Item 1. Description of Business
We are a leading national computer and communications technology management company providing information technology (“IT”) networking, communications, software applications and data center services, including secure access, voice over internet protocol (“VOIP”), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Business Strategy
There is a rapidly growing trend among companies to outsource their computer services requirements. This entails client companies obtaining all or a portion of their data processing and related requirements from solution providers, such as us, that specialize in the technology service, product or application required by these client companies. Our strategy is to be the national leader in providing sophisticated network solutions to the middle market using a combination of carefully managed internal growth and acquisitions. We offer our clients selective outsourced infrastructure solutions at competitive prices. We are focusing our efforts on developing our higher margin recurring service offerings, while maintaining control over our expenses and improving our balance sheet. These services include our outsourced support services; contract programming; voice over internet protocol (VOIP) solutions; network consulting; network management and monitoring; security solutions; collaboration solutions focused primarily on Microsoft Exchange; data storage (including disaster recovery and data back-up) and IT staff augmentation.
Since 1991, we have evolved to become a provider of IT managed solutions. We are focusing our current marketing efforts in accelerating growth in such areas. Services accounted for approximately 28% of our revenues for the fiscal year ended March 31, 2005, as compared to approximately 25% in the fiscal year ended March 31, 2004, with a small portion of these revenues derived from maintenance and repair services. The trend toward services revenue has accelerated, however as a result of our acquisition program, with service revenue accounting for approximately 30% of our revenue in the quarter ended March 31, 2005.
Our acquisition program is an important part of our business strategy.
Acquisition Program
One of our principal goals is to grow our business through the acquisition of additional companies. These acquisitions would expand our business into geographic regions where we do not yet have a strong presence, strengthen our technical capabilities and provide new service offerings. These benefits would enable us to better service the needs of middle market business and divisions of large enterprises. To fund the cash portions of the acquisitions which we have made to date, we have relied on private institutional financing.
On January 29, 2004 we entered into an agreement (the “Pequot Purchase Agreement”) with Pequot to sell to Pequot an aggregate of up to $25 million of Series A Convertible Preferred Stock, together with warrants to purchase additional shares of common stock. We subsequently sold shares of Series A-1 Convertible Preferred Stock and Series A-2 Convertible Preferred Stock, in each case together with common stock warrants, to Pequot, to fund the cash portions of the
purchase prices for our acquisitions of DataVox Technologies, Inc. and Network Catalyst, Inc., respectively, referred to below.
On December 7, 2004, Pequot assigned to Constellation all of Pequot’s rights and obligations under the Pequot Purchase Agreement to purchase a portion of the shares of the Series A-3 Convertible Preferred Stock and common stock warrants covered by that agreement. On that date we also entered into a purchase agreement (the “Pequot/Constellation Purchase Agreement”) with Pequot and Constellation for up to $40 million (or in certain limited circumstances, up to $47.5 million) of additional financing in the form of 7% convertible secured notes in three tranches. We subsequently sold to Pequot and Constellation shares of Series A-3 Preferred Stock and common stock warrants under the Pequot Purchase Agreement, and Series A-4 First Tranche Notes under the Pequot/Constellation Agreement, to fund the cash portion of the purchase price for our acquisition of the Vector ESP entities; and Series A-4 Second Tranche Notes under the latter agreement to fund the cash portion of our purchase price for our acquisition of Info Systems, Inc. The Series A-4 First Tranche Notes and Series A-4 Second Tranche Notes were converted into shares of our Series A-4 Preferred Stock upon approval of such convertibility by our shareholders on June 23, 2005.
We believe that there is an opportunity to consolidate similar businesses throughout the United States. We will focus our acquisition strategy on businesses providing secure access, voice over internet protocol (VOIP), storage, networking and messaging solutions. The acquisition targets will include companies providing IT services and products, as well as certain managed solutions. We intend to seek acquisitions to enhance our current service offerings and extend our geographic presence. We seek to identify businesses which will add technical expertise and service offerings, customers, sales capabilities and/or geographic coverage while generating a positive rate of return on investment. Furthermore, we intend to capitalize on the business practices of acquired companies that we believe will best maintain or strengthen our competitive advantage and ensure ongoing delivery of high quality IT solutions to our customers. The acquisition candidates we may investigate can be large, and their acquisition by us could have a significant and lasting impact on our business.
In executing our growth-through-acquisition strategy during our 2005 fiscal year, we have acquired the businesses and operating assets of the first three of the following four companies, and all of the outstanding capital stock of the fourth one:
• DataVox Technologies, Inc., a Cisco AVVID (Architecture for Voice, Video and Integrated Data) authorized partner, offering advanced technology solutions, including IP telephony, security, storage, networking and wireless technologies solutions, as well as network facilities engineering and data center technology consulting and services.
• Network Catalyst, Inc., a provider of advanced technology solutions in the VOIP (voice over internet protocol), infrastructure and security fields to clients located throughout the Southern California region.
• Vector ESP, Inc. and Vector ESP Management, Inc., providers of secure access, consulting services, information technology products, technology solutions, applications, messaging and collaboration products and services, remote connectivity and workforce mobility products and services.
• Info Systems, Inc., a provider of VOIP, security and storage solutions, as well as telecommunications and structured cabling services, outsourced information technology (IT), staff augmentation and remote network monitoring, management and support services through its Network Operations Center.
Business Services
We are a leading national computer and communications technology management company providing IT networking, communications, software applications and data center services, including secure access, voice over internet protocol (VOIP), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-
critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution, from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Our services can be broadly categorized into the following:
• Managed services
• Consulting, integration and professional services
• IT outsourcing (including staff outsourcing)
• Product provisioning (including on-line purchasing)
• Repair and restorative services
Managed Services
We provide our clients with a suite of managed services through the use of our Pivot Technology system which includes our proprietary network management and monitoring software system. Our Pivot Technology system provides our clients with real-time monitoring of their computing and storage systems, VOIP systems and network infrastructure to immediately detect component failures, critical security events (such as, for example, hacking attempts), deteriorating performance and also to report on the health of these systems. The Pivot Technology system is a combination of our proprietary network management and monitoring software and best-of-breed third party licensed software. Monitoring of our clients’ networks is performed by our certified engineering staff operating on a 24x7x365 basis from two of our network operations centers (“NOC”). Our NOCs are located in Delaware and California.
In addition to monitoring, our managed services include managed hosting and a suite of hosted applications, including VOIP and e-mail. We offer our customers a choice of two collocation facilities to host their computing systems. Our field engineering resources are available in each of our regions to provide field support and technical resources in connection with our managed services.
Consulting, Integration and Professional Services
Our staff of certified technology professionals provide our clients with a full suite of services ranging from advanced configurations and complex project management, project logistics and planning. We provide design, consulting, implementation and support services in our seven areas of core competence. These are network infrastructure (including LAN, WAN and Wireless), VOIP, storage solutions, operating systems, security, facilities design and access infrastructure.
Our capability to address all phases of technology projects, from needs analysis and definition through implementation and support, allows us to offer our customers a single point of accountability for a broad range of technology projects. As technology infrastructure becomes progressively more sophisticated and complex, our clients demand total project accountability from a single vendor. With our national presence, engineering expertise, and extensive relationships with top tier vendors, we are able to undertake most technology infrastructure projects for our clients and provide them that critical single point of accountability.
We provide professional consulting services for most of the infrastructure technologies that our clients utilize. These include expertise in the technology of a number of leading manufactures of infrastructure technology. For example, we are a Cisco Gold partner, a Citrix Platinum Solutions Advisor, a Hewlett Packard Gold and Enterprise Storage Elite partner, Microsoft Gold partner, an Avaya Gold partner, a Captaris Platinum partner, and a Nortel Elite partner. For those
manufactures that we believe are critical to our client’s technology infrastructure we generally hold the highest level of certification granted by such manufacturers.
In many of our regions we operate large project staging facilities, where technology systems associated with of our clients’ complex projects are staged, configured, tested and verified prior to delivery to the clients’ premise. We also provide accredited and topic-specific professional training services for our clients at several training facilities across the United States. Each of these facilities is fully equipped with the necessary equipment and lab facilities specific to the curriculum being delivered. In addition, we frequently offer seminars and technology awareness events for the benefit of our existing and prospective clients.
IT Outsourcing
Many of our potential clients have adopted an approach to technology of focusing on their core business competencies, while outsourcing non-core technology systems. These clients, however, often find it more cost effective to outsource than to fund the cost of a full-time internal IT staff to operate the sophisticated technology systems necessary which support their core business. Additionally, some clients are faced with extensive legal and regulatory compliance mandates that require sophisticated technology solutions. Again, for some of these clients, maintaining a full-time internal staff to operate those systems is not feasible.
Our IT outsourcing solutions provide a cost effective solution to such clients by providing targeted support to fill gaps in their technology staffing on a project basis. We also offer solutions which allow clients to adopt a “pay-as-you-go” approach for supporting their IT requirements by providing hosted systems solutions that do not require substantial upfront capital investments. We believe that our technology outsourcing solutions allow our clients to achieve productivity enhancements, meet their legal and regulatory compliance requirements and improve financial performance by deploying advanced technologies on an outsourced basis. These solutions range from outsourcing of specific targeted business functions (such as application hosting, help desk operations) to strategy definition and execution on a virtual CIO basis.
For clients with defined staff augmentation needs, our IT outsourcing provides cost-effective staffing alternatives in connection with both long and short term client projects by maintaining an extensive staff of highly trained consultants meeting many of the same qualifications as those which our clients demand of our own professional staff resources.
Product Provisioning Services and On-line Sourcing
We provide all aspects of infrastructure technology product delivery to our clients. Through our relationships as a certified partner with most of the key top tier infrastructure technology product manufacturers and with key infrastructure technology distributors, we are able to provide our clients with cost-effective product sourcing solutions to meet their requirements for managed, timely and competitive product procurement.
We offer an on-line, web-based and secure product purchasing option for those clients who prefer a self-service alternative. Our eCommerce portal allows our clients to obtain product pricing, place unit or volume orders, and track the delivery process of their orders on line.
For clients who require their purchased products to be staged, pre-configured, field tested, assembled or integrated, we provide these services in one of two extensive staging facilities (in California and Connecticut). Staging can be provided with or without the client’s participation, as directed by the client.
Repair and Restorative Services
Many of our clients require a guaranteed response to their system outages. Through our national staff of certified technicians and related field resources, we provide service level guarantees to our customers in response to problems with their infrastructure technology outages that are communicated to us, or that are detected through our Pivot Technology monitoring
systems as part of a managed services solution. We offer our clients various degrees of guaranteed response depending on the severity of the outage or the client’s specific response requirements. Our technical staff providing these services is fully trained in and accredited with each of the vendors’ technology systems.
Industry
The network computer industry has become a multi-billion dollar industry since its development in the late 1970’s. Today, industry participants face intense competition, the challenge of constant technological advancement and the ongoing need for business process optimization. The outsourcing of computer solutions is a rapidly growing trend in which a client company obtains all or a portion of its data processing requirements from a systems integrator, such as us, that specializes in the computer service, product or application required by the client.
We believe the strongest demand for our IT services is among companies which typically lack the time and technical resources to satisfy all of their IT needs internally. These companies typically require sophisticated, experienced IT assistance to achieve their business objectives. These companies often rely on IT service providers to help implement and manage their systems. However, many of these companies rely on multiple providers for their IT needs. Generally, we believe that this reliance on multiple providers results from the fact that larger IT service providers do not target these companies, while smaller IT service providers lack sufficient breadth of services or industry knowledge to satisfy all of these companies’ needs.
Companies have recognized the importance of IT systems in supporting their business processes and are turning to IT solutions to complete more effectively. At the same time the process of designing, developing and implementing IT solutions has become increasingly complex. The accelerated rate of development of new technologies is placing increasing demand on our clients to understand the opportunity and impact which these technologies can have on their business. IT services organizations like ours are faced with an increasing demand to keep up with these developments so as to effectively serve as consultants and advisors to our clients.
During the period 2001 to 2004 following the burst of the “internet bubble,” the technology industry was impacted by a dramatic slowdown in IT spending. Companies refrained from funding critical technology projects necessary to keep up with the advances in IT, and often those necessary for the basic upkeep and maintenance of their installed technology base. Companies used the period of economic slowdown to reassess the return on investment associated with their past IT spending; and, we believe, concluded that past levels of IT spending can not be sustained at historical levels in today’s competitive marketplace. As such, future spending may increasingly be targeted and scrutinized from the standpoint of necessity and business impact. Importantly, companies have indicated that their intent is to focus on the effectiveness of IT solutions, not merely on the level of IT spending. This important development may result in the differentiation between technology providers who focus on offering total solutions versus those who focus on product resales.
Advances in virtualization at the device and application level have suggested a trend toward a centralized computing model. This cycle, which started with mainframes, then workgroup mini-computers, then highly distributed applications running on micro-computers and PCs, may now be returning to a model where an increasing portion of business applications are implemented in a centralized computing model, using increasingly sophisticated terminal services to access these applications. This shift may be one of the most significant developments driving the re-definition by IT service providers of product and service solutions for the foreseeable future.
Sales and Marketing
Our marketing efforts are focused on divisions of large corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipalities and educational institutions. Except for major corporate accounts, these customers generally do not have internal computer support personnel. We believe that the increasing complexity of computer
systems, increased usage of computers in the workplace and the trend toward network interconnecting will cause business and institutional customers to require significant levels of outsourced customer support services, such as those provided by us. We believe that these customers are increasingly relying on their dealers and suppliers to provide, in addition to competitive pricing, a one-stop solution-based approach to their data processing requirements. We use such an approach, which addresses purchasing, compatibility, maintenance, support, training and obsolescence.
Our customers are diversified in such industries as securities, financial institutions, pharmaceuticals, manufacturing, distribution, law and accounting firms as well as municipalities and educational institutions. For the years ended March 31, 2005, 2004 and 2003, approximately 20%, 34%, and 18% of our revenue was from one customer, Verizon Wireless. We entered into a three-year desktop maintenance and support contract with Verizon Wireless, which expired in April 2005. We continue to provide services to Verizon and are currently negotiating an extension to the agreement.
As of May 31, 2005, we employed 122 salespersons, sales assistants and marketing persons who are paid salaries, commissions and/or a combination of both. Our sales executives regularly call on management at companies seeking solutions for their computer problems.
We also make joint sales presentations with certain of our major suppliers to existing and prospective customers. Certain of these suppliers’ customer fulfillment option programs allow customers who purchase directly from the supplier to apply purchases from us to their purchase obligations under those agreements. As a result, these customers have the flexibility of purchasing products from us to take advantage of our added services and our ability to integrate multiple manufacturers’ products. Most major manufacturers have instituted either a moratorium or a selective authorization procedure on the approval of additional authorized dealership locations. While in effect, such policies may preclude us and certain of our competitors from becoming authorized dealers for new vendors.
Suppliers
We purchase software, computers and related products directly from numerous suppliers as either an authorized dealer or a value added reseller. We have entered into authorization agreements with our major suppliers. Typically, these agreements provide that we have been appointed, on a non-exclusive basis, as an authorized dealer and systems integrator of specified products of the supplier at specified locations. Most of the authorization agreements provide that the supplier may terminate the agreement with or without cause upon 30 to 90 days notice or immediately upon the occurrence of certain events. We believe that we have excellent relationships with our major suppliers; however, there can be no assurance that the aforementioned agreements will be renewed. If these agreements are not renewed, we may have difficulty in obtaining inventory at a sufficiently low cost to allow for resale at a competitive price.
Distributors and integrators in the computer industry currently face a number of adverse business conditions, including price and gross profit margin pressures and market consolidation. In recent years, major hardware vendors have instituted aggressive price reductions in response to lower component costs and discount pricing by certain computer manufacturers. The increased price competition among major hardware vendors has resulted in declining gross margins for many computer distributors and may result in a reduction in existing vendor subsidies. We believe that these current conditions, which are forcing certain of our direct competitors out of business, may present us with opportunities to expand our business. There can be no assurance, however, that we will be able to continue to compete effectively in this industry.
Pursuant to the terms of most of our authorized dealership agreements, we furnish firm purchase orders 30 to 90 days in advance of shipment. Under the terms of these agreements, we are generally liable for up to a 5% restocking fee to many manufacturers and suppliers for the return of previously received merchandise. We have not experienced any significant cancellation penalties or restocking fees to date.
We receive certain discretionary cost subsidies, typical for the industry, from certain major suppliers to promote sales and support activities relating to their products. We have used these funds to subsidize marketing, advertising and our connectivity and communication laboratory.
Our suppliers permit us to pass through to its customers all warranties and return policies applicable to the suppliers’ products. To date, we have experienced few returns of product and have been reimbursed by the suppliers for most warranty work done for its customers. All service work after the expiration of the warranty period is at the customer’s expense. We offer service contracts of varying lengths under which we agree to be responsible for all service costs for a fixed term in exchange for a set fee paid by the customer.
Software and other related products are purchased from numerous industry suppliers. As is customary, we do not have any long-term agreements or commitments with these suppliers, because competitive sources of supply are generally available for such products.
Competition
The markets in which we operate are highly competitive with respect to performance, quality and price. In our professional services business our competition ranges from small, specialty integrators, to other service providers of comparable size and profile to us, as well as large national and global professional services firms and integrators. Our smaller competitors generally are highly focused on their immediate market segment and can respond more quickly to changes in customer needs. Our larger competitors generally have greater financial resources and may be able to compete more effectively than we can on prices and payment terms offered to potential customers. In our product provisioning business we directly compete with local, regional and national distributors and mail order providers of computer and IT products and services, including network integrators and corporate divisions of retail superstores.
