Management’s
Discussion and Analysis contains statements that are forward-looking. These
statements are based on current expectations and assumptions that are subject
to
risks and uncertainties. Actual results could differ materially because of
factors discussed in “Risk Factors” and elsewhere in this report. The Company
undertakes no duty to update any forward-looking statement to conform the
statement to actual results or changes in the Company’s expectations.
Conversion
Services International, Inc. provides professional services to the Global 2000,
as well as mid-market clientele relating to strategic consulting, data
warehousing, business intelligence and data management and, through strategic
partners, the sale of software which is used to survey and quantify the quality
of data. The Company’s services based clients are primarily in the financial
services, pharmaceutical, healthcare and telecommunications industries, although
it has clients in other industries as well. The Company’s clients are primarily
located in the northeastern United States. The Company is committed to being
a
leader in data warehousing and business intelligence consulting, enabling it
to
be a valuable asset and trusted advisor to its customers. See Item 1 - Business
for a full description of our services and offerings.
The
Company began operations in 1990. Its services were originally focused on
e-business solutions and data warehousing. In the late 1990s, the Company
strategically repositioned itself to capitalize on its data warehousing
expertise in the fast growing business intelligence/data warehousing space.
The
Company became a public company via its merger with a wholly owned subsidiary
of
LCS Group, Inc., effective January 30, 2004.
The
Company’s core strategy includes capitalizing on the already established
in-house business intelligence/data warehousing (“BI/DW”) technical expertise
and its seasoned sales force. This is expected to result in organic growth
through the addition of new customers. In addition, this foundation will be
leveraged as the Company pursues targeted strategic acquisitions.
The
Company derives a majority of its revenue from professional services
engagements. Its revenue depends on the Company’s ability to generate new
business, in addition to preserving present client engagements. The general
domestic economic conditions in the industries the Company serves, the pace
of
technological change, and the business requirements and practices of its clients
and potential clients directly affect this. When economic conditions decline,
companies generally decrease their technology budgets and reduce the amount
of
spending on the type of information technology (IT) consulting the Company
provides. The Company’s revenue is also impacted by the rate per hour it is able
to charge for its services and by the size and chargeability, or utilization
rate, of its professional workforce. If the Company is unable to maintain its
billing rates or sustain appropriate utilization rates for its professionals,
its overall profitability may decline. The Company continues to see improvements
in economic conditions, which have recently led to increased spending on
consulting services in certain vertical markets, particularly in financial
services. The Company’s growing national presence and experienced, highly
skilled workforce have enabled it to successfully differentiate its value and
capabilities from those of its competitors, in effect, lessening the impact
of
current market pricing pressures.
The
Company will continue to focus on a variety of growth initiatives in order
to
improve its market share and increase revenue. Moreover, as the Company
endeavors to achieve top line growth, it will concentrate on improving margins
and driving earnings to the bottom line. The Company will continue its best
efforts to improve margins by limiting its use of outside consultants as
employees provide higher levels of profitability. In addition, it will
complement its service offerings with higher level management consulting
opportunities, and continuously evaluating the size of its workforce in order
to
balance the Company’s skill base with the market demand for
services.
In
addition to the conditions described above for growing the Company’s current
business, the Company will continue to grow through acquisitions. One of
the Company’s objectives is to make acquisitions of companies offering services
complementary to the Company’s lines of business. This is expected to accelerate
the Company’s business plan at lower costs than it would generate internally and
also improve its competitive positioning and expand the Company’s offerings in a
larger geographic area. The service industry is very fragmented, with a handful
of large international firms having data warehousing and/or business
intelligence divisions, and hundreds of regional boutiques throughout the United
States. These smaller firms do not have the financial wherewithal to scale
their businesses or compete with the larger players. To that end, the
service industry has experienced consolidation during the past 24 months
and the Company has been a participant in this consolidation. The Company has
been active in acquiring companies during the last two years:
° In
March
2004, the Company acquired DeLeeuw Associates, a management consulting firm
in
the information technology sector with core competency in delivering Change
Management Consulting, including both Six Sigma and Lean domain expertise to
enhance service delivery, with proven process methodologies resulting in time
to
market improvements within the financial services and banking industries.
Historically, the DeLeeuw Associates business was involved in the operational
integration of mergers and acquisitions, and would prescribe the systems
integration work necessary. DeLeeuw Associates has now begun to sell the
expanded suite of services offered by the Company, from operational integration
to systems integration.
° In
May
2004, the Company acquired 49% of all issued and outstanding shares of common
stock of Leading Edge Communications Corporation (“LEC”). LEC provides
enterprise software and services solutions for technology infrastructure
management.
° In
June
2004, the Company acquired substantially all of the assets and assumed
substantially all of the liabilities of Evoke Software Corporation, which
designed, developed, marketed and supported software programs for data analysis,
data profiling and database migration applications and provides related support
and consulting services. In July 2005, the Company divested substantially all
of
the assets of Evoke Software Corporation. The market for software has changed,
and the Company determined that data profiling should no longer be a standalone
product and needed to be part of a suite of tools. This is evidenced by the
subsequent acquisition of the Evoke software product by Similarity Systems
in
July 2005 and then Informatica in January 2006.
° In
July
2005, the Company acquired McKnight Associates, Inc. Since inception, McKnight
Associates has focused on successfully designing, developing and implementing
data warehousing and business intelligence solutions for its clients in numerous
industries. Mr. William McKnight, the founder of McKnight Associates who joined
the Company as Senior Vice President - Data Warehousing, is
a
well-known industry leader, frequently
speaks at national trade shows and contributes
to major data management trade publications.
° In
July
2005, the Company acquired Integrated Strategies, Inc. (“ISI”). With offices in
New York City, ISI is a professional services firm with a solutions-oriented
approach to complex business and technical challenges. Similar to our wholly
owned subsidiary, DeLeeuw Associates, which is best known for its large-scale
merger integration management and business process change programs for the
financial services markets, ISI also counts many industry leaders in this sector
among its customers. Because of this shared focus, the operations of ISI were
essentially folded into DeLeeuw Associates.
The
Company’s most significant costs are personnel expenses, which consist of
consultant fees, benefits and payroll-related expenses.
Results
of Operations
The
following table sets forth selected financial data for the periods
indicated:
|
|
Selected
Statement of Operations Data for the Years
|
|
|
|
Ended
December 31,
|
|
|
|
2005
|
|
2004
|
|
Net
Revenue
|
|
$
|
27,269,909
|
|
$
|
23,893,106
|
|
Gross
Profit
|
|
|
7,097,506
|
|
|
5,046,129
|
|
Net
loss from continuing operations
|
|
|
(3,386,378
|
)
|
|
(22,697,298
|
)
|
Loss
from discontinued operations
|
|
|
(1,103,971
|
)
|
|
(12,650,908
|
)
|
Net
loss
|
|
|
(4,490,349
|
)
|
|
(35,348,206
|
)
|
Basic
loss per share
|
|
|
|
|
|
|
|
From
continuing operations
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per share
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
Diluted
loss per share:
|
|
|
|
|
|
|
|
From
continuing operations
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per share
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
|
|
Selected
Statement of Financial Position Data for the Years
|
|
|
|
Ended
December 31,
|
|
|
|
2005
|
|
2004
|
|
Working
capital
|
|
$
|
(6,959,936
|
)
|
$
|
(13,923,181
|
)
|
Total
assets
|
|
|
18,478,469
|
|
|
28,868,029
|
|
Long-term
debt
|
|
|
3,042,914
|
|
|
6,659,449
|
|
Related
party debt |
|
|
1,772,368 |
|
|
307,981 |
|
Total
stockholders' equity
|
|
|
2,257,063
|
|
|
1,294,522
|
|
Years
Ended December 31, 2005 and 2004
Revenues
for the Company are categorized by strategic consulting, business intelligence,
data warehousing and data management. They are reflected in the chart below
as a
percentage of overall revenues:
Category
of Services
|
|
Percentage
of Revenues for the year ended
|
|
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
Strategic
Consulting
|
|
|
40.6
|
%
|
|
35.9
|
%
|
Business
Intelligence
|
|
|
22.4
|
%
|
|
22.7
|
%
|
Data
Warehousing
|
|
|
22.8
|
%
|
|
16.7
|
%
|
Data
Management
|
|
|
13.2
|
%
|
|
23.4
|
%
|
Software
& Support
|
|
|
0.0
|
%
|
|
1.0
|
%
|
Other
|
|
|
1.0
|
%
|
|
0.3
|
%
|
Strategic
consulting revenues were 40.6% of total revenues for the year ended December
31,
2005, increasing by 4.7% as compared to 35.9% of total revenues for the
comparable prior year period. During March 2004, the Company acquired DeLeeuw
Associates, whose revenue base is entirely in the strategic consulting category
of services. In July 2005, the Company acquired Integrated Strategies, Inc.
(ISI), whose revenue base is also entirely in the strategic consulting category
of services. DeLeeuw and ISI account for all of the Company’s strategic
consulting revenues. For the year ended December 31, 2005, DeLeeuw revenues
were
$9.3 million, as compared to $5.5 million year ended December 31, 2004,
representing an increase of $3.8 million. The increase is mostly attributable
to
the increase in revenues at DeLeeuw’s
largest client, which represented a $3.5 million increase in billings for the
year ended December 31, 2005 and the addition of a new client that produced
$0.7
million in revenues for that period. ISI’s revenues were $1.9 million for the
year ended December 31, 2005.
The
DeLeeuw Associates acquisition in 2004 and the ISI acquisition in 2005 increased
the Company’s revenue base and, as a result, the percentage of revenues
contributed by each of the other services categories was impacted by the
increased overall revenues in the strategic consulting category. The Company
intends to continue to focus on increasing revenues in the strategic consulting,
business intelligence and data warehousing lines of business during 2006 and
is
de-emphasizing the data management line of business since this category is
less
profitable to the Company than the other service categories.
Business
intelligence service revenues were 22.4% of total revenues for the year ended
December 31, 2005, decreasing by 0.3% as compared to 22.7% of total revenues
for
the comparable prior year period. On an absolute dollar basis, business
intelligence revenues increased by $1.3 million for the year ended December
31,
2005 from $5.4 million for the year ended December 31, 2004 to $6.2 million
for
the year ended December 31, 2005. This increase is primarily attributable to
an
increase in average billing rates of 19.2% for the year ended December 31,
2005
versus the prior period, though it is partially offset by a 12.0% decrease
in
billable hours for this line of business. The increase in billing rates is
attributable to the utilization of higher skilled consultants, while the
decrease in billable hours is attributable to the reduction in the number of
consultants utilized. The average number of consultants utilized for the year
ended December 31, 2005 decreased by 10.9% as compared to the prior
year.
Data
warehousing revenues were 22.8% of total revenues for the year ended December
31, 2005, increasing by 6.1% as compared to 16.7% of total revenues for the
comparable prior year period. On an absolute dollar basis, data warehousing
revenues increased by $1.4 million for the year ended December 31,
2005, partially attributable to $0.5 million of revenues from McKnight
Associates, from $4.9 million for the year ended December 31, 2004 to $6.3
million for the year ended December 31, 2005. This increase for the year ended
December 31, 2005 is primarily attributable to a 48.7% increase in total hours
billed in this line of business for the period versus the same period in the
prior year, though it is partially offset by a 13.2% decrease in billable rates
for this line of business. The increase in billable hours is attributable to
an
increase in number of consultants utilized, which includes contributions of
McKnight Associates, whose business is concentrated in data warehousing. The
decrease in billable rates is primarily attributable to a reduction of
higher-skilled consultants utilized by the Company. The average number of
consultants utilized for the year ended December 31, 2005 increased by 57.1%
as
compared to the prior year.
Data
management revenues were $3.6 million, or 13.2% of total revenues, for the
year
ended December 31, 2005, decreasing by $1.8 million, or 10.2% as compared to
$5.4 million, or 23.4% of total revenues, for the comparable prior year period.
This category of services is less profitable to the Company than the other
service categories and, as a result, is being de-emphasized and the Company’s
resources are being focused on the more profitable service categories.
Years
ended December 31, 2005 and 2004
Revenue
The
Company’s revenues are primarily comprised of billings to clients for consulting
hours worked on client projects. Revenues for the year ended December 31, 2005
were $27.6 million, an increase of $3.7 million, or 15.6%, as compared to
revenues of $23.9 million for the year ended December 31, 2004.
Services
Services
revenues for the year ended December 31, 2005 were $23.4 million, an increase
of
$3.6 million, or 18.4% of services revenues, as compared to services revenues
of
$19.8 million for the year ended December 31, 2004, respectively. DeLeeuw
Associates contributed an additional $3.8 million of services revenue during
the
year ended December 31, 2005 as compared to the 10 month period subsequent
to
the acquisition of DeLeeuw Associates in the prior year. ISI contributed $1.9
million during the current year. Partially offsetting this increase is a
reduction in revenues from services of $2.1 million relating to a decrease
in
the number of consultants in the ongoing CSI business. Exclusive
of DeLeeuw Associates, billable hours declined by 25.7% due to a 19.0%
reduction in the number of consultants on billing for the year ended December
31, 2005 compared to the same period for the prior year. This decline in the
number of consultants on billing was attributable to the completion of certain
client engagements, which resulted in unutilized consultant time for significant
portions of the year ended December 31, 2005.
Related
party services
Revenues
from related parties for the year ended December 31, 2005 were $3.7 million,
representing a decrease of $0.1 million, or 2.8% as compared to related party
revenues of $3.8 million for the year ended December 31, 2004. The decrease
for
the year ended December 31, 2005 compared to the same period in the prior year,
is primarily attributed to a 16.5% reduction in billable hours for the year
ended December 31, 2005 versus the same period for the prior year. This is
mostly offset by a 11.6% increase in billable rates. The decrease in billable
hours is attributable to a reduction in the number of consultants required
by
our related party.
Cost
of revenue
Cost
of
revenue primarily includes payroll and benefits costs for the Company’s
consultants. Cost of revenue was $20.5 million, or 74.3% of revenue,
for the year ended December 31, 2005, compared to $18.8 million,
or 78.9% of total revenue, for the year ended December 31, 2004, representing
an
increase of $1.7 million, or 8.9% as compared to the prior year.
Cost
of
revenue for the year ended December 31, 2004 included a $1.4 million charge
for
stock based compensation. The cost of revenue would have been $17.4 million
had
this charge not occurred, or 73.0% of cost of revenue. The cost of revenue
would
have increased by 1.3% for the year ended December 31, 2005 compared to the
year
ended December 31, 2004.
Services
Cost
of
services was $17.3 million, or 74.0% of services revenue, for the year ended
December 31, 2005, compared to $15.4 million, or 77.8% of services revenue,
for
the year ended December 31, 2004, representing an increase of $1.9 million,
or
12.7%. DeLeeuw Associates generated a $2.4 million increase in cost of services,
directly associated with its increase in revenues in this category, for the
year
ended December 31, 2005 as compared to the 10 month period subsequent to the
acquisition of DeLeeuw Associates in the prior year. ISI and McKnight
contributed a cost of services of $1.5 million and $0.4 million in 2005.
Partially offsetting
this increase was a reduction in cost of services of $0.5
million resulting from a 25.7%
decrease in billable hours due to a 19.0%
reduction in the number of consultants on billing and a 22.0%
increase in the average pay rates for consultants. This shift reflects the
higher skilled consultants employed in the categories of strategic consulting
and data warehousing, whose revenues increase as a percentage of revenues as
compared to the lower skilled consultants required in the shrinking category
of
data management.
Related
party services
Cost
of
related
party services
was $3.2 million, or 86.2% of related party services revenue, for the year
ended
December 31, 2005, compared to $3.3 million, or 87.2% of related party services
revenue, for the year ended December 31, 2004, respectively. The decreased
cost
as a percentage of related party services revenue is due to a 16.5% decrease
in
hours offset by an 18.2% increase in average pay rate. The decrease in billable
hours is attributable to a reduction in the number of consultants utilized,
while the increase in average pay reflects a reduction in the use of lower
skilled consultants, resulting in an average higher pay rate.
Gross
Profit
Gross
profit was $7.1 million, or 25.7% of total revenue, for the year ended
December
31,
2005,
compared to $5.0 million, or 21.1% of total revenue, for the year ended
December
31,
2004. Gross profit for the year ended December 31, 2004 included a $1.4
million charge for stock based compensation. The gross profit would have been
27.0% had this charge not occurred, in which case gross profit would have
decreased by 1.3% for the year ended December 31, 2005 compared to the year
ended December 31, 2004.
As
a
percentage of total gross profit for the years ended December
31,
2005
and 2004, respectively, services contributed 85.6% and
87.0%
(89.8% if the charge for stock-based compensation had not occurred),
respectively, related party services contributed 7.3% and 9.7% (7.6% if the
charge for stock-based compensation had not occurred), respectively, and other,
including software, support and maintenance contributed 7.1% and 3.3% (2.6%
if
the charge for stock-based compensation had not occurred), respectively,.
Services
Gross
profit from services was
$6.1
million, or 26.0% of services revenue, for the year ended December 31, 2005,
an
increase of $1.7 million as compared to $4.4 million, or 22.2% services revenue,
for the year ended December 31, 2004, respectively. Gross
profit from services for the year ended December 31, 2004 included a $1.4
million charge for stock based compensation. The gross profit from services
would have been $5.8 million or 29.3% for the year ended December 31, 2004
had
this charge not occurred, or an increase instead of $0.3 million from the year
ended December 31, 2005 compared to the year ended December 31, 2004.
DeLeeuw
Associates contributed a 34.1% gross profit for the year ended December 31,
2005
as compared to a 33.0% gross profit for the year ended December 31, 2004.
Exclusive of DeLeeuw Associates, the Company contributed a 21.5% gross profit
for the year ended December 31, 2005 as compared to a 25.1% gross profit for
the
year ended December 31, 2004 (had the aforementioned charge for stock based
compensation not occurred).
Exclusive
of DeLeeuw Associates, billable hours declined by 25.7% due to a 19.0% reduction
in the number of consultants on billing for the year ended December 31, 2005
compared to the same period for the prior year. The decrease in billable hours,
along with a 22% increase in average pay rate, accounted for the decrease in
gross profit. The decrease in billable hours is attributable to a reduction
in
the number of consultants utilized, resulting from unutilized consultant time
for significant portions of the year ended December 31, 2005. This cost had
to
be absorbed by the Company while the consultants were not utilized. The increase
in average pay reflects a reduction in the use of lower skilled consultants,
resulting in an average higher pay rate.
Related
party services
Gross
profit for related party services was $0.5 million, or
13.8%
of related party services revenue, for the year ended December 31, 2005,
compared to $0.5 million, or 12.8% of related party services revenue, for the
year ended December 31, 2004, respectively. Gross
profit was flat due to a
11.6%
increase in billable rates, which was impacted by an 18.2% increase in average
pay rate, as well as a 16.5% reduction in billable hours. The decrease in
billable hours is attributable to a reduction in the number of consultants
utilized, while the increase in average pay reflects a reduction in the use
of
lower skilled consultants, resulting in an average higher pay rate.
Selling
and marketing
Selling
and marketing expenses include payroll, employee benefits and other
headcount-related costs associated with sales and marketing personnel and
advertising, promotions, tradeshows, seminars and other programs. Selling
and marketing expenses were $4.5 million, or 16.4% of revenue for the year
ended
December 31, 2005, compared to $3.2 million, or 13.4% of revenue for the year
ended December 31, 2004, representing an increase of $1.3 million, or 5.5%
of
revenue, as compared to the prior year.
$0.7
million of this increase relates to increased payroll expense, of which $0.4
million relates to the reclassification of a senior executive of the Company
from general and administrative expense to sales and marketing expense and
$0.3
million of the increase relates to increases in salaries and commissions.
Additionally, $0.2 million of the increase relates to increased advertising,
public relations and trade show expense during the year as the Company has
continued to increase its visibility in the industry and the marketplace, $0.2
million relates to the acquisition of ISI in 2005, and the remaining $0.2
million primarily relates to increased professional fees, travel and
subscriptions.
General
and administrative
General
and administrative costs include payroll, employee benefits and other
headcount-related costs associated with the finance, legal, facilities, certain
human resources and other administrative headcount, and legal and other
professional and administrative fees. General and administrative costs
were $6.4 million, or 23.2% of revenue for the year ended December 31, 2005
compared to $6.1 million, or 25.5% of revenue for the year ended December 31,
2004, representing an increase of $0.3 million, or 1.4% of revenues, as compared
to the prior year.
General
and administrative expense increased by $0.4 million as a result of the ISI
and
McKnight Associates acquisitions that occurred during 2005. Additionally, the
Company recorded charges of $0.5 million in 2005 due to issuances of stock
at
below market prices, professional fees and insurance expense increased by $0.2
million, and other expenses increased by $0.1 million. These increases were
partially offset by a $0.2 million reduction in bad debt expense, a $0.3 million
reduction in current year expense due to costs associated with the addition
of
certain employees of Software Forces and the LCS reverse merger in 2004, and
$0.4 million reduction due to the reclassification of a senior executive of
the
Company.
Goodwill
and intangibles impairment
Impairment
of goodwill of $1.3 million for the year ended December 31, 2005 resulted from
the Company’s annual impairment review of the goodwill for the ISI and McKnight
Associates acquisitions which occurred in 2005. Statement of Financial
Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill
and Other Intangible Assets”,
instructs the Company to test intangible assets for impairment annually, or
more
frequently if events or changes in circumstances indicate that the asset might
be impaired. There were no specific events or changes in circumstances in either
of the two acquired companies that would have required an interim impairment
charge. The Company performed its annual impairment review as of December 31,
2005 and determined that a goodwill impairment charge of $0.8 million was
required relating to the goodwill associated with the ISI acquisition and $0.5
million related to the goodwill associated with the McKnight Associates
acquisition. The $12.2 million impairment charge for the year ended December
31,
2004 resulted from an $11.5 million impairment of the DeLeeuw Associates
goodwill and a $0.7 million impairment of goodwill recorded for other Company
assets.
Depreciation
and amortization
Depreciation
expense is recorded on the Company’s property and equipment which is generally
depreciated over a period between three to seven years. Amortization of
leasehold improvements is taken over the shorter of the estimated useful life
of
the asset or the remaining term of the lease. The Company amortizes deferred
financing costs utilizing the effective interest method over the term of the
related debt instrument. Acquired software is amortized on a straight-line
basis
over an estimated useful life of three years. Acquired contracts are amortized
over a period of time that approximates the estimated life of the contracts,
based upon the estimated annual cash flows obtained from those contracts,
generally five to six years. Depreciation and amortization expenses were
$0.9 million for the year ended December 31, 2005 compared to
$0.5
million for the year ended December 31, 2004, representing an increase of $0.4
million as compared to the prior year. $0.2 million of this increase relates
to
amortization of intangibles associated with the McKnight Associates acquisition
which occurred in 2005. The remaining $0.2 million increase relates to the
amortization of the deferred financing costs being amortized for a full year
in
2005 as opposed to four months in 2004.
Interest
Expense
The
Company incurs interest expense on loans from financial institutions, from
capital lease obligations related to the acquisition of equipment used in its
business, and on outstanding convertible line of credit notes. Amortization
of
the discount on debt issued of $2.9 million and $0.9 million for the years
ended
December 31, 2005 and 2004, respectively, is also recorded as interest expense.
In 2004, a $1.2 million charge for a beneficial conversion feature was also
recorded as interest expense. Interest expense recorded was $4.2 million for
the
year ended December 31, 2005 compared to $5.0 million for the year ended
December 31, 2004. This increase is primarily related to the Laurus, Sands
and
Taurus financing transactions described below in the Liquidity and Capital
Resources section.
Other
income (expense)
The
Company recorded interest income of $69,000 and no other income for the year
ended December 31, 2005, compared to interest income of $22,000 and other income
of $7,300 for the year ended December 31, 2004. The
Company recorded equity income in its investments in DeLeeuw International
(Turkey) and Leading Edge Communications Corporation of approximately $5,000
for
the year ended December 31, 2005 and $6,000 for the year ended December 31,
2004.
The
Company adjusts the fair value of its financial instruments relating to its
warrant and embedded derivative liabilities each quarter and records a gain
or
loss on the instruments. During the year ended December 31, 2005, the Company
recorded a $8.4 million gain on the financial instruments and during the year
ended December 31, 2004, the Company recorded a $0.6 million loss on the
financial instruments. For
accounting purposes, the Company recorded the renegotiation of the Laurus debt
instruments in July 2005 and November 2005 as early extinguishments of debt
and
recorded the remaining discount and liability to gain or loss on the early
extinguishments of debt. See
Footnote 10 of
the
Notes to the Consolidated Financial Statements for further
discussion.
Income
Taxes
The
Company evaluates the amount of deferred tax assets that are recorded against
expected taxable income over its forecasting cycle which is currently two years.
As a result of this evaluation, the Company has recorded a valuation allowance
of $10.1
million
and $8.0 million during the years ended December 31, 2005 and 2004,
respectively. This allowance was recorded because, based on the weight of
available information, it is more likely than not that some, or all, of the
deferred tax asset may not be realized.
Years
Ended December 31, 2004 and 2003
Revenue
Revenues
for the Company are categorized by strategic consulting, business intelligence,
data warehousing and data management. They are reflected in the chart below
as a
percentage of overall revenues:
Category
of Services
|
|
Percentage
of Revenues for the year ended
|
|
|
|
December
31,
|
|
|
|
2004
|
|
2003
|
|
Strategic
Consulting
|
|
|
35.9
|
%
|
|
17.3
|
%
|
Business
Intelligence
|
|
|
22.7
|
%
|
|
22.2
|
%
|
Data
Warehousing
|
|
|
16.7
|
%
|
|
14.8
|
%
|
Data
Management
|
|
|
23.4
|
%
|
|
45.7
|
%
|
Software
|
|
|
1.0
|
%
|
|
0.0
|
%
|
Other
|
|
|
0.3
|
%
|
|
0.0
|
%
|
Strategic
consulting revenues increased from 17.3% to 35.9% of total revenues for the
years ended December 31, 2003 and 2004, respectively. This is primarily
attributable to the $5.4 million, or 62.8% of strategic consulting revenues,
derived from DeLeeuw Associates which was acquired by the Company in March
2004.
After the acquisition of DeLeeuw Associates, the CSI core business flowed all
strategic consulting work through DeLeeuw Associates. Excluding DeLeeuw
Associates, strategic consulting revenues as a percent of total revenue for
the
year ended December 31, 2004 were 16.1%, a decrease of 1.2% from the 17.3%
in
the comparable prior year period. During 2004, the Company obtained new business
and increased existing client business in this segment by 4.1% of total 2004
revenues, however, due to the acquisition of a new software business segment
in
2004 which resulted in a larger revenue base attributable to a new business
segment, the overall percentage of comparable year-to-year revenues (excluding
the 2004 impact of the DeLeeuw Associates acquisition) declined.
Business
intelligence services revenues were 22.7% of total revenues for the year ended
December 31, 2004, increasing by 0.5% of revenues as compared to 22.2% for
the
comparable prior year period. While the percentage of total revenues
attributable to this category increased in 2004 as compared to the prior year,
the increase is primarily due to the acquisition of DeLeeuw Associates, which
substantially increased revenues in the strategic consulting line of business.
On an absolute dollar basis, revenues in this category of $5.4 million for
the
year ended December 31, 2004 increased by $2.2 million, or 68.8%, from $3.2
million for the year ended December 31, 2003.
Data
warehousing revenues represented 16.7% of total revenues for the year ended
December 31, 2004, increasing by 1.9% of total revenues from 14.8% for the
year
ended December 31, 2003. While the percentage of total revenues attributable
to
this category remained constant in 2004 as compared to the prior year, this
is
primarily due to the acquisition of DeLeeuw Associates which substantially
increased revenues in the strategic consulting line of business. On an absolute
dollar basis, however, revenues in this category of $4.0 million for the year
ended December 31, 2004 increased by $1.8 million, or 81.8%, from $2.2 million
for the year ended December 31, 2003.
Data
management revenues decreased as a percentage of total revenues by 22.4% of
revenues, from 45.7% for the year ended December 31, 2003 to 23.4% for the
year
ended December 31, 2004. While the percentage of total revenues attributable
to
this category declined in 2004 as compared to the prior year, 15.4% of the
decline is due to the acquisition of DeLeeuw Associates which substantially
increased revenues in the strategic consulting line of business and 5.4% of
the
decline is due to a shift in the mix of the Company’s business from the data
management line of business to the strategic consulting, business intelligence
and data warehousing lines of business in 2004. In absolute dollars, 2004
revenues in the data management line of business of $5.7 million, decreased
by
$0.9 million, or 13.6%, from $6.6 million for the year ended December 31, 2003.
The
Company’s revenues are primarily comprised of billings to clients for consulting
hours worked on client projects. Revenues for the year ended December 31, 2004
were $23.9 million, an increase of $9.5 million, or 66.0%, over revenues of
$14.4 million for the year ended December 31, 2003.
Services
Revenues
from services for the year ended December 31, 2004 were $19.8 million, an
increase of $5.8 million, or 41.4%, over revenues of $14.0 million for the
year
ended December 31, 2003. $5.5 million, or 27.3% of 2004 services revenues
relates to revenues derived from DeLeeuw Associates which was acquired by the
Company in March 2004.
The
remaining $0.4 million of increased 2004 revenue as compared to the prior year
relates to an increase in the average billing rates coupled with a reduction
in
hours billed. The Company experienced a 15.9% increase in the average billing
rate in 2004 as compared to the prior year, exclusive of the impact of the
DeLeeuw Associates acquisition.
This is
a direct result of the increased revenues in the strategic consulting and
business intelligence segments, both of which command higher billing rates
than
the other segments. Hours billed for time and material based work in 2004 were
approximately 16.2% less than hours billed in 2003. This decline is partially
due to resources that were utilized on a substantial fixed-price project that
was undertaken by the Company during 2004. Additionally, the Company experienced
some attrition in the consulting workforce coupled with increased nonbillable
time due to gaps in the completion of ongoing assignments versus the start
dates
of new assignments.
Related
party services
Revenues
from related parties for the year ended December 31, 2004 were $3.8 million,
an
increase of $3.4 million over revenues of $0.4 million for the year ended
December 31, 2003. The
increase in 2004 results from a full year of invoicing to LEC during 2004,
versus six weeks in the prior year, under the independent contractor agreement
executed by the Company and LEC in November 2003. Additionally, the average
billing rate increased by 7.6% in 2004 as compared to 2003 which is primarily
due to the hiring of six higher level consultants for a project obtained by
this
related party.
Software
Software
revenues are derived from the sale of third-party software to our clients as
part of a consulting engagement. Revenues from software for the year ended
December 31, 2004 were $0.2 million as compared to zero in the prior year.
Cost
of revenue
Cost
of
revenue primarily includes payroll and benefits costs for the Company’s
consultants as well as the cost of software that is sold or licensed by the
company. Cost of revenue was $18.8 million, or 78.9% of revenue for
the year ended December 31, 2004, compared to $10.3 million, or 71.5% of revenue
for the year ended December 31, 2003.
Services
Cost
of
services was $15.4 million, or 77.8% of services revenue for the year ended
December 31, 2004, compared to $10.0 million, or 71.2% of services revenue
for
the year ended December 31, 2003. Cost of revenue for DeLeeuw Associates, which
was acquired by the Company on March 4, 2004, for the period March 4, 2004
through December 31, 2004 was $3.7 million, or 18.6% of services revenues.
Additionally, during 2004, the Company recorded a stock-based compensation
charge of $1.4 million, or 7.0% of services revenues, to cost of services.
Cost
of services for the Company (excluding DeLeeuw Associates and the stock-based
compensation charge) for the year ended December 31, 2004 were $10.3 million,
an
increase of $0.3 million, or 3.0%, as compared to $10.0 million for the year
ended December 31, 2003. This increase is attributed to a 15.7% average increase
in compensation cost, in 2004, for the Company’s consulting force as compared to
the prior year. This increase is primarily attributable to hiring highly skilled
consultants in the strategic consulting, data warehousing and business
intelligence lines of business.
Related
party services
Cost
of
related
party services
was $3.3 million, or 87.2% of related party services revenue for the year ended
December 31, 2004, compared to $0.3 million, or 82.5% of related party services
revenue for the year ended December 31, 2003. The
increase in 2004 results from a full year of costs related to the consultants
which are providing services for this related party in 2004, versus six weeks
of
cost incurred in the prior year. Further, the
increase in 2004 reflects the cost of six higher level consultants hired for
specialized work during the year and annual increases for the consulting
force.
Software
Cost
of
software was $0.1 million, or 72.6% of software revenue for the year ended
December 31, 2004, compared to zero for the year ended December 31, 2003.
Gross
Profit
Gross
profit was $5.0 million, or 21.1% of revenue for the year ended December 31,
2004, compared to $4.1 million, or 28.5% of revenue for the year ended December
31, 2003.
As
a
percentage of total gross profit for the years ended December 31, 2004 and
2003,
services contributed 87.0% and 98.4%, respectively, related party services
contributed 9.7% and 1.6%, respectively, software contributed 3.3% and zero,
respectively.
The
gross
profit percentage for the year ended December 31, 2004, was 33.2% and 17.5%
for
DeLeeuw
Associates
and
ongoing operations of the Company, respectively. The Company’s gross profit
percentage for the year ended December 31, 2003 was 28.5%. There is no
comparable prior year amount for DeLeeuw Associates as they were acquired by
the
Company in 2004.
Services
Gross
profit from services was
$4.4
million, for the year ended December 31, 2004, an increase of $0.4 million,
or
10.0%, as compared to $4.0 million for the year ended December 31, 2003. As
a
percent of services revenues, gross profit of 22.2% for the year ended December
31, 2004 represented a decrease of 6.6% points as compared to 28.8% of services
revenues for the year ended December 31, 2003. The Company recorded a $1.4
million stock-based compensation charge during 2004 which reduced gross profit
by 7.0% of services revenues. Excluding this charge, the 2004 gross profit
percentage would have been 29.3%, an increase of 0.5% as compared to the prior
year. This increase is the result of the
gross
profit attributable to DeLeeuw
Associates, which had a gross profit percentage of 33.2% for the ten months
ended December 31, 2004.
Related
party services
Gross
profit for
related
party services
was $0.5 million, or 12.8% of related party services revenue for the year ended
December 31, 2004, compared to $64,000, or 17.5% of related party services
revenue for the year ended December 31, 2003. The 4.7% point decline in the
related party services gross profit percentage relates to increased consultant
costs in 2004 as compared to the prior year without corresponding increases
in
the billing rates charged to the client.
Software
Gross
profit resulting
from software was $0.1 million, or 27.4% of software revenue for the year ended
December 31, 2004, compared to zero for the year ended December 31, 2003.
Selling
and marketing
Selling
and marketing expenses include payroll, employee benefits and other
headcount-related costs associated with sales and marketing personnel and
advertising, promotions, tradeshows, seminars and other programs. Selling
and marketing expenses were $3.2 million, or 13.4% of revenue for the year
ended
December 31, 2004, compared to $1.6 million, or 10.8% of revenue for the year
ended December 31, 2003.
$0.4
million of the increase in selling and marketing expenses during the year ended
December 31, 2004 is attributed to the costs related to operating
DeLeeuw
Associates
which
was acquired during 2004. $0.7 million of the increase resulted from
increased payroll and related costs associated with the increased headcount
in
the Company’s existing sales force. The remaining $0.5 million is
reflected in the addition of six additional employees and a Director of
Marketing and Corporate Communications both through new hires and retaining
existing employees of the acquired companies as part of our strategy to gain
new
clients and increase revenue.
General
and administrative
General
and administrative costs include payroll, employee benefits and other
headcount-related costs associated with the finance, legal, facilities, certain
human resources and other administrative headcount, and legal and other
professional and administrative fees. General and administrative costs
were $6.1 million, or 25.5% of revenue for the year ended December 31, 2004
compared to $2.7 million, or 18.8% of revenue for the year ended December 31,
2003.
$1.2
million of the increase in general and administrative expenses during the year
ended December 31, 2004 is attributed to the costs of operating DeLeeuw
Associates
subsequent to the acquisition during 2004. Additionally, $1.4 million is
attributed to an increase in general and administrative payroll costs as the
result of
hiring
a chief financial officer during the fourth quarter of 2003 and increasing
the
salaries of other Company officers to compensate them competitively with other
public companies the size of the Company. $0.5 million represents an increase
in
development headcount by twelve employees during 2004, as compared to 2003,
to
support the increased size of the business and the increased compliance
requirements inherent in becoming a public company. Professional fees related
to
legal and accounting increased by $0.3 million primarily due to work related
to
the Company’s public filing requirements.
Goodwill
impairment
Impairment
of goodwill of $12.2 million for the year ended December 31, 2004 resulted
primarily from the Company’s annual impairment review for the DeLeeuw Associates
acquisition which occurred in 2004. Statement of Financial Accounting Standards
No. 142 (“SFAS No. 142”), “Goodwill
and Other Intangible Assets”,
instructs the Company to test intangible assets for impairment annually, or
more
frequently if events or changes in circumstances indicate that the asset might
be impaired. There were no specific events or changes in circumstances in the
acquired company that would have required an interim impairment charge. The
Company performed its annual impairment review as of December 31, 2004 and
determined that an impairment charge of $12.2 million was required consisting
of
$11.5 million related to the goodwill previously recorded for DeLeeuw
Associates, and $0.7 million related to goodwill recorded for other assets.
There were no goodwill impairment charges recorded during the year ended
December 31, 2003.
Depreciation
and amortization
Depreciation
expense is recorded on the Company’s property and equipment which is generally
depreciated over a period between three to seven years. Amortization of
leasehold improvements is taken over the shorter of the estimated useful life
of
the asset or the remaining term of the lease. The Company amortizes deferred
financing costs utilizing the effective interest method over the term of the
related debt instrument. Acquired software is amortized on a straight-line
basis
over an estimated useful life of three years. Acquired contracts are amortized
over a period of time that approximates the estimated life of the contracts,
based upon the estimated annual cash flows obtained from those contracts,
generally five to six years. Depreciation and amortization expenses
were $0.5 million for the year ended December 31, 2004 compared to
$0.2
million for the year ended December 31, 2003. This increase in depreciation
and
amortization during the year ended December 31, 2004 is attributed to
amortization of the acquired DeLeeuw Associates intangible assets and to
depreciation on newly acquired assets.
