Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K/A
Amendment
No. 1
x |
Annual
report pursuant to section 13 or 15(d) of the Securities Exchange Act
of 1934.
For
the fiscal year ending December 31,
2006
|
Or
o |
Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934.
For
the transition period from
________ to ________.
|
Commission
file number 001-32623
CONVERSION
SERVICES INTERNATIONAL, INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
|
20-0101495
|
(State
or other jurisdiction
of
incorporation or organization)
|
|
(IRS
Employer
Identification
number)
|
|
|
|
100
Eagle Rock Avenue, East Hanover, NJ
|
|
07936
|
(Address
of Principal Executive Offices)
|
|
(Zip
Code)
|
973-560-9400
(Registrant’s
Telephone Number, Including Area Code)
Securities
registered pursuant to Section 12(b) of the Act:
Title
of Each Class
|
|
Name
of Each Exchange
On
Which Registered
|
Common
Stock, $.001 par value
|
|
American
Stock Exchange
|
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities
Act.
Yes o No x.
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 o 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 x NO o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not 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-K or any amendment to
this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o
|
|
Accelerated
filer o
|
|
Non-accelerated
filer x
|
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
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant was approximately $5,541,871 as of March 27,
2007 (based on the closing price for such stock as of March 27,
2007).
As
of
March 27, 2007, there were 56,480,153 shares of common stock, par value $0.001
per share, of the registrant outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
None
Explanatory
Note
This
Amendment No. 1 to this Annual Report on Form 10-K for the year ended December
31, 2006 was filed in order to provide selected quarterly financial data
required by Item 302 of Regulation S-K and to clarify our disclosure of
the
effectiveness of the Company’s controls and procedures.
Part
II,
Item 9A. was amended to reflect the controls and procedures disclosure
and the
Notes to Consolidated Financial Statements have been amended to include
Note-25,
Quarterly Information. This amendment does not otherwise update information
in
the original filing to reflect facts or events occurring subsequent to
the date
of the original filing. All information contained in this document and
the
original filing is subject to updating and supplementing as provided in
periodic
reports subsequent to the original filing date of this Form 10-K/A with
the
Securities and Exchange Commission.
TABLE
OF CONTENTS
|
PART
I
|
|
Item
1.
|
Business
|
3
|
Item
1A.
|
Risk
Factors
|
18
|
Item
1B.
|
Unresolved
Staff Comments
|
35
|
Item
2.
|
Properties
|
35
|
Item
3.
|
Legal
Proceedings
|
35
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
36
|
|
|
|
|
PART
II
|
|
Item
5.
|
Market
For Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
37
|
Item
6. .
|
Selected
Financial Data
|
38
|
Item
7.
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
39
|
Item 7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
62
|
Item
8.
|
Financial
Statements and Supplementary Data
|
62
|
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
63
|
Item 9A.
|
Controls
and Procedures
|
63
|
Item 9B.
|
Other
Information
|
65
|
|
|
|
|
PART
III
|
|
Item
10.
|
Directors
and Executive Officers of the Registrant
|
66
|
Item
11.
|
Executive
Compensation
|
71
|
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
86
|
Item
13.
|
Certain
Relationships and Related Transactions
|
88
|
Item
14.
|
Principal
Accounting Fees and Services
|
90
|
|
|
|
|
PART
IV
|
|
Item
15.
|
Exhibits
and Financial Statement Schedules
|
91
|
PART
I
ITEM
1. BUSINESS
References
in this Form 10-K 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 primarily through time and material engagements.
We
believe that our primary strengths that distinguish us from our competitors
are
our:
|
·
|
role
as a full life-cycle solution
provider;
|
|
·
|
ability
to provide strategic guidance and ensure that business requirements
are
properly supported by technology;
|
|
·
|
ability
to provide solutions that integrate people, improve process and
integrate
technologies;
|
|
·
|
extensive
service offerings as it relates to data warehousing, business
intelligence, strategy and data
quality;
|
|
·
|
perspective
regarding the accuracy of data and our data purification
process;
|
|
·
|
best
practices methodology, process and
procedures;
|
|
·
|
experience
in architecting, recommending and implementing large and complex
data
warehousing and business intelligence solutions;
|
|
·
|
understanding
of data management solutions; and
|
|
·
|
ability
to consolidate inefficient environments into robust, scalable, reliable
and manageable enterprise
solutions.
|
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:
|
·
|
enhance
our brand and mindshare;
|
|
·
|
continue
growth both organically and via
acquisition;
|
|
·
|
increase
our geographic coverage;
|
|
·
|
expand
our client relationships;
|
|
·
|
introduce
new and creative service offerings;
and
|
|
·
|
leverage
our strategic alliances.
|
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 14-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.”
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
|
·
|
Information,
Process and Infrastructure (IPI) Diagrams (Claritypath) - A blueprinting
process and service that facilitates and accelerates the strategic
planning process.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
Regulatory
Compliance (The Health Insurance Portability and Accountability
Act of
1996, Basel II) - Work with clients to analyze, design and implement
operational control, procedures and business intelligence that
will align
the organization to meet new regulatory requirements.
|
|
·
|
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.
|
|
·
|
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.
|
Technology
Consulting
|
·
|
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.
|
|
·
|
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.
|
|
·
|
Business
Intelligence Strategy - Helping clients develop a roadmap to leverage
a
business intelligence platform throughout the enterprise aligning
the
client with best practices.
|
|
·
|
BI/DW
Software Selection - Evaluation, analysis and recommendation of
appropriate software tools for deploying business intelligence/data
warehousing 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.
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
Outsourcing
- Development of new reports offsite/offshore and redeployment
of reports
in new technologies in support of technology
consolidation.
|
|
·
|
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.
|
Data
Warehousing: A
consolidated view of high quality enterprise information, making it simpler
and
more efficient to analyze and report on that information.
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
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.
|
|
·
|
Outsourcing
- Implementing and supporting a client data warehouse solution at
a CSI
location.
|
Data
Management: Innovative
solutions for managing data (information) throughout an enterprise.
|
·
|
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.
|
|
·
|
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 revenues provided by each category of services as
a
component of total revenues from continuing operations:
For
the year ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
$
|
|
%
of total revenues
|
|
$
|
|
%
of total revenues
|
|
$
|
|
%
of total revenues
|
|
Strategic
Consulting
|
|
|
11,811,153
|
|
|
46.0
|
%
|
|
11,221,888
|
|
|
40.6
|
%
|
|
8,577,625
|
|
|
35.9
|
%
|
Business
Intelligence
|
|
|
5,061,205
|
|
|
19.7
|
%
|
|
6,184,955
|
|
|
22.4
|
%
|
|
5,423,735
|
|
|
22.7
|
%
|
Data
Warehousing
|
|
|
6,285,363
|
|
|
24.6
|
%
|
|
6,299,619
|
|
|
22.8
|
%
|
|
3,990,149
|
|
|
16.7
|
%
|
Data
Management
|
|
|
2,478,348
|
|
|
9.7
|
%
|
|
3,647,148
|
|
|
13.2
|
%
|
|
5,590,987
|
|
|
23.4
|
%
|
Software
& Support
|
|
|
-
|
|
|
-
|
%
|
|
-
|
|
|
-
|
%
|
|
238,931
|
|
|
1.0
|
%
|
Other
|
|
|
37,988
|
|
|
-
|
%
|
|
276,299
|
|
|
1.0
|
%
|
|
71,679
|
|
|
0.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
25,674,057
|
|
|
100.0
|
%
|
|
27,629,909
|
|
|
100.0
|
%
|
|
23,893,106
|
|
|
100.0
|
%
|
Recent
Acquisitions and Divestiture
We
will
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.
Integration
of DeLeeuw Associates’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. In
addition, we expanded our Data Warehouse Assessment, Business Technology
Alignment (BTA) and Quality Management Offering (QMO) related offerings in
2005,
which was 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 and 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). 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 July 2005, we completed the sale of substantially all
of
the assets of Evoke to Similarity Systems (“Similarity”) and Similarity Vector
Technologies, Ltd. (“SVT”). In February 2006, the Company received $2,050,000
from Informatica, Similarity and SVT related to Informatica’s acquisition of
Similarity and SVT 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. Mr. William 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"). ISI is a professional
services firm with a solutions-oriented approach to complex business and
technical challenges. The operations of ISI were folded into DeLeeuw
Associates.
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 17 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
Financings
The
Company effectuated the following financing transactions between January 1,
2006
and March 28, 2007:
Taurus
In
February 2006, we entered into a Securities Purchase Agreement with investors
represented by Taurus Advisory Group, LLC (“Taurus”), pursuant to which
we issued 19,000 shares of our 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. We received proceeds of
$1,900,000. 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 our election,
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 adjustment). 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
the Taurus investors, on February 1, 2011. Pursuant to the Securities Purchase
Agreement, the Taurus investors were also granted a warrant to purchase
1,900,000 shares of our common stock exercisable at a price of $0.60 per share
(subject to adjustment), exercisable for a period of five years.
In
August
2006, we entered into a Stock Purchase Agreement with an investor represented
by
Taurus, pursuant to which we issued 20,000 shares of our newly created
Series B Convertible Preferred Stock, $.001 par value (the “Series B
Preferred”). Each share of Series B Preferred has a stated value of $100.00. We
received proceeds of $2,000,000. The Series B Preferred has a cumulative annual
dividend equal to the Prime Rate plus one percent (1%), which is payable
monthly in cash or common stock, at our election, and is convertible into
shares of our common stock at any time at a price equal to the lower of (1)
$0.85 or (2) the average daily volume weighted market price for the five
consecutive trading days immediately prior to the date for which such price
is
determined, with a minimum price of $0.50. In addition, the Series B Preferred
has no voting rights, but has liquidation preferences and certain other
privileges. Pursuant to the Stock Purchase Agreement, warrants to purchase
1,276,471 shares of our common stock were issued, exercisable at a price of
$0.94 per share (subject to adjustment), and exercisable for a period of five
years.
In
December 2006, we entered into a Stock Purchase Agreement with certain investors
pursuant to which we issued 3,000,000 shares of our common stock, and we
received proceeds of $750,000. The
investors were
also
granted a warrant to purchase 1,500,000 shares of our common stock, exercisable
at a price of $0.30 per share (subject to adjustment). The warrant is
exercisable for a period of five years.
In
March
2007, we issued a 10% Convertible Unsecured Note to certain investors
represented by TAG Virgin
Islands, Inc.
for
$4.0 million. The 10% Convertible Unsecured Note will automatically
convert into 13,333,333 shares of our common stock, upon the effectiveness
of
the Information Statement on Schedule 14C, filed with the SEC on March 8, 2007.
This Information Statement relates to the proposed increase in the number of
authorized shares of common stock, from 100,000,000 to
200,000,000. The
investors were
also
granted a warrant to purchase 13,333,333 shares of our common stock, exercisable
at a price of $0.33 per share (subject to adjustment). The warrant
is exercisable for a period of five years.
The
note was subsequently amended in March 2007 to $4.25 million and the number
of
shares of common stock that the note will convert into was increased to
14,166,667 shares of our common stock. Additionally, the warrant was also
amended to entitled the investor to purchase 14,166,667 shares of our common
stock, exercisable at a price of $0.33 per share (subject to adjustment). The
warrant is 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”). The Company
renegotiated the terms of this financing arrangement several times between
August 2004 and December 2005.
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 $1.0 million to Laurus (the “Term Note”), (b) issued a secured
non-convertible revolving note in the principal amount of $10.0 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. Laurus
exercised a portion of this option in 2006 when they purchased 1,580,000 shares
of the Company’s common stock. An option to purchase 1,500,000 shares remains
outstanding as of December 31, 2006. 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. Amounts due under the Revolving Note
as
of February 1, 2006 included $3,101,084 which was loaned to the Company under
an
Overadvance Side Letter. 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 were to
be
made in equal monthly amounts until maturity of both notes on December 31,
2007.
In
March
2007, we repaid in full the Overadvance Side Letter, dated as of February 1,
2006, with a cash payment of $2,601,084 and the issuance of a warrant to
purchase 1,785,714 shares of Common Stock at an exercise price of $0.01 (after
making the first two payments in February 2007, we were to pay Laurus
approximately $258,424 per month until the aggregate principal amount of
$3,101,084 was paid in full by December 31, 2007). Further, we satisfied
in full the outstanding amount on the Term Note with a cash payment of
approximately $409,722.
Laidlaw/Sands
In
September 2004, the Company borrowed an aggregate of $1.0 million, due in one
year and bearing interest at 8% per annum, from three affiliates of Sands
Brothers Venture Capital (“Sands”). Upon maturity of the notes in September
2005, the Company executed an amended note with these affiliates of Sands for
an
aggregate principal amount of $1.08 million, due in January 2007 and bearing
interest at 12% per annum.
Between
January and March 2007, we executed several extension agreements with Sands
to
repay the amended subordinated secured convertible promissory notes, in which
we
agreed to pay $1.05 million cash, as well as issue shares of Common Stock and
warrants to purchase Common Stock, on four separate payment dates of April
2,
2007, July 2, 2007, October 1, 2007 and December 31, 2007. We paid Sands a
total of $0.65 million between February and March 2007. The remaining $0.4
million is due to be paid between October and December 2007.
Clients
For
17
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 2006, the Company had sales to three major customers,
Sapphire Technologies (17.6%) Comsys (9.7%), and LEC, a related party (9.7%),
which accounted collectively for approximately 37.0% of revenues. During the
year ended December 31, 2005, two of our clients, LEC, 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,
LEC, 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 and our
sales
force comprised of 14 employees as of December 31, 2006. 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:
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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.
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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.
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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. 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.
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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.
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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).
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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.
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Vendor
Relations:
We are continually identifying key vendor relationships. With the
ability
to leverage our 17 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:
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Database
Vendors:
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Oracle
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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.
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Microsoft
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We
are a Gold Microsoft Certified Solution Provider. We maintain the
required
number of Microsoft certified professionals to hold this
designation.
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Netezza
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We
are a Systems Integration and Reseller Partner.
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Business
Intelligence Vendors:
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Business
Objects
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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.
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Cognos
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We
are a Systems Integration and Reseller Partner. We employ and maintain
a
staff of professionals that are certified in the vendor’s
technology.
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Exeros
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We
are an alliance partner.
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APOS
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We
are a Systems Integration and Reseller Partner.
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Data
Warehousing Vendors:
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Appfluent
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We
are a strategic marketing and reseller partner.
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Master
Data Management Vendors:
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Siperian
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We
are a Systems Integration and Reseller
Partner.
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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 email 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.
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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. 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:
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Cap
Gemini Ernst & Young
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Employees
As
of
December 31, 2006, we had 35 outside consultants, 87 consultants on the payroll
and 41 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 who are consultants. Such
consultants are 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 William Hendry, 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-K.
SPECIAL
NOTE ON FORWARD LOOKING STATEMENTS
In
addition to historical information, this Annual Report on Form 10-K 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:
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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;
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our
ability to retain members of our management team and our
employees;
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our
ability to retain existing clients or attract new
clients;
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our
ability to adapt to the rapid technological change constantly occurring
in
the areas in which we provide
services
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our
ability to offer pricing for services which is acceptable to clients;
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the
competition that may arise in the future;
and
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identifying
suitable acquisition candidates and integrating new
acquisitions.
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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.
Item
1A. 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, 2006, services provided to three of our clients,
Sapphire Technologies (17.6%), Comsys (9.7%) and LEC, a related party (9.7%)
accounted for an aggregate of approximately 37.0% of total revenues. During
the
year ended December 31, 2005, two of our clients, LEC, a related party (13.4%),
and Bank of America (27.2%), accounted collectively for approximately 40.6%
of
total revenues. Further, the majority of our current assets consist of accounts
receivable, and as of December 31, 2006, receivables relating to Sapphire
Technologies, Comsys and LEC accounted for 28.2%, 4.2%, and 7.5% of our accounts
receivable balance, respectively. With the 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:
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obtain
additional contracts for projects similar in scope to those previously
obtained from our clients;
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be
able to retain existing clients or attract new
clients;
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provide
services in a manner acceptable to
clients;
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offer
pricing for services which is acceptable to clients; or
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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.
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The
Company has received a modified audit opinion on its ability to continue
as a going concern.
The
audit
report our independent registered public accounting firm issued on our audited
financial statements for the fiscal year ended December 31, 2006 contains a
modification regarding our ability to continue as a going concern. This
modification indicates that the
Company’s recent losses, negative cash flows for operations, its net working
capital deficiency and its ability to pay its outstanding debt raises
substantial doubt on the part of our independent registered public
accounting firm that we can continue as a going concern. Such an opinion
from our independent registered public accounting firm may limit our ability
to
access certain types of financing, or may prevent us from obtaining financing
on
acceptable terms.
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 from the SEC related to our
Registration Statement on Form SB-2/A, we and our independent registered public
accounting firm recognized that our internal controls had material weaknesses.
In April 2005, we restated our results of operations for our 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 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 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 the filing
of
our Form 10-Q for the period ending June 30, 2006, 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 our 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 our Form 10-KSB for the fiscal
year ended December 31, 2005 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.
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 year ended December 31, 2006 and the fiscal years ended December 31, 2005
and 2004, we sustained operating losses and cannot be sure that we will operate
profitably in the future. During the year ended December 31, 2006, we recorded
a
net loss in the approximate amount of ($9.6 million). During the fiscal year
ended December 31, 2005, we reported a net loss in the approximate amount of
($5.1 million). During the fiscal year ended December 31, 2004, we sustained
a
net loss in the approximate amount of ($35.3 million). 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 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 December 31, 2006 was approximately $15.1 million and, as of March
27, 2007 was $14.6 million (which includes the $4.25 million convertible note
issued to Taurus in March 2007, convertible upon the effectiveness of the
Information Statement referenced above). The degree to which we are leveraged
could have important consequences to us, including the following:
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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;
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Our
indebtedness increases our vulnerability to changes in general economic
and industry conditions;
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Our
ability to obtain additional financing for working capital, capital
expenditures, general corporate purposes or other purposes could
be
impaired;
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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
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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.
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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 (the $1 million note
was repaid in full in March 2007). The note and related agreements contain
several events of default which include:
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failure
to pay interest, principal payments or other fees when
due;
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failure
to pay taxes when due unless such taxes are being contested in good
faith;
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breach
by us of any material covenant or term or condition of the notes
or any
agreements made in connection
therewith;
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default
on any indebtedness to which we or our subsidiaries are a
party;
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breach
by us of any material representation or warranty made in the notes
or in
any agreements made in connection
therewith;
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attachment
is made or levy upon collateral securing the Laurus debt which is
valued
at more than $150,000 and is not timely
mitigated;
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any
lien created under the notes and agreements is not valid and perfected
having a first priority interest;
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assignment
for the benefit of our creditors, or a receiver or trustee is appointed
for us;
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bankruptcy
or insolvency proceeding instituted by or against us and not dismissed
within 30 days;
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the
inability to pay debts as they become due or cease business
operations;
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sale,
assignment, transfer or conveyance of any assets except as
permitted;
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a
person or group becomes a beneficial owner of 35% on a fully diluted
basis
of the outstanding voting equity interest or the present directors
cease
to be the majority on the Board of
Directors;
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indictment
or threatened criminal indictment, or commencement of threatened
commencement of any criminal or civil proceeding against us or any
executive officer; and
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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.
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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 many 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:
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our
clients' perceptions of our ability to add value through our
services;
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pricing
policies of our competitors;
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our
ability to accurately estimate, attain and sustain engagement revenues,
margins and cash flows over increasingly longer contract
periods;
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the
use of globally sourced, lower-cost service delivery capabilities
by our
competitors and our clients; and
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general
economic and political conditions.
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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
and strategic consulting services. During the last several years, we have
focused our efforts on providing data warehousing and other strategic services
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, strategic services 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.
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 of 2002 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 December 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, effective
in 2008, 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, 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 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:
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engage
in more extensive research and
development;
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undertake
more extensive marketing campaigns;
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adopt
more aggressive pricing policies;
and
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make
more attractive offers to our existing and potential employees and
strategic partners.
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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 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 and Glenn Peipert. Although we have entered into employment
agreements with Messrs. Newman and Peipert, the loss of either 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 and
Peipert.
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:
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the
extent to which our solutions and services gain market
acceptance;
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the
level of revenues from current and future solutions and
services;
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the
expansion of operations;
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the
costs and timing of product and service developments and sales and
marketing activities;
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the
costs related to acquisitions of technology or businesses;
and
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competitive
developments.
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We
will
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 that
such
additional capital will be available on terms acceptable to us, if at all.
Further, if we raise capital through an equity or debt financing at a 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. 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, our 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, our executive officers
and
two of our directors, beneficially own approximately 34.7% and 18.2%,
respectively, of our outstanding common stock. This concentration of ownership
of our common stock may:
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delay
or prevent a change in the control;
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impede
a merger, consolidation, takeover or other transaction involving
us;
or
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discourage
a potential acquirer from making a tender offer or otherwise attempting
to
obtain control of us.
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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 investors
represented by Taurus Advisory Group, LLC and 20,000 shares of Series B
Convertible Preferred Stock to an individual investor.
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 our security measures,
it
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:
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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;
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losses
resulting from the on-going operations of these acquisitions could
adversely affect our cash flow; and
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our
stockholders could suffer significant dilution of their interest
in our
common stock.
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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
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. On June 29,
2006, we received a letter from AMEX indicating that we are below certain of
the
Exchange's continued listing standards as set forth in Sections 1003(a)(i),
1003(a)(ii) and 1003(a)(iv) of the AMEX Company Guide. We were afforded the
opportunity to submit a plan of compliance to the Exchange by July 31, 2006
that
demonstrates our ability to regain compliance with Section 1003 of the AMEX
Company Guide within 18 months. We submitted our plan to AMEX on July 31, 2006,
and AMEX accepted our plan on September 26, 2006. We were granted
an extension until December 28, 2007 to regain compliance with the continued
listing standards. We are subject to periodic review by the Exchange Staff
during the extension period. Failure to make progress consistent with the plan
or to regain compliance with the continued listing standards by the end of
the
extension period could result in our common stock being delisted from the
Exchange.
On
January 25, 2007, we received notice from AMEX indicating that we no longer
comply with the Exchange’s continued listing standards and our plan of
compliance submitted in July 2006, and that our securities are subject to be
delisted from the Exchange. The Company has filed an appeal of this
determination and has a hearing before a committee of AMEX planned for April
2007. If the committee does not grant the relief sought by the Company, its
securities will be delisted from AMEX and may continue to be quoted on the
OTC
Bulletin Board.
As
a
result of failing to file our Annual Report on Form 10-KSB/A for fiscal 2005
in
a timely fashion, we failed to meet the continued listing requirements of the
AMEX from its due date on April 17, 2006 until April 21, 2006. In the future,
if
we fail to timely file our required reports, we could be subject to
delisting.
If
our
common stock is delisted 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.
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 and Glenn Peipert, 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.
Additional
authorized shares of our common stock and preferred stock available for issuance
may adversely affect the market.
We
are
authorized to issue 100,000,000 shares of our common stock. On March 8,
2007, we preliminarily filed an Information Statement on Schedule 14C with
the
SEC relating
to a stockholder action which has been approved by written consent of
stockholders of the Company who hold approximately 56% (in excess of a majority)
of the voting power of our common stock. Such stockholder action approved
a Certificate of Amendment to our Certificate of Incorporation pursuant to
which
our authorized common stock will be increased from 100,000,000 shares up to
200,000,000 shares of such Common Stock. In addition, the Information
Statement disclosed the issuance of a convertible note in which 13,333,333
shares of common stock will be issued upon the effectiveness of the Information
Statement (and the issuance of a warrant to purchase an additional 13,333,333
shares of common stock). This Information Statement will be as subsequently
amended to reflect the modification of the convertible note in which 14,166,667
shares of common stock will now be issued upon the effectiveness of the
Information Statement (and the issuance of a warrant to purchase an additional
14,166,667 shares of common stock).