In addition, the computer and IT products and services industries have each experienced a significant amount of consolidation through mergers and acquisitions. In the future, we may face further competition from new market entrants and possible alliances between existing competitors. Further, certain computer superstores have expanded their marketing efforts to target segments of our customer base, which could have a material adverse impact on our operations and financial results. Some of our competitors have, or may have, greater financial, marketing and other resources than us. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, benefit from greater purchasing economies, offer more aggressive hardware and service pricing to customers, or devote greater resources to the promotion of their products and services. There can be no assurance that we will be able to compete successfully in the future with such competitors. We also compete with manufacturers, including those serving as our vendors, which market through direct sales forces and distributors. More aggressive competition by principal manufacturers of computer and IT products, such as offering a full range of services in addition to products, could have a material adverse effect on our operations and financial results.
We believe that we will continue to be able to compete effectively against our various competitors by combining fair pricing with a wide range of customer support services designed to provide our customers with high-end technological services, multi-vendor technical support, maintenance of their computer product needs, a dedicated, trained staff of salespersons and technicians, complete solutions for single user, multi-user or network systems and specialized vertical market software.
We believe that our backlog of unfilled customer orders is not material.
Proprietary Information
We do not hold any patents, but have several trademarks and service marks. We also may affix copyright notices on our support service, training and service manuals. While such protection may become important to use, it is not considered essential to the success of our business. We rely
on the know-how, experience and capabilities of our management, sales and service personnel. We require our employees to sign confidentiality or non-competition agreements.
Employees
Our growth-through-acquisition strategy has resulted in a substantial increase in the number of employees. As of May 31, 2004, prior to commencing our acquisition strategy, we employed 151 persons and as of May 31, 2005, after completing four acquisitions, we employed 616 persons, all but 30 of whom are full-time personnel. Of these employees, 15 were in management, 122 were in sales and marketing, 388 were in technical support, 91 were in operations, finance and administration.
As of June 29, 2005, none of our personnel was represented by a union. We consider our employee relations to be good. On May 21, 2005, we received a Notice of Filing of Petition for Union Representation Election for the cabling unit of our Info Systems, Inc. subsidiary. This unit comprises approximately 25 employees. An election with respect to union representation is scheduled for July 15, 2005.
Incorporation
We were incorporated on May 12, 1986 in the State of New York.
Item 2.
Item 2. Properties
Our principal executive offices are currently located at 850 Canal Street, Stamford, Connecticut. We occupy approximately 6,500 square feet at this location. The lease for this location expires in September, 2009. The monthly base rent for this location is approximately $11,800.
We are also responsible for real estate taxes, insurance, utilities and maintenance expenses relating to all of our other leased facilities. These expenses for all of our leased facilities including the Stamford, Connecticut facility totaled approximately $1.4 million for the year ended March 31, 2005.
Item 3.
Item 3. Legal Proceedings
None.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
Market for Our Common Stock
Our common stock is traded on The Nasdaq SmallCap Market under the symbol “MTMC.” Set forth in the following table is the range of the high and low bid quotations for our common stock for each of the quarters during our last two completed fiscal years, based upon data provided by Nasdaq. These quotations reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, and may not represent actual transactions.
Record Holders
As of June 15, 2005, there were 143 record holders of our common stock. We believe that there are approximately 1,100 beneficial holders of our common stock, based on information gathered in connection with the recently held special meeting of our shareholders.
Dividends
We have never declared or paid any dividends to the holders of our common stock and we do not expect to pay cash dividends in the foreseeable future. We currently intend to retain all earnings for use in connection with the further development of our business and for general corporate purposes. Our board of directors will have the sole discretion in determining whether to declare and pay dividends in the future. The declaration of dividends will depend on our profitability, financial condition, cash requirements, future prospects and other factors deemed relevant by our board of directors. In addition, provisions contained in our certificate of incorporation governing the terms of our Series A Convertible Preferred Stock, as well as our financing agreements with The CIT Group/Business Credit, Inc. (“CIT”) and Textron Financial Corporation (“Textron”), place restrictions on our ability to declare or make any cash dividends on our common stock. In addition, our ability to pay cash dividends on our common stock in the future could be further limited or prohibited by the terms of future financing agreements that we may enter into or by the terms of any preferred stock that we may authorize and issue.
Equity Compensation Plan Information
The following table sets forth, as of March 31, 2005:
• the number of shares of our common stock issuable upon exercise of outstanding options, warrants and rights, separately identified by those granted under equity incentive plans approved by our shareholders and those granted under plans, including individual compensation contracts, not approved by our shareholders (column A),
• the weighted average exercise price of such options, warrants and rights, also as separately identified (column B), and the number of shares remaining available for future issuance under such plans, other than those shares issuable upon exercise of outstanding options, warrants and rights (column C).
The shares issuable upon exercise of outstanding options, warrants and rights granted under plans not approved by shareholders consist of:
Equity Compensation Plan Information excludes warrants issued in connection with our Series A-4 First Tranche Notes and Series A-4 Second Tranche Notes as these warrants were not exercisable as of March 31, 2005. A total of 984,617 such warrants were issued as of March 31, 2005 with an exercise price of $4.06 per share.
Item 6.
Item 6. Selected Financial Data
The following selected financial data for the fiscal years ended March 31, 2005, 2004, 2003, 2002, and 2001 have been derived from our consolidated financial statements. This data should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K.
Income Statement Data:
Balance Sheet Data:
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our updated consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
Use of Estimates
The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America requires management to make estimates and assumptions that effect the amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Overview
We are a leading national computer and communications technology management company providing IT networking, communications, software applications and data center services, including secure access, voice over internet protocol (VOIP), storage, security and messaging solutions. We serve as a single source provider of advanced technology solutions to support our clients’ mission-critical business processes. Our clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
We provide services to our clients that address the full life cycle of a business solution, from needs analysis, through planning, solution development, deployment, and testing, to on-going maintenance and support. We act a single-source provider of business technology solutions to our clients, an increasingly mandated requirement in today’s marketplace.
Critical Accounting Policies
We prepare our financial statements in accordance with U.S. generally accepted accounting principles. As such, management is required to make certain estimates, judgments and assumptions it believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The Securities and Exchange Commission has defined critical accounting policies as policies that involve critical accounting estimates that require (a) management to make assumptions that are highly uncertain at the time the estimate is made and (b) different estimates that could have been reasonably used for the current period, or changes in the estimates that are reasonably likely to occur from period to period, which would have a material impact on the presentation of our financial condition, changes in financial condition or in result of operations. Based on this definition, our most critical policies include: revenue recognition, allowance for doubtful accounts, inventory valuation reserve, impairment of long-lived assets, the assessment of recoverability of goodwill and intangible assets, and valuation of deferred tax assets.
Revenue Recognition
We recognize revenue in accordance with Staff Accounting Bulletin No. 104. We recognize revenue from the sales of hardware when the rights and risks of ownership have passed to the customer, upon shipment or receipt by the customer, depending on the terms of the sales contract with the customer. Revenue from the sales of software not requiring significant modification or customization is recognized upon delivery or installation. Revenue from services is recognized upon performance and acceptance after consideration of all of the terms and conditions of the customer contract. Service contracts generally do not extend over one year, and are billed when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, and collection of the resulting receivable is reasonable assured. Revenue arrangements generally do not include specific customer acceptance criteria. For arrangements with multiple deliverables, delivered items are accounted for separately, provided that the delivered item has value to the customer on a stand alone basis and there is objective and reliable evidence of the fair value of the undelivered items. Revenue billed on retainer is recognized as services are performed and amounts not recognized are recorded as deferred revenue.
We periodically receive discretionary cost reimbursements from suppliers. These reimbursements are accounted for as reductions to the cost of sales products.
Goodwill and Intangibles
The Company tests goodwill for impairment at the reporting unit level on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves calculating the fair values of the applicable reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net income (loss).
Circumstances that could trigger an impairment test include but are not limited to: significant adverse change in the business climate or legal factors; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; the likelihood that a reporting unit or significant portion of a reporting unit will be sold or otherwise disposed of; results of testing for recoverability of a significant asset group within a reporting unit; and recognition of a goodwill impairment loss in the financial statement of a subsidiary that is a component of a reporting unit.
Intangible Assets
We recorded intangible assets with related to the acquisitions of DataVox Technologies, Inc., Network Catalyst, Inc., Vector Global ESP, Inc. and Info Systems, Inc.
Intangibles consist of the following:
The customer relationships and know-how are being amortized over periods of 3 to 4 years.
Amortization expense amounted to $0.8 million for the year ended March 31, 2005. Estimated amortization expense for the next four years is as follows:
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts, based on certain percentages of aged receivables. We estimate doubtful accounts based on historical bad debts, factors related to specific customers’ ability to pay and current economic trends. We write off accounts receivable against the allowance when a balance is determined to be uncollectible.
Inventories
Inventories, comprised principally of computer hardware and software, are stated at the lower of cost or market using the first-in, first-out method.
Property and Equipment
Property and equipment is stated at cost and is depreciated using the straight-line method. Furniture, fixtures and other equipment and software development costs have useful lives ranging from 3-7 years. Leasehold improvements are amortized over the shorter of the lease term or economic life of the related improvement. Expenditures which extend the useful lives of the existing assets are capitalized. Maintenance and repairs are charged to operations as incurred.
We incurred approximately $1.7 million, $1.6 million and $1.6 million of depreciation and amortization expense for the years March 31, 2005, 2004 and 2003, respectively.
Contractual Obligations
The following table set forth as of March 31, 2005 the Company's known contractual obligations.
Results of Operations
The following table sets forth for the periods presented information derived form our audited consolidation statement of operations expressed as a percentage of net revenue:
Years Ended March 31, 2005 and 2004
Net Revenue
Net revenue for the year ended March 31, 2005, was $101.2 million, as compared with net revenue of $52.3 million for the comparable 2004 year. The Company has achieved growth of 88% for products and 111% for services over the prior year. Revenue split for services amounted to 28% for the year ended March 31, 2005, compared to 25% in the prior year. The increase in revenue primarily was due to the inclusion of the results of our acquisitions during the year as well as an increase in customer demand for our products and services.
Gross Profit
Gross profit amounted to $18.8 million for the year ended March 31, 2005, as compared with a gross profit of $2.4 million for the prior year. The Company achieved blended gross margins of 19% for the year ended March 31, 2005 with margins for services at 35% and margins for product margins at 12%. In the prior year, blended gross margins amounted to 5% with services margins at 9% and product margins at 3%. Improved gross margins resulted primarily from the impact of our acquisitions.
Selling, General and Administrative
Selling, general and administrative expenses increased to $21.8 million for the year ended March 31, 2005 from $10 million in the comparable period. Included in the general and administrative expenses for the 2005 year is a $1.1 million charge for special compensation arrangements incurred in connection with the Pequot investment. Increased expenses are predominately related to the additional costs incurred from the integration of our acquisitions.
EBITDA
Earnings before interest, taxes, depreciation and amortization (“EBITDA”) amounted to a negative $0.4 million for the year ended March 31, 2005, as compared to a negative $6 million in the comparable year ended 2004. The EBITDA improvements resulted from both increased net revenue and improved gross margins discussed above, partially offset by increased selling, general and administrative expenses. The following table sets forth a reconciliation of EBITDA to the net loss for the years presented.
The Company believes that its non-GAAP measure of EBITDA provides investors with a useful supplemental measure of its operating performance by excluding the impact of interest, taxes, depreciation, and amortization. Management uses EBITDA to assist in evaluating operating performance. These non-GAAP results should be evaluated in light of the Company’s financial results prepared in accordance with GAAP. EBITDA is not a recognized measure for financial statement presentation under GAAP. Non-GAAP earnings measures do not have any standardized definition and are therefore unlikely to be comparable to similar measures presented by other
reporting companies. This non-GAAP measure is provided to assist readers in evaluating the Company’s operating performance. Readers are encouraged to consider this non-GAAP measure in conjunction with the Company’s GAAP results.
Interest Expense
Interest expense was $4.7 million in the year ended March 31, 2005, and $0.5 million for the comparable period in 2004. The primary increase is due to non-cash interest expense of $4.1 million related to the convertible subordinated notes issued by us in December 2004 and March 2005. On June 23, 2005 the convertible notes were converted into Series A-4 Preferred Stock.
Net Income (Loss)
The Company had a net loss of $7.7 million for the year ended March 31, 2005 as compared to a net loss of $8.1 million in the comparable 2004 year. The reduction in net loss resulted from an increase in net revenues and an improvement in both product and service gross profit margins. These improvements were offset, in part, by an increase in selling, general and administrative expenses, a non-cash interest expense of $4.1 million related to convertible notes issued by the Company in December 2004 and March 2005, and a $1.1 million expense relating to special compensation arrangements incurred in connection with the closing of the initial Pequot investment in May 2004.
Liquidity and Capital Resources
We measure our liquidity in a number of ways, including the following:
Cash and cash equivalents generally consist of cash and money market funds. We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.
During the year ended March 31, 2005, we used cash of approximately $11.5 million in operating activities. This primarily resulted from the decreases in accounts payable of $8.3 million, a decrease in deferred revenue of $1.4 million, and increase in prepaid expenses and current assets of $1.0 and an increase in accounts receivable from customers of $0.9 million, depreciation and amortization charges of $2.6 million, amortization of debt discount of $3.8 million, and the net loss of $7.7 million.
Net cash used in investing activities amounted to approximately $31.4 million. The significant uses were for the acquisition of businesses of $28.8 million, an increase in restricted cash of $1.0 million and for the acquisition of property and equipment in the amount of $1.6 million. In addition, net cash provided by financing activities was $46.5 million primarily related to the net proceeds from the issuance of shares of Series A Preferred Stock in the amount of $23.8 million, proceeds from the issuance of subordinated promissory notes $16.0 million and net borrowings under our secured notes payable and inventory financing $7.2 million.
As a result of the foregoing, our cash increased approximately $3.6 million.
On June 8, 2005, we entered into a secured revolving credit facility (the “CIT Facility”) with CIT Group/Business Credit, Inc. (“CIT”) and a new Amended and Restated Loan and Security Agreement (the “New Textron Facility”) with Textron Financial Corporation (“Textron”), providing a combined maximum availability of up to $40 million. The CIT Facility and the New Textron Facility will be used to fund working capital and floor-planning needs, and were also used to
refinance the existing Textron floor planning facility under the former Textron facility (the “Old Textron Facility”).
The CIT Facility is a three year revolving credit facility for up to $25 million, subject to a borrowing base based on eligible accounts receivable, eligible in-transit inventory (up to $0.5 million) and eligible finished goods inventory (up to $0.5 million). The CIT Facility requires, among other things, that we maintain certain financial covenants including that we maintain Consolidated Senior Leverage of not greater than 4.00 to 1.00 for the trailing four quarters and that we maintain a Consolidated Fixed Charge Coverage Ratio of not less than 1.00 to 1.00 for the trailing four quarters, restricts our ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. Amounts borrowed under the CIT facility will bear interest at either the prime rate or at LIBOR plus 3%, in each case at our option.
The New Textron Facility allows us to finance inventory purchases up to $15 million from approved vendors on a 45-day interest-free basis in most cases. This replaces the $10 million Old Textron Facility. Interest accrues after expiration of the applicable interest free period at the rate equal to a specified prime rate plus 4%. The financial and other covenants in the New Textron Facility are substantially the same as those in the CIT Facility.
Our total outstanding debt under the revolving receivable financing portion of the Old Textron Facility was $13.6 million at March 31, 2005 and $5.9 million at March 31, 2004. The amount outstanding under the inventory portion of the Old Textron Facility agreement was $2.9 million at March 31, 2005 and $3.5 million at March 31, 2004.
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We place our cash with high credit quality institutions. At times, such amounts may be in excess of the FDIC insurance limits.
Credit is extended to customers based on an evaluation of their financial condition, and collateral is generally not required. The evaluation of financial condition is performed to reduce the risk of loss.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Our risk investments only consisted of cash deposited in various money market funds. We do not use interest rate derivative instruments to manage our exposure to interest rate changes. Due to the limited investment risks involving money market funds, we do not anticipate any material loss in connection with such investments.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Set forth below is a list of our audited consolidated financial statements included in this Annual Report on Form 10-K and their location.
* Page follows Part III to this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A.
Item 9A. Controls and Procedures.
An evaluation was performed, as of March 31, 2005, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on such evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of March 31, 2005. There has been no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
Directors and Executive Officers
Set forth below is a brief description of the background of each of our current directors and executive officers, based on information provided to us by them.
Gerald A. Poch has served as Managing Director of Pequot Capital Management, Inc., the investment manager/advisor for Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III L.P., since January 2000. He is also a Managing General Partner of both Pequot Fund and Pequot Partners. From August 1998 through January 2000, he was a principal of Pequot Capital Management, Inc. and co-leader of Pequot Fund’s and Pequot Partners’ venture capital team. From August 1996 to June 1998 he was the Chairman, President and Chief Executive Officer of GE Capital Information Technology Solutions, Inc., a technology solutions provider. Prior to that, he was a founder, and served as Co-Chairman and Co-President, of AmeriData Technologies, Inc., a value-added reseller and systems integrator of hardware and software systems. Mr. Poch is also a director of Analex Corporation, Andrew Corporation, and NETGEAR, Inc., each a publicly-traded company. In addition, Mr. Poch is a director of a number of private companies.