Interest
Expense
The
Company incurs interest expense on loans from financial institutions, from
capital lease obligations related to the acquisition of equipment used in its
business, and on the outstanding convertible line of credit notes. Amortization
of the discount on debt issued of $0.9 million is also recorded as interest
expense. Interest expense recorded was $5.0 million for the year ended December
31, 2004 compared to $0.1 million for the year ended December 31, 2003. This
increase is primarily related to the Laurus and Sands financing transactions
described below in the Liquidity and Capital Resources section.
Other
income (expense)
The
Company recorded interest income of $22,000 and other income of approximately
$7,300 for the year ended December 31, 2004, compared to interest income of
$5,000 for the year ended December 31, 2003. The
Company recorded equity income in its investment in DeLeeuw International
(Turkey) of approximately $5,000 for the year ended December 31,
2004.
Income
Taxes
The
Company evaluates the amount of deferred tax assets that are recorded against
expected taxable income over its forecasting cycle which is currently two years.
As a result of this evaluation, the Company has recorded a valuation allowance
of $9.0 million during the year ended December 31, 2004. This allowance was
recorded because, based on the weight of available evidence, it is more likely
than not that some, or all, of the deferred tax asset may not be
realized.
No
income
tax expense or benefit was recorded in the prior year as the Company was an
“S”
Corporation through September 30, 2003. Pro forma income taxes for the prior
year would have been an income tax benefit of $0.2 million using the effective
tax rate of 40%.
LIQUIDITY
AND CAPITAL RESOURCES
Cash
totaled $0.2 million as of December 31, 2005 compared to $1.0 million as of
December 31, 2004. The Company’s cash balance is primarily derived from customer
remittances, bank borrowings and acquired cash and is used for general working
capital needs.
The
Company’s working capital deficit is ($7.0 million) as of December 31, 2005
compared to ($13.9 million) as
of
December 31, 2004. The Company’s working capital position has improved during
the current year primarily due to gains resulting from the fair value
adjustments to the financial instruments during the current year. However,
the
losses generated by the Company have resulted in the need for $2.0 million
of
additional borrowings against the Company’s line of credit, a $1.0 million loan
on a short term note payable, $1.3 million raised through the sale of Company
common stock, and an additional $1.4 million of loans to the Company by the
Chief Executive Officer and the Chief Operating Officer of the
Company.
Cash used in operating activities during the year ended December 31, 2005
was
approximately $3.6 million, a decrease in cash used in operating activities
of
$0.8 million from the year ended December 31, 2004. Cash used in operating
activities primarily relates to cash used as a result of operating losses
of
approximately $3.9 million and a decline in accounts payable of approximately
$0.6 million relating to the sale of Evoke Software Corporation, which
is
partially offset by payables acquired related to the acquisitions of McKnight
Associates and Integrated Strategies. Partially offsetting this cash
decline is a approximately $1.0 million reduction in accounts receivable,
also
resulting from the sale of Evoke, partially offset by acquired receivables
from
the acquisitions of McKnight Associates and Integrated Strategies and the
timing
of collections from customers.
Cash
used
by investing activities was $2.5 million during the year ended December 31,
2005. This was due to payments of $2.2 million made primarily as acquisition
payments for Integrated Strategies and $1.0 for McKnight Associates. This
was
offset by $0.6 million of cash received as part of the Evoke
acquisition.
Cash
provided by financing activities was $5.3 million during the year ended
December
31, 2005. During 2005, $1.8 million was raised from stockholders, and $1.0
million was raised from the issuance of a short-term note payable, additional
line of credit borrowings of $1.9 million and $1.2 million was raised from
the
sale of Company common stock. $0.7 million of principal payments on long-term
debt and on capital lease obligations, of which $0.4 million of
payments were made on stockholder loans, were made by the Company during
this
time period.
There
are currently no material commitments for capital expenditures.
The
Company also expects to incur costs, in 2006, of approximately $0.3 million
in
order to improve its internal controls surrounding financial reporting and
disclosure and in ensuring compliance with Sarbanes-Oxley
requirements.
As
of
December 31, 2005 and 2004, the Company had accounts receivable due from LEC
of
approximately $0.6 million and $0.8 million, respectively. There are no known
collections problems with respect to LEC.
For
the
years ended December 31, 2005 and 2004, we invoiced LEC $3.7 million and $3.8
million, respectively, for the services of consultants subcontracted to LEC
by
us. The majority of its billing is derived from Fortune 100 clients. The
collection process is slow as these clients require separate approval on their
own internal systems, which extends the payment cycle. We feel confident in
the
collectibility of these accounts receivable as the majority of the revenues
from
LEC derive from Fortune 100 clients.
In
2004
and 2005, the Company experienced negative cash flow and operating losses,
therefore it effectuated the following transactions to support the
Company:
Taurus
In
May
2004, pursuant to the complete conversion of a $2.0 million unsecured
convertible line of credit note issued in October 2003 at $1.80 per
share
and a
conversion price adjustment in September 2004 at $1.575,
certain
investors represented by Taurus Advisory Group, LLC (“Taurus”) received
1,269,841
shares
of
our common stock, plus interest paid in cash. The Taurus investors also received
a warrant to purchase 277,778 shares of our common stock, which has an exercise
price of $1.575 per share and expires in June 2009. Further in May 2004, we
raised an additional $2.0 million pursuant to a new five-year unsecured
promissory note with Taurus. In June 2004, we replaced the May 2004 note by
issuing a five-year $2.0 million unsecured convertible line of credit note
with
Taurus. The
note
accrues interest at an annual rate of 7%, and the conversion price of the shares
of common stock issuable under the note is equal to $1.575 per
share.
In
July
2005, the Company obtained two $250,000 short term loans from certain investors
represented by Taurus. Both notes bear interest at 8% per annum. The first
note
is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
date for this note has been extended to May 6, 2006. The second note is dated
July 22, 2005 and originally matured on September 22, 2005. The maturity date
for this note has been extended to April 22, 2006. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
In
December 2005, the Company obtained a $1 million short term loan from certain
investors represented by Taurus. This note bears interest at 8% per annum.
The
note is dated December 19, 2005 and initially matured on January 31, 2006.
The
maturity date for this note has been extended to June 1, 2006. In conjunction
with this note, these investors received a warrant to purchase 277,777 shares
of
our common stock with an exercise price of $0.675 per share in December 2005,
a
warrant to purchase 277,777 shares of our common stock with an exercise price
of
$0.75 per share in
February 2006 and
a
warrant to purchase 554,000 shares of our common stock with an exercise price
of
$1.30 per share in March 2006. These warrants expire in December 2008, January
2009 and February 2009, respectively. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
On
February 2, 2006, the Company entered into a Securities Purchase Agreement
with
Taurus, pursuant to which the Company issued 19,000 shares of the Company’s
newly created Series A Convertible Preferred Stock, $.001 par value (the “Series
A Preferred”). Each share of Series A Preferred has a stated value of $100.00.
The Company utilized the proceeds ($1.9 million) to repurchase shares of its
common stock from WHRT I Corp. (see above). The Series A Preferred has a
cumulative annual dividend equal to five percent (5%), which is payable
semi-annually in cash or common stock, at the election of the Company, and
is convertible into shares of the Company’s common stock at any time at a price
equal to $0.50 per share (subject to adjustments
related to stock splits, reclassifications, combinations, dividends, change
of
control or the issuance of pari passu securities). In addition, the
Series A Preferred has no voting rights, but has liquidation preferences and
certain other privileges. All shares of Series A Preferred not previously
converted shall be redeemed by the Company, in cash or common stock, at the
election of Taurus, on February 1, 2011. Pursuant to the Securities Purchase
Agreement, Taurus was also granted a warrant to purchase 1,900,000 shares of
the
Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
related to stock splits, reclassifications, combinations, dividends, change
of
control or the issuance of pari passu securities), exercisable for a
period of five years.
Laurus
In
August
2004, we replaced our $3.0 million line of credit with North Fork Bank with
a
revolving line of credit with Laurus Master Fund, Ltd. (“Laurus”), whereby we
had access to borrow up to $6.0 million based upon eligible accounts receivable.
We paid $0.75 million in brokerage and transaction closing related costs.
On
February 1, 2006, the Company restructured its financing with Laurus by entering
into financing agreements with Laurus which removed all conversion features
in
the originally issued notes, pursuant to which it, among other things, (a)
issued a secured non-convertible term note in the principal amount of $1 million
to Laurus (the “Term Note”), (b) issued a secured non-convertible revolving note
in the principal amount of $10 million to Laurus (the “Revolving Note”,
collectively with the Term Note, the “Notes”), and (c) issued an option to
purchase up to 3,080,000 shares of the Company's common stock to Laurus (the
“Option”) at an exercise price of $.001 per share. We had no obligation to meet
financial covenants under the notes. The proceeds from the issuance of the
Notes
were used to refinance the Company’s outstanding obligations under the existing
facility with Laurus (originally entered into in August 2004 and subsequently
amended in July 2005) at a 5% premium. The Notes bear an annual interest rate
of
prime (as reported in the Wall Street Journal, which was 7.25% as of January
31,
2006) plus 1.0%, with a floor of 5.0%. Payments and interest will be made in
equal monthly amounts until maturity of the Notes on December 31, 2007, at
which
time the 5% premium will also be due. In addition, payments of principal on
the
Term Note will be made in equal monthly amounts until maturity of the Notes
on
December 31, 2007. A common stock purchase warrant issued to Laurus in August
2004 provides Laurus with the right to purchase 800,000 shares of our common
stock. The exercise price for the first 400,000 shares acquired under the
warrant is $4.35 per share, the exercise price for the next 200,000 shares
acquired under the warrant is $4.65 per share, and the exercise price for the
final 200,000 shares acquired under the warrant is $5.25 per share. The common
stock purchase warrant expires on August 15, 2011.
In
connection with the Notes, the Company and Laurus entered into an Overadvance
Letter Agreement, pursuant to which Laurus exercised its discretion granted
to
it pursuant to the Security Agreement entered into in August 2004 to make a
loan
to the Company in excess of the “Formula Amount” (as defined therein). The
Company also entered into a Stock Pledge Agreement and Security Agreement
securing its obligations to Laurus, both prior to and including the Notes,
as
well as a Registration Rights Agreement pursuant to which the Company agreed
to
file a registration statement to register the shares of the Company’s common
stock underlying the Option, as well as the shares of the Company’s common stock
and the shares of the Company’s common stock underlying the warrants held by
Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
809,525 shares of the Company’s common stock, an option to purchase up to
3,080,000 shares of the Company's common stock at an exercise price of $.001
per
share and the aforementioned warrant.
As
a
result of the issuance of warrants, the Company has recorded a discount on
debt
(valued at $2.2 million as of December 31, 2005) and a liability. The discount
is being amortized over the remaining term of the debt instrument, and the
liability is being adjusted to fair value using an option-pricing model.
Additionally, the convertible notes contain an embedded derivative pertaining
to
the conversion feature in the notes, and the Company has recorded a discount
and
a liability to reflect this derivative.
Laidlaw/Sands
In
September 2004, we issued to Sands Brothers Venture Capital LLC, Sands Brothers
Venture Capital III LLC and Sands Brothers Venture Capital IV LLC (collectively,
“Sands”) three subordinated secured convertible promissory notes equaling $1.0
million (the “Notes”), each with an annual interest rate of 8% expiring
September 22, 2005. The Notes were secured by substantially all corporate
assets, subordinate to Laurus. The Notes are convertible into shares of our
common stock at the election of Sands at any time following the consummation
of
a convertible debt or equity financing with gross proceeds of $5.0 million
or
greater (a “Qualified Financing”). The conversion price of the shares of our
common stock issuable upon conversion of the Notes shall be equal to a price
per
share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. Since no Qualified
Financing had been consummated by September 8, 2005, Sands is entitled to elect
to convert the Notes at a fixed conversion price of $2.10 per share. In the
event that we issue stock or derivatives convertible into our stock for a price
less than the aforementioned fixed conversion price, then the fixed conversion
price is reset using a weighted average dilution calculation. We also issued
Sands three common stock purchase warrants (the “Warrants”) providing Sands with
the right to purchase 400,000 shares of our common stock. The exercise price
of
the shares of our common stock issuable upon exercise of the Warrants shall
be
equal to a price per share of common stock equal to forty percent (40%) of
the
price of the securities issued pursuant to a Qualified Financing. The latest
that the Warrants may expire is September 8, 2008.
On
September 22, 2005, upon maturity of the September 2004 notes, the Company
issued to Sands three amended subordinated secured convertible promissory notes
equaling $1.08 million, each with an annual interest rate of 12% expiring on
January 1, 2007. The Company also issued Sands three common stock purchase
warrants (the “Additional Warrants”) providing Sands with the right to purchase
400,000 shares of the Company’s common stock. The exercise price of the shares
of the Company’s common stock issuable upon exercise of the Additional Warrants
shall be equal to a price per share of common stock equal to one hundred twenty
percent (120%) of the price of the securities issued pursuant to a Qualified
Financing. If no Qualified Financing has been consummated by December 15, 2006,
then Sands may elect to exercise the Additional Warrants at a fixed conversion
price of $2.10 per share. The latest that the Warrants may expire is December
15, 2009.
As
of
April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
to
personally support our cash requirements to enable us to fulfill our obligations
through June 1, 2007, to the extent necessary, up to a maximum amount of $1.5
million, based upon their ability to sell their Company common stock. Mr. Newman
guaranties up to approximately $0.9 million, Mr. Peipert guaranties up to
approximately $0.4 million and Mr. DeLeeuw guaranties approximately $0.2
million. We believe that these written commitments provide us with the legal
right to request and receive such advances from any of these officers. Any
loan
by Messrs. Newman, Peipert and DeLeeuw to the Company would bear interest at
8%
per annum. As of December 31, 2005, Mr. Newman’s outstanding loan balance to the
Company was approximately $0.9 million, and Mr. Peipert’s outstanding loan
balance to the Company was approximately $0.9 million. The unsecured loans
by
Mr. Newman and Mr. Peipert each accrue interest at a simple rate of 8% per
annum, and each has a term expiring on April 30, 2007. As of the date of this
filing, the entire $1.5 million was still available pursuant to the guaranties
outlined above.
The
following is a summary of the debt instruments outstanding as of March 31,
2006
Lender
|
Type
of facility
|
Outstanding
as of March 31, 2006 (not including interest) (all numbers
approximate)
|
|
Remaining
Availability (if applicable)
|
Laurus
Master Fund, Ltd.
|
Line
of Credit
|
$5,752,000
|
|
$0
|
Laurus
Master Fund, Ltd.
|
Term
Note
|
$955,000
|
|
$0
|
Sands
Brothers Venture Capital LLC
|
Convertible
Promissory Note
|
$54,000
|
|
$0
|
Sands
Brothers Venture Capital III LLC
|
Convertible
Promissory Note
|
$918,000
|
|
$0
|
Sands
Brothers Venture Capital IV LLC
|
Convertible
Promissory Note
|
$108,000
|
|
$0
|
Taurus
Advisory Group, LLC investors
|
Convertible
Promissory Note
|
$3,500,000
|
|
$0
|
Taurus
Advisory Group, LLC investors
|
Series
A Convertible Preferred Stock
|
$1,900,000
|
|
$0
|
Scott
Newman
|
Promissory
Note
|
$
863,000
|
|
$0
|
Glenn
Peipert
|
Promissory
Note
|
$
909,000
|
|
$0
|
TOTAL
|
|
$14,959,000
|
|
$0
|
The
Company has generated losses that exceeded expectations during 2004 and
continued throughout 2005. To that extent, the Company has experienced continued
negative cash flow which has created a liquidity issue for the Company. To
address this issue, in addition to the various transactions above, in November
2004, the Company entered into a Stock Purchase Agreement (the “Agreement”) with
a private investor, CMKX-treme, Inc. Pursuant to the Agreement,
CMKX-treme, Inc. agreed to purchase 833,333 shares of common stock for a
purchase price of $1.75 million. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 238,095 shares of common stock for $0.5
million, and it was required to purchase the remaining 595,238 shares of common
stock for $1.25 million by December 31, 2004. As of March 17, 2005, CMKX-treme,
Inc. remitted final payment for the remaining 595,238 shares.
In
2004,
the Company completed various financing transactions through the issuance of
common stock, as well as the issuance of notes and warrants convertible into
our
common stock, while a registration statement was on file with the Securities
and
Exchange Commission but had not yet been declared effective. Those transactions
were with the following entities:
|
· Taurus
Advisory Group, LLC
|
$4.0
million
|
|
|
· Laurus
Master Fund, Ltd.
|
$11.0
million
|
|
|
· Sands
Brothers International Ltd.
|
|
|
|
(3
affiliated entities)
|
$1.0
million
|
|
Even
though all stockholders, noteholders and warrantholders have been advised of
their rights to rescind those financing transactions and they each have waived
their rights to rescind those transactions, there is a remote possibility that
each of those transactions could be reversed. In such an event, the Company
could be adversely affected and may have an obligation to fund such
rescissions.
Although
the Company has negative working capital at December 31, 2005 and March 31,
2006, and has incurred significant operating losses, the Company believes
existing cash plus funds provided by operations, borrowing capacity under the
line of credit and projected borrowing against, or the guarantees of the primary
stockholders should be sufficient to fund operations through January 1, 2007.
Nevertheless, the Company is presently exploring various financing alternatives,
including debt or additional sales of equity securities in order to finance
the
core business of the Company and help provide adequate working capital for
operations. There is no assurance that funds will be provided by operations
or
that such additional financing will be available, or if available, will be
available on acceptable terms. Should the Company experience significant
shortfalls in planned revenues, or experience unforeseen fixed expenses, the
Company believes it has the ability to make additional reductions to variable
expenses to extend its capital. Any decision or ability to obtain financing
through debt or through equity investment will depend on various factors,
including, among others, financial market conditions, strategic acquisition
and
investment opportunities, and developments in the Company's markets. The sale
of
additional equity securities or future conversion of any convertible debt would
result in additional dilution to the Company's
stockholders.
Off-balance
sheet arrangements
The
Company does not have any transactions, agreements or other contractual
arrangements that constitute off-balance sheet arrangements.
Contractual
Obligations
At
December 31, 2005, the Company had certain contractual cash obligations and
other commercial commitments, as set forth in the following table (amounts
in
table are noted in millions):
|
|
|
|
Less
than 1
|
|
|
|
|
|
Contractual
Obligations
|
|
Total
|
|
year
|
|
1-3
years
|
|
4-5
years
|
|
Long-term
debt
|
|
$
|
3.9
|
|
$
|
0.5
|
|
$
|
1.4
|
|
$
|
2.0
|
|
Related
Party Debt |
|
|
1.8 |
|
|
- |
|
|
1.8 |
|
|
- |
|
Capital
lease obligations
|
|
|
0.1
|
|
|
0.1
|
|
|
-
|
|
|
-
|
|
Operating
leases
|
|
|
2.0
|
|
|
0.5
|
|
|
1.1
|
|
|
0.4
|
|
Employment
agreements
|
|
|
3.9
|
|
|
3.9
|
|
|
-
|
|
|
-
|
|
Total
|
|
$
|
11.7
|
|
|
5.0
|
|
$
|
4.3
|
|
$
|
2.4
|
|
APPLICATION
OF CRITICAL ACCOUNTING POLICIES
Revenue
recognition
Our
revenue recognition policy is significant because revenues are a key component
of our results from operations. In addition, revenue recognition determines
the
timing of certain expenses, such as incentive compensation. We follow very
specific and detailed guidelines in measuring revenue; however, certain
judgments and estimates affect the application of the revenue policy. Revenue
results are difficult to predict and any shortfall in revenues or delay in
recognizing revenues could cause operating results to vary significantly from
quarter to quarter and could result in future operating losses or reduced net
income.
Services
Revenue
from consulting and professional services is recognized at the time the services
are performed on a project by project basis. For projects charged on a time
and
materials basis, revenue is recognized based on the number of hours worked
by
consultants at an agreed-upon rate per hour. For large services projects where
costs to complete the contract could reasonably be estimated, the Company
undertakes projects on a fixed-fee basis and recognizes revenues on the
percentage of completion method of accounting based on the evaluation of actual
costs incurred to date compared to total estimated costs. Revenues recognized
in
excess of billings are recorded as costs in excess of billings. Billings in
excess of revenues recognized are recorded as deferred revenues until revenue
recognition criteria are met. Reimbursements, including those relating to travel
and other out-of-pocket expenses, are included in revenues, and an equivalent
amount of reimbursable expenses are included in cost of services.
Business
Combinations
We
are
required to allocate the purchase price of acquired companies to the tangible
and intangible assets acquired and liabilities assumed based on their estimated
fair values. Such a valuation requires us to make significant estimates and
assumptions, especially with respect to intangible assets. Critical estimates
in
valuing certain intangible assets include, but are not limited to, future
expected cash flows from customer contracts, customer lists, distribution
agreements and acquired developed technologies, and estimating cash flows from
projects when completed
and discount rates. Our estimates of fair value are based upon assumptions
believed to be reasonable, but which are inherently uncertain and unpredictable
and, as a result, actual results may differ from estimates. These estimates
may
change as additional information becomes available regarding the assets acquired
and liabilities assumed. Additionally,
in accordance with “EITF 99-12,” the Company values an acquisition based upon
the market price of its common stock for a reasonable period before and after
the date the terms of the acquisition are agreed to and announced.
Impairment
of Goodwill, Intangible Assets and Other Long-Lived
Assets
We
evaluate our identifiable goodwill, intangible assets, and other long-lived
assets for impairment on an annual basis and whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable based on expected undiscounted cash flows attributable to that
asset. Future impairment evaluations could result in impairment charges, which
would result in an expense in the period of impairment and a reduction in the
carrying value of these assets.
Allowances
for Doubtful Accounts
We
make
judgments regarding our ability to collect outstanding receivables and provide
allowances for the portion of receivables when collection becomes doubtful.
Provisions are made based upon a specific review of all significant outstanding
invoices. For those invoices not specifically reviewed, provisions are provided
at differing rates, based upon the age of the receivable. In determining these
percentages, we analyze our historical collection experience and current
economic trends. If the historical data we use to calculate the allowance
provided for doubtful accounts does not reflect the future ability to collect
outstanding receivables, additional provisions for doubtful accounts may be
needed and our future results of operations could be materially affected. During
2005, $56,123 of uncollectible accounts receivable were written off of the
accounts receivable against the allowance for doubtful accounts.
Discount
on Debt
The
Company has allocated the proceeds received from convertible debt instruments
between the underlying debt instruments and the detachable warrants, and
has
recorded the conversion feature as a liability in accordance with SFAS No.
133.
The conversion feature and certain other features that are considered embedded
derivative instruments, such as a variable interest rate feature, a conversion
reset provision and redemption option, have been recorded at their fair value
within the terms of SFAS No. 133 as its fair value can be separated from
the
convertible note and its conversion is independent of the underlying note
value.
The conversion liability is marked to market each reporting period with the
resulting gains or losses shown on the Statement of Operations. The Company
has
also recorded the resulting discount on debt related to the warrants and
conversion feature and is amortizing the discount using the effective interest
rate method over the life of the debt instruments. The discount is classified
as
a deferred financing cost.
Financial
Instruments
The
carrying value of the Company’s financial instruments, including cash and cash
equivalents, accounts receivable, note receivable, accounts payable and
accrued
liabilities approximate fair value because of the short maturities of those
instruments. Based on borrowing rates currently available to the Company
for
loans with similar terms, the carrying value of convertible notes and notes
payable are also approximate fair value.
We
review
the terms of convertible debt and equity instruments we issued to determine
whether there are embedded derivative instruments, including the embedded
conversion option, that are required to be bifurcated and accounted for
separately as a derivative financial instrument. Generally, where the ability
to
physical or net-share settle the conversion option is deemed to be not
within
the control of the company, the embedded conversion option is required
to be
bifurcated and accounted for as a derivative financial instrument
liability.
In
connection with the sale of convertible debt and equity instruments, we
may also
issue freestanding options or warrants. Additionally, we may issue options
or
warrants to non-employees in connection with consulting or other services
they
provide. Although the terms of the options and warrants may not provide
for
net-cash settlement, in certain circumstances, physical or net-share settlement
is deemed to not be within the control of the company and, accordingly,
we are
required to account for these freestanding options and warrants as derivative
financial instrument liabilities, rather than as equity.
Derivative
financial instruments are initially measured at their fair value. For derivative
financial instruments that are accounted for as liabilities, the derivative
instrument is initially recorded at its fair value and is then re-valued
at each
reporting date, with changes in the fair value reported as charges or credits
to
income. For option-based derivative financial instruments, we use the
Black-Scholes option pricing model to value the derivative
instruments.
In
circumstances where the embedded conversion option in a convertible instrument
is required to be bifurcated and there are also other embedded derivative
instruments in the convertible instrument that are required to be bifurcated,
the bifurcated derivative instruments are accounted for as a single, compound
derivative instrument.
If
freestanding options or warrants were issued and will be accounted for
as
derivative instrument liabilities (rather than as equity), the proceeds
are
first allocated to the fair value of those instruments. When the embedded
derivative instrument is to be bifurcated and accounted for as a liability,
the
remaining proceeds received are then allocated to the fair value of the
bifurcated derivative instrument. The remaining proceeds, if any, are then
allocated to the convertible instrument itself, usually resulting in that
instrument being recorded at a discount from its face amount. In circumstances
where a freestanding derivative instrument is to be accounted for as an
equity
instrument, the proceeds are allocated between the convertible instrument
and
the derivative equity instrument, based on their relative fair
values.
The
discount from the face value of the convertible debt instrument resulting
from
the allocation of part of the proceeds to embedded derivative instruments
and/or
freestanding options or warrants is amortized over the life of the instrument
through periodic charges to income, using the effective interest method.
The
classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end
of
each reporting period. Derivative instrument liabilities are classified
in the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument is expected within 12 months of
the
balance sheet date.
Equity
investments
Prior
to
the Company’s acquisition of DeLeeuw in 2004, DeLeeuw had acquired a
non-controlling interest in DeLeeuw International (a company formed under
the
laws of Turkey). The Company accounts for its share of the income (losses)
of
this investment under the equity method.
Stock-based
Compensation
We
issue
stock options to our employees and provide our employees the right to purchase
ordinary shares under employee stock purchase plans. We account for our
stock-based compensation plans under the intrinsic value method of accounting
as
defined by Accounting Principles Board Opinion No. 25, “Accounting
for Stock Issued to Employees”
(“APB 25”) and related interpretations. For equity instruments under fixed
plans, APB 25 does not require that any amount of expense to be recorded in
the statement of income; however, SFAS No. 123, “Accounting
for Stock-Based Compensation”
does
require disclosure of these amounts in a pro forma table to the financial
statements. In determining this disclosure the value of an option is estimated
using the Black Scholes option valuation model. This model requires the input
of
highly subjective assumptions and a change in our assumptions could materially
affect the fair value estimate, and thus the total calculated costs associated
with the grant of stock options or issuance of stock under employee stock
purchase plans. In addition, in disclosing the fair-value cost of stock-based
compensation, we estimate that we will be able to obtain a 40% tax benefit
on
these costs. There is the potential that this tax benefit will not be obtained
to this extent or at all, which directly impacts the level of expenses
associated with stock-based compensation. We expect our accounting policies,
regarding stock-based compensation to be materially affected by our adoption
of
SFAS123R, which is described under “Recent Pronouncements.” We have not yet
determined what the impact of the adoption of SFAS123R will be on our
compensation philosophy.
Deferred
Income Taxes
Determining
the consolidated provision for income tax expense, income tax liabilities and
deferred tax assets and liabilities involves judgment. We record a
valuation allowance to reduce our deferred tax assets to the amount of future
tax benefit that is more likely than not to be realized. We have considered
future taxable income and prudent and feasible tax planning strategies in
determining the need for a valuation allowance. A valuation allowance is
maintained by the Company due to the impact of the current years net operating
loss (NOL). In the event that we determine that we would not be able to realize
all or part of our net deferred tax assets, an adjustment to the deferred tax
assets would be charged to net income in the period such determination is made.
Likewise, if we later determine that it is more likely than not that the net
deferred tax assets would be realized, then the previously provided valuation
allowance would be reversed. Our current valuation allowance relates
predominately to benefits derived from the utilization of our
NOL’s.
Recent
Pronouncements
SFAS
No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based Payment,”
issued in December 2004, is a revision of FASB Statement 123, “Accounting for
Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting
for Stock Issued to Employees,” and its related implementation guidance. The
Statement focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. SFAS
No. 123R requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award. On March 29, 2005, the SEC issued Staff Accounting
Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views
regarding interactions between SFAS No. 123R and certain SEC rules and
regulations and provides interpretations of the valuation of share-based
payments for public companies.
SFAS
No. 123(R) permits public companies to adopt its requirements using one of
two methods:
(1)
A
“modified prospective” method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS
No. 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123 for all awards
granted to employees prior to the effective date of SFAS No. 123(R) that
remain unvested on the effective date.
(2)
A
“modified retrospective” method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based
on the amounts previously recognized under SFAS No. 123 for purposes of pro
forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.
This
statement is effective for the beginning of the first annual reporting period
that begins after June 15, 2005, therefore, we will adopt the standard in
the first quarter of fiscal 2006 using the modified prospective method. As
permitted by SFAS No. 123, we currently account for share-based payments to
employees using the intrinsic value method prescribed in APB Opinion 25 and,
as
such, generally recognize no compensation cost for employee stock options.
Although we have not completed our assessment, we believe the impact on our
consolidated financial position or results or operations will not be material
given the current number of outstanding stock options. The effect on our results
of operations of expensing stock options using the Black-Scholes method is
presented in the disclosure of pro forma net income and earnings per share
in
Note 2. SFAS No. 123(R) 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.
This
requirement will reduce net operating cash flows and increase net financing
cash
flows in periods after adoption.
ITEM
7. FINANCIAL
STATEMENTS.
The
Financial Statements of the Company and the accompanying notes thereto, and
the
independent auditor’s report required by this item are included as part of this
Form 10-KSB and immediately follow the signatures page of this Form
10-KSB.
ITEM
8. CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On
June
1, 2004, Ehrenkrantz Sterling & Co., LLC (“Ehrenkrantz”) merged with the
firm of Friedman Alpren & Green LLP. The new entity, Friedman LLP
(“Friedman”), was retained by us, and our Board of Directors approved this
decision on June 7, 2004. For the period since Ehrenkrantz's appointment through
June 7, 2004, there have been no disagreements with Ehrenkrantz on any matter
of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction
of
Ehrenkrantz would have caused them to make reference thereto in their report.
In
addition, for the period since Ehrenkrantz's appointment through June 7, 2004,
we did not consult with Friedman regarding any matter that was the subject
of a
"disagreement" with Ehrenkrantz, as that term is defined in Item 304(a)(1)(iv)
of Regulation S-K and the related instructions to Item 304 of Regulation S-K,
or
with regard to any "reportable event," as that term is defined in Item
304(a)(1)(v) of Regulation S-K, except as such consultations as may have been
made with former employees of Ehrenkrantz who are now employees of
Friedman.
ITEM
8A. CONTROLS AND PROCEDURES
Evaluation
of disclosure controls and procedures.
Under
the
supervision and with the participation of our management, including our chief
executive officer and our chief financial officer, we have assessed the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Securities Exchange Act of 1934 Rule 13a-15(e) as
of the
end of the period covered by this report. Based on that assessment, our
management has concluded that our internal control over financial reporting
was
not effective as of December 31, 2005 because of the material weaknesses
identified and described below.
Control
Activities:
1.
The
Company did not maintain effective controls over the accounting for embedded
derivatives in certain financial instruments. Specifically the Company did
not
have controls designed and in place to ensure the completeness, accuracy
and
evaluation of embedded derivatives in its financing transactions with Laurus
Master Fund, Ltd. and with three entities affiliated with Sands Brothers
International Limited. The instruments included, among other things, convertible
notes, freestanding warrant agreements and registration rights agreements.
The
warrant agreements are subject to registration rights agreements which require
that the Company register the shares within a specified period of time and,
in
the event this is not done, provides for significant liquidated damages.
In
accordance with EITF 00-19 “Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own Stock,” the Company
previously recorded a liability for these warrants. However, although the
convertible notes are also subject to the registration rights agreements
and are
not “conventionally convertible,” the Company had not previously recorded a
liability for the derivative associated with the conversion feature.
Additionally, in July 2005, the Company renegotiated its financing with Laurus.
As part of this transaction, the Company repaid $4.3 million to Laurus, issued
an option to purchase Company stock at $0.015 per share and increased the
availability under the revolving line of credit by $500,000. Since future
cash
flows under the new agreement with Laurus are more than 10% different than
under
the 2004 agreement with Laurus, it has been determined that this transaction
should have been accounted for as an early extinguishment of debt as opposed
to
a modification of existing debt.
The
deficiency resulted in a restatement of its financial statements for the
three
and nine months ended September 30, 2004, the year ended December 31, 2004,
the
three months ended March 31, 2005, the three and six months ended June 30,
2005
and the three and nine months ended September 30, 2005 as appropriate to
properly account for the above transactions.
2.
The
Company did not maintain effective controls to ensure the completeness, accuracy
and valuation over the accounting for business combinations, including the
inability to prepare financial statements and footnotes in accordance with
SEC
rules and regulations and with our 2004 acquisitions of DeLeeuw Associates,
Inc.
and Evoke Software Corporation. We misapplied generally accepted accounting
principles whereby we did not value the acquisitions and record the resulting
purchase accounting in accordance with SFAS 141 and EITF 99-12. As a result,
we
were required in April 2005 to restate our financial statements for the three
months ended March 31, 2004, for the three and six months ended June 30,
2004
and for the three and nine months ended September 30, 2004. Management
determined that the disclosure controls and procedures for these three quarters
were not effective.
3.
The
Company did not maintain effective controls over the period end financial
reporting process. Specifically, controls were not designed and in place
to
ensure that to the Company identified certain transactions, primarily
contractual, and accounted for them in the proper periods. This does not
relate
to the subject matter of the material weaknesses described above, yet combined
with the above-referenced material weaknesses, constitute in the aggregate
a
material weakness in our internal control over financial reporting.
4.
The
Company did not maintain effective controls over the accounting for income
taxes
to ensure amounts disclosed are accurately accounted for in accordance
with
GAAP. Specifically, the Company did not have controls designed and functioning
to ensure that accounting personnel prepared the necessary disclosures
required
by FASB No. 109 “Accounting for Income Taxes.”
Remediation
of Material Weaknesses in Internal Control over Financial Reporting
In
light
of the need for these restatements and the material weaknesses described
above,
management began in the second quarter of our 2005 fiscal year, and continuing
through the period covered by this report, to undertake a review of our
disclosure, financial information and internal controls and procedures regarding
these areas for future complex financing transactions and acquisitions. This
review has included efforts by our management and directors, as well as the
use
of additional outside resources, as follows:
•
Senior
accounting personnel and our chief financial officer will continue to review
any
complex financing transaction in order to evaluate, document and approve
its
accounting treatment in accordance with EITF 00-19 and EITF 00-27;
•
Senior
accounting personnel and our chief financial officer will continue to review
any
future acquisition or divestiture in order to evaluate, document and approve
its
accounting treatment in accordance with SFAS 141 and EITF 99-12;
•
We
will
augment, as necessary, such procedures by obtaining concurrence with independent
outside accounting experts prior to finalizing financial reporting for such
transactions; and
•
We
will
incorporate the applicable parts of the action plan described
below.
In
conjunction with the measures outlined below, we believe these actions will
strengthen our internal control over our review of complex financing
transactions. We also believe these actions have sufficiently strengthened
our
internal control over our valuation and purchase accounting of acquisitions,
and
this material weakness should be resolved. Management does not anticipate
any
extra cost from this change over our review of complex financing transactions
and in its valuation and purchase accounting of future acquisitions. Management
established an action plan in the first quarter of 2005 that it believes
will
correct the aggregated material weaknesses described above. Our estimated
costs
related to the correction of these material weaknesses is approximately $0.25
million, most notably related to our conversion to the Great Plains accounting
system during the third quarter of 2004. Other measures included in our action
plan are as follows:
•
Our
Disclosure Committee, formed in the second quarter of 2005, consists of our
chief executive officer, chief operating officer, senior vice president of
sales, general counsel and controller, chaired by our chief financial officer.
The Disclosure Committee is comprised of these key members of senior management
who have knowledge of significant portions of our internal control system,
as
well as the business and competitive environment in which we operate. One
of the
key responsibilities of each Disclosure Committee member is to review quarterly
reports, annual
reports and registration statements to be filed with the SEC as each progress
through the preparation process. Open lines of communication to financial
reporting management exist for Disclosure Committee members to convey comments
and suggestions;
•
A
process has been established whereby material agreements are reviewed by
the
legal and sales departments and an executive
management member that includes determination of appropriate accounting and
disclosure;
•
Our
accounting and legal departments are working closely and in conjunction to
accurately account for period-end financial reporting and complex financing
transactions;
•
We
are
constantly assessing our existing environment and continue to make further
changes, as appropriate, in our finance and accounting organization to create
clearer segregation of responsibilities and supervision, and to increase
the
level of technical accounting expertise including the use of outside accounting
experts;
•
There
has been closer monitoring of the preparation of our monthly and quarterly
financial information. We have instituted regular quarterly meetings to review
each department’s significant activities and respective disclosure controls and
procedures;
•
Department managers have been tasked with tracking relevant non-financial
operating metrics and other pertinent operating information and communicating
their findings to a member of the Disclosure Committee; and
•
We
have
conducted quarterly reviews of the effectiveness of our disclosure controls
and
procedures, and we have enhanced our quarterly close process to include detailed
analysis in support of the financial accounts, and improved supervision over
the
process.
We
believe that we will satisfactorily address the control deficiencies and
material weakness relating to these matters by the end of the third quarter
of
2006, although there can be no assurance that we will do so.
Given
the
presence of material weaknesses in our internal control over financial
reporting, there is a more than a remote likelihood that a material misstatement
of the annual or interim financial statements will not be prevented or detected.
Our financial reporting process includes extensive procedures we undertake
in
order to obtain assurance regarding the reliability of our published financial
statements, notwithstanding the material weaknesses in internal control.