As
of
March 27, 2007, there were 56,480,153 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 27, 2007, we had
15,436,507 shares of common stock underlying convertible notes (including the
note mentioned in the prior paragraph that will automatically convert upon
the
effectiveness of the Information Statement), and we will have reserved shares
of
our common stock for issuance in connection with the potential conversion
thereof as of the effectiveness of the Information Statement. As of March
27, 2007, we had outstanding stock options and warrants to purchase
approximately 30,890,298 shares of our common stock, the exercise prices of
which range between $0.01
and
$5.25 per
share, and we will have reserved shares of our common stock for issuance in
connection with the potential exercise thereof upon the effectiveness of the
Information Statement. Of the reserved shares, a total of 10,000,000
shares are currently reserved for issuance in connection with our 2003 Incentive
Plan. 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,
we
have issued 19,000 shares of Series A Convertible Preferred Stock to Taurus
Advisory Group LLC (convertible into 3,800,000 shares of common stock) and
20,000 shares of Series B Convertible Preferred Stock (convertible into up
to
4,000,000 shares of common stock based upon the lowest contractual conversion
price) to an individual investor. While we presently have no 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
a 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
1B. UNRESOLVED STAFF COMMENTS
None
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, Inc. has an office at Suite 1460, Charlotte
Plaza, 201 South College Street, Charlotte, North Carolina 28244. DeLeeuw
Associates leases this space which has a stated expiration date of December
31,
2010.
The
Company is committed under several operating leases for automobiles that expire
during 2007.
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. The
case
was dismissed with prejudice in favor of CSI on December 4, 2006, and the
Company is presently considering whether to continue its
countersuit.
In
July
2005, in conjunction with the acquisition of Integrated Strategies, Inc.
(“ISI”), the Company issued a subordinated promissory note in the principal
amount of $165,000 payable to Adam Hock and Larry Hock (the “Hocks”), the former
principal stockholders of ISI. This note, along with $35,000 cash, was to be
held in escrow for 15 months. This note matured on October 28, 2006. Pursuant
to
the indemnification provisions of the merger agreement among the Company and
the
Hocks, the $200,000 was to be held in escrow to cover any liabilities by any
failure of any representation or warranty of ISI or the Hocks to be true and
correct at or before the closing, and any act, omission or conduct of ISI and
the Hocks prior to the closing, whether asserted or claimed prior to, or at
or
after, the closing. After the note matured, the Hocks requested the entire
$200,000 from the Company, while the Company, after offsetting certain
undisclosed liabilities, responded that the actual amount owed is significantly
less. The Hocks then filed a lawsuit in the State of Florida on December 22,
2006 for recovery of the entire $200,000. On March 1, 2007, a circuit court
in
Hillsborough County, Florida denied the Company’s motion to dismiss the lawsuit
for lack of jurisdiction without explanation to its ruling. The Company is
appealing this decision. Management
believes the suit against the Company to be without merit and intends to
vigorously defend the Company against this action and is presently considering
a
countersuit.
On
March
21, 2007, we filed a lawsuit in the Superior Court of New Jersey against our
former employees, Timothy Furey and Craig Cordasco. We are alleging that
Messrs. Furey and Cordasco misappropriated confidential information, broke
their
outstanding contractual obligations to us, unfairly competed, and tortuously
interfered with economic gain. We are seeking injunctive relief and
monetary damages.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of security holders during the fourth quarter
of the fiscal year ended December 31, 2006.
PART
II
ITEM
5. |
MARKET
FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF
EQUTY SECURITIES
|
(a) Market
Information.
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 bid prices for each quarter from
January 1, 2005 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 December 31, 2006. All numbers give
effect to a 1 for 15 reverse stock split effected on September 20,
2005.
|
|
High
|
|
Low
|
|
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
|
|
April
1 - June 30
|
|
$
|
1.15
|
|
$
|
0.65
|
|
July
1 - September 30
|
|
$
|
1.01
|
|
$
|
0.52
|
|
October
1 - December 31
|
|
$
|
0.56
|
|
$
|
0.25
|
|
On
March
27, 2007, the closing price for shares of our common stock, as reported by
the
American Stock Exchange, was $0.27.
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 27, 2007, there were 461 registered holders of our common stock, including
shares held in street name. As of March 27, 2007, there were 56,480,153 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.
(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 disclosed in a quarterly report on Form 10-Q or a current report
on
Form 8-K.
ITEM
6. |
SELECTED
FINANCIAL DATA
|
The
following tables should be read in conjunction with our financial statements
and
the notes thereto appearing elsewhere in this Annual Report on Form 10-K.
The selected financial data has been derived from our financial statements,
which have been audited by Friedman LLP, independent registered public
accounting firm, as indicated in their report included elsewhere herein.
SELECTED
FINANCIAL DATA
For
the
fiscal year ending December 31, 2006
|
|
2006
|
|
2005
(b)
|
|
2004
(a)
|
|
2003
(c)
|
|
2002
(c)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenue
|
|
$
|
25,674,057
|
|
$
|
27,629,909
|
|
$
|
23,893,106
|
|
$
|
14,366,456
|
|
$
|
16,244,790
|
|
Gross
profit
|
|
|
5,743,123
|
|
|
7,097,506
|
|
|
5,046,129
|
|
|
4,100,648
|
|
|
5,567,264
|
|
Income
(loss) from continuing operations
|
|
|
(11,661,778
|
)
|
|
(4,014,302
|
)
|
|
(22,697,298
|
)
|
|
(306,763
|
)
|
|
623,249
|
|
Income
(loss) from discontinued operations
|
|
|
2,050,000
|
|
|
(1,103,971
|
)
|
|
(12,650,908
|
)
|
|
-
|
|
|
-
|
|
Net
income (loss)
|
|
|
(9,611,778
|
)
|
|
(5,118,273
|
)
|
|
(35,348,206
|
)
|
|
(306,763
|
)
|
|
623,249
|
|
Net
income (loss) attributable to common stockholders
|
|
|
(10,204,128
|
)
|
|
(5,118,273
|
)
|
|
(35,348,206
|
)
|
|
(306,763
|
)
|
|
623,249
|
|
Basic
income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
From
continuing operations
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
|
|
|
|
|
|
From
discontinued operations
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
|
|
|
|
|
|
Net
loss per common share
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
Net
loss per common share attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
Diluted
income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
From
continuing operations
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
|
|
|
|
|
|
From
discontinued operations
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
|
|
|
|
|
|
Net
loss per common share
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
Net
loss per common share attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working
capital
|
|
$
|
(6,272,148
|
)
|
$
|
(7,587,860
|
)
|
$
|
(13,923,181
|
)
|
$
|
(655,496
|
)
|
$
|
(89,710
|
)
|
Total
assets
|
|
|
14,530,811
|
|
|
18,478,469
|
|
|
28,868,029
|
|
|
4,759,900
|
|
|
3,212,218
|
|
Long-term
obligations and redeemable preferred stock
|
|
|
3,729,693
|
|
|
5,178,682
|
|
|
7,099,017
|
|
|
270,828
|
|
|
464,965
|
|
Total
stockholders' equity (deficit)
|
|
|
(513,129
|
)
|
|
1,629,139
|
|
|
1,294,522
|
|
|
1,219,144
|
|
|
766,233
|
|
(a) |
Includes
the results from the acquisition to the end of the fiscal year
of both
DeLeeuw Associates, which was acquired on March 4, 2004, and
Evoke
Software Corporation, which was acquired on June 28,
2004.
|
(b) |
Includes
the results from the acquisition to the end of the fiscal year
of both
McKnight Associates, which was acquired on July 22, 2005, and
Integrated
Strategies, Inc., which was acquired on July 29, 2005. Also,
reflects the disposition of substantially all of the assets
of Evoke
Software Corporation in July,
2005.
|
(c) |
Prior
to the period when the Company became publicly traded and,
as a result,
does not reflect the
recapitalization.
|
ITEM
7.
|
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. 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 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 strategic consulting division. 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 our ability to accomplish these goals.
When economic conditions decline, companies generally decrease their technology
budgets and reduce the amount of spending on the type of information technology
(IT) consulting provided by the Company. 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 has noted improvements in economic conditions, which have recently
resulted in increased spending on consulting services in certain vertical
markets, particularly in financial services. However, several large clients
have
changed their business practices with respect to consulting services. Such
clients now require that we contract with their vendor management organizations
in order to continue to perform services. These organizations charge fees
generally based upon the hourly rates being charged to the end client. Our
revenues and gross margins are being negatively affected by this
practice.
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, through entry on new approved vendor
lists, penetrating new vertical markets, and expanding its time and material
and
permanent placement business, the Company will concentrate its efforts on
improving margins and driving earnings to the bottom line.
In
addition to the conditions described above for growing the Company’s current
business, the Company expects to 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
36 months and the Company has been a participant in this consolidation. The
Company has been active in acquiring companies during the last three
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”). 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 industry leaders
in
this sector among its customers. Because of this shared focus, the operations
of
ISI were merged into DeLeeuw Associates.
The
Company’s most significant costs are personnel expenses, which consist of
consultant fees, benefits and payroll-related expenses.
SFAS
No. 123 (Revised 2004) (“SFAS No. 123R”), “Share-Based
Payment,”
was
issued in December 2004 and is a revision of FASB Statement 123, “Accounting
for Stock-Based Compensation”.
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. The Company is required to adopt this standard effective
with the beginning of the first annual reporting period that begins after
December 15, 2005, therefore, we have adopted the standard in the first quarter
of fiscal 2006. We previously accounted for share-based payments to employees
using the intrinsic value method prescribed in APB Opinion 25 and, as such,
generally recognized no compensation cost for employee stock options. 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 future periods. As a result of our adoption of SFAS No. 123R in 2006,
we recognized stock compensation expense totaling $2.0 million.
Years
Ended December 31, 2006 and 2005
The
Company’s revenues are primarily comprised of billing to clients for consulting
hours worked on client projects. Revenues of $25.7 million for the year ended
December 31, 2006 decreased by $1.9 million, or 7.1%, compared to revenues
of
$27.6 million for the year ended December 31, 2005.
Revenues
for the Company are categorized by strategic consulting, business intelligence,
data warehousing and data management. The chart below reflects revenue by line
of business for the years ended December 31, 2006, 2005 and 2004.
|
|
For
the year ended December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
$
|
|
%
of total revenues
|
|
$
|
|
%
of total revenues
|
|
$
|
|
%
of total revenues
|
|
Strategic
Consulting
|
|
|
11,811,153
|
|
|
46.0
|
%
|
|
11,221,888
|
|
|
40.6
|
%
|
|
8,577,625
|
|
|
35.9
|
%
|
Business
Intelligence
|
|
|
5,061,205
|
|
|
19.7
|
%
|
|
6,184,955
|
|
|
22.4
|
%
|
|
5,423,735
|
|
|
22.7
|
%
|
Data
Warehousing
|
|
|
6,285,363
|
|
|
24.6
|
%
|
|
6,299,619
|
|
|
22.8
|
%
|
|
3,990,149
|
|
|
16.7
|
%
|
Data
Management
|
|
|
2,478,348
|
|
|
9.7
|
%
|
|
3,647,148
|
|
|
13.2
|
%
|
|
5,590,987
|
|
|
23.4
|
%
|
Software
& Support
|
|
|
-
|
|
|
-
|
%
|
|
-
|
|
|
-
|
%
|
|
238,931
|
|
|
1.0
|
%
|
Other
|
|
|
37,988
|
|
|
-
|
%
|
|
276,299
|
|
|
1.0
|
%
|
|
71,679
|
|
|
0.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
25,674,057
|
|
|
100.0
|
%
|
|
27,629,909
|
|
|
100.0
|
%
|
|
23,893,106
|
|
|
100.0
|
%
|
Strategic
Consulting
The
strategic consulting line of business includes work related to planning and
assessing both process and technology for clients, performing gap analysis,
making recommendations regarding technology and business process improvements
to
assist clients to realize their business goals and maximize their investments
in
both people and technology. The Company performs strategic consulting work
through its DeLeeuw Associates and Integrated Strategies divisions.
Strategic
consulting revenues of $11.8 million and 46.0% of total revenues for the year
ended December 31, 2006, increased by $0.6 million, or 5.4% points, as compared
to revenues of $11.2 million, or 40.6% of total revenues for the comparable
prior year period. The Company acquired Integrated Strategies (“ISI”) during
July 2005. ISI’s revenues are entirely in the strategic consulting category of
services. Revenues recognized by the Company relating to ISI during the full
year 2006 of $2.9 million, increased by $1.0 million, from revenues of $1.9
million recognized during the five months subsequent to the acquisition in
2005.
DeLeeuw’s largest customer, Bank of America, implemented a change in their
business model during the beginning of 2006 which required DeLeeuw to invoice
its vendor management organization, Sapphire Technologies, for work performed
at
Bank of America. As a result of this change, the hourly billing rates for many
of the DeLeeuw consultants were reduced by approximately 8% to Bank of America
and additional fees were charged by Sapphire Technologies. These changes reduced
the Company’s Bank of America related revenue during 2006 by approximately $1.0
million as compared to the prior year. Partially offsetting this decline was
a
$0.4 million increase in Six Sigma consulting business during 2006 at another
DeLeeuw client.
Business
Intelligence
The
business intelligence line of business includes work performed with various
applications and technologies for gathering, storing, analyzing and providing
clients with access to data in order to allow enterprise users to make better
and faster business decisions. This type of work is generally invoiced to
clients on a time and materials basis.
Business
intelligence revenues of $5.1 million were 19.7% of total revenues for the
year
ended December 31, 2006, decreasing by $1.1 million, or 2.7% points, as compared
to business intelligence revenues of $6.2 million, or 22.4% of total revenues
for the comparable prior year period. During 2006, the practice director and
several lead consultants in the business intelligence line of business left
the
Company. Since the nature of the business intelligence work is relatively
short-term project type work, the revenue base in this category temporarily
declined, utilization of the consultants declined by approximately 9%, and
the
Company suffered a corresponding decline in billable hours during this
transition period. A new practice director was appointed in December 2006 and
is
attempting to rebuild this line of business. Additionally, the Company reduced
its number of business intelligence strategic partnerships to focus on the
most
profitable partnerships.
Data
Warehousing
The
data
warehousing line of business includes work performed for client companies to
provide a consolidated view of high quality enterprise information. CSI provides
services in the data warehouse and data mart design, development and
implementation, prepares proof of concepts, implements data warehouse solutions
and integrates enterprise information.
Data
warehousing revenues of $6.3 million were 24.6% of total revenues for the year
ended December 31, 2006, remaining even with the prior year’s data warehousing
revenues, but increasing by 1.8% points of total revenues, as compared to $6.3
million, or 22.8% of total revenues for the year ended December 31,
2005. The
Company acquired McKnight Associates (“McKnight”) during July 2005. McKnight’s
revenues are all attributable to the data warehousing line of business.
McKnight’s revenues in this category during the full year 2006 of $1.0 million
increased by $0.5 million, from revenues recognized during the five months
subsequent to the acquisition in 2005 of $0.5 million. CSI’s data warehousing
practice declined in revenue, during 2006, by $0.5 million. Billable hours
declined by approximately 14.8% during 2006 as compared to the prior year.
This
decline was partially offset by an increase in average bill rates of
approximately 22.2%. The decline in billable hours was primarily due to the
loss
of approximately six consultants at a large client during the year. This client
hired several of the Company’s consultants and several others completed their
projects at the client during the year.
Data
Management
The
data
management line of business includes such activities as Enterprise Information
Architecture, Metadata Management, Data Quality/Cleansing/Profiling. The Company
performs these activities through its exclusive subcontractor agreement with
its
related party, LEC.
Data
management revenues of $2.5 million were 9.7% of total revenues for the year
ended December 31, 2006, decreasing by $1.1 million, or 3.5% points as compared
to data management revenues of $3.6 million, or 13.2% of total revenues, for
the
comparable prior year period. This category of services is less profitable
to
the Company than the other service categories. As a result, the Company has
not
pursued opportunities in this category. During 2006, CSI’s only participation in
this line of business was through its exclusive subcontractor agreement with
its
related party, LEC. CSI’s billable hours for consultants assigned to LEC
projects declined in 2006, as compared to 2005, by 41.9%. This is due to a
47%
reduction in the number of consultants billing through LEC during the current
year. Additionally, the Company suffered a 6.3% reduction in the average bill
rate during 2006 as compared to 2005.
Cost
of revenue
Cost
of
revenue includes payroll and benefit and other direct costs for the Company’s
consultants. Cost of revenue of $19.9 million was 77.6% of total revenues for
the year ended December 31, 2006, decreasing by $0.6 million, but increasing
as
a percent of total revenue by 3.3% points as compared to cost of revenue of
$20.5 million, or 74.3% of total revenues, for the comparable prior year
period.
Services
Cost
of
services of $17.6 million was 76.1% of services revenues for the year ended
December 31, 2006, increasing by $0.3 million or 2.1% points as compared to
cost
of services of $17.3 million, or 74.0% of services revenue, for the comparable
prior year period. The Company realized increased cost of services during 2006
of $0.4 million relating to stock
compensation charges due to the Company’s implementation of SFAS 123(R) in 2006.
Additionally, the number of employee consultants declined by 13 people, for
a
reduction in payroll expense of $0.6 million, during 2006 as compared to the
prior year, however, the number of independent contractors employed by the
Company during 2006 increased by 10 contractors, an additional $0.8 million
in
independent contractor fees, as compared to the prior year. Consultant travel
expense, primarily in the business intelligence services category, declined
by
$0.3 million during 2006.
Related
Party Services
Cost
of
related party services of $2.3 million was 93.1% of related party services
revenues for the year ended December 31, 2006, decreasing $0.9 million, but
increasing 6.9% points as compared to cost of related party services of $3.2
million, or 86.2% of related party services revenues, for the comparable prior
year period. The
decline in the absolute dollars corresponds to the reduction in related party
service revenues, however, the 6.9% point increase in related party cost of
revenues as a percentage of related party revenues is due to both a 7.9% average
pay increase during 2006 and the hiring of independent contractors to replace
employee consultants that left the Company. The independent contractors have
a
higher pay rate than the employees, however, the bill rate was not increased
enough to maintain the margin percentage.
Gross
profit
Gross
profit of $5.7 million or 22.4% of total revenues for the year ended December
31, 2006, decreased by $1.4 million or 3.3% points as compared to gross profit
of $7.1 million or 25.7% of total revenues for the comparable prior year
period.
Services
Gross
profit from services of $5.5 million or 23.9% of services revenues for the
year
ended December 31, 2006, decreased by $0.5 million or 2.1% points as compared
to
gross profit from services of $6.1 million, or 26.0% of services revenues,
for
the comparable prior year period. This decrease has been outlined previously
in
the revenues and cost of revenue discussions.
Related
Party Services
Gross
profit from related party services of $0.2 million or 6.9% of related party
services revenues, decreased by $0.3 million or 6.9% points as compared to
gross
profit from related party services of $0.5 million, or 13.8% of related party
services revenues, for the comparable prior year period. This decrease has
been
outlined previously in the revenues and cost of revenue
discussions.
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 of
$5.1
million, or 19.8% of revenue for the year ended December 31, 2006, increased
by
$0.6 million, or 3.4% points of total revenue, as compared to $4.5 million,
or
16.4% of total revenue, for the year ended December 31, 2005. The $0.6 million
increase in selling and marketing expense is primarily due to $1.0
million of stock compensation charges resulting from the Company’s
implementation of SFAS 123(R) in 2006.
This
increase was partially offset by a $0.1 million reduction in payroll expense
due
to a reduction in sales and marketing headcount and reduced revenues during
the
current period. Additionally, advertising expense declined by an aggregate
of
$0.3 million due to a reduction in trade shows attended and industry activities
during the current year as the Company attempted to reduce discretionary
costs.
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 of $5.5 million or 21.2% of revenue for the year ended
December 31, 2006, decreased by $0.9 million or 2.0% points of total revenues
as
compared to $6.4 million, or 23.2% of total revenues for the year ended December
31, 2005. The
$0.9
million decrease in general and administrative expense is primarily due to
$0.6
million of reduced payroll cost both due to the reclassification of a company
executive from general and administrative to selling and marketing in July
2005
and to reduced headcount during the current year, a $0.4 million overall
reduction in accounting, legal and professional fees during the current year
due
to reduced transaction and consulting related costs, a $0.1 million reduction
in
bad debt expense, and $0.1 million of various other reductions. These reductions
were partially offset by a $0.1 million increase in stock compensation expense
recorded in the current period resulting from the Company’s implementation of
SFAS 123(R) in 2006, and $0.2 million of increased business licenses, taxes
and
AMEX stock exchange related fees in the current period.
Goodwill
and intangibles impairment
Goodwill
impairment of $0.3 million for the year ended December 31, 2006 resulted
primarily from an unfavorable change with respect to the economics of the
Integrated Strategies business. An impairment of the Integrated Strategies
goodwill of $0.3 million was recorded during 2006. Additionally, the Company
determined that, due to a change in the Company’s marketing and positioning of
the Scosys business, the $20,000 intangible for the rights to use the Scosys
name has been impaired and recorded a charge during 2006. 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. Goodwill and intangibles impairment of $1.3 million for the year
ended December 31, 2005 resulted from the Company’s annual impairment review for
the ISI and McKnight Associates acquisitions which occurred in 2005.
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 $0.8 million for the year ended December 31,
2006, decreasing by $0.1 million as compared to $0.9 million for the year ended
December 31, 2005. Amortization expense decreased by $0.3 million during 2006
due to the reduction in deferred financing costs resulting from the
restructuring of the Company’s line of credit. However, amortization expense
increased in 2006 by $0.2 million due to the recording of a full year of
amortization expense on the McKnight intangible assets in the current year
versus only five months of amortization in the prior year.
Other
income (expense)
In
February 2006, the Company restructured its debt with Laurus. This restructuring
was treated, for accounting purposes, as an early extinguishment of debt. A
loss
of $2,040,837 was recognized on this extinguishment. Additionally, due to
issuances of warrants to Taurus in February and March 2006 relating to the
$1.0
million short term loan obtained in December 2005, the Company had an early
extinguishment of this debt in both February and March 2006. The Company
recorded an aggregate $270,642 loss on these two early extinguishments of debt.
For the year ended December 31, 2005, the Company recorded a $1,607,763 loss
on
early extinguishment of debt as the result of recording early extinguishments
of
the Laurus debt in July and November 2005.
During
the year ended December 31, 2006, the Company recognized a $0.4 million loss
on
the revaluation of its Compound Embedded Derivative Liabilities and on the
revaluation of its freestanding derivative financial instruments relating to
its
warrants. During the year ended December 31, 2005, the Company recorded a $7.8
million gain on the revaluation of its Compound Embedded Derivative Liabilities
and on the revaluation of its freestanding derivative financial instruments
relating to its warrants.
Interest
expense, which includes amortization of the discount on debt of $1.3 million
and
$2.8 million for the years ended December 31, 2006 and 2005, respectively,
was
$3.1 million and $4.2 million for the years ended December 31, 2006 and 2005,
respectively. The reduction in interest expense in the current year was
primarily due to the reduction in the amortization of the discount on debt.
The
amortization of the discount on debt was reduced due to early extinguishments
of
the related Laurus debt.
These
reductions were offset by $0.1 million of increased interest on short term
notes
as compared to the prior year. Included
as a component of the interest expense for the year ended December 31, 2006
is a
$0.5 million increase of expense related to amortization of relative fair value
on Taurus warrants.
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 $12.4 million and $9.5 million during the years ended December 31, 2006
and
2005, 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, 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.
Strategic
Consulting
The
strategic consulting line of business includes work related to planning and
assessing both process and technology for clients, performing gap analysis,
making recommendations regarding technology and business process improvements
to
assist clients to realize their business goals and maximize their investments
in
both people and technology. The Company performs strategic consulting work
through its DeLeeuw Associates and Integrated Strategies (beginning in July
2005) divisions.