Francis J. Alfano has served as our Chief Executive Officer since May 2004. He served as Chief Executive Officer, President and a director of Interliant, Inc., an Internet infrastructure business focused on collaboration, security, and managed hosting solutions from August 2002 to June 2003. On August 5, 2002, Interliant filed for protection under title 11 of the U.S. Bankruptcy Code. Mr. Alfano led the restructuring of Interliant’s businesses resulting in the ultimate sale of its operations. From May 2001 through July 2002, he served as Interliant’s Chief Financial Officer. From December 1998 to May 2001, he was Interliant’s Senior Vice President of Corporate Development, with responsibility for strategic business relationships and execution of all merger and acquisitions. Prior to that time Mr. Alfano served as Vice President of Business Development at G.E. Capital Information Technology Solutions, Inc., (the successor to AmeriData Technologies, Inc.) and was with Ernst & Young.
Steven H. Rothman has served as an Executive Vice President since May 2004. He served as our Chairman of the Board from September 2002 to May 2004. From May 1986 to August 2002, he served as our President. Mr. Rothman served as our Chief Executive Officer from September 1996 to August 2002 and as Co-Chief Executive Officer from May 1986 to August 1996.
Clifford H. Friedman, served as a Senior Managing Director of Constellation since September 1997. From January 1996 through August 1997, Mr. Friedman served as a Senior Vice President of Universal Studios where he was responsible for the creation and development of the Studio's New Media Group. From February 1995 through January 1996, Mr. Friedman served as Vice President-Strategic Development at NBC and from 1990 through January 1995, he was a Senior
Managing Director in the Media and Technology Group at Bear Stearns. Mr. Friedman serves as a director of Net Insight AB and Savvis Communications. In addition, Mr. Friedman is a director of a number of private companies.
Arnold J. Wasserman has served as chairman of our audit committee since March 1999 and our lead independent director since June 2002. Mr. Wasserman has been a principal of Panda Financial Associates, Inc., a leasing/consulting firm, for the past 35 years. He is a director of Stratasys, Inc., a Nasdaq National Market listed company which manufactures rapid prototyping systems and materials, and serves as chairman of its audit committee.
Richard R. Heitzmann has served as a Senior Vice President at Pequot Capital Management, Inc., where he focuses on software and services investments, since January 2004. From June 2003 to January 2004, Mr. Heitzmann was Vice President of Corporate Development with First Advantage Corp., a public company involved in the risk mitigation industry. From November 2001 to June 2003, Mr. Heitzmann was the Senior Vice President of Corporate Development and a member of the board of directors of US Search.Com, Inc. From August 1999 to November 2001, Mr. Heitzmann served as a Vice President of Pequot Capital Management, Inc. Mr. Heitzmann served as an executive with Nationsbanc Montgomery Securities from July 1998 to September 1998 and with Booz-Allen and Hamilton in its Financial Services and Healthcare Group from September 1997 to December 1997. Mr. Heitzmann was a financial analyst and associate at Houlihan Lokey Howard and Zukin from July 1994 to September 1997.
William Lerner has served as chairman of our corporate governance and nominating committee since November 2003. Mr. Lerner has been engaged in the private practice of corporate and securities law in New York since 1961 and in Pennsylvania since 1990. Mr. Lerner is a director of Rent-way, Inc., New York Stock Exchange listed company engaged in the rental-purchase industry; and Cortland Trust, Inc., a money market mutual fund distributed primarily through securities brokerage firms and commercial banks.
Alvin E. Nashman has been an independent consultant in the field of computer service for the past ten years. Dr. Nashman is a director of James Monroe Bancorp Inc.
Steven Stringer has served as our President since June 2005 and as our Chief Operating Officer since October 1, 2004. From June through September 2004 he was employed by Pequot as a consultant and was made available by Pequot to us to assist with the selection, evaluation and integration of acquisitions. From January 2002 through May 2004 Mr. Stringer pursued private investment opportunities. Prior to that time he served in a number of senior executive roles with Rhythms NetConnections Inc. (“Rhythms”), including as chief executive officer and president from July through December 2001, chief executive officer, president and chief operating officer from April through July 2001, and president and chief operating officer from April 1999 through March 2001. Rhythms was a national provider of digital subscriber line services and operated one of the largest DSL networks in the United States, serving 60 major markets with 67,000 digital subscriber lines in service.
Alan Schwartz is a certified public accountant who has served as a Senior Vice President, as well as our Chief Financial Officer, since May 2004. Mr. Schwartz served as Vice President-Finance for Interliant, Inc. from 1999 to 2003, where he managed financial and operational reporting for various domestic and international segments of the business. From August 1996 until joining Interliant, Mr. Schwartz was employed by GE Capital IT Solutions, last serving as Vice President-Financial Planning and Analysis. For four years prior to his serving at GE Capital IT Solutions, Mr. Schwartz was employed by AmeriData Technologies, Inc., last serving in the position of Vice President-Finance.
John F. Kohler has served as a Senior Vice President, as well as our General Counsel and Corporate Secretary, since May 2004. From May 2000 to January 2003, he served as Vice President-Mergers and Acquisitions for Interliant, Inc., a technology solutions provider, primarily responsible for Interliant’s acquisition and restructuring activities. From May 1995 to April 2000, he was a corporate lawyer with Weil, Gotshal & Manges LLP, a law firm in New York, and from September 1993 to April 1995, he was a corporate lawyer with Jenkens & Gilchrist, P.C., a law
firm in Dallas. Mr. Kohler served as an officer in the United States Army from May 1986 to September 1990.
Board Committees
Our board of directors currently has four standing committees, consisting of an audit committee, a compensation committee, a corporate governance committee and an independent directors committee.
Our audit committee currently is composed of William Lerner, Alvin E. Nashman and Arnold J. Wasserman, with Mr. Wasserman serving as its chairman. We believe that each of these committee members are “independent,” within the meaning of such term under applicable law and the Marketplace Rules of The Nasdaq Stock Market, Inc. Our board of directors has determined that Mr. Wasserman is an “audit committee financial expert,” as such term is defined by the SEC. The audit committee is primarily concerned with the accuracy and effectiveness of the audits of our financial statements by our internal audit staff and by our independent auditors. Its duties include:
• selecting and retaining the independent auditors, as well as ascertaining the auditors’ independence;
• reviewing the scope of the audits to be conducted, as well as the results of their audits;
• approving non-audit services provided to our company by the independent auditors;
• reviewing the organization and scope of our internal system of audit, financial and disclosure controls;
• appraising our financial reporting activities, including our Annual Report on Form 10-K, and the accounting standards and principles followed; and
• conducting other reviews relating to compliance by employees with our internal policies and applicable laws.
Our compensation committee currently is composed of Richard Heitzmann, William Lerner and Alvin Nashman, with Mr. Heitzmann serving as its chairman. The duties of our compensation committee include recommending to the full board of directors remuneration to be paid our executive officers, determining the number and conditions to exercise of options and other equity incentives granted pursuant to our various stock option plans and recommending the establishment of and monitoring a compensation and incentive program for all of our executive officers.
Our corporate governance committee currently is composed of Richard Heitzmann, William Lerner, Arnold J. Wasserman and Clifford Friedman, with Mr. Lerner serving as its chairman. The duties of our corporate governance committee include overseeing that our board’s policies, as well as ensuring that we are in compliance with all applicable federal and state securities laws and the Nasdaq rules, and determining our board of directors’ slate of director-nominees for each shareholder election of directors.
Our independent directors committee was formed by our Board in September 2004. It consists only of directors who are neither members of the management nor associated with Pequot or Constellation (or other similar investors) and is to consider, review and provide guidance and oversight regarding transactions or other situations in which other board members, who are either members of management or employees of Pequot or Constellation (or other similar investors), have interests that may be in addition to, or different from, the interests of the shareholders in general. This committee currently is composed of William Lerner, Alvin E. Nashman and Arnold J. Wasserman, with Mr. Wasserman serving as its chairman.
Meetings of Our Board of Directors and its Committees
Our board of directors held 15 formal meetings during our fiscal year ended March 31, 2005. Our audit committee held 7 formal meetings, our compensation committee held 4 formal meetings, our corporate governance committee held 1 formal meetings, and our independent directors
committee held 3 formal meetings, during our 2005 fiscal year. Each member of our board of directors attended, in person or telephonically, at least 75% of the total number of meetings of our board and each committee of the board on which the director serves.
Director Fees
Each director who is not an employee of our company receives an annual fee of $16,000 as compensation for serving on our board of directors, plus an additional $1,500 for each board meeting attended in person and $750 for each board meeting attended by telephonic conference call. Each member of the board’s audit, compensation and corporate governance committees receives $2,500 per year, and each chairman of the committees receives $3,500 (except the chairman of the audit committee who receives $5,000), as compensation for serving on such committees, as well as an additional $1,000 for each committee meeting attended in person and $500 for each committee meeting attended by telephonic conference call, in each case if the committee meeting is held on a day other than a day on which the board itself is meeting.
Audit Committee Charter
Our board of directors adopted a charter for its audit committee in 2001. We amended the audit committee charter in June 2003 in order to comply with rules mandated by the Securities and Exchange Commission. A copy of the revised charter was made Appendix A to the proxy statement we issued in connection with the annual meeting of our shareholders held on November 7, 2003.
Section 16(a) Beneficial Ownership Reporting Compliance
Based solely upon a review of Forms 3, 4 and 5 and amendments to these forms furnished to us, together with representations received by us from applicable parties that no Form 5 was required to be filed by such parties, all parties subject to the reporting requirements of Section 16(a) of the Exchange Act filed all such required reports during and with respect to our 2005 fiscal year.
Code of Ethics
Our board of directors has established a code of ethics that applies to our principal executive, financial and accounting officer(s). A copy of our code of ethics was filed as exhibit 14.1 to our Annual Report on Form 10-K for fiscal year 2004.
Item 11.
Item 11. Executive Compensation
Summary Compensation
The following table sets forth, with respect to the our fiscal years ended March 31, 2005, 2004 and 2003, all compensation earned by each person who served as our chief executive officer during our 2005 fiscal year and such other persons who were serving as executive officers at the end of our 2005 fiscal year and whose total annual salary and bonus earned during our 2005 fiscal year exceeded $100,000.
Option Grants In Last Fiscal Year
The following table sets forth, with respect to our fiscal year ended March 31, 2005, all grants of stock options to each named executive officer listed in the Summary Compensation Table contained in this Item 11.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
None of the named executive officers listed in the Summary Compensation Table contained in this Item 11 exercised any of their options during the year ended March 31, 2005.
The following table sets forth:
• the total number of unexercised options held, as of March 31, 2005, by each of the named executive officers listed in the Summary Compensation Table contained in this Item 11, separately identified between those exercisable and those not exercisable, and
• the aggregate value of in-the-money, unexercised options held, as of March 31, 2005, by each of the named executive officers, separately identified between those exercisable and those not exercisable.
Stock Plans
We have adopted the following stock plans:
The 1993 Stock Option Plan has expired. Accordingly, we can no longer grant options under such plan.
Employees (including officers), directors and others who provide services to us are eligible to participate in our stock plans. The plans are administered by our board of directors or the compensation committee of the board. Options granted under the plans may be incentive stock options (as defined in Section 422 of the Internal Revenue Code of 1986, as amended), or non-qualified stock options. Non-qualified stock options may be granted in tandem with stock appreciation rights. The exercise price of options may not be less than 100% of the fair market value of the common stock as of the date of grant, except that this limitation does not apply to options granted under the 1998 Stock Option Plan and the exercise price of ISOs granted to an employee who owns more than ten percent of the outstanding common stock may not be less than 110% of the fair market value as of the date of grant. Options may not be exercised more than ten years after the date of grant, or five years in the case of ISOs granted to an employee who owns more than 10% of the outstanding shares of our common stock. An option may be exercised by tendering payment of the purchase price to us or, at the discretion of the administrator of the plans, by delivery of shares of our common stock having a fair market value equal to the exercise
price. The number of shares that may be acquired upon exercise of an option and the exercise price of an option are subject to adjustment in the event of a merger, recapitalization, stock split or stock dividend.
The 2000 Long Term Performance Plan and 2002 Long Term Performance Plan permits the grant of any form of award, including stock options, stock appreciation rights, and stock or cash awards. Awards under the 2000 Long Term Performance Plan may be in stock or denominated in units of stock, which may be subject to restrictions on transfer and include forfeiture provisions.
Our shareholders approved our 2004 Equity Incentive Plan in May 2004. We have reserved a total of 3 million shares of our common stock for issuance under the 2004 plan. The types of awards that may be granted under the 2004 plan include one or more of the following types, either alone or in any combination thereof:
• options, including incentive stock options and non-qualified options;
• stock appreciation rights;
• restricted stock;
• performance grants;
• stock bonuses; and
• any other type of award deemed by the administrator of the 2004 plan to be consistent with the purposes of the 2004 plan (including, but not limited to, awards of or options or similar rights granted with respect to unbundled stock units or components thereof, and awards to be made to participants who are foreign nationals or are employed or performing services outside the United States).
Employment Agreements
We entered into an employment agreement, dated May 21, 2004, with Francis J. Alfano (as amended, the “Alfano Employment Agreement”) to employ Mr. Alfano as our Chief Executive Officer. The Alfano Employment Agreement has an initial term of three (3) years (the “Initial Term”). On the third and each subsequent anniversary of the commencement of such agreement, the term of the agreement shall automatically be extended for an additional period of twelve (12) months; provided, however, that either party may elect not to extend the agreement by giving written notice to the other party at least twelve (12) months prior to any such anniversary date. Mr. Alfano is paid a base salary of $350,000 per annum and is entitled to receive additional compensation, at such times and in such amounts, as shall be determined in the sole discretion of the Board of Directors. In the event of a termination of Mr. Alfano's employment during the term of the agreement by us other than for “cause” or by Mr. Alfano for “good reason” or as a result of his death or permanent and total disability we shall provide him, among other things, a continuance of his then current base salary for a period equal to the greater of (i) one (1) year from the date of termination or (ii) the period ending on the last day of the Initial Term (the “Severance Period”). Additionally, in the event of termination for other than “cause” or for “good reason,” any unvested stock options or restricted stock units shall become fully vested and immediately exercisable and shall remain exercisable for the remainder of their term.
We also entered into employment agreements, dated May 21, 2004, with Steven H. Rothman (the “Rothman Employment Agreement”) and Howard A. Pavony (as amended, the “Pavony Employment Agreement” and together with the Rothman Employment Agreement, the “Founder Employment Agreements”) to employ Mr. Rothman and Mr. Pavony as Executive Vice Presidents. The Founder Employment Agreements are on substantially the same terms as the Alfano Employment Agreement, including with respect to the acceleration of stock option and restricted stock units. Each of Mr. Rothman and Mr. Pavony are paid a base salary of $265,000 per annum.
Additionally, we entered into a severance agreement, dated May 21, 2004, with Alan Schwartz (as amended the “Schwartz Severance Agreement”) and John Kohler (as amended the “Kohler Severance Agreement” and together with the Schwartz Severance Agreement, the “Severance Agreements”) to employ Mr. Schwartz as our Chief Financial Officer and Mr. Kohler as our
General Counsel. Each Severance Agreement has a term of four (4) years. In the event of a termination of Mr. Schwartz's or Mr. Kohler's employment during the term of his agreement by the Company other than for “cause” or by such executive for “good reason” or as a result of his death or permanent and total disability we shall provide such executive, among other things, a continuance of his then current base salary for a period equal to one (1) year. Mr. Schwartz is paid a base salary of $250,000 per annum and Mr. Kohler is paid a base salary of $200,000. Additionally, in the event of termination of the executive for other than “cause” or for “good reason,” any unvested stock options or restricted stock units shall become fully vested and immediately exercisable and shall remain exercisable for the remained of their term.
Securities Authorized for Issuance Under Equity Incentive Plans
We have provided in the “Equity Compensation Plan Information” section of Item 5 of this Annual Report on Form 10-K certain information with respect to securities authorized for issuance under our equity incentive plans.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee is or was an officer employee of our company, nor had any relationship requiring disclosure under Item 13 of this Annual Report on Form 10-K. In addition, to our knowledge, none of our executive officers:
• served as a member of a compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on our compensation committee;
• served as a director of another entity, one of whose executive officers served on our compensation committee; nor
• served as a member of a compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a director of our company.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Our Current Beneficial Owners
Our Series A Convertible Preferred Stock and common stock are the only classes of our voting securities presently outstanding. The Series A Preferred Stock votes on an “as converted” basis, such that each share of Series A Preferred Stock is entitled to that number of votes as equals the number of shares of common stock that the holder of such share of Series A Preferred Stock would receive upon conversion of the share of Series A Preferred Stock, but such number of votes shall not exceed such number of shares of common stock which would be received based on a conversion price of $1.45 per preferred share (in the case of Series A-1, A-2 and A-3 shares) or the market price of the common stock on the date of issuance of the preferred shares (in the case of Series A-4 and A-5 shares).