We have
expanded our year-end closing procedures. We have expanded our review of
embedded derivative in our financial instruments. We have expanded our review
of
accounting for business combinations. All of the above mentioned procedures
have
been designed to help compensate for our material weaknesses in order to
provide
assurance that the financial statements are free of material inaccuracies
or
omissions of material fact. As a result, management, to the best of its
knowledge, believes that (i) the report does not contain any untrue statements
of a material fact or omits any material fact and (ii) the consolidated
financial statements and other financial information included in this report
for
the year ended December 31, 2005 have been prepared in conformity with GAAP
and
fairly present in all material aspects our financial condition, results of
operations and cash flows.
Management,
including our chief executive officer and our chief financial officer, does
not
expect that our disclosure controls and internal controls will prevent all
error
or all fraud, even as the same are improved to address any deficiencies and/or
weaknesses. A control system, no matter how well conceived and operated,
can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Over time, controls may become inadequate because
of
changes in conditions or deterioration in the degree of compliance with policies
or procedures. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in
all
control systems, no evaluation of controls can provide absolute assurance
that
all control issues and instances of fraud, if any, within the Company have
been
detected. These inherent limitations include the realities that judgments
in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control.
Changes
in internal control over financial reporting.
We
are in
the process of developing a comprehensive remediation plan to address our
deficiencies and expect that this plan will extend into the third quarter
of the
2006 fiscal year. The following list describes remedial actions that have
been
implemented since
our
last Annual Report:
•
Senior
accounting personnel and our chief financial officer continue to review any
complex financing transaction in order to evaluate, document and approve
its
accounting treatment in accordance with EITF 00-19 and EITF 00-27;
•
Senior
accounting personnel and our chief financial officer continue to review any
future acquisition or divestiture in order to evaluate, document and approve
its
accounting treatment in accordance with SFAS 141 and EITF 99-12;
•
We
have
augmented, as necessary, such procedures by obtaining concurrence with
independent outside accounting experts prior to finalizing financial reporting
for such transactions;
•
Our
Disclosure Committee meets at the end of every quarter;
•
Our
accounting and legal departments continue to work more closely and in
conjunction to accurately account for period-end financial reporting and
complex
financing transactions;
•
There
has been closer monitoring of the preparation of our monthly and quarterly
financial information. We have instituted regular quarterly meetings to review
each department’s significant activities and respective disclosure controls and
procedures; and
•
Department managers have been tasked with tracking relevant non-financial
operating metrics and other pertinent operating information and communicating
their findings to a member of the Disclosure Committee.
Not
applicable.
PART
III
ITEM
9. DIRECTORS,
EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION
16(A)
OF THE EXCHANGE ACT.
The
following table sets forth the names and ages of our current directors and
executive officers, the principal offices and positions with us held by each
person and the date such person became a director or executive officer. Our
Board of Directors elects our executive officers annually. Each year the
stockholders elect the members of our Board of Directors.
Our
directors and executive officers are as follows:
Name
|
Year
First Elected As an Officer Or Director
|
Age
|
Position(s)
Held
|
Scott
Newman
|
2004
|
46
|
President,
Chief Executive Officer and Chairman
|
Glenn
Peipert
|
2004
|
45
|
Executive
Vice President, Chief Operating Officer and Director
|
Mitchell
Peipert
|
2004
|
47
|
Vice
President, Chief Financial Officer, Secretary and Treasurer
|
Robert
C. DeLeeuw
|
2004
|
49
|
Senior
Vice President and President of DeLeeuw Associates, LLC
|
William
McKnight
|
2005
|
40
|
Senior
Vice President - Data Warehousing
|
Lawrence
K. Reisman*
|
2004
|
46
|
Director
|
Joseph
Santiso**
|
2005
|
61
|
Director
|
*Chair
of
the Audit Committee, the Compensation Committee and the Nominating and Corporate
Governance Committee.
**
Member
of the Audit Committee, the Compensation Committee and the Nominating and
Corporate Governance Committee.
SCOTT
NEWMAN has been our President, Chief Executive Officer and Chairman since
January 2004. Mr. Newman founded the former Conversion Services International,
Inc. in 1990 (before its merger with and into LCS Group, Inc.) and is our
largest stockholder. He has over twenty years of experience providing technology
solutions to major companies internationally. Mr. Newman has direct experience
in strategic planning, analysis, design, testing and implementation of complex
big-data solutions. He possesses a wide range of software and hardware
architecture/discipline experience, including, client/server, data discovery,
distributed systems, data warehousing, mainframe, scaleable solutions and
e-business. Mr. Newman has been the architect and lead designer of several
commercial software products used by Chase, Citibank, Merrill Lynch and Jaguar
Cars. Mr. Newman advises and reviews data warehousing and business intelligence
strategy on behalf of our Global 2000 clients, including AT&T Capital,
Jaguar Cars, Cytec and Chase. Mr. Newman is a member of the Young Presidents
Organization, a leadership organization that promotes the exchange of ideas,
pursuit of learning and sharing strategies to achieve personal and professional
growth and success. Mr. Newman received his B.S. from Brooklyn College in
1980.
GLENN
PEIPERT has been our Executive Vice President, Chief Operating Officer and
Director since January 2004. Mr. Peipert held the same positions with the former
Conversion Services International, Inc. since its inception in 1990 and is
our
second largest stockholder. Mr. Peipert has over two decades of experience
consulting to major organizations about leveraging technology to enable
strategic change. He has advised clients representing a broad cross-section
of
rapid growth industries worldwide. Mr. Peipert has hands on experience with
the
leading data warehousing products. His skills include architecture design,
development and project management. He routinely participates in architecture
reviews and recommendations for our Global 2000 clients. Mr. Peipert has managed
major technology initiatives at Chase, Tiffany, Morgan Stanley, Cytec and the
United States Tennis Association. He speaks nationally on applying data
warehousing technologies to enhance business effectiveness and has authored
multiple white papers regarding business intelligence. Mr. Peipert is a member
of the Institute of Management Consultants, as well as TEC International, a
leadership organization whose mission is to increase the effectiveness and
enhance the lives of chief executives and those they influence. Mr. Peipert
is
the brother of Mitchell Peipert, our Vice President, Chief Financial Officer,
Secretary and Treasurer. Mr. Peipert received his B.S. from Brooklyn College
in
1982.
MITCHELL
PEIPERT has been our Vice President, Chief Financial Officer, Secretary and
Treasurer since January 2004. Mr. Peipert is a Certified Public Accountant
who
held the same positions with the former Conversion Services International,
Inc.
from January 2001 to September 2002. From September 2002 to December 2003,
Mr.
Peipert was Senior Sales Executive for NIA Group and President of E3 Management
Advisors. From April 1992 until January 2001, Mr. Peipert served as Senior
Vice
President of Operations and Controller of TSR Wireless LLC, where he directed
the accounting, operations and human resources functions. He also assisted
the
chief executive officer in strategic planning, capital raising and acquisitions.
Prior to his employment by TSR, he held various managerial roles for Anchin,
Block & Anchin, certified public accountants, Merrill Lynch and Grant
Thornton. Mr. Peipert is the brother of Glenn Peipert, our Executive Vice
President, Chief Operating Officer and Director. Mr. Peipert received his B.S.
from Brooklyn College in 1980 and received his M.B.A. in Finance from Pace
University in 1986.
ROBERT
C.
DELEEUW has been our Senior Vice President and the President of our wholly
owned
subsidiary, DeLeeuw Associates, LLC, since March 2004 and is our third largest
stockholder. Mr. DeLeeuw founded DeLeeuw Associates, LLC, formerly known as
DeLeeuw Associates, Inc., in 1991. Mr. DeLeeuw has over twenty-five years
experience in banking and consulting. During this time, he has managed and
supported some of the largest merger projects in the history of the financial
services industry and has implemented numerous large-scale business and process
change programs for his clients. He has been published in American Banker,
Mortgage Banking Magazine, The Journal of Consumer Lending and Bank Technology
News where he has also served as a member of the Editorial Advisory Board.
Mr.
DeLeeuw received his B.S. from Rider University in 1979 and received his M.S.
in
Management from Stevens Institute of Technology in 1986.
WILLIAM
MCKNIGHT has been our Senior Vice President - Data Warehousing since July 2005.
Mr. McKnight founded McKnight Associates, Inc. in 1998. Prior to forming his
company, from 1992-1998, Mr. McKnight held various information technology
management positions at Visa, and Anthem Blue Cross Blue Shield. From 1990-1992,
Mr. McKnight was a consultant for Platinum Technology, and he was a developer
of
the DB2 product at IBM from 1987-1990. Mr. McKnight received his B.S. in
Computer Science from Southern College in 1987 and received his M.B.A. from
Santa Clara University in 1994.
LAWRENCE
K. REISMAN has been a Director of our company since February 2004 and is the
Chair of the Audit Committee, the Compensation Committee and the Nominating
and
the Corporate Governance Committee. Mr. Reisman is a Certified Public Accountant
who has been the principal of his own firm, The Accounting Offices of L.K.
Reisman, since 1986. Prior to forming his company, Mr. Reisman was a tax manager
at Coopers & Lybrand and Peat Marwick Mitchell. He routinely provides
accounting services to small and medium-sized companies, which services include
auditing, review and compilation of financial statements, corporate, partnership
and individual taxation, designing accounting systems and management consulting
services. Mr. Reisman received his B.S. and M.B.A. in Finance from St. John’s
University in 1981 and 1985, respectively.
JOSEPH
SANTISO has been a Director of our company since May 2005 and was appointed
by
the Board to sit on the Board's Audit Committee, Nominating and Corporate
Governance Committee and Compensation Committee in May 2005. Mr. Santiso founded
and is President of The BCI Group, which consists of Breakthrough Concepts
Inc.,
BCI Systems Inc. and BCI Knowledge Inc., since 1991. Prior to founding BCI,
Mr.
Santiso was the Chief Accounting Officer for Citibank Stock Transfer Services
Division, a Financial Analyst in the Comptrollers Department of the Operational
Services Division at Irving Trust and a Professor of Accounting at Jersey City
State College. Mr. Santiso received his B.S. from Pace University in 1973 with
a
major in Accounting and Finance.
Directors
do not receive compensation for their duties as directors.
Code
of Conduct and Ethics
Our
Board
of Directors has adopted a Code of Conduct and Ethics which is applicable to
all
our directors, officers, employees, agents and representatives, including our
principal executive officer and principal financial officer, principal
accounting officer or controller, or other persons performing similar functions.
We have made available on our website copies of our Code of Conduct and Ethics
and charters for the committees of our Board and other information that may
be
of interest to investors.
Director
Independence
The
Board
has reviewed each of the directors' relationships with the Company in
conjunction with Section 121(A) of the listing standards of the American Stock
Exchange ("AMEX") and has affirmatively determined that two of our directors,
Lawrence K. Reisman and Joseph Santiso, are independent of management and free
of any relationship that would interfere with the independent judgment as
members of the Audit Committee. The
Company is in the process of interviewing independent director candidates so
the
Board of Directors will have a majority of independent
directors.
Committees
of the Board of Directors
The
Board
of Directors has established three standing committees: (1) the Audit Committee,
(2) the Compensation Committee and (3) the Nominating and Corporate Governance
Committee. Each committee operates under a charter that has been approved by
the
Board. Copies of the Audit Committee, Compensation Committee and Nominating
and
Corporate Governance Committee's' charters are posted on the Company's website.
Mr. Reisman and Mr. Santiso are the members of each of such committees. Mr.
Reisman serves as the Chair of each of such committees.
Audit
Committee
The
Audit
Committee was formed in April 2005. The Audit Committee has met once since
its
formation and each member of the Audit Committee was present at such meeting,
and acted by unanimous written consent four times. The Audit Committee is
responsible for matters relating to financial reporting, internal controls,
risk
management and compliance. These responsibilities include appointing,
overseeing, evaluating and approving the fees of our independent auditors,
reviewing financial information which is included in our Annual Report on Form
10-KSB/A, discussions with management and the independent auditors the results
of the annual audit and our quarterly financial statements, reviewing with
management our system of internal controls and financial reporting process
and
monitoring our compliance program and system.
The
Audit
Committee operates pursuant to a written charter, which sets forth the functions
and responsibilities of this committee. A copy of the charter can be viewed
on
our website. All members of this committee are independent directors under
the
SEC rules. The Board of Directors has determined that Lawrence K. Reisman,
the
committee’s chairman, meets the SEC criteria of an “audit committee financial
expert”, as defined in Item 401(e) of Regulation S-B.
Compensation
Committee
The
Compensation Committee was formed in May 2005 and did not meet during fiscal
2005. The Compensation Committee is responsible for matters relating to the
development, attraction and retention of the Company’s management and for
matters relating to the Company’s compensation and benefit programs. As part of
its responsibilities, this committee evaluates the performance and determines
the compensation of the Company’s Chief Executive Officer and approves the
compensation of our senior officers.
The
Compensation Committee operates under a written charter that sets forth the
functions and responsibilities of this committee. A copy of the charter can
be
viewed on our website.
Pursuant
to its charter, the Compensation Committee must be comprised of at least two
(2)
Directors who, in the opinion of the Board of Directors, must meet the
definition of “independent director” within the rules and regulations of the
SEC. The Board of Directors has determined that all members of this committee
are independent directors under the SEC rules.
Nominating
and Corporate Governance Committee
The
Nominating and Corporate Governance Committee is responsible for providing
oversight on a broad range of issues regarding our corporate governance
practices and policies and the composition and operation of the Board of
Directors. These responsibilities include reviewing potential candidates for
membership on the Board and recommending to the Board nominees for election
as
directors of the Company. The Nominating and Corporate Governance Committee
was
formed in May 2005 and did not meet during fiscal 2005. A complete description
of the Nominating and Corporate Governance Committee’s responsibilities is set
forth in the Nominating and Corporate Governance written charter. A copy of
the
charter is available to stockholders on the Company’s website. All members of
the Nominating and Corporate Governance Committee are independent directors
as
defined by the rules and regulations of the SEC. The Nominating and Corporate
Governance Committee will consider director nominees recommended by
stockholders. There are no minimum qualifications for consideration for
nomination to be a director of the Company. The nominating committee will assess
all director nominees using the same criteria. Nominations made by stockholders
must be made by written notice received by the Secretary of the Company within
30 days of the date on which notice of a meeting for the election of directors
is first given to stockholders. The Nominating and Corporate Governance
Committee and the Board of Directors carefully considers nominees regardless
of
whether they are nominated by stockholders, the Nominating and Corporate
Governance Committee or existing board-members.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our officers,
directors and persons who beneficially own more than 10% of a registered class
of our equity securities (“ten percent stockholders”) to file reports of
ownership and changes in ownership with the Securities and Exchange
Commission. Officers, directors and ten percent stockholders are charged
by the SEC regulations to furnish us with copies of all Section 16(a) forms
they
file.
Based
solely upon a review of Forms 3, 4 and 5 and amendments thereto furnished to
us
during the past fiscal year, and, if applicable, written representations that
Form 5 was not required, we believe that all Section 16(a) filing requirements
applicable to our officers, directors and ten percent stockholders were
fulfilled.
ITEM
10. EXECUTIVE
COMPENSATION.
The
following table sets forth, for the fiscal years indicated, all compensation
awarded to, paid to or earned by the following type of executive officers for
the fiscal years ended December 31, 2005, 2004 and 2003: (i) individuals who
served as, or acted in the capacity of, our principal executive officer for
the
fiscal year ended December 31, 2005; and (ii) our other most highly compensated
executive officer, who together with the principal executive officer are our
most highly compensated officers whose salary and bonus exceeded $100,000 with
respect to the fiscal year ended December 31, 2005 and who were employed at
the
end of fiscal year 2005.
SUMMARY
COMPENSATION TABLE*
|
|
|
Long
Term Compensation
|
|
|
Annual
Compensation(1)
|
Awards
|
Payouts
|
Name
and Principal Position
|
Year
|
Salary
|
Bonus
|
Other
Annual
Compensation
|
Restricted
Stock
Award(s)
|
Securities
Underlying
Options/SARs
|
LTIP
Payouts
|
All
Other
Compensation
|
|
|
($)
|
($)
|
($)
|
($)
|
(#)
|
($)
|
($)
|
|
|
|
|
|
|
|
|
|
Scott
Newman
President,
Chief Executive Officer and Chairman
|
2005
|
500,000
|
—
|
—
|
—
|
—
|
—
|
39,809
(2)
|
2004
|
500,000
|
—
|
—
|
—
|
—
|
—
|
38,054
(2)
|
2003
|
244,452
|
—
|
—
|
—
|
—
|
—
|
206,686
(3)
|
|
|
|
|
|
|
|
|
Glenn
Peipert
Executive
Vice President, Chief Operating Officer and Director
|
2005
|
375,000
|
—
|
—
|
—
|
250,000
|
—
|
40,779
(2)
|
2004
|
375,000
|
—
|
—
|
—
|
—
|
—
|
38,054
(2)
|
2003
|
223,016
|
—
|
—
|
—
|
—
|
—
|
171,309
(4)
|
Mitchell
Peipert, Vice President, Chief Financial Officer, Treasurer and
Secretary
|
2005
|
209,375
|
—
|
—
|
—
|
150,000
|
—
|
24,129
(2)
|
2004
|
190,000
|
—
|
—
|
—
|
300,000
|
—
|
14,413
(2)
|
2003
|
10,000
|
—
|
—
|
—
|
—
|
—
|
1,133
(2)
|
Robert
C. DeLeeuw, Senior Vice President
|
2005
2004
|
350,000
329,400
|
—
—
|
56,695
(5)
—
|
—
—
|
250,000
—
|
—
—
|
17,736
(2)
592
(6)
|
William
McKnight, Senior Vice President -Data Warehousing
|
2005
|
125,047
|
—
|
—
|
—
|
|
—
|
10,494
(2)
|
|
|
|
|
|
|
|
|
_________________________
* |
Salary
reflects total compensation paid to these executives (both before
and
after the merger described in Item
1).
|
(1) |
The
annual amount of perquisites and other personal benefits, if any,
did not
exceed the lesser of $50,000 or 10% of the total annual salary reported
for each named executive officer and has therefore been omitted,
unless
otherwise stated above.
|
(2) |
Amounts
shown reflect payments related to medical, dental and life insurance
and
car payments.
|
(3) |
Amounts
shown reflect distributions resulting from the operating entity’s past tax
status as a Subchapter S corporation of $153,738 in 2003, as well
as
$66,262 in 2003 of expenses, which include auto, travel and equipment
purchases paid for by the Company.
|
(4) |
Amounts
shown reflect distributions resulting from the operating entity’s past tax
status as a Subchapter S corporation of $101,988 in 2003, as well
as
$63,645 in 2003 of expenses, which include auto, travel and equipment
purchases paid for by the Company.
|
(5) |
Incentive
compensation received based on profibility of business units under
Mr.
DeLeeuw’s control.
|
(6) |
Amounts
shown reflect payment related to life
insurance.
|
Option/SAR
Grants During Fiscal 2005
Name
|
Number
of securities underlying options/SARs granted (#) (1)
|
Percent
of total options/SARs granted to employees in fiscal year
|
Exercise
or base price ($/Sh)
|
Expiration
Date
|
Glenn
Peipert
|
250,000
(2)
|
9.3%
|
$0.83
|
November
15, 2010
|
Robert
C. DeLeeuw
|
250,000
(2)
|
9.3%
|
$0.83
|
November
15, 2010
|
Mitchell
Peipert
|
100,000
(3)
|
3.7%
|
$0.83
|
November
15, 2015
|
(1) All
options were granted under the Company's 2003 Incentive Plan. All of the above
options were granted on November
16, 2005.
(2) One-third
of such options vest upon the one year month anniversary of the grant date,
one-third vest on the two year anniversary of the grant date, and one-third
vest
on the three year anniversary of the grant date.
(3) One-third
of such options vest upon the six month anniversary of the grant date, one-third
vest on the eighteen month anniversary of the grant date, and one-third vest
on
the thirty month anniversary of the grant date.
AGGREGATE
OPTIONS EXERCISEABLE IN LAST FISCAL YEAR
AND
FISCAL YEAR END OPTION VALUES
|
|
Number
of Securities
Underlying
Unexercised
Options
at December 31, 2005 (1)
|
Value
of Unexercised
In-the-Money
Options
at
December 31, 2005 (1)
|
Name
and Principal Position
|
Exercisable
|
Unexercisable
|
Exercisable
|
Unexercisable
|
Glenn
Peipert, Executive
Vice President, Chief Operating Officer and Director
|
0
|
250,000
|
$0
|
$0
|
Robert
C. DeLeeuw, Senior Vice President
|
0
|
250,000
|
$0
|
$0
|
Mitchell
Peipert
Vice
President , Chief Financial Officer, Secretary
and Treasurer
|
100,000
|
350,000
|
$0
|
$0
|
(1)
As of
December 30, 2005 the market value of a share of common stock was $0.53. No
shares were exercised by executive officers or directors in fiscal year ended
December 31, 2005.
2003
Incentive Plan
General
The
2003
Incentive Plan was approved at a special meeting of our stockholders on January
23, 2004. The Plan authorizes us to issue 6,666,667 shares of common stock
for
issuance upon exercise of options, and such shares have been reserved. It also
authorizes the issuance of stock appreciation rights, referred to herein as
SARs. The Plan authorizes us to grant:
|
·
|
incentive
stock options to purchase shares of our common stock,
|
|
·
|
non-qualified
stock options to purchase shares of common stock, and
|
|
·
|
SARs
and shares of restricted common
stock.
|
The
Plan
may be amended, terminated or modified by our Board of Directors or our Stock
Option Committee at any time, subject to stockholder approval as required by
law, rule or regulation. No such termination, modification or amendment may
affect the rights of an optionee under an outstanding option or the grantee
of
an award.
Objectives
The
objective of the Plan is to provide incentives to our officers, other key
employees, consultants, professionals and non-employee directors to achieve
financial results aimed at increasing stockholder value and attracting talented
individuals to CSI. Persons eligible to be granted incentive stock options
under
the Plan will be those employees, consultants, professionals and non-employee
directors whose performance, in the judgment of the Stock Option Committee
of
our Board of Directors, can have a significant effect on our
success.
Oversight
The
Stock
Option Committee, consisting of our independent directors Lawrence K. Reisman
(chairman) and Joseph Santiso, administers the Plan by making determinations
regarding the persons to whom options should be granted and the amount, terms,
conditions and restrictions of the awards. The Board or the Stock Option
Committee also has the authority to interpret the provisions of the Plan and
to
establish and amend rules for its administration subject to the Plan’s
limitations.
Types
of grants
The
Plan
allows us to grant incentive stock options, non-qualified stock options, shares
of restricted stock, SARs in connections with options and independent SARs.
The
Plan does not specify what portion of the awards may be in the form of any
of
the foregoing. Incentive stock options awarded to our employees are qualified
stock options under the Internal Revenue Code.
Eligibility
Under
the
Plan, we may grant incentive stock options only to our officers and employees,
and we may grant non-qualified options to officers and employees, as well as
our
directors, independent contractors and agents.
Statutory
Conditions on Stock Options
Exercise
Price.
To the
extent that Options designated as incentive stock options become exercisable
by
an optionee for the first time during any calendar year for common stock having
a fair market value greater than One Hundred Thousand Dollars ($100,000), the
portions of such options which exceed such amount shall be treated as
nonqualified stock options. Incentive stock options granted to any person who
owns, immediately after the grant, stock possessing more than 10% of the
combined voting power of all classes of our stock, or of any parent or
subsidiary of ours, must have an exercise price at least equal to 110% of the
fair market value of common stock on the date of grant and the term of the
option may not be longer than five years.
Expiration
Date.
Any
option granted under the Plan will expire at the time fixed by the Board or
the
Stock Option Committee, which cannot be more than ten (10) years after the
date
it is granted or, in the case of any person who owns more than 10% of the
combined voting power of all classes of our stock or of any parent or subsidiary
corporation, not more than five years after the date of grant.
Exerciseability.
The
Board or its committee may also specify when all or part of an option becomes
exercisable, but in the absence of such specification, the option will
ordinarily be exercisable in whole or part at any time during its term. However,
the Board or its committee may accelerate the exerciseability of any option
at
its discretion.
Assignability.
Options
granted under the Plan are not assignable, except by the laws of descent and
distribution or as may be otherwise provided by the Board or its committee.
Payment
Upon Exercise Of Options
Payment
of the exercise price for any option may be in cash or by broker assisted
exercise.
Stock
Appreciation Rights
A
Stock
Appreciation Right is the right to benefit from appreciation in the value of
common stock. A SAR holder, on exercise of the SAR, is entitled to receive
from
us in cash or common stock an amount equal to the excess of: (a) the fair market
value of common stock covered by the exercised portion of the SAR, as of the
date of such exercise, over (b) the fair market value of common stock covered
by
the exercised portion of the SAR as of the date on which the SAR was granted.
The
Board
or the Stock Option Committee may grant SARs in connection with all or any
part
of an option granted under the Plan, either concurrently with the grant of
the
option or at any time thereafter, and may also grant SARs independently of
options.
Tax
Consequences
An
employee or director will not recognize income on the awarding of incentive
stock options and nonstatutory options under the Plan.
An
optionee will recognize ordinary income as the result of the exercise of a
nonstatutory stock option in the amount of the excess of the fair market value
of the stock on the day of exercise over the option exercise price.
An
employee will not recognize income on the exercise of an incentive stock option,
unless the option exercise price is paid with stock acquired on the exercise
of
an incentive stock option and the following holding period for such stock has
not been satisfied. The employee will recognize long-term capital gain or loss
on a sale of the shares acquired on exercise, provided the shares acquired
are
not sold or otherwise disposed of before the earlier of:
|
(i) |
two
years from the date of award of the option, or
|
|
(ii)
|
one
year from the date of exercise.
|
If
the
shares are not held for the required period of time, the employee will recognize
ordinary income to the extent the fair market value of the stock at the time
the
option is exercised exceeds the option price, but limited to the gain recognized
on sale. The balance of any such gain will be a short-term capital gain.
Exercise of an option with previously owned stock is not a taxable disposition
of such stock. An employee generally must include in alternative minimum taxable
income the amount by which the price such employee paid for an incentive stock
option is exceeded by the option’s fair market value at the time his or her
rights to the stock are freely transferable or are not subject to a substantial
risk of forfeiture.
As
of
December 31, 2005, options to purchase a total of 4,883,114 shares
of
common stock were outstanding at exercise prices ranging from $0.825 to
$3.45
per
share. Generally, one-third of the options granted vest on the first
anniversary, one-third of the options granted vest on the second anniversary
and
one-third of the options granted vest on the third anniversary. All options
expire on the ten year anniversary of their grant date.
All
options described above have been issued pursuant to the 2003 Incentive Plan
described above.
Employment
Agreements
Scott
Newman, our President and Chief Executive Officer, agreed to a five-year
employment agreement dated as of March 26, 2004. The agreement provides for
an
annual salary to Mr. Newman of $500,000 and an annual bonus to be awarded by
our
Compensation Committee. No bonus was awarded in 2005. The agreement also
provides for health, life and disability insurance, as well as a monthly car
allowance. In the event that Mr. Newman’s employment is terminated other than
with good cause, he will receive a lump sum payment of 2.99 times his base
salary.
Glenn
Peipert, Executive Vice President and Chief Operating Officer, agreed to a
five-year employment agreement dated as of March 26, 2004. The agreement
provides for an annual salary to Mr. Peipert of $375,000 and an annual bonus
to
be awarded by our Compensation Committee. No bonus was awarded in 2005. The
agreement also provides for health, life and disability insurance, as well
as a
monthly car allowance. In the event that Mr. Peipert’s employment is terminated
other than with good cause, he will receive a lump sum payment of 2.99 times
his
base salary.
Mitchell
Peipert, Vice President, Chief Financial Officer, Treasurer and Secretary,
agreed to a three-year employment agreement dated as of March 26, 2004. The
agreement provides for an annual salary to Mr. Peipert of $200,000 and an annual
bonus to be awarded by our Compensation Committee. No bonus was awarded in
2005.
In August 2005, Mr. Peipert received an increase to his annual salary to
$225,000. The agreement also provides for health, life and disability insurance,
as well as a monthly car allowance. In the event that Mr. Peipert’s employment
is terminated other than with good cause, he will receive a lump sum payment
of
2.99 times his base salary.
Robert
C.
DeLeeuw, Senior Vice President and President of our wholly owned subsidiary,
DeLeeuw Associates, LLC, agreed to a three-year employment agreement dated
as of
February 27, 2004. The agreement provides for an annual salary to Mr. DeLeeuw
of
$350,000 and an annual bonus to be awarded by our Compensation Committee. No
bonus was awarded in 2005. The agreement also provides for health, life and
disability insurance. In the event that Mr. DeLeeuw’s employment is terminated
other than with good cause, he will receive a lump sum payment of the longer
of
(1) one year's base salary or (2) the period from the date of termination
through the expiration date.
William
McKnight, Senior Vice President - Data Warehousing, agreed to a three-year
employment agreement dated as of July 22, 2005. The agreement provides for
an
annual salary to Mr. McKnight of $250,000 and an annual bonus to be awarded
by
our Compensation Committee. No bonus was awarded in 2005. The agreement also
provides for health, life and disability insurance. In the event that Mr.
McKnight’s employment is terminated other than with good cause, he will receive
a lump sum payment of the longer of (1) one year's base salary or (2) the period
from the date of termination through the expiration date.
ITEM
11. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The
following table sets forth certain information regarding the beneficial
ownership of our common stock, our only class of outstanding voting securities
as of March 31, 2006, based on 49,997,834 aggregate shares of common stock
outstanding as of such date, by: (i) each person who is known by us to own
beneficially more than 5% of our outstanding common stock with the address
of
each such person, (ii) each of our present directors and officers, and (iii)
all
officers and directors as a group:
Name
and Address of
Beneficial
Owner(1)(2)
|
Amount
of Common
Stock
Beneficially Owned
|
Percentage
of Outstanding
Common
Stock Beneficially Owned
|
Scott
Newman(3)
|
19,613,056
|
39.2%
|
Glenn
Peipert(4)
|
9,346,032
|
18.7%
|
Mitchell
Peipert(5)
|
250,000
|
*
|
Robert
C. DeLeeuw(6)
|
5,333,334
|
10.7%
|
William
McKnight(7)
|
909,091
|
1.8%
|
Lawrence
K. Reisman(8)
|
20,000
|
*
|
Joseph
Santiso(9)
|
0
|
|
All
directors and officers as a group (7 persons)
|
35,471,513
|
70.6%
|
*
|
Represents
less than 1% of the issued and outstanding Common
Stock.
|
(1)
|
Each
stockholder, director and executive officer has sole voting power
and sole
dispositive power with respect to all shares beneficially owned by
him,
unless otherwise indicated.
|
(2)
|
All
addresses are c/o Conversion Services International, Inc., 100
Eagle Rock Avenue, East Hanover, New Jersey
07936.
|
(3)
|
Mr.
Newman is the Company’s President, Chief Executive Officer and Chairman of
the Board.
|
(4)
|
Mr.
Glenn Peipert is the Company’s Executive Vice President, Chief Operating
Officer and Director. Does not include an option to purchase 250,000
shares of common stock granted on November 16, 2005 and expiring
on
November 16, 2010 at an exercise price of $.83 per share, which vest
as
follows: (i) 83,333 on November 16, 2006; (ii) 83,333 on November
16,
2007; (iii) 83,334 on November 16, 2008.
|
(5)
|
Mr.
Mitchell Peipert is the Company’s Vice President, Chief Financial Officer,
Secretary and Treasurer. Consists of an option to purchase 300,000
shares
of common stock granted on March 29, 2004 at an exercise price of
$2.475
per share, 200,000 of which have vested and 100,000 of which shall
vest on
March 29, 2007. The
option grant expires on March 28, 2014. Consists of an option to
purchase
150,000 shares of common stock granted on November 16, 2005 at an
exercise
price of $.83 per share, 50,000 of which have vested, 50,000 of which
vest
on May 16, 2007 and 50,000 of which vest on May 16, 2008.
|
(6)
|
Mr.
DeLeeuw is the Company’s Senior Vice President and the President of the
Company’s wholly owned subsidiary, DeLeeuw Associates, LLC. Does not
include an option to purchase 250,000 shares of common stock granted
on
November 16, 2005 and expiring on November 16, 2010 at an exercise
price
of $.83 per share, which vest as follows: (i) 83,333 on November
16, 2006;
(ii) 83,333 on November 16, 2007; (iii) 83,334 on November 16, 2008.
Does
not include an option to purchase 1,000,000 shares of common stock
granted
on January 9, 2006 and expiring on January 9, 2011 at an exercise
price of
$.46 per share, which vest as follows: (i) 333,333 on January 9,
2007;
(ii) 333,333 on January 9, 2008; (iii) 333,334 on January 9,
2009.
|
(7) |
Mr.
McKnight is the Company’s Senior Vice President - Data
Warehousing.
|
(8)
|
Mr.
Reisman is a Director. Consists of an option to purchase 20,000 shares
of
common stock granted on May 28, 2004 at an exercise price of $3.00
per
share, 10,000 of which have vested and 10,000 of which vest on May
28,
2006. Does
not include an option to purchase 10,000 shares of common stock granted
on
May 28, 2004 at an exercise price of $3.00 per share, which vest
on May
28, 2007. The option grant expires on May 27, 2014. Does not include
an
portion to purchase 20,000 shares of common stock granted on November
16,
2005 at an exercise price of $.83 which vest as follows: (i) 6,666
on
November 16, 2006; (ii) 6,667 on November 16, 2007; (iii) 6,667 on
November 16, 2008
|
(9)
|
Mr.
Santiso is a Director. Does
not include an option to purchase 10,000 shares of common stock granted
on
November 16, 2005 at an exercise price of $0.83 per share, which
vest as
follows: (i) 3,333 on November
16, 2006;
(ii) 3,333 on November
16, 2007;
(iii) 3,334 on November
16, 2008.
|
Equity
Compensation Plan Disclosure
The
following table sets forth certain information as of December 31, 2005 regarding
securities:
Plan
Category
|
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights
|
|
Weighted-average
exercise price of outstanding options, warrants and rights
|
|
Number
of securities remaining available for future issuance under equity
compensation plans
|
|
|
|
|
|
|
|
|
|
Equity
Compensation Plans Approved by Security Holders
|
|
|
4,883,114
|
|
$
|
1.43
|
|
|
1,783,553
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
Compensation Plans Not Approved by Security Holders
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,883,114
|
|
$
|
1.43
|
|
|
1,783,553
|
|
|
|
|
|
|
|
|
|
|
|
|
ITEM
12. CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
On
November 8, 2004, Mr. Scott Newman entered into a stock purchase agreement
with
a private investor, CMKX-treme, Inc. Pursuant to the agreement,
CMKX-treme, Inc. agreed to purchase 188,889 shares of common stock for a
purchase price of $250,000. As of April 10, 2006, the shares have not been
issued to CMKX-treme, Inc. because it has not yet remitted payment for the
shares.
On
November 8, 2004, Mr. Glenn Peipert entered into a stock purchase agreement
with
a private investor, CMKX-treme, Inc. Pursuant to the agreement,
CMKX-treme, Inc. agreed to purchase 377,778 shares of common stock for a
purchase price of $500,000. As of June 9, 2005, CMKX-treme, Inc. remitted
final payment for the shares.
On
November 10, 2004, the Company and Dr. Michael Mitchell, the former President,
Chief Executive Officer and sole director of LCS, executed a one-year consulting
agreement whereby Dr. Mitchell would perform certain consulting services on
behalf of the Company. Dr. Mitchell will receive an aggregate amount of $0.25
million as compensation for services provided to the Company. During 2005,
an
aggregate amount of $175,000 was paid to Mr. Mitchell for services provided
under this consulting agreement.
As
of
November 16, 2004, Mr. Newman and Mr. Peipert repaid in full to the Company
loans in the aggregate of approximately $0.2 million, including accrued
interest. These loans bore interest at 3% per annum and were due and payable
by
December 31, 2005.
As
of
April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
to
personally support our cash requirements to enable us to fulfill our obligations
through June 1, 2007, to the extent necessary, up to a maximum amount of $1.5
million, based upon their ability to sell their Company common stock. Mr. Newman
guaranties up to approximately $0.9 million, Mr. Peipert guaranties up to
approximately $0.4 million and Mr. DeLeeuw guaranties approximately $0.2
million. We believe that these written commitments provide us with the legal
right to request and receive such advances from any of these officers. Any
loan
by Messrs. Newman, Peipert and DeLeeuw to the Company would bear interest at
8%
per annum. As of December 31, 2005, Mr. Newman’s outstanding loan balance to the
Company was $0.9 million, and Mr. Peipert’s outstanding loan balance to the
Company was $0.9 million. The unsecured loans by Mr. Newman and Mr. Peipert
each
accrue interest at a simple rate of 8% per annum, and each has a term expiring
on April 30, 2007. As of the date of this filing, the entire $1.5 million was
still available pursuant to the guaranties outlined above.
Other
than those described above, during the last two fiscal years, we have no
material transactions which involved or are planned to involve a direct or
indirect interest of a director, executive officer, greater than 5% stockholder
or any family of such parties.
2.1
Agreement
and Plan of Reorganization, dated August 21, 2003, among the Company, LCS
Acquisition Corp., Conversion Services International, Inc. and certain
affiliated stockholders of Conversion Services International, Inc. (filed as
Appendix A on Schedule 14A on January 5, 2004).
2.2
First
Amendment to Agreement and Plan of Reorganization, dated November 28, 2003,
among the Company, LCS Acquisition Corp., Conversion Services International,
Inc. and certain affiliated stockholders of Conversion Services International,
Inc. (filed as Appendix A on Schedule 14A on January 5, 2004).
2.4
Acquisition
Agreement, dated February 27, 2004, among the Company, DeLeeuw Associates,
Inc.
and Robert C. DeLeeuw (filed as Exhibit 2.1 on Form 8-K on March 16,
2004).
2.5
Plan
and
Agreement of Merger and Reorganization, dated February 27, 2004, among the
Company, DeLeeuw Associates, Inc. and DeLeeuw Conversion LLC filed as Exhibit
2.1 on Form 8-K on March 16, 2004).
2.6
Asset
Purchase Agreement, dated May 26, 2004, among the Registrant, Evoke Asset
Purchase Corp. and Evoke Software Corporation (filed as Exhibit 2.1 on Form
8-K
on July 13, 2004).