Strategic
consulting revenues of $11.2 million were 40.6% of total revenues for the year
ended December 31, 2005, increasing by $2.6 million or 4.7% points as compared
to $8.6 million or 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.
Business
Intelligence
The
business intelligence line of business includes work performed with various
applications and technologies for gathering, storing, analyzing and providing
clients with access to data in order to allow enterprise users to make better
and faster business decisions. This type of work is generally invoiced to
clients on a time and materials basis.
Business
intelligence service revenues of $6.2 million were 22.4% of total revenues
for
the year ended December 31, 2005, increasing by $0.8 million, but decreasing
by
0.3% points as a percentage of total revenues as compared to $5.4 million or
22.7% of total revenues for the comparable prior year period. On an absolute
dollar basis, business intelligence revenues increased by $0.8 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
The
data
warehousing line of business includes work performed for client companies to
provide a consolidated view of high quality enterprise information. CSI provides
services in the data warehouse and data mart design, development and
implementation, prepares proof of concepts, implements data warehouse solutions
and integrates enterprise information.
Data
warehousing revenues of $6.3 million were 22.8% of total revenues for the year
ended December 31, 2005, increasing by $2.3 million or 6.1% points as compared
to $4.0 million or 16.7% of total revenues for the comparable prior year period.
On an absolute dollar basis, data warehousing revenues increased by $2.3 million
for the year ended December 31, 2005, primarily attributable to $0.5 million
of
revenues from McKnight Associates, and a 48.7% increase in total hours billed
in
this line of business in CSI 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 McKnight’s
contribution of hours. 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
The
data
management line of business includes such activities as Enterprise Information
Architecture, Metadata Management, Data Quality/Cleansing/Profiling. During
2005, the Company performed these activities through its exclusive subcontractor
agreement with its related party, LEC. During 2004, CSI performed a portion
of
this work through LEC and performed some work directly.
Data
management revenues were $3.6 million, or 13.2% of total revenues, for the
year
ended December 31, 2005, decreasing by $2.0 million, or 10.2% points as compared
to $5.6 million, or 23.4% of total revenues, for the comparable prior year
period. Related party revenues were $3.6 million for the year ended December
31,
2005, declining by $0.2 million as compared to $3.8 million for the year ended
December 31, 2004. This decline is primarily attributable to a 16.5% reduction
in billable hours for the current year, which was partially offset by an 11.6%
increase in average bill rates. The decline in billable hours is due to a
reduction in the number of consultants required by LEC to service its business
during 2005. 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.
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 of $7.1 million, or 25.7% of total revenue, for the year ended
December
31,
2005,
increased by $2.1 million or 4.6% points as 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% points 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 of
$6.1
million, or 26.0% of services revenue, for the year ended December 31, 2005,
increased by $1.7 million or 3.8% points 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. This
change in gross profit from services as compared to the prior year has been
outlined previously in the revenues and cost of revenues analysis.
Related
party services
Gross
profit from related party services was $0.5 million, or
13.8%
of related party services revenue, for the year ended December 31, 2005,
representing no change in gross profit but increasing by 1.0% points of related
party services revenue as 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.
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 3.0%
points 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 2.3% points 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 that
did
not recur in 2005, 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 $2.8 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 $7.8 million gain on the financial instruments and during the year
ended December 31, 2004, the Company recorded a $0.5 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 $9.5 million and $7.7 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.
LIQUIDITY
AND CAPITAL RESOURCES
The
Company has relied upon cash from its financing activities to fund its ongoing
operations as it has not been able to generate sufficient cash from its
operating activities in the past, and there is no assurance that it will be
able
to do so in the future. The Company has incurred net losses and negative cash
flows from operating activities for the years ended December 31, 2006, 2005
and
2004, and had an accumulated deficit of ($51.0 million) at December 31, 2006.
Due to this history of losses and operating cash consumption, we cannot predict
how long we will continue to incur further losses or whether we will become
profitable again, or if the Company’s business will improve. These factors raise
substantial doubt as to our ability to continue as a going concern.
The
Company has experienced continued losses that exceeded expectations from 2004
through 2006. To that extent, the Company has continued to experience negative
cash flow which has perpetuated the Company’s liquidity issues. To address the
liquidity issue, the Company entered into various debt instruments between
August 2004 and December 2006 and, as of December 31, 2006 had approximately
$11.2 million of debt outstanding in addition to an aggregate of $3.9 million
of
Series A and Series B Convertible Preferred Stock which was issued in 2006.
Additionally, the Company raised $0.75 million through the sale of common stock
in the Company during 2006.
Financing
transactions effectuated in 2006, and through March 27, 2007, are as
follows:
Taurus
In
February 2006, we entered into a Securities Purchase Agreement with investors
represented by Taurus, pursuant to which we issued 19,000 shares of our
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.
We received proceeds of $1,900,000. 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 our election,
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 adjustment). 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
the Taurus investors, on February 1, 2011. Pursuant to the Securities Purchase
Agreement, the Taurus investors were also granted a warrant to purchase
1,900,000 shares of our common stock exercisable at a price of $0.60 per share
(subject to adjustment), exercisable for a period of five years.
In
August
2006, we entered into a Stock Purchase Agreement with an investor represented
by
Taurus, pursuant to which we issued 20,000 shares of our newly created
Series B Convertible Preferred Stock, $.001 par value (the “Series B
Preferred”). Each share of Series B Preferred has a stated value of $100.00. We
received proceeds of $2,000,000. The Series B Preferred has a cumulative annual
dividend equal to the Prime Rate plus one percent (1%), which is payable
monthly in cash or common stock, at our election, and is convertible into
shares of our common stock at any time at a price equal to the lower of (1)
$0.85 or (2) the average daily volume weighted market price for the five
consecutive trading days immediately prior to the date for which such price
is
determined, with a minimum price of $0.50. In addition, the Series B Preferred
has no voting rights, but has liquidation preferences and certain other
privileges. Pursuant to the Stock Purchase Agreement, warrants to purchase
1,276,471 shares of our common stock were issued, exercisable
at a price of $0.94 per share (subject to adjustment), and exercisable for
a period of five years.
In
December 2006, we entered into a Stock Purchase Agreement with certain investors
pursuant to which we issued 3,000,000 shares of our common stock, and we
received proceeds of $750,000. The
investors were
also
granted a warrant to purchase 1,500,000 shares of our common stock, exercisable
at a price of $0.30 per share (subject to adjustment). The warrant is
exercisable for a period of five years.
In
March
2007, we issued a 10% Convertible Unsecured Note to certain investors
represented by TAG Virgin
Islands, Inc.
for
$4,000,000. The 10% Convertible Unsecured Note will automatically convert
into 13,333,333 shares of our common stock, upon the effectiveness of the
Information Statement on Schedule 14C, filed with the SEC on March 8, 2007.
The
investors were
also
granted a warrant to purchase 13,333,333 shares of our common stock, exercisable
at a price of $0.33 per share (subject to adjustment). The warrant
is exercisable for a period of five years. The
note
was subsequently amended in March 2007 to $4.25 million and the number of shares
of common stock that the note will convert into was increased to 14,166,667
shares of our common stock. Additionally, the warrant was also amended to
entitle the investor to purchase 14,166,667 shares of our common stock,
exercisable at a price of $0.33 per share (subject to adjustment). The warrant
is 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”). These
agreements were renegotiated several times between August 2004 and December
2005.
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 $1.0 million to Laurus (the “Term Note”), (b) issued a secured
non-convertible revolving note in the principal amount of $10.0 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. Laurus
exercised a portion of this option in 2006 when they purchased 1,580,000 shares
of the Company’s common stock. An option to purchase 1,500,000 shares remains
outstanding as of December 31, 2006. 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. Amounts due under the Revolving Note
as
of February 1, 2006 included $3,101,084 which was loaned to the Company under
an
Overadvance Side Letter. 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 were to
be
made in equal monthly amounts until maturity of both notes on December 31,
2007.
In
March
2007, we repaid in full the Overadvance Side Letter, dated as of February 1,
2006, with a cash payment of $2,601,084 and the issuance of a warrant to
purchase 1,785,714 shares of Common Stock at an exercise price of $0.01 (after
making the first two payments in February 2007, we were to pay Laurus
approximately $258,424 per month until the aggregate principal amount of
$3,101,084 was paid in full by December 31, 2007). Further, we satisfied
in full the outstanding amount on the Term Note with a cash payment of
approximately $409,722.
Laidlaw/Sands
In
September 2004, the Company borrowed an aggregate of $1.0 million, due in one
year and bearing interest at 8% per annum, from three affiliates of Sands
Brothers Venture Capital (“Sands”). Upon maturity of the notes in September
2005, the Company executed an amended note with these affiliates of Sands for
an
aggregate principal amount of $1.08 million, due in January 2007 and bearing
interest at 12% per annum.
Between
January and March 2007, we executed several extension agreements with Sands
to
repay the amended subordinated secured convertible promissory notes, in which
we
agreed to pay $1.05 million cash, as well as issue shares of Common Stock and
warrants to purchase Common Stock, on four separate payment dates of April
2,
2007, July 2, 2007, October 1, 2007 and December 31, 2007. We paid Sands a
total of $0.65 million between February and March 2007. The remaining $0.4
million is due to be paid between October and December 2007.
As
of
December 31, 2006, the Company’s debt level required interest and dividends of
approximately $104,000 per month. Approximately, $4.9 million of debt
instruments mature on or before December 31, 2007. Additionally, the Company’s
line of credit expires on December 31, 2007 and $1.5 million of short term
notes
are currently being extended on a month-to-month basis.
In
order
to fund these maturities, the Company obtained $4.25 million in new financing
in
March 2007 and repaid both the Laurus overadvance and the Laurus term note,
in
full, through a combination of a $3.1 million cash payment and $0.5 million
in a
warrant to purchase common stock. Additionally, a $0.6 million cash payment
was
paid to Sands. A final cash payment of $0.4 million and additional common stock
and warrants is to be made in the fourth quarter of 2007 to satisfy this
obligation in full.
The
$4.25
million of new financing was in the form of a promissory note bearing a 10%
annual interest rate and a maturity date of August 31, 2007, which will
automatically convert to common stock at such time as the Company has authorized
shares sufficient to complete the transaction. This is expected to occur in
April 2007. As a result, the Company expects to incur approximately $60,000
of
interest under this note prior to conversion to equity. Subsequent to this
instrument being converted to equity, the Company’s monthly debt service
obligation is expected to decline to approximately $68,000 per month, of which
$23,000 will continue to be paid in Company common stock and the remaining
$45,000 will require monthly interest payments.
Cash
totaled $0.7 million as of December 31, 2006, compared to $0.2 million as of
December 31, 2005. 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 ($6.3 million) as of December 31, 2006
compared to ($7.6 million) as
of
December 31, 2005. The Company’s working capital position has improved during
the current year primarily due to proceeds received from the sale of equity
securities and a significant reduction in the financial instruments liability
during the current year. However, the losses generated by the Company during
the
current year have resulted in the need for $1.0 million of additional borrowings
against the Company’s line of credit and $3.9 million raised through the sale of
Series A and Series B preferred stock. Additionally, a $1.08 million note due
January 1, 2007 was reclassified from long term to current liabilities during
the year.
Cash
used
in operating activities during the year ended December 31, 2006 was $4.8
million, an increase in cash used in operating activities of $1.2 million from
$3.6 million for the year ended December 31, 2005. Cash used in operating
activities primarily relates to a $3.8 million “cash-based” loss from operating
activities, as determined by adding the non-cash charges incurred of $7.9
million to the reported loss from continuing operations of $11.7 million for
the
year ended December 31, 2006, a $0.5 million increase in accounts receivable
due
primarily to the shift to the vendor management organization for the work that
was previously paid directly by Bank of America, a $0.2 million decrease in
the
related party receivables due to the declining business, a $0.6 million decrease
in accounts payable and accrued expenses during the year largely due to a $0.3
million payment to William McKnight during 2006 as part of the acquisition
agreement and reductions in trade accounts payable, a $0.2 million increase
in
the allowance for doubtful accounts due to the increased age of the open
accounts receivable, and $0.1 million of various other declines.
Cash
provided by investing activities of $2.05 million during 2006 relates to a
settlement payment received from Similarity Systems relating to the sale of
Evoke Software to Similarity Systems in July 2005. Cash used by investing
activities was $2.5 million during 2005. This was due to $3.1 million of
acquisition payments for Integrated Strategies and McKnight Associates,
partially offset by $0.6 million received from the sale of Evoke
Software.
Cash
provided by financing activities was $3.2 million during the year ended December
31, 2006. During 2006, $3.9 million was raised from the issuance Series A
and Series B preferred stock, $0.5 million from the issuance of a short term
note payable, $0.75 million from the sale of Company common stock, $0.4 million
in proceeds from the issuance of a long term note payable, and $0.8 million
in
additional borrowings from the line of credit. However, $1.8 million was paid
by
the Company to acquire treasury stock, $0.6 million was repaid to related
related parties, $0.5 million of principal was repaid on long term debt, the
Company incurred $0.1 million in financing costs and $0.1 million was paid
on
capital lease obligations.
There
are
currently no material commitments for capital expenditures.
The
Sarbanes-Oxley Act of 2002 requires the Company’s management to provide its
assessment of internal controls for the year ended December 31, 2007. As a
result, the Company expects to incur costs, in 2007, of approximately $0.2
million in order to provide its assessment of controls surrounding financial
reporting and disclosure in order to comply with this requirement.
As
of
December 31, 2006 and 2005, the Company had accounts receivable due from LEC
of
approximately $0.3 million and $0.6 million, respectively. There are no known
collections problems with LEC.
For
the
years ended December 31, 2006 and 2005, we invoiced LEC $2.5 million and $3.7
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.
On
January 29, 2007, the Company announced that it received notice from the Staff
of the American Stock Exchange indicating that the Company no longer complies
with the Exchange's continued listing standards due to the Company's inability
to maintain compliance with certain AMEX continued listing requirements, as
set
forth in Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iv) of the AMEX Company
Guide and its plan of compliance submitted in July 2006, and that its securities
are subject to be delisted from the Exchange. The Company received notice on
June 29, 2006, from the Staff indicating that the Company was below certain
of
the Exchange's continued listing standards. The Company was afforded the
opportunity to submit a plan of compliance to the Exchange; and on July 31,
2006, the Company presented its plan to the Exchange. On September 26, 2006,
the
Exchange notified the Company that it accepted the Company's plan of compliance
and granted the Company an extension until December 28, 2007, to regain
compliance with the continued listing standards.
The
Company has filed an appeal of this determination and has a hearing before
a
committee of AMEX planned for April 2007. Once filed, the appeal automatically
stays the delisting of the Company's common stock pending a hearing date and
the
Exchange's decision. The time and place of such a hearing will be determined
by
the Exchange. There can be no assurance that the Company's request for continued
listing will be granted. If the committee does not grant the relief sought
by
the Company, its securities will be delisted from the Exchange and may continue
to be quoted on the OTC Bulletin Board.
As
of
December 31, 2006, Mr. Newman had no outstanding loan balance to the Company.
Mr. Peipert’s outstanding loan balance to the Company was approximately $0.1
million. The unsecured loan by Mr. Peipert accrues interest at a simple rate
of
8% per annum, and has a term expiring on April 30, 2007.
The
following is a summary of the debt instruments outstanding as of March 27,
2007:
Lender
|
|
Type
of facility
|
|
Outstanding
as of March 27, 2007 (not including interest) (all numbers
approximate)
|
|
Remaining
Availability (if applicable)
|
|
Laurus
Master Fund, Ltd.
|
|
|
Line
of Credit
|
|
$
|
2,200,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Sands
Brothers Venture Capital LLC and affiliates
|
|
|
Short
term notes payable
|
|
$
|
400,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Taurus
Advisory Group, LLC investors
|
|
|
Short
term notes payable
|
|
$
|
5,750,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Taurus
Advisory Group, LLC investors
|
|
|
Long
term debt
|
|
$
|
2,000,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Taurus
Advisory Group, LLC investors
|
|
|
Series
A and B Convertible Preferred Stock
|
|
$
|
3,900,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Larry
and Adam Hock
|
|
|
Short
term notes payable
|
|
$
|
200,000
|
* |
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
Glenn
Peipert
|
|
|
Related
party note payable
|
|
$
|
105,000
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
|
|
|
$
|
14,555,000
|
|
$
|
0
|
|
|
·
|
The
Company and the Hocks are presently disputing how much is owed under
this
promissory note. See Item 3 - Legal
Proceedings.
|
The
Company needs additional capital in order to survive because
of the Company’s recent losses, negative cash flows for operations, its net
working capital deficiency and its ability to pay its outstanding debt.
Additional capital will be needed to fund current working capital requirements,
ongoing debt service and to repay the obligations that are maturing over the
upcoming 12 month period. Our primary sources of liquidity are cash flows from
operations, borrowings under our revolving credit facility, and various short
and long term financings. We plan to continue to strive to increase revenues
and
to continue to execute on our expense reduction program which began in 2006
in
order to reduce, or eliminate, the operating losses. Additionally, we will
continue to seek equity financing in order to enable us to continue to meet
our
financial obligations until we achieve profitability. There can be no assurance
that any such funding will be available to us on favorable terms, or at all.
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,
2006
were $1.5 million. Failure to obtain sufficient equity financing would have
substantial negative ramifications to the Company.
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, 2006, 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):
Contractual
Obligations
|
|
Total
|
|
Less
than 1 year
|
|
1-3
years
|
|
4-5
years
|
|
Long-term
debt
|
|
$
|
2.6
|
|
$
|
0.6
|
|
$
|
2.0
|
|
$
|
-
|
|
Related
party note payable |
|
|
0.1 |
|
|
0.1 |
|
|
- |
|
|
- |
|
Operating
leases
|
|
|
1.1
|
|
|
0.4
|
|
|
0.7
|
|
|
-
|
|
Employment
agreements
|
|
|
3.0
|
|
|
3.0
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
6.8
|
|
|
4.1
|
|
$
|
2.7
|
|
$
|
-
|
|
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.
Stock-based
Compensation
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 adopted the standard in the
first quarter of fiscal 2006 using the modified prospective method. As permitted
by SFAS No. 123, we previously accounted for share-based payments to
employees using the intrinsic value method prescribed in APB Opinion 25 and,
as
such, generally recognized no compensation cost for employee stock options.
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.
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
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 does not expect the adoption of this pronouncement to have a material
impact on it’s consolidated financial statements.
In
July
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainties in
Income Taxes” (FIN 48). The Company does not expect the adoption of this
pronouncement to have a material impact on it’s consolidated financial
statements.
In
August
2006, the FASB Emerging Issues Task Force Issued EITF 06-6, “Debtor’s Accounting
for a Modification (or Exchange) of Convertible Debt Instruments”. EITF 06-6
addresses the issue of how a modification of a debt instrument (or an exchange
of debt instruments) that affects the terms of an embedded conversion option
should be considered in the issuer’s analysis of whether debt extinguishment
accounting should be applied. The Company does not expect the adoption of this
pronouncement to have a material impact on it’s consolidated financial
statements.
In
September 2006, the FASB issued FAS 157, “Fair Value Measurements,” which
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. FAS 157 does not require any new
fair
value measurements. The Company is required to adopt this statement effective
the first quarter of 2008, and is currently evaluating the impact the new
standard will have on the Company.
In
September 2006, the Securities and Exchange Commission issued Staff Accounting
Bulletin (“SAB”) 108, “Quantifying Financial Statement Misstatements.” In SAB
108, the Securities and Exchange Commission’s staff establishes an approach that
requires quantification of financial statement errors based on the effects
of
the error on each of the Company’s consolidated financial statements and the
related consolidated financial statement disclosures. SAB 108 is effective
for
the Company as of December 31, 2006; however it is not expected to have a
material affect on the Company’s consolidated financial statements.
ITEM
7A. |
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
|
ITEM
8 |
FINANCIAL
STATEMENTS AND SUPPLEMENTARY
DATA
|
Reference
is made to pages 97 through 133 comprising a portion of this Annual
Report on Form 10-K.
ITEM
9. |
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
|
Not
applicable.
.
ITEM
9A. |
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 evaluated 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 evaluation, the
chief
executive officer and chief financial officer concluded that the design and
operation of these disclosure controls and procedures were not effective to
ensure that information required to be disclosed by the Company in reports
that
it files or submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms due to a control deficiency related to lack
of
certain internal controls over period-end
financial reporting.
In
connection with the preparation of our Annual Reports for the years ended
December 31, 2004 and December 31, 2005, our management identified certain
weaknesses in our internal control procedures and in our evaluation of complex
financing transactions in 2004 and 2005, and in the valuation and purchase
accounting of our acquisitions in 2004. In addition, management previously
identified another internal control matter regarding period-end financial
reporting related to the identification of transactions, primarily contractual,
and accounting for them in the proper periods. We believe that we have
satisfactorily addressed the control deficiencies and material weakness relating
to the accounting for complex financing transactions and the valuation and
purchase accounting for acquisitions during 2005 and 2006. The following
action
plan has been established to address the control deficiency related to the
lack
of certain internal controls over period-end financial
reporting.
Management
established an action plan in the first quarter of 2005, which continues through
the date of this Annual Report, that it believes will correct the control
deficiency described above. 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 presidents and
general counsel, 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
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 fiscal 2007, although
there can be no assurance that we will do so.
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.
Our
company also maintains a system of internal controls. The term “internal
controls,” as defined by the American Institute of Certified Public Accountants’
Codification of Statement on Auditing Standards, AU Section 319, means controls
and other procedures designed to provide reasonable assurance regarding the
achievement of objectives in the reliability of our financial reporting,
the
effectiveness and efficiency of our operations and our compliance with
applicable laws and regulations. In connection with the preparation of this
Annual Report, our management identified certain weaknesses in our internal
control procedures and in our evaluation of complex financing transactions
in
2004 and 2005, and in the valuation and purchase accounting of our acquisitions
in 2004. Our management and Board of Directors adopted corrective measures
in
the first quarter 2005, and such corrective measures were incorporated into
the
controls and procedures of the Company, finally effective as of the third
quarter 2006. As a result, no significant changes were made in our internal
control over financial reporting during the Company’s fourth quarter that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
ITEM
9B. OTHER
INFORMATION
Not
applicable.
PART
III
ITEM
10. 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
Director
or
Officer
|
|
Age
|
|
Positions
Held
|
Scott
Newman
|
|
2004
|
|
47
|
|
President,
Chief Executive Officer and Chairman
|
Glenn
Peipert
|
|
2004
|
|
46
|
|
Executive
Vice President, Chief Operating Officer and Director
|
William
Hendry
|
|
2006
|
|
46
|
|
Vice
President, Chief Financial Officer and Treasurer
|
William
McKnight
|
|
2005
|
|
41
|
|
Senior
Vice President - Data Warehousing
|
Bryan
Carey
|
|
2007
|
|
49
|
|
Senior
Vice President - Strategic Consulting
|
Lawrence
K. Reisman*
|
|
2004
|
|
45
|
|
Director
|
Frederick
Lester**
|
|
2006
|
|
49
|
|
Director
|
Thomas
Pear***
|
|
2006
|
|
54
|
|
Director
|
*
Chair
of the Audit Committee, and member of the Compensation and Stock Option
Committee and the Nominating and Corporate Governance Committee.
**
Chair
of the Nominating and Corporate Governance Committee, and member of the Audit
Committee and the Compensation and Stock Option Committee.
***
Chair
of the Compensation and Stock Option Committee, and member of the Audit
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. in 2004) 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. 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 received his B.S. from Brooklyn
College in 1982.
WILLIAM
HENDRY
has been
our Vice President, Chief Financial Officer and Treasurer since October 2006.
Mr. Hendry previously served as the Company’s Controller from 2004-2006. Prior
to joining the Company, Mr. Hendry was controller of Scientific Games Online
Entertainment Systems, a developer, installer and operator of online, instant
and video lottery systems, from 2002-2004. From 2000-2002, Mr. Hendry was a
consultant to Cipolla Sziklay Zak & Co. and Pharmacia. Prior to this, Mr.