The following table sets forth as of June 23, 2005 the beneficial ownership of the following persons:
• each person known by us to beneficially own 5% or more of our Series A Preferred Stock and/or our common stock, based on filings with the SEC and certain other information;
• each of our “named executive officers” and directors; and
• all of our executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the SEC and includes voting and investment power. In addition, under SEC rules, a person is deemed to be the beneficial owner of securities which may be acquired by such person upon the exercise of options and warrants or the conversion of convertible securities within 60 days from the date on which
beneficial ownership is to be determined. Our “named executive officers,” in accordance with SEC rules, are those executive officers who are required to be listed Summary Compensation Table provided in Item 11 of this Annual Report on Form 10-K. Except as otherwise indicated in the notes to the Beneficial Ownership Table:
• we believe that all shares are beneficially owned, and investment and voting power is held by, the persons named as owners; and the address for each beneficial owner listed in the table, except where otherwise noted, is MTM Technologies, Inc., 850 Canal Street, Stamford, Connecticut 06902.
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Series A-4 Preferred Stock owned of record by BSC, (h) 20,799 shares of Series A-4 Preferred Stock owned of record by CVC, (i) 1,076,923 shares of Series A-4 Preferred Stock which the Constellation Group has a right to purchase from us at any time prior to September 10, 2005, and (j) 1,538,462 shares of Series A-5 Preferred Stock which the Constellation Group has a right to purchase from us at any time prior to December 10, 2005. Does not include any shares of Series A Preferred Stock that we may issue in lieu of cash dividends on the Series A Preferred Stock for the period between May 21, 2006 and May 20, 2008. Accrual of dividends on the Series A Preferred Stock will not commence until May 21, 2006.
(9)
Represents (a) the maximum 6,206,796 shares of our common stock issuable upon conversion of all of the Series A Preferred Stock currently owned of record and that may be issued to the Constellation Group, as discussed in note (8) to this Beneficial Ownership Table, which shares are convertible within the 60 days following the date of the Beneficial Ownership Table, (b) 353,306 shares of our common stock issuable upon exercise of warrants held of record by Constellation Venture, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table, (c) 163,490 shares of our common stock issuable upon exercise of warrants held of record by Constellation Offshore, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table, (d) 157,552 shares of our common stock issuable upon exercise of warrants held of record by BSC, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table, (e) 8,823 shares of our common stock issuable upon exercise of warrants held of record by CVC, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table, and (f) 215,384 shares of our common stock issuable upon exercise of warrants that the Constellation Group shall acquire in connection with its purchase of 1,076,923 shares of Series A-4 Preferred Stock, which common stock will be immediately exercisable upon acquisition of such warrants. The numbers of shares of our common stock issuable upon conversion of the Series A Preferred Stock and exercise of the warrants which the Constellation Group owns of record or has the right to acquire from us are subject to anti-dilution
adjustment. Does not include any shares of Series A Preferred Stock that we may issue in lieu of cash dividends on the Series A Preferred Stock for the period between May 21, 2006 and May 20, 2008. Accrual of dividends on the Series A Preferred Stock will not commence until May 21, 2006.
(10)
According to a Schedule 13D filed with the SEC on December 20, 2004, Bear Stearns Asset Management Inc. is the Managing Member of Constellation Ventures Management II, LLC, Constellation Ventures Management II, LLC is the sole general partner of Constellation Venture, the sole general partner of Constellation Offshore and one of two general partners of BSC. Pursuant to an investment management agreement, Bear Stearns Asset Management Inc. has voting power with respect to the securities owned by CVC and makes investment decisions on behalf of CVC. The address for Bear Stearns Asset Management Inc. is 383 Madison Avenue, New York, New York 10179.
(11)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (8) to this Beneficial Ownership Table).
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Bear Stearns Asset Management Inc. disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(12)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (9) to this Beneficial Ownership Table). Bear Stearns Asset Management Inc. disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(13)
According to a Schedule 13D filed with the SEC on December 20, 2004, Constellation Ventures Management II, LLC is the sole general partner of Constellation Venture, the sole general partner of Constellation Offshore and one of two general partners of BSC. The address for Bear Stearns Asset Management Inc is 383 Madison Avenue, New York, New York 10179.
(14)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore and BSC (see note (8) to this Beneficial Ownership Table). Constellation Ventures Management II, LLC disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(15)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore and BSC (see note (9) to this Beneficial Ownership Table). Constellation Ventures Management II, LLC disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(16)
The address for Mr. Friedman is c/o Bear Stearns Asset Management Inc., 383 Madison Avenue, New York, New York 10179.
(17)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (8) to this Beneficial Ownership Table). Clifford Friedman is a Senior Managing Director of Bear Stearns Asset Management Inc. Clifford Friedman is also a member of CVC. Clifford Friedman disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(18)
Includes the shares of our common stock beneficially owned by Constellation Venture, Constellation Offshore, BSC and CVC (see note (9) to this Beneficial Ownership Table). Clifford Friedman is a Senior Managing Director of Bear Stearns Asset Management Inc. Clifford Friedman is also a member of CVC. Clifford Friedman disclaims beneficial ownership of such securities except to the extent of its pecuniary interest in the securities held by those entities.
(19)
Includes 115,200 shares of our common stock issuable upon exercise of options granted to Mr. Rothman, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 8,000 shares of our common stock issuable upon exercise of options, which shares are not exercisable within the 60 days following the date of this Beneficial Ownership table nor does it include 2,000 restricted share units which do not vest within the 60 days following the date of this Beneficial Ownership table, or 1,125 shares of our common stock held by Mr. Rothman’s spouse.
(20)
Includes 115,200 shares of our common stock issuable upon exercise of options granted to Mr. Pavony, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.
(21)
Includes 118,000 shares of our common stock issuable upon exercise of options granted to Mr. Wasserman, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.
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(22)
Includes 90,500 shares of our common stock issuable upon exercise of options granted to Mr. Lerner, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.
(23)
Includes 85,500 shares of our common stock issuable upon exercise of options granted to Dr. Nashman, which are exercisable within the 60 days following the date of this Beneficial Ownership Table.
(24)
Represents 150,000 shares of our common stock issuable upon exercise of options granted to Mr. Alfano, which are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 314,000 shares of our common stock issuable upon exercise of options, which are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include 8,000 restricted stock units which do not vest within the 60 days following the date of this Beneficial Ownership table.
(25)
Represents 28,125 shares of our common stock issuable upon exercise of options granted to Mr. Kohler, which shares are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 58,875 shares of our common stock issuable upon exercise of options, which shares are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include the 1,500 restricted stock units which do not vest within the 60 days following the date of this Beneficial Ownership Table.
(26)
The address for Mr. Heitzmann is c/o Pequot Capital Management, Inc., 500 Nyala Farm Road, Westport, Connecticut 06880.
(27)
Does not include the shares of Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc. (see note (2) to this Beneficial Ownership Table), of which Mr. Heitzmann is a Senior Vice President. Messrs. Heitzmann does not have voting power nor investment power with respect to the Series A Preferred Stock beneficially owned by Pequot Capital Management, Inc.
(28)
Does not include the shares of our common stock beneficially owned by Pequot Capital Management, Inc. (see note (3) to this Beneficial Ownership Table), of which Mr. Heitzmann is a Senior Vice President. Messrs. Heitzmann does not have voting power nor investment power with respect to our common stock beneficially owned by Pequot Capital Management, Inc.
(29)
Represents 56,250 shares of our common stock issuable upon exercise of options granted to Mr. Schwartz, which are exercisable within the 60 days following the date of this Beneficial Ownership Table. Does not include 117,750 shares of our common stock issuable upon exercise of options, which are not exercisable within the 60 days following the date of this Beneficial Ownership Table nor does it include 3,000 restricted stock units which do not vest within 60 days following the date of this Beneficial Ownership table.
(30)
Includes those Series A Preferred Stock beneficially owned by our current executives officers and directors, as set forth in notes to this Beneficial Ownership Table.
(31)
Includes those common shares beneficially owned by our current executives officers and directors, as set forth in notes to this Beneficial Ownership Table.
Restated Shareholders’ Agreement
We entered into a Shareholders’ Agreement with the Pequot Fund, Pequot Partners, Howard A. Pavony and Steven H. Rothman on May 21, 2004, as a condition to the consummation of our sale to the Pequot Fund and Pequot Partners of an aggregate 3,255,814 shares of Series A-1 Preferred Stock.
On December 21, 2004 we entered into an Amended and Restated Shareholders' Agreement (the “Restated Shareholders' Agreement”) with Pequot, Constellation, Howard A. Pavony and Steven H. Rothman. The Restated Shareholders’ Agreement reflected Mr. Pavony’s resignation
from the Board of Directors which became effective on March 31, 2005. The parties agreed to vote, or cause to be voted, all securities of the company owned by such party or over which such party has voting control so that the number of directors will consist of: (i) the company’s chief executive officer (“CEO”); (ii) two directors designated by Pequot Capital Management, Inc., or its assignee; (iii) one director designated by Constellation or its assignee; (iv) Mr. Rothman; (v) three “independent” directors, within the meaning of “independent” under the current rules of Nasdaq, selected by the company’s nominating and corporate governance committee; and (vi) two additional independent directors to be selected by the CEO and reasonably acceptable to the company's nominating and corporate governance committee. Under certain circumstances where Pequot holds less than 25% of the securities Pequot purchased pursuant to the Purchase Agreement, the right to designate two directors in (ii) above will be reduced to one director and the above voting provisions will be adjusted in the manner described in the Restated Shareholders' Agreement.
The obligation of the parties under the Restated Shareholders' Agreement will expire upon the earliest to occur of (i) the completion of any voluntary or involuntary liquidation or dissolution of the Company, (ii) the sale of all or substantially all of the company’s assets or of a majority of the outstanding equity of the Company to any person that is not a party to the Restated Shareholders’ Agreement, or (iii) December 10, 2009. The obligation of the Investors to vote in favor of the appointment of Mr. Rothman as a Director will expire on May 21, 2007, provided that he has not terminated his employment, other than for “good reason,” nor has been terminated for “cause.” Messrs. Rothman and Pavony’s obligation to vote for (i) two directors designated by Pequot Capital Management, Inc., and (ii) one director designated by Constellation or its assignee, shall terminate if (a) Pequot or their assignees own less than 10% of the Outstanding Series A Preferred Stock (or shares of our common stock issuable upon conversion thereof) issued to Pequot, (b) Constellation or its assignees own less than 10% of the Series A-3 Preferred Stock (or shares of our common stock issuable upon conversion thereof) issued to Constellation, or (c) any other shareholders that are introduced to the company by Pequot own less than 10% of the shares acquired by such shareholders from the company in a transaction not including a public offering or (ii) if Messrs. Pavony and Rothman individually own less than less than 10% of the number of shares of common stock owned by such person on December 10, 2004.
The Restated Shareholders' Agreement also contains provisions (i) restricting the transfer of any securities by shareholders party to the Restated Shareholders' Agreement in certain circumstances and (ii) granting the Investors certain rights of first refusal and tag-along rights with respect to any dispositions by Messrs. Pavony and Rothman of their shares of Common Stock.
Item 13.
Item 13. Certain Relationships and Related Party Transactions.
Not applicable.
Item 14.
Item 14. Principal Accountant Fees and Services.
Principal Accounting Fees and Services
The following table sets forth the fees billed by our independent accountants for each of our last two fiscal years for the categories of services indicated.
(1)
Consists of fees billed for the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q and services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.
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(2)
Consists of assurance and related services that are reasonably related to the performance of the audit and reviews of our financial statements and are not included in “audit fees” in this table. The services provided by our accountants within this category consisted of advice relating to SEC matters and employee benefit matters.
(3)
Consists of professional services rendered by a company aligned with our principal accountant for tax compliance, tax advice and tax planning.
(4)
The services provided by our accountants within this category consisted of advice and other services relating to our transaction with the Pequot entities and other matters.
Such fees have been preapproved by our Audit Committee.
Audit Committee Pre-Approval Policy
In addition to retaining Goldstein Golub Kessler LLP to audit our consolidated financial statements for the years ended March 31, 2005 and 2004, we retained Goldstein Golub Kessler to provide other auditing and advisory services to us in our 2005 and 2004 fiscal years. We understand the need for Goldstein Golub Kessler to maintain objectivity and independence in its audit of our financial statements. To minimize relationships that could appear to impair the objectivity of Goldstein Golub Kessler, our audit committee has restricted the non-audit services that Goldstein Golub Kessler and its aligned company may provide to us primarily to tax services and merger and acquisition due diligence and audit services, and has determined that we would obtain even these non-audit services from Goldstein Golub Kessler and/or its aligned company only when the services offered by Goldstein Golub Kessler and its aligned company are more effective or economical than services available from other service providers.
The audit committee also has adopted policies and procedures for pre-approving all non-audit work performed by Goldstein Golub Kessler and any other accounting firms we may retain. Specifically, the audit committee has pre-approved the use of Goldstein Golub Kessler and its aligned company for detailed, specific types of services within the following categories of non-audit services: merger and acquisition due diligence and audit services; tax services; internal control reviews; and reviews and procedures that we request Goldstein Golub Kessler to undertake to provide assurances of accuracy on matters not required by laws or regulations. In each case, the audit committee has also set a specific annual limit on the amount of such services which we would obtain from Goldstein Golub Kessler, and has required management to report the specific engagements to the committee on a quarterly basis and to obtain specific pre-approval from the audit committee for all engagements.
Item 15.
Item 15. Exhibits, Financial Statements Schedules.
Exhibits
Set forth below is a list of the exhibits to this Annual Report on Form 10-K.
* Incorporated by Reference. See Exhibit Index.
Financial Statements and Schedules
We have provided in Item 8 to this Annual Report on Form 10-K a complete list of the financial statements being filed with this Form 10-K. There are no financial statement schedules applicable to this Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
MTM TECHNOLOGIES, INC.
We have audited the accompanying consolidated balance sheets of MTM Technologies, Inc. and Subsidiaries as of March 31, 2005 and 2004, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended March 31, 2005. These 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of MTM Technologies, Inc. and Subsidiaries as of March 31, 2005 and 2004 and the results of their operation and their cash flows for each of the three years in the period ended March 31, 2005 in conformity with United State generally accepted accounting principles.
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
June 3, 2005, except for the fifth, sixth and seventh paragraphs of Note 2, as to which the date is June 8, 2005 and the eleventh paragraph of Note 10 as to which the date is June 23, 2005.
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See Notes to Consolidated Financial Statements
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
See Notes to Consolidated Financial Statements
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except for per share amounts)
1. Summary of Significant Accounting Policies
Principles of Consolidation and Nature of Operations
The accompanying consolidated financial statements include the accounts of MTM Technologies, Inc. (formerly Micros-to-Mainframes, Inc.) and its wholly owned subsidiaries, Data.Com RESULTS, Inc. (“Data.Com”), MTM Advanced Technology, Inc. (“MTM”), PTI Corporation (formerly known as Pivot Technologies) (“Pivot”), MTM Technologies (California), Inc., MTM Technologies (Texas), Inc., MTM Technologies (US), Inc. and Info Systems, Inc. hereinafter collectively referred to as the “Company.” All significant intercompany accounts and transactions have been eliminated.
“Pequot Fund” refers to Pequot Private Equity Fund III, L.P., “Pequot Partners” refers to Pequot Offshore Private Equity Partners III, L.P., and collectively with Pequot Fund, “Pequot,” “Constellation Venture” refers to Constellation Venture Capital II, L.P., “Constellation Offshore” refers to Constellation Venture Capital Offshore II, L.P., “BSC” refers to The BSC Employee Fund VI, L.P., “CVC” refers to CVC Partners II, LLC, and collectively with Constellation Venture, Constellation Offshore and BSC, “Constellation,” and together with Pequot, the “Investors.”
The Company is a leading national computer and communications technology management company providing information technology (“IT”) networking, communications, software applications and data center services, including secure access, voice over internet protocol (“VOIP”), storage, security and messaging solutions. The Company serves as a single source provider of advanced technology solutions to support its clients' mission-critical business processes. The Company's clients consist of divisions of Fortune 100 and Fortune 500 corporations, middle market corporations (generally those with $50 million to $1 billion in revenues), municipal, state and federal government agencies, and educational institutions. The Company serves clients in most major US metropolitan.
The Company purchases software, computers and related products directly from suppliers as either an authorized dealer or a value-added reseller. The Company has entered into authorization agreements with major suppliers, which can be terminated by the supplier, with or without cause, upon short notice, or immediately upon the occurrence of certain events. The sales of products from the Company's four largest suppliers accounted for 27%, 14%, 13% and 12% of all product sales for the year ended March 31, 2005. The sales from the Company's three largest suppliers accounted for 40%, 23% and 9% of all product sales for the year ended March 31, 2004. The sales of product from the Company's three largest suppliers accounted for 42%, 26% and 8% of all product sales for the year ended March 31, 2003. The Company believes it has excellent relationships with its suppliers; however, there can be no assurance that the aforementioned agreements will be renewed. If these agreements are not renewed, the Company may have difficulty in obtaining inventory at a sufficiently low cost to allow for resale at a competitive market price.
Liquidity
The Company sustained net losses during the years ended March 31, 2005, 2004 and 2003 and at March 31, 2005 had a net working capital deficit of $18,792. To improve its working capital position the Company undertook cost reduction initiatives, discontinued certain sales of low margin products, and negotiated new credit facilities as discussed in Note 2. In addition, to fund its growth through acquisition strategy the Company sold notes and preferred stock as discussed in Notes 9 and 10. The Company anticipates that the preferred stock, debt and credit facilities will provide the Company with the capital necessary to meet its obligations as they come due.