2.7 Asset
Purchase Agreement, dated July 18, 2005 by and among the registrant, Similarity
Vector Technologies (Sivtech) Limited (d/b/a Similarity Systems), Similarity
Systems Inc. and Evoke Software Corporation (filed as Exhibit 2.1 on Form
8-K on
September 27, 2004).
2.8 Agreement
and Plan of Merger, dated July 22, 2005 among the Registrant., McKnight
Associates, Inc., McKnight Associates, Inc. and William McKnight (filed as
Exhibit 2 on Form 8-K on July 28, 2005).
2.9 Agreement
and Plan of Merger, dated July 29, 2005 by and among the Registrant, ISI
Merger
Corp., Integrated Strategies, Inc., ISI Consulting LLC, Adam Hock and Larry
Hock
(filed as Exhibit 2 on Form 8-K on August 3, 2005).
3.1
Certificate
of Incorporation, as amended (filed as Exhibit 3.1 on Form 10-SB on December
9,
1999).
3.2
Certificate
of Amendment to the Company's Certificate of incorporation, dated January
27,
2004, amending, among other things, the authorized shares of common and
preferred stock (filed as Exhibit 3.1 on Form 8-K on February 17,
2004).
3.3
Certificate
of Amendment to the Company's Certificate of Incorporation, dated January
30,
2004, changing the name of the Company from LCS Group, Inc. to Conversion
Services International, Inc. (filed as Exhibit 3.2 on Form 8-K on February
17,
2004).
3.4
Certificate
of Merger, dated January 30, 2004, relating to the merger of LCS Acquisition
Corp. and Conversion Services International, Inc. (filed as Exhibit 2.3 on
Form
8-K on February 17, 2004).
3.5
Amended
and Restated Bylaws (filed as Exhibit 3.3 on Form 8-K on February 17,
2004).
3.6
Certificate
of Merger (Delaware) of McKnight Associates, Inc. (filed as Exhibit 3.1 on
Form
8-K on July 28, 2005).
3.7 Articles
of Merger (Texas) of McKnight Associates, Inc. (filed as Exhibit 3.1 on Form
8-K
on July 28, 2005).
3.8 Certificate
of Merger of Integrated Strategies, Inc. and ISI Consulting, LLC with and
into
ISI Merger Corp. (filed as Exhibit 3.1 on Form 8-K on August 3,
2005).
4.1 Common
Stock Purchase Warrant, dated August 16, 2004, in favor of Laurus Master
Fund,
Ltd. (filed as Exhibit 4.7 on Form 10-QSB on August 23, 2004).
4.2 Secured
Convertible Minimum Borrowing Note, dated August 16, 2004 (filed as Exhibit
4.4
on Form 10-QSB on August 23, 2004).
4.3 Secured
Revolving Note, dated August 16, 2004 (filed as Exhibit 4.5 on Form 10-QSB
on
August 23, 2004).
4.4 Secured
Convertible Term Note, dated August 16, 2004 (filed as Exhibit 4.6 on Form
10-QSB on August 23, 2004).
4.5 Senior
Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
in
favor of Sands Brothers Venture Capital LLC (filed as Exhibit 10.1 on Form
8-K
on September 27, 2004).
4.6 Senior
Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
in
favor of Sands Brothers Venture Capital III LLC (filed as Exhibit 10.2 on
Form
8-K on September 27, 2004).
4.7 Senior
Subordinated Secured Convertible Promissory Note, dated September 22, 2004,
in
favor of Sands Brothers Venture Capital IV LLC (filed as Exhibit 10.3 on
Form
8-K on September 27, 2004).
4.8 Common
Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
Venture Capital LLC (filed as Exhibit 4.1 on Form 8-K on September 27,
2004).
4.9 Common
Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
Venture Capital III LLC (filed as Exhibit 4.2 on Form 8-K on September 27,
2004).
4.10 Common
Stock Purchase Warrant, dated September 22, 2004, in favor of Sands Brothers
Venture Capital IV LLC (filed as Exhibit 4.3 on Form 8-K on September 27,
2004).
4.11 Promissory
Note, dated July 29, 2005, in favor of Adam Hock and Larry Hock (filed as
Exhibit 10.1 on Form 8-K on August 3, 2005)
4.12 Subordinated
Promissory Note, dated July 29, 2005, in favor of Adam Hock and Larry Hock
(filed as Exhibit 10.2 on Form 8-K on August 3, 2005)
4.13 Option
to
purchase shares of common stock, dated July 28, 2005, (filed as Exhibit 4.1
on
Form 8-K on August 3, 2005).
4.14 Amended
and Restated Revolving Note, dated August 16, 2004, in favor of Laurus Master
Fund, Ltd. (filed as Exhibit 10.1 on Form 8-K on August 3, 2005).
4.15 Amended
and Restated Secured Convertible Term Note, dated August 16, 2004, in favor
of
Laurus Master Fund, Ltd. (filed as Exhibit 10.2 on Form 8-K on August 3,
2005).
4.16 Amended
and Restated Secured Revolving Note, dated August 16, 2004, as amended and
restated on July 28, 2005 in favor of Laurus Master Fund, Ltd (filed as Exhibit
10.1 on Form 8-K on December 6, 2005).
4.17 Amended
and Restated Secured Convertible Term Note, dated August 16, 2004, as amended
and restated on July 28, 2005 in favor of Laurus Master Fund, Ltd (filed
as
Exhibit 10.2 on Form 8-K on December 6, 2005).
4.18 Amended
and Restated Secured Convertible Minimum Borrowing Note, dated August 16,
2004,
as amended and restated on July 28, 2005 in favor of Laurus Master Fund,
Ltd
(filed as Exhibit 10.3 on Form 8-K on December 6, 2005).
4.19 Option
to
purchase shares of common stock, dated February 1, 2006 (filed as Exhibit
4.1 on
Form 8-K on February 7, 2006).
4.20 Secured
Non-Convertible Revolving Note, dated February 1, 2006, in favor of Laurus
Master Fund, Ltd (filed as Exhibit 10.1 on Form 8-K on February 7,
2006).
4.21 Certificate
of Designations of Preferences, Rights and Limitations of Series A Convertible
Preferred Stock of the Registrant (filed as Exhibit 4.1 on Form 8-K on February
8, 2006).
4.22 Common
Stock Purchase Warrant, dated February 2, 2006 (filed as Exhibit 10.3 on
Form
8-K on February 8, 2006).
10.1
Employment
Agreement among the Company and Scott Newman, dated March 26, 2004 (filed
as
Exhibit 10.1 on Form 8-K/A on April 1, 2004).
10.2
Employment
Agreement among the Company and Glenn Peipert, dated March 26, 2004 (filed
as
Exhibit 10.2 on Form 8-K/A on April 1, 2004).
10.3
Employment
Agreement among the Company and Mitchell Peipert, dated March 26, 2004 (filed
as
Exhibit 10.3 on Form 8-K/A on April 1, 2004).
10.4 Employment
Agreement among the Company and Robert DeLeeuw, dated March 26, 2004 (filed
as
Exhibit 10.4 on Form SB-2/A on September 30, 2004).
10.5 2003
Incentive Plan (filed as Exhibit 4.1 to Form S-8 filed on November 11,
2005).
10.6 Security
Agreement, dated August 16, 2004, among the Registrant, DeLeeuw Associates,
LLC,
CSI Sub Corp. (DE), Evoke Software Corporation and Laurus Master Fund, Ltd.
(filed as Exhibit 4.1 on Form 10-QSB on August 23, 2004).
10.7 Stock
Pledge Agreement, dated August 16, 2004, among the Registrant and Laurus
Master
Fund, Ltd. (filed as Exhibit 4.8 on Form 10-QSB on August 23,
2004).
10.8 Securities
Purchase Agreement, dated August 16, 2004, among the Registrant and Laurus
Master Fund, Ltd. (filed as Exhibit 4.2 on Form 10-QSB on August 23,
2004).
10.9 Registration
Rights Agreement, dated August 16, 2004, among the Registrant and Laurus
Master
Fund, Ltd. (filed as Exhibit 4.3 on Form 10-QSB on August 23,
2004).
10.10 Security
Agreement, dated September 22, 2004, among the Registrant, Sands Brothers
Venture Capital LLC, Sands Brothers Venture Capital III LLC and Sands Brothers
Venture Capital IV LLC (filed as Exhibit 10.4 on Form 8-K on September 27,
2004).
10.11 Subordination
Agreement, dated September 22, 2004, among the Registrant, Sands Brothers
Venture Capital LLC, Sands Brothers Venture Capital III LLC, Sands Brothers
Venture Capital IV LLC and Laurus Master Fund, Ltd. (filed as Exhibit 10.5
on
Form 8-K on September 27, 2004).
10.12 Registration
Rights Agreement, dated September 22, 2004, among the Company, Sands Brothers
Venture Capital LLC, Sands Brothers Venture Capital III LLC and Sands Brothers
Venture Capital IV LLC (filed as Exhibit 4.4 on Form 8-K on September 27,
2004).
10.13 Consulting
Agreement with Morgan Stanley & Co., Incorporated (filed as Exhibit 10.18 on
Form SB-2/A on January 19, 2005).
10.14 Consulting
Agreement with Cellco Partnership (now known as Verizon Wireless) (filed
as
Exhibit 10.19 on Form SB-2/A on January 19, 2005).
10.15
Restricted
Account Agreement by and among the Registrant, North Fork Bank and Laurus
Master
Fund, Ltd. (filed as Exhibit 10.11 on Form 10-KSB/A on July 26,
2005).
10.16 Employment
Agreement dated July 22, 2005 by and between the Registrant and William McKnight
(filed as Exhibit 10.1 on Form 8-K on July 28, 2005).
10.17 Omnibus
Amendment, dated July 28, 2005 (filed as Exhibit 10.3 on Form 8-K on August
3,
2005).
10.18 Joinder,
dated July 28, 2005 (filed as Exhibit 10.4 on Form 8-K on August 3,
2005).
10.19 Reaffirmation
and Ratification Agreement, dated July 28, 2005 (filed as Exhibit 10.5 on
Form
8-K on August 3, 2005).
10.20 Overadvance
Letter, dated July 28, 2005 (filed as Exhibit 10.6 on Form 8-K on August
3,
2005).
10.21 Omnibus
Amendment, dated November 30, 2005 (filed as Exhibit 10.4 on Form 8-K on
December 6, 2005).
10.22 Reaffirmation
and Ratification Agreement, dated November 30, 2005 (filed as Exhibit 10.5
on
Form 8-K on December 6, 2005).
10.23 Security
Agreement dated February 1, 2006 by and among Laurus Master Fund, Ltd., the
Registrant, DeLeeuw Associates, LLC, CSI Sub Corp. (DE), Integrated Strategies,
Inc., CSI Sub Corp. II (DE), and McKnight Associates, Inc. (filed as Exhibit
10.3 on Form 8-K on February 7, 2006).
10.24
Stock
Pledge Agreement, dated February 1, 2006 (filed as Exhibit 10.4 on Form 8-K
on
February 7, 2006).
10.25 Overadvance
Side Letter dated February 1, 2006 (filed as Exhibit 10.5 on Form 8-K on
February 7, 2006).
10.26 Stock
Purchase Agreement dated February 2, 2006 by and between the Registrant and
Taurus Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February
8,
2006).
10.27 Registration
Rights Agreement dated February 2, 2006 by and between the Registrant and
Taurus
Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February 8,
2006).
14.1 Code
of
Conduct and Ethics (filed as Exhibit 14 on Form SB-2, filed on November 24,
2004).
21*
Subsidiaries
of the Company.
23.1* Consent
of Friedman LLP, Independent Registered Public Accounting Firm.
31.1*
Certification of the Company's Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2*
Certification of the Company's Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1*
Certification of the Company's Chief Executive Officer pursuant to Rule
13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
Section
1350.
32.2*
Certification of the Company's Chief Financial Officer pursuant to Rule
13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
Section
1350.
____________________
*
filed
herewith
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The
following table sets forth fees billed to us by our independent registered
public accounting firms during the fiscal years ended December 31, 2005 and
December 31, 2004 for: (i) services rendered for the audit of our annual
financial statements and the review of our quarterly financial statements;
(ii)
services by our independent registered public accounting firms that are
reasonably related to the performance of the audit or review of our financial
statements and that are not reported as Audit Fees; (iii) services rendered
in
connection with tax compliance, tax advice and tax planning; and (iv) all other
fees for services rendered.
|
|
|
December
31, 2005
|
|
|
December
31, 2004
|
|
Audit
Fees
|
|
$
|
319,748 |
|
$
|
281,975
|
|
Audit
Related Fees
|
|
$
|
8,700
|
|
$
|
212,480
|
|
Tax
Fees
|
|
$
|
78,850
|
|
$
|
36,799
|
|
All
Other Fees
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
$ |
407,298 |
|
$
|
531,254
|
|
|
|
|
|
|
|
|
|
Audit
Committee Policies
The
board
of directors is solely responsible for the approval in advance of all audit
and
permitted non-audit services to be provided by the independent auditors
(including the fees and other terms thereof), subject to the de minimus
exceptions for non-audit services provided by Section 10A(i)(1)(B) of the
Exchange Act, which services are subsequently approved by the board of directors
prior to the completion of the audit. None of the fees listed above are for
services rendered pursuant to such de minimus exceptions.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The
Board
of Directors and Stockholders
Conversion
Services International, Inc. and Subsidiaries
East
Hanover, New Jersey
We
have
audited the accompanying consolidated balance sheets of Conversion Services
International, Inc. and Subsidiaries as of December 31, 2005 and 2004, and
the
related consolidated statements of operations, stockholders' equity, and cash
flows for the two years then ended. These consolidated financial statements
are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Conversion Services
International, Inc. and Subsidiaries as of December 31, 2005, and the
consolidated results of its operations and its cash flows for the two years
then
ended, in conformity with accounting principles generally accepted in the United
States of America.
As
discussed in Notes 1 and 22 to the consolidated financial statements, the
Company has restated its consolidated financial statements for the year ended
December 31, 2004.
/s/
Friedman LLP
East
Hanover, New Jersey
April
20,
2006
CONVERSION
SERVICES INTERNATIONAL, INC.
|
AND
SUBSIDIARIES
|
CONSOLIDATED
BALANCE SHEETS
|
DECEMBER
31,
|
|
|
2005
|
|
2004
|
|
ASSETS
|
|
|
|
(as
Restated, see Notes 1 and 22 )
|
|
CURRENT
ASSETS
|
|
|
|
|
|
Cash
|
|
$
|
176,073
|
|
$
|
1,028,146
|
|
Restricted
cash
|
|
|
-
|
|
|
83,375
|
|
Accounts
receivable, net of allowance for doubtful accounts of $489,070 and
$209,582 in 2005 and 2004, respectively
|
|
|
3,194,375
|
|
|
4,349,229
|
|
Accounts
receivable from related parties; (Note 21)
|
|
|
569,908
|
|
|
781,100
|
|
Prepaid
expenses
|
|
|
142,432
|
|
|
309,459
|
|
TOTAL
CURRENT ASSETS
|
|
|
4,082,788
|
|
|
6,551,309
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT, at cost, net; (Note 6)
|
|
|
417,469
|
|
|
587,575
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
Restricted
cash
|
|
|
-
|
|
|
4,269,377
|
|
Goodwill
|
|
|
7,239,566
|
|
|
4,690,972
|
|
Intangible
assets, net of accumulated amortization of $740,350 and $911,142
in 2005
and 2004, respectively; (Note 7)
|
|
|
1,862,964
|
|
|
3,627,096
|
|
Deferred
financing costs, net of accumulated amortization of $467,604 and
$126,767
in 2005 and 2004, respectively; (Note 8)
|
|
|
425,705
|
|
|
766,542
|
|
Discount
on debt issued, net of accumulated amortization of $678,917 and $941,212
in 2005 and 2004, respectively; (Note 9)
|
|
|
4,177,428
|
|
|
8,217,278
|
|
Equity
investments
|
|
|
149,117
|
|
|
144,460
|
|
Other
assets
|
|
|
123,432
|
|
|
13,420
|
|
|
|
|
13,978,212
|
|
|
21,729,145
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
18,478,469
|
|
$
|
28,868,029
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
Line
of credit; (Note 10)
|
|
$
|
4,713,312
|
|
$
|
3,733,403
|
|
Current
portion of long-term debt
|
|
|
495,122
|
|
|
120,834
|
|
Accounts
payable and accrued expenses
|
|
|
2,519,446
|
|
|
3,777,940
|
|
Short
term note payable; (Note 11)
|
|
|
1,063,990
|
|
|
1,000,000
|
|
Deferred
revenue
|
|
|
41,121
|
|
|
1,327,222
|
|
Financial
instruments; (Note 12)
|
|
|
2,209,733
|
|
|
10,515,091
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
11,042,724
|
|
|
20,474,490
|
|
|
|
|
|
|
|
|
|
LONG-TERM
DEBT, net of current portion, (Note 13)
|
|
|
3,042,914
|
|
|
6,659,449
|
|
RELATED
PARTY NOTE PAYABLE; (Note 21)
|
|
|
1,772,368
|
|
|
307,981
|
|
DEFERRED
TAXES
|
|
|
363,400
|
|
|
-
|
|
Total
Liabilities
|
|
|
16,221,406
|
|
|
27,441,920
|
|
|
|
|
|
|
|
|
|
MINORITY
INTEREST
|
|
|
-
|
|
|
131,587
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES; (Note 20)
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value, 85,000,000 shares
authorized;
|
|
|
|
|
|
|
|
54,093,916
and 51,472,140 issued and outstanding in 2005 and 2004,
respectively
|
|
|
54,094
|
|
|
51,472
|
|
Additional
paid in capital
|
|
|
42,264,407
|
|
|
36,814,064
|
|
Accumulated
deficit
|
|
|
(40,061,438
|
)
|
|
(35,576,312
|
)
|
Accumulated
other comprehensive income
|
|
|
-
|
|
|
5,298
|
|
Total
Stockholders' Equity
|
|
|
2,257,063
|
|
|
1,294,522
|
|
|
|
|
|
|
|
|
|
Total
Liabilities and Stockholders' Equity
|
|
$
|
18,478,469
|
|
$
|
28,868,029
|
|
|
|
|
|
|
|
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
|
AND
SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
FOR
THE YEARS ENDED DECEMBER 31,
|
|
|
|
|
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
(as
Restated, see Notes 1 and 22)
|
|
REVENUE:
|
|
|
|
|
|
Services
|
|
$
|
23,392,464
|
|
$
|
19,755,370
|
|
Related
party services
|
|
|
3,731,198
|
|
|
3,837,065
|
|
Software
|
|
|
123,198
|
|
|
184,882
|
|
Support
and maintenance
|
|
|
225,133
|
|
|
42,979
|
|
Other
|
|
|
157,916
|
|
|
72,810
|
|
|
|
|
27,629,909
|
|
|
23,893,106
|
|
COST
OF REVENUE:
|
|
|
|
|
|
|
|
Services
(inclusive of stock-based compensation of zero and $1.4 million
at
December 31, 2005 and 2004, respectively)
|
|
|
17,316,494
|
|
|
15,367,477
|
|
Related
party services
|
|
|
3,215,909
|
|
|
3,345,318
|
|
Software
|
|
|
-
|
|
|
134,182
|
|
Support
and maintenance
|
|
|
-
|
|
|
-
|
|
Other
|
|
|
-
|
|
|
-
|
|
|
|
|
20,532,403
|
|
|
18,846,977
|
|
GROSS
PROFIT
|
|
|
7,097,506
|
|
|
5,046,129
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
4,521,054
|
|
|
3,210,790
|
|
General
and administrative (inclusive of stock-based compensation of $0.5
million
and $0.1 million at December 31, 2005 and 2004,
respectively)
|
|
|
6,418,245
|
|
|
6,086,017
|
|
Goodwill
and intangibles impairment
|
|
|
1,321,543
|
|
|
12,247,234
|
|
Depreciation
and amortization
|
|
|
911,772
|
|
|
468,235
|
|
|
|
|
13,172,614
|
|
|
22,012,276
|
|
LOSS
FROM OPERATIONS
|
|
|
(6,075,108
|
)
|
|
(16,966,147
|
)
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
Equity
in earnings from investments
|
|
|
4,657
|
|
|
5,684
|
|
Financial
instruments
|
|
|
8,424,493
|
|
|
(551,241
|
)
|
Loss
on early extinguishment of debt
|
|
|
(1,607,763
|
)
|
|
-
|
|
Other
income
|
|
|
-
|
|
|
7,300
|
|
Interest
income
|
|
|
69,166
|
|
|
22,355
|
|
Interest
expense
|
|
|
(4,201,823
|
)
|
|
(5,024,449
|
)
|
|
|
|
2,688,730
|
|
|
(5,540,351
|
)
|
LOSS
BEFORE INCOME TAXES AND DISCONTINUED OPERATIONS
|
|
|
(3,386,378
|
)
|
|
(22,506,498
|
)
|
INCOME
TAXES
|
|
|
-
|
|
|
190,800
|
|
NET
LOSS FROM CONTINUING OPERATIONS
|
|
|
(3,386,378
|
)
|
|
(22,697,298
|
)
|
|
|
|
|
|
|
|
|
DISCONTINUED
OPERATIONS (Note 4):
|
|
|
|
|
|
|
|
Gain
on disposal of discontinued operations
|
|
$
|
49,148
|
|
$
|
-
|
|
Loss
from discontinued operations
|
|
|
(1,153,119
|
)
|
|
(12,650,908
|
)
|
|
|
|
(1,103,971
|
)
|
|
(12,650,908
|
)
|
NET
LOSS
|
|
$
|
(4,490,349
|
)
|
$
|
(35,348,206
|
)
|
|
|
|
|
|
|
|
|
Basic
net loss per share from continuing operations
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
Basic
net loss per share from discontinued operations
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Basic
net loss per share
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
Diluted
net loss per share from continuing operations
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
Diluted
net loss per share from discontinued operations
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Diluted
net loss per share
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
Weighted
average shares used to compute net loss per share:
|
|
|
|
|
|
|
|
Basic
|
|
|
52,919,340
|
|
|
46,548,065
|
|
Diluted
|
|
|
52,919,340
|
|
|
46,548,065
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
|
AND
SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
Retained
|
|
Other
|
|
Total
|
|
|
|
|
|
Common
|
|
Capital
|
|
Paid-in
|
|
Earnings
|
|
Comprehensive
|
|
Stockholders'
|
|
Comprehensive
|
|
|
|
Shares
|
|
Stock
|
|
Capital
|
|
(Deficit)
|
|
Income
|
|
Equity
|
|
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2003
|
|
|
66,667
|
|
$
|
67
|
|
$
|
1,447,183
|
|
$
|
(228,106
|
)
|
$
|
-
|
|
$
|
1,219,144
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(35,348,206
|
)
|
|
|
|
|
(35,348,206
|
)
|
|
(35,348,206
|
)
|
Foreign
currency translation
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5,298
|
|
|
5,298
|
|
|
5,298
|
|
Effect
of Conversion Services International recapitalization
|
|
|
(66,667
|
)
|
|
(67
|
)
|
|
67
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Relative
fair value of warrants issued
|
|
|
-
|
|
|
-
|
|
|
500,000
|
|
|
-
|
|
|
-
|
|
|
500,000
|
|
|
|
|
Issuance
of Common Stock in connection with the reverse merger into LCS
Golf.
|
|
|
39,533,333
|
|
|
39,533
|
|
|
(39,533
|
)
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Issuance
of Common Stock in connection with the acquisition of DeLeeuw Associates,
Inc.
|
|
|
5,333,333
|
|
|
5,333
|
|
|
15,834,667
|
|
|
-
|
|
|
-
|
|
|
15,840,000
|
|
|
|
|
Issuance
of Common Stock in connection with the conversion of debt into
Company
stock.
|
|
|
1,269,841
|
|
|
1,270
|
|
|
1,998,730
|
|
|
-
|
|
|
-
|
|
|
2,000,000
|
|
|
|
|
Issuance
of Common Stock in connection with the acquisition of Evoke Software
Corporation.
|
|
|
5,097,537
|
|
|
5,098
|
|
|
12,379,000
|
|
|
-
|
|
|
-
|
|
|
12,384,098
|
|
|
|
|
Issuance
of Common Stock in connection with a stock purchase
agreement.
|
|
|
238,095
|
|
|
238
|
|
|
499,762
|
|
|
-
|
|
|
-
|
|
|
500,000
|
|
|
|
|
Compensation
expense for stock and stock option grants
|
|
|
-
|
|
|
-
|
|
|
1,479,902
|
|
|
-
|
|
|
-
|
|
|
1,479,902
|
|
|
|
|
Discount
on debt issued
|
|
|
-
|
|
|
-
|
|
|
1,500,000
|
|
|
-
|
|
|
-
|
|
|
1,500,000
|
|
|
|
|
Unsecured
convertible line of credit beneficial conversion feature
|
|
|
-
|
|
|
-
|
|
|
1,214,286
|
|
|
-
|
|
|
-
|
|
|
1,214,286
|
|
|
|
|
Total
comprehensive loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(35,342,908
|
)
|
Balance,
December 31, 2004, as restated (See Notes 1 and 22)
|
|
|
51,472,139
|
|
$
|
51,472
|
|
$
|
36,814,064
|
|
$
|
(35,576,312
|
)
|
$
|
5,298
|
|
$
|
1,294,522
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(4,490,349
|
)
|
|
-
|
|
|
(4,490,349
|
)
|
|
(4,490,349
|
)
|
Foreign
currency translation
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(75
|
)
|
|
(75
|
)
|
|
(75
|
)
|
Sale
of Evoke Software Corp.
|
|
|
- |
|
|
- |
|
|
- |
|
|
5,223 |
|
|
(5,223 |
)
|
|
- |
|
|
|
|
Issuance
of Common Stock in connection with a stock purchase
agreement.
|
|
|
595,238
|
|
|
595
|
|
|
1,249,405
|
|
|
-
|
|
|
-
|
|
|
1,250,000
|
|
|
|
|
Issuance
of Common Stock in connection with a conversion of debt to
equity.
|
|
|
476,190
|
|
|
476
|
|
|
999,524
|
|
|
-
|
|
|
-
|
|
|
1,000,000
|
|
|
|
|
Issuance
of Common Stock in connection with a legal settlement.
|
|
|
21,368
|
|
|
21
|
|
|
80,107
|
|
|
-
|
|
|
-
|
|
|
80,128
|
|
|
|
|
Issuance
of Common Stock in connection with the Evoke Software Corp.
acquisition.
|
|
|
286,204
|
|
|
287
|
|
|
429,019
|
|
|
-
|
|
|
-
|
|
|
429,306
|
|
|
|
|
Issuance
of Common Stock in connection with the acquisition of McKnight
Associates
|
|
|
909,091
|
|
|
909
|
|
|
1,771,818
|
|
|
-
|
|
|
-
|
|
|
1,772,727
|
|
|
|
|
Issuance
of Common Stock in connection with a stock option
exercise.
|
|
|
333,334
|
|
|
334
|
|
|
776,333
|
|
|
-
|
|
|
-
|
|
|
776,667
|
|
|
|
|
Issuance
of fractional shares resulting from the 1:15 reverse stock
split.
|
|
|
352
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Compensation
expense for stock and stock option grants.
|
|
|
-
|
|
|
-
|
|
|
33,026
|
|
|
-
|
|
|
-
|
|
|
33,026
|
|
|
|
|
Relative
fair value of warrants issued.
|
|
|
-
|
|
|
-
|
|
|
111,111
|
|
|
-
|
|
|
-
|
|
|
111,111
|
|
|
|
|
Total
comprehensive loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(4,490,424
|
)
|
Balance,
December 31, 2005
|
|
|
54,093,916
|
|
$
|
54,094
|
|
$
|
42,264,407
|
|
$
|
(40,061,438
|
)
|
$
|
|
|
$
|
2,257,063
|
|
|
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
|
AND
SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
FOR
THE YEARS ENDED DECEMBER 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
(as
Restated, see Notes 1 and 22)
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
Net
loss
|
|
$
|
(4,490,349
|
)
|
$
|
(35,348,205
|
)
|
Net
loss from discontinued operations
|
|
|
(1,103,971
|
)
|
$
|
(12,650,908
|
)
|
Net
loss from continuing operations
|
|
$
|
(3,386,378
|
)
|
$
|
(22,697,297
|
)
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net loss from continuing operations to net cash used
in
operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization of leasehold improvements
|
|
|
137,798
|
|
|
132,890
|
|
Amortizaton
of intangible assets
|
|
|
433,137
|
|
|
217,503
|
|
Amortization
of discount on debt
|
|
|
2,873,617
|
|
|
941,212
|
|
Amortization
of relative fair value of warrants issued
|
|
|
110,105
|
|
|
60,652
|
|
Amortization
of deferred financing costs
|
|
|
340,837
|
|
|
134,402
|
|
Excess
of derivative value over notional amount of debt
|
|
|
449,275
|
|
|
2,305,360
|
|
Beneficial
conversion feature associated with convertible debt
instruments
|
|
|
-
|
|
|
1,214,286
|
|
Deferred
taxes
|
|
|
-
|
|
|
190,800
|
|
Goodwill
impairment
|
|
|
1,321,543
|
|
|
12,247,235
|
|
Stock
and stock option based compensation
|
|
|
542,460
|
|
|
1,479,902
|
|
(Gain)
loss on change in fair value of financial instruments
|
|
|
(8,424,493
|
)
|
|
551,240
|
|
Loss
on early extinguishment of debt
|
|
|
1,607,763
|
|
|
-
|
|
Allowance
for doubtful accounts
|
|
|
92,862
|
|
|
91,823
|
|
Write-off
deferred loan costs
|
|
|
-
|
|
|
45,213
|
|
Loss
on disposal of equipment
|
|
|
-
|
|
|
88,190
|
|
Income
from equity investments
|
|
|
(4,657
|
)
|
|
(5,684
|
)
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
(Increase)
decrease in accounts receivable
|
|
|
1,042,245
|
|
|
(1,040,154
|
)
|
(Increase)
decrease in accounts receivable from related parties
|
|
|
211,192
|
|
|
(388,100
|
)
|
(Increase)
decrease in prepaid expenses
|
|
|
69,419
|
|
|
(95,574
|
)
|
(Increase)
decrease in other assets
|
|
|
(108,375
|
)
|
|
14,721
|
|
Increase
(decrease) in accounts payable and accrued expenses
|
|
|
(550,502
|
)
|
|
1,639,815
|
|
Increase
(decrease) in deferred revenue
|
|
|
(75,546
|
)
|
|
116,667
|
|
Net
cash used in operating activities of continuing
operations
|
|
|
(3,317,698
|
)
|
|
(2,754,898
|
)
|
Net
cash used in operating activities of discontinued
operations
|
|
|
(302,260
|
)
|
|
(1,692,381
|
)
|
Net
cash used in operating activities
|
|
|
(3,619,958
|
)
|
|
(4,447,279
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Acquisition
of property and equipment
|
|
|
(31,498
|
)
|
|
(143,582
|
)
|
Investment
in DeLeeuw Associates, net of cash acquired
|
|
|
-
|
|
|
(2,010,266
|
)
|
Investment
in Evoke Software Corp., net of cash acquired
|
|
|
-
|
|
|
334,073
|
|
Investment
in McKnight Associates, Inc., net of cash acquired
|
|
|
(946,412
|
)
|
|
|
|
Investment
in Integrated Strategies, Inc., net of cash acquired
|
|
|
(2,175,820
|
)
|
|
|
|
Equity
investment in Leading Edge Communications Corp.
|
|
|
-
|
|
|
(83,000
|
)
|
Net
cash used in investing activities of continuing
operations
|
|
|
(3,153,730
|
)
|
|
(1,902,775
|
)
|
Net
cash used in investing activities of discontinued
operations
|
|
|
-
|
|
|
(4,251
|
)
|
Net
proceeds from the sale of discontinued operations
|
|
|
644,958
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(2,508,772
|
)
|
|
(1,907,026
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Net
advances under line of credit
|
|
|
1,838,307
|
|
|
1,950,704
|
|
Principal
payment on short-term notes
|
|
|
(76,054
|
)
|
|
|
|
Issuance
of short-term note payable
|
|
|
1,000,000
|
|
|
1,000,000
|
|
Issuance
of long-term note payable
|
|
|
-
|
|
|
4,730,623
|
|
Issuance
of long-term note payable to stockholders
|
|
|
1,767,914
|
|
|
307,981
|
|
Deferred
loan costs
|
|
|
-
|
|
|
(893,309
|
)
|
Principal
payments on long-term debt
|
|
|
(4,348,695
|
)
|
|
(665,085
|
)
|
Proceeds
from sale of Company common stock
|
|
|
1,255,000
|
|
|
500,000
|
|
Principal
payments on capital lease obligations
|
|
|
(117,778
|
)
|
|
(85,595
|
)
|
Proceeds
from repayment of stockholder loans
|
|
|
-
|
|
|
203,623
|
|
Principal
payments on stockholder loans
|
|
|
(381,561
|
)
|
|
-
|
|
Restricted
cash
|
|
|
4,334,375
|
|
|
(83,375
|
)
|
Net
cash provided by financing activities
|
|
|
5,271,508
|
|
|
6,965,567
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
5,149
|
|
|
5,298
|
|
|
|
|
|
|
|
|
|
NET
(DECREASE) INCREASE IN CASH
|
|
|
(852,073
|
)
|
|
616,560
|
|
CASH,
beginning of period
|
|
|
1,028,146
|
|
|
411,586
|
|
|
|
|
|
|
|
|
|
CASH,
end of period
|
|
$
|
176,073
|
|
$
|
1,028,146
|
|
|
|
|
|
|
|
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
|
AND
SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
FOR
THE YEARS ENDED DECEMBER 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
(as
Restated, see Notes 1 and 22)
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
558,419
|
|
$
|
276,680
|
|
Cash
paid for income taxes
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
|
|
|
|
During
2005 and 2004, the Company entered into various capital lease arrangements
for computer and trade show equipment in the amount of $55,782 and
$249,241, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On
March 4, 2004, the Company acquired DeLeeuw Associates, Inc. The
components and allocations of the purchase price were based on the
fair
value of assets and liabilities acquired as of the acquisition date.
The
following assets and liabilities were obtained as a result of the
acquisition.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
$
|
-
|
|
$
|
975,000
|
|
Approved
vendor status
|
|
|
-
|
|
|
539,000
|
|
Tradename
|
|
|
-
|
|
|
722,000
|
|
Goodwill
|
|
|
-
|
|
|
15,844,000
|
|
Investment
in limited liability company
|
|
|
-
|
|
|
56,000
|
|
Current
liabilities
|
|
|
-
|
|
|
(286,000
|
)
|
|
|
|
|
|
|
|
|
On
June 28, 2004, the Company acquired substantially all of the assets
and
liabilities of Evoke Software Corporation. The components and allocations
of the purchase price were based on the fair value of assets and
liabilities acquired as of the acquisition date. The following assets
and
liabilities were obtained as a result of the
acquisition.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
-
|
|
$
|
497,000
|
|
Accounts
receivable
|
|
|
-
|
|
|
580,000
|
|
Customer
contracts (six year life)
|
|
|
-
|
|
|
1,962,000
|
|
Tradename
(indefinite life)
|
|
|
-
|
|
|
651,000
|
|
Computer
software (three year life)
|
|
|
-
|
|
|
1,381,000
|
|
Goodwill
|
|
|
|
|
|
|
|
Prepaid
expenses
|
|
|
-
|
|
|
78,000
|
|
Other
assets
|
|
|
-
|
|
|
11,000
|
|
Furniture
and equipment
|
|
|
-
|
|
|
184,000
|
|
Deferred
revenue
|
|
|
-
|
|
|
(1,254,000
|
)
|
Deferred
compensation
|
|
|
-
|
|
|
(443,000
|
)
|
Other
liabilities
|
|
|
-
|
|
|
|
|
Minority
interest
|
|
|
-
|
|
|
(199,000
|
)
|
|
|
|
|
|
|
|
|
On
July 18, 2005, the company sold certain assets and liabilities of
Evoke to
Similarity Systems. The following assets and liabilities of Evoke
were
sold to Similarity Systems:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
8,000
|
|
$
|
-
|
|
Accounts
receivable, net
|
|
|
692,000
|
|
|
-
|
|
Prepaid
expenses
|
|
|
100,000
|
|
|
-
|
|
Property
and equipment, net
|
|
|
77,000
|
|
|
-
|
|
Other
assets
|
|
|
5,000
|
|
|
-
|
|
Deferred
revenue
|
|
|
(1,649,995
|
)
|
|
-
|
|
Accrued
expenses
|
|
|
(163,000
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
On
July 22, 2005, the Company acquired all of the outstanding shares
of
McKnight Associates, Inc. The components and allocations of the purchase
price were based on the fair value of the assets and liabilities
acquired
as of the acquisition date. The following assets and liabilities
were
obtained as a result of the acquisition.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
116,000
|
|
$
|
-
|
|
Accounts
receivable
|
|
|
298,000
|
|
|
-
|
|
Customer
relationships (2.5 year life)
|
|
|
685,000
|
|
|
-
|
|
Order
backlog (5 month life)
|
|
|
50,000
|
|
|
-
|
|
Proprietary
presentation format (3 year life)
|
|
|
173,000
|
|
|
-
|
|
Goodwill
|
|
|
1,865,000
|
|
|
-
|
|
Accounts
payable and accrued expenses
|
|
|
(105,000
|
)
|
|
-
|
|
Deferred
tax liability
|
|
|
(363,000
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
On
July 29, 2005, the Company acquired all of the outstanding shares
of
Integrated Strategies, Inc. The components and allocations of the
purchase
price were based on the fair value of the assets and liabilities
acquired
as of the acquisition date. The following assets and liabilities
were
obtained as a result of the acquisition.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
119,000
|
|
$
|
-
|
|
Accounts
receivable
|
|
|
661,000
|
|
|
-
|
|
Prepaid
expenses
|
|
|
2,000
|
|
|
-
|
|
Fixed
assets
|
|
|
2,000
|
|
|
-
|
|
Other
assets
|
|
|
13,000
|
|
|
-
|
|
Goodwill
|
|
|
1,800,000
|
|
|
-
|
|
Accounts
payable and accrued expenses
|
|
|
(173,000
|
)
|
|
-
|
|
Notes
payable
|
|
|
(241,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
AND
SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
1 - Accounting Policies
Organization
and Business
Conversion
Services International, Inc. (“CSI”) was incorporated in the State of Delaware
and has been conducting business since 1990. CSI and its wholly owned
subsidiaries (together the “Company”) are principally engaged in the information
technology services industry in the following areas: strategic consulting,
business intelligence, data warehousing, and data management, on credit, to
its
customers principally located in the northeastern United States.
|
·
|
On
November 1, 2002, the Company acquired the operations of Scosys,
Inc.