Hendry served as the corporate controller of AlphaNet Solutions, a publicly-held
information technology professional services company, as the corporate
controller of Biosource International, a publicly-held international
manufacturer of technology products, and as vice president - finance of
Quarterdeck, a publicly-held publisher of utility and software applications.
Mr.
Hendry began his career at KPMG LLP. Mr. Hendry has an M.B.A. in finance and
a
B.S. in accounting from Fairleigh Dickinson University, is a certified public
accountant in New Jersey, and is a member of the American Institute of Certified
Public Accountants, the New Jersey Society of Certified Public Accountants,
and
the Financial Executive Institute.
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.
BRYAN
CAREY
has been
our Senior Vice President - Strategic Consulting, and managing director of
our
wholly owned subsidiary DeLeeuw Associates, since February 2007. Prior
to
joining DeLeeuw Associates in 2000 as a senior vice president of business
development, Carey spent nearly 20 years as an executive in project and change
management in the banking industry, including Bank of America. Mr. Carey was
promoted to executive vice president of DeLeeuw Associates in 2003, where he
was
responsible for major account relationships, project oversight and business
development. Mr. Carey built DeLeeuw Associates's Lean and Six Sigma practice
providing the leadership, consulting, training and discipline to grow the
business from a start-up to a successful, thriving business. Most recently,
Mr.
Carey has led Lean Six Sigma roll-out initiatives at NY Independent System
Operators, Bank of New York, Cendant Corporation and JPMorgan Chase. Mr. Carey
has spoken at numerous Six Sigma events, as well as authored a number of
articles on change and project management utilizing Lean and Six Sigma. Mr.
Carey received his B.S in Philosophy from Notre Dame in 1980 and received his
M.B.A. in finance from the University of South Carolina in 1983.
LAWRENCE
K. REISMAN
has been
a Director of our company since February 2004, is Chairman of the Board’s Audit
Committee, and a member of the Compensation and Stock Option Committee and
the
Nominating and 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.
FREDERICK
LESTER has
been
a Director of our company since August 2006, is Chairman of the Board’s
Nominating and Corporate Governance Committee, and a member of the Audit
Committee and the Compensation and Stock Option Committee. Presently he is
the
Regional Consulting Partner, NE Banking & Capital Markets, Teradata
Corporation. From 2005-2006, Mr. Lester was the Consulting Director at Cognos
Corporation, and from 1999-2005, he was the Managing Director at Competitive
Advantage, Inc. Prior to this, Mr. Lester served as Consulting Director for
KPMG
and Managing Partner at Teradata. Mr.
Lester’s undergraduate studies at Columbia University focused on nuclear physics
and mathematics.
THOMAS
PEAR has
been
a Director of our company since August 2006, is Chairman of the Board’s
Compensation and Stock Option Committee, and a member of the Audit Committee
and
the Nominating and Corporate Governance Committee.
Presently he is a principal in Saw Mill Sports Management and
a management consultant. From 1993 to 2006, Mr. Pear
served as chief financial officer of The Atlantic Club, and also served as
its
president from 2002 to 2006. Prior to this, Mr. Pear served as vice
president and general manager of DM Engineering, vice president and chief
financial officer of Tennis Equities, and staff accountant at Malkin, Studley
and Ramey CPA, PC. Mr. Pear received his B.S. in Accounting from Nichols
College in 1974.
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 and has affirmatively determined that three of our directors, Lawrence
K. Reisman, Frederick Lester and Thomas Pear are independent of management
and
free of any relationship that would interfere with the independent judgment
as
members of the Board of Directors or any committee thereof.
Committees
of the Board of Directors
The
Board
of Directors has established three standing committees: (1) the Audit Committee,
(2) the Compensation and Stock Option 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 charters of the
Audit Committee, the Compensation and Stock Option Committee and the Nominating
and Corporate Governance Committee are posted on our website. Mr. Reisman,
Mr.
Lester and Mr. Pear are members of each of such committees.
Audit
Committee
The
Audit
Committee was formed in April 2005. The Audit Committee met 6 times in fiscal
year 2006 and each member of the Audit Committee was present at such meeting,
and acted by unanimous written consent 1 time. 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-K, 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(h) of Regulation S-K.
Compensation
and Stock Option Committee
The
Compensation Committee and the Stock Option Committee merged in March 2007,
and
acted by written consent 5 times during fiscal 2006. The Compensation and Stock
Option 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, as well as to fix and determine awards
to
employees of stock options, restricted stock and other types of stock-based
awards.
The
Compensation and Stock Option 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
and Stock Option 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 met 1 time during fiscal 2006. 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 consider 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
11. EXECUTIVE
COMPENSATION.
The
following table summarizes compensation information for the last three fiscal
years for (i) Mr. Scott Newman, our Principal Executive Officer,
(ii) Mr. William Hendry, our Principal Financial Officer and
(iii) the three most highly compensated executive officers other than the
Principal Executive Officer and Principal Financial Officer, who were serving
as
executive officers at the end of the fiscal year and who we refer to
collectively, the Named Executive Officers.
SUMMARY
COMPENSATION TABLE
Name
and Principal Position
|
|
|
Year
|
|
|
Salary
|
|
|
Bonus
|
|
|
Stock
Awards
|
|
|
Option
Awards(s)
|
|
|
Non-Equity
Incentive Plan Compensation
|
|
|
Non-Qualified
Deferred Compensation Earnings
|
|
|
All
Other Compensation
|
|
|
Total
|
|
|
|
|
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
|
|
|
($)
|
|
|
($)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Scott
Newman
|
|
|
2006
|
|
|
479,167
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
45,401
|
(1)
|
|
524,568
|
|
President,
Chief Executive
|
|
|
2005
|
|
|
500,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
51,208
|
(1)
|
|
551,208
|
|
Officer
and Chairman
|
|
|
2004
|
|
|
500,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
42,455
|
(1)
|
|
542,455
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Glenn
Peipert
|
|
|
2006
|
|
|
359,375
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
38,300
|
(1)
|
|
397,675
|
|
Executive
Vice President, Chief
|
|
|
2005
|
|
|
375,000
|
|
|
—
|
|
|
—
|
|
|
179,050
|
|
|
—
|
|
|
—
|
|
|
37,151
|
(1)
|
|
591,201
|
|
Operating
Officer and Director
|
|
|
2004
|
|
|
375,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
36,690
|
(1)
|
|
411,690
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
William
Hendry, Vice
|
|
|
2006
|
|
|
155,250
|
|
|
5,000
|
|
|
—
|
|
|
33,555
|
|
|
—
|
|
|
—
|
|
|
|
|
|
193,805
|
|
President,
Chief Financial
|
|
|
2005
|
|
|
142,224
|
|
|
—
|
|
|
—
|
|
|
20,541
|
|
|
—
|
|
|
—
|
|
|
|
|
|
162,765
|
|
Officer
and Treasurer
|
|
|
2004
|
|
|
90,250
|
(3)
|
|
—
|
|
|
—
|
|
|
72,663
|
|
|
—
|
|
|
—
|
|
|
|
|
|
162,913
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert
C. DeLeeuw
|
|
|
2006
|
|
|
415,959
|
|
|
—
|
|
|
—
|
|
|
392,100
|
|
|
—
|
|
|
—
|
|
|
21,147
|
(1)
|
|
829,206
|
|
Senior
Vice President
|
|
|
2005
|
|
|
350,000
|
|
|
—
|
|
|
—
|
|
|
179,050
|
|
|
—
|
|
|
—
|
|
|
21,379
|
(1)
|
|
550,429
|
|
|
|
|
2004
|
|
|
329,400
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
17,462
|
(1)
|
|
346,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
William
McKnight, Senior Vice
|
|
|
2006
|
|
|
250,000
|
|
|
39,510
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
23,373
|
(1)
|
|
312,883
|
|
President
-Data Warehousing
|
|
|
2005
|
|
|
125,047
|
(3)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
125,047
|
|
(1) |
Amounts
shown reflect payments related to medical, dental and life insurance,
car
payments and 401(k) contributions by the
Company.
|
(2) |
The
annual amount of perquisites and other personal benefits, if any,
did not
exceed $10,000 for each named executive officer and has therefore
been
omitted, unless otherwise stated
above.
|
(3) |
Represents
a partial year of compensation.
|
The
following table summarizes grants of plan-based awards to each Named Executive
Officer during 2006:
Grants
of Plan-Based Awards for 2006
|
|
|
|
Estimated
Future
Payouts
Under Non-
Equity
Incentive Plan
Awards
|
|
Estimated
Future Payouts
Under
Equity Incentive
Plan
Awards
|
|
All
Other Stock Awards: Number of
|
|
All
Other Option Awards: Number of Securities
|
|
Exercise
or Base Price of
|
|
Name
|
|
Grant
Date
|
|
Tresh-old
($)
|
|
Target
($)
|
|
Maximum
($)
|
|
Treshold
(#)
|
|
Target
(#)
|
|
Maximum
(#)
|
|
Shares
of Stock or Units (#)
|
|
Underlying
Options
(#)
|
|
Option
Awards
($/Sh)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
|
(b)
|
|
(c)
|
|
(d)
|
|
(e)
|
|
(f)
|
|
(g)
|
|
(h)
|
|
(i)
|
|
(j)
|
|
(k)
|
|
William
Hendry
|
|
|
10/10/06
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
150,000
|
|
|
150,000
|
|
|
150,000
|
|
|
-
|
|
|
-
|
|
$
|
0.25
|
|
Robert
C. DeLeeuw
|
|
|
1/9/06
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,000,000
|
|
|
1,000,000
|
|
|
1,000,000
|
|
|
-
|
|
|
-
|
|
$
|
0.46
|
|
The
following table shows outstanding equity awards at December 31,
2006:
Outstanding
Equity Awards at Fiscal Year-End
|
|
Option
Awards
|
|
Stock
Awards
|
|
Name
|
|
Number
of Securities Underlying Unexercised Options
(#)
Exercisable
|
|
Number
of Securities Underlying Unexercised Options
(#)
Unexercisable
|
|
Equity
Incentive Plan Awards: Number of Securities Underlying Unexercised
Unearned Options (#)
|
|
Option
Exercise Price ($)
|
|
Option
Expiration Date
|
|
Number
of Shares or Units of Stock That Have Not Vested (#)
|
|
Market
Value of Shares or Units of Stock That Have Not Vested ($)
|
|
Equity
Incentive Plan Awards: Number of Unearned Shares, Units or Other
Rights
That Have Not Vested (#)
|
|
Equity
Incentive Plan Awards: Market or Payout Value of Unearned Shares,
Units or
Other Rights That have not Vested ($)
|
|
(a)
|
|
(b)
|
|
(c)
|
|
(d)
|
|
(e)
|
|
(f)
|
|
(g)
|
|
(h)
|
|
(i)
|
|
(j)
|
|
Glenn
Peipert
|
|
|
83,333
|
|
|
166,667
|
|
|
-
|
|
$
|
0.83
|
|
|
11/16/10
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
William
Hendry
|
|
|
20,000
10,000
-
|
|
|
10,000
20,000
150,000
|
|
|
-
-
-
|
|
$
$
$
|
3.00
0.83
0.25
|
|
|
5/28/14
11/16/15
10/10/16
|
|
|
-
-
-
|
|
|
-
-
-
|
|
|
-
-
-
|
|
|
-
-
-
|
|
Robert
DeLeeuw
|
|
|
250,000
1,000,000
|
|
|
-
-
|
|
|
-
|
|
$
$
|
0.83
0.46
|
|
|
11/16/15
1/9/16
|
|
|
-
-
|
|
|
-
-
|
|
|
-
-
|
|
|
-
-
|
|
The
following table shows the option awards exercised, value realized on exercise,
number of stock awards acquired and value of stock awards realized for each
our
Named Executive Officers during 2006:
Option
Exercises and Stock Vested for 2006
|
|
Option
Awards
|
|
Stock
Awards
|
|
Name
|
|
Number
of Shares Acquired on Exercise
(#)
|
|
Value
Realized on Exercise
($)
|
|
Number
of Shares Acquired on Vesting
(#)
|
|
Value
Realized on Vesting
($)
|
|
(a)
|
|
(b)
|
|
(c)
|
|
(d)
|
|
(e)
|
|
Glenn
Peipert
|
|
|
-
|
|
|
-
|
|
|
83,333
|
|
|
25,000
|
|
William
Hendry
|
|
|
-
|
|
|
-
|
|
|
20,000
|
|
|
11,300
|
|
Robert
C. DeLeeuw
|
|
|
-
|
|
|
-
|
|
|
1,250,000
|
|
|
421,667
|
|
Pension
Benefits for 2006
N/A
Nonqualified
Deferred Compensation for 2006
N/A
The
following table shows the details of compensation paid to outside directors
of
the Company during 2006:
Director
Compensation for 2006
Name
|
|
Fees
Earned
or
Paid
in
Cash
($)
|
|
Stock
Awards
($)
|
|
Option
Awards
($)
|
|
Non-Equity
Incentive
Plan
Compensation
($)
|
|
Change
in
Pension
Value
and
Nonqualified
Deferred
Compensation
Earnings
|
|
All
Other
Compensation
($)
|
|
Total
($)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
|
(b)
|
|
(c)
|
|
(d)
|
|
(e)
|
|
(f)
|
|
(g)
|
|
(h)
|
|
Frederick
Lester
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
Thomas
Pear
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
Lawrence
K. Reisman
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5,592
|
|
COMPENSATION
DISCUSSION AND ANALYSIS
Our
Compensation Discussion and Analysis addresses the following
topics:
*
The
members and role of our Compensation Committee;
*
Our
compensation-setting process;
*
Our
compensation philosophy and policies regarding executive
compensation;
*
The
components of our executive compensation program; and
*
Our
compensation decisions for fiscal year 2006.
In
this
“Compensation Discussion and Analysis” section, the terms, "we," "our," "us,"
and the "Committee" refer to the Compensation Committee of our Board of
Directors.
The
Compensation and Stock Option Committee
Committee
Members and Independence
Thomas
Pear, Frederick Lester and Lawrence K. Reisman are the members of the
Compensation and Stock Option Committee. Mr. Pear is the Committee Chairman.
Each member of the Compensation and Stock Option Committee qualifies as an
independent director under American Stock Exchange listing
standards.
Role
of
Committee
We
operate under a written charter adopted by the Board. A copy of the charter
is
available at www.csiwhq.com under Investors - Corporate Governance - Committee
Charters. The fundamental responsibilities of our Committee are:
a. |
Set
the compensation for the Chairman of the Board and the Chief Executive
Officer ("CEO");
|
b. |
Set
the compensation of other executive officers based upon the recommendation
of the CEO;
|
c. |
Make
awards to executives under the 2003 Incentive Plan and other plans
as
approved by the Board of Directors;
|
d. |
Review
and approve the design of other benefit plans pertaining to executives
of
the company;
|
e. |
Approve
such reports on compensation as are necessary for filing with the
SEC and
other government bodies;
|
f. |
Review,
recommend to the Board of Directors, and administer all plans that
require
“disinterested administration” under Rule 16b-3 under the Securities
Exchange Act of 1934, as amended;
|
g. |
Approve
the amendment or modification of any compensation or benefit plan
pertaining to executives of the Company that does not require stockholder
approval;
|
h. |
Review
and recommend to the Board of Directors changes to the outside directors'
compensation;
|
i. |
Retain
outside consultants and obtain assistance from members of management
as
the Committee deems appropriate in the exercise of its
authority;
|
j. |
Make
reports and recommendations to the Board of Directors within the
scope of
its functions;
|
k. |
Approve
all special perquisites, special cash payments and other special
compensation and benefit arrangements for the Company's executive
officers; and
|
l. |
Review
the Committee charter from time to time and recommend any changes
thereto
to the Board of Directors.
|
Committee
Meetings
Our
Committee meets as often as necessary to perform its duties and
responsibilities. We held one meeting during fiscal 2006 and have held one
meeting so far during fiscal 2007. We intend to schedule more regular meetings
without management present.
We
receive and review materials in advance of each meeting. These materials include
information that management believes will be helpful to the Committee as well
as
materials that we have specifically requested. Depending on the agenda for
the
particular meeting, these materials may include:
*
Financial
reports on year-to-date performance compared to prior year
performance;
*
Calculations
and reports on levels of achievement of individual and corporate performance
objectives;
*
Information
on the executive officers' stock ownership, employment agreements and option
holdings;
*
Information
regarding equity compensation plan dilution;
*
Estimated
grant-date values of stock options (using the Black-Scholes valuation
methodology);
|
* |
Tally
sheets setting forth the total compensation of the named executive
officers, including base salary and cash incentives;
and
|
|
* |
Equity
awards, perquisites and other compensation and any amounts payable
to the
executives upon voluntary or involuntary termination, early or
normal
retirement or following a change-in-control of
CSI.
|
The
Committee Process
A
Continuing Process
Although
many compensation decisions are made in the first quarter of a fiscal year,
our
compensation planning process neither begins nor ends with any particular
Committee meeting. Compensation decisions are designed to promote our
fundamental business objectives and strategy. Business and succession planning,
evaluation of management performance and consideration of the business
environment are year-round processes.
Management's
Role in the Compensation-Setting Process
Executive
Management plays a significant role in the compensation-setting process. The
most significant aspects of management's role are:
* Evaluating
employee performance;
*
Establishing
business performance targets and objectives; and
*
Recommending
salary levels and option awards.
Executive
Management works with the General Counsel and Committee Chair in establishing
the agenda for Committee meetings. Management also prepares meeting information
for each Committee meeting.
Executive
Management also participates in Committee meetings at the Committee's request
to
provide:
*
Background
information regarding CSI’s strategic objectives;
*
Their
evaluation of the performance of the senior executive officers; and
*
Compensation
recommendations as to senior executive officers.
Committee
Advisors
The
Committee Charter grants us the sole and direct authority to hire and fire
our
advisors and compensation consultants and approve their compensation. CSI is
obligated to pay our advisors and consultants. If hired, these advisors would
report directly to the Committee.
Annual
Evaluation
We
meet
in executive session each year to evaluate the performance of the named
executive officers, to determine their bonuses, if any, for the prior fiscal
year, to set their base salaries for the next calendar year (assuming such
salary is not already mandated by an employment agreement), and to consider
and
approve any grants to them of equity incentive compensation.
Performance
Objectives
We
are
considering beginning a process to establish individual and corporate
performance objectives for senior executive officers in the first quarter of
each fiscal year. We would engage in an active dialogue with the Chief Executive
Officer concerning strategic objectives and performance targets. We would review
the appropriateness of the financial measures used in incentive plans and the
degree of difficulty in achieving specific performance targets. Corporate
performance objectives would typically be established on the basis of a targeted
return on capital employed for CSI or a particular business unit.
Benchmarking
We
do not
believe that it is appropriate to establish compensation levels primarily based
on benchmarking. We believe that information regarding pay practices at other
companies is useful in two respects, however. First, we recognize that our
compensation practices must be competitive in the marketplace. Second, this
marketplace information is one of the many factors that we could consider in
assessing the reasonableness of compensation.
Targeted
Compensation Levels
Together
with the performance objectives, we intend to establish targeted total
compensation levels (i.e., maximum achievable compensation) for each of the
senior executive officers. In making this determination, we will be guided
by
the compensation philosophy described below. We also will consider historical
compensation levels and the relative compensation levels among the Company's
senior executive officers. We may also consider industry conditions, corporate
performance versus a peer group of companies and the overall effectiveness
of
our compensation program in achieving desired performance levels.
As
targeted total compensation levels are determined, we also will consider
determining the portion of total compensation that will be contingent,
performance-based pay. Performance-based pay generally includes cash bonuses
for
achievement of specified performance objectives and stock-based compensation
whose value is dependent upon long-term appreciation in stock
price.
Committee
Effectiveness
We
will
review, on an annual basis, the performance of our Committee and the
effectiveness of our compensation program in obtaining desired
results.
Compensation
Philosophy
Our
executive compensation program is designed with one fundamental objective:
to
support CSI’s core values and strategic objectives. Our compensation philosophy
is intended to align the interests of management with those of our stockholders.
The following principles influence and guide our compensation
decisions:
We
Believe in a Pay for Performance Culture
At
the
core of our compensation philosophy is our guiding belief that pay should be
directly linked to performance. This philosophy has will guide many compensation
related decisions in fiscal 2007:
|
* |
We
would like to have a substantial portion of executive officer compensation
contingent on, and variable with, achievement of objective corporate
and/or individual performance
objectives.
|
|
* |
It
is our policy to prohibit discounted stock options, reload stock
options
and re-pricing of stock options.
|
Compensation
and Performance Pay Should Reflect Position and Responsibility
Total
compensation and accountability should generally increase with position and
responsibility. Consistent with this philosophy:
|
* |
Total
compensation is higher for individuals with greater responsibility
and
greater ability to influence CSI’s achievement of targeted results and
strategic initiatives.
|
|
* |
As
position and responsibility increases, a greater portion of the executive
officer's total compensation is performance-based pay contingent
on the
achievement of performance
objectives.
|
|
* |
Equity-based
compensation is higher for persons with higher levels of responsibility,
making a significant portion of their total compensation dependent
on
long-term stock appreciation.
|
Compensation
Decisions Should Promote the Interests of Stockholders
Compensation
should focus management on achieving strong short-term (annual) performance
in a
manner that supports and ensures the Company's long-term success and
profitability. We believe that stock options create long-term incentives that
align the interest of management with the long-term stockholders.
Compensation
should be Reasonable and Responsible
It
is
essential that CSI’s overall compensation levels be sufficiently competitive to
attract talented leaders and motivate those leaders to achieve superior results.
At the same time, we believe that compensation should be set at responsible
levels. Our executive compensation is intended to be consistent with CSI’s
constant focus on controlling costs.
Compensation
Disclosures Should be clear and complete
We
believe that all aspects of executive compensation should be clearly,
comprehensibly and promptly disclosed in plain English. We believe that
compensation disclosures should provide all of the information necessary to
permit stockholders to understand our compensation philosophy, our
compensation-setting process and how and how much our executives are
paid.
Elements
of Executive Compensation
Base
Salary
Base
pay
is a critical element of executive compensation because it provides executives
with a base level of monthly income. In determining base salaries, we consider
the executive's qualifications and experience, scope of responsibilities and
future potential, the goals and objectives established for the executive, the
executive's past performance, competitive salary practices, internal pay equity
and the tax deductibility of base salary.
Equity
Based Compensation
We
believe that equity compensation is an effective means of creating a long-term
link between the compensation provided to officers and other key management
personnel with gains realized by the stockholders. We have elected to use stock
options as the equity compensation vehicle. All stock options incorporate the
following features:
|
* |
The
term of the grant does not exceed 5-10
years;
|
|
* |
The
grant price is not less than the market price on the date of
grant;
|
|
* |
Grants
do not include "reload" provisions;
|
|
* |
Repricing
of options is prohibited; and
|
|
* |
Options
vest 33.33% per year over three years beginning with the first anniversary
of the date of grant.
|
We
will
continue to use stock options as a long-term incentive vehicle
because:
|
* |
Stock
options align the interests of executives with those of the stockholders,
support a pay-for-performance culture, foster employee stock ownership,
and focus the management team on increasing value for the
stockholders.
|
|
* |
Stock
options are performance based. All the value received by the recipient
from a stock option is based on the growth of the stock price above
the
option price.
|
|
* |
The
vesting period encourages executive retention and the preservation
of
stockholder value.
|
In
determining the number of options to be granted to senior executive officers,
we
will take into account the individual's position, scope of responsibility,
ability to affect profits and stockholder value and the individual’s historic
and recent performance and the value of stock options in relation to other
elements of total compensation.
Additional
Benefits
Executive
officers participate in other employee benefit plans generally available to
all
employees on the same terms as similarly situated employees.