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents generally consist of cash and money market funds. We consider all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.
Restricted Cash
The Company has restricted $1,000,000 of cash in a blocked account for the benefit of a lender under the Old Textron Facility discussed in Note 2.
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts, based on certain percentages of aged receivables. The Company estimates doubtful accounts based on historical bad debts, factors related to specific customers' ability to pay and current economic trends. The Company writes off accounts receivable against the allowance when a balance is determined to be uncollectible.
Inventories
Inventories, comprised principally of computer hardware and software, are stated at the lower of cost or market using the first-in, first-out method.
Property and Equipment
Property and equipment is stated at cost and is depreciated using the straight-line method. Furniture, fixtures and other equipment and software development costs have useful lives ranging from 3-7 years. Leasehold improvements are amortized over the shorter of the lease term or economic life of the related improvement. Expenditures which extend the useful lives of the existing assets are capitalized. Maintenance and repairs are charged to operations as incurred.
The Company incurred approximately $1,731, $1,636 and $1,604 of depreciation and amortization expense for the years March 31, 2005, 2004 and 2003, respectively.
The following is a summary of property and equipment held by the Company:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
Software Development Costs
The cost of software developed for internal use incurred during the preliminary project stage is expensed as incurred. Direct costs incurred during the application development stage are capitalized. Costs incurred during the post implementation/operation stage are expensed as incurred. Capitalized software development costs are amortized on a straight-line basis over their estimated useful lives.
Impairment of Living-Lived Assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An asset is considered to be impaired when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition exceeds its carrying amount. The amount of impairment loss, if any, is measured as the difference between the net book value of the asset and its estimated fair value. At March 31, 2005, no such impairment existed.
Income Taxes
Deferred income taxes are provided, using the asset and liability method, for temporary differences between financial and tax reporting purposes which arise principally from the deduction related to the allowances for doubtful accounts, certain capitalized software costs, the basis of inventory and differences arising from book versus tax depreciation methods.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin No. 104. The Company recognizes revenue from the sales of hardware when the rights and risks of ownership have passed to the customer, upon shipment or receipt by the customer, depending on the terms of the sales contract with the customer. Revenue from the sales of software not requiring significant modification or customization is recognized upon delivery or installation. Revenue from services is recognized upon performance and acceptance after consideration of all of the terms and conditions of the customer contract. Service contracts generally do not extend over one year, and are billed when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, and collection of the resulting receivable is reasonably assured. Revenue arrangements generally do not include specific customer acceptance criteria. For arrangements with multiple deliverables, delivered items are accounted for separately, provided that the delivered item has value to the customer on a stand alone basis and there is objective and reliable evidence of the fair value of the undelivered items. Revenue billed on retainer is recognized as services are performed and amounts not recognized are recorded as deferred revenue.
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
The Company periodically receives discretionary cost reimbursements from suppliers. These reimbursements are accounted for as reductions to the cost of sales products.
Shipping and handling costs are included in the cost of sales.
Fair Value of Financial Instruments
The estimated fair value of amounts reported in the consolidated financial statements has been determined by using available market information and appropriate valuation methodologies. All current assets are carried at their cost and current liabilities are recorded at their contract amount, which approximates fair value because of their short term nature. The fair value of the convertible subordinated promissory notes approximate their principal amount due to their short term nature.
Per Share Data
Basic net (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted net (loss) per share is calculated using the weighted-average number of common shares plus dilutive potential common shares outstanding during the period. Dilutive securities amounting to 23,012, 983, and 887 in the year ended March 31, 2005, 2004 and 2003, respectively, have not been included in the weighted-average shares used for the calculation of earnings per share because the effect of such securities would be anti-dilutive.
Stock-Based Compensation
The Company has elected, in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” to apply the current accounting rules under APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for employee stock options and, accordingly, has presented the disclosure-only information as required by SFAS No. 123. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date, as prescribed by SFAS No. 123, net (loss) and net (loss) per common share for the years ended March 31, 2005, 2004 and 2003 would approximate the pro forma amounts indicated in the tables below.
Pro forma information regarding net (loss) and earnings per share is required by SFAS No. 123, and has been determined as if the Company accounted for its employee stock options under the fair value method of the statement. The fair value of these options was estimated at the date of grant using a Black-Sholes option pricing model with the following with following weighted-average assumptions for the years ended March 31, 2005, 2004, and 2003: risk-free interest rate of 4.1%, 3% -4% , and 2.8%, respectively: no dividend yield; a volatility factor of the expected market price of the Company's common stock of 1.13, 1.00 and 1.24, respectively; and an expected life of 4.0, 4.0 and 4.0 years, respectively.
The Black-Sholes option valuation model was developed for use in estimating the fair value of publicly traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the Black-Sholes option valuation model does not necessarily provide a reliable single measure of the fair value of its employee stock options.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We place our cash with high credit quality institutions. At times, such amounts may be in excess of the FDIC insurance limits.
The Company does not have any customer at March 31, 2005 which accounts for more than 10% of our total accounts receivable.
At March 31, 2004 one customer accounted for approximately 16% of the Company's accounts receivable.
Credit is extended to customers based on an evaluation of their financial condition, and collateral is generally not required. The evaluation of financial condition is performed to reduce the risk of loss.
Goodwill
The Company tests goodwill for impairment at the reporting unit level on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit's fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit's goodwill with the carrying value of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net income (loss).
Circumstances that could trigger an impairment test include but are not limited to: significant adverse change in the business climate or legal factors; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; the likelihood that a reporting unit or significant portion of a reporting unit will be sold or otherwise disposed of; results of testing for recoverability of a significant asset group within a reporting unit; and recognition of a goodwill impairment loss in the financial statement of a subsidiary that is a component of a reporting unit.
Intangibles Assets
The company recorded intangible assets which related to the acquisitions of the assets of DataVox Technologies, Inc., Network Catalyst, Inc., Vector ESP, Inc. and the capital stock of Info Systems, Inc.
Intangibles consist of the following:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
The customer relationships and know-how are being amortized over periods of 3 to 4 years.
Amortization expense amounted to $0.8 million for the year ended March 31, 2005. Estimated amortization expense for the next four years is as follows:
Recently Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in an entity's statement of income. The accounting provisions of SFAR 123R are effective for annual reporting periods beginning after June 15, 2005. The Company is required to adopt the provisions of SFAS 123R in the quarter ending June 30, 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Although the Company has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, the Company is evaluating the requirements under SFAS 123R and expects the adoption to have a material impact on the consolidated statements of operations and net income (loss) per share.
Management does not believe any other recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements.
2. Credit Facilities
On May 21, 2004, the Company and its subsidiaries entered into an Amended and Restated Financing Facility (the “Old Textron Facility”) with Textron Financial Corporation (“Textron”). The Old Textron Facility provided for a credit facility of up to $15 million, secured by all of the Company's assets, except for permitted encumbrances, and was to expire on May 21, 2005. Effective as of December 27, 2004, the Schedule to the Old Textron Facility was amended to change certain of the financial covenants contained therein.
On February 1, 2005, the Company received a temporary increase from Textron in the maximum amount of the Old Textron Facility to $20 million.
Two forms of loans were made under the Old Textron Facility: floor plan financings and revolving receivable financings. The floor plan financings generally allowed the Company to finance inventory purchases from approved vendors on a 30-day interest-free basis. Interest accrued on floor plan financings after such 30-day period at the rate equal to six basis points over a specified prime rate. The revolving receivable financings allowed the Company to borrow against current account receivables that meet certain specified standards. Interest accrued on revolving receivable financings immediately upon funding at a specified prime rate. The Old Textron Facility contained
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
other affirmative and negative covenants, including those relating to the Company's tangible capital funds and other financial conditions. The Company was required to pay additional fees if it exceeded the maximum permitted aggregate loan amount then in effect or if the Company was found to be in default under the Old Textron Facility.
The Company's total outstanding debt under the Old Textron Facility's revolving receivable financing facility was $13,614 as at March 31, 2005 and $5,919 as at March 31, 2004. The amount outstanding under the Old Textron Facility's inventory financing was $2,930 as at March 31, 2005 and $3,456 as at March 31, 2004.
On June 8, 2005, the Company entered into a secured revolving credit facility (the “CIT Facility”) with CIT Group/Business Credit Inc. (“CIT”) and a new Amended and Restated Loan and Security Agreement (the “New Textron Facility”) with Textron, providing a combined maximum availability of up to $40 million. The CIT Facility and the New Textron Facility will be used to fund working capital and floor-planning needs, and were also used to refinance the Old Textron Facility.
The CIT Facility is a three year revolving credit facility for up to $25 million, subject to a borrowing base based on eligible accounts receivable, eligible in-transit inventory (up to $0.5 million) and eligible finished goods inventory (up to $0.5 million). The CIT Facility requires, among other things, that the Company maintain certain financial covenants including that the Company maintain Consolidated Senior Leverage of not greater than 4.00 to 1.00 for the trailing four quarters and that the Company maintain a Consolidated Fixed Charge Coverage Ratio of not less than 1.00 to 1.00 for the trailing four quarters, restricts the Company's ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. Amounts borrowed under the CIT facility will bear interest at either the prime rate or at LIBOR plus 3%, in each case at the Company's option.
The New Textron Facility allows the Company to finance inventory purchases up to $15 million from approved vendors on a 45-day interest-free basis in most cases. Interest accrues after expiration of the applicable interest free period at the rate equal to a specified prime rate plus 4%. The financial and other covenants in the New Textron Facility are substantially the same as those in the CIT Facility.
At March 31, 2005, the Company was in violation of certain covenants contained in the Old Textron Facility. The Company received a letter of forbearance from Textron related to these violations. In connection with the New Textron Facility, the covenants contained in the Old Textron Facility were eliminated and replaced with new covenants. The Company anticipates that it will be in compliance with the new covenants at the respective measurement dates.
The components of debt as of March 31 are as follows:
The Company's future debt maturities at March 31, 2005 are summarized below:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
3. Shareholders' Equity
Preferred Stock
As of March 31, 2005, the Company had authorized 20 million shares of preferred stock, 14 million of which are designated Series A Preferred Stock, par value $.001 per share and 6 million of which are “blank check” preferred stock, par value $.001 per share. As of March 31, 2005 there were 9.1 million shares of Series A Preferred Stock issued. See Note 10 for a discussion of the issuance of Series A Preferred Stock. As of March 31, 2004, the Company had authorized 2 million shares of “blank check” preferred stock, par value $.001 per share. As of March 31, 2004 there were no preferred shares issued.
Stock Options
The 1993 Employee Stock Option Plan (the “1993 Plan”) was adopted by the Company in May 1993; the 1996 Stock Option Plan (the “1996 Plan”) was approved by the shareholders of the Company on August 20, 1996; and the 1998 Stock Option Plan (the “1998 Plan”) was approved by the shareholders of the Company on October 16, 1998. The 2000 Employee Stock Option Plan (the “2000 Plan”) was adopted by the Company in September 2000. The 2002 Long-Term Performance Plan (the “2002 Plan”) was approved by the shareholders of the Company on November 8, 2002. The 2004 Equity Incentive Plan (the “2004 Plan”) was approved by the shareholders of the Company on May 21, 2004 and an amendment to the 2004 Plan was approved by the shareholders of the Company on November 19, 2004.
The plans provide for granting of options, including incentive stock options, nonqualified stock options and stock appreciation rights to qualified employees, outside directors, independent contractors, consultants and other individuals, to purchase up to an aggregate of 250, 350, 250, 350, 250 and 3,000 shares of the Company's common stock under the 1993 Plan, the 1996 Plan, the 1998 Plan, the 2000 Plan, the 2002 Plan and the 2004 Plan, respectively. The exercise price of options generally may not be less than 100% of the fair market value of the Company's common stock at the date of grant. Options may not be exercised more than 10 years after the date of grant. Options granted under the plans become exercisable in accordance with different vesting schedules determined at the time of grant.
A summary of the status of the Company's options as of March 31, 2005, 2004 and 2003, and changes during the years then ended, is presented below:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
The weighted-average contractual life of the total options outstanding at March 31, 2005 is 8.1 years.
The weighted-average fair value of options granted during the years ended March 31, 2005, 2004, and 2003 is $2.58, $1.19 and $0.75, respectively.
There were 1,046, 983 and 784 options exercisable at March 31, 2005, 2004 and 2003, respectively. The weighted-average exercise price of the total options exercisable at March 31, 2005 is $2.19. Granted and Outstanding at end of year totals for 2005 include 58 restricted stock units which do not have an exercise price. The value of the restricted stock units is approximately $180 and $10 was charged to operations for the year ended March 31, 2005.
Earnings per Share
The following table presents the computation of basic and diluted (loss) per share:
4. Accounts Payable and Accrued Expenses
Accounts Payable and accrued expenses consist of the following:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
5. Income Taxes
The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The provision (benefit) for income taxes consists of the following:
The reconciliations of income tax provision (benefit) computed at the federal statutory tax rates to actual income tax provision (benefit) are as follows:
The tax effects of temporary differences that give rise to the net short-term deferred income tax asset at March 31, 2005 and 2004 are presented below:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
The tax effects of temporary differences that give rise to the net long-term deferred income tax asset (liability) are presented below:
The Company has net operating loss carryforwards of (a) $16,579 to offset federal taxable income, and (b) $19,507 of available state carryforwards to offset taxable income through the year 2025. Realization of the benefit of the carryforward losses depends on earning sufficient taxable income before expiration of loss carryforwards. The utilization of the net operating loss carry forwards may also be limited as a result of ownership changes. At March 31, 2005 and 2004, the Company has established a valuation allowance that offsets the deferred tax assets.
6. Commitments and Contingencies
The Company leases 27 locations for its administrative and operational functions under operating leases expiring at various dates through 2016. Certain leases are subject to escalation based on the Company's share of increases in operating expenses for the locations. In addition, the Company leases equipment used in operations.
Approximate future minimum annual lease payments under noncancelable operating leases are as follows:
Rental expense for operating leases including amounts from cancelable leases approximated $1,077, $742 and $703 for the years ended March 31, 2005, 2004 and 2003, respectively.
Employment Agreements
The Company has entered into employment agreements, which require the following payments:
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
In addition, certain other agreements provide for bonus compensation based on certain performance goals, as defined.
Litigation
The Company is involved in various claims and legal actions arising in the ordinary course of business. Management is of the opinion that the ultimate outcome of these matters would not have a material adverse impact on the financial position of the Company or the results of its operations.
7. Employee Savings Plan
The Company has an employee savings plan which qualifies under Section 401(k) of the Internal Revenue Code. Under this plan, all employees who are at least 20.5 years of age are eligible to defer up to 60% of their pretax compensation, but not more than the limit prescribed by the Internal Revenue Service. Company matches are discretionary. The Company contributed approximately $26, $29 and $30 to the plan for the years ended March 31, 2005, 2004 and 2003, respectively.
8. Allowance for Doubtful Accounts
Information relating to the allowance for doubtful accounts is as follows:
(a)
Write-off of uncollectible accounts receivable and/or revision to estimates computed.
(b)
Allowance for doubtful accounts assumed through acquisitions.
9. Acquisitions
In executing its growth-through-acquisition strategy during the 2005 fiscal year, the Company has acquired the businesses and operating assets of three companies and all of the outstanding stock of a fourth company.
On July 2, 2004, the Company acquired the assets and business operations of DataVox Technologies, Inc. (“DataVox”), a Cisco AVVID (Architecture for Voice, Video and Integrated Data) authorized partner, offering advanced technology solutions, including IP telephony, security, storage, networking and wireless technology solutions, as well as network facilities engineering and data center technology consulting services. The results of operations are included in the Company's financial results as of July 2, 2004. The purchase price of DataVox was recorded as $2,089 and was allocated to specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in amount of $650, promissory notes in the amount of $250, 753 shares (at $1.58 per share, or $1,189 total), plus transaction costs of $51 (including 12 shares).
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition. The Company performed a valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships.
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
Goodwill related to the acquisition of DataVox amounted to $1,635 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $82 is expected to be deductible for tax purposes.
On September 17 2004, the Company acquired the assets and business operations of Network Catalyst Inc. (“Network Catalyst”). Network Catalyst provides advanced technology solutions in the VOIP (Voice Over Internet Protocol), infrastructure and security fields to clients located throughout the Southern California region. Network Catalyst was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the Company's financials results beginning September 18, 2004. The purchase price of the Network Catalyst acquisition was recorded as $4,800 and was allocated to the specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in the amount of $4,000, 500 shares (at $1.60 per share, or $800 total) of the Company's common stock, plus transaction costs of $239. As part of the purchase price, the Company agreed to pay to the former shareholders of Network Catalyst additional cash amounts as well as transfer to the former shareholders of Network Catalyst additional shares of common stock on the achievement of certain financial targets. More particularly, in the event that as of the end of any fiscal quarter, the earnings before interest, taxes, depreciation and amortization (“EBITDA”) attributable to the acquired business during the period beginning October 1, 2004 and ending on September 30, 2005 (the “Network Catalyst Earnout Period”) equals or exceeds $2,000 then the Company is required to (x) pay to the former shareholders of Network Catalyst $960 in cash, and (y) issue to the former shareholders of Network Catalyst that number of shares of common stock determined by dividing $240 by the greater of (A) the average trading price of the common stock for the 20 business days ending immediately preceding the end of the Network Catalyst Earnout Period and (B) $2.15.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation estimate of certain intangible assets and allocated a portion of the purchase price to Customer Relationships. Therefore, the allocation of the purchase price is subject to refinement.