(“Scosys”). Scosys is engaged in the information technology services
industry.
|
|
·
|
On
January 30, 2004, the Company became a public company through its
merger
with a wholly owned subsidiary of LCS Group, Inc. Although LCS Group,
Inc.
(now known as Conversion Services International, Inc.) was the legal
survivor in the merger and remains the Registrant with the Securities
and
Exchange Commission, the merger was accounted for as a reverse
acquisition, whereby the Company was considered the accounting “acquirer”
of LCS Group, Inc. for financial reporting purposes, as the Company’s
stockholders controlled approximately 76% of the post transaction
combined
company. Among other matters, reverse merger accounting requires
LCS
Group, Inc. to present in all financial statements and other public
filings, prior historical and other information of the Company, and
a
retroactive restatement of the Company’s historical stockholders’ equity.
The retroactive restatement took place subsequent to the merger on
January
30, 2004.
|
|
·
|
On
March 4, 2004, the Company acquired DeLeeuw Associates, Inc. and
merged
the company into DeLeeuw Associates, LLC (“DeLeeuw”), a subsidiary of CSI.
DeLeeuw is a management consulting firm specializing in integration,
reengineering and project management.
|
|
·
|
On
May 1, 2004, the Company acquired a 49% interest in Leading Edge
Communications Corporation (“LEC”), a provider of enterprise software and
services solutions for technology infrastructure management.
|
|
·
|
On
June 28, 2004, the Company acquired substantially all the assets
of Evoke
Software Corporation and the stock of Evoke’s foreign subsidiaries
(“Evoke”), a provider of data discovery, profiling and quality management
software. On July 18, 2005, the Company sold certain assets and
liabilities of Evoke to Similarity Systems. See Note 5 of the Notes
to the
Consolidated Financial Statements for further
discussion.
|
|
·
|
On
July 22, 2005, the Company acquired McKnight Associates, Inc. and
merged
the company into McKnight Associates, Inc. (“McKnight”), a subsidiary of
CSI. McKnight is a management consulting firm specializing in data
warehousing projects for a variety of clients
worldwide.
|
|
·
|
On
July 29, 2005, the Company acquired Integrated Strategies, Inc. and
merged
the company into Integrated Strategies, Inc. (“ISI”), a subsidiary of CSI.
ISI is a management consulting firm specializing in integration and
project management.
|
|
·
|
Doorways,
Inc. is a wholly owned subsidiary of the Company that is currently
dormant.
|
|
·
|
LEC
Corporation of NJ is a wholly owned subsidiary of the Company that
incurs
an insignificant amount of payroll expense and has no other
operations.
|
|
·
|
CSI
Sub Corp. (DE) is a wholly owned subsidiary of the Company and is
the
primary operating entity for the
Company.
|
Principles
of Consolidation
The
accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries, Doorways, Inc., DeLeeuw, Integrated Strategies,
Inc., McKnight Associates, LEC Corporation of NJ, and CSI Sub Corp. (DE). All
intercompany transactions and balances have been eliminated in the
consolidation. Investments in business entities in which the Company does not
have control, but has the ability to exercise significant influence (generally
20-50% ownership), are accounted for by the equity method. The results of Evoke
Software Corporation (formerly known as Evoke Asset Purchase Corp. and now
known
as CSI Sub Corp. II (DE)) have been included in these consolidated financial
statements as a component of discontinued operations. Substantially all assets
of Evoke were sold to Similarity Systems in July 2005. See Note 5 of the Notes
to the Consolidated Financial Statements for further discussion.
Revenue
recognition
Revenue
from consulting and professional services is recognized at the time the services
are performed on a project by project basis. For projects charged on a time
and
materials basis, revenue is recognized based on the number of hours worked
by
consultants at an agreed-upon rate per hour. For large services projects where
costs to complete the contract could reasonably be estimated, the Company
undertakes projects on a fixed-fee basis and recognizes revenues on the
percentage of completion method of accounting based on the evaluation of actual
costs incurred to date compared to total estimated costs. Revenues recognized
in
excess of billings are recorded as costs in excess of billings. Billings in
excess of revenues recognized are recorded as deferred revenues until revenue
recognition criteria are met. Reimbursements, including those relating to travel
and other out-of-pocket expenses, are included in revenues, and an equivalent
amount of reimbursable expenses are included in cost of services and are
immaterial.
Business
Combinations
Business
combinations are accounted for in accordance with SFAS No. 141,
“Business
Combinations”
(“SFAS 141”), which requires the purchase method of accounting for business
combinations be followed and in accordance with EITF No. 99-12 “Determination
of the Measurement Date for the Market Price of Acquirer Securities Issued
in a
Purchase Business Combination” (“EITF
99-12”).
In
accordance with SFAS 141, the Company determines the recognition of
intangible assets based on the following criteria: (i) the intangible asset
arises from contractual or other rights; or (ii) the intangible is
separable or divisible from the acquired entity and capable of being sold,
transferred, licensed, returned or exchanged. In accordance with SFAS 141,
the Company allocates the purchase price of its business combinations to the
tangible assets, liabilities and intangible assets acquired based on their
estimated fair values. The excess purchase price over those fair values is
recorded as goodwill. Additionally, in accordance with EITF 99-12, the Company
values an acquisition based upon the market price of its common stock for a
reasonable period before and after the date the terms of the acquisition are
agreed to and announced.
Accounts
receivable
The
Company carries its accounts receivable at cost less an allowance for doubtful
accounts. On a periodic basis, the Company evaluates its accounts receivable
and
adjusts the allowance for doubtful accounts, when deemed necessary, based upon
its history of past write-offs and collections, contractual terms and current
credit conditions. During 2005 and 2004, $56,123 and $114,785 of uncollectible
accounts receivable were written off against the allowance for doubtful
accounts, respectively.
Property
and equipment
Property
and equipment are stated at cost and includes equipment held under capital
lease
arrangements. Depreciation is computed principally by an accelerated method
and
is based on the estimated useful lives of the various assets ranging from three
to seven years. Leasehold improvements are amortized over the shorter of the
asset life or the remaining lease term on a straight-line basis. When assets
are
sold or retired, the cost and accumulated depreciation are removed from the
accounts and any gain or loss is included in operations.
Expenditures
for maintenance and repairs have been charged to operations. Major renewals
and
betterments have been capitalized.
Goodwill
and intangible assets
Goodwill
and intangible assets are accounted for in accordance with
SFAS No. 142 “Goodwill
and Other Intangible Assets”
(“SFAS 142”). Under SFAS 142, goodwill and indefinite lived intangible
assets are not amortized but instead are reviewed annually for impairment,
or
more frequently if impairment indicators arise. Separable intangible assets
that
are not deemed to have an indefinite life will continue to be amortized over
their estimated useful lives. The Company tests for impairment whenever events
or changes in circumstances indicate that the carrying amount of goodwill or
other intangible assets may not be recoverable, or at least annually at December
31 of each year. These tests are performed at the reporting unit level using
a
two-step, fair-value based approach. The first step compares the fair value
of
the reporting unit with its carrying amount, including goodwill. If the fair
value of the reporting unit is less than its carrying amount, a second step
is
performed to measure the amount of impairment loss. The second step allocates
the fair value of the reporting unit to the Company’s tangible and intangible
assets and liabilities. This derives an implied fair value for the reporting
unit’s goodwill. If the carrying amount of the reporting unit’s goodwill exceeds
the implied fair value of that goodwill, an impairment loss is recognized equal
to that excess. In the event that the Company determines that the value of
goodwill or other intangible assets have become impaired, the Company will
incur
a charge for the amount of the impairment during the fiscal quarter in which
the
determination is made.
Goodwill
represents the amounts paid in connection with the acquisitions of Scosys,
DeLeeuw, Integrated Strategies and McKnight Associates. Additionally, as part
of
the Scosys, DeLeeuw and McKnight acquisitions, the Company acquired identifiable
intangible assets. The Company performed its annual impairment review as of
December 31, 2005 and has determined that goodwill related to both the
Integrated Strategies and McKnight Associates acquisitions was impaired at
that
date and, accordingly, recorded impairment charges of approximately $836,000
and
$485,000, respectively. The Company performed its annual impairment review
as of
December 31, 2004 and determined that goodwill and certain intangible assets
were impaired at that date and, accordingly, recorded an impairment charge
of
approximately $12,247,000 primarily relating to goodwill associated with the
DeLeeuw acquisition.
Acquired
contracts are amortized over a period that approximates the estimated life
of
the contracts, based upon the estimated annual cash flows obtained from those
contracts, generally five years. The approved vendor status intangible asset
is
being amortized over an estimated life of forty months. The proprietary
presentation format intangible asset is being amortized over an estimated life
of three years. The customer relationship intangible asset is being amortized
over an estimated life of thirty months. The order backlog intangible asset
is
being amortized over an estimated life of five months.
Deferred
financing costs
The
Company capitalizes costs associated with the issuance of debt instruments.
These costs are amortized on a straight-line basis over the term of the related
debt instruments, which currently range from one to three years.
Discount
on debt
The
Company has allocated the proceeds received from convertible debt instruments
between the underlying debt instruments and the detachable warrants, and has
recorded the conversion feature as a liability in accordance with SFAS No.
133.
The conversion feature and certain other features that are considered embedded
derivative instruments, such as a variable interest rate feature, a conversion
reset provision and redemption option, have been recorded at their fair value
within the terms of SFAS No. 133 as its fair value can be separated from the
convertible note and its conversion is independent of the underlying note value.
The conversion liability is marked to market each reporting period with the
resulting gains or losses shown on the Statement of Operations. The Company
has
also recorded the resulting discount on debt related to the warrants and
conversion feature and is amortizing the discount using the effective interest
rate method over the life of the debt instruments. The discount is classified
as
a deferred financing cost.
Stock
compensation
The
Company follows Accounting Principles Board Opinion No. 25, “Accounting for
Stock Issued to Employees” (“APB 25”) in accounting for its employee stock
options. Under APB 25, because the exercise of the Company’s employee stock
option equals the market price of the underlying stock on the date of grant,
no
compensation expense is recognized in the Company’s consolidated statements of
operations. The Company is required under Statement of Financial Accounting
Standards (SFAS) 123, “Accounting for Stock-Based Compensation”, which
established a fair value based method of accounting for stock compensation
plans
with employees and others to disclose pro forma financial information regarding
option grants made to its employees.
The
Company follows EITF No. 96-18, “Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services” (“EITF 96-18”) in accounting for stock options issued to
non-employees. Under EITF 96-18, the equity instruments should be measured
at
the fair value of the equity instrument issued. During the year ended December
31, 2004, the Company granted 650,000 stock options to non-employee recipients.
In compliance with EITF 96-18, the fair value of these options was determined
using the Black-Scholes option pricing model. The Company is recognizing the
fair value of these options as expense over the three year vesting period of
the
options.
Had
the
Company determined compensation cost based upon the fair value at the grant
date
for its stock options under SFAS No. 123, the Company’s net loss would have
changed to the pro forma amounts indicated below:
|
|
Year
ended
|
|
Year
ended
|
|
|
|
December
31, 2005
|
|
December
31, 2004
|
|
Net loss:
|
|
|
|
|
|
As
reported
|
|
$
|
(4,490,349
|
)
|
$
|
(35,348,206
|
)
|
Add:
Stock based compensation expense recorded
|
|
|
33,026
|
|
|
1,466,777
|
|
Less:
Compensation expense per SFAS 123
|
|
|
(1,243,073
|
)
|
|
(2,998,232
|
)
|
Pro
forma
|
|
$
|
(5,700,396
|
)
|
$
|
(36,879,661
|
)
|
Net loss
per share:
|
|
|
|
|
|
|
|
As
reported
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
Diluted
|
|
|
(0.08
|
)
|
|
(0.76
|
)
|
Pro
forma
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.11
|
)
|
$
|
(0.79
|
)
|
Diluted
|
|
|
(0.11
|
)
|
|
(0.79
|
)
|
There
were no options granted prior to 2004. The per share weighted average fair
value
of stock options granted during 2004 was $0.16 per share on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
Expected
dividend yield
|
|
|
0.0
|
%
|
Risk-free
interest rate
|
|
|
2.5
|
%
|
Expected
volatility
|
|
|
148.0
|
%
|
Expected
option life (years)
|
|
|
3.0
|
|
The
per
share weighted average fair value of stock options granted during 2005 was
$0.71
per share on the date of grant using the Black-Scholes option-pricing model
with
the following weighted average assumptions:
Expected
dividend yield
|
|
|
0.0
|
%
|
Risk-free
interest rate
|
|
|
4.34
|
%
|
Expected
volatility
|
|
|
186.6
|
%
|
Expected
option life (years)
|
|
|
3.0
|
|
Pro
forma
information regarding net loss and net loss per share is required by
SFAS 123, as amended by SFAS 148, and has been determined as if the
Company had accounted for its employee stock options under the fair-value
method. The Black-Scholes option pricing model used in this valuation was
developed for use in estimating the fair value of traded options, which have
no
vesting restrictions and are fully transferable. Option valuation models require
the input of highly subjective assumptions. The Company’s stock-based
compensation has characteristics significantly different from those of traded
options, and changes in the assumptions used can materially affect the fair
value estimate.
Concentrations
of credit risk
Financial
instruments which potentially subject the Company to concentrations of credit
risk are cash and accounts receivable arising from its normal business
activities. The Company routinely assesses the financial strength of its
customers, based upon factors surrounding their credit risk, establishes an
allowance for doubtful accounts, and as a consequence believes that its accounts
receivable credit risk exposure beyond such allowances is limited. At December
31, 2005, LEC and Comsys accounted for approximately 14% and 12% of the
Company’s accounts receivable balance, respectively.
The
Company maintains its cash with a high credit quality financial institution.
Each account is secured by the Federal Deposit Insurance Corporation up to
$100,000.
Advertising
The
Company expenses advertising costs as incurred. Advertising costs amounted
to
approximately $380,000 and $152,000 for the years ended December 31, 2005 and
2004, respectively.
Income
taxes
The
Company accounts for income taxes, in accordance with SFAS No. 109, “Accounting
for Income Taxes” (“SFAS 109”) and related interpretations, under an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company’s financial statements or tax returns. In estimating
future tax consequences, the Company generally considers all expected future
events other than enactments of changes in the tax laws or rates.
The
Company records a valuation allowance to reduce the deferred tax assets to
the
amount that is more likely than not to be realized. The Company’s current
valuation allowance primarily relates to benefits from the Company’s
NOL’s.
Derivatives
The
Company accounts for derivatives in accordance with SFAS No. 133,
“Accounting
for Derivative Instruments and Hedging Activities”
(“SFAS 133”) and related interpretations. SFAS 133, as amended,
requires companies to recognize all derivative instruments as either assets
or
liabilities in the balance sheet at fair value. The accounting for changes
in
the fair value of a derivative instrument depends on: (i) whether the
derivative has been designated and qualifies as part of a hedging relationship,
and (ii) the type of hedging relationship. For those derivative instruments
that are designated and qualify as hedging instruments, a company must designate
the hedging instrument based upon the exposure being hedged as either a fair
value hedge, cash flow hedge or hedge of a net investment in a foreign
operation. At December 31, 2005, the Company had not entered into any
transactions which were considered hedges under SFAS 133.
Financial
Instruments
The
carrying value of the Company’s financial instruments, including cash and cash
equivalents, accounts receivable, note receivable, accounts payable and accrued
liabilities approximate fair value because of the short maturities of those
instruments. Based on borrowing rates currently available to the Company
for
loans with similar terms, the carrying value of convertible notes and notes
payable are also approximate fair value.
We
review
the terms of convertible debt and equity instruments we issued to determine
whether there are embedded derivative instruments, including the embedded
conversion option, that are required to be bifurcated and accounted for
separately as a derivative financial instrument. Generally, where the ability
to
physical or net-share settle the conversion option is deemed to be not within
the control of the company, the embedded conversion option is required to
be
bifurcated and accounted for as a derivative financial instrument
liability.
In
connection with the sale of convertible debt and equity instruments, we may
also
issue freestanding options or warrants. Additionally, we may issue options
or
warrants to non-employees in connection with consulting or other services
they
provide. Although the terms of the options and warrants may not provide for
net-cash settlement, in certain circumstances, physical or net-share settlement
is deemed to not be within the control of the company and, accordingly, we
are
required to account for these freestanding options and warrants as derivative
financial instrument liabilities, rather than as equity.
Derivative
financial instruments are initially measured at their fair value. For derivative
financial instruments that are accounted for as liabilities, the derivative
instrument is initially recorded at its fair value and is then re-valued
at each
reporting date, with changes in the fair value reported as charges or credits
to
income. For option-based derivative financial instruments, we use the
Black-Scholes option pricing model to value the derivative
instruments.
In
circumstances where the embedded conversion option in a convertible instrument
is required to be bifurcated and there are also other embedded derivative
instruments in the convertible instrument that are required to be bifurcated,
the bifurcated derivative instruments are accounted for as a single, compound
derivative instrument.
If
freestanding options or warrants were issued and will be accounted for as
derivative instrument liabilities (rather than as equity), the proceeds are
first allocated to the fair value of those instruments. When the embedded
derivative instrument is to be bifurcated and accounted for as a liability,
the
remaining proceeds received are then allocated to the fair value of the
bifurcated derivative instrument. The remaining proceeds, if any, are then
allocated to the convertible instrument itself, usually resulting in that
instrument being recorded at a discount from its face amount. In circumstances
where a freestanding derivative instrument is to be accounted for as an equity
instrument, the proceeds are allocated between the convertible instrument
and
the derivative equity instrument, based on their relative fair
values.
The
discount from the face value of the convertible debt instrument resulting
from
the allocation of part of the proceeds to embedded derivative instruments
and/or
freestanding options or warrants is amortized over the life of the instrument
through periodic charges to income, using the effective interest method.
The
classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed at the end
of
each reporting period. Derivative instrument liabilities are classified in
the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument is expected within 12 months of the
balance sheet date.
Equity
investments
Prior
to
the Company’s acquisition of DeLeeuw in 2004, DeLeeuw had acquired a
non-controlling interest in DeLeeuw International (a company formed under the
laws of Turkey). The Company accounts for its share of the income (losses)
of
this investment under the equity method.
The
Company acquired 49% of all issued and outstanding shares of common stock of
LEC
as of May 1, 2004. The acquisition was completed through a Stock Purchase
Agreement between the Company and the sole stockholder of LEC. In connection
with the acquisition, the Company (i) repaid a bank loan on behalf of the seller
in the amount of $35,000; (ii) repaid an LEC bank loan in the amount of $38,000;
and (iii) satisfied an LEC obligation for $10,000 of prior compensation to
an
employee. The Company accounts for its share of the income (losses) of this
investment under the equity method.
Foreign
Currency Translation
Local
currencies are the functional currencies for Evoke’s foreign subsidiaries.
Assets and liabilities are translated using the exchange rates in effect at
the
balance sheet date. Income and expenses are translated at the average exchange
rates during the period. Translation gains and losses not reflected in earnings
are reported as a component of stockholders’ equity. Foreign currency
translation gains (losses) are included as a component of the gain (loss) from
discontinued operations.
Comprehensive
Income
Accumulated
other comprehensive income is comprised of foreign currency translation gains
and losses which have been excluded from net income. The Company has reported
the components of comprehensive income on the consolidated statements of
stockholders’ equity.
Restatement
of Previously Issued Financial Statements
We
have
amended the annual reports for the year ended December 31, 2004 and quarterly
reports of the quarters ended September 30, 2004, March 31, 2005, June 30,
2005
and September 30, 2005 to revise the accounting for the convertible term
note,
warrants and options and related registration rights in connection with our
financing transaction entered into with Laurus
Master Funds, Ltd. (“Laurus”) and Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively “Sands”) during 2004.
As
a
result of the restatement, warrants and options have been reclassified as
derivative liabilities. The warrants and options had previously been measured
based on a relative fair method and are now measured at their full fair value
and will be marked to market on each balance sheet date.
Embedded
derivatives contained in the convertible debenture and the secured line of
credit are now bifurcated from the host debt and measured at fair value and
classified as derivative liabilities. These embedded derivatives will also
be
marked to market on each balance sheet date.
The
resulting debt discount will be amortized over the period of the convertible
debt and the secured line of credit as interest and other expenses in our
accompanying consolidated statements of operations.
The
effect on our accompanying consolidated balance sheet as of December 31,
2004
was an increase in liabilities by $6,555,091 and corresponding decrease in
stockholders' equity of $6,748,621. The effect on our consolidated statements
of
operations for the year ended December 31, 2004 was an increase in our net
loss
of $2,077,192. Basic and diluted earning per share for the year ended December
31, 2004 changed from loss per share $0.71 to $0.76, which gives effect to
the
1:15 reverse stock split on September 21, 2005.
For
the
impact of the restatement for the periods noted above, see Note 22 of the
Consolidated Financial Statements.
Reclassification
Certain
amounts in prior periods have been reclassified to conform to the 2005 financial
statement presentation.
Use
of estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at
the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Note
2: Liquidity
The
Company has incurred net losses and negative cash flows from operating
activities for the three months ended March 31, 2006 and the years ended
December 31, 2005 and 2004, and has an accumulated deficit of $40.1 million
at
December 31, 2005.
As
of
December 31, 2005, the Company had a cash balance of approximately $0.2 million.
As of March 31, 2006, Company had cash on hand and amounts available under
its
line of credit of approximately $2.7 million.
Our
primary liquidity needs are for working capital and debt service (see Notes
11,
12 and 13 to the consolidated financial statements). Our primary sources
of
liquidity are cash flows from operations, borrowings under our revolving
credit
facility, and various short and long term financings. Certain short term
note
holders have agreed to extend their maturity dates of the Notes on a
month-to-month basis until the Company raises sufficient funds to pay the
Notes
in full. Amounts outstanding under the Notes at December 31, 2005 was $1.5
million. In addition, Mr. Scott Newman, Mr. Glenn Peipert and Mr. Robert
C.
Deleeuw have agreed to personally support our cash requirements to enable
us to
fufill our obligations through June 1, 2007, to the extent necessary, up
to $1.5
million based on their ability to sell their Company common stock in order
to
provide the necessary financing.
Although
the Company has negative working capital at December 31, 2005 and March 31,
2006, and has incurred significant operating losses, the Company believes
existing cash plus funds provided by operations, borrowing capacity under the
line of credit and projected borrowing against, or the guarantees of the primary
stockholders should be sufficient to fund operations through January 1, 2007.
Nevertheless, the Company is presently exploring various financing alternatives,
including debt or additional sales of equity securities in order to finance
the
core business of the Company and help provide adequate working capital for
operations. There is no assurance that funds will be provided by operations
or
that such additional financing will be available, or if available, will be
available on acceptable terms. Should the Company experience significant
shortfalls in planned revenues, or experience unforeseen fixed expenses, the
Company believes it has the ability to make additional reductions to variable
expenses to extend its capital. Any decision or ability to obtain financing
through debt or through equity investment will depend on various factors,
including, among others, financial market conditions, strategic acquisition
and
investment opportunities, and developments in the Company's markets. The sale
of
additional equity securities or future conversion of any convertible debt would
result in additional dilution to the Company's stockholders.
Note
3: Recently
Issued Accounting Pronouncements
SFAS
No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based Payment,”
issued in December 2004, is a revision of FASB Statement 123, “Accounting for
Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting
for Stock Issued to Employees,” and its related implementation guidance. The
Statement focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. SFAS
No. 123R requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award. On March 29, 2005, the SEC issued Staff Accounting
Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views
regarding interactions between SFAS No. 123R and certain SEC rules and
regulations and provides interpretations of the valuation of share-based
payments for public companies.
SFAS
No. 123(R) permits public companies to adopt its requirements using one of
two methods:
(1)
A
“modified prospective” method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS
No. 123(R) for all share-based payments granted after the effective date
and (b) based on the requirements of SFAS No. 123 for all awards
granted to employees prior to the effective date of SFAS No. 123(R) that
remain unvested on the effective date.
(2)
A
“modified retrospective” method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based
on the amounts previously recognized under SFAS No. 123 for purposes of pro
forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.
This
statement is effective for the beginning of the first annual reporting period
that begins after June 15, 2005, therefore, we will adopt the standard in
the first quarter of fiscal 2006 using the modified prospective method. As
permitted by SFAS No. 123, we currently account for share-based payments to
employees using the intrinsic value method prescribed in APB Opinion 25 and,
as
such, generally recognize no compensation cost for employee stock options.
Although we have not completed our assessment, we believe the impact on our
consolidated financial position or results or operations will not be material
given the current number of outstanding stock options. The effect on our results
of operations of expensing stock options using the Black-Scholes method is
presented in the disclosure of pro forma net income and earnings per share
in
Note 1 – Accounting Policies. SFAS No. 123(R) 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. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after adoption.
In
December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary
Assets”,
an
amendment of APB Opinion No. 29. SFAS 153 eliminates the exception from
fair value measurement for nonmonetary exchanges of similar productive assets
in
paragraph 21 (b) of APB Opinion No. 29, “Accounting for Nonmonetary
Transactions” (““APB 29”), and replaces it with an exception for exchanges that
do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected
to
change significantly as a result of the exchange. SFAS 153 is effective for
the
fiscal periods beginning after June 15, 2005 and the Company will adopt
this Statement in the first quarter of 2006. The Company currently does not
anticipate that the effects of the statement will materially affect its
consolidated financial position or consolidated results of operations upon
adoption.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
Corrections - A Replacement of APB Opinion No. 20 and FASB Statement
No. 3”
(“SFAS
No. 154”).
SFAS
No. 154 requires the retrospective application to prior periods’ financial
statements of changes in accounting principle, unless it is impractible to
determine either the period-specific effects or cumulative effect of the
accounting change. SFAS No. 154 also requires that a change in
depreciation, amortization, or depletion method for long-lived non-financial
assets be accounted for as a change in accounting estimate affected by a change
in accounting principle. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2004 and we will adopt this provision, as applicable, during fiscal year 2006.
In
February 2006, the FASB issued SFAS 155 - “Accounting for Certain Hybrid
Financial Instruments—an amendment of FASB Statements No. 133 and 140.”
This Statement amends FASB Statements No. 133, Accounting for Derivative
Instruments and Hedging Activities, and No. 140, Accounting for Transfers
and
Servicing of Financial Assets and Extinguishments of Liabilities. This Statement
resolves issues addressed in Statement 133 Implementation Issue No. D1,
“Application of Statement 133 to Beneficial Interests in Securitized Financial
Assets.” This Statement:
|
a.
|
Permits
fair value remeasurement for any hybrid financial instrument that
contains
an embedded derivative that otherwise would require
bifurcation
|
|
b.
|
Clarifies
which interest-only strips and principal-only strips are not subject
to
the requirements of Statement 133
|
|
c.
|
Establishes
a requirement to evaluate interests in securitized financial assets
to
identify interests that are freestanding derivatives or that are
hybrid
financial instruments that contain an embedded derivative requiring
bifurcation
|
|
d.
|
Clarifies
that concentrations of credit risk in the form of subordination
are not
embedded derivatives
|
|
e.
|
Amends
Statement 140 to eliminate the prohibition on a qualifying special-purpose
entity from holding a derivative financial instrument that pertains
to a
beneficial interest other than another derivative financial
instrument.
|
This
Statement is effective for all financial instruments acquired or issued after
the beginning of our first fiscal year that begins after September 15,
2006. The fair value election provided for in paragraph 4(c) of this
Statement may also be applied upon adoption of this Statement for hybrid
financial instruments that had been bifurcated under paragraph 12 of Statement
133 prior to the adoption of this Statement. Earlier adoption is permitted
as of
the beginning of our fiscal year, provided we have not yet issued financial
statements, including financial statements for any interim period, for that
fiscal year. Provisions of this Statement may be applied to instruments that
we
hold at the date of adoption on an instrument-by-instrument basis. The
Company is currently reviewing the effects of adoption of this statement
but it
is not expected to have a material impact on our financial
statements.
In
March
2005, the FASB issued FIN No. 47, “Accounting for Conditional Asset
Retirement Obligations - an interpretation of FASB Statement No. 143
“Accounting for Asset Retirement Obligations (“SFAS No. 143”)” (“FIN 47”).
FIN 47 clarifies that the term conditional
asset retirement obligation
as used
in SFAS No. 143, refers to a legal obligation to perform an asset
retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of
the
entity. Accordingly, an entity is required to recognize a liability for the
fair
value of a conditional asset retirement obligation if the fair value of the
liability can be reasonably estimated. The liability for the conditional
asset
retirement obligation should be recognized when incurred. This Interpretation
also clarifies when an entity would have sufficient information to reasonably
estimate the fair value of an asset retirement obligation. FIN 47 is effective
for fiscal periods beginning after December 15, 2005, and we will adopt
this provision, as applicable, during fiscal year 2006.
Note
4 - Mergers and acquisitions
Acquisition
of McKnight Associates
On
July
22, 2005, the Company entered into (and simultaneously consummated) a merger
agreement with McKnight Associates. In consideration of this merger agreement,
the Company paid the following consideration: $500,000 in cash, the commitment
to pay an additional $250,000, in cash, by June 2006 (the Company paid Mr.
McKnight $125,000 in March 2006), the issuance of 909,091 shares of the Company
common stock, plus the assumption of substantially all of the liabilities of
McKnight.
The
components of the purchase price were allocated to the various assets and
liabilities of McKnight Associates as follows:
COMPONENTS
OF PURCHASE PRICE (in thousands):
Value
of common stock
|
|
$
|
1,773
|
|
Cash
consideration
|
|
|
922
|
|
Acquisition
costs
|
|
|
24
|
|
|
|
$
|
2,719
|
|
ALLOCATION
OF PURCHASE PRICE (in thousands):
Cash
|
|
|
(116
|
)
|
|
|
|
Accounts
receivable
|
|
|
(298
|
)
|
|
|
|
Goodwill
|
|
|
(1,865
|
)
|
|
(indefinite
life)
|
|
Customer
relationship
|
|
|
(685
|
)
|
|
(2.5
year estimated life)
|
|
Order
backlog
|
|
|
(50
|
)
|
|
(5
month estimated life)
|
|
Proprietary
presentation format
|
|
|
(173
|
)
|
|
(3
year estimated life)
|
|
Deferred
tax liability
|
|
|
363
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
|
105
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
Acquisition
of Integrated Strategies
On
July
29, 2005 the Company, entered into (and simultaneously consummated) an agreement
and plan of merger (the "Agreement") among ISI Merger Corp., a Delaware
corporation and wholly owned subsidiary of the Company ("Merger Sub"),
Integrated Strategies, Inc., a Delaware corporation ("ISI"), ISI Consulting,
LLC, a Delaware limited liability company ("LLC"), and Adam and Larry Hock,
individual majority stockholders and members of ISI and LLC, respectively (the
"Majority Stockholders"). Pursuant to the Agreement, ISI and LLC merged with
and
into Merger Sub and the Company and Merger Sub paid the following consideration:
$2,050,000 in cash (reduced by certain amounts), the issuance by Merger Sub
of a
promissory note in the amount of $580,000 (which was later reduced), the
issuance by the Company of a subordinated promissory note in the amount of
$165,000, and the assumption of substantially all the liabilities of ISI and
LLC. The Agreement also provides for the commitment, subject to certain revenue
and profit thresholds (as described in the Agreement), to pay additional cash
and issue shares of the Company common stock. On August 1, 2005, Merger Sub
changed its name to Integrated Strategies, Inc.
Exclusive
of contingent consideration, the components of the purchase price were allocated
to the various assets and liabilities of Integrated Strategies as
follows:
COMPONENTS
OF PURCHASE PRICE (in thousands):
Cash
|
|
$
|
2,148
|
|
|
|
|
Promissory
notes
|
|
|
241
|
|
|
|
|
Acquisition
costs
|
|
|
28
|
|
|
|
|
|
|
$
|
2,417
|
|
|
|
|
ALLOCATION
OF PURCHASE PRICE (in thousands):
|
|
|
|
Cash
|
|
|
(119
|
)
|
|
|
|
Accounts
receivable
|
|
|
(661
|
)
|
|
|
|
Prepaid
expenses
|
|
|
(3
|
)
|
|
|
|
Property
and equipment, net
|
|
|
(2
|
)
|
|
|
|
Goodwill
|
|
|
(1,792
|
)
|
|
(Indefinite
life)
|
|
Other
assets
|
|
|
(13
|
)
|
|
|
|
Accounts
payable and accrued expenses
|
|
|
173
|
|
|
|
|
|
|
$
|
-
|
|
|
|
|
The
pro
forma consolidated statements of operations for the years ended December 31,
2004 and 2005, respectively, set forth below gives effect to the acquisitions
of
McKnight Associates, Inc. and Integrated Strategies, Inc. as if they occurred
on
January 1, 2004.
|
|
Year
ended
|
|
Year
ended
|
|
|
|
December
31, 2005
|
|
December
31, 2004
|
|
Revenues
|
|
$
|
32,440,262
|
|
$
|
32,083,229
|
|
Net Loss
|
|
$
|
(3,487,152
|
)
|
$
|
(22,449,341
|
)
|
Net Loss
per share
|
|
$
|
(0.07
|
)
|
$
|
(0.48
|
)
|
Note
5 - Discontinued Operations
In
July
2005, the Board of Directors approved, and the Company completed, the sale
of
substantially all of the assets of Evoke Software Corporation and received
aggregate consideration of $645,000 cash, the assumption by Similarity Systems
and Similarity Vector Technologies, Ltd. of certain liabilities, 821,053 shares
which are issuable by Similarity subject to the Company’s satisfactory
completion of certain post-closing obligations, and an earnout in an amount
equal to 13% of certain Similarity revenues. The maximum earnout consideration
to which the Company is entitled under this agreement is $1,400,000 and would
be
received over a three year period. CSI changed the name of its “Evoke Software
Corporation” subsidiary to “CSI Sub Corp II (DE)” in August 2005.
The
821,053 shares and the earnout noted above as consideration to be received
by
the Company are both contingent upon certain post-closing events. However,
as a
result of Informatica Corporation’s acquisition of Similarity Systems in
February 2006, the Company received $2,050,000 as a final payment on all future
consideration related to our agreement with Similarity.
Total
assets and liabilities of Evoke, as of the date of the sale, were as
follows:
Cash
|
|
$
|
35,026
|
|
Accounts
receivable, net
|
|
|
692,459
|
|
Prepaid
expenses
|
|
|
101,115
|
|
Property
and equipment, net
|
|
|
77,878
|
|
Intangible
assets, net
|
|
|
1,694,044
|
|
Other
assets
|
|
|
4,850
|
|
|
|
$
|
2,605,372
|
|
Accounts
payable and accrued expenses
|
|
$
|
(503,238
|
)
|
Deferred
revenue
|
|
|
(1,649,995
|
)
|
Due
to CSI
|
|
|
(1,482,312
|
)
|
Minority
interest
|
|
|
(75,067
|
)
|
|
|
$
|
(3,710,612
|
)
|
The
Company is liquidating the portion of Evoke that was not acquired by Similarity
Systems. As a result of the divestiture and liquidation of the Evoke subsidiary,
the Company recorded a charge for uncollectible intercompany receivables to
Evoke amounting to $1,482,312.
Transaction costs related to the sale were $44,000. The Company reported a
gain
on disposal of the Evoke subsidiary of $49,148 which is included as a component
of other income (expense).
The
Evoke
revenue by line of business, and loss from discontinued operations is as
follows:
|
|
For
the year ended December 31,
|
|
|
|
2005
|
|
2004
|
|
Revenue:
|
|
|
|
|
|
Services
|
|
$
|
58,184
|
|
$
|
132,834
|
|
Software
|
|
|
646,269
|
|
|
108,623
|
|
Support
and maintenance
|
|
|
862,118
|
|
|
1,031,953
|
|
Other
|
|
|
5,512
|
|
|
|
|
|
|
$
|
1,572,083
|
|
$
|
1,273,410
|
|
Net
loss
|
|
$
|
(1,153,119
|
)
|
$
|
(12,650,908
|
)
|
Note
6 - Property and equipment
|
|
|
|
|
|
Property
and equipment consisted of the following:
|
|
|
|
|
|
|
|
December
31,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
Computer
equipment
|
|
$
|
998,339
|
|
$
|
979,494
|
|
Furniture
and fixtures
|
|
|
161,543
|
|
|
232,648
|
|
Leasehold
improvements
|
|
|
92,459
|
|
|
216,306
|
|
|
|
|
1,252,341
|
|
|
1,428,448
|
|
Accumulated
depreciation
|
|
|
(834,872
|
)
|
|
(840,873
|
)
|
|
|
$
|
417,469
|
|
$
|
587,575
|
|
Depreciation
and amortization expense related to property and equipment totaled $0.1 million
and $0.1 million for 2005 and 2004, respectively.