Our
Compensation Decisions
This
section describes the compensation decisions that we made with respect to the
named executive officers for fiscal 2006 and during the first quarter of fiscal
2007.
Executive
Summary
In
summary, the compensation decisions made in fiscal 2006 and the first quarter
of
fiscal 2007 for the named executive officers were as follows:
|
* |
We
did not increase base salaries for the named executive officers,
and there
is no plan to do so in fiscal 2007.
|
|
* |
In
2006, no bonuses were awarded to the then-named executive officers
in 2006
(except for the bonus granted to William McKnight pursuant to his
employment agreement).
|
|
* |
In
2006, only one then-named executive officer received a stock option
grant.
|
|
* |
Performance-based
pay represented 0% of the total compensation actually paid to the
named
executive officers for fiscal 2006, and the Committee is presently
assessing this for fiscal 2007.
|
We
believe that these decisions are consistent with our core compensation
principles:
|
* |
We
believe in a pay for performance
culture;
|
|
* |
Compensation
decisions should promote the interests of long-term stockholders;
and
|
|
* |
Compensation
should be reasonable and
responsible.
|
Base
Salary
The
base
salaries are mandated in employment agreements with the named executive
officers:
Name
|
|
|
Title
|
|
|
2007
Base Salary
|
|
Scott
Newman
|
|
|
President
and Chief Executive Officer
|
|
$
|
500,000
|
|
Glenn
Peipert
|
|
|
Executive
Vice President and Chief Operating Officer
|
|
$
|
375,000
|
|
William
McKnight
|
|
|
Senior
Vice President - Data Warehousing
|
|
$
|
250,000
|
|
Stock
Option Grants
We
granted the following stock options to the named executive officers in fiscal
2006:
Name
|
|
Options
Granted (# of underlying shares)
|
|
William
Hendry (1)
|
|
|
150,000
|
|
Robert
C. DeLeeuw (2)
|
|
|
1,000,000
|
|
(1)
The
options vest ratably over a three year period and expire ten years from the
date
of grant.
(2)
Mr.
DeLeeuw’s employment with CSI ended on December 31, 2006. All 1,250,000 options
that had been granted to Mr. DeLeeuw were fully vested on December 31,
2006.
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
Committee. The agreement also provides for health, life and disability
insurance, as well as a monthly car allowance.
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 Committee. The agreement also provides for health, life and
disability insurance, as well as a monthly car allowance.
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 Committee. The agreement also provides for health, life and disability
insurance.
Severance
Arrangements
The
following named executive officers have arrangements that provide for payment
of
severance payments:
|
* |
In
the event that Scott Newman’s employment is terminated other than with
good cause, Mr. Newman will receive a lump sum payment of 2.99 times
his
base salary.
|
|
* |
In
the event that Glenn Peipert’s employment is terminated other than with
good cause, Mr. Peipert will receive a lump sum payment of 2.99 times
his
base salary.
|
|
* |
In
the event that William McKnight’s employment is terminated other than with
good cause, Mr. McKnight 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.
|
Change-in-Control
Arrangements
Messrs.
Newman, Peipert and McKnight would be entitled to the above severance
arrangements on a change of control. Further, our 2003 Incentive Plan provides
that upon a change in control, all unvested stock options shall immediately
become vested (unless the Committee determines otherwise).
At
present, the named executive officers hold the following unvested stock options
that would become vested upon a change in control.
Name
|
|
|
Number
of Shares Underlying Vested Options (#)
|
|
|
Number
of Shares Underlying Unvested Options (#)
|
|
Glenn
Peipert
|
|
|
83,333
|
|
|
166,667
|
|
William
Hendry
|
|
|
30,000
|
|
|
180,000
|
|
Bryan
Carey
|
|
|
63,888
|
|
|
244,445
|
|
Stock
Ownership Requirement for Management
The
Company does not have a formal policy requiring stock ownership by management.
One of the key objectives of the 2003 Incentive Plan is to promote ownership
of
the Company’s stock by management.
Compensation
Policies
Internal
Pay Equity
We
believe that internal equity is an important factor to be considered in
establishing compensation for the officers. We have not established a policy
regarding the ratio of total compensation of the Chief Executive Officer to
that
of the other officers, but we do review compensation levels to ensure that
appropriate equity exists. We intend to continue to review internal compensation
equity and may adopt a formal policy in the future if we deem such a policy
to
be appropriate.
Internal
Revenue Code Section 162(m)
Section 162(m)
of the Internal Revenue Code generally disallows a tax deduction to public
companies for compensation in excess of $1 million paid to the CEO or any named
executive officer unless such compensation is paid pursuant to a qualified
performance-based compensation plan. We believe that the 2003 Incentive Plan
qualifies under the current IRS definition of performance-based compensation.
The Committee has expressed the intention of continued reliance upon such
performance-based compensation in order to preserve its deductibility for
federal income tax purposes to the extent reasonably practicable.
Financial
Restatement
It
is the
Board of Directors' Policy that the Committee will, to the extent permitted
by
governing law, have the sole and absolute authority to make retroactive
adjustments to any cash or equity based incentive compensation paid to executive
officers and certain other officers where the payment was predicated upon the
achievement of certain financial results that were subsequently the subject
of a
restatement. Where applicable, the Company will seek to recover any amount
determined to have been inappropriately received by the individual
executive.
Timing
of
Stock Option Grants
CSI
has
adopted a policy on stock option grants that includes the following provisions
relating to the timing of option grants:
|
* |
CSI
executives make recommendations to the Committee related to selecting
the
grant date.
|
|
* |
The
grant date of the stock options is always the date of approval of
the
grants (or a specified later date if for any reason the grant is
approved
during a time when CSI is in possession of material, non-public
information).
|
|
* |
The
exercise price is the closing price of the underlying common stock
on the
grant date.
|
ITEM
12. 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 27, 2007, based on 56,480,153 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)
|
|
|
19,619,385
|
|
|
34.7
|
%
|
Glenn
Peipert(4)
|
|
|
10,281,227
|
|
|
18.2
|
%
|
William
Hendry(5)
|
|
|
30,000
|
|
|
*
|
|
William
McKnight(6)
|
|
|
829,091
|
|
|
1.5
|
%
|
Bryan
Carey (7)
|
|
|
63,888
|
|
|
*
|
|
Lawrence
K. Reisman(8)
|
|
|
26,666
|
|
|
*
|
|
Frederick
Lester(9)
|
|
|
0
|
|
|
*
|
|
Thomas
Pear(10)
|
|
|
200
|
|
|
*
|
|
Robert
C. DeLeeuw(11)
|
|
|
6,558,334
|
|
|
11.4
|
%
|
All
directors and officers as a group (8 persons)
|
|
|
30,850,457
|
|
|
54.4
|
%
|
* |
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. Consists of an option to purchase 83,333 shares
of
Common Stock granted on November 16, 2005, and expiring on November
16,
2010, at an exercise price of $0.83 per share, and does not include
an
option to purchase 166,667 shares of Common Stock which vest as follows:
(i) 83,333 on November 16, 2007 and (ii) 83,334 on November 16, 2008.
|
(5)
|
Mr.
William Hendry is the Company’s Vice President, Chief Financial Officer
and Treasurer. Consists of an option to purchase 20,000 shares of
Common
Stock granted on May 28, 2004, and expiring on May 28, 2014, at an
exercise price of $3.00 per share, and does not include an option
to
purchase 10,000 shares of Common Stock, which shall vest on May 28,
2007.
Consists
of an option to purchase 10,000 shares of Common Stock granted on
November
16, 2005, and expiring on November 16, 2015, at an exercise price
of $0.83
per share, and does not include an option to purchase 20,000 shares
of
Common Stock which vest as follows: (i) 10,000 on May 16, 2007 and
(ii)
10,000 on May 16, 2008. Does not include an option to purchase 150,000
shares of Common Stock granted on October 10, 2006, and expiring
on
October 10, 2016, at an exercise price of $0.25, which vests as follows:
(i) 50,000 on October 10, 2007, (ii) 50,000 on October 10, 2008 and
(iii)
50,000 on October 10, 2009.
|
(6)
|
Mr.
McKnight is the Company’s Senior Vice President - Data
Warehousing.
|
(7)
|
Mr.
Carey is the Company’s Senior Vice President - Strategic Consulting.
Consists of an option to purchase 22,222 shares of Common Stock granted
on
May 28, 2004, and expiring on May 28, 2014, at an exercise price
of $3.00
per share, and does not include an option to purchase 11,111 shares
of
Common Stock, which shall vest on May 28, 2007.
Consists
of an option to purchase 41,666 shares of Common Stock granted on
November
16, 2005, and expiring on November 16, 2015, at an exercise price
of $0.83
per share, and does not include an option to purchase 83,334 shares
of
Common Stock which vest as follows: (i) 41,666 on May 16, 2007 and
(ii)
41,668 on May 16, 2008. Does not include an option to purchase 150,000
shares of Common Stock granted on October 10, 2006, and expiring
on
October 10, 2016, at an exercise price of $0.25, which vests as follows:
(i) 50,000 on October 10, 2007, (ii) 50,000 on October 10, 2008 and
(iii)
50,000 on October 10, 2009.
|
(8)
|
Mr.
Reisman is a Director. Consists of an option to purchase 20,000 shares
of
Common Stock granted on May 28, 2004, and expiring on May 28, 2014,
at an
exercise price of $3.00 per share, and does not include an option
to
purchase 10,000 shares of Common Stock, which shall vest on May 28,
2007.
Consists
of an option to purchase 6,666 shares of Common Stock granted on
November
16, 2005, and expiring on November 16, 2015, at an exercise price
of $0.83
per share, and does not include an option to purchase 13,334 shares
of
Common Stock which vest as follows: (i) 6,666 on November 16, 2007
and
(ii) 6,668 on November 16, 2008. Does not include an option to purchase
25,000 shares of Common Stock granted on October 10, 2006, and expiring
on
October 10, 2016, at an exercise price of $0.25, which vests as follows:
(i) 8,333 on October 10, 2007, (ii) 8,333 on October 10, 2008 and
(iii)
8,334 on October 10, 2009.
|
(9)
|
Mr.
Lester is a Director. Does not include an option to purchase 25,000
shares of Common Stock granted on October 10, 2006, and expiring
on
October 10, 2016, at an exercise price of $0.25, which vests as follows:
(i) 8,333 on October 10, 2007, (ii) 8,333 on October 10, 2008 and
(iii)
8,334 on October 10, 2009.
|
(10)
|
Mr.
Pear is a Director. Does not include an option to purchase 25,000
shares
of Common Stock granted on October 10, 2006, and expiring on October
10,
2016, at an exercise price of $0.25, which vests as follows: (i)
8,333 on
October 10, 2007, (ii) 8,333 on October 10, 2008 and (iii) 8,334
on
October 10, 2009.
|
(11)
|
Mr.
DeLeeuw was formerly the Company’s Senior Vice President and director.
Includes a fully vested option to purchase 250,000 shares of Common
Stock
granted on November 16, 2005 and expiring on November 16, 2015 at
an
exercise price of $0.83 per share. Also includes a fully vested option
to
purchase 1,000,000 shares of Common Stock granted on January 9, 2006
and
expiring on January 9, 2016 at an exercise price of $0.46 per
share.
|
ITEM
13. CERTAIN
RELATIONSHIPS AND 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,
2006, 2005 and 2004, the Company invoiced LEC $2,478,342, $3,731,198 and
$3,837,065, respectively, for the services of consultants subcontracted to
LEC
by the Company. As of December 31, 2006, 2005 and 2004, the Company had accounts
receivable due from LEC of approximately $330,000, $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.
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 was to receive an aggregate amount of $0.25
million as compensation for services provided to the Company. During 2004 and
2005, an aggregate amount of $225,000 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
August 23, 2006, approximately $0.6 million and $0.5 million remained
outstanding to Messrs. Newman and Peipert, respectively, on their loans to
the
Company. On August 23, 2006, pursuant
to a unanimous resolution of the independent members of the Board of Directors,
certain loans made to the Company by Messrs.
Newman and Peipert
were
converted into shares of common stock of the Company. Per the Board resolution,
the shares of common stock received were based on a conversion price of $0.63,
or the closing market price of the Company's common stock on the American Stock
Exchange on the date of conversion (August 23, 2006). Mr. Newman received
980,491 shares of restricted common stock, and Mr. Peipert received 851,862
shares of restricted common stock.
As
of
December 31, 2006, Mr. Newman had no outstanding loan balance to the Company,
and Mr. Peipert’s outstanding loan balance to the Company was $0.1 million. The
unsecured loan by Mr. Peipert accrues interest at a simple rate of 8% per annum,
and has a term expiring on April 30, 2007.
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.
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, 2006 and
December 31, 2005 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, 2006
|
|
|
December
31, 2005
|
|
Audit
Fees
|
|
$
|
256,367
|
|
$
|
319,748
|
|
Audit
Related Fees
|
|
$
|
2,500
|
|
$
|
8,700
|
|
Tax
Fees
|
|
$ |
93,733
|
|
|
78,850
|
|
All
Other Fees
|
|
$
|
18,030
|
|
$
|
- |
|
|
|
$
|
370,630 |
|
$
|
407,298 |
|
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.
Part
IV
ITEM
15. EXHIBITS
2.1
Agreement
and Plan of Reorganization, dated August 21, 2003, among Registrant, 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 Registrant, 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).
2.3
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).
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
Registrant, 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 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 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 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 28, 2005 among Registrant, ISI Merger Corp.,
a
Delaware corporation, Integrated Strategies, Inc., a Delaware corporation,
ISI
Consulting, LLC, a Delaware limited liability company, Adam Hock, and Larry
Hock
(filed as Exhibit 2 on Form 8-K on August 2, 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 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 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 Amendment to Certificate of Incorporation, dated September 20, 2005,
effecting, among other things, the 1 for 15 reverse stock split (filed as
Exhibit D on Schedule 14A on July 26, 2005).
3.5 Certificate
of Amendment to Certificate of Incorporation, dated August 8, 2006, increasing
the authorized shares of common stock (filed as Exhibit A on Schedule 14A
on
July 17, 2006).
3.6 Certificate
of Designations of Preferences, Rights and Limitations of Series A Convertible
Preferred Stock of Registrant dated February 2, 2006 (filed as Exhibit 4.1
on
Form 8-K on February 8, 2006).
3.7 Certificate
of Designations of Preferences, Rights and Limitations of Series B Convertible
Preferred Stock of Registrant (filed as Exhibit 4.1 on Form 8-K on August
16,
2006).
3.8
Amended
and Restated Bylaws (filed as Exhibit 3.3 on Form 8-K on February 17,
2004).
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
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).
4.3
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).
4.4
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).
4.5
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).
4.6
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).
4.7
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).
4.8 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).
4.9 Option
to
purchase shares of common stock dated February 1, 2006, in favor of Laurus
Master Fund, Ltd. (filed as Exhibit 4.1 on Form 8-K on February 7,
2006).
4.10 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).
4.11 Common
Stock Purchase Warrant dated February 2, 2006, in favor of Taurus Advisory
Group, LLC (filed as Exhibit 10.3 on Form 8-K on February 8, 2006).
4.12 Common
Stock Purchase Warrant, dated August 11, 2006, in favor of Matthew J. Szulik
(filed as Exhibit 10.3 on Form 8-K on August 16, 2006).
4.13 Common
Stock Purchase Warrant, dated August 11, 2006, in favor of Feiner Family
Trust
(filed as Exhibit 10.4 on Form 8-K on August 16, 2006).
4.14 Common
Stock Purchase Warrant in favor of certain investors represented by Taurus
Advisory Group, LLC, dated December 29, 2006 (filed as Exhibit 10.3 on Form
8-K
on January 5, 2007).
4.15 Common
Stock Purchase Warrant in favor of investors represented by TAG Virgin
Islands,
Inc., dated March 1, 2007 (filed as Exhibit 10.3 on Form 8-K on March 7,
2007).
4.16 Common
Stock Warrant in favor of Laurus Master Fund, Ltd., dated March 1, 2007
(filed
as Exhibit 10.6 on Form 8-K on March 7, 2007).
4.17 10%
Convertible Unsecured Note issued to investor represented by TAG Virgin
Islands,
Inc., dated March 1, 2007 (filed as Exhibit 10.1 on Form 8-K on March 7,
2007).
10.1
Employment
Agreement among Registrant 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 Registrant 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 Registrant 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 Registrant 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, as amended (filed as Exhibit 4.1 on Form S-8 POS on October
18,
2006).
10.6 Security
Agreement, dated September 22, 2004, among 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).
10.7 Subordination
Agreement, dated September 22, 2004, among 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).
10.8 Registration
Rights Agreement, dated September 22, 2004, among Registrant, 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).
10.9
Bill
of
Sale, Assignment And Assumption Agreement dated July 18, 2005 by and among
Evoke
Software Corporation and Similarity Vector Technologies (Sivtech) Limited
(filed
as Exhibit 2.2 on Form 8-K on July 22, 2005).
10.10 Bill
of
Sale, Assignment and Assumption Agreement dated July 18, 2005 by and among
Evoke
Software Corporation and Similarity Systems, Inc. (filed as Exhibit 2.3
on Form
8-K on July 22, 2005).
10.11 Restricted
Account Agreement by and among Registrant, North Fork Bank and Laurus Master
Fund, Ltd. (filed as Exhibit 10.11 on Form 10-KSB/A on July 26,
2005).
10.12 Employment
Agreement dated July 22, 2005 by and between Registrant and William McKnight
(filed as Exhibit 10.1 on Form 8-K on July 28, 2005).
10.13 Omnibus
Amendment dated July 28, 2005 with Laurus Master Fund, Ltd. (filed as Exhibit
10.3 on Form 8-K on August 3, 2005).
10.14 Joinder
In Subsidiary Guaranty, Master Security Agreement, Stock Pledge Agreement
and
Security Agreement with Laurus Master Fund, Ltd., dated July 28, 2005 (filed
as
Exhibit 10.4 on Form 8-K on August 3, 2005).
10.15 Reaffirmation
and Ratification Agreement with Laurus Master Fund, Ltd., dated July 28,
2005
(filed as Exhibit 10.5 on Form 8-K on August 3, 2005).
10.16 Overadvance
Letter with Laurus Master Fund, Ltd., dated July 28, 2005 (filed as Exhibit
10.4
on Form 8-K on August 3, 2005).
10.17 Omnibus
Amendment with Laurus Master Fund, Ltd., dated November 30, 2005 (filed as
Exhibit 10.4 on Form 8-K on December 6, 2005).
10.18 Reaffirmation
and Ratification Agreement with Laurus Master Fund, Ltd., dated November
30,
2005 (filed as Exhibit 10.5 on Form 8-K on December 6, 2005).
10.19 Security
Agreement dated February 1, 2006 by and among Laurus Master Fund, Ltd.,
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).
10.20
Stock
Pledge Agreement with Laurus Master Fund, Ltd., dated February 1, 2006 (filed
as
Exhibit 10.4 on Form 8-K on February 7, 2006).
10.21 Overadvance
Side Letter with Laurus Master Fund, Ltd., dated February 1, 2006 (filed
as
Exhibit 10.5 on Form 8-K on February 7, 2006).
10.22 Stock
Purchase Agreement dated February 2, 2006 by and between Registrant and Taurus
Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February 7,
2006).
10.23 Registration
Rights Agreement dated February 2, 2006 by and between Registrant and Taurus
Advisory Group, LLC (filed as Exhibit 10.1 on Form 8-K on February 7,
2006).
10.24 Stock
Purchase Agreement dated August 11, 2006 by and between Registrant and Matthew
J. Szulik (filed as Exhibit 10.1 on Form 8-K on August 16, 2006).
10.25 Registration
Rights Agreement dated August 11, 2006 by and between Registrant, Matthew
J.
Szulik and the Feiner Family Trust (filed as Exhibit 10.2 on Form 8-K on
August
16, 2006).
10.26 Stock
Purchase Agreement by and between Registrant and certain investors represented
by Taurus Advisory Group, LLC, dated December 29, 2006 (filed as Exhibit
10.1 on
Form 8-K on January 5, 2007).
10.27 Registration
Rights Agreement by and between Registrant and certain investors represented by
Taurus Advisory Group, LLC, dated December 29, 2006 (filed as Exhibit 10.2
on
Form 8-K on January 5, 2007).
10.28 Registration
Rights Agreement by and between Registrant and investor represented by TAG
Virgin Islands, Inc., dated March 1, 2007 (filed as Exhibit 10.2 on Form
8-K on
March 7, 2007).
10.29 Third
Extension Agreement among Registrant and Sands Brothers Venture Capital LLC,
Sands Brothers Venture Capital III LLC and Sands Brothers Venture Capital
IV
LLC, dated March 1, 2007 (filed as Exhibit 10.4 on Form 8-K on March 7,
2007).
10.30 Omnibus
Amendment and Waiver No. 2 among Registrant, CSI Sub Corp. (DE), DeLeeuw
Associates, Inc. and Laurus Master Fund, Ltd. dated March 1, 2007 (filed
as
Exhibit 10.5 on Form 8-K on March 7, 2007).
10.31 Assumption,
Adoption and Consent Agreement among Registrant, CSI Sub Corp. (DE), DeLeeuw
Associates, Inc. and Laurus Master Fund, Ltd. dated March 1, 2007 (filed
as
Exhibit 10.7 on Form 8-K on March 7, 2007).
10.32 Amended
and Restated Registration Rights Agreement among Registrant and Laurus dated
March 1, 2007 (filed as Exhibit 10.8 on Form 8-K on March 7,
2007).
21*
Subsidiaries
of Registrant.
23.1*
Consent of Friedman LLP, Independent Registered Public Accounting
Firm
31.1*
Certification
of Registrant’s Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of
the Securities Exchange Act of 1934.
31.2*
Certification
of Registrant’s Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of
the Securities Exchange Act of 1934.
32.1*
Certification
of Registrant’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 Registrant’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
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, 2006 and 2005, and
the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for the years ended December 31, 2006, 2005 and 2004. 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, 2006 and 2005, and
the
consolidated results of its operations and its cash flows for the years ended
December 31, 2006, 2005 and 2004, in conformity with accounting principles
generally accepted in the United States of America.
As
discussed in Note 1 to the consolidated financial statements, effective January
1, 2006 the Company adopted Statement of Financial Accounting Standards (“SFAS”)
“Share-Based
Payment” (“SFAS 123(R)”) which
requires companies to estimate fair value of share-based payment awards on
the
date of grant using an option-pricing model.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company's recurring losses, negative
cash
flows from operations, its net working capital deficiency and its ability to
pay
its outstanding debt raise substantial doubt about its ability to continue
as a
going concern. Management's plans in regard to these matters are also described
in Note 2. The consolidated financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
/s/
Friedman LLP
East
Hanover, New Jersey
March
29,
2007, except for note 25 as to which the date is September 5, 2007
CONVERSION
SERVICES INTERNATIONAL, INC.