Goodwill related to the acquisition of Network Catalyst amounted to $4,583 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $153 is expected to be
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
deductible for tax purposes. In addition, amounts allocated to Customer Relationships is $1,779, with an expected life of 3 years.
On December 10, 2004, the Company acquired the assets and business operations of Vector ESP, Inc. and Vector ESP Management, Inc. (collectively, “Vector”). Vector provides advanced technology solutions in application delivery and deployment, network infrastructure, messaging and collaboration, remote office connectivity and workforce mobility products and services. Vector was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the Company's financial results beginning December 1, 2004. The purchase price of the Vector acquisition was recorded as $19,765 and was allocated to the specific assets acquired and liabilities assumed. The purchase price was paid in the form of cash in the amount of $16,833, promissory notes in the amount of $667, and 434 shares (at $5.22 per share or $2,265 total) of the Company's common stock, plus transaction costs of $712. As part of the Vector purchase price, the Company agreed to issue to Vector Global Services, Inc. (the “Vector Shareholder”) additional shares of common stock on the achievement of certain financial targets. More particularly, if the EBITDA attributable to the acquired business during the period beginning on January 1, 2005 and ending on the date one year thereafter (the “Vector Earnout Period”) equals or exceeds $2,975, then, as additional consideration the Company shall issue to the Vector Shareholder the number of shares of common stock determined by (x) dividing $3,000 by the greater of (A) the weighted average trading price of the Company's common stock for the 10 business days immediately preceding the end of the Vector Earnout Period and (B) $2.75 and (y) multiplying such amount by a fraction, the numerator of which shall equal the EBITDA of the acquired business for the year ending on the last day of the Vector Earnout Period and the denominator of which shall equal $3,500 (the “Vector Earnout Consideration”); provided, however, that in no event shall the value of the Vector Earnout Consideration exceed $3,000.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships and Know-How.
Goodwill related to the acquisition of Vector amounted to $18,520 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $412 is expected to be deductible for tax purposes. In addition, amounts allocated to Customer Relationships and Know-How is $3,880 with an average expected life of 3.5 years.
On March 11, 2005, the Company acquired all of the stock of Info Systems, Inc. (“Info Systems). Info Systems conducts an information technology business and certain management and consulting businesses consisting of providing connectivity (network infrastructure), server architecture (applications, directory and computing infrastructure), convergence (legacy and VOIP, security (assessment, policy design) and storage (SAN, data migration) solutions, as well as telecommunications and structured cabling services, outsourced information technology (IT), staff
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
augmentation and remote network monitoring, management and support services throuth its Network Operations Center. InfoSystems was acquired to improve the geographical presence and deepen the technical capabilities of the Company. The results of operations are included in the company's financial results beginning March 1, 2005. The aggregate purchase price for the stock of Info Systems amounted to $11,121 and consisted of $8,300 in cash, an aggregate of 868 shares (at $3.25 per share or $2,821 total) of the Company's common stock, plus transaction costs of $225. The Earnout Consideration is as follows: if the EBITDA attributable to the Business during the six months following March 11, 2005 (the “Earnout Period”) equals or exceeds $600, then we shall, at our option, either (i) pay $500 in cash to the shareholders of Info Systems, or (ii) issue to the shareholders of Info Systems, the number of shares of the Company's common stock determined by dividing $500 by the greater of (A) the average NASDAQ closing price of the common stock for the 10 business days ending immediately prior to the end of the Earnout Period and (B) $2.75 (the amounts payable to the shareholders of Info Systems pursuant to this paragraph, the “Initial Earnout Consideration”). For each $1.00 of the EBITDA attributable to the acquired business during the Earnout Period in excess of $600, the Company shall, at its option, either (i) pay to the shareholders of Info Systems cash in an amount equal to 30% of such excess, or, (ii) issue to the shareholders of Info Systems the number of shares of common stock determined by dividing 30% of such excess by the greater of (x) the average NASDAQ closing price of common stock for the 10 business days ending immediately prior to the end of the Earnout Period and (y) $2.75, (the amounts payable to the shareholders of Info Systems pursuant to Section 3.2(b) of the stock purchase agreement), the “Additional Earnout Consideration” and together with the Initial Earnout Consideration, the “Earnout Consideration”); provided, however, that in no event shall the value of the Additional Earnout Consideration exceed $200.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company obtained a third party valuation of certain intangible assets and allocated a portion of the purchase price to Customer Relationships.
Goodwill related to the stock purchase of Info Systems amounted to $8,269 and is expected to be deductible for tax purposes. For the year ended March 31, 2005, $46 is expected to be deductible for tax purposes. In addition, amounts allocated to Customer Relationships is $1,374, with an expected life of 4 years.
The Company believes that there is an opportunity to consolidate similar businesses throughout the United States. The Company will focus its acquisition strategy on businesses providing secure access, voice over internet protocol (VOIP), storage, networking and messaging solutions. The acquisition targets will include companies providing IT services and products, as well as certain managed solutions. The Company intends to seek acquisitions to enhance our current service offerings and extend its geographic presence. The Company seeks to identify businesses which will add technical expertise and service offerings, customers, sales capabilities and/or geographic coverage while generating a positive rate of return on investment. Furthermore, the Company intends to capitalize on the business practices of acquired companies that the Company believes will best maintain or strengthen its competitive advantage and ensure ongoing delivery of
MTM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(In thousands, except for per share amounts)
high quality IT solutions to its customers. The acquisition candidates the Company may investigate can be large, and their acquisition by the Company could have a significant and lasting impact on our business.
Unaudited Pro Forma Summary
The following pro forma consolidated amounts give effect to the Company's Network Catalyst, Vector and Info Systems acquisitions accounted for by the purchase method of accounting as if they had occurred at the beginning of the period by consolidating the results of operations of the acquired net assets for the year ended March 31, 2005.
The pro forma consolidated statements of operations are not necessarily indicative of the operating results that would have been achieved had the transaction been in effect as of the beginning of the periods presented and should not be construed as being representative of future operating results.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for share amounts)
(1) Interest expense includes 3,102 and 7,220 of non-cash interest related to convertible debt, for the years ended March 31, 2005 and 2004, respectively.
(2) The weighted average shares used to compute proforma basic and diluted net (loss) per share for the year ended March 31, 2004 includes 1,801 shares of common stock issued as if the shares were issued on April 1, 2003.
10. Debt, Capital Lease Obligations and Series A Preferred Stock and Notes
On January 29, 2004 the Company entered into an agreement (the “Pequot Purchase Agreement”) with Pequot to sell to Pequot an aggregate of up to $25 million of Series A Convertible Preferred Stock, together with warrants to purchase additional shares of common stock.
The Series A Preferred Stock accrues dividends at 6% per annum payable semi-annual, commencing on May 21, 2006. Therefore, the Company will accrue dividends payable each applicable semi-annual period commencing May 21, 2006. Both the accretion of and dividends on the Series A Preferred Stock will reduce net income attributable to our common shareholders.
On May 21, 2004, Pequot purchased $7 million of Series A-1 Convertible Preferred Stock which is convertible into 3,256 shares of the Company's common stock at the conversion price of $2.15 per share, and 500 common stock warrants which are exercisable at a price of $2.46 per share. Pequot also received rights to purchase, solely at its option, Series A-2 Convertible Preferred Stock and Series A-3 Convertible Preferred Stock aggregating up to $18 million, plus warrants to purchase additional shares of common stock. Costs incurred in connection with the consummation of the initial Pequot transaction amounted to approximately $1 million which was recorded as a reduction of the proceeds. Payments aggregating $1.1 million were made to two officers of the Company and an additional $400 funded a rabbi trust from which payments aggregating $200 will be paid to these officers on each of May 21, 2005 and 2006. These payments are included in selling, general and administrative expenses. On September 16, 2004, Pequot purchased $5.5 million of Series A-2 Convertible Preferred Stock which is convertible into 2,000 shares of the Company's common stock at the conversion price of $2.75 per share, and 400 common stock warrants which are exercisable at a price of $3.44 per share. Pequot retained its right to purchase, solely at its option, Series A-3 Convertible Preferred Stock aggregating up to $12.5 million, plus warrants to purchase additional shares of common stock. Costs incurred in connection with the consummation of the second Pequot transaction amounted to approximately $25. The Company used the proceeds from these sales to fund the cash portions of the purchase prices for the acquisitions of DataVox Technologies, Inc. and Network Catalyst, respectively, referred to in Note 9.
On December 7, 2004, Pequot assigned to Constellation all of Pequot's rights and obligations under the Pequot Purchase Agreement to purchase a portion of the shares of the Series A-3 Convertible Preferred Stock and common stock warrants covered by that agreement. On that date the Company also entered into a purchase agreement (the “Pequot/Constellation Purchase Agreement”) with Pequot and Constellation for up to $40 million (or in certain limited circumstances, up to $47.5 million) of additional financing in the form of 7% convertible secured notes in three tranches. Immediately thereafter, Pequot purchased from the Company $6,250 of the Series A-3 Convertible Preferred Stock and 385 common stock warrants and Constellation purchased $6,250 of the Series A-3 Convertible Preferred Stock and 385 common stock warrants. The A-3 Convertible Preferred Stock is convertible into 3,846 shares of common stock at a conversion price of $3.25 per share and the associated common stock warrants are exercisable for 769 shares of common stock at an exercise price of $4.06 per share.
In connection with the initial Pequot investment, the Company allocated the net proceeds from the sale of the (a) Series A-1 Convertible Preferred Stock, (b) warrants to purchase 500 shares of the Company's common stock and (c) rights to purchase the Series A-2 Convertible Preferred Stock, Series A-3 Convertible Preferred Stock and related warrants based on their relative fair values as at the date of the sale of the Series A-1 Convertible Preferred Stock and 500 warrants. The Company allocated and recorded $2.9 million to the Series A-1 Convertible Preferred Stock and assigned and credited to additional paid-in capital (x) $600 for the 500 warrants sold with the Series A-1 Preferred Stock and (y) $3.2 million for the rights to purchase the Series A-2 Convertible Preferred Stock, Series A-3 Convertible Preferred Stock and related warrants based on an independent appraisal. Additionally, the Company paid a finder's fee consisting of $70 in cash and 27 shares of the Company's common stock, valued at $45, which was charged against additional paid-in capital.
In connection with the Pequot purchase of the Series A-2 Convertible Preferred Stock and related warrants the Company allocated and recorded $5.1 million to the Series A-2 Convertible Preferred Stock and assigned and credited to additional paid in capital $0.4 million for the fair value of the warrants. The value attributed to the warrants was determined by independent valuation utilizing the Black Scholes Model.
In connection with the Pequot and Constellation purchase of the Series A-3 Convertible Preferred Stock and related warrants the Company allocated and recorded $9.0 million to Series A-3 Convertible Preferred Stock and assigned and credited to additional paid in capital $3.5 million for the fair value of the warrants. The value attributed to the warrants was determined by independent valuation utilizing the Black Scholes Model.
On December 10, 2004, to fund the cash portion of the purchase price for the assets of Vector the Company sold to Pequot and Constellation pursuant to the Pequot/Constellation Purchase Agreement, $10,000 aggregate principal amount of notes (the “Series A-4 First Tranche Notes”) and issued to Pequot and Constellation warrants to purchase 615 shares of the Company's common stock at an exercise price of $4.06 per share (the “Series A-4 First Tranche Warrants”).
On March 10, 2005, to fund the cash portion of the purchase of Info Systems the Company sold to Pequot and Constellation pursuant to the Pequot/Constellation Purchase Agreement, $6,000 aggregate principal amount of notes (the “Series A-4 Second Tranche Notes”) and issued to Pequot and Constellation warrants to purchase 369 shares of the Company's common stock at an exercise price of $4.06 per share (the “Series A-4 Second Tranche Warrants”). The Series A-4 First Tranche Notes and the Series A-4 Second Tranche Notes are collectively referred to as “Series A-4 Notes.”
The Series A-4 Notes bear interest at an annual rate of 7%, payable quarterly. The interest accrued on each such payment date will be added to the principal of the Series A-4 Notes. The Series A-4 Notes are convertible into 7,692 shares of Series A-4 Convertible Preferred Stock which is in turn convertible into 7,692 shares of the Company's common stock at a conversion price of $3.25.
The outstanding principal and accrued interest will be automatically converted into Series A-4 Convertible Preferred Stock on the date of shareholders' approval. If the Series A-4 Notes have not already been converted into Series A-4 Convertible Preferred Stock, they will be due and payable on demand, which may be given by 662⁄3% of the holders of the notes at any time following the later of the date that is (x) 150 days following the date of issuance or (y) if the Securities and Exchange Commission (the “SEC”) reviews the Company's filings seeking shareholder approval, 180 days following the date of issuance. The Series A-4 Notes were converted into shares of Series A-4 Preferred Stock upon approval by the Company's shareholders on June 23, 2005.
The Company assigned a value of $6,797 to the beneficial conversion feature of the Series A-4 notes, the warrants, and the options based on the relative fair values (using the Black Scholes Model) at the date of issuance and recorded this value as a discount to the Series A-4 Notes. This discount is being accreted to interest expense over the expected term of the Series A-4 Notes. During the period ended March 31, 2005 the discount accreted to interest expense amounted to approximately $3.8 million. At March 31, 2005, the remaining discounted to be accreted amounted to approximately $2.9 million.
Pequot and Constellation (or in certain circumstances, a third party) also have the right to purchase up to an additional $9,000 in aggregate principal amount of Series A-4 Notes, which amounts may be adjusted in accordance with the terms of the Pequot/Constellation Purchase Agreement. This additional right is exercisable until September 10, 2005. Pequot and Constellation also have the right to purchase up to $15,000 (or in certain limited circumstances, up to $22,500) in aggregate principal amount of notes (the “Series A-5 Notes”), which following shareholder approval will be converted into 4,615 shares (or in certain limited circumstances, 6,923 shares) of Series A-5 Convertible Preferred Stock, which is in turn convertible into 4,615 shares (or in certain limited circumstances, 6,923 shares) of the Company's common stock at a conversion price of $3.25. This additional right is exercisable until December 10, 2005.
In accordance with Emerging Issues Task Force Issue 00-19 (“EITF 00-19”), ”Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled in, a Company's Own Stock,“ the Company has initially accounted for the fair value of $6.8 million for the warrants and the option as a liability since the Company is required to register the underlying common stock. The
fair value of the warrants was calculated utilizing the Black Scholes Model. From the date of issuance through the end of the fiscal year, there was a change in the market value of the Company's common stock, and therefore, the Company recorded a $462 decrease in the carrying value of the liability which is included as a reduction in selling, general and administrative expenses. Any additional change in the future market value of the underlying securities may cause the value of the liability to change. Any change in the carrying value of the liability will be made through the Company's current statement of operations.
11. Segment Information
In prior years the Company reported three separate segments. As a result of the acquisitions completed during the fiscal year and the changes in the structure of the Company's internal organization, the Company has concluded that it currently operates in a single operating segment. The Company currently operates only within the United States. Substantially, all of the Company's revenue generating operations have similar economic characteristics, including the nature of the products and services sold, the type and class of clients for products and services, the methods used to deliver products and services and regulatory environments.
12. Quarterly Results of Operations
The following is a summary of the quarterly results of operations for the years ended March 31, 2005, 2004, and 2003.
Earnings (loss) per common share calculations for each of the quarters were based on the weighted-average number of shares outstanding and the sum of the quarters may not necessarily be equal to the full year earnings per common share amount.
[LETTERHEAD OF SQUAR MILNER]
INDEPENDENT AUDITORS’ REPORT
To the Stockholders
NETWORK CATALYST, INC.
We have audited the accompanying balance sheets of Network Catalyst, Inc. (the “Company”) as of June 30, 2004 and December 31, 2003, and the related statements of operations and accumulated deficit, and cash flows for the six month period ended June 30, 2004 and the year ended December 31, 2003. These 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits 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 financial position of Network Catalyst, Inc. as of June 30, 2004 and December 31, 2003, and the results of its operations and cash flows for the six month period ended June 30, 2004 and the year ended December 31, 2003 in conformity with accounting principles generally accepted in the United States.
As discussed in Note 10, the Company sold substantially all of its assets to a publicly traded company on September 17, 2004.
/s/ Squar, Milner, Reehl & Williamson, LLP
July 30, 2004, except for the last paragraph of this report
and Note 10 as to which the date is September 17, 2004
Newport Beach, California
NETWORK CATALYST, INC.
BALANCE SHEETS
June 30, 2004 and December 31, 2003
NETWORK CATALYST, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
For the Six Month Period Ended June 30, 2004 and
the Year Ended December 31, 2003
NETWORK CATALYST, INC.
STATEMENT OF CASH FLOWS
For the Six Month Period Ended June 30, 2004 and
the Year Ended December 31, 2003
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS
1. Organization
Network Catalyst, Inc. (the “Company” ) was incorporated on March 11, 1991, and engages in computer network design, consulting, and implementation throughout the United States.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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. Significant estimates made by management, among others, are the realization of inventories, the realization of long-lived assets, and the allowance for doubtful accounts. Actual results could differ from those estimates.
Concentrations of Credit Risk
The Company currently maintains substantially all of its day-to-day operating cash with one major financial institution. At times, cash balances may be in excess of amounts insured by the Federal Deposit Insurance Corporation.