Note
7 - Intangible assets
|
|
December
31,
|
|
December
31,
|
|
Amortization
|
|
|
|
2005
|
|
2004
|
|
period
|
|
Customer
contracts
|
|
$
|
414,000
|
|
$
|
1,876,424
|
|
|
5
years
|
|
Computer
software
|
|
|
-
|
|
|
1,381,000
|
|
|
3
years
|
|
Approved
vendor status
|
|
|
538,814
|
|
|
538,814
|
|
|
40
months
|
|
Customer
relationships
|
|
|
685,000
|
|
|
-
|
|
|
2.5
years
|
|
Tradename
|
|
|
722,000
|
|
|
722,000
|
|
|
Indefinite
|
|
Proprietary
presentation format
|
|
|
173,000
|
|
|
-
|
|
|
3
years
|
|
Order
backlog
|
|
|
50,500
|
|
|
-
|
|
|
5
months
|
|
Proprietary
rights and rights to the name of Scosys, Inc.
|
|
|
20,000
|
|
|
20,000
|
|
|
Indefinite
|
|
|
|
|
2,603,314
|
|
|
4,538,238
|
|
|
|
|
Accumulated
amortization
|
|
|
(740,350
|
)
|
|
(911,142
|
)
|
|
|
|
|
|
$
|
1,862,964
|
|
$
|
3,627,096
|
|
|
|
|
The
estimated amortization expense for the next five years related to other
finite-lived intangible assets is estimated to be as follows:
|
|
Amortization
of Intangible
assets
|
|
|
|
|
|
2006
|
|
576,107
|
|
2007
|
|
488,385
|
|
2008
|
|
56,472
|
|
Thereafter
|
|
-
|
|
|
|
$
|
1,120,964
|
|
Note
8 - Deferred financing costs
The
Company has incurred and capitalized financing costs in connection with two
financing transactions consummated during 2004. These costs were deferred and
are being amortized over the life of the related financing agreement. The
following illustrates the components of the deferred financing
costs:
|
|
Year
Ended
|
|
Year
Ended
|
|
|
|
December
31,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
Laurus
Master Fund
|
|
$
|
766,270
|
|
$
|
766,270
|
|
Sands
Brothers
|
|
|
127,039
|
|
|
127,039
|
|
|
|
$
|
893,309
|
|
$
|
893,309
|
|
Accumulated
amortization
|
|
|
(467,604
|
)
|
|
(126,767
|
)
|
|
|
$
|
425,705
|
|
$
|
766,542
|
|
Note
9 - Discount on debt
The
Company has recorded the discounts on its debt instruments due to both warrant
issuances and embedded derivatives contained in convertible notes as deferred
charges. These deferred charges are being amortized to interest expense over
the
life of the related debt instruments, which currently range from one to five
years. The following illustrates the components of the discount on debt and
their applicable amortization period:
|
|
December
31,
|
|
December
31,
|
|
|
|
|
|
2005
|
|
2004
|
|
Amortization
period
|
|
Laurus
Master Fund
|
|
$
|
2,276,345
|
|
$
|
6,658,490
|
|
|
36
months
|
|
Sands
Brothers
|
|
|
1,080,000
|
|
|
1,000,000
|
|
|
12-15
months
|
|
Taurus
Advisory Group
|
|
|
1,500,000
|
|
|
1,500,000
|
|
|
5
years
|
|
|
|
|
4,856,345
|
|
|
9,158,490
|
|
|
|
|
Accumulated
amortization
|
|
|
(678,917
|
)
|
|
(941,212
|
)
|
|
|
|
|
|
$
|
4,177,428
|
|
$
|
8,217,278
|
|
|
|
|
Note
10 - Line of credit
In
August
2004, we replaced our $3.0 million line of credit with North Fork Bank with
a
revolving line of credit with Laurus Master Fund, Ltd. (“Laurus”), whereby we
had access to borrow up to $6.0 million based upon eligible accounts receivable.
A portion of Laurus’s revolving line of credit was used to pay off all
outstanding borrowings from North Fork Bank. This revolving line, effectuated
through a $2.0 million convertible minimum borrowing note and a $4.0 million
revolving note, provided for advances at an advance rate of 90% against eligible
accounts receivable, with an annual interest rate of prime rate (as reported
in
the Wall Street Journal) plus 1%, and matured in three years. We had no
obligation to meet financial covenants under the $2.0 million convertible
minimum borrowing note or the $4.0 million revolving note. This line of credit
is secured by substantially all the corporate assets. Both the $2.0 million
convertible minimum borrowing note and the $4.0 million revolving note provided
for conversion at the option of the holder of the amounts outstanding into
our
common stock at a fixed conversion price of $2.10 per share.
Additionally,
in exchange for a $5,000,000 secured convertible term note bearing interest
at
prime rate (as reported in the Wall Street Journal) plus 1%, Laurus had
established a $5.0 million account to be used only for acquisition targets
identified by us that were approved by Laurus in Laurus’ sole discretion. We had
no obligation to meet financial covenants under the $5.0 million secured
convertible term note. This note was convertible into our common stock at a
fixed conversion price of $2.10 per share. This note was to mature in three
years. We issued Laurus a common stock purchase warrant that provided Laurus
with the right to purchase 800,000 shares of our common stock. The exercise
price for the first 400,000 shares acquired under the warrant is $4.35 per
share, the exercise price for the next 200,000 shares acquired under the warrant
is $4.65 per share, and the exercise price for the final 200,000 shares acquired
under the warrant is $5.25 per share. The common stock purchase warrant expires
on August 15, 2011. We paid $0.75 million in brokerage and transaction closing
related costs. These costs were deducted from the $5.0 million restricted cash
balance being provided to us by Laurus.
In
May
2005, Laurus elected to convert $1,000,000 of debt underlying the minimum
borrowing note into the Company’s common stock. As a result of this conversion,
the Company obtained $1,000,000 of additional borrowing capacity under its
revolving line of credit and in return, issued 476,191 shares
of
Company common stock to Laurus.
In
July
2005, the Company entered into amendments of the notes dated August 16, 2004
between the Company and Laurus. Pursuant to the amendment, the Company released
$4,327,295 (the “Funds”) to Laurus, which was being held in the Restricted
Account (which was available to the Company for acquisitions) and issued an
amended and restated convertible note in the principal amount of $749,000.
In
satisfaction of the balance of the accrued interest and any liquidated damages
to which it was entitled pursuant the Registration Rights Agreement entered
into
in August 2004, the Company issued an option to purchase 333,334 shares of
the
Company’s common stock at a purchase price of $0.015 per share. Laurus fully
exercised this option to purchase Company stock on August 1, 2005. Laurus also
agreed to extend the required filing date and effective date of the Registration
Statement. For accounting purposes, the Company recorded this transaction as
an
early extinguishment of debt and recognized the remaining discount on debt
and
liability as a component of other income (expense).
The
Company also issued an amended and restated convertible secured revolving note
in the principal amount of $4.5 million in favor of Laurus which amended the
$4
million Revolving Note executed in August 2004. In connection with this note,
the Company and Laurus entered into an Overadvance Letter Agreement, pursuant
to
which Laurus made a loan to the Company in excess of the amount available using
the Company accounts receivable as collateral in the principal amount of $2.7
million. The Company utilized the $2.7 million which was advanced to it by
Laurus to acquire McKnight Associates, Inc., Integrated Strategies, Inc. and
ISI
Consulting, LLC. Except as noted above, all terms of the August 2004 agreements
continued to remain in effect.
On
November 30, 2005, the Company (i) amended and restated the convertible
term note in the principal amount of $749,000 by reducing the conversion rate
of
such note from $2.10 to $1.00, (ii) amended and restated the secured
revolving convertible note by increasing the principal amount available from
$4,500,000 to $5,500,000 and reducing the conversion rate from $2.10 to $1.00,
and (iii) amended and restated the secured convertible minimum borrowing
note in the principal amount of $2,000,000 by reducing the fixed conversion
price from $2.10 to $0.65.
As
a
result of the issuance of warrants, the Company has recorded a discount on
debt
(valued at $2.2 million as of December 31, 2005) and a liability. The discount
is being amortized over the remaining term of the debt instrument, and the
liability is being adjusted to fair value using an option-pricing model.
Additionally, the convertible notes contain embedded derivatives pertaining
to the conversion feature, conversion reset provision, redemption option and
variable interest rate feature in the notes, and the Company has recorded a
discount on debt and a liability to reflect the fair value of these
derivatives.
The
note
and related agreements contain several events of default which
include:
|
·
|
failure
to pay interest, principal payments or other fees when
due;
|
|
·
|
failure
to pay taxes when due unless such taxes are being contested in good
faith;
|
|
·
|
breach
by us of any material covenant or term or condition of the notes
or any
agreements made in connection
therewith;
|
|
·
|
default
on any indebtedness to which we or our subsidiaries are a
party;
|
|
·
|
breach
by us of any material representation or warranty made in the notes
or in
any agreements made in connection
therewith;
|
|
·
|
attachment
is made or levy upon collateral securing the Laurus debt which is
valued
at more than $150,000 and is not timely
mitigated.
|
|
·
|
any
lien created under the notes and agreements is not valid and perfected
having a first priority interest;
|
|
·
|
assignment
for the benefit of our creditors, or a receiver or trustee is appointed
for us;
|
|
·
|
bankruptcy
or insolvency proceeding instituted by or against us and not dismissed
within 30 days;
|
|
·
|
the
inability to pay debts as they become due or cease business
operations;
|
|
·
|
sale,
assignment, transfer or conveyance of any assets except as
permitted;
|
|
·
|
a
person or group becomes beneficial owner of 35% on fully diluted
basis of
the outstanding voting equity interest or the present directors cease
to
be the majority on the Board of
Directors;
|
|
·
|
indictment
or threatened criminal indictment, or commencement of threatened
commencement of any criminal or civil proceeding against the Company
or
any executive officer; and
|
|
·
|
common
stock suspension for five consecutive days or five days during any
10
consecutive days from a principal market, provided that we are unable
to
cure such suspension within 30 days or list our common stock on another
principal market within 60 days.
|
If
we
default on the notes and the holder demands all payments due and payable, the
cash required to pay such amounts would most likely come out of working capital,
which may not be sufficient to repay the amounts due. The default payment shall
be 130% of the outstanding principal amount of the note (reduced to 115% in
February 2006), plus accrued but unpaid interest, all other fees then remaining
unpaid, and all other amounts payable thereunder. In addition, since we rely
on
our working capital for our day to day operations, such a default on the note
could materially adversely affect our business, operating results or financial
condition to such extent that we are forced to restructure, file for bankruptcy,
sell assets or cease operations. Further, our obligations under the notes are
secured by substantially all of our assets. Failure to fulfill our obligations
under the notes and related agreements could lead to loss of these assets,
which
would be detrimental to our operations. As of April 17, 2006, the Company does
not believe that it is in default of any of the provisions of the Laurus
agreements.
As
of
December 31, 2005, approximately $4.7 million was outstanding under the
revolving line of credit and Overadvance Letter Agreement. The interest rate
on
the revolving line and the overadvance letter was 8.25% as of December 31,
2005.
Note
11 - Short Term Notes Payable
In
July
2005, the Company obtained two $250,000 short term loans from certain investors
represented by Taurus. Both notes bear interest at 8% per annum. The first
note
is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
date for this note has been extended to May 6, 2006. The second note is
dated July 22, 2005 and originally matured on September 22, 2005. The maturity
date for this note has been extended to April 22, 2006. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
In
July
2005, in conjunction with the acquisition of Integrated Strategies, the Company
issued a short term note in the principal amount of $165,000 payable to Adam
Hock and Larry Hock, the former principle stockholders of Integrated Strategies.
This note bears interest at 5% per annum and matures on October 28,
2006.
In
December 2005, the Company obtained a $1,000,000 short term loan from certain
investors represented by Taurus. This note bears interest at 8% per annum.
The
note is dated December 19, 2005 and initially matured on January 31, 2006.
The
maturity date for this note has been extended to June 1, 2006. These investors
received a warrant to purchase 277,777 shares of our common stock with an
exercise price of $0.675 per share. The warrant expires in December 2008. As
of
December 31, 2005, the Company had borrowed $500,000 under this note.
These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
Using
the
Black-Scholes option pricing model, the Company calculated the relative fair
value of the warrant to purchase 277,777 shares of Company common stock to
be
$111,111. This relative fair value has been recorded as a reduction of the
$1,000,000 liability and an addition to additional paid-in capital. This amount
is being amortized to interest expense over the term of the debt instrument.
The
assumptions used in the relative fair value calculation are as follows: Company
stock price on December 19, 2005 of $0.54 per share; exercise price of the
warrants of $0.675 per share; three year term; volatility of 162.52%; annual
rate of dividends of 0%; and a risk free interest rate of 4.5%.
Note
12 - Financial Instruments
Laurus
The
Notes
are hybrid instruments which contain both freestanding derivative financial
instruments and more than one embedded derivative feature which would
individually warrant separate accounting as a derivative instrument under
SFAS
No. 133. The freestanding derivative financial instruments include the warrant,
which was valued individually, and totaled $2,394,000 at the date of inception.
The various embedded derivative features have been bundled together as a
single,
compound embedded derivative instrument that has been bifurcated from the
debt
host contract, referred to as the “Compound Embedded Derivative Liability”. The
single compound embedded derivative features include the conversion feature
within the notes, the conversion reset feature, the early redemption option
and
the interest rate adjustments. The value of the single compound embedded
derivative liability was bifurcated from the debt host contract and recorded
as
a derivative liability, which resulted in a reduction of the initial carrying
amount (as unamortized discount) of the notes. The unamortized discount is
amortized to interest expense using the effective interest method over the
life
of the notes, or 36 months.
In
order
to correct the consolidated financial statements so that they comply with
US
generally accepted accounting principles, the Company previously restated
the
consolidated financial statements as of December 31, 2004 to reclassify the
Laurus warrants from additional paid in capital to liabilities and interest
expense effective September 2004 to reflect that the registration rights
agreement into which the Company entered in connection with its issuance
of the
warrants requires the Company to pay liquidated damages, which in some cases
could exceed a reasonable discount for delivering unregistered shares and
thus
would require the warrants to be classified as a liability until the earlier
of
the date the warrants are exercised or expire. In accordance with EITF 00-19,
“Accounting
for Derivative Financial Instruments Indexed To, and Potentially Settled
In, a
Company’s Own Stock”, the
Company has allocated a portion of the offering proceeds to the warrants
based
on their fair value. EITF 00-19 also requires that the Company revalue the
warrants as a derivative instrument periodically to compute the value in
connection with changes in the underlying stock price and other assumptions,
with the change in value recorded as other expense or other income.
In
conjunction with the Laurus credit facility, Laurus was paid a fee of $749,000,
in August 2004, and received a seven-year warrant to purchase up to 800,000
shares of the Company’s common stock at prices ranging from $4.35 to $5.25 per
share. The warrant, which is exercisable immediately, was valued at $2,394,000
using a Black-Scholes option pricing model. The value of the warrant and
the
fees paid to Laurus were recorded as a discount to the note and are being
amortized over the term of the loan using the effective interest
method.
The
Laurus notes were amended in July 2005 and this amendment was accounted for
as
an extinguishment of the debt, however, it has been determined that the proper
accounting treatment is to account for the transaction as an early
extinguishment of debt. In order to correct the financial statements so that
they comply with US generally accepted accounting principles, the Company
has
restated the consolidated financial statements and this amendment to the
note
was accounted for as an extinguishment of debt in accordance with EITF 96-19
“Debtor’s
Accounting for a Modification or Exchange of Debt Instruments.”
Accordingly, the unamortized discounts, of the warrants and the compound
embedded derivatives, aggregating $4,954,482 and the fair value of the 333,333
options to purchase Company common stock issued in connection with the
amendment, amounting to approximately $772,000, were included in the Company’s
determination of the debt extinguishment recorded in the third quarter of
fiscal
year 2005. The $244,000 aggregate gain from these transactions accounted
for as
an early extinguishment of debt included in other income (expense) for the
year
ended December 31, 2005.
The
Laurus agreements were amended again in November 2005 and this amendment
was
treated as an early extinguishment of debt by the Company. The unamortized
discounts aggregating $3,291,000 and the fair value of the warrant and embedded
derivative liability amounting to $1,439,000 were included in the Company’s
determination of the debt extinguishment recorded in the fourth quarter of
fiscal 2005. The aggregate loss of $1,852,000 from these transactions were
accounted for as an extinguishment of debt is included in other expenses
for the
year ended December 31, 2005.
The
Company determined the fair value of the warrants as of the following issuance
dates:
As
of
August 16, 2004, the Company used the Black-Scholes option-pricing model
with
the following assumptions: an expected life equal to the contractual term
of the
warrants (seven years); no dividends; a risk free rate of return of 3.89%;
and a
volatility of 150.0%. Using these assumptions, the Black-Scholes option-pricing
model yielded a value of $1,199,000 for the warrants with a $4.35 exercise
price, $598,000 for the warrants with a $4.65 exercise price, and $597,000
for
the warrants with a $5.25 exercise price for an aggregate fair value of
$2,394,000.
The
Company performed the same calculation as of September 30, 2004 to revalue
the
warrants as of that date. In using the Black-Scholes option-pricing model,
the
Company used an
expected life of 6.87 years; an underlying stock price of $3.45 per share;
no
dividends; a risk free rate of 3.79% and volatility of 150.0%. The resulting
aggregate allocated value of the warrants as of September 30, 2004 equaled
$2,622,000.
The
Company performed the same calculation as of December 31, 2004 to revalue
the
warrants as of that date. In using the Black-Scholes option-pricing model,
the
Company used an expected life of 6.62 years; an underlying stock price of
$3.67
per share; no dividends; a risk free rate of 3.94% and volatility of 150.0%.
The
resulting aggregate allocated value of the warrants as of December 31, 2004
equaled $2,781,000. The change in fair value of the warrants resulted in
an
amount of $387,000 and included as part of financial instruments for the
year
ended December 31, 2004.
For
the
year ended December 31, 2005, the Company performed the Black-Scholes
calculation to revalue the warrants as of that date. In using this model,
the
Company used an expected life of 5.62 years; an underlying stock price of
$0.41
per share; no dividends; a risk free rate of 4.36% and volatility of 150.0%.
The
resulting aggregate allocated value of the warrants as of December 31, 2005
equaled $264,000. The change in fair value of the warrants resulted in an
amount
of ($2,517,000) and is included as a charge to financial instruments for
the
year ended December 31, 2005.
Upon
the
earlier of the warrant exercise or the expiration date, the warrant liability
will be reclassified into stockholders’ equity. Until that time, the warrant
liability will be recorded at fair value based on the methodology described
above. Changes in the fair value during each period will be recorded as other
income or other expense. Liquidated damages under the registration rights
agreement will be expensed as incurred and will be included in operating
expenses.
The
Company is also restating the consolidated financial statements to record
an
embedded derivative liability rather than the beneficial conversion feature
previously recorded of $4,100,000 as of December 31, 2004.
Using
a
probability-weighted discounted cash flow model, the fair value of the Compound
Embedded Derivative Liability was computed at $4,265,000, $4,519,000 and
$725,000 at August 16, 2004 (date of inception), December 31, 2004 and December
31, 2005, respectively. The model replicated the economics of the notes and
applied different events based on various conditions likely to occur over
the
life of the note. Multiple scenarios were used in the model and the underlying
assumptions below were applied. The value of this single, compound embedded
derivative instrument was bifurcated from the debt host contract and recorded
as
a derivative liability which resulted in a reduction of the initial carrying
amount (as unamortized discount) to the notional amounts of the convertible
notes.
Sands
The
Notes
are hybrid instruments which contain both freestanding derivative financial
instruments and more than one embedded derivative feature which would
individually warrant separate accounting as a derivative instrument under SFAS
No. 133. The freestanding derivative financial instruments include the warrant,
which was valued individually, and totaled $1,563,000 at the date of inception.
The various embedded derivative features have been bundled together as a single,
compound embedded derivative instrument that has been bifurcated from the debt
host contract, referred to as the “Compound Embedded Derivative Liability”. The
single compound embedded derivative features include the conversion feature
within the notes, the conversion reset feature, the early redemption option,
and
the interest rate adjustments. The value of the single compound embedded
derivative liability was bifurcated from the debt host contract and recorded
as
a derivative liability, which resulted in a reduction of the initial carrying
amount (as unamortized discount) of the notes. The unamortized discount is
amortized to interest expense using the effective interest method over the
life
of the notes, or 12 months.
In
order
to correct the financial statements so that they comply with US generally
accepted accounting principles, the Company previously restated the consolidated
financial statements as of December 31, 2004 to reclassify the Sands warrants
from additional paid in capital to liabilities and interest expense effective
September 2004 to reflect the registration rights agreement into which the
Company entered in connection with its issuance of the warrants requires
the
Company to pay liquidated damages, which in some cases could exceed a reasonable
discount for delivering unregistered shares and thus would require the warrants
to be classified as a liability until the earlier of the date the warrants
are
exercised or expire. In accordance with EITF 00-19, “Accounting
for Derivative Financial Instruments Indexed To, and Potentially Settled
In, a
Company’s Own Stock” the
Company revalued the warrants as a derivative instrument periodically to
compute
the value in connection with changes in the underlying stock price and other
assumptions, with the change in value recorded as other expense or other
income.
In
conjunction with the Sands transaction, in September 2004, Sands received
a
three-year warrant to purchase up to 400,000 shares of the Company’s common
stock at $2.10 per share. The warrant, which is exercisable immediately,
was
valued at $1,742,000 using a Black-Scholes option pricing model. The value
of
the warrant was recorded as a discount to the note and is being amortized
over
the term of the loan using the effective interest method.
The
Company determined the fair value of the warrants as of the following issuance
dates:
As
of
September 22, 2004, the Company used the Black-Scholes option-pricing model
with
the following assumptions: an expected life equal to the contractual term
of the
warrants (three years); an underlying stock price of $3.30 per share; no
dividends; a risk free rate of return of 2.78%; and a volatility of 150.0%.
Using these assumptions, the Black-Scholes option-pricing model yielded a
fair
value of $1,742,000 for the warrants.
The
Company performed the same calculation as of September 30, 2004 to revalue
the
warrants as of that date. In using the Black-Scholes option-pricing model,
the
Company used an expected life of 3.00 years; an underlying stock price of
$3.45
per share; no dividends; a risk free rate of 2.89% and volatility of 150.0%.
The
resulting aggregate allocated value of the warrants as of September 30, 2004
equaled $1,828,000.
The
Company performed the same calculation as of December 31, 2004 to revalue
the
warrants as of that date. In using the Black-Scholes option-pricing model,
the
Company used an expected life of 3.00 years; an underlying stock price of
$3.67
per share; no dividends; a risk free rate of 3.25% and volatility of 150.0%.
The
resulting aggregate allocated value of the warrants as of December 31, 2004
equaled $1,788,000. The change in fair value of the warrants resulted in
an
amount of was $46,000 and is included as a component of financial instruments
for the year ended December 31, 2004.
For
the
year ended December 31, 2005, the Company performed the Black-Scholes
calculation to revalue the warrants as of that date. In using this model,
the
Company used an expected life of 2.69 years; an underlying stock price of
$0.53
per share; no dividends; a risk free rate of 4.37% and volatility of 150.0%.
The
resulting aggregate allocated value of the warrants as of December 31, 2005
equaled $142,000. The change in fair value of the warrants resulted in a
decrease of the liability of ($1,646,000) and is included as a component
of
financial instruments for the year ended December 31, 2005.
Upon
the
earlier of the warrant exercise or the expiration date, the warrant liability
will be reclassified into stockholders’ equity. Until that time, the warrant
liability will be recorded at fair value based on the methodology described
above. Changes in the fair value during each period will be recorded as other
income or other expense. Liquidated damages under the registration rights
agreement will be expensed as incurred and will be included in operating
expenses.
The
Company is also restating the consolidated financial statements to record
embedded derivatives rather than the beneficial conversion features previously
recorded of $571,000 as of September 22, 2004.
Using
a
probability-weighted discounted cash flow model, the fair value of the Compound
Embedded Derivative Liability was computed at $1,563,000 and $1,428,000 at
September 22, 2004 (date of inception) and December 31, 2004, respectively.
The
note matured on September 22, 2005 and a new note was executed with Sands.
Using
the probability-weighted discounted cash flow model, the fair value of the
Compound Embedded Derivative Liability was computed at $962,000 and $889,000
at
September 22, 2005 (date of inception) and December 31, 2005, respectively.
The
model replicated the economics of the notes and applied different events
based
on various conditions likely to occur over the life of the note. Multiple
scenarios were used in the model and the underlying assumptions below were
applied. The value of this single, compound embedded derivative instrument
was
bifurcated from the debt host contract and recorded as a derivative liability
which resulted in a reduction of the initial carrying amount (as unamortized
discount) to the notional amounts of the Convertible Notes.
Probability-Weighted
Expected Cash Flow
Methodology
|
|
|
Liability
|
|
|
|
|
December
31,
|
|
|
December
31,
|
|
Assumption
|
|
|
2005
|
|
|
2004
|
|
Risk-free
interest rate
|
|
|
4.41
|
%
|
|
3.25
|
%
|
Prime
Rate
|
|
|
7.25
|
%
|
|
5.25
|
%
|
Increasing
.25% each quarter
|
|
|
|
|
|
|
|
Registration
Default
|
|
|
0
|
%
|
|
0
|
%
|
Increasing
1% monthly up to 5%
|
|
|
|
|
|
|
|
Default
status
|
|
|
5
|
%
|
|
5
|
%
|
Increasing
.1% monthly
|
|
|
|
|
|
|
|
Alternative
financing available
|
|
|
0
|
%
|
|
0
|
%
|
Increasing
2.5% monthly up to 25%
|
|
|
|
|
|
|
|
Trading
volume, gross 22 day volume
|
|
$
|
541,800
|
|
$
|
363,610
|
|
Monthly
increase
|
|
|
1
|
%
|
|
2
|
%
|
Annual
growth rate of stock price
|
|
|
31.485
|
%
|
|
31.725
|
%
|
Future
projected volatility
|
|
|
150
|
%
|
|
150
|
%
|
Reset
Provisions occurring
|
|
|
50
|
%
|
|
40
|
%
|
Weighted
Average Conversion Reset Price
|
|
|
0.59
|
|
|
1.52
|
|
Note
13 - Long Term Debt
Long-term
debt consisted of the following:
|
|
|
|
|
|
|
|
December
31,
|
|
December
31,
|
|
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
Secured
convertible term note with a maturity date of August 16, 2007 unless
converted into common stock at the note holder's option. The initial
conversion price is $2.10 per share, however, was reduced to $1.00
per
share on November 30, 2005. Interest accrues at a rate of prime
plus one
percent. As of December 31, 2005, the interest rate on this note
was
8.25%. See note 10 - Line of credit, for further description of this
transaction.
|
|
$
|
651,305
|
|
$
|
5,000,000
|
|
|
|
|
|
|
|
|
|
Convertible
line of credit note with a maturity date of June 6, 2009 unless
converted
into common stock at the Company or the note holder’s option. Interest
accrues at 7% per annum. The original conversion price to shares
of common
stock is equal to 75% of the average trading price for the prior
ten
trading days. In September 2004, the price was reset to $1.58 per
share. A
warrant to purchase 277,778 shares of Company common stock was
also
issued. The exercise price of the warrant is $2.10 per share and
the
warrant expires on June 6, 2009. An allocation of the relative
fair value
of the warrant and the debt instrument was performed. The relative
fair
value of the warrant was determined to be $500,000 and is being
amortized
to interest expense over the life of the note. A discount on debt
issued
of $1,500,000 was recorded in September 2004 based on the reset
conversion
terms.
|
|
|
2,000,000
|
|
|
2,000,000
|
|
|
|
|
|
|
|
|
|
Senior
subordinated secured convertible promissory note with a maturity
date of
January 1, 2007 unless converted into common stock at the note
holder's
option. Interest accrues at 12% per annum. A warrant to purchase
400,000
shares of Company common stock was also issued. The exercise price
of the
warrant is $2.10 per share and the warrant expires on December
15,
2009.
|
|
|
1,080,000
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Notes
payable under capital lease obligations payable to various finance
companies for equipment at varying rates of interest, ranging from
18% to
33% as of December 31, 2005, and have maturity dates through 2008.
|
|
|
148,393
|
|
|
221,949
|
|
|
|
|
3,879,698
|
|
|
7,221,949
|
|
|
|
|
|
|
|
|
|
Relative
fair values, at issuance, ascribed to warrants associated with
the above
debt agreements. This amount is being accreted to the debt instrument
over
the 5 year term of the related debt agreement.
|
|
|
(341,662
|
)
|
|
(441,666
|
)
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
3,538,036
|
|
|
6,780,283
|
|
|
|
|
|
|
|
|
|
Less:
Current portion of long-term debt, including obligations under
capital
leases of $104,342 and current portion of long term debt of $390,780
as of
December 31, 2005 and current portion of capital leases of $120,834
as of
December 31, 2004.
|
|
|
(495,122
|
)
|
|
(120,834
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
3,042,914
|
|
$
|
6,659,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future
annual payments of long-term debt is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Years
Ending December 31,
|
|
|
|
|
|
2005
|
|
$
|
-
|
|
$
|
120,834
|
|
2006
|
|
|
495,122
|
|
|
87,553
|
|
2007
|
|
|
1,373,756
|
|
|
5,013,562
|
|
2008
|
|
|
10,820
|
|
|
-
|
|
2009
|
|
|
2,000,000
|
|
|
2,000,000
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,879,698
|
|
$
|
7,221,949
|
|
|
|
|
|
|
|
|
|
Obligations
under Capital Leases
The
Company has entered into various capital leases that are collateralized by
computer equipment and a trade show booth with an original cost of approximately
$411,000.
The
following schedule lists future minimum lease payments under the capital leases
with their present value as of December 31, 2005:
|
|
December
31, 2005
|
|
December
31, 2004
|
|
|
|
|
|
|
|
Years
Ending December 31,
|
|
|
|
|
|
2005
|
|
$
|
-
|
|
$
|
160,231
|
|
2006
|
|
|
122,125
|
|
|
98,907
|
|
2007
|
|
|
37,451
|
|
|
14,233
|
|
2008
|
|
|
11,523
|
|
|
-
|
|
|
|
|
171,099
|
|
|
273,371
|
|
Less:
Amount representing interest
|
|
|
(22,706
|
)
|
|
(51,422
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
148,393
|
|
$
|
221,949
|
|
During
2005, the Company recorded depreciation expense related to equipment under
capital leases of approximately $105,000.
On
October 29, 2003, the Company made arrangements to obtain a $2.0 million
Unsecured Convertible Line of Credit Note. The terms of this note provide for
interest accruing on advances at 7% per annum with a maturity date of October
28, 2008, unless converted into Common Stock at the Company’s or the Note
holder’s option. In February 2004, the Company borrowed the entire $2.0 million
available under this line of credit. In May 2004, pursuant to the complete
conversion of this unsecured convertible line of credit note, the participating
investor received 1,111,111 shares of our common stock, plus interest. Due
to an
adjustment in the conversion price in September 2004, participating investors
received an additional 158,730 shares of common stock. As a result of the
initial conversion and the adjustment, we recorded a beneficial conversion
charge of $1.2 million. Further in May 2004, we raised an additional $2.0
million pursuant to a new five-year unsecured promissory note with the same
investor. In June 2004, we replaced the May 2004 note by issuing a five-year
$2.0 million unsecured convertible line of credit note with the same investor.
The note accrues at an annual interest rate of 7%, and the conversion price
of
the shares of common stock issuable under the note is equal to $1.58 per share.
In addition, such investor received a warrant to purchase 277,778 shares of
our
common stock at an exercise price of $1.58 per share. This warrant expires
in
June 2009. This note also contains beneficial conversion features, and as a
result, we recorded a beneficial conversion charge of $1.5 million which is
being amortized into income over the life of the debt instrument. Additionally,
using the Black-Scholes option pricing model, we determined the fair value
of
the warrant to be $0.5 million. The Company valued the warrant in accordance
with EITF 00-27 using the Black-Scholes option pricing model and the following
assumptions: contractual term of five years, an average risk free interest
rate
of 1.33%, a dividend yield of 0%, and volatility of 138.62%. The relative fair
value attributed to the warrant issued is amortized over the note’s maturity
period (60 months) as interest expense.
In
September 2004, the Company issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, “Sands”) three subordinated secured convertible promissory notes
equaling $1.0 million (the “Notes”), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes were secured by substantially all
corporate assets, but subordinate to Laurus. The Notes were convertible into
shares of the Company’s common stock at the election of Sands at any time
following the consummation of a convertible debt or equity financing with gross
proceeds of $5 million or greater (a “Qualified Financing”). The Company also
issued Sands three common stock purchase warrants (the “Warrants”) providing
Sands with the right to purchase 400,000 shares of the Company’s common stock.
The exercise price of the shares of the Company’s common stock issuable upon
exercise of the Warrants shall be equal to a price per share of common stock
equal to forty percent (40%) of the price of the securities issued pursuant
to a
Qualified Financing. If no Qualified Financing has been consummated by September
8, 2005, then Sands may elect to exercise the Warrants at a fixed conversion
price of $2.10 per share. The latest that the Warrants may expire is September
8, 2008.
On
September 22, 2005, upon maturity of the September 2004 notes, the Company
issued to Sands three new subordinated secured convertible promissory notes
equaling $1.080 million, each with an annual interest rate of 12% expiring
on
January 1, 2007. The Company also issued Sands three common stock purchase
warrants (the “Warrants”) providing Sands with the right to purchase 400,000
shares of the Company’s common stock. The exercise price of the shares of the
Company’s common stock issuable upon exercise of the Warrants shall be equal to
a price per share of common stock equal to one hundred twenty percent (120%)
of
the price of the securities issued pursuant to a Qualified Financing. If no
Qualified Financing has been consummated by December 15, 2006, then Sands may
elect to exercise the Warrants at a fixed conversion price of $2.10 per share.
The latest that the Warrants may expire is December 15, 2009.
The
Sands
notes
contain the following default provisions:
|
·
|
failure
to pay interest, principal payments or other fees when
due;
|
|
·
|
default
in the payment when due of any obligation in excess of
$100,000;
|
|
·
|
default
of covenant in notes remains uncured for 30
days;
|
|
·
|
breach
by us of any material representation or warranty made in the notes
or in
any agreements made in connection
therewith;
|
|
·
|
the
notes and agreements are no longer a binding obligation of the Company
or
any lien created under the notes and agreements is not valid and
perfected;
|
|
·
|
judgments
against the Company in excess of $100,000 are not vacated, satisfied
or
discharged within 30 days;
|
|
·
|
violation
of any law or regulation for more than 30 days after written notice
and
has a material adverse effect on the Company;
and
|
|
·
|
suspension
of Company operations and such suspension would reasonably be expected
to
have a material adverse effect on the
Company.
|
Note
14 - Income Taxes
The
Company provides for federal and state income taxes in accordance with current
rates applied to accounting income before taxes. The provision for income taxes
is as follows:
|
|
Years
ended December 31,
|
|
|
|
2005
|
|
2004
|
|
Current
- Federal
|
|
$
|
-
|
|
$
|
-
|
|
Current
- State
|
|
|
-
|
|
|
-
|
|
Deferred
- Federal
|
|
|
|
|
|
147,800
|
|
Deferred
- State
|
|
|
|
|
|
43,000
|
|
|
|
$
|
|
|
$
|
190,800
|
|
The
Company’s provision for income taxes is based on estimated effective annual
income tax rates. The provision may differ from income taxes currently payable
because certain items of income and expense are recognized in different periods
for financial statement purposes than for tax return purposes.
The
company has $10.0 million of capital loss carry-forwards expiring in 2010 and
$12.5 million of net operating loss carry-forwards for both federal and state
purposes expiring between 2023 and 2025.
|
|
December
31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(As
Restated)
|
|
Net
operating losses
|
|
$
|
4,997,000
|
|
$
|
|
|
Capital
loss
carryforwards |
|
|
4,000,000 |
|
|
- |
|
Accounts
receivable
|
|
|
196,000
|
|
|
|
|
Property
and equipment
|
|
|
(1,000
|
)
|
|
|
)
|
Accounts
payable and accrued expenses
|
|
|
3,000
|
|
|
|
|
Long-term
debt
|
|
|
(394,000
|
)
|
|
|
|
Goodwill
|
|
|
(34,000
|
)
|
|
|
|
Intangible
assets
|
|
|
(517,000
|
)
|
|
|
|
Stock
based compensation |
|
|
605,000 |
|
|
605,000 |
|
|
|
$
|
8,855,000
|
|
|
|
|
Valuation
allowance
|
|
|
(8,855,000
|
)
|
|
|
)
|
|
|
$ |
- |
|
$
|
-
|
|
The
Company evaluates the amount of deferred tax assets that are recorded against
expected taxable income over its forecasting cycle which is currently two years.
As a result of this evaluation, the Company has recorded a valuation allowance
of $8,855,000 and $7,727,000 for the years ended December 31, 2005 and 2004,
respectively, representing a current year change in the valuation allowance
of
($1,128,000). This allowance was recorded because, based on the weight of
available evidence, it is more likely than not that some, or all, of the
deferred tax asset may not be realized.
Income
taxes computed at the federal statutory rate differ from the amounts provided
as
follows:
|
|
For
the year ended December 31,
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
Provision
for Federal taxes at statutory rate (34%)
|
|
|
(34.0
|
)
|
|
(34.0
|
)
|
State
taxes, net of Federal benefit
|
|
|
(3.7
|
)
|
|
(2.9
|
)
|
Permanent
difference due to non-deductible items
|
|
|
12.6
|
%
|
|
17.1
|
%
|
Foreign
income taxed at different rates
|
|
|
0.0
|
%
|
|
0.4
|
%
|
Valuation
allowance applied against income tax benefit
|
|
|
25.1
|
%
|
|
20.0
|
%
|
|
|
|
|
|
|
|
|
Income
tax provision
|
|
|
0.0
|
%
|
|
0.6
|
%
|
Note
15 - Common Stock Warrants
On
June
7, 2004, the Company granted a warrant to purchase 277,778 shares of the
Company’s common stock to the Taurus Advisory Group LLC in connection with the
issuance of an unsecured convertible line of credit note at an exercise price
of
$2.10 per share and an expiration date of June 6, 2009. See Note 13 for further
discussion regarding this transaction.
On
August
16, 2004, the Company granted a warrant to purchase an aggregate of 800,000
shares of the Company’s common stock to Laurus Master Fund, Ltd. in connection
with a secured convertible term note, a secured revolving note, and a secured
convertible minimum borrowing note. The first 400,000 shares acquired under
the
warrant have an exercise price of $4.35 per share, the next 200,000 shares
acquired have an exercise price of $4.65 per share, and the final 200,000 shares
have an exercise price of $5.25 per share. The expiration date of the warrant
is
August 16, 2011. See Note 10 for further discussion of this
transaction.
On
September 22, 2004, the Company granted a warrant to purchase an aggregate
of
400,000 shares of the Company’s common stock to three affiliates of Sands
Brothers Venture Capital. Sands Brothers Venture Capital III LLC received a
warrant to purchase 340,000 shares of Company common stock, Sands Brothers
Venture Capital LLC received a warrant to purchase 20,000 shares of Company
common stock, and Sands Brothers Venture Capital IV LLC received a warrant
to
purchase 40,000 shares of Company common stock. Each warrant provides for an
exercise price equal to forty percent (40%) of the price per share of common
stock received by the Company in connection with a financing in excess of a
predetermined amount. In the event that the Company does not consummate a
financing at this level on or before September 7, 2005, the exercise price
adjusts to $2.10 per share. The warrants expire on September 7, 2008. See Note
13 for further discussion of this transaction.