AND
SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
DECEMBER
31,
|
|
2006
|
|
2005
|
|
ASSETS
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
Cash
|
|
$
|
668,006
|
|
$
|
176,073
|
|
Accounts
receivable, net of allowance for doubtful accounts of $279,422
and
$489,070 as of December 31, 2006 and 2005,
respectively
|
|
|
3,912,000
|
|
|
3,194,375
|
|
Accounts
receivable from related parties, net of allowance for doubtful
accounts of
$8,972 and zero as of December 31, 2006 and 2005, respectively;
(Note
24)
|
|
|
330,006
|
|
|
569,908
|
|
Prepaid
expenses
|
|
|
132,087
|
|
|
142,432
|
|
TOTAL
CURRENT ASSETS
|
|
|
5,042,099
|
|
|
4,082,788
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT, at cost, net
|
|
|
265,084
|
|
|
417,469
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
Goodwill
|
|
|
6,826,705
|
|
|
7,239,566
|
|
Intangible
assets, net of accumulated amortization of $1,265,958 and $740,350
as of
December 31, 2006 and 2005, respectively; (Note 7)
|
|
|
1,266,856
|
|
|
1,862,964
|
|
Deferred
financing costs, net of accumulated amortization of $52,609 and
$467,604
as of December 31, 2006 and 2005, respectively; (Note
8)
|
|
|
57,391
|
|
|
425,705
|
|
Discount
on debt issued, net of accumulated amortization of $1,793,921 and
$678,917
as of December 31, 2006 and 2005, respectively; (Note
9)
|
|
|
786,079
|
|
|
4,177,428
|
|
Equity
investments
|
|
|
176,152
|
|
|
149,117
|
|
Other
assets
|
|
|
110,445
|
|
|
123,432
|
|
|
|
|
9,223,628
|
|
|
13,978,212
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
14,530,811
|
|
$
|
18,478,469
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
Line
of credit; (Note 10)
|
|
$
|
5,795,552
|
|
$
|
4,713,312
|
|
Current
portion of long-term debt
|
|
|
578,685
|
|
|
495,122
|
|
Accounts
payable and accrued expenses
|
|
|
1,957,501
|
|
|
2,519,446
|
|
Short
term notes payable; (Note 11)
|
|
|
2,745,000
|
|
|
1,063,990
|
|
Deferred
revenue
|
|
|
74,450
|
|
|
41,121
|
|
Related
party note payable; (Note 24)
|
|
|
110,831
|
|
|
-
|
|
Financial
instruments; (Note 12)
|
|
|
52,228
|
|
|
2,837,657
|
|
TOTAL
CURRENT LIABILITIES
|
|
|
11,314,247
|
|
|
11,670,648
|
|
|
|
|
|
|
|
|
|
LONG-TERM
DEBT, net of current portion
|
|
|
1,769,154
|
|
|
3,042,914
|
|
RELATED
PARTY NOTE PAYABLE; (Note 24)
|
|
|
-
|
|
|
1,772,368
|
|
DEFERRED
TAXES
|
|
|
363,400
|
|
|
363,400
|
|
Total
Liabilities
|
|
|
13,446,801
|
|
|
16,849,330
|
|
|
|
|
|
|
|
|
|
SERIES
A CONVERTIBLE PREFERRED STOCK, $0.001 par value, $100.00 stated
value,
20,000,000 shares authorized; 19,000 and zero shares issued and
outstanding at December 31, 2006 and 2005, respectively; (Note
16)
|
|
|
348,333
|
|
|
-
|
|
|
|
|
|
|
|
|
|
SERIES
B CONVERTIBLE PREFERRED STOCK, $0.001 par value, $100.00 stated
value,
20,000,000 shares authorized; 20,000 and zero shares issued and
outstanding at December 31, 2006 and 2005, respectively; (Note
16)
|
|
|
1,248,806
|
|
|
-
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value, 100,000,000 shares
authorized;
|
|
|
|
|
|
|
|
57,625,535
and 54,093,916 issued and outstanding at December 31, 2006 and
2005,
respectively
|
|
|
57,625
|
|
|
54,094
|
|
|
|
|
|
|
|
|
|
Additional
paid in capital
|
|
|
50,829,255
|
|
|
42,264,407
|
|
Treasury
stock, at cost, 1,145,382 and zero shares in treasury as of December
31,
2006 and 2005, respectively; (Note 17)
|
|
|
(423,869
|
)
|
|
-
|
|
Accumulated
deficit
|
|
|
(50,976,140
|
)
|
|
(40,689,362
|
)
|
Total
Stockholders' Equity (Deficit)
|
|
|
(513,129
|
)
|
|
1,629,139
|
|
|
|
|
|
|
|
|
|
Total
Liabilities and Stockholders' Equity (Deficit)
|
|
$
|
14,530,811
|
|
$
|
18,478,469
|
|
See
Notes
to Consolidated Financial Statements
CONVERSION
SERVICES INTERNATIONAL, INC.
AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
FOR
THE YEARS ENDED DECEMBER 31,
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
REVENUE:
|
|
|
|
|
|
|
|
Services
|
|
$
|
23,157,727
|
|
$
|
23,392,464
|
|
$
|
19,755,370
|
|
Related
party services
|
|
|
2,478,342
|
|
|
3,731,198
|
|
|
3,837,065
|
|
Other
|
|
|
37,988
|
|
|
506,247
|
|
|
300,671
|
|
|
|
|
25,674,057
|
|
|
27,629,909
|
|
|
23,893,106
|
|
COST
OF REVENUE:
|
|
|
|
|
|
|
|
|
|
|
Services
(inclusive of stock based compensation of $0.4 million, zero and
$1.4
million for the years ended December 31, 2006, 2005 and 2004,
respectively.)
|
|
|
17,623,747
|
|
|
17,316,494
|
|
|
15,367,477
|
|
Related
party services
|
|
|
2,307,187
|
|
|
3,215,909
|
|
|
3,345,318
|
|
Other
|
|
|
|
|
|
-
|
|
|
134,182
|
|
|
|
|
19,930,934
|
|
|
20,532,403
|
|
|
18,846,977
|
|
GROSS
PROFIT
|
|
|
5,743,123
|
|
|
7,097,506
|
|
|
5,046,129
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing (inclusive of stock based compensation of $1.0 million,
zero
and zero for the years ended December 31, 2006, 2005 and 2004,
respectively.)
|
|
|
5,072,532
|
|
|
4,521,054
|
|
|
3,210,790
|
|
General
and administrative (inclusive of stock based compensation of $0.6
million,
$0.5 million and $0.1 million for the years ended December 31, 2006,
2005
and 2004, respectively.
|
|
|
5,451,324
|
|
|
6,418,245
|
|
|
6,086,017
|
|
Goodwill
& intangibles impairment
|
|
|
349,000
|
|
|
1,321,543
|
|
|
12,247,234
|
|
Depreciation
and amortization
|
|
|
802,386
|
|
|
911,772
|
|
|
468,235
|
|
|
|
|
11,675,242
|
|
|
13,172,614
|
|
|
22,012,276
|
|
LOSS
FROM OPERATIONS
|
|
|
(5,932,119
|
)
|
|
(6,075,108
|
)
|
|
(16,966,147
|
)
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
Equity
in earnings from investments
|
|
|
27,035
|
|
|
4,657
|
|
|
5,684
|
|
Gain
(loss) on financial instruments
|
|
|
(351,132
|
)
|
|
7,796,569
|
|
|
(551,241
|
)
|
Loss
on early extinguishment of debt
|
|
|
(2,311,479
|
)
|
|
(1,607,763
|
)
|
|
-
|
|
Other
income
|
|
|
-
|
|
|
-
|
|
|
7,300
|
|
Interest
income
|
|
|
-
|
|
|
69,166
|
|
|
22,355
|
|
Interest
expense
|
|
|
(3,094,083
|
)
|
|
(4,201,823
|
)
|
|
(5,024,449
|
)
|
|
|
|
(5,729,659
|
)
|
|
2,060,806
|
|
|
(5,540,351
|
)
|
LOSS
BEFORE INCOME TAXES
|
|
|
(11,661,778
|
)
|
|
(4,014,302
|
)
|
|
(22,506,498
|
)
|
INCOME
TAXES
|
|
|
-
|
|
|
-
|
|
|
190,800
|
|
LOSS
FROM CONTINUING OPERATIONS
|
|
|
(11,661,778
|
)
|
|
(4,014,302
|
)
|
|
(22,697,298
|
)
|
|
|
|
|
|
|
|
|
|
|
|
DISCONTINUED
OPERATIONS:
|
|
|
|
|
|
|
|
|
|
|
Gain
on disposal of discontinued operations
|
|
|
2,050,000
|
|
|
49,148
|
|
|
-
|
|
Loss
from discontinued operations
|
|
|
-
|
|
|
(1,153,119
|
)
|
|
(12,650,908
|
)
|
|
|
|
2,050,000
|
|
|
(1,103,971
|
)
|
|
(12,650,908
|
)
|
NET
LOSS
|
|
|
(9,611,778
|
)
|
|
(5,118,273
|
)
|
|
(35,348,206
|
)
|
Accretion
of issuance costs associated with convertible preferred
stock
|
|
|
(429,747
|
)
|
|
-
|
|
|
-
|
|
Dividends
on convertible preferred stock
|
|
|
(162,603
|
)
|
|
-
|
|
|
-
|
|
NET
LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS
|
|
$
|
(10,204,128
|
)
|
$
|
(5,118,273
|
)
|
$
|
(35,348,206
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Basic
loss per common share from continuing operations
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
Basic
income (loss) per common share from discontinued
operations
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Basic
loss per common share
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
Basic
loss per common share attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
loss per common share from continuing operations
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
Diluted
income (loss) per common share from discontinued
operations
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Diluted
loss per common share
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
Diluted
loss per common share attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
Weighted
average common shares used to compute income (loss) per common
share:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,792,504
|
|
|
52,919,340
|
|
|
46,548,065
|
|
Diluted
|
|
|
51,792,504
|
|
|
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 (DEFICIT)
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
Retained
|
|
Other
|
|
Stockholders'
|
|
|
|
|
|
Common
|
|
Capital
|
|
Treasury
|
|
Paid-in
|
|
Earnings
|
|
Comprehensive
|
|
Equity
|
|
Comprehensive
|
|
|
|
Shares
|
|
Stock
|
|
Stock
|
|
Capital
|
|
(Deficit)
|
|
Income
|
|
(Deficit)
|
|
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
|
|
|
51,472,139
|
|
|
51,472
|
|
|
-
|
|
|
36,814,064
|
|
|
(35,576,312
|
)
|
|
5,298
|
|
|
1,294,522
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
|
|
|
-
|
|
|
(5,118,273
|
)
|
|
-
|
|
|
(5,118,273
|
)
|
|
(5,118,273
|
)
|
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
|
|
|
-
|
|
|
-
|
|
|
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(5,118,348
|
)
|
Balance,
December 31, 2005
|
|
|
54,093,916
|
|
|
54,094
|
|
|
-
|
|
|
42,264,407
|
|
|
(40,689,362
|
)
|
|
-
|
|
|
1,629,139
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,611,778
|
)
|
|
|
|
|
(9,611,778
|
)
|
|
(9,611,778
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends
payable on preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
(162,603
|
)
|
|
|
|
|
|
|
|
(162,603
|
)
|
|
|
|
Shares
issued due to exercise of stock options
|
|
|
1,620,100
|
|
|
1,620
|
|
|
|
|
|
33,043
|
|
|
|
|
|
|
|
|
34,663
|
|
|
|
|
Treasury
shares acquired
|
|
|
(4,145,382
|
)
|
|
|
|
|
(1,848,869
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,848,869
|
)
|
|
|
|
Compensation
expense for stock and stock option grants.
|
|
|
|
|
|
|
|
|
|
|
|
2,022,223
|
|
|
|
|
|
|
|
|
2,022,223
|
|
|
|
|
Relative
fair value of warrants issued
|
|
|
|
|
|
|
|
|
|
|
|
2,500,121
|
|
|
|
|
|
|
|
|
2,500,121
|
|
|
|
|
Convertible
preferred stock beneficial conversion feature
|
|
|
|
|
|
|
|
|
|
|
|
1,012,190
|
|
|
|
|
|
|
|
|
1,012,190
|
|
|
|
|
Issuance
of stock options in conjunction with debt restructure
|
|
|
|
|
|
|
|
|
|
|
|
1,694,000
|
|
|
|
|
|
|
|
|
1,694,000
|
|
|
|
|
Laurus
warrant liability reclassified to equity
|
|
|
|
|
|
|
|
|
|
|
|
703,567
|
|
|
|
|
|
|
|
|
703,567
|
|
|
|
|
Dividends
on series A preferred stock paid in shares
|
|
|
79,166
|
|
|
79
|
|
|
|
|
|
39,504
|
|
|
|
|
|
|
|
|
39,583
|
|
|
|
|
Shares
issued due to conversion of debt to equity
|
|
|
1,832,353
|
|
|
1,832
|
|
|
|
|
|
1,152,550
|
|
|
|
|
|
|
|
|
1,154,382
|
|
|
|
|
Issuance
of Common Stock in connection with a stock purchase
agreement
|
|
|
3,000,000
|
|
|
|
|
|
1,425,000
|
|
|
-
|
|
|
(675,000
|
)
|
|
|
|
|
750,000
|
|
|
|
|
Accretion
of issuance costs associated with convertible preferred
stock
|
|
|
|
|
|
|
|
|
|
|
|
(429,747
|
)
|
|
|
|
|
|
|
|
(429,747
|
)
|
|
|
|
Total
comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,611,778
|
)
|
Balance,
December 31, 2006
|
|
|
56,480,153
|
|
$
|
57,625
|
|
$
|
(423,869
|
)
|
$
|
50,829,255
|
|
$
|
(50,976,140
|
)
|
$
|
-
|
|
$
|
(513,129
|
)
|
|
|
|
See
Notes
to Consolidated Financial Statements.
CONVERSION
SERVICES INTERNATIONAL, INC.
AND
SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE YEARS ENDED DECEMBER 31,
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(9,611,778
|
)
|
$
|
(5,118,273
|
)
|
$
|
(35,348,206
|
)
|
Net
income (loss) from discontinued operations
|
|
|
2,050,000
|
|
|
(1,103,971
|
)
|
|
(12,650,908
|
)
|
Net
loss from continuing operations
|
|
$
|
(11,661,778
|
)
|
$
|
(4,014,302
|
)
|
$
|
(22,697,298
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net loss from continuing operations to net cash used
in
operating activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
of property and equipment and amortization of leasehold
improvements
|
|
|
152,386
|
|
|
137,798
|
|
|
132,890
|
|
Amortizaton
of intangible assets
|
|
|
576,108
|
|
|
433,137
|
|
|
217,503
|
|
Amortization
of debt discounts
|
|
|
1,307,022
|
|
|
2,873,617
|
|
|
941,212
|
|
Amortization
of relative fair value of warrants issued
|
|
|
710,072
|
|
|
110,105
|
|
|
60,652
|
|
Amortization
of deferred financing costs
|
|
|
73,894
|
|
|
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
|
|
|
349,000
|
|
|
1,321,543
|
|
|
12,247,235
|
|
Stock
and stock option based compensation
|
|
|
2,022,223
|
|
|
542,460
|
|
|
1,479,902
|
|
(Gain)
loss on change in fair value of financial instruments
|
|
|
351,132
|
|
|
(7,796,569
|
)
|
|
551,240
|
|
Loss
on early extinguishment of debt
|
|
|
2,311,479
|
|
|
1,607,763
|
|
|
-
|
|
Increase
(decrease) in allowance for doubtful accounts
|
|
|
(200,675
|
)
|
|
92,862
|
|
|
91,823
|
|
Write-off
deferred loan costs
|
|
|
-
|
|
|
-
|
|
|
45,213
|
|
Loss
on disposal of equipment
|
|
|
-
|
|
|
-
|
|
|
88,191
|
|
Income
from equity investments
|
|
|
(27,035
|
)
|
|
(4,657
|
)
|
|
(5,684
|
)
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
(Increase)
decrease in accounts receivable
|
|
|
(507,978
|
)
|
|
1,042,245
|
|
|
(1,040,154
|
)
|
(Increase)
decrease in accounts receivable from related parties
|
|
|
230,930
|
|
|
211,192
|
|
|
(388,100
|
)
|
(Increase)
decrease in prepaid expenses
|
|
|
10,344
|
|
|
69,419
|
|
|
(95,574
|
)
|
Decrease
in goodwill
|
|
|
83,861
|
|
|
-
|
|
|
-
|
|
(Increase)
decrease in other assets
|
|
|
12,987
|
|
|
(108,375
|
)
|
|
14,721
|
|
Increase
(decrease) in accounts payable and accrued expenses
|
|
|
(595,445
|
)
|
|
(550,502
|
)
|
|
1,639,815
|
|
Increase
(decrease) in deferred revenue
|
|
|
33,329
|
|
|
(75,546
|
)
|
|
116,667
|
|
Net
cash used in operating activities of continuing
operations
|
|
|
(4,768,144
|
)
|
|
(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
|
|
|
(4,768,144
|
)
|
|
(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 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
|
)
|
|
(2,236,848
|
)
|
Investment
in Evoke Software Corp., net of cash acquired
|
|
|
-
|
|
|
-
|
|
|
334,073
|
|
Net
cash used in investing activities of discontinued
operations
|
|
|
-
|
|
|
-
|
|
|
(4,251
|
)
|
Net
proceeds from the sale of discontinued operations
|
|
|
2,050,000
|
|
|
644,958
|
|
|
-
|
|
Net
cash provided by (used in) investing activities
|
|
|
2,050,000
|
|
|
(2,508,772
|
)
|
|
(1,907,026
|
)
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
Net
advances under line of credit
|
|
|
791,156
|
|
|
1,838,307
|
|
|
1,950,704
|
|
Proceeds
from issuance of short-term note payable
|
|
|
500,000
|
|
|
1,000,000
|
|
|
1,000,000
|
|
Proceeds
from issuance of long-term note payable
|
|
|
381,256
|
|
|
-
|
|
|
4,730,623
|
|
Proceeds
from issuance of long-term note payable to
stockholders
|
|
|
-
|
|
|
1,767,914
|
|
|
511,604
|
|
Increase
in deferred financing costs
|
|
|
(110,000
|
)
|
|
-
|
|
|
(893,309
|
)
|
Principal
payments on long-term debt
|
|
|
(487,110
|
)
|
|
(4,348,695
|
)
|
|
(665,085
|
)
|
Principal
payments on short-term notes
|
|
|
-
|
|
|
(76,054
|
)
|
|
-
|
|
Proceeds
from sale of Company common stock and exercise of stock
options
|
|
|
34,663
|
|
|
1,255,000
|
|
|
500,000
|
|
Acquisition
of treasury stock
|
|
|
(1,848,869
|
)
|
|
-
|
|
|
-
|
|
Reissuance
of treasury stock
|
|
|
750,000
|
|
|
-
|
|
|
-
|
|
Proceeds
from sale of Series A Convertible Preferred Stock
|
|
|
1,900,000
|
|
|
-
|
|
|
-
|
|
Proceeds
from sale of Series B Convertible Preferred Stock
|
|
|
2,000,000
|
|
|
-
|
|
|
-
|
|
Principal
payments on capital lease obligations
|
|
|
(104,340
|
)
|
|
(117,778
|
)
|
|
(85,595
|
)
|
Principal
payments on related party notes
|
|
|
(596,679
|
)
|
|
(381,561
|
)
|
|
-
|
|
Restricted
cash
|
|
|
-
|
|
|
4,334,375
|
|
|
(83,375
|
)
|
Net
cash provided by financing activities
|
|
|
3,210,077
|
|
|
5,271,508
|
|
|
6,965,567
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
-
|
|
|
5,149
|
|
|
5,298
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH
|
|
|
491,933
|
|
|
(852,073
|
)
|
|
616,560
|
|
CASH,
beginning of period
|
|
|
176,073
|
|
|
1,028,146
|
|
|
411,586
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH,
end of period
|
|
$
|
668,006
|
|
$
|
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,
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
866,189
|
|
$
|
558,419
|
|
$
|
276,680
|
|
Cash
paid for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Series
A convertible preferred stock dividend satisfied by issuing Company
common
stock
|
|
|
39,583
|
|
|
-
|
|
|
-
|
|
Related
party note payable repayment through issuance of Company common
stock
|
|
|
1,154,382
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
The
Company did not enter into any capital lease arrangements during
the year
ended December 31, 2006. During the years ended December 31, 2005
and
2004, the Company entered into various capital lease arrangements
for
computer and trade show equipment in the approximate 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
|
|
|
-
|
|
|
-
|
|
|
10,269,000
|
|
Prepaid
expenses
|
|
|
-
|
|
|
-
|
|
|
78,000
|
|
Other
assets
|
|
|
-
|
|
|
-
|
|
|
11,000
|
|
Furniture
and equipment
|
|
|
-
|
|
|
-
|
|
|
184,000
|
|
Deferred
revenue
|
|
|
-
|
|
|
-
|
|
|
(1,254,000
|
)
|
Deferred
compensation
|
|
|
-
|
|
|
-
|
|
|
(443,000
|
)
|
Other
liabilities
|
|
|
-
|
|
|
-
|
|
|
(1,302,000
|
)
|
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.
On October 1, 2006, the corporate structure was changed and this
subsidiary became DeLeeuw Associates, Inc. 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. As of December
31, 2006, McKnight was merged with and into CSI Sub Corp. (DE).
|
|
·
|
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. As of December 31, 2006, ISI was merged with
and into
DeLeeuw Associates, Inc.
|
|
|
|
|
·
|
Doorways,
Inc. is a wholly owned subsidiary of the Company that is currently
dormant. Doorways was dissolved on December 26,
2006.
|
|
·
|
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.
As
of December 31, 2006, this corporation was merged with and into CSI
Sub
Corp. (DE).
|
|
|
|
|
·
|
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. 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 2006, 2005 and 2004, $147,272, $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, ISI and McKnight. Additionally, as part of the Scosys, DeLeeuw and
McKnight acquisitions, the Company acquired identifiable intangible assets.
As
of December 31, 2006, the Company performed its annual impairment review and
determined as a result of an unfavorable change with respect to the economics
of
the ISI business, a $329,000 impairment charge was required. Additionally,
the
Company determined that, due to a change in the Company’s marketing and
positioning of the Scosys business, the $20,000 intangible for the rights to
use
the Scosys name has been impaired and recorded a charge as of that date. As
of
December 31, 2005, the Company performed its annual impairment review and
determined that goodwill related to both the ISI and McKnight 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
was
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 conventionally convertible
debt
instruments between the underlying debt instrument and the freestanding
warrants, and had recorded the conversion feature as a discount on the debt
in
accordance with Emerging Issues Task Force No. 00-27 "Application of Issue
No.
98-5 to Certain Convertible Instruments". The Company is amortizing the
discount on the debt using the effective interest rate method over the life
of
the debt instruments.
Stock
compensation
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.
The
Company is required to adopt this standard effective with the beginning of
the
first annual reporting period that begins after December 15, 2005, therefore,
we
have adopted the standard in the first quarter of fiscal 2006 using the modified
prospective method. We previously accounted for share-based payments to
employees using the intrinsic value method prescribed in APB Opinion 25 and,
as
such, generally recognized no compensation cost for employee stock options.
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 future periods.
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 fiscal years ended December 31, 2004 and 2005,
the
Company granted approximately 43,000 and 48,000 stock options, respectively,
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.
The
per
share weighted average fair value of stock options granted during 2004 was
$2.40
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
|
|
|
2.50
|
%
|
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
|
|
The
per
share weighted average fair value of stock options granted during 2006 was
$0.34
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
|
|
|
4.97
|
%
|
Expected
volatility
|
|
|
177.5
|
%
|
Expected
option life (years)
|
|
|
3.0
|
|
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, 2006, Sapphire Technologies accounted for approximately 28.2% of the
Company’s accounts receivable balance.
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 $134,000, $380,000 and $152,000 for the years ended December
31,
2006, 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, 2006, 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 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.
Reclassification
Certain
amounts in prior periods have been reclassified to conform to the 2006 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: Going concern
The
Company has relied upon cash from its financing activities to fund its ongoing
operations as it has not been able to generate sufficient cash from its
operating activities in the past, and there is no assurance that it will be
able
to do so in the future. The Company has incurred net losses and negative cash
flows from operating activities for the years ended December 31, 2006, 2005
and
2004, and had an accumulated deficit of ($51.0 million) at December 31, 2006.
Due to this history of losses and operating cash consumption, we cannot predict
how long we will continue to incur further losses or whether we will become
profitable again, or if the Company’s business will improve. These factors raise
substantial doubt as to our ability to continue as a going concern.
As
of
December 31, 2006, the Company had a cash balance of approximately $0.7 million
and a working capital deficiency of ($6.3 million).