The Company’s accounts receivable result primarily from sales to customers in California, Arizona and Massachusetts. The Company extends credit to customers based upon evaluation of each customer’s financial condition and credit history. The Company generally does not require collateral from customers.
At June 30, 2004 and December 31, 2003, one customer and three customers accounted for approximately 52% and 73% of gross accounts receivable, respectively. No other single customer accounted for more than 10% of gross accounts receivable at either balance sheet date. For the six months ended June 30, 2004 and the year ended December 31, 2003, two customers and one customer accounted for approximately 41% and 40% of net sales, respectively. No other single customer accounted for more than 10% of net sales for either reporting period. For the six month period ended June 30, 2004 and the year ended December 31, 2003, one vendor and another different vendor accounted for approximately 52% and 15% of total purchases, respectively. No other single vendor accounted for more than 10% of total purchases for either reporting period.
Allowance for Doubtful Accounts
The Company performs periodic reviews of collectibility and provides an allowance for doubtful accounts receivable as management deems necessary. Management considers historical and industry trends in establishing such allowance. Management considers the allowance for doubtful accounts at June 30, 2004 and December 31, 2003 of approximately $2,000 to be adequate to provide for losses, which could be sustained in the realization of these accounts. Although the Company expects to collect net amounts due, actual collections may differ from these estimated amounts.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market, and consist primarily of computer networking equipment. Market is determined by comparison with recent sales or net realizable value. Such net realizable value is based on management’s forecasts for sales of the Company’s products in the ensuing years. The industry the Company operates in is characterized by technological change. Should the demand for the Company’s products prove to be significantly
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
less than anticipated, the ultimate realizable value of the Company’s inventory could be substantially less than the amount in the accompanying balance sheet. The Company periodically reviews the age and turnover of its inventory to determine whether any inventory has become obsolete or has declined in value and records a charge to cost of revenues for known and estimated inventory obsolescence. At June 30, 2004, the allowance for obsolete inventory was approximately $100,000. There was no such obsolescence allowance at December 31, 2003.
Property and Equipment
Property and equipment are stated at cost. Major renewals and improvements are capitalized, while replacements, maintenance and repairs, which do not significantly improve the useful life of the asset, are expensed when incurred. Depreciation is provided over the estimated useful lives of the assets, which range from five to seven years, using accelerated methods. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the improvements or the lease term.
Revenue Recognition
The Company has four primary sources of revenue: (1) Sales of network hardware and third party developed software; (2) Network consulting revenue; (3) Third party maintenance contracts; and (4) Managed service maintenance contracts. The Company records revenue from sales of network hardware and third party developed software at the time the products are shipped. Network consulting revenue is recognized upon performance of the related consulting services. Revenue from third party maintenance contracts, in which the Company acts as an agent, is recognized at the time such contracts are sold. Managed service maintenance contract revenue is recognized on a straight-line basis over the related maintenance contract period, generally one year in duration. Incremental direct costs associated with acquisition of the managed service maintenance contracts are also deferred and amortized over the contract period in accordance with Statement of Financial Accounting Standards No. 91 (“SFAS 91”) and FASB Technical Bulletin 90-1 (“FTB 90-1”). Deferred revenues and costs were approximately $690,000 and $188,000 at June 30, 2004, respectively. The Company did not engage in managed service maintenance contract activity prior to January 1, 2004.
Income Taxes
The Company has elected to be taxed as an “S” corporation for federal and state income tax purposes. Accordingly, the Company has not provided for federal income taxes, as the income tax liability is the responsibility of the individual shareholders. The Company is subject to California state income taxes at the rate of 1.5% of taxable income and, accordingly, a provision for such taxes has been included in the accompanying financial statements.
Long Lived Assets
The Company periodically evaluates the carrying value of its long-lived assets under the provisions of Statement of Financial Accounting Standards No. 144 ( “SFAS No. 144” ), “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires impairment losses to be recorded on long-lived assets used in operations, including amortizable intangible assets when indicators of impairment are present. Indicators of impairment include an economic downturn or a change in the assessment of future operations. In the event a condition is identified that may indicate an impairment issue, an assessment is performed using a variety of methodologies, including analysis of undiscounted future cash flows, estimates of sales proceeds and independent appraisals. If such assets are impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the estimated fair market value
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
of the assets. Assets to be disposed of are reported at the lower of the carrying value or estimated fair market value, less cost to sell. Based on management’s analysis, no such impairment charges existed or were deemed necessary during the six month period ended June 30, 2004 or the year ended December 31, 2003. There can be no assurance, however, that market conditions will not change or demand for the Company’s products or services will continue which could result in impairment of long-lived assets in the future.
Stock Options
The Company has one stock option plan and accounts for such plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. No stock-based compensation expense is reflected in the accompanying financial statements since all options were granted prior to 2002, vested immediately, and had an exercise price equal to or greater than the estimated fair market value of the underlying common stock on the date of grant. Accordingly, the disclosures required under SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure, an Amendment of FASB Statement No. 123”, are not applicable.
Significant Recent Accounting Pronouncements
SFAS No. 146, “Accounting for Costs Associated with Exit and Disposal Activities,” was issued in June 2002 and is effective for exit and disposal activities initiated after December 31, 2002. Management currently believes that such pronouncement will not have a material impact on the Company’s future financial statements.
In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, while the disclosure requirements became applicable in 2002. Management believes FIN No. 45 currently has no effect on the Company’s financial statements.
In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB 51.” The primary objectives of FIN No. 46 are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors (if any) do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46 for public entities that are small business issuers, as defined (“SBIs”), are as follows: (a) For interests in special-purpose entities: periods ended after December 15, 2003; and (b) For all other VIEs: periods ending after December 31, 2004. The December 2003 amendment of FIN No. 46 also includes transition provisions that govern how an SBI, which previously adopted the pronouncement (as it was originally issued), must account for consolidated VIEs. The Company is evaluating the effects of FIN No. 46 on its financial statements and currently believes the adoption of FIN No. 46 will not have a material impact.
In April 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. This pronouncement is effective for contracts entered into or modified after June 30, 2003 (with certain exceptions), and for hedging relationships designated after June 30, 2003. Management currently believes the adoption of SFAS No. 149 will not have a material impact on the Company’s financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and is effective (except for certain mandatorily redeemable non-controlling interests) for financial instruments entered into or modified after May 31, 2003. Management currently believes the adoption of SFAS No. 150 will not have a material impact on the Company’s financial statements.
3. Property and Equipment
Property and equipment consist of the following at June 30, 2004 and December 31, 2003:
4. Line-of-Credit
During 2001, the Company entered into a credit facility agreement with Deutsche Financial Services (“DFS”) that was personally guaranteed by the stockholders. Under such agreement, as amended, a $3,000,000 accounts receivable facility (“AR Facility”) and an $8,000,000 inventory floor plan credit facility (“Inventory Facility”) were established. Under the AR Facility, the Company could borrow up to 80% of eligible accounts receivable, as defined. Under the Inventory Facility, the Company could borrow to purchase inventory from approved vendors or for other approved purposes. The principal amount outstanding under the AR Facility and the Inventory Facility, in the aggregate, may not exceed $8,000,000. Interest accrued at the prime rate, with a 6% floor, plus 1.25%. This credit facility was secured by substantially all of the assets of the Company. Additionally, the Company could assign accounts receivable to DFS to borrow additional amounts. Such borrowings were under the same terms as the credit facility agreement above, with the exception that amounts borrowed were not part of the aforementioned $8,000,000 maximum.
Such line-of-credit was terminated and paid in full during April 2003.
5. Factoring Agreement
During April 2003, the Company entered into a financing agreement with a lender to transfer ownership of accounts receivable in exchange for cash (“factoring agreement”). Such agreement has been accounted for under SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities-a Replacement of FASB Statement No. 125,” as a factoring arrangement whereby the customer account receivable is considered transferred to the lender and removed from the Company’s books in exchange for cash, less a factoring fee of 0.4%
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
to 0.5%. At June 30, 2004 and December 31, 2003, the amount of accounts receivable factored was approximately $777,000 and $3,261,000, respectively. Such balances also bear a finance charge under the factoring agreement of not less than 7.0% annually. Factoring fees have been recorded as interest expense in the accompanying financial statements.
The Company’s stockholders have personally guaranteed the lender against certain losses outside the ordinary course of business under this agreement.
Such agreement was terminated in July 2004.
6. Related Party Transactions
The Company periodically advances funds and receives repayments from its stockholders or their affiliate company, Network Catalyst Software, LLC. These advances are non-interest bearing, due on demand and are to be repaid as cash becomes available. At June 30, 2004 and December 31, 2003, such advances totaled $1,294,969 and $1,049,455, respectively. During the six months ended June 30, 2004 and the year ended December 31, 2003, the Company made additional advances of approximately $245,514 and $367,810, respectively. During the six month period ended June 30, 2004, one stockholder advanced $200,000 to the Company, which comprises advances from related party in the accompanying balance sheets. There were no repayments of advances by stockholders for either reporting period in the accompanying financial statements.
During the six months ended June 30, 2004 and the year ended December 31, 2003, a stockholder contributed $1,190,000 and $196,000, respectively, to the Company as additional paid-in capital.
7. Commitments and Contingencies
The Company leases office space at several locations and various pieces of equipment under noncancelable operating leases which expire at various times through 2005.
At June 30, 2004, future minimum payments under these noncancelable operating leases are as follows for the years ending June 30:
Rent expense for the six months ended June 30, 2004 and the year ended December 31, 2003 approximated $163,000 and $332,000, respectively.
8. Stock Option Plan
As discussed in Note 2, the Company has a nonqualified stock option plan (the “Plan”), which provides for the granting of options to employees, consultants, and nonemployee directors. A maximum of 1,000,000 shares of common stock may be issued under the Plan. The option price, number of shares and grant date are determined at the discretion of the Company’s board of directors. Grantees vest in the options at the option grant date. Options granted under the Plan are exercisable for a period not to exceed ten years from the option grant date. During the year ended December 31, 2003, there were 10,000 options granted under the Plan. There were no options granted during the six month period ended June 30, 2004. A total of 380,000 and 390,000 stock options were outstanding at June 30, 2004 and December 31, 2003, respectively.
NETWORK CATALYST, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
Stock option activity and information is summarized as follows:
The weighted average remaining life of the options at June 30, 2004 was approximately 5 years. The pro-forma disclosure requirements under Statement of Financial Accounting Standards No. 123 (“SFAS 123”), Accounting for Stock Based Compensation, are not significant.
9. Employee Benefit Plan
The Company has a profit sharing plan for the purpose of establishing a salary deferral program under Section 401(k) of the Internal Revenue Code. During the six months ended June 30, 2004 and the year ended December 31, 2003, the Company made no matching or discretionary contributions to this plan.
10. Event Subsequent to the July 30, 2004 Date of the Independent Auditors’ Report (Unaudited)
On September 17, 2004 pursuant to an asset purchase agreement, the Company sold substantially all its assets to a publicly traded company known as MTM Technologies, Inc. (“MTM”), in exchange for cash, the assumption of certain Company liabilities, and the issuance of MTM restricted common stock.
INDEPENDENT AUDITOR’S REPORT
Board of Directors and Shareholders
VECTOR GLOBAL SERVICES, INC.
We have audited the accompanying consolidated balance sheet of Vector Global Services, Inc. (a Delaware corporation), and subsidiaries (the “Company”) as of September 30, 2004, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the nine months then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 the management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vector Global Services, Inc., and subsidiaries as of September 30, 2004, and the results of their operations and their cash flows for the nine months then ended, in conformity with accounting principles generally accepted in the United States of America.
UHY LLP
New York, New York
November 5, 2004
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2004
See Notes to Financial Statements
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Nine Months Ended September 30, 2004
See Notes to Financial Statements
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Nine Months Ended September 30, 2004
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2004
See Notes to Financial Statements
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
Note 1-Organization and Summary of Significant Accounting Policies
Organization
Vector Global Services, Inc., and subsidiaries (collectively, the “Company”) is a leading server-based computing integrator in the United States. The Company provides information system integration services and sells the related hardware and software products through its operating subsidiary, Vector ESP, Inc. The Company is in the initial stages of developing application and infrastructure management services. These services will encompass the management or hosting of both the applications and infrastructure on behalf of small and medium-sized enterprises. The Company was incorporated under the laws of the state of Delaware on March 3, 2000, and is headquartered in Houston, Texas.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
Revenue from the resale of computer hardware and software is recorded upon shipment or upon installation when required under contract terms. The related shipping and handling costs for delivery of hardware and software are included in cost of equipment and software on the accompanying consolidated statement of operations.
The Company also generates revenue from consulting services, implementation services, training, and postcontract support. Revenue from consulting and implementation services is recognized as the services are provided. Revenue from customer training and education is recognized at the date the services are performed. Revenue from postcontract support, consisting principally of help desk support, is recognized ratably over the period the support is provided.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist principally of cash on deposit with a bank and money market accounts that are stated at cost, which approximates fair value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, and accounts receivable. Sales to the Company’s customers are generally made on an open account. The Company performs initial and periodic credit evaluations of its significant customers and generally does not require collateral. Losses related to receivables have not been significant.
The Company maintains cash deposits in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced losses in such accounts and does not currently believe it is exposed to any significant credit risk related to its cash and cash equivalents.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include accounts receivable and accounts payable, approximate their fair values at September 30, 2004.
Inventory
Inventory, consisting of computer hardware and software held for resale, is recorded at the lower of cost or market. Cost is determined using the specific identification and first in, first-out methods.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the lease term.
Income Taxes
The Company accounts for its income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price. Deferred compensation is amortized and expensed in accordance with the graded vesting approach provided for in Financial Accounting Standards Board (“FASB”) Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company accounts for stock issued to nonemployees in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. The Company uses the Black-Scholes option pricing model to value options granted to nonemployees. The related expense is recorded over the period in which the related services are received.
The following table illustrates the effect on net income if the fair value recognition provisions of SFAS No. 123 had been applied to all outstanding and unvested awards:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
Goodwill
Goodwill represents the excess of the aggregate purchase price paid by the Company in acquisitions accounted for as purchases over the fair value of the net tangible assets acquired. Prior to 2002, goodwill was amortized on a straight-line basis over 3 years. Effective January 1, 2002, the Company adopted SFAS No. 142, which requires companies to assess goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred.
No impairment of goodwill has been recorded during the nine months ended September 30, 2004.
Reportable Segments
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for disclosures about operating segments, products and services, geographical areas and major customers. The Company is organized and operates as one reportable segment, providing server-based computing services. The Company operates in one geographic area, the United States.
Note 2-Property and Equipment
The Company’s property and equipment was comprised of the following as of September 30, 2004:
Note 3-Income Taxes
The Company files a consolidated federal income tax return, which includes the operations of the acquired companies for periods subsequent to their acquisitions.
The income tax benefit consists of a current state benefit of $26,202 for the period ended September 30, 2004.
The following table reconciles the differences between the statutory federal income tax rate (34%) and the effective tax rate for the years ended September 30, 2004:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The net deferred tax assets and liabilities at September 30, 2004, are comprised of the following:
The Company has net operating loss carryforwards of $11,973,495 for federal income tax purposes at September 30, 2004, which, if not utilized, will expire in 2020 through 2024.
The Company has recorded a valuation allowance for the full amount of deferred tax assets in light of its operating loss since its inception and the uncertainty regarding the realization of the net deferred tax assets.
Note 4-Credit Facilities
Notes Payable
The Company has a note payable with a financial institution totaling $22,485 at September 30, 2004. The note bears interest at competitive market rates, requires monthly payments and matures in 2005. Interest expense totaled $812 for the period ended September 30, 2004.
Accounts Receivable Credit Arrangement
In February 2002, the Company entered into a purchase and sale agreement (the “Agreement”) with a bank which permits the Company to sell and/or assign trade receivables to the bank for financing purposes. Generally, the bank will advance 80% of the face amount of the receivable, and fund the remaining portion, net of financing fees, when the customer remits payment. As of September 30, 2004, the Company had no balance outstanding under the Agreement. If at any time there is an amount outstanding under the Agreement, such obligation would be secured by the assets of the Company. In addition, the Company would be required to repurchase any receivable which extends beyond 90 days from the date of sale or if any dispute arises with respect to the underlying receivable.
Note 5-Leases
The Company leases office space and computer equipment under noncancelable capital and operating leases with various expiration dates through 2016. The Company leases certain facilities at market rates from certain shareholders who are also employees of the Company. Certain of the operating leases for office space provide for escalating annual rent. Rent expense under operating
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
leases for the period ended September 30, 2004, was $600,598, which includes amounts to related parties of $151,332.
Future minimum lease payments under noncancelable capital and operating leases, together with the present value of the net minimum lease payments, as of September 30, 2004, are as follows:
Assets capitalized under capital leases totaled $76,164 at September 30, 2004. Accumulated amortization for assets capitalized under capital leases totaled $73,671. Amortization of leased assets is included in depreciation and amortization expense.
Note 6-Shareholders’ Equity
Preferred Stock
The Company currently has authorized for issuance an aggregate of 30,000,000 shares of $0.01 par value preferred stock. At September 30, 2004, the following table represents shares of each series of preferred stock, authorized and issued and outstanding:
The holders of preferred stock have various rights and preferences as follows:
Voting-Each share of preferred stock has voting rights equal to an equivalent number of shares of common stock, into which it is convertible, and votes together as one class with the common stock subject to a Series A-1 and A-2 preferred stock class vote for certain actions. The Series A-1 and A-2 preferred stock voting as a single class, and excluding all other classes, has the right to elect four of seven members of the board of directors.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
Dividends-Holders of Series A-1, A-2, B, B-2, B-3, and B-4 convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock and Series C preferred stock when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. Holders of Series C convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock (but subordinate to holders of Series A-1, A-2, B, B-2, and B-3 preferred stock) when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. No dividends on convertible preferred stock or common stock have been declared by the board for the period ended September 30, 2004.
Liquidation-Upon any liquidation, dissolution or winding up of the Company, the holders of Series A-2 preferred stock pari passu with the holders of Series B-4 preferred stock, before any other class of stock, are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-1, B, B-2, and B-3 preferred stock, before the holders of Series C preferred stock (but subordinate to Series A-2 and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series C preferred stock, before the holders of common stock (but subordinate to Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. At the option of the preferred shareholders, a liquidating event can include the following: any merger, consolidation, business combination, reorganization, or recapitalization of the Company in which the shareholders of the Company immediately prior to such transaction own less than 50% of the Company’s voting power immediately following the transaction.
Conversion-Each share of preferred stock is convertible, at the option of the holder, into the number of shares of common stock as determined by the then effective conversion ratio (1:1 as of September 30, 2004). Each share of preferred stock automatically converts into the number of shares of common stock into which such shares are convertible at the then-effective conversion ratio upon the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000.
Warrants to Purchase Common Stock
As of September 30, 2004, the Company has outstanding warrants to purchase 1,659,818 shares of common stock for $0.01 per share at any time up to the date of the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000. The warrants were recorded at their fair market value at the time of issuance.
The Company has reserved shares of common stock for issuance as follows at September 30, 2004:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
Note 7-Stock Compensation Plans
2000 Stock Incentive Plan
Under the Company’s 2000 stock incentive plan (the “Plan”), the Company is authorized to issue up to 7,089,625 shares of common stock to directors, employees and consultants. The Plan provides for the issuance of stock purchase rights, restricted stock awards, incentive stock options, and nonstatutory stock options. Options granted generally expire 10 years after the grant date and vest ratably over a five-year period.
On August 28, 2000, the board of directors approved the issuance of 1,555,750 shares of restricted common stock to certain members of management, of which no shares were forfeited during 2004. The shares have a purchase price of $0.01 per share, are restricted from transfer and are subject to repurchase at $0.01 per share upon termination of employment. These restrictions lapse 20% per year on the anniversary date of the grant until fully vested. These shares of restricted common stock become fully vested upon the occurrence of a change of control (as defined in the Plan) or a qualified initial public offering (as defined in the agreement, as amended, pursuant to which the grants were issued). The Company recorded $1,151,255 of deferred compensation on September 30, 2000, for the difference between the purchase price of the Company’s restricted stock under the Plan and the fair value of the underlying common stock at the time of the grant. Such amount has been presented as a reduction of shareholders’ equity and is being amortized over the vesting period. The Company has recognized no compensation (income) expense related to the amortization of the deferred compensation for these stock grants for the period ended September 30, 2004.
In November 2000, the Company sold 54,545 shares of Series B-2 convertible preferred stock to an employee in exchange for a note. The note provides for the annual forgiveness of 20% of the outstanding principal and related interest, provided the participant is currently employed. The note is secured by the Series B-2 convertible preferred stock. This transaction has been accounted for as a stock grant, and the related $149,999 of deferred compensation is being amortized ratably over the five-year term of the note. The Company has recognized $9,190 of compensation expense, (which is included in general and administrative expense) related to the amortization of the deferred compensation for this stock grant for the period ended September 30, 2004.
A summary of the activity under the Plan is as follows for the years ended September 30, 2004:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
September 30, 2004
The following table summarizes information concerning currently outstanding and exercisable options as of September 30, 2004:
The fair value of each option grant is estimated on the date of grant using the minimum value option pricing model with the following weighted average assumptions: no dividend yield for all periods, risk-free interest rate of 3.26% in 2003 and 4.74% in 2002, and an expected useful life of seven years.
Note 8-Employee Benefit Plan
Effective February 1, 2001, the Company formed a new 401(k) plan (the “401k Plan”) which is available to all full-time Company employees who have completed at least six months of service. Participants are permitted, in accordance with the provisions of Section 401(k) of the Internal Revenue Code, to contribute up to 19% of their earnings into the 401k Plan. The Company matches 50% of employees’ contributions not to exceed 6% of employees’ eligible compensation. The Company incurred $137,402 of expenses related to all defined contribution plans for the period ended September 30, 2004.
Note 9-Significant Event
On September 29, 2004, the Company entered into a Letter of Intent with a potential acquirer to sell all of the assets in operations of the Company for an amount in excess of the carrying amount of the Company’s assets.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
VECTOR GLOBAL SERVICES, INC.
We have audited the accompanying consolidated balance sheets of Vector Global Services, Inc. (a Delaware corporation), and subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the years then ended. These 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 auditing standards generally accepted in the 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 Vector Global Services, Inc., and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
ERNST & YOUNG LLP
February 20, 2004
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
VECTOR GLOBAL SERVICES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
See accompanying notes.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003
1. Organization and Summary of Significant Accounting Policies
Organization
Vector Global Services, Inc. and subsidiaries (collectively, the “Company”) is a leading information technology integrator in the United States focused on the secure deployment of network and application infrastructure. The Company provides information system integration services and sells the related hardware and software products through its operating subsidiary, Vector ESP, Inc. The Company was incorporated under the laws of the state of Delaware on March 3, 2000, and is headquartered in Houston, Texas.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist principally of cash on deposit with a bank and money market accounts that are stated at cost, which approximates fair value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, and accounts receivable. Sales to the Company’s customers, which are primarily located in the United States, are generally made on an open account. The Company performs initial and periodic credit evaluations of its significant customers and generally does not require collateral. Losses related to receivables have not been significant.
The Company maintains cash deposits in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced losses in such accounts and does not currently believe it is exposed to any significant credit risk related to its cash and cash equivalents.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include accounts receivable and accounts payable, approximate their fair values at December 31, 2003 and 2002.
Inventory
Inventory, consisting of computer hardware and software held for resale, is recorded at the lower of cost or market. Cost is determined using the specific identification and first-in, first-out methods.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the lease term.
Income Taxes
The Company accounts for its income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Revenue Recognition
Revenue from the resale of computer hardware and software is recorded upon shipment or upon installation when required under contract terms. The related shipping and handling costs for delivery of hardware and software are included in cost of equipment and software on the accompanying consolidated statements of operations.
The Company also generates revenue from consulting services, implementation services, training, and postcontract support. Revenue from consulting and implementation services is recognized as the services are provided. Revenue from customer training and education is recognized at the date the services are performed. Revenue from postcontract support, i.e., telephone support, is recognized ratably over the period the support is provided.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price. Deferred compensation is amortized and expensed in accordance with the graded vesting approach provided for in Financial Accounting Standards Board (“FASB”) Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company accounts for stock issued to nonemployees in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. The Company uses the Black-Scholes option pricing model to value options granted to nonemployees. The related expense is recorded over the period in which the related services are received.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
The following table illustrates the effect on net loss if the fair value recognition provisions of SFAS No. 123 had been applied to all outstanding and unvested awards in each period:
Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written down to their estimated fair values.
Goodwill
Goodwill represents the excess of the aggregate purchase price paid by the Company in acquisitions accounted for as purchases over the fair value of the net tangible assets acquired. Prior to 2002, goodwill was amortized on a straight-line basis over three years. As further discussed in Note 3, effective January 1, 2002, goodwill is no longer subject to scheduled amortization, but is subjected to an annual impairment test. There was no impairment of goodwill in 2003.
Reportable Segments
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for disclosures about operating segments, products and services, geographical areas and major customers. The Company is organized and operates as one reportable segment, providing server-based computing services. The Company operates in one geographic area, the United States.
Recent Accounting Pronouncements
In November 2002, the FASB issued Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of annual periods ending after December 15, 2002. The adoption of FIN No. 45 did not have a material impact on the results of the Company’s operations and financial position.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated With Exit or Disposal Activities, which addresses accounting for restructuring, discontinued operation, plant
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
closing, or other exit or disposal activity. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 did not have an impact on the Company’s financial position and results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, to account for employee stock options. The additional disclosures required under SFAS No. 148 are effective for fiscal years ending after December 15, 2002, and have been provided in Note 1.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. This consensus requires that revenue arrangements with multiple deliverables be divided into separate units of accounting if the delivered items have value to the customer on a standalone basis, there is objective and reliable evidence of fair value of the undelivered items and, if the arrangement includes a general right of return, performance of the undelivered item is considered probable and substantially in the Company’s control. The final consensus is applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on the Company’s financial statements.
2. Property and Equipment
The Company’s property and equipment was comprised of the following as of December 31:
3. Goodwill
Effective January 1, 2002, the Company adopted SFAS No. 142, which requires companies to assess goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred. In addition to discontinuing the regular charge, or amortization, of goodwill against income, the new standard also introduces more rigorous criteria for determining how much goodwill should be reflected as an asset in a company’s balance sheet.
To perform the transitional impairment testing required by SFAS No. 142 under its new, more rigorous impairment criteria, the Company broke its operations into “reporting units,” as prescribed by the new standard, and tested each of these reporting units for impairment by comparing the unit’s fair value to its carrying value. The fair value of each reporting unit was
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
estimated using a discounted cash flow model combined with market valuation approaches. Significant estimates and assumptions were used in assessing the fair value of reporting units. These estimates and assumptions involved future cash flows, growth rates, discount rates, weighted-average cost of capital, and estimates of market valuations for each of the reporting units.
As provided by SFAS No. 142, the transitional impairment loss identified by applying the standard’s new, more rigorous valuation methodology upon initial adoption of the standard was reflected as a cumulative effect of a change in accounting principle in the Company’s statement of operations. The resulting non-cash charge was $27,671,227.
The changes in the carrying amount of goodwill for the year ended December 31, 2003 and 2002 are as follows:
(a)
A portion of this goodwill balance is included in assets related to discontinued operations in the Company’s consolidated balance sheet.
4. Income Taxes
The Company will file a consolidated federal income tax return which includes the operations of the acquired companies for periods subsequent to their acquisitions.
The income tax provision consists of the following for the years ended December 31, 2003 and 2002:
The following table reconciles the differences between the statutory federal income tax rate (34%) and the effective tax rate for the years ended December 31:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The net deferred tax assets and liabilities at December 21, 2003 and 2002, are comprised of the following:
The Company had federal and state net operating loss carryovers for income tax purposes of $11,712,424 and $12,177,375 at December 31, 2003, respectively, which, if not utilized, the federal net operating loss carryovers will expire in 2020 through 2023.
The Company has recorded a valuation allowance for the full amount of deferred tax assets in light of its operating loss since its inception and the uncertainty regarding the realization of the net deferred tax assets.
5. Credit Facilities
Accounts Receivable Credit Arrangement
In February 2002, the Company entered into a purchase and sale agreement (the “Agreement”) with a bank which permits the Company to sell and/or assign trade receivables to the bank for financing purposes. Generally, the bank will advance 80% of the face amount of the receivable up to $10.0 million, and fund the remaining portion, net of financing fees, when the customer remits payment. As of December 31, 2003 and 2002, the Company had $-0- outstanding under the Agreement. If at any time there is an amount outstanding under the Agreement, such obligation would be secured by the assets of the Company. In addition, the Company would be required to repurchase any receivable which extends beyond 90 days from the date of sale or if any dispute arises with respect to the underlying receivable. Interest and financing fees totaled $1,224 in 2003 and $1,829 in 2002.
6. Leases
The Company leases office space and computer equipment under noncancelable capital and operating leases with various expiration dates through 2016. The Company leases certain facilities at market rates from the former owners of acquired companies, who are shareholders of and continue to be employed by the Company. Certain of the operating leases for office space provide for escalating yearly rent. Rent expense under operating leases for the years ended December 31,
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
2003 and 2002, was $1,074,272 and $1,068,345, respectively, which includes amounts to related parties of $219,530 and $237,088, respectively.
Future minimum lease payments under noncancelable capital and operating leases, together with the present value of the net minimum lease payments, as of December 31, 2003, are as follows:
Assets capitalized under capital leases totaled $78,577 at December 31, 2003 and 2002. Accumulated amortization for assets capitalized under capital leases totaled $66,357 and $43,205 at December 31, 2003 and 2002, respectively. Amortization of leased assets is included in depreciation and amortization expense.
7. Shareholders’ Equity
Preferred Stock
The Company currently has authorized for issuance an aggregate of 30,000,000 shares of $0.01 par value preferred stock. At December 31, 2003, the following numbers of shares of each series of preferred stock were authorized and were issued and outstanding:
The holders of preferred stock have various rights and preferences as follows:
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
a. Voting-Each share of preferred stock has voting rights equal to an equivalent number of shares of common stock, into which it is convertible, and votes together as one class with the common stock subject to a Series A-1 and A-2 preferred stock class vote for certain actions. The Series A-1 and A-2 preferred stock voting as a single class, and excluding all other classes, has the right to elect four of seven members of the board of directors.
b. Dividends-Holders of Series A-1, A-2, B, B-2, B-3, and B-4 convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock and Series C preferred stock when and if declared by the board of directors based on the number of shares of common stock held on an as-if-converted basis. Holders of Series C convertible preferred stock are entitled to receive noncumulative dividends in preference to holders of common stock (but subordinate to holders of Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock) when and if declared by the board of directors based on the number of shares of common stock held on an as-if converted basis. No dividends on convertible preferred stock or common stock have been declared by the board for the years ended December 31, 2003 and 2002.
c. Liquidation-Upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-2 preferred stock pari passu with the holders of Series B-4 preferred stock, before any other class of stock, are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series A-1, B, B-2, and B-3 preferred stock, before the holders of Series C preferred stock (but subordinate to Series A-2 and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. Similarly, upon any liquidation, dissolution, or winding up of the Company, the holders of Series C preferred stock, before the holders of common stock (but subordinate to Series A-1, A-2, B, B-2, B-3, and B-4 preferred stock), are entitled to be paid out of the assets of the Company an amount equal to the original issue price plus all declared but unpaid dividends. At the option of the preferred shareholders, a liquidating event can include the following: any merger, consolidation, business combination, reorganization, or recapitalization of the Company in which the shareholders of the Company immediately prior to such transaction own less than 50% of the Company’s voting power immediately following the transaction.
d. Conversion-Each share of preferred stock is convertible, at the option of the holder, into the number of shares of common stock as determined by the then-effective conversion ratio (1:1 as of December 31, 2003). Each share of preferred stock automatically converts into the number of shares of common stock into which such shares are convertible at the then-effective conversion ratio upon the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000.
Warrants to Purchase Common Stock
As of December 31, 2003, the Company has outstanding warrants to purchase 1,659,818 shares of common stock for $0.01 per share at any time up to the date of the closing of a public offering of common stock at a per share price of at least $8.25 per share with gross proceeds of at least $30,000,000. The warrants were recorded at their fair market value at the time of issuance.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
Shares Reserved for Future Issuance
The Company has reserved shares of common stock for issuance as follows at December 31, 2003:
8. Stock Compensation Plans
2000 Stock Incentive Plan
Under the Company’s 2000 stock incentive plan (the “Plan”), the Company is authorized to issue up to 7,089,625 shares of common stock to directors, employees and consultants. The Plan 8. Stock Compensation Plans provides for the issuance of stock purchase rights, restricted stock awards, incentive stock options, and nonstatutory stock options. Options granted generally expire ten years after the grant date and vest ratably over a five-year period.
On August 28, 2000, the board of directors approved the issuance of 1,555,750 shares of restricted common stock to certain members of management. The shares have a purchase price of $0.01 per share, are restricted from transfer and are subject to repurchase at $0.01 per share upon termination of employment. These restrictions lapse 20% per year on the anniversary date of the grant until fully vested. These shares of restricted common stock become fully vested upon the occurrence of a change of control (as defined in the Plan) or a qualified initial public offering (as defined in the agreement, as amended, pursuant to which the grants were issued). The Company recorded $1,151,255 of deferred compensation on December 31, 2000, for the difference between the purchase price of the Company’s restricted stock under the Plan and the fair value of the underlying common stock at the time of the grant. Such amount has been presented as a reduction of shareholders’ equity and is being amortized over the vesting period. During 2003 and 2002, respectively, 193,000 and 323,400 shares of the restricted stock grants were forfeited. The Company has recognized $125,152 and $44,591 of compensation income related to the amortization of the deferred compensation for these stock grants for the years ended December 31, 2003 and 2002, respectively, as a result of the difference in the vesting period of the options compared to the amount of compensation expense previously recognized using the graded vesting approach of FASB Interpretation No. 28 (see Note 1).
In November 2000, the Company sold 54,545 shares of Series B-2 convertible preferred stock to an employee in exchange for a note. The note provides for the annual forgiveness of 20% of the outstanding principal and related interest, provided that employment is continuing. The note is secured by the Series B-2 convertible preferred stock. This transaction has been accounted for as a stock grant, and the related $149,999 of deferred compensation is being amortized ratably over the five-year term of the note. The Company has recognized $21,831 and $36,000 of compensation expense related to the amortization of