On
September 22, 2005, the Company granted a warrant to purchase an aggregate
of
400,000 shares of the Company’s common stock to three affiliates of Sands
Brothers Venture Capital. Sands Brothers Venture Capital III LLC received a
warrant to purchase 340,000 shares of Company common stock, Sands Brothers
Venture Capital LLC received a warrant to purchase 20,000 shares of Company
common stock, and Sands Brothers Venture Capital IV LLC received a warrant
to
purchase 40,000 shares of Company common stock. Each warrant provides for an
exercise price equal to forty percent (40%) of the price per share of Common
Stock received by the Company in connection with the first Qualified Financing
occurring after the date of the warrant agreement. In the event the Company
does
not consummate a Qualified Financing on or before December 15, 2006, the
conversion price adjusts to $2.10 per share. The warrants expire on December
15,
2009. See Note 13 for further discussion of the transaction.
On
December 19, 2005, the Company granted a warrant to purchase an aggregate of
277,777 shares of the Company’s common stock to Taurus Advisory Group, LLC. The
warrant has an exercise price of $0.675 per share. The warrant expires in
December 2008. See Note 11 for further discussion of this
transaction.
Note
16 - Stock Based Compensation
The
2003
Incentive Plan (“2003 Plan”) authorizes the issuance of up to 6,666,667 shares
of common stock for issuance upon exercise of options. It also authorizes the
issuance of stock appreciation rights. The options granted may be a combination
of both incentive and nonstatutory options, generally
vest over a three year period from the date of grant, and expire ten years
from
the date of grant.
To
the
extent that CSI derives a tax benefit from options exercised by employees,
such
benefit will be credited to additional paid-in capital when realized on the
Company’s income tax return. There were no tax benefits realized by the Company
during 2005 or 2004.
The
following summarizes the stock option transactions under the 2003 Plan during
2005:
|
|
|
|
Weighted
average
|
|
|
|
Shares
|
|
exercise
price
|
|
Options
outstanding at December 31, 2004
|
|
|
2,751,063
|
|
$
|
0.15
|
|
Options
granted
|
|
|
2,694,500
|
|
|
0.82
|
|
Options
exercised
|
|
|
-
|
|
|
-
|
|
Options
canceled
|
|
|
(562,449
|
)
|
|
2.71
|
|
Options
outstanding at December 31, 2005
|
|
|
4,883,114
|
|
$
|
1.43
|
|
The
following table summarizes information concerning outstanding and exercisable
Company common stock options at December 31, 2005:
|
|
|
|
Weighted
|
|
Weighted
average
|
|
|
|
Weighted
|
|
Range
of exercise
|
|
Options
|
|
average
|
|
remaining
|
|
Options
|
|
average
|
|
prices
|
|
outstanding
|
|
exercise
price
|
|
contractual
life
|
|
exercisable
|
|
exercise
price
|
|
$0.600
|
|
|
130,000
|
|
$
|
0.600
|
|
|
10.0
|
|
|
-
|
|
$
|
0.600
|
|
$0.825-0.830
|
|
|
3,142,899
|
|
|
0.830
|
|
|
9.7
|
|
|
593,399
|
|
|
0.825
|
|
$2.475-3.45
|
|
|
1,610,215
|
|
|
2.680
|
|
|
8.3
|
|
|
542,178
|
|
|
2.680
|
|
|
|
|
4,883,114
|
|
|
|
|
|
|
|
|
1,135,577
|
|
|
|
|
On
October 18, 2004, options to purchase 593,399 shares of our common stock were
granted to several employees below fair market value at an exercise price of
$0.825 per share, when the fair market value on date of grant was $3.15. These
options are non-qualified stock options, are all immediately vested, and expire
ten years from the date of grant. As a result of this issuance of stock options
at a price below fair market value on the date of grant, the Company has
recorded a stock-based compensation charge of approximately $1,380,000 during
the fourth quarter of 2004.
Note
17 - Loss Per Share
Basic
loss per share is computed on the basis of the weighted average number of common
shares outstanding. Diluted loss per share is computed on the basis of the
weighted average number of common shares outstanding plus the effect of
outstanding stock options using the “treasury stock” method.
Basic
and
diluted loss per share were determined as follows:
|
|
|
For
the years ended December 31,
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
Net
loss from continuing operations (A)
|
|
$
|
(3,386,378
|
)
|
$
|
(22,697,298
|
)
|
Net
loss from discontinued operations (B)
|
|
$
|
(1,103,971
|
)
|
$
|
(12,650,908
|
)
|
Net
loss (C)
|
|
$
|
(4,490,349
|
)
|
$
|
(35,348,206
|
)
|
Weighted
average outstanding shares of common stock (D)
|
|
|
52,919,340
|
|
|
46,548,065
|
|
Common
stock and common stock equivalents (E)
|
|
|
52,919,340
|
|
|
46,548,065
|
|
|
|
|
|
|
|
Basic
loss per share:
|
|
|
|
|
|
From
continuing operations (A/D)
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations (B/D)
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per share (C/D)
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
Diluted
loss per share:
|
|
|
|
|
|
|
|
From
continuing operations (A/E)
|
|
$
|
(0.06
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations (B/E)
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per share (C/E)
|
|
$
|
(0.08
|
)
|
$
|
(0.76
|
)
|
For
the
year ended December 31, 2005, 4,883,114 shares attributable to outstanding
stock
options were excluded from the calculation of diluted loss per share because
the
effect was antidilutive. Additionally, the effect of 2,155,555 warrants which
were issued on June 7, 2004, August 16, 2004, September 22, 2004, September
22,
2005 and December 19, 2005 were excluded from the calculation of diluted loss
per share for the years ended December 31, 2005 and December 31, 2004 because
the effect was antidilutive.
Note
18 - Major Customers
During
2005, the Company had sales to two major customers, LEC, a related party (13.4%)
and Bank of America (27.2%), which totaled approximately $11,232,000. Amounts
due from these customers included in accounts receivable were approximately
$885,000 at December 31, 2005. As of December 31, 2005, LEC and Bank of America
accounted for approximately 14.0% and 7.7% of the Company’s accounts receivable
balance, respectively.
During
2004, the Company had sales to two major customers, LEC, a related party (16.1%)
and Bank of America (16.7%), which totaled approximately $7,828,000. Amounts
due
from these customers included in accounts receivable were approximately
$1,292,000 at December 31, 2004. As of December 31, 2004, LEC and Bank of
America accounted for approximately 19.3% and 10.4% of the Company’s accounts
receivable balance, respectively.
Note
19 - Employee Benefit Plan
The
Company has a defined contribution profit sharing plan under Section 401(k)
of
the Internal Revenue Code that covers substantially all employees. Eligible
employees may contribute on a tax deferred basis a percentage of compensation
up
to the maximum allowable amount. Although the plan does not require a matching
contribution by the Company, the Company may make a contribution. The Company’s
contributions to the plan for the years ended December 31, 2005 and 2004 were
approximately $81,000 and $44,000, respectively.
Note
20 - Commitments and Contingencies
Legal
Proceedings
On
August
1, 2005, Sridhar Bhupatiraju and Scosys, Inc. commenced legal action against
the
Company in the Superior Court of New Jersey. The complaint alleges, among other
things, the Company’s failure to make certain payments pursuant to an asset
purchase agreement with Scosys, Inc. and the Company’s failure to make certain
payments to Sridhar Bhupatiraju in accordance with his employment agreement
with
the Company. The plaintiffs are seeking unspecified compensatory damages,
punitive damages, fees and other costs. On September 30, 2005, the Company
filed
its answer to complaint and third-party complaint against Scorpio Systems,
alleging that Mr. Bhupatiraju embarked on a scheme to circumvent his contractual
obligations under the asset purchase agreement, his non-compete agreement with
the Company, and in violation of his duties of loyalty and fidelity to his
employer (the Company) via Scorpio Systems, among other things. Notwithstanding
Mr. Bhupatiraju’s contractual obligations, the Company alleges that he sold the
assets of Scosys while at the same time operating and/or owning a competing
business, Scorpio Systems. Management believes the suit against the Company
to
be without merit and intends to vigorously defend the Company against this
action and pursue its countersuit.
Employment
Agreements
Scott
Newman, our President and Chief Executive Officer, agreed to a five-year
employment agreement dated as of March 26, 2004. The agreement provides for
an
annual salary to Mr. Newman of $500,000 and an annual bonus to be awarded by
the
Compensation Committee. The agreement also provides for health, life and
disability insurance, as well as a monthly car allowance. In the event that
Mr.
Newman’s employment is terminated other than with good cause, he will receive a
lump sum payment of 2.99 times his base salary.
Glenn
Peipert, Executive Vice President and Chief Operating Officer, agreed to a
five-year employment agreement dated as of March 26, 2004. The agreement
provides for an annual salary to Mr. Peipert of $375,000 and an annual bonus
to
be awarded by the Compensation Committee. The agreement also provides for
health, life and disability insurance, as well as a monthly car allowance.
In
the event that Mr. Peipert’s employment is terminated other than with good
cause, he will receive a lump sum payment of 2.99 times his base
salary.
Mitchell
Peipert, Vice President, Chief Financial Officer, Treasurer and Secretary,
agreed to a three-year employment agreement dated as of March 26, 2004. The
agreement provides for an annual salary to Mr. Peipert of $200,000 and an annual
bonus to be awarded by the Compensation Committee. In August 2005, Mr. Peipert
received an increase to his annual salary to $225,000. The agreement also
provides for health, life and disability insurance, as well as a monthly car
allowance. In the event that Mr. Peipert’s employment is terminated other than
with good cause, he will receive a lump sum payment of 2.99 times his base
salary.
Robert
C.
DeLeeuw, Senior Vice President and President of our wholly owned subsidiary,
DeLeeuw Associates, LLC, agreed to a three-year employment agreement dated
as of
February 27, 2004. The agreement provides for an annual salary to Mr. DeLeeuw
of
$350,000 and an annual bonus to be awarded by the Compensation Committee. The
agreement also provides for health, life and disability insurance. In the event
that Mr. DeLeeuw’s employment is terminated other than with good cause, he will
receive a lump sum payment of the longer of (1) one year's base salary or (2)
the period from the date of termination through the expiration
date.
William
McKnight, Senior Vice President - Data Warehousing, agreed to a three-year
employment agreement dated as of July 22, 2005. The agreement provides for
an
annual salary to Mr. McKnight of $250,000 and an annual bonus to be awarded
by
the Compensation Committee. The agreement also provides for health, life and
disability insurance. In the event that Mr. McKnight’s employment is terminated
other than with good cause, he will receive a lump sum payment of the longer
of
(1) one year's base salary or (2) the period from the date of termination
through the expiration date.
Lease
Commitments
The
Company's corporate headquarters are located at 100 Eagle Rock Avenue, East
Hanover, New Jersey 07936, where it operates under an amended lease agreement
expiring December 31, 2010. Our monthly rent with respect to our East
Hanover, New Jersey facility is $26,290. In addition to minimum rentals,
the Company is liable for its proportionate share of real estate taxes and
operating expenses, as defined. DeLeeuw Associates, LLC has an office at
Suite 1460, Charlotte Plaza, 201 South College Street, Charlotte, North Carolina
28244. DeLeeuw leases this space which had an original expiration date of
December 31, 2005, but has been extended until December 31, 2010. Our
monthly rent with respect to our Charlotte, North Carolina facility is
$2,382.
The
Company also leases office space at 11 Penn Plaza, New York, NY 10001. The
monthly lease payment is approximately $5,000 per month. The current lease
expiration date is March 31, 2006, however, this has been extended until March
31, 2007. The monthly lease payment during the lease extension period is
approximately $4,300 per month.
Rent
expense, including automobile rentals, totaled approximately $462,000 and
$420,000 in 2005 and 2004, respectively.
The
Company is committed under several operating leases for automobiles that expire
during 2007.
Future
minimum lease payments due under all operating lease agreements as of December
31, 2005 are as follows:
Years
Ending December 31
|
|
Office
|
|
Automobiles
|
|
Total
|
|
2006
|
|
$
|
414,788
|
|
$
|
48,729
|
|
$
|
463,517
|
|
2007
|
|
|
358,178
|
|
|
17,161
|
|
|
375,339
|
|
2008
|
|
|
354,694
|
|
|
–
|
|
|
354,694
|
|
2009
|
|
|
355,931
|
|
|
–
|
|
|
355,931
|
|
2010
|
|
|
373,821
|
|
|
–
|
|
|
373,821
|
|
Thereafter
|
|
|
–
|
|
|
0
|
|
|
–
|
|
|
|
$
|
1,857,412
|
|
$
|
65,890
|
|
$
|
1,923,302
|
|
Note
21 - Related Party Transactions
In
November 2003, the Company executed an Independent Contractor Agreement with
LEC, whereby the Company agreed to be a subcontractor for LEC, and to provide
consultants as required to LEC. In return for these services, the Company
receives a fee from LEC based on the hourly rates established for consultants
subcontracted to LEC. In May 2004, the Company acquired 49% of all issued and
outstanding shares of common stock of LEC. For the years ended December 31,
2005
and 2004, the Company invoiced LEC $3,731,198 and $3,837,065, respectively,
for
the services of consultants subcontracted to LEC by the Company. As of December
31, 2005 and 2004, the Company had accounts receivable due from LEC of
approximately $570,000 and $781,000, respectively. There are no known collection
problems with respect to LEC. The majority of their billing is derived from
Fortune 1000 clients. The collection process is slow as these clients require
separate approval on their own internal systems, which extends the payment
cycle. The Company feels confident in the collectibility of these accounts
receivable as the majority of the revenues from LEC derive from Fortune 1000
clients.
On
November 8, 2004, Mr. Newman entered into a stock purchase agreement with a
private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 188,889 shares of common stock for a purchase price
of
$250,000. As of April 2, 2006, the shares have not been issued to
CMKX-treme, Inc. because it has not yet remitted payment for the
shares.
On
November 8, 2004, Mr. Peipert entered into a stock purchase agreement with
a
private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 377,778 shares of common stock for a purchase price
of
$500,000. As of June 9, 2005, CMKX-treme, Inc. remitted final payment for
the shares.
On
November 10, 2004, the Company and Dr. Michael Mitchell, the former President,
Chief Executive Officer and sole director of LCS, executed a one-year consulting
agreement whereby Dr. Mitchell would perform certain consulting services on
behalf of the Company. Dr. Mitchell will receive an aggregate amount of $250,000
as compensation for services provided to the Company. During 2005, an aggregate
amount of $175,000 was paid to Mr. Mitchell for services provided under this
consulting agreement.
As
of
April 7, 2006, Mr. Scott Newman, President, Chief Executive Officer and
Chairman, Mr. Glenn Peipert, Executive Vice President, Chief Operating Officer
and Director, and Mr. Robert C. DeLeeuw, Senior Vice President, have agreed
to
personally support our cash requirements to enable us to fulfill our obligations
through June 1, 2007, to the extent necessary, up to a maximum amount of
$1,500,000, based upon their ability to sell their Company common stock. Mr.
Newman guaranties up to $858,000, Mr. Peipert guaranties up to $409,500 and
Mr.
DeLeeuw guaranties approximately $232,500. We believe that our reliance on
such
commitments is reasonable and that Messrs. Newman, Peipert and DeLeeuw have
sufficient liquidity and net worth to honor such commitments. We believe that
these written commitments provide us with the legal right to request and receive
such advances from any of these officers. Any loan by Messrs. Newman, Peipert
and DeLeeuw to the Company would bear interest at 8% per annum. As of December
31, 2005, Mr. Newman’s outstanding loan balance to the Company was $900,000, and
Mr. Peipert’s outstanding loan balance to the Company was $900,000. The
unsecured loans by Mr. Newman and Mr. Peipert each accrue interest at a simple
rate of 8% per annum, and each has a term expiring on April 30, 2007.
Note
22 - Restatements of Previously Reported Financial
Information
During
2004, the Company consummated financing transactions with Laurus and with Sands.
The documents included, among other things, convertible notes, freestanding
warrant agreements and registration rights agreements. The warrant agreements
are subject to the registration rights agreement which require that the Company
register the shares within a specified period of time and, in the event this
is
not done, provides for significant liquidated damages. In accordance with EITF
00-19 “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock”, the Company previously recorded
a liability for these warrants. However, although the convertible notes are
also
subject to the registration rights agreement and are not “conventionally
convertible”, the Company has not previously recorded a liability for the
derivative associated with the conversion feature.
Additionally,
in July 2005, the Company renegotiated its financing with Laurus. As part of
this transaction, the Company repaid $4,300,000 to Laurus, issued an option
to
purchase Company stock at $0.015 per share, and increased the availability
under
the revolving line of credit by $500,000. Since future cash flows under the
new
agreement with Laurus are more than 10% different than under the old agreement
with Laurus, it has been determined that this transaction should have been
accounted for as an early extinguishment of debt as opposed to a modification
of
existing debt.
The
Board
of Directors of the Company determined that the Company would restate its
financial statements for the three and nine months ended September 30, 2004,
the
year ended December 31, 2004, the three months ended March 31, 2005, the three
and six months ended June 30, 2005 and the three and nine months ended September
30, 2005 as appropriate to properly account for the above
transactions.
CONVERSION
SERVICES INTERNATIONAL,
INC.
|
|
AND
SUBSIDIARIES
|
|
CONSOLIDATED
BALANCE
SHEET
|
|
September
30,2004
|
|
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
882,986
|
|
$
|
– |
|
$
|
882,986
|
|
Restricted
cash
|
|
|
83,375
|
|
|
– |
|
|
83,375
|
|
Accounts
receivable, net of allowance for doubtful accounts of
$150,755
|
|
|
4,216,357
|
|
|
– |
|
|
4,216,357
|
|
Accounts
receivable from related parties
|
|
|
900,942
|
|
|
– |
|
|
900,942
|
|
Prepaid
expenses
|
|
|
188,513
|
|
|
– |
|
|
188,513
|
|
Costs
in excess of billings
|
|
|
139,565
|
|
|
– |
|
|
139,565
|
|
Deferred
tax asset
|
|
|
63,938
|
|
|
– |
|
|
63,938
|
|
Total
Current Assets
|
|
|
6,475,676
|
|
|
–
|
|
|
6,475,676
|
|
|
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
697,399
|
|
|
– |
|
|
697,399
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Restricted
Cash
|
|
|
4,251,000
|
|
|
– |
|
|
4,251,000
|
|
Due
from stockholders, including accrued interest of $25,696
|
|
|
207,719
|
|
|
– |
|
|
207,719
|
|
Goodwill
|
|
|
27,327,899
|
|
|
– |
|
|
27,327,899
|
|
Intangible
assets, net of accumulated amortization of $548,065
|
|
|
5,140,749
|
|
|
– |
|
|
5,140,749
|
|
Deferred
Financing costs, net of accumulated amortization of
$30,881
|
|
|
850,539
|
|
|
– |
|
|
850,539
|
|
Discount
on Debt issued , net of accumulated amortization of $248,122
(2)
|
|
|
9,464,397
|
|
|
(554,029
|
)
|
|
8,910,368
|
|
Equity
investments
|
|
|
113,876
|
|
|
– |
|
|
113,876
|
|
Other
assets
|
|
|
4,433
|
|
|
– |
|
|
4,433
|
|
|
|
|
47,360,612
|
|
|
(554,029
|
)
|
|
46,806,583
|
|
Total
Assets
|
|
$
|
54,533,687
|
|
$
|
(554,029
|
)
|
$
|
53,979,658
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
Line
of Credit
|
|
$
|
3,200,000
|
|
$
|
– |
|
$
|
3,200,000
|
|
Current
portion of long-term debt
|
|
|
110,622
|
|
|
– |
|
|
110,622
|
|
Accounts
payable and accrued expenses
|
|
|
3,947,987
|
|
|
– |
|
|
3,947,987
|
|
Short
term note payable
|
|
|
1,000,000
|
|
|
– |
|
|
1,000,000
|
|
Deferred
revenue
|
|
|
1,057,533
|
|
|
– |
|
|
1,057,533
|
|
Financial
Instruments (3)
|
|
|
3,840,000
|
|
|
6,645,071
|
|
|
10,485,071
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
13,156,142
|
|
|
6,645,071
|
|
|
19,801,213
|
|
|
|
|
|
|
|
|
|
|
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
6,670,187
|
|
|
– |
|
|
6,670,187
|
|
|
|
|
|
|
|
|
|
|
|
|
DEFERRED
TAXES
|
|
|
36,900
|
|
|
– |
|
|
36,900
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
19,863,229
|
|
|
6,645,071
|
|
|
26,508,300
|
|
|
|
|
|
|
|
|
|
|
|
|
MINORITY
INTEREST
|
|
|
157,104
|
|
|
– |
|
|
157,104
|
|
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.001 par value, 85,000,000 shares authorized;
|
|
|
|
|
|
|
|
|
|
|
51,234,045
issued and outstanding (4)
|
|
|
768,511
|
|
|
(717,277
|
)
|
|
51,234
|
|
Additional
paid in capital (5)
|
|
|
38,883,178
|
|
|
(3,954,152
|
)
|
|
34,929,026
|
|
Accumulated
deficit
|
|
|
(5,138,335
|
)
|
|
(2,527,671
|
)
|
|
(7,666,006
|
)
|
Total
Stockholders Equity
|
|
|
34,513,354
|
|
|
(7,199,100
|
)
|
|
27,314,254
|
|
Total
Liabilities and Stockholders Equity
|
|
$
|
54,533,687
|
|
$
|
(554,029
|
)
|
$
|
53,979,658
|
|
Explanatory
Notes: September 2004 Balance sheet
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended September 30, 2004 and filed with the Securities
and
Exchange Commission on November 21,
2005.
|
(2) |
Discount
on debt: Reflects
the reversal of the Laurus beneficial conversion feature charges
for the
conversion feature in the convertible notes and the related amortization,
recording the new Laurus discount and amortization based upon the
calculation of the embedded derivative for the conversion feature,
and
reversing the discount for the Sands warrants and then recording
the new
amount based upon the derivative
calculation.
|
(3) |
Financial
Instruments:Reflects
the reversal of the liability and fair value adjustment previously
recorded for the Sands warrants, recording the new liability and
fair
value adjustment for the Sands warrants, and recording the liability
and
fair value adjustment related to the embedded derivative for the
conversion feature of the Laurus
note.
|
(4) |
Common
Stock: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
(5) |
Additional
paid-in capital: Reflects
the reversal of the beneficial conversion feature related to the
conversion feature in the Laurus convertible note and the reverse
stock
split..
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
AND
SUBSIDIARIES
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
September
30, 2004
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30, 2004
|
|
Nine
Months Ended September 30, 2004
|
|
|
|
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
Previously
Reported
(1)
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
REVENUE
|
|
$
|
6,877,872
|
|
$
|
– |
|
$
|
6,877,872
|
|
$
|
18,655,937
|
|
$
|
– |
|
$
|
18,655,937
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SERVICES
|
|
|
4,585,407
|
|
|
– |
|
|
4,585,407
|
|
|
12,804,332
|
|
|
– |
|
|
12,804,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
2,292,465
|
|
|
–
|
|
|
2,292,465
|
|
|
5,851,605
|
|
|
–
|
|
|
5,851,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
1,378,434
|
|
|
– |
|
|
1,378,434
|
|
|
2,745,802
|
|
|
– |
|
|
2,745,802
|
|
General
and administrative
|
|
|
1,761,592
|
|
|
– |
|
|
1,761,592
|
|
|
4,956,671
|
|
|
– |
|
|
4,956,671
|
|
Research
and development
|
|
|
270,976
|
|
|
– |
|
|
270,976
|
|
|
270,976
|
|
|
– |
|
|
270,976
|
|
Depreciation
and amortization
|
|
|
458,059
|
|
|
– |
|
|
458,059
|
|
|
610,411
|
|
|
– |
|
|
610,411
|
|
|
|
|
3,869,061
|
|
|
–
|
|
|
3,869,061
|
|
|
8,583,860
|
|
|
–
|
|
|
8,583,860
|
|
LOSS
FROM OPERATIONS
|
|
|
(1,576,596
|
)
|
|
–
|
|
|
(1,576,596
|
)
|
|
(2,732,255
|
)
|
|
–
|
|
|
(2,732,255
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in losses from investments
|
|
|
(8,812
|
)
|
|
– |
|
|
(8,812
|
)
|
|
(24,900
|
)
|
|
– |
|
|
(24,900
|
)
|
Other
income
|
|
|
289
|
|
|
– |
|
|
289
|
|
|
7,295
|
|
|
– |
|
|
7,295
|
|
Loss
on Financial Instruments (2)
|
|
|
(240,000
|
)
|
|
(281,221
|
)
|
|
(521,221
|
)
|
|
(240,000
|
)
|
|
(281,221
|
)
|
|
(521,221
|
)
|
Interest
income
|
|
|
1,519
|
|
|
– |
|
|
1,519
|
|
|
3,391
|
|
|
– |
|
|
3,391
|
|
Interest
expense (3)
|
|
|
(997,545
|
)
|
|
(2,246,450
|
)
|
|
(3,243,995
|
)
|
|
(1,802,326
|
)
|
|
(2,246,450
|
)
|
|
(4,048,776
|
)
|
|
|
|
(1,244,549
|
)
|
|
(2,527,671
|
)
|
|
(3,772,220
|
)
|
|
(2,056,540
|
)
|
|
(2,527,671
|
)
|
|
(4,584,211
|
)
|
LOSS
BEFORE INCOME TAXES AND MINORITY INTEREST
|
|
|
(2,821,145
|
)
|
|
(2,527,671
|
)
|
|
(5,348,816
|
)
|
|
(4,788,795
|
)
|
|
(2,527,671
|
)
|
|
(7,316,466
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
TAXES
|
|
|
623,608
|
|
|
– |
|
|
623,608
|
|
|
163,730
|
|
|
– |
|
|
163,730
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LOSS
BEFORE MINORITY INTEREST
|
|
|
(3,444,753
|
)
|
|
(2,527,671
|
)
|
|
(5,972,424
|
)
|
|
(4,952,525
|
)
|
|
(2,527,671
|
)
|
|
(7,480,196
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MINORITY
INTEREST
|
|
|
42,296
|
|
|
– |
|
|
42,296
|
|
|
42,296
|
|
|
– |
|
|
42,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
LOSS
|
|
$ |
|
) |
$ |
(2,527,671
|
)
|
$ |
(5,930,128
|
)
|
$ |
(4,910,229
|
)
|
$ |
(2,527,671
|
)
|
$ |
(7,437,900
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
) |
|
– |
|
|
($0.12
|
)
|
|
($0.01
|
)
|
|
– |
|
|
($0.17
|
)
|
Diluted
|
|
|
|
) |
|
– |
|
|
($0.12
|
)
|
|
($0.01
|
)
|
|
– |
|
|
($0.17
|
)
|
Shares
used to compute net loss per share (4):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,113,272
|
|
|
|
|
|
51,113,272
|
|
|
44,939,912
|
|
|
|
|
|
44,939,912
|
|
Diluted
|
|
|
|
|
|
|
|
|
51,113,272
|
|
|
44,939,912
|
|
|
|
|
|
44,939,912
|
|
Explanatory
Notes: September 2004 Income Statement
|
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended September 30, 2004 and filed with the Securities
and
Exchange Commission on November 21,
2005.
|
|
(2) |
Loss
on financial instruments: Record
the loss on financial instruments related to both the fair value
adjustment for the outstanding warrants and the embedded derivative
related to the conversion feature in the convertible
notes.
|
|
(3) |
Interest
expense: Record
adjustments to interest expense for the revised amortization of the
discount on debt for both the warrants and the embedded
derivatives.
|
|
(4) |
Shares
used to compute net loss per share: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEET
|
|
|
|
|
|
|
|
December
31,2004
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,028,146
|
|
$ |
– |
|
$
|
1,028,146
|
|
Restricted
cash
|
|
|
83,375
|
|
|
– |
|
|
83,375
|
|
Accounts
receivable, net of allowance for doubtful accounts of
$290,582
|
|
|
4,349,229
|
|
|
– |
|
|
4,349,229
|
|
Accounts
receivable from related parties
|
|
|
781,100
|
|
|
– |
|
|
781,100
|
|
Prepaid
expenses
|
|
|
309,459
|
|
|
– |
|
|
309,459
|
|
Total
Current Assets
|
|
|
6,551,309
|
|
|
–
|
|
|
6,551,309
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
587,575
|
|
|
– |
|
|
587,575
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Restricted
Cash
|
|
|
4,269,377
|
|
|
– |
|
|
4,269,377
|
|
Goodwill
|
|
|
4,690,972
|
|
|
– |
|
|
4,690,972
|
|
Intangible
assets, net of accumulated amortization of $911,142
|
|
|
3,627,096
|
|
|
– |
|
|
3,627,096
|
|
Deferred
Financing costs, net of accumulated amortization of
$126,767
|
|
|
766,542
|
|
|
– |
|
|
766,542
|
|
Discount
on Debt issued , net of accumulated amortization of $941,211
(2)
|
|
|
8,410,808
|
|
|
(193,530
|
)
|
|
8,217,278
|
|
Equity
investments
|
|
|
144,460
|
|
|
– |
|
|
144,460
|
|
Other
assets
|
|
|
13,420
|
|
|
– |
|
|
13,420
|
|
|
|
|
21,922,675
|
|
|
(193,530
|
)
|
|
21,729,145
|
|
Total
Assets
|
|
$
|
29,061,559
|
|
$
|
(193,530
|
)
|
$
|
28,868,029
|
|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
Line
of Credit
|
|
$
|
3,733,403
|
|
$ |
– |
|
$
|
3,733,403
|
|
Current
portion of long-term debt
|
|
|
120,834
|
|
|
– |
|
|
120,834
|
|
Accounts
payable and accrued expenses
|
|
|
3,777,941
|
|
|
– |
|
|
3,777,941
|
|
Short
term note payable
|
|
|
1,000,000
|
|
|
– |
|
|
1,000,000
|
|
Deferred
revenue
|
|
|
1,327,222
|
|
|
– |
|
|
1,327,222
|
|
Financial
Instruments (3)
|
|
|
3,960,000
|
|
|
6,555,091
|
|
|
10,515,091
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
13,919,400
|
|
|
6,555,091
|
|
|
20,474,491
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
6,967,430
|
|
|
– |
|
|
6,967,430
|
|
Total
Liabilities
|
|
|
20,886,830
|
|
|
6,555,091
|
|
|
27,441,921
|
|
MINORITY
INTEREST
|
|
|
131,587
|
|
|
–
|
|
|
131,587
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.001 par value, 85,000,000 shares authorized;
|
|
|
|
|
|
|
|
|
|
|
51,472,140
issued and outstanding (4)
|
|
|
772,082
|
|
|
(720,610
|
)
|
|
51,472
|
|
Additional
paid in capital (5)
|
|
|
40,764,881
|
|
|
(3,950,819
|
)
|
|
36,814,062
|
|
Accumulated
deficit
|
|
|
(33,499,119
|
)
|
|
(2,077,192
|
)
|
|
(35,576,311
|
)
|
Accumulated
other comprehensive income
|
|
|
5,298
|
|
|
– |
|
|
5,298
|
|
Total
Stockholders Equity
|
|
|
8,043,142
|
|
|
(6,748,621
|
)
|
|
1,294,521
|
|
Total
Liabilities and Stockholders Equity
|
|
$
|
29,061,559
|
|
$
|
(193,530
|
)
|
$
|
28,868,029
|
|
Explanatory
Notes: December 2004 Balance sheet
(1) |
As
previously reported in the Company’s annual report on form 10-KSB/A for
the period ended December 31, 2004 and filed with the Securities
and
Exchange Commission on November 21,
2005.
|
(2) |
Discount
on debt: Reflects
the reversal of the Laurus beneficial conversion feature charges
for the
conversion feature in the convertible notes and the related amortization,
recording the new Laurus discount and amortization based upon the
calculation of the embedded derivative for the conversion feature,
and
reversing the discount for the original Sands warrants (dated 9/22/2004)
and then recording the new amount based upon the derivative calculation.
|
(3) |
Financial
Instruments: Reflects
the reversal of the liability and fair value adjustment previously
recorded for the Sands warrants, recording the new liability and
fair
value adjustment for the Sands warrants, and recording the liability
and
fair value adjustment related to the embedded derivative for the
conversion feature of the Laurus
note.
|
(4) |
Common
Stock: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
(5) |
Additional
paid-in capital: Reflects
the reversal of the beneficial conversion feature related to the
conversion feature in the Laurus convertible note and the effect
of the
reverse stock split.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
For
the
year ended December 31, 2004
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
REVENUE:
|
|
|
|
|
|
|
|
Services
|
|
$
|
19,888,205
|
|
$ |
– |
|
$
|
19,888,205
|
|
Related
party services
|
|
|
3,837,065
|
|
|
– |
|
|
3,837,065
|
|
Software
|
|
|
293,504
|
|
|
– |
|
|
293,504
|
|
Support
and maintenance
|
|
|
1,074,933
|
|
|
– |
|
|
1,074,933
|
|
Other
|
|
|
72,810
|
|
|
– |
|
|
72,810
|
|
|
|
|
25,166,517
|
|
|
–
|
|
|
25,166,517
|
|
COST
OF SERVICES
|
|
|
|
|
|
|
|
|
|
|
Services
( inclusive of stock based compensation of $1.4 million at December
31,
2004)
|
|
|
15,451,392
|
|
|
– |
|
|
15,451,392
|
|
Related
party services
|
|
|
3,345,318
|
|
|
– |
|
|
3,345,318
|
|
Software
|
|
|
185,688
|
|
|
– |
|
|
185,688
|
|
Support
and maintenance
|
|
|
31,127
|
|
|
– |
|
|
31,127
|
|
Other
|
|
|
–
|
|
|
– |
|
|
–
|
|
|
|
|
19,013,525
|
|
|
–
|
|
|
19,013,525
|
|
GROSS
PROFIT
|
|
|
6,152,992
|
|
|
–
|
|
|
6,152,992
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
4,087,617
|
|
|
– |
|
|
4,087,617
|
|
General
and administrative ( inclusive of stock–based compensation of $0.1
milliion at December 31, 2004)
|
|
|
6,819,039
|
|
|
– |
|
|
6,819,039
|
|
Research
and development
|
|
|
516,425
|
|
|
– |
|
|
516,425
|
|
Goodwill
and intangible impairment
|
|
|
23,298,810
|
|
|
– |
|
|
23,298,810
|
|
Depreciation
and amortization
|
|
|
1,117,209
|
|
|
– |
|
|
1,117,209
|
|
|
|
|
35,839,100
|
|
|
–
|
|
|
35,839,100
|
|
LOSS
FROM OPERATIONS
|
|
|
(29,686,108
|
)
|
|
–
|
|
|
(29,686,108
|
)
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
Equity
in income (losses) from investments
|
|
|
5,684
|
|
|
– |
|
|
5,684
|
|
Other
income
|
|
|
8,531
|
|
|
– |
|
|
8,531
|
|
Loss
on Financial Instruments (2)
|
|
|
(360,000
|
)
|
|
(191,241
|
)
|
|
(551,241
|
)
|
Interest
income
|
|
|
22,388
|
|
|
– |
|
|
22,388
|
|
Interest
expense (3)
|
|
|
(3,138,521
|
)
|
|
(1,885,951
|
)
|
|
(5,024,472
|
)
|
|
|
|
(3,461,918
|
)
|
|
(2,077,192
|
)
|
|
(5,539,110
|
)
|
LOSS
BEFORE INCOME TAXES AND MINORITY INTEREST
|
|
|
(33,148,026
|
)
|
|
(2,077,192
|
)
|
|
(35,225,218
|
)
|
INCOME
TAXES
|
|
|
190,800
|
|
|
– |
|
|
190,800
|
|
LOSS
BEFORE MINORITY INTEREST
|
|
|
(33,338,826
|
)
|
|
(2,077,192
|
)
|
|
(35,416,018
|
)
|
MINORITY
INTEREST
|
|
|
67,813
|
|
|
– |
|
|
67,813
|
|
NET
LOSS
|
|
$ |
|
) |
$ |
(2,077,192
|
)
|
$ |
(35,348,205
|
)
|
Net
Loss per share:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
) |
|
|
|
|
($0.76
|
)
|
Diluted
|
|
|
|
) |
|
|
|
|
($0.76
|
)
|
Shares
used to compute net loss per share (4):
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
46,548,065
|
|
|
|
|
|
46,548,065
|
|
Diluted
|
|
|
46,548,065
|
|
|
|
|
|
46,548,065
|
|
Explanatory
Notes: December 2004 Income Statement
(1)
|
As
previously reported in the Company’s annual report on form 10-KSB/A for
the period ended December 31, 2004 and filed with the Securities
and
Exchange Commission on November 21, 2005.
|
(2)
|
Loss
on financial instruments: Record the loss on financial instruments
related to both the fair value adjustment for the outstanding warrants
and
the embedded derivative related to the conversion feature in the
convertible notes.
|
(3)
|
Interest
expense: Record adjustments to interest expense for the revised
amortization of the discount on debt for both the warrants and
the
embedded derivatives.