The
Company has experienced continued losses that exceeded expectations from 2004
through 2006. To that extent, the Company has continued to experience negative
cash flow which has perpetuated the Company’s liquidity issues. To address the
liquidity issue, the Company entered into various debt instruments between
August 2004 and December 2006 and, as of December 31, 2006 had approximately
$11.2 million of debt outstanding in addition to an aggregate of $3.9 million
of
Series A and Series B Convertible Preferred Stock which was issued in 2006.
Additionally, the Company raised $0.75 million through the sale of common stock
in the Company during 2006.
As
of
December 31, 2006, the Company’s debt level required interest and dividends of
approximately $104,000 per month. Approximately, $4.9 million of debt
instruments mature on or before December 31, 2007. Additionally, the Company’s
line of credit expires on December 31, 2007 and $1.5 million of short term
notes
are currently being extended on a month-to-month basis.
In
order
to fund these maturities, the Company obtained $4.25 million in new financing
in
March 2007 and repaid both the Laurus overadvance and the Laurus term note,
in
full, through a combination of a $3.1 million cash payment and $0.5 million
in a
warrant to purchase common stock. Additionally, a $0.6 million cash payment
was
paid to Sands. A final cash payment of $0.4 million and additional common stock
and warrants is to be made in the fourth calendar quarter of 2007 to satisfy
this obligation in full.
The
$4.25
million of new financing was in the form of a promissory note bearing a 10%
annual interest rate and a maturity date of August 31, 2007, which will
automatically convert to common stock at such time as the Company has authorized
shares sufficient to complete the transaction. This is expected to occur in
April 2007. As a result, the Company expects to incur approximately $60,000
of
interest under this note prior to conversion to equity. Subsequent to this
instrument being converted to equity, the Company’s monthly debt service
obligation is expected to decline to approximately $68,000 per month, of which
$23,000 will continue to be paid in Company common stock and the remaining
$45,000 will require monthly interest payments.
The
Company needs additional capital in order to survive. Additional capital will
be
needed to fund current working capital requirements, ongoing debt service and
to
repay the obligations that are maturing over the upcoming 12 month period.
Our
primary sources of liquidity are cash flows from operations, borrowings under
our revolving credit facility, and various short and long term financings.
.
We
plan
to continue to strive to increase revenues and to continue to execute on our
expense reduction program which began in 2006 in order to reduce, or eliminate,
the operating losses. Additionally, we will continue to seek equity financing
in
order to enable us to continue to meet our financial obligations until we
achieve profitability. There can be no assurance that any such funding will
be
available to us on favorable terms, or at all. 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, 2006 were $1.5 million.
Failure to obtain sufficient equity financing would have substantial negative
ramifications to the Company.
Note
3: Recently
Issued Accounting Pronouncements
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 consolidated financial
statements.
In
July
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainties in
Income Taxes” (FIN 48). The Company is currently evaluating the impact that the
new standard is expected to have upon its implementation in the first quarter
of
2007 but it is not expected to have a material impact on our consolidated
financial statements.
In
August
2006, the FASB Emerging Issues Task Force Issued EITF 06-6, “Debtor’s Accounting
for a Modification (or Exchange) of Convertible Debt Instruments”. EITF 06-6
addresses the issue of how a modification of a debt instrument (or an exchange
of debt instruments) that affects the terms of an embedded conversion option
should be considered in the issuer’s analysis of whether debt extinguishment
accounting should be applied. The Company does not expect this pronouncement
to
have a material impact on our consolidated financial statements.
In
September 2006, the FASB issued FAS 157, “Fair Value Measurements,” which
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. FAS 157 does not require any new
fair
value measurements. The Company is required to adopt this statement effective
the first quarter of 2008, and is currently evaluating the impact the new
standard will have on the Company.
In
September 2006, the Securities and Exchange Commission issued Staff Accounting
Bulletin (“SAB”) 108, “Quantifying Financial Statement Misstatements.” In SAB
108, the Securities and Exchange Commission’s staff establishes an approach that
requires quantification of financial statement errors based on the effects
of
the error on each of the company’s financial statements and the related
financial statement disclosures. SAB 108 will be effective for the Company
as of
December 31, 2006; however it is not expected to have a material affect on
the
Company’s consolidated financial statements.
Note
4 - Mergers and acquisitions
On
July
22, 2005, the Company entered into (and simultaneously consummated) a merger
agreement with McKnight. 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 and the balance in June 2006), the issuance of 909,091
shares of the Company common stock, plus the assumption of substantially all
of
the liabilities of McKnight.
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.
The
pro
forma consolidated statements of operations for the years ended December 31,
2005 and 2004, respectively, set forth below gives effect to the acquisitions
of
McKnight and ISI 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
Income (Loss)
|
|
$
|
(4,115,076
|
)
|
$
|
(22,449,341
|
)
|
Net
Income (Loss) per share
|
|
$
|
(0.08
|
)
|
$
|
(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.
Note
6 - Property and equipment
Property
and equipment consisted of the
following:
|
|
December
31,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Computer
equipment
|
|
$
|
998,339
|
|
$
|
998,339
|
|
Furniture
and fixtures
|
|
|
161,543
|
|
|
161,543
|
|
Leasehold
improvements
|
|
|
92,459
|
|
|
92,459
|
|
|
|
|
1,252,341
|
|
|
1,252,341
|
|
Accumulated
depreciation
|
|
|
(987,257
|
)
|
|
(834,872
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
265,084
|
|
$
|
417,469
|
|
Depreciation
and amortization expense related to property and equipment totaled $0.2 million,
$0.1 million and $0.1 million for 2006, 2005 and 2004 respectively.
Note
7 - Intangible assets
Intangibles
acquired have been assigned as follows:
|
|
December
31,
|
|
December
31,
|
|
Amortization
|
|
|
|
2006
|
|
2005
|
|
period
|
|
|
|
|
|
|
|
|
|
Customer
contracts
|
|
$
|
414,000
|
|
$
|
414,000
|
|
|
5
years
|
|
Approved
vendor status
|
|
|
538,814
|
|
|
538,814
|
|
|
40
months
|
|
Customer
relationships
|
|
|
685,000
|
|
|
685,000
|
|
|
2.5
years
|
|
Tradename
|
|
|
722,000
|
|
|
722,000
|
|
|
Indefinite
|
|
Proprietary
presentation format
|
|
|
173,000
|
|
|
173,000
|
|
|
3
years
|
|
Order
backlog
|
|
|
-
|
|
|
50,500
|
|
|
5
months
|
|
Proprietary
rights and rights to the name of Scosys, Inc.
|
|
|
-
|
|
|
20,000
|
|
|
Indefinite
|
|
|
|
|
2,532,814
|
|
|
2,603,314
|
|
|
|
|
Accumulated
amortization
|
|
|
(1,265,958
|
)
|
|
(740,350
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,266,856
|
|
$
|
1,862,964
|
|
|
|
|
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
|
|
|
|
|
|
2007
|
|
|
488,384
|
|
2008
|
|
|
56,472
|
|
2009
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
|
|
$
|
544,856
|
|
Note
8 - Deferred financing costs
The
Company has incurred and capitalized financing costs in connection with
financing transactions consummated between 2004 and 2006. 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:
|
|
December
31, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
Laurus
Master Fund
|
|
$
|
110,000
|
|
$
|
766,270
|
|
Sands
Brothers
|
|
|
-
|
|
|
127,039
|
|
|
|
$
|
110,000
|
|
$
|
893,309
|
|
Accumulated
amortization
|
|
|
(52,609
|
)
|
|
(467,604
|
)
|
|
|
$
|
57,391
|
|
$
|
425,705
|
|
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, 2006
|
|
December
31, 2005
|
|
Amortization
period
|
|
|
|
|
|
|
|
|
|
Laurus
Master Fund
|
|
$
|
-
|
|
$
|
2,276,345
|
|
|
36
months
|
|
Sands
Brothers
|
|
|
1,080,000
|
|
|
1,080,000
|
|
|
12-15
months
|
|
Taurus
Advisory Group
|
|
|
1,500,000
|
|
|
1,500,000
|
|
|
5
years
|
|
|
|
|
2,580,000
|
|
|
4,856,345
|
|
|
|
|
Accumulated
amortization
|
|
|
(1,793,921
|
)
|
|
(678,917
|
)
|
|
|
|
|
|
$
|
786,079
|
|
$
|
4,177,428
|
|
|
|
|
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.
This revolving line 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. This line of credit is secured by
substantially all the corporate assets. Laurus had the option to convert amounts
outstanding into our common stock at a fixed conversion price of $2.10 per
share.
Additionally,
in exchange for a $5.0 million 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 this 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 $1.0 million of debt underlying the minimum
borrowing note into the Company’s common stock. As a result of this conversion,
the Company obtained $1.0 million 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 amended its line of credit notes to increase the amount of
borrowing available to the Company to $6.5 million, based upon eligible accounts
receivable. Additionally, 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 and ISI. Except as noted
above, all terms of the August 2004 agreements continued to remain in
effect.
On
November 30, 2005, the Company (i) amended the convertible term note in the
principal amount of $749,000 by reducing the conversion rate of the note from
$2.10 to $1.00, (ii) amended the line of credit notes by increasing the
principal amount available, based upon eligible accounts receivable, from $6.5
million to $7.5 million and reducing the conversion rate from $2.10 to between
$0.65 and $1.00.
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 $1.0 million to Laurus (the “Term Note”), (b) issued a secured
non-convertible revolving note in the principal amount of $10.0 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. 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
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
2,389,525 shares of the Company’s common stock, options to purchase up to
1,500,000 shares of the Company's common stock at an exercise price of $.001
per
share, a warrant to purchase 1,785,714 shares of the Company’s common stock at
an exercise price of $0.01 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.
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.
As
of
December 31, 2006, approximately $5.8 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 9.25% as of December 31,
2006.
Note
11 - Short Term Notes Payable
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 was equal to $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 $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.
|
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 second
note is dated July 22, 2005 and originally matured on September 22, 2005. 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 ISI, 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 ISI. This note bears interest at
5%
per annum and matured on October 28, 2006. Due to a dispute between the Company
and the noteholders, as of December 31, 2006, this note has not been
repaid.
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.
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 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.
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 was amortized to interest expense during
2006. The assumptions used in the relative fair value calculation were 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.
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 required 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 had allocated a portion of the offering proceeds to the warrants based
on their fair value. EITF 00-19 also required 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 were being
amortized over the term of the loan using the effective interest
method.
The
Company has previously restated the December 31, 2005 consolidated financial
statements and, as part of this restatement, the July 2005 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
Laurus agreements were amended again in February 2006 and this amendment was
treated as an early extinguishment of debt by the Company. The unamortized
discounts aggregating $2,084,000 and the fair value of the warrant and embedded
derivative liability amounting to $2,433,000 were included in the Company’s
determination of the debt extinguishment recorded in the first quarter of fiscal
2006. The aggregate gain of $349,000 from these transactions was accounted
for
as an extinguishment of debt and is included in other expenses for the year
ended December 31, 2006.
The
Company determined the fair value of the warrants as of the following issuance
dates:
As
of
December 31, 2004, the Company used the Black-Scholes option-pricing model
with
the following assumptions: 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 $0.53
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
was
approximately $349,000. The change in fair value of the warrants was
approximately ($2,432,000) for the year ended December 31, 2005.
The
Company performed the Black-Scholes calculation as of February 1, 2006 to
revalue the warrants just prior to the debt amendment which has been accounted
for as an early extinguishment of debt. In using this model, the Company used
an
expected life of 5.54 years; an underlying stock price of $0.70 per share;
no
dividends; a risk free rate of 4.51%; and a volatility of 150.0%. The resulting
aggregate allocated value of the warrants as of February 1, 2006 equaled
$468,496. Since all convertible features included in the previous Laurus
transactions were removed during the February 1, 2006 amendment, subsequent
to
the amendment, the warrants no longer met the requirements for accounting
treatment under EITF 00-19, “Accounting
for Derivative Financial Instruments Indexed To, and Potentially Settled In,
a
Company’s Own Stock”. As
a
result, the Company reclassified the fair value of the warrants, $703,567,
from
the financial instrument liability account to additional paid in
capital.
Using
a
probability-weighted discounted cash flow model, the fair value of the Compound
Embedded Derivative Liability was computed at $4,519,000 and $1,267,500 at
December 31, 2004 and December 31, 2005, respectively. Due to the early
extinguishment of the debt in February 2006, there was no accounting derivative
accounting required subsequent to that date. 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.
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. This registration rights agreement 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 was amortized over the
one year 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
December 31, 2004, the Company used the Black-Scholes option-pricing model
with
the following assumptions: 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
was $46,000 and was 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 September 2004 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.
For
the
year ended December 31, 2005, the Company performed the Black-Scholes
calculation to revalue the September 2005 warrants as of that date. In
using this model, the Company used an expected life of 3.00 years; an underlying
stock price of $0.53 per share, no dividends; a risk free rate of 4.37% and
a
volatility of 150.0%. The resulting aggregate allocated value of warrants
as of December 31, 2005 equaled $190,000.
For
the
year ended December 31, 2006, the Company performed the Black-Scholes
calculation to revalue the warrants issued in September 2004 as of that date.
In
using this model, the Company used an expected life of 1.69 years; an underlying
stock price of $0.34 per share; no dividends; a risk free rate of 4.82% and
volatility of 97.0%. The resulting aggregate allocated value of the warrants
as
of December 31, 2006 equaled $19,000. The change in fair value of the warrants
resulted in a decrease of the liability of ($122,000) and is included as a
component of financial instruments for the year ended December 31, 2006.
Additionally,
for the year ended December 31, 2006, the Company performed the Black-Scholes
calculation to revalue the warrants issued in September 2005 as of that date.
In
using this model, the Company used an expected life of 2.49 years; an underlying
stock price of $0.34 per share; no dividends; a risk free rate of 4.72% and
volatility of 100.0%. The resulting aggregate allocated value of the warrants
as
of December 31, 2006 equaled $33,000. The change in fair value of the warrants
resulted in a decrease of the liability of ($158,000) and is included as a
component of financial instruments for the year ended December 31,
2006.
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.
Using
a
probability-weighted discounted cash flow model, the fair value of the Compound
Embedded Derivative Liability was computed at $1,428,000 at December 31, 2004.
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 $889,000 and $0 at
December 31, 2005 and 2006, 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
as of December 31,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
Assumption:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-free
interest rate
|
|
|
4.72
|
%
|
|
4.41
|
%
|
|
3.25
|
%
|
Prime
rate - increasing .25% each quarter
|
|
|
8.25
|
%
|
|
7.25
|
%
|
|
5.25
|
%
|
Registration
default - increasing 1% monthly up to 5%
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Default
status - increasing .25% monthly
|
|
|
5
|
%
|
|
5
|
%
|
|
5
|
%
|
Alternative
financing available - increasing 5% monthly up to 25%
|
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Trading
volume, gross 22 day volume
|
|
|
309,104
|
|
|
541,800
|
|
|
363,610
|
|
Monthly
increase
|
|
|
|
|
|
1
|
%
|
|
2
|
%
|
Annual
growth rate of stock price
|
|
|
31.715
|
%
|
|
31.485
|
%
|
|
31.725
|
%
|
Future
projected volatility
|
|
|
150
|
%
|
|
150
|
%
|
|
150
|
%
|
Reset
provisions occurring
|
|
|
50
|
%
|
|
50
|
%
|
|
40
|
%
|
Weighted
average conversion reset price
|
|
|
-
|
|
|
1.098
|
|
|
1.52
|
|
Long-term
debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
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
|
|
|
|
|
|
|
|
|
|
Secured
non-convertible term note with a maturity date of December 31, 2007.
Interest accrues at a rate of prime plus one percent. As of December
31,
2006, the interest rate on this note was 9.25%. See note 10 - Line
of
credit for further description of this transaction.
|
|
|
545,454
|
|
|
-
|
|
|
|
|
|
|
|
|
|
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.
|
|
|
44,051
|
|
|
148,393
|
|
|
|
|
2,589,505
|
|
|
3,879,698
|
|
|
|
|
|
|
|
|
|
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 term of the related debt agreements, which range from three to
five
years.
|
|
|
(241,666
|
)
|
|
(341,662
|
)
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
2,347,839
|
|
|
3,538,036
|
|
|
|
|
|
|
|
|
|
Less:
Current portion of long-term debt, including obligations under capital
leases of $33,231 and current portion of long term debt of $545,454
as of
December 31, 2006 and current portion of capital leases of $104,342
and
current portion of long term debt of $390,780 as of December 31,
2005.
|
|
|
(578,685
|
)
|
|
(495,122
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
1,769,154
|
|
$
|
3,042,914
|
|
|
|
|
|
|
|
|
|
Future
annual payments of long-term debt is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years
Ending
|
|
|
|
|
|
|
|
2006
|
|
$
|
-
|
|
$
|
495,122
|
|
2007
|
|
|
578,685
|
|
|
1,373,756
|
|
2008
|
|
|
10,820
|
|
|
10,820
|
|
2009
|
|
|
2,000,000
|
|
|
2,000,000
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,589,505
|
|
$
|
3,879,698
|
|
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
$100,000.
The
following schedule lists future minimum lease payments under the capital leases
with their present value as of December 31, 2006:
|
|
December
31, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
2006
|
|
$ |
|
|
$ |
122,125
|
|
2007
|
|
|
37,451
|
|
|
37,451
|
|
2008
|
|
|
11,523
|
|
|
11,523
|
|
|
|
|
|
|
|
|
|
|
|
|
48,974
|
|
|
171,099
|
|
Less:
Amount representing interest
|
|
|
(4,923
|
)
|
|
(22,706
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
44,051
|
|
$
|
148,393
|
|
During
2006, 2005 and 2004, the Company recorded depreciation expense related to
equipment under capital leases of approximately $0, $0.1 million and $0.1
million, respectively.
In
June
2004, the Company issued a five-year $2.0 million unsecured convertible line
of
credit note. 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.
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,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Current
- Federal
|
|
$
|
-
|
|
$
|
-
|
|
Current
- State
|
|
|
-
|
|
|
-
|
|
Deferred
- Federal
|
|
|
-
|
|
|
-
|
|
Deferred
- State
|
|
|
-
|
|
|
-
|
|
|
|
$ |
- |
|
$
|
-
|
|
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 $25.8 million of net operating loss carry-forwards for both federal
and state purposes expiring between 2023 and 2026.
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Net
operating losses
|
|
$
|
10,321,000
|
|
$
|
8,661,000
|
|
Accounts
receivable
|
|
|
82,000
|
|
|
195,000
|
|
Property
and equipment
|
|
|
38,000
|
|
|
(1,000
|
)
|
Accounts
payable and accrued expenses
|
|
|
15,000
|
|
|
(3,000
|
)
|
Debt
|
|
|
(56,000
|
) |
|
(26,000
|
)
|
Goodwill
|
|
|
199,000
|
|
|
268,000
|
|
Intangible
assets
|
|
|
(392,000
|
)
|
|
(592,000
|
)
|
Stock
based compensation
|
|
|
1,821,000
|
|
|
604,000
|
|
|
|
|
12,028,000
|
|
|
9,106,000
|
|
Valuation
allowance
|
|
|
(12,391,400
|
)
|
|
(9,469,400
|
)
|
|
|
$
|
(363,400
|
)
|
$
|
(363,400
|
)
|
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 $12,391,400 and $9,469,400 for the years ended December 31, 2006 and 2005,
respectively, representing a current year change in the valuation allowance
of
($2,922,000). 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,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Provision
for Federal taxes at statutory rate (34%)
|
|
|
(34.0
|
%)
|
|
(34.0
|
%)
|
State
taxes, net of Federal benefit
|
|
|
(4.6
|
%)
|
|
(4.0
|
%)
|
Permanent
difference due to non-deductible items
|
|
|
1.6
|
%
|
|
11.1
|
%
|
Incentive
stock option compensation |
|
|
4.9 |
%
|
|
- |
%
|
Goodwill
impairment |
|
|
1.2 |
%
|
|
- |
%
|
Valuation
allowance applied against income tax benefit
|
|
|
30.9
|
%
|
|
26.9
|
%
|
|
|
|
|
|
|
|
|
Income
tax provision
|
|
|
0.0
|
%
|
|
0.0
|
%
|
Note
15 - Common Stock
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.
On
December 29, 2006, the Company entered into a Stock Purchase Agreement with
certain investors, pursuant to which the Company issued 3,000,000 shares of
the
Company's common stock, $0.001 par value, and the Company received proceeds
of
$750,000. Pursuant to the Stock Purchase Agreement, the Investors were also
granted a warrant to purchase 1,500,000 shares of the Company's common stock,
exercisable at a price of $0.30 per share (subject to adjustment). The warrant
is exercisable for a period of five years.
Note
16 - Preferred Stocks
In
February 2006, we entered into a Securities Purchase Agreement with investors
represented by Taurus, pursuant to which we issued 19,000 shares of our
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.
We received proceeds of $1,900,000. 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 our election, 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 adjustment). 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 the Taurus investors, on February 1, 2011.
Pursuant to the Securities Purchase Agreement, the Taurus investors were also
granted a warrant to purchase 1,900,000 shares of our common stock exercisable
at a price of $0.60 per share (subject to adjustment), exercisable for a period
of five years.
Using
the
Black-Scholes option pricing model, the Company calculated the relative fair
value of the warrant to purchase 1,900,000 shares of Company common stock to
be
approximately $1,128,000. This relative fair value has been recorded as a
reduction of the $1,900,000 mezzanine equity balance for the preferred stock
and
an addition to additional paid-in capital. The assumptions used in the relative
fair value calculation are as follows: Company stock price on February 2, 2006
of $1.49 per share; exercise price of the warrants of $0.60 per share; five
year
term; volatility of 187.13%; annual rate of dividends of 0%; and a risk free
interest rate of 4.82%. Additionally, the Company calculated a beneficial
conversion feature charge related to the conversion price for the preferred
stock to common stock of approximately $772,000.
In
August
2006, we entered into a Stock Purchase Agreement with an investor represented
by
Taurus, pursuant to which we issued 20,000 shares of our newly created
Series B Convertible Preferred Stock, $.001 par value (the “Series B
Preferred”). Each share of Series B Preferred has a stated value of $100.00. We
received proceeds of $2,000,000. The Series B Preferred has a cumulative annual
dividend equal to the Prime Rate plus one percent (1%), which is payable
monthly in cash or common stock, at our election, and is convertible into
shares of our common stock at any time at a price equal to the lower of (1)
$0.85 or (2) the average daily volume weighted market price for the five
consecutive trading days immediately prior to the date for which such price
is
determined, with a minimum price of $0.50. In addition, the Series B Preferred
has no voting rights, but has liquidation preferences and certain other
privileges. Pursuant to the Stock Purchase Agreement, warrants to purchase
1,276,471 shares of our common stock were issued, exercisable
at a price of $0.94 per share (subject to adjustment), and exercisable for
a
period of five years.
Using
the
Black-Scholes option pricing model, the Company calculated the relative fair
value of the warrants to purchase 1,276,471 shares of Company common stock
to be
approximately $593,000. This relative fair value has been recorded as a
reduction of the $2,000,000 mezzanine equity balance for the preferred stock
and
an addition to additional paid-in capital. The assumptions used in the relative
fair value calculation are as follows: Company stock price on August 11, 2006
of
$0.70 per share; exercise price of the warrants of $0.94 per share; five year
term; volatility of 175.44%; annual rate of dividends of 0%; and a risk free
interest rate of 4.97%. Additionally, the Company calculated a beneficial
conversion feature charge related to the conversion price for the preferred
stock to common stock of approximately $240,000.
Note
17 - Treasury Stock
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
December 2006, the Company sold 3,000,000 shares of its common stock to an
investor for $750,000. Treasury shares were re-issued during this transaction
and a charge to retained earnings was recorded for the difference between the
$0.475 per share acquisition cost and the $0.25 per share price at which the
shares were re-issued.
Note
18 - 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
$1.575 per share and an expiration date of June 7, 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 15, 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 $2.10 per share. The warrants expire on September 7,
2008. See Note 11 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 $2.10 per share. The warrants expire on December 15,
2009. See Note 11 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 December
18, 2008. See Note 11 for further discussion of this transaction. Additionally,
on February 1, 2006, the Company granted a warrant to purchase an aggregate
of
277,777 shares of the Company’s common stock to Taurus Advisory Group, LLC in
consideration for granting the Company an extension on the maturity of the
note.
The warrant has an exercise price of $0.75 per share and expires on January
31,
2009. On March 1, 2006, the Company granted a warrant to purchase an aggregate
of 554,000 shares of the Company’s common stock to Taurus Advisory Group, LLC in
consideration for granting the Company a further extension of the maturity
date
of the note. The warrant has an exercise price of $1.30 per share and expires
on
February 28, 2009.
On
February 2, 2006, the Company granted a warrant to purchase an aggregate of
1,900,000 shares of the Company’s common stock to Taurus Advisory Group, LLC in
connection with the sale of 19,000 shares of the Company’s Series A preferred
stock. The warrant has an exercise price of $0.60 per share and expires on
January 30, 2011. See Note 16 for further discussion of this
transaction.
In
August
2006, in connection with the sale of Series B preferred stock, warrants to
purchase 1,276,471 shares of our common stock were issued exercisable
at a price of $0.94 per share (subject to adjustment), and expiring on August
10, 2011. See Note 16 for further discussion of this transaction.
In
December 2006, the Company issued a warrant to purchase 1,500,000 shares of
the
Company’s common stock to TAG Virgin Islands, Inc. investors. The warrant is
exercisable at a price of $0.30 per share and expires on December 28, 2011.
See
Note 15 for further discussion of this transaction.
Note
19 - Stock Based Compensation
The
2003
Incentive Plan (“2003 Plan”) authorizes the issuance of up to 10,000,000 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
2006:
|
|
Shares
|
|
Weighted
average exercise price
|
|
|
|
|
|
|
|
Options
outstanding at December 31, 2005
|
|
|
4,883,114
|
|
$
|
1.43
|
|
Options
granted
|
|
|
4,570,000
|
|
|
0.38
|
|
Options
exercised
|
|
|
(40,100
|
)
|
|
1.23
|
|
Options
canceled
|
|
|
(2,576,899
|
)
|
|
1.21
|
|
Options
outstanding at December 31, 2006
|
|
|
6,836,115
|
|
$
|
1.21
|
|
The
following table summarizes information concerning outstanding and exercisable
Company common stock options at December 31, 2006:
Range
of exercise prices
|
|
Options
outstanding
|
|
Weighted
average exercise price
|
|
Weighted
average remaining contractual life
|
|
Options
exercisable
|
|
Weighted
average exercise price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.250
|
|
|
2,630,000
|
|
$
|
0.250
|
|
|
9.8
|
|
|
50,000
|
|
$
|
0.250
|
|
$0.30-0.70
|
|
|
1,455,000
|
|
|
0.490
|
|
|
9.6
|
|
|
1,001,666
|
|
|
0.450
|
|
$0.825-0.830
|
|
|
1,738,785
|
|
|
0.830
|
|
|
8.1
|
|
|
812,097
|
|
|
0.830
|
|
$2.475-3.45
|
|
|
1,012,330
|
|
|
2.720
|
|
|
7.3
|
|
|
741,529
|
|
|
2.700
|
|
|
|
|
6,836,115
|
|
|
|
|
|
|
|
|
2,605,292
|
|
|
|
|
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, were 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 recorded a
stock-based compensation charge of approximately $1,380,000 during 2004.
Note
20 - 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,
|
|
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations (A)
|
|
$
|
(11,661,778
|
)
|
$
|
(4,014,302
|
)
|
$
|
(22,697,298
|
)
|
Income
(loss) from discontinued operations (B)
|
|
$
|
2,050,000
|
|
$
|
(1,103,971
|
)
|
$
|
(12,650,908
|
)
|
Net
loss (C)
|
|
$
|
(9,611,778
|
)
|
$
|
(5,118,273
|
)
|
$
|
(35,348,206
|
)
|
Net
loss attributable to common stockholders
|
|
$
|
(10,204,128
|
)
|
$
|
(5,118,273
|
)
|
$
|
(35,348,206
|
)
|
Weighted
average common shares used to compute income (loss) per common
share
|
|
|
|
|
|
|
|
|
|
|
(D)
|
|
|
51,792,504
|
|
|
52,919,340
|
|
|
46,548,065
|
|
Common
stock and common stock equivalents (E)
|
|
|
51,792,504
|
|
|
52,919,340
|
|
|
46,548,065
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
From
continuing operations (A/D)
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations (B/D)
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per common share (C/D)
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
Net
loss attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
From
continuing operations (A/E)
|
|
$
|
(0.23
|
)
|
$
|
(0.08
|
)
|
$
|
(0.49
|
)
|
From
discontinued operations (B/E)
|
|
$
|
0.04
|
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Net
loss per common share (C/E)
|
|
$
|
(0.19
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
Net
loss attributable to common stockholders
|
|
$
|
(0.20
|
)
|
$
|
(0.10
|
)
|
$
|
(0.76
|
)
|
For
the
years ended December 31, 2006, 2005, and 2004, 6,836,115 shares, 4,883,114
shares, and 2,751,063 shares, respectively, attributable to outstanding stock
options were excluded from the calculation of diluted loss per share because
the
effect was antidilutive. Additionally, the effect of 1,477,778 warrants which
were issued during 2004, 677,777 warrants which were issued during 2005, and
5,508,248 warrants which were issued in 2006 were excluded from the calculation
of diluted loss per share for the years ended December 31, 2006, 2005 and 2004,
as appropriate, because the effect was antidilutive. Also excluded from the
calculation of loss per share because their effect was antidilutive were
1,269,841 shares of common stock underlying the $2,000,000 convertible line
of
credit note to Taurus, 591,429 shares of common stock underlying the convertible
promissory note to Sands, 7,800,000 shares underlying the Series A and Series
B
convertible preferred stock, and 1,500,000 options outstanding to
Laurus.
Note
21 - Major Customers
During
2006, the Company had sales to three major customers, Sapphire Technologies
(17.6%) Comsys (9.7%), and LEC, a related party (9.7%), which totaled
approximately $9,470,000. Amounts due from these customers included in accounts
receivable were approximately $1,764,000 at December 31, 2006. Sapphire
Technologies, Comsys, and LEC accounted for approximately 28.2%, 4.2%, and
7.5%
of the Company’s accounts receivable balance, respectively.
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
22 - 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, 2006, 2005 and 2004
were approximately $97,000, $81,000 and $44,000, respectively.
Note
23 - 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.
The
case was dismissed with prejudice in favor of CSI on December 4, 2006, and
the
Company is presently considering whether to continue its
countersuit.
In
July
2005, in conjunction with the acquisition of ISI, the Company issued a
subordinated promissory note in the principal amount of $165,000 payable to
Adam
Hock and Larry Hock (the “Hocks”), the former principal stockholders of ISI.
This note, along with $35,000 cash, was to be held in escrow for 15 months.
This
note matured on October 28, 2006. Pursuant to the indemnification provisions
of
the merger agreement among the Company and the Hocks, the $200,000 was to be
held in escrow to cover any liabilities by any failure of any representation
or
warranty of ISI or the Hocks to be true and correct at or before the closing,
and any act, omission or conduct of ISI and the Hocks prior to the closing,
whether asserted or claimed prior to, or at or after, the closing. After the
note matured, the Hocks requested the entire $200,000 from the Company, while
the Company, after offsetting certain undisclosed liabilities, responded that
the entire amount owed is significantly less. The Hocks then filed a lawsuit
in
the State of Florida on December 22, 2006 for recovery of the entire $200,000.
On March 1, 2007, a circuit court in Hillsborough County, Florida denied the
Company’s motion to dismiss the lawsuit for lack of jurisdiction without
explanation to its ruling. The Company is appealing this decision. Management
believes the suit against the Company to be without merit and intends to
vigorously defend the Company against this action and is presently considering
a
countersuit.
On
March
21, 2007, we filed a lawsuit in the Superior Court of New Jersey against our
former employees, Timothy Furey and Craig Cordasco. We are alleging that
Messrs. Furey and Cordasco misappropriated confidential information, broke
their
outstanding contractual obligations to us, unfairly competed, and tortuously
interfered with economic gain. We are seeking injunctive relief and
monetary damages.
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.
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. Mr.
DeLeeuw’s contract was terminated as of December 31, 2006.
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. The Company has provided notification to the
landlord that this lease will not be extended subsequent to its March 31, 2007
expiration.
Rent
expense, including automobile rentals, totaled approximately $489,000, $461,000
and $420,000 in 2006, 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, 2006 are as follows:
Years
Ending December 31
|
|
Office
|
|
Automobiles
|
|
Total
|
|
|
|
|
|
|
|
|
|
2007
|
|
$
|
330,026
|
|
$
|
17,161
|
|
$
|
347,187
|
|
2008
|
|
|
247,384
|
|
|
-
|
|
|
247,384
|
|
2009
|
|
|
248,621
|
|
|
-
|
|
|
248,621
|
|
2010
|
|
|
230,741
|
|
|
-
|
|
|
230,741
|
|
2011
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
$
|
1,056,772
|
|
$
|
17,161
|
|
$
|
1,073,933
|
|
Note
24 - 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,
2006, 2005 and 2004, the Company invoiced LEC $2,478,342, $3,731,198 and
$3,837,065, respectively, for the services of consultants subcontracted to
LEC
by the Company. As of December 31, 2006, 2005 and 2004, the Company had accounts
receivable due from LEC of approximately $330,000, $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.
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 was to receive an aggregate amount of
$250,000 as compensation for services provided to the Company. During 2004
and
2005, an aggregate amount of $225,000 was paid to Dr. Mitchell for services
provided under this consulting agreement.
As
of
December 31, 2006, 2005, and 2004, Mr. Newman’s outstanding loan balance to the
Company was $0, $900,000, and $200,000, respectively, and Mr. Peipert’s
outstanding loan balance to the Company was $111,000, $900,000, and $125,000,
respectively. 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
25 - Quarterly Information (unaudited)
The
following tables contain selected quarterly financial data for the fiscal years
2006 and 2005. Our Evoke Software Corporation subsidiary (“Evoke”) was sold in
July 2005 and, subsequent to that date, we accounted for Evoke as a discontinued
operation. As a result, the operating results of this business have been
segregated from continuing operations in our financial statements and in these
tables.
|
|
For
the three months ended:
|
|
|
|
March
31,
|
|
June
30,
|
|
September
30,
|
|
December
31,
|
|
|
|
2006
|
|
2006
|
|
2006
|
|
2006
|
|
Revenue
|
|
$
|
6,839,882
|
|
$
|
6,635,443
|
|
$
|
6,067,143
|
|
$
|
6,131,589
|
|
Gross
profit
|
|
|
1,443,928
|
|
|
1,596,269
|
|
|
1,146,863
|
|
|
1,556,063
|
|
Loss
from operations
|
|
|
(1,437,073
|
)
|
|
(1,205,023
|
)
|
|
(2,020,690
|
)
|
|
(1,269,333
|
)
|
Loss
from continuing operations
|
|
|
(6,876,198
|
)
|
|
(1,403,592
|
)
|
|
(1,902,487
|
)
|
|
(1,479,501
|
)
|
Income
from discontinued operations
|
|
|
2,050,000
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Net
loss
|
|
|
(4,826,198
|
)
|
|
(1,403,592
|
)
|
|
(1,902,487
|
)
|
|
(1,479,501
|
)
|
Net
loss attributable to common stockholders
|
|
$
|
(4,905,364
|
)
|
$
|
(1,522,342
|
)
|
$
|
(2,079,502
|
)
|
$
|
(1,696,920
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
loss per common share from continuing operations
|
|
$
|
(0.13
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.03
|
)
|
Basic
income per common share from discontinued operations
|
|
$
|
0.04
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Basic
loss per common share
|
|
$
|
(0.09
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.03
|
)
|
Basic
loss per common share attributable to common stockholders
|
|
$
|
(0.09
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.04
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
loss per common share from continuing operations
|
|
$
|
(0.13
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.03
|
)
|
Diluted
income per common share from discontinued operations
|
|
$
|
0.04
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Diluted
loss per common share
|
|
$
|
(0.09
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.03
|
)
|
Diluted
loss per common share attributable to common stockholders
|
|
$
|
(0.09
|
)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.04
|
)
|
Weighted
average common shares used to compute income (loss) per common
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,658,897
|
|
|
49,988,634
|
|
|
51,921,996
|
|
|
53,577,979
|
|
Diluted
|
|
|
51,658,897
|
|
|
49,988,634
|
|
|
51,921,996
|
|
|
53,577,979
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the three months ended:
|
|
|
|
March
31,
|
|
|
June
30,
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
|
2005
|
|
Revenue
|
|
$
|
6,245,115
|
|
$
|
6,583,837
|
|
$
|
7,700,423
|
|
$
|
7,100,534
|
|
Gross
profit
|
|
|
1,704,660
|
|
|
1,817,271
|
|
|
1,915,649
|
|
|
1,659,926
|
|
Loss
from operations
|
|
|
(1,254,117
|
)
|
|
(989,691
|
)
|
|
(1,607,056
|
)
|
|
(2,224,244
|
)
|
Income
(loss) from continuing operations
|
|
|
(2,256,782
|
)
|
|
2,352,587
|
|
|
(5,085,874
|
)
|
|
975,767
|
|
Income
(loss) from discontinued operations
|
|
|
(583,296
|
)
|
|
(365,491
|
)
|
|
(146,727
|
)
|
|
(8,457
|
)
|
Net
income (loss)
|
|
|
(2,840,078
|
)
|
|
1,987,096
|
|
|
(5,232,601
|
)
|
|
967,310
|
|
Net
income (loss) attributable to common stockholders
|
|
$
|
(2,840,078
|
)
|
$
|
1,987,096
|
|
$
|
(5,232,601
|
)
|
|
967,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) per common share from continuing operations
|
|
$
|
(0.05
|
)
|
$
|
0.05
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
Basic
income (loss) per common share from discontinued
operations
|
|
$
|
(0.01
|
)
|
$
|
(0.01
|
)
|
$
|
-
|
|
$
|
-
|
|
Basic
income (loss) per common share
|
|
$
|
(0.06
|
)
|
$
|
0.04
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
Basic
income (loss) per common share attributable to common
stockholders
|
|
$
|
(0.06
|
)
|
$
|
0.04
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
income (loss) per common share from continuing operations
|
|
$
|
(0.05
|
)
|
$
|
0.05
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
Diluted
income (loss) per common share from discontinued
operations
|
|
$
|
(0.01
|
)
|
$
|
(0.01
|
)
|
$
|
-
|
|
$
|
-
|
|
Diluted
income (loss) per common share
|
|
$
|
(0.06
|
)
|
$
|
0.04
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
Diluted
income (loss) per common share attributable to common
stockholders
|
|
$
|
(0.06
|
)
|
$
|
0.04
|
|
$
|
(0.10
|
)
|
$
|
0.02
|
|
Weighted
average common shares used to compute income (loss) per common
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,531,664
|
|
|
52,344,049
|
|
|
53,676,751
|
|
|
54,093,866
|
|
Diluted
|
|
|
51,531,664
|
|
|
52,344,049
|
|
|
53,676,751
|
|
|
54,093,866
|
|
Information
previously reported on Form 10Q has been modified in this disclosure due to
a
reclassification of accretion of issuance costs associated with convertible
preferred stock from interest expense to a component of the net loss
attributable to common stockholders as follows:
|
|
For
the three months ended:
|
|
|
|
March
31, 2006
|
|
June
30, 2006
|
|
September
30, 2006
|
|
|
|
As
reported
|
|
Restated
|
|
As
reported
|
|
Restated
|
|
As
reported
|
|
Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
$
|
978,381
|
|
$
|
915,048
|
|
$
|
1,019,498
|
|
$
|
924,498
|
|
$
|
729,624
|
|
$
|
605,249
|
|
Income
(loss) from continuing operations
|
|
|
(6,939,531
|
)
|
|
(6,876,198
|
)
|
|
(1,498,592
|
)
|
|
(1,403,592
|
)
|
|
(2,026,862
|
)
|
|
(1,902,487
|
)
|
Net
income (loss)
|
|
|
(4,889,531
|
)
|
|
(4,826,198
|
)
|
|
(1,498,592
|
)
|
|
(1,403,592
|
)
|
|
(2,026,862
|
)
|
|
(1,902,487
|
)
|
Accretion
of issuance costs associated with convertible preferred
stock
|
|
|
-
|
|
|
63,333
|
|
|
-
|
|
|
95,000
|
|
|
-
|
|
|
124,375
|
|
Net
income (loss) attributable to common stockholders
|
|
$
|
(4,905,364
|
)
|
$
|
(4,905,364
|
)
|
$
|
(1,522,342
|
)
|
$
|
(1,522,342
|
)
|
$
|
(2,079,502
|
)
|
$
|
(2,079,502
|
)
|
Note
26 - Subsequent Events
On
September 22, 2005, upon maturity of the September 2004 notes, the Company
issued Amended and Restated Senior Subordinated Convertible Promissory Notes
to
Sands Brothers Venture Capital LLC, to Sands Brothers Venture Capital III LLC,
and to Sands Brothers Venture Capital IV LLC (the "Notes") equaling $1.080
million in the aggregate, each with an annual interest rate of 12% expiring
on
January 1, 2007. Sands Brothers Venture Capital LLC, Sands Brothers Venture
Capital III LLC and Sands Brothers Venture Capital IV LLC, in exchange for
an
extension fee of $15,000, agreed to extend the Maturity Date to February 1,
2007
and then, upon maturity and in exchange for a $150,000 payment to be applied
against the principal balance outstanding on the Notes, agreed to extend the
maturity date to March 1, 2007. All other terms of the Notes remain in full
force and effect. On March 1, 2007, the Company, and each of Sands Brothers
Venture Capital LLC, Sands Brothers Venture Capital III LLC and Sands Brothers
Venture Capital IV LLC (collectively, the "Funds"), have agreed that the Company
will pay the Funds $900,000 cash during 2007, as well as issue shares of Common
Stock and warrants to purchase Common Stock as final payment to satisfy the
Sands Notes in full. The Company made its first two cash payments totaling
$500,000 on March 7, 2007.
On
February 1, 2007, the Company issued a 10% Unsecured Promissory Note (the
“Note”) to an investor represented by TAG Virgin Islands, Inc., for $705,883.
The Note matured on March 1, 2007. This Note was retired and included as part
of
the March 1, 2007, 10% Note in the principal amount of $4,000,000.
On
March
1, 2007, the Company issued a 10% Convertible Unsecured Note (the "Note") to
certain investors represented by TAG Virgin Islands, Inc. (the "Investor")
for
$4,000,000. The Note will automatically convert into 13,333,333 shares of the
Company's common stock upon the effectiveness of the Information Statement
on
Schedule 14C, filed preliminarily by the Company with the Securities and
Exchange Commission on March 8, 2007 (the "Information Statement"). The Investor
was also granted a warrant (the "Warrant") to purchase 13,333,333 shares of
the
Common Stock, exercisable at a price of $0.33 per share (subject to adjustment).
The Warrant is exercisable for a period of five years. Pursuant to a
Registration Rights Agreement, the Company agreed to file a registration
statement covering the shares of Common Stock underlying the Note and the
Warrant. Such registration rights are more fully set forth in the Registration
Rights Agreement. .
The
note
was subsequently amended in March 2007 to $4.25 million and the number of shares
of common stock that the note will convert into was increased to 14,166,667
shares of our common stock. Additionally, the warrant was also amended to
entitled the investor to purchase 14,166,667 shares of our common stock,
exercisable at a price of $0.33 per share (subject to adjustment). The warrant
is exercisable for a period of five years.
The
Information Statement relates to a stockholder action which has been approved
by
written consent of stockholders of the Company who hold approximately 56% (in
excess of a majority) of the voting power of the Common Stock. Such stockholder
action has approved: (i) a Certificate of Amendment to the Certificate of
Incorporation of the Company (the "Certificate of Amendment") pursuant to which
the authorized Common Stock of the Company under the Certificate of
Incorporation, as amended, will be increased from 100,000,000 shares up to
200,000,000 shares of such Common Stock, to be effective as of the filing of
the
Certificate of Amendment with the Delaware Secretary of State, and (ii)
as
required by the rules of the American Stock Exchange, the issuance of the Note
that, upon exercise and conversion thereof, would result in the issuance in
an
aggregate amount greater than 20% of our outstanding shares of Common Stock.
In
accordance with Rule 14c-2 under the Securities Exchange Act of 1934, as
amended, the stockholder action is expected to become effective twenty
(20)
calendar days following the mailing of the Information Statement, or as soon
thereafter as is reasonably practicable.
Pursuant
to the Overadvance Side Letter (the "Letter") dated as of February 1, 2006
among
the Company, its subsidiaries and Laurus. The Company was to pay Laurus
approximately $258,424 per month, starting February 1, 2007, until the aggregate
principal amount of $3,101,084 is paid in full (the Company made the first
two
payments in February 2007). The Company and Laurus have agreed that the Company
will pay to Laurus $2,084,237 and issue a warrant to purchase 1,785,714 shares
of Common Stock at an exercise price of $0.01 as final payment to satisfy the
Letter in full. This agreement is reflected in the Omnibus Amendment and Waiver
No. 2 among the Company, CSI Sub Corp. (DE), DeLeeuw Associates, Inc. and
Laurus, as well as an Amended and Restated Registration Rights Agreement.
Additionally, the Company, CSI Sub Corp. (DE), DeLeeuw Associates, Inc. and
Laurus entered into that certain Assumption, Adoption and Consent Agreement,
detailing an agreement among the parties related to the Company's corporate
consolidation. Finally, on March 7, 2007, the Company satisfied the outstanding
amount on that certain Secured Non-Convertible Term Note, issued to Laurus
on
February 1, 2006, with a cash payment to Laurus of $409,722.
On
January 29, 2007, the Company announced that it received notice from the Staff
of the American Stock Exchange indicating that the Company no longer complies
with the Exchange's continued listing standards due to the Company's inability
to maintain compliance with certain AMEX continued listing requirements, as
set
forth in Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iv) of the AMEX Company
Guide and its plan of compliance submitted in July 2006, and that its securities
are subject to be delisted from the Exchange. The Company received notice on
June 29, 2006, from the Staff indicating that the Company was below certain
of
the Exchange's continued listing standards. The Company was afforded the
opportunity to submit a plan of compliance to the Exchange; and on July 31,
2006, the Company presented its plan to the Exchange. On September 26, 2006,
the
Exchange notified the Company that it accepted the Company's plan of compliance
and granted the Company an extension until December 28, 2007, to regain
compliance with the continued listing standards.
The
Company has filed an appeal of this determination and has a hearing before
a
committee of AMEX planned for April 2007. Once filed, the appeal automatically
stays the delisting of the Company's common stock pending a hearing date and
the
Exchange's decision. The time and place of such a hearing will be determined
by
the Exchange. There can be no assurance that the Company's request for continued
listing will be granted. If the committee does not grant the relief sought
by
the Company, its securities will be delisted from the Exchange and may continue
to be quoted on the OTC Bulletin Board.
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:
September
5, 2007
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/s/
Scott
Newman |
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Scott
Newman |
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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
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Title
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Date
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/s/
Scott Newman
Scott
Newman
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President,
Chief Executive Officer and Chairman
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September
5, 2007
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/s/
William Hendry
William
Hendry
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Vice
President, Chief Financial Officer and Treasurer
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/s/
Glenn Peipert
Glenn
Peipert
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Executive
Vice President, Chief Operating Officer and Director
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/s/
Lawrence K. Reisman
Lawrence
K. Reisman
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Director
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/s/
Thomas Pear
Thomas
Pear
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Director
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/s/
Frederick Lester
Frederick
Lester
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Director
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