|
(4)
|
Shares
used to compute net loss per share: Reflects the effect of the 1:15
reverse stock split that occurred on September 21,
2005.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEET
|
|
|
|
|
|
|
|
March
31, 2005
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,205,172
|
|
$ |
– |
|
$
|
1,205,172
|
|
Accounts
receivable, net of allowance for doubtful accounts of
$259,147
|
|
|
3,676,742
|
|
|
– |
|
|
3,676,742
|
|
Accounts
receivable from related parties
|
|
|
782,830
|
|
|
– |
|
|
782,830
|
|
Prepaid
expenses
|
|
|
263,114
|
|
|
– |
|
|
263,114
|
|
Total
Current Assets
|
|
|
5,927,858
|
|
|
–
|
|
|
5,927,858
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
564,697
|
|
|
– |
|
|
564,697
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Restricted
Cash
|
|
|
4,293,569
|
|
|
– |
|
|
4,293,569
|
|
Goodwill
|
|
|
4,690,972
|
|
|
– |
|
|
4,690,972
|
|
Intangible
assets, net of accumulated amortization of $1,191,031
|
|
|
3,347,207
|
|
|
– |
|
|
3,347,207
|
|
Deferred
Financing costs, net of accumulated amortization of
$222,653
|
|
|
670,656
|
|
|
– |
|
|
670,656
|
|
Discount
on Debt issued , net of accumulated amortization of $1,674,264
(2)
|
|
|
7,347,336
|
|
|
136,889
|
|
|
7,484,225
|
|
Equity
investments
|
|
|
188,184
|
|
|
– |
|
|
188,184
|
|
Other
assets
|
|
|
80,088
|
|
|
– |
|
|
80,088
|
|
|
|
|
20,618,012
|
|
|
136,889
|
|
|
20,754,901
|
|
Total
Assets
|
|
$
|
27,110,567
|
|
$
|
136,889
|
|
$
|
27,247,456
|
|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
Line
of Credit
|
|
$
|
3,784,623
|
|
$ |
– |
|
$
|
3,784,623
|
|
Current
portion of long-term debt
|
|
|
129,890
|
|
|
– |
|
|
129,890
|
|
Accounts
payable and accrued expenses
|
|
|
3,314,514
|
|
|
– |
|
|
3,314,514
|
|
Short
term note payable
|
|
|
1,000,000
|
|
|
– |
|
|
1,000,000
|
|
Related
party short term note payable
|
|
|
299,554
|
|
|
– |
|
|
299,554
|
|
Deferred
revenue
|
|
|
1,783,097
|
|
|
– |
|
|
1,783,097
|
|
Financial
Instruments (3)
|
|
|
4,260,000
|
|
|
6,197,169
|
|
|
10,457,169
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
14,571,678
|
|
|
6,197,169
|
|
|
20,768,847
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
6,660,087
|
|
|
– |
|
|
6,660,087
|
|
Total
Liabilities
|
|
|
21,231,765
|
|
|
6,197,169
|
|
|
27,428,934
|
|
MINORITY
INTEREST
|
|
|
100,885
|
|
|
– |
|
|
100,885
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.001 par value, 85,000,000 shares authorized;
|
|
|
|
|
|
|
|
|
|
|
52,067,378
issued and outstanding (4)
|
|
|
781,011
|
|
|
(728,944
|
)
|
|
52,067
|
|
Additional
paid in capital (5)
|
|
|
42,021,747
|
|
|
(3,942,485
|
)
|
|
38,079,262
|
|
Accumulated
deficit
|
|
|
(37,027,539
|
)
|
|
(1,388,851
|
)
|
|
(38,416,390
|
)
|
Accumulated
other comprehensive income
|
|
|
2,698
|
|
|
– |
|
|
2,698
|
|
Total
Stockholders Equity
|
|
|
5,777,917
|
|
|
(6,060,280
|
)
|
|
(282,363
|
)
|
Total
Liabilities and Stockholders Equity
|
|
$
|
27,110,567
|
|
$
|
136,889
|
|
$
|
27,247,456
|
|
Explanatory
Notes: March 2005 Balance Sheet
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended March 31, 2005 and filed with the Securities and
Exchange
Commission on November 21, 2005.
|
(2) |
Discount
on debt: Reflects
the reversal of the Laurus beneficial conversion feature charges
for the
conversion feature in the convertible notes and the related amortization,
recording the new Laurus discount and amortization based upon the
calculation of the embedded derivative for the conversion feature,
and
reversing the discount for the original Sands warrants (dated 9/22/2004)
and then recording the new amount based upon the derivative
calculation.
|
(3) |
Financial
Instruments: Reflects
the reversal of the liability and fair value adjustment previously
recorded for the Sands warrants, recording the new liability and
fair
value adjustment for the Sands warrants, and recording the liability
and
fair value adjustment related to the embedded derivative for the
conversion feature of the Laurus
note.
|
(4) |
Common
Stock: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
(5) |
Additional
paid-in capital: Reflects
the reversal of the beneficial conversion feature related to the
conversion feature in the Laurus convertible note and the effect
of the
reverse stock split.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
March
31, 2005
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
REVENUE:
|
|
|
|
|
|
|
|
Services
|
|
$
|
5,015,293
|
|
$
|
– |
|
$
|
5,015,293
|
|
Related
party services
|
|
|
1,096,402
|
|
|
– |
|
|
1,096,402
|
|
Software
|
|
|
293,368
|
|
|
– |
|
|
293,368
|
|
Support
and maintenance
|
|
|
432,005
|
|
|
– |
|
|
432,005
|
|
Other
|
|
|
35,470
|
|
|
– |
|
|
35,470
|
|
|
|
|
6,872,538
|
|
|
–
|
|
|
6,872,538
|
|
COST
OF SERVICES
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
3,528,596
|
|
|
– |
|
|
3,528,596
|
|
Related
party services
|
|
|
1,011,858
|
|
|
– |
|
|
1,011,858
|
|
Software
|
|
|
44,450
|
|
|
– |
|
|
44,450
|
|
Support
and maintenance
|
|
|
13,068
|
|
|
– |
|
|
13,068
|
|
Other
|
|
|
–
|
|
|
– |
|
|
–
|
|
|
|
|
4,597,972
|
|
|
–
|
|
|
4,597,972
|
|
GROSS
PROFIT
|
|
|
2,274,566
|
|
|
–
|
|
|
2,274,566
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
1,527,223
|
|
|
– |
|
|
1,527,223
|
|
General
and administrative
|
|
|
1,940,135
|
|
|
– |
|
|
1,940,135
|
|
Research
and development
|
|
|
241,676
|
|
|
– |
|
|
241,676
|
|
Depreciation
and amortization
|
|
|
431,456
|
|
|
– |
|
|
431,456
|
|
|
|
|
4,140,490
|
|
|
–
|
|
|
4,140,490
|
|
LOSS
FROM OPERATIONS
|
|
|
(1,865,924
|
)
|
|
–
|
|
|
(1,865,924
|
)
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
Equity
in income from investments
|
|
|
43,292
|
|
|
– |
|
|
43,292
|
|
Other
expense
|
|
|
(2,191
|
)
|
|
– |
|
|
(2,191
|
)
|
Loss
on Financial Instrument (2)
|
|
|
(300,000
|
)
|
|
357,922
|
|
|
57,922
|
|
Interest
income
|
|
|
24,192
|
|
|
– |
|
|
24,192
|
|
Interest
expense (3)
|
|
|
(1,458,490
|
)
|
|
330,419
|
|
|
(1,128,071
|
)
|
|
|
|
(1,693,197
|
)
|
|
688,341
|
|
|
(1,004,856
|
)
|
LOSS
BEFORE INCOME TAXES AND MINORITY INTEREST
|
|
|
(3,559,121
|
)
|
|
688,341
|
|
|
(2,870,780
|
)
|
INCOME
TAXES
|
|
|
–
|
|
|
– |
|
|
–
|
|
LOSS
BEFORE MINORITY INTEREST
|
|
|
(3,559,121
|
)
|
|
688,341
|
|
|
(2,870,780
|
)
|
MINORITY
INTEREST
|
|
|
30,702
|
|
|
– |
|
|
30,702
|
|
NET
LOSS
|
|
$ |
(3,528,419
|
)
|
$ |
688,341
|
|
$ |
(2,840,078
|
)
|
Basic
|
|
|
|
)
|
|
– |
|
|
($0.06
|
)
|
Diluted
|
|
|
|
)
|
|
– |
|
|
($0.06
|
)
|
Shares
used to compute net loss per share (4):
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,531,664
|
|
|
|
|
|
51,531,664
|
|
Diluted
|
|
|
51,531,664
|
|
|
|
|
|
51,531,664
|
|
Explanatory
Notes: March 2005 Income Statement
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended March 31, 2005 and filed with the Securities and
Exchange
Commission on November 21, 2005.
|
(2) |
Loss
on financial instruments: Record
the loss on financial instruments related to both the fair value
adjustment for the outstanding warrants and the embedded derivative
related to the conversion feature in the convertible
notes.
|
(3) |
Interest
expense: Record
adjustments to interest expense for the revised amortization of the
discount on debt for both the warrants and the embedded
derivatives.
|
(4) |
Shares
used to compute net loss per share: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEET
|
|
|
|
|
|
|
|
June
30, 2005
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
646,006
|
|
$
|
– |
|
$
|
646,006
|
|
Accounts
receivable, net of allowance for doubtful accounts of
$216,437
|
|
|
4,305,995
|
|
|
– |
|
|
4,305,995
|
|
Accounts
receivable from related parties
|
|
|
1,060,053
|
|
|
– |
|
|
1,060,053
|
|
Prepaid
expenses
|
|
|
376,813
|
|
|
– |
|
|
376,813
|
|
Total
Current Assets
|
|
|
6,388,867
|
|
|
–
|
|
|
6,388,867
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
539,702
|
|
|
– |
|
|
539,702
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Restricted
Cash
|
|
|
4,327,295
|
|
|
– |
|
|
4,327,295
|
|
Goodwill
|
|
|
4,690,972
|
|
|
– |
|
|
4,690,972
|
|
Intangible
assets, net of accumulated amortization of $1,542,122
|
|
|
2,996,116
|
|
|
– |
|
|
2,996,116
|
|
Deferred
Financing costs, net of accumulated amortization of
$318,539
|
|
|
574,770
|
|
|
– |
|
|
574,770
|
|
Discount
on Debt issued , net of accumulated amortization of $2,474,271
(2)
|
|
|
6,283,865
|
|
|
400,353
|
|
|
6,684,218
|
|
Equity
investments
|
|
|
191,578
|
|
|
– |
|
|
191,578
|
|
Other
assets
|
|
|
115,295
|
|
|
– |
|
|
115,295
|
|
|
|
|
19,179,891
|
|
|
400,353
|
|
|
19,580,244
|
|
Total
Assets
|
|
$
|
26,108,460
|
|
$
|
400,353
|
|
$
|
26,508,813
|
|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
Line
of Credit
|
|
$
|
3,413,830
|
|
$
|
– |
|
$
|
3,413,830
|
|
Current
portion of long-term debt
|
|
|
133,527
|
|
|
– |
|
|
133,527
|
|
Accounts
payable and accrued expenses
|
|
|
3,189,132
|
|
|
– |
|
|
3,189,132
|
|
Short
term note payable
|
|
|
1,000,000
|
|
|
– |
|
|
1,000,000
|
|
Related
party short term note payable
|
|
|
1,632,325
|
|
|
– |
|
|
1,632,325
|
|
Deferred
revenue
|
|
|
1,759,205
|
|
|
– |
|
|
1,759,205
|
|
Financial
Instruments (3)
|
|
|
1,920,000
|
|
|
3,998,436
|
|
|
5,918,436
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
13,048,019
|
|
|
3,998,436
|
|
|
17,046,455
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
6,671,140
|
|
|
– |
|
|
6,671,140
|
|
Total
Liabilities
|
|
|
19,719,159
|
|
|
3,998,436
|
|
|
23,717,595
|
|
MINORITY
INTEREST
|
|
|
79,943
|
|
|
– |
|
|
79,943
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.001 par value, 85,000,000 shares authorized;
|
|
|
|
|
|
|
|
|
|
|
52,564,936
issued and outstanding (4)
|
|
|
788,474
|
|
|
(735,909
|
)
|
|
52,565
|
|
Additional
paid in capital (5)
|
|
|
43,019,484
|
|
|
(3,935,520
|
)
|
|
39,083,964
|
|
Accumulated
deficit
|
|
|
(37,502,640
|
)
|
|
1,073,346
|
|
|
(36,429,294
|
)
|
Accumulated
other comprehensive income
|
|
|
4,040
|
|
|
– |
|
|
4,040
|
|
Total
Stockholders Equity
|
|
|
6,309,358
|
|
|
(3,598,083
|
)
|
|
2,711,275
|
|
Total
Liabilities and Stockholders Equity
|
|
$
|
26,108,460
|
|
$
|
400,353
|
|
$
|
26,508,813
|
|
Explanatory
Notes: June 2005 Balance Sheet
(1) |
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended June 30, 2005 and filed with the Securities and
Exchange
Commission on November 21, 2005.
|
(2) |
Discount
on debt: Reflects
the reversal of the Laurus beneficial conversion feature charges
for the
conversion feature in the convertible notes and the related amortization,
recording the new Laurus discount and amortization based upon the
calculation of the embedded derivative for the conversion feature,
and
reversing the discount for the original Sands warrants (dated 9/22/2004)
and then recording the new amount based upon the derivative
calculation.
|
(3) |
Financial
Instruments: Reflects
the reversal of the liability and fair value adjustment previously
recorded for the Sands warrants, recording the new liability and
fair
value adjustment for the Sands warrants, and recording the liability
and
fair value adjustment related to the embedded derivative for the
conversion feature of the Laurus
note.
|
(4) |
Common
Stock: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
(5) |
Additional
paid-in capital: Reflects
the reversal of the beneficial conversion feature related to the
conversion feature in the Laurus convertible note and the effect
of the
reverse stock split.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30,2005
|
|
Six
Months Ended June 30,2005
|
|
|
|
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
Previously
Reported
(1)
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
REVENUE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
$
|
5,417,199
|
|
$
|
– |
|
$
|
5,417,199
|
|
$
|
10,432,492
|
|
$
|
– |
|
$
|
10,432,492
|
|
Related
party services
|
|
|
1,075,235
|
|
|
– |
|
|
1,075,235
|
|
|
2,171,637
|
|
|
– |
|
|
2,171,637
|
|
Software
|
|
|
387,560
|
|
|
– |
|
|
387,560
|
|
|
680,928
|
|
|
– |
|
|
680,928
|
|
Support
and maintenance
|
|
|
496,003
|
|
|
– |
|
|
496,003
|
|
|
928,008
|
|
|
– |
|
|
928,008
|
|
Other
|
|
|
30,250
|
|
|
– |
|
|
30,250
|
|
|
65,720
|
|
|
– |
|
|
65,720
|
|
|
|
|
7,406,247
|
|
|
–
|
|
|
7,406,247
|
|
|
14,278,785
|
|
|
–
|
|
|
14,278,785
|
|
COST
OF SERVICES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
3,860,470
|
|
|
– |
|
|
3,860,470
|
|
|
7,389,066
|
|
|
– |
|
|
7,389,066
|
|
Related
party services
|
|
|
923,596
|
|
|
– |
|
|
923,596
|
|
|
1,935,454
|
|
|
– |
|
|
1,935,454
|
|
Software
|
|
|
51,512
|
|
|
– |
|
|
51,512
|
|
|
95,962
|
|
|
– |
|
|
95,962
|
|
Support
and maintenance
|
|
|
13,068
|
|
|
– |
|
|
13,068
|
|
|
26,136
|
|
|
– |
|
|
26,136
|
|
Other
|
|
|
–
|
|
|
– |
|
|
–
|
|
|
–
|
|
|
– |
|
|
–
|
|
|
|
|
4,848,646
|
|
|
–
|
|
|
4,848,646
|
|
|
9,446,618
|
|
|
–
|
|
|
9,446,618
|
|
GROSS
PROFIT
|
|
|
2,557,601
|
|
|
–
|
|
|
2,557,601
|
|
|
4,832,167
|
|
|
–
|
|
|
4,832,167
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
1,566,764
|
|
|
– |
|
|
1,566,764
|
|
|
3,093,987
|
|
|
– |
|
|
3,093,987
|
|
General
and administrative
|
|
|
1,622,275
|
|
|
– |
|
|
1,622,275
|
|
|
3,562,410
|
|
|
– |
|
|
3,562,410
|
|
Research
and development
|
|
|
234,445
|
|
|
– |
|
|
234,445
|
|
|
476,121
|
|
|
– |
|
|
476,121
|
|
Depreciation
and amortization
|
|
|
503,906
|
|
|
– |
|
|
503,906
|
|
|
935,362
|
|
|
– |
|
|
935,362
|
|
|
|
|
3,927,390
|
|
|
–
|
|
|
3,927,390
|
|
|
8,067,880
|
|
|
–
|
|
|
8,067,880
|
|
LOSS
FROM OPERATIONS
|
|
|
(1,369,789
|
)
|
|
–
|
|
|
(1,369,789
|
)
|
|
(3,235,713
|
)
|
|
–
|
|
|
(3,235,713
|
)
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in income from investments
|
|
|
3,393
|
|
|
– |
|
|
3,393
|
|
|
46,685
|
|
|
– |
|
|
46,685
|
|
Other
expense
|
|
|
(6,335
|
)
|
|
– |
|
|
(6,335
|
)
|
|
(8,526
|
)
|
|
– |
|
|
(8,526
|
)
|
Gain on
Financial Instruments (2)
|
|
|
2,340,000
|
|
|
2,198,733
|
|
|
4,538,733
|
|
|
2,040,000
|
|
|
2,556,655
|
|
|
4,596,655
|
|
Interest
income
|
|
|
33,726
|
|
|
– |
|
|
33,726
|
|
|
57,918
|
|
|
– |
|
|
57,918
|
|
Interest
expense (3)
|
|
|
(1,497,038
|
)
|
|
263,464
|
|
|
(1,233,574
|
)
|
|
(2,955,528
|
)
|
|
593,883
|
|
|
(2,361,645
|
)
|
|
|
|
873,746
|
|
|
2,462,197
|
|
|
3,335,943
|
|
|
(819,451
|
)
|
|
3,150,538
|
|
|
2,331,087
|
|
INCOME
(LOSS) BEFORE MINORITY INTEREST
|
|
|
(496,043
|
)
|
|
2,462,197
|
|
|
1,966,154
|
|
|
(4,055,164
|
)
|
|
3,150,538
|
|
|
(904,626
|
)
|
MINORITY
INTEREST
|
|
|
20,942
|
|
|
– |
|
|
20,942
|
|
|
51,644
|
|
|
– |
|
|
51,644
|
|
NET
INCOME (LOSS)
|
|
$
|
(475,101
|
)
|
$
|
2,462,197
|
|
$
|
1,987,096
|
|
$
|
(4,003,520
|
)
|
$
|
3,150,538
|
|
$
|
(852,982
|
)
|
Basic
|
|
|
|
) |
|
– |
|
|
$0.04
|
|
|
($0.08
|
)
|
|
|
|
|
($0.02
|
)
|
Diluted
|
|
|
|
) |
|
|
|
|
$0.04
|
|
|
($0.08
|
)
|
|
|
|
|
($0.02
|
)
|
Shares
used to compute net income (loss) per share (4):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
52,344,049
|
|
|
|
|
|
52,344,049
|
|
|
51,937,351
|
|
|
|
|
|
51,937,351
|
|
Diluted
|
|
|
52,344,049
|
|
|
|
|
|
52,344,049
|
|
|
51,937,351
|
|
|
|
|
|
51,937,351
|
|
Explanatory
Notes: June 2005 Income Statement
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB/A for
the period ended June 30, 2005 and filed with the Securities and
Exchange
Commission on November 21, 2005.
|
(2) |
Gain
(Loss) on financial instruments: Record
the gain (loss) on financial instruments related to both the fair
value
adjustment for the outstanding warrants and the embedded derivative
related to the conversion feature in the convertible
notes.
|
(3) |
Interest
expense: Record
adjustments to interest expense for the revised amortization of the
discount on debt for both the warrants and the embedded
derivatives.
|
(4) |
Shares
used to compute net income (loss) per share: Reflects
the effect of the 1:15 reverse stock split that occurred on September
21,
2005.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEET
|
|
|
|
|
|
|
|
September
30, 2005
|
|
|
|
|
|
|
|
|
|
Previously
|
|
Restatement
|
|
|
|
|
|
Reported
(1)
|
|
Adjustment
|
|
Restated
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
|
Cash
|
|
$
|
306,035
|
|
$
|
– |
|
$
|
306,035
|
|
Accounts
receivable, net of allowance for doubtful accounts of
$482,864
|
|
|
4,552,728
|
|
|
– |
|
|
4,552,728
|
|
Accounts
receivable from related parties
|
|
|
557,559
|
|
|
– |
|
|
557,559
|
|
Prepaid
expenses
|
|
|
149,164
|
|
|
– |
|
|
149,164
|
|
Total
Current Assets
|
|
|
5,565,486
|
|
|
–
|
|
|
5,565,486
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
433,583
|
|
|
– |
|
|
433,583
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
8,348,130
|
|
|
– |
|
|
8,348,130
|
|
Intangible
assets, net of accumulated amortization of $573,780
|
|
|
2,029,534
|
|
|
– |
|
|
2,029,534
|
|
Deferred
financing costs, net of accumulated amortization of
$403,748
|
|
|
489,561
|
|
|
– |
|
|
489,561
|
|
Discount
on debt issued , net of accumulated amortization of $568,270
(2)
|
|
|
3,575,142
|
|
|
2,159,970
|
|
|
5,735,112
|
|
Equity
investments
|
|
|
189,921
|
|
|
– |
|
|
189,921
|
|
Other
assets
|
|
|
123,432
|
|
|
– |
|
|
123,432
|
|
|
|
|
14,755,720
|
|
|
2,159,970
|
|
|
16,915,690
|
|
Total
Assets
|
|
$
|
20,754,789
|
|
$
|
2,159,970
|
|
$
|
22,914,759
|
|
LIABILITIES
AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
Line
of credit
|
|
$
|
5,322,714
|
|
$
|
– |
|
$
|
5,322,714
|
|
Current
portion of long-term debt
|
|
|
510,304
|
|
|
– |
|
|
510,304
|
|
Accounts
payable and accrued expenses
|
|
|
2,775,971
|
|
|
– |
|
|
2,775,971
|
|
Short
term note payable
|
|
|
576,054
|
|
|
– |
|
|
576,054
|
|
Related
party short term note payable
|
|
|
1,511,848
|
|
|
– |
|
|
1,511,848
|
|
Deferred
revenue
|
|
|
26,709
|
|
|
– |
|
|
26,709
|
|
Financial
Instruments (3)
|
|
|
3,064,000
|
|
|
4,939,289
|
|
|
8,003,289
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
13,787,600
|
|
|
4,939,289
|
|
|
18,726,889
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
3,280,159
|
|
|
– |
|
|
3,280,159
|
|
Deferred
Taxes
|
|
|
363,400
|
|
|
– |
|
|
363,400
|
|
Total
Liabilities
|
|
|
17,431,159
|
|
|
4,939,289
|
|
|
22,370,448
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
–
|
|
|
–
|
|
|
–
|
|
STOCKHOLDERS
EQUITY
|
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.001 par value, 85,000,000 shares authorized;
|
|
|
|
|
|
|
|
|
|
|
54,093,745
issued and outstanding
|
|
|
54,094
|
|
|
– |
|
|
54,094
|
|
Additional
paid in capital (4)
|
|
|
44,425,073
|
|
|
(2,278,184
|
)
|
|
42,146,889
|
|
Accumulated
deficit
|
|
|
(41,160,760
|
)
|
|
(501,135
|
)
|
|
(41,661,895
|
)
|
Accumulated
other comprehensive income
|
|
|
5,223
|
|
|
– |
|
|
5,223
|
|
Total
Stockholders Equity
|
|
|
3,323,630
|
|
|
(2,779,319
|
)
|
|
544,311
|
|
Total
Liabilities and Stockholders Equity
|
|
$
|
20,754,789
|
|
$
|
2,159,970
|
|
$
|
22,914,759
|
|
Explanatory
Notes: September 2005 Balance Sheet
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB for
the period ended September 30, 2005 and filed with the Securities
and
Exchange Commission on November 21,
2005.
|
(2) |
Discount
on debt: Reflects
the reversal of the Laurus beneficial conversion feature charges
for the
conversion feature in the convertible notes and the related amortization,
recording the new Laurus discount and amortization based upon the
calculation of the embedded derivative for the conversion feature,
and
reversing the discount for the original Sands warrants (dated 9/22/2004)
and then recording the new amount based upon the derivative calculation.
Additionally, the Company recorded the value of the embedded derivative
for the new Sands note (dated 9/22/2005) and the early extinguishment
of
debt due to the renegotiation of the Laurus debt instruments on July
28,
2005.
|
(3) |
Financial
Instruments: Reflects
the reversal of the liability and fair value adjustment previously
recorded for the Sands warrants, recording the new liability and
fair
value adjustment for the Sands warrants, recording the liability
and fair
value adjustment related to the embedded derivative for the conversion
feature of the Laurus note, and recording the liabilities for both
the
fair value of the warrants issued and the embedded derivative for
the new
Sands note (dated 9/22/2005).
|
(4) |
Additional
paid-in capital: Reflects
the reversal of the beneficial conversion feature related to the
conversion feature in the Laurus convertible
note.
|
CONVERSION
SERVICES INTERNATIONAL, INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AND
SUBSIDIARIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September
30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30,2005
|
|
Nine
Months Ended September 30,2005
|
|
|
|
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
Previously
Reported
(1)
|
|
Restatement
Adjustment
|
|
Restated
Total
|
|
REVENUE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
$
|
6,721,841
|
|
$
|
– |
|
$
|
6,721,841
|
|
$
|
17,105,033
|
|
$
|
– |
|
$
|
17,105,033
|
|
Related
party services
|
|
|
899,142
|
|
|
– |
|
|
899,142
|
|
|
3,070,779
|
|
|
– |
|
|
3,070,779
|
|
Software
|
|
|
–
|
|
|
– |
|
|
–
|
|
|
81,249
|
|
|
– |
|
|
81,249
|
|
Support
and maintenance
|
|
|
46,800
|
|
|
– |
|
|
46,800
|
|
|
178,333
|
|
|
– |
|
|
178,333
|
|
Other
|
|
|
32,640
|
|
|
– |
|
|
32,640
|
|
|
93,982
|
|
|
– |
|
|
93,982
|
|
|
|
|
7,700,423
|
|
|
–
|
|
|
7,700,423
|
|
|
20,529,376
|
|
|
–
|
|
|
20,529,376
|
|
COST
OF SERVICES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
|
5,045,004
|
|
|
– |
|
|
5,045,004
|
|
|
12,416,571
|
|
|
– |
|
|
12,416,571
|
|
Related
party services
|
|
|
739,770
|
|
|
– |
|
|
739,770
|
|
|
2,675,224
|
|
|
– |
|
|
2,675,224
|
|
|
|
|
5,784,774
|
|
|
–
|
|
|
5,784,774
|
|
|
15,091,795
|
|
|
–
|
|
|
15,091,795
|
|
GROSS
PROFIT
|
|
|
1,915,649
|
|
|
–
|
|
|
1,915,649
|
|
|
5,437,581
|
|
|
–
|
|
|
5,437,581
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
1,122,239
|
|
|
– |
|
|
1,122,239
|
|
|
3,353,306
|
|
|
– |
|
|
3,353,306
|
|
General
and administrative (2)
|
|
|
2,144,261
|
|
|
(771,667
|
)
|
|
1,372,594
|
|
|
5,292,449
|
|
|
(771,667
|
)
|
|
4,520,782
|
|
Depreciation
and amortization
|
|
|
256,205
|
|
|
– |
|
|
256,205
|
|
|
642,691
|
|
|
– |
|
|
642,691
|
|
|
|
|
3,522,705
|
|
|
(771,667
|
)
|
|
2,751,038
|
|
|
9,288,446
|
|
|
(771,667
|
)
|
|
8,516,779
|
|
LOSS
FROM OPERATIONS
|
|
|
(1,607,056
|
)
|
|
771,667
|
|
|
(835,389
|
)
|
|
(3,850,865
|
)
|
|
771,667
|
|
|
(3,079,198
|
)
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in income (losses) from investments
|
|
|
(1,657
|
)
|
|
– |
|
|
(1,657
|
)
|
|
45,028
|
|
|
– |
|
|
45,028
|
|
Gain
(Loss) on Financial Instruments (3)
|
|
|
(540,000
|
)
|
|
(2,262,611
|
)
|
|
(2,802,611
|
)
|
|
1,500,000
|
|
|
294,044
|
|
|
1,794,044
|
|
Gain
on early extinguishment of debt (4)
|
|
|
0
|
|
|
244,265
|
|
|
244,265
|
|
|
–
|
|
|
244,265
|
|
|
244,265
|
|
Interest
income
|
|
|
11,247
|
|
|
– |
|
|
11,247
|
|
|
69,165
|
|
|
– |
|
|
69,165
|
|
Interest
expense (5)
|
|
|
(1,373,927
|
)
|
|
(327,802
|
)
|
|
(1,701,729
|
)
|
|
(4,329,455
|
)
|
|
266,081
|
|
|
(4,063,374
|
)
|
|
|
|
(1,904,337
|
)
|
|
(2,346,148
|
)
|
|
(4,250,485
|
)
|
|
(2,715,262
|
)
|
|
804,390
|
|
|
(1,910,872
|
)
|
NET
LOSS FROM CONTINUING OPERATIONS
|
|
|
(3,511,393
|
)
|
|
(1,574,481
|
)
|
|
(5,085,874
|
)
|
|
(6,566,127
|
)
|
|
1,576,057
|
|
|
(4,990,070
|
)
|
DISCONTINUED
OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
on disposal of discontinued operations
|
|
|
24,910
|
|
|
– |
|
|
24,910
|
|
|
24,910
|
|
|
– |
|
|
24,910
|
|
Net
loss from discontinued operations
|
|
|
(171,637
|
)
|
|
– |
|
|
(171,637
|
)
|
|
(1,120,423
|
)
|
|
– |
|
|
(1,120,423
|
)
|
|
|
|
(146,727
|
)
|
|
–
|
|
|
(146,727
|
)
|
|
(1,095,513
|
)
|
|
–
|
|
|
(1,095,513
|
)
|
NET
LOSS
|
|
|
|
) |
|
($1,574,481
|
)
|
|
($5,232,601
|
)
|
|
($7,661,640
|
)
|
$
|
1,576,057
|
|
|
($6,085,583
|
)
|
Basic
net loss per share from continuing operations
|
|
|
|
) |
|
|
|
|
($0.10
|
)
|
|
($0.13
|
)
|
|
|
|
|
($0.10
|
)
|
Basic
net loss per share from discontinued operations
|
|
|
|
|
|
|
|
|
$0.00
|
|
|
($0.02
|
)
|
|
|
|
|
($0.02
|
)
|
Basic
net loss per share
|
|
|
|
) |
|
|
|
|
($0.10
|
)
|
|
($0.15
|
)
|
|
|
|
|
($0.12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net loss per share from continuing operations
|
|
|
|
) |
|
|
|
|
($0.10
|
)
|
|
($0.13
|
)
|
|
|
|
|
($0.10
|
)
|
Diluted
net loss per share from discontinued operations
|
|
|
$0.00
|
|
|
|
|
|
$0.00
|
|
|
($0.02
|
)
|
|
|
|
|
($0.02
|
)
|
Diluted
net loss per share
|
|
|
|
) |
|
|
|
|
($0.10
|
)
|
|
($0.15
|
)
|
|
|
|
|
($0.12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used to compute net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
53,676,751
|
|
|
|
|
|
53,676,751
|
|
|
52,523,523
|
|
|
|
|
|
52,523,523
|
|
Diluted
|
|
|
53,676,751
|
|
|
|
|
|
53,676,751
|
|
|
52,523,523
|
|
|
|
|
|
52,523,523
|
|
Explanatory
Notes: September 2005 Income Statement
(1)
|
As
previously reported in the Company’s quarterly report on form 10-QSB for
the period ended September 30, 2005 and filed with the Securities
and
Exchange Commission on November 21,
2005.
|
(2) |
Reclassification of charge from general and
administrative expense to gain on early extinguishment of
debt. |
(3) |
Gain
(Loss) on financial instruments: Record
the gain (loss) on financial instruments related to both the fair
value
adjustment for the outstanding warrants and the embedded derivative
related to the conversion feature in the convertible
notes.
|
(4) |
Gain
on early extinguishment of debt: To
record the gain associated with the early extinguishment of debt
generated
by the renegotiation of the Laurus debt instruments on July 28,
2005.
|
(5) |
Interest
expense: Record
adjustments to interest expense for the revised amortization of the
discount on debt for both the warrants and the embedded
derivatives.
|
Note
23 - Subsequent Events
On
February 1, 2006, the Company restructured its financing with Laurus again
by
entering into financing agreements with Laurus, pursuant to which it, among
other things, (a) issued a secured non-convertible term note in the principal
amount of $1,000,000 to Laurus (the “Term Note”), (b) issued a secured
non-convertible revolving note in the principal amount of $10,000,000 to Laurus
(the “Revolving Note”, collectively with the Term Note, the “Notes”), and (c)
issued an option to purchase up to 3,080,000 shares of the Company's common
stock to Laurus (the “Option”) at an exercise price of $.001 per share. The
proceeds from the issuance of the Notes were used to refinance the Company’s
outstanding obligations under the existing facility with Laurus (originally
entered into in August 2004 and subsequently amended in July 2005) at a 5%
premium. The Notes bear an annual interest rate of prime (as reported in the
Wall Street Journal, which was 7.25% as of January 31, 2006) plus 1.0%, with
a
floor of 5.0%. Payments of principal and interest will be made in equal monthly
amounts until maturity of both notes on December 31, 2007, at which time the
5%
premium will also be due.
In
connection with the Notes, the Company and Laurus entered into an Overadvance
Letter Agreement, pursuant to which Laurus exercised its discretion granted
to
it pursuant to the Security Agreement entered into in August 2004 to make a
loan
to the Company in excess of the “Formula Amount” (as defined therein). The
Company also entered into a Stock Pledge Agreement and Security Agreement
securing its obligations to Laurus, both prior to and including the Notes,
as
well as a Registration Rights Agreement pursuant to which the Company agreed
to
file a registration statement to register the shares of the Company’s common
stock underlying the Option, as well as the shares of the Company’s common stock
and the shares of the Company’s common stock underlying the warrants held by
Laurus, within 90 days. As of the date of this filing, Laurus owns approximately
809,525 shares of the Company’s common stock, an option to purchase up to
3,080,000 shares of the Company's common stock at an exercise price of $.001
per
share and warrants to purchase 400,000 shares of the Company’s common stock at
$4.35 per share, 200,000 shares of the Company’s common stock at $4.65 per share
and 200,000 shares of the Company’s common stock at $5.25 per
share.
In
February 2006, the Company entered into a Securities Purchase Agreement with
Taurus Advisory Group LLC, pursuant to which it issued 19,000 shares of the
Company’s newly created Series A Convertible Preferred Stock, $0.001 par value.
Each shares of Series A preferred stock has a stated value of $100.00. The
Company also granted Taurus a warrant to purchase 1,900,000 shares of the
Company’s common stock exercisable at a price of $0.60 per share (subject to
adjustments
related to stock splits, reclassifications, combinations, dividends, change
of
control or the issuance of pari passu securities). The warrant is
exercisable for a period of five years.
In
February 2006, the Company repurchased 3,892,355 shares of its common stock
from
the Company’s largest non-affiliated stockholder, WHRT I Corp. for
$1,848,868.80, and such shares were placed back into the Company’s treasury. An
additional 253,027 shares of our common stock relating to the escrowed shares
were also placed back into treasury. The Company utilized the proceeds from
its
issuance of its Series A Convertible Preferred Stock in order to finance this
common stock repurchase.
In
February 2006, the Company received $2,050,000 as a result of Informatica
Corporation’s acquisition of Similarity Systems. In July 2005, the Company sold
substantially all the assets of its subsidiary, Evoke Software Corporation,
to
Similarity Systems for cash and future consideration.
In
January 2006, the Company granted a stock option to purchase 1,000,000 shares
of
Company common stock to an executive. The exercise price is $0.46 per share,
the
options vest over a three year period from the date of grant, expire five
years from the date of grant and had a fair value on the grant date of $430,000.
Additionally, in April 2006, incentive stock options to purchase 130,000 shares
of Company common stock were granted to employees. The exercise price for this
grant is $1.05 per share, the options vest over a three year period from the
date of grant, expire ten years from the date of grant and had a fair value
on
the grant date of $135,200.
In
December 2005, the Company obtained a $1,000,000 short term loan from certain
investors represented by Taurus. This note bears interest at 8% per annum.
The
note is dated December 19, 2005 and initially matured on January 31, 2006.
The
maturity date for this note has been extended to June 1, 2006. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes. As of December 31, 2005, $500,000 had been drawn down on this
loan. The Company obtained the remaining $500,000 available under this loan
in
January 2006. In conjunction with this note, these investors received a warrant
to purchase 277,777 shares of our common stock with an exercise price of $0.675
per share in December 2005, a warrant to purchase 277,777 shares of our common
stock with an exercise price of $0.75 per share in February 2006 and a
warrant to purchase 554,000 shares of our common stock with an exercise price
of
$1.30 per share in March 2006. These warrants expire in December
2008, January 2009 and February 2009, respectively.
In
July
2005, the Company obtained two $250,000 short term loans from certain investors
represented by Taurus. Both notes bear interest at 8% per annum. The first
note
is dated July 6, 2005 and initially matured on September 5, 2005. The maturity
date for this note has been extended to May 6, 2006. The second note is dated
July 22, 2005 and originally matured on September 22, 2005. The maturity date
for this note has been extended to April 22, 2006. These
short term note holders have agreed to extend their maturity date on a
month-to-month basis until the Company raises sufficient funds to repay the
notes.
On
April
18, 2006, the Company received a letter from the American Stock Exchange
related
to its late filing of this Form 10-KSB. The late filing was in violation
of the
continued listing standards of the American Stock Exchange. The letter requires
the Company to become compliant with the continued listing standards of the
American Stock Exchange by June 16, 2006, and the Company believes that it
became compliant upon the filing of this Form 10-KSB.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by
the undersigned thereunto duly authorized.
Dated:
April 20, 2006
/s/
Scott Newman
Scott
Newman
President,
Chief Executive Officer and Chairman
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Signature
|
Title
|
Date
|
/s/
Scott Newman
Scott
Newman
|
President,
Chief Executive Officer and Chairman
|
April
20, 2006
|
|
|
|
/s/
Mitchell Peipert
Mitchell
Peipert
|
Vice
President, Chief Financial Officer, Secretary and
Treasurer
|
April
20, 2006
|
|
|
|
/s/
Glenn Peipert
Glenn
Peipert
|
Executive
Vice President, Chief Operating Officer and Director
|
April
20, 2006
|
|
|
|
/s/
Lawrence K. Reisman
Lawrence
K. Reisman
|
Director
|
April
20, 2006
|
|
|
|
/s/
Joseph Santiso
Joseph
Santiso
|
Director
|
April
20, 2006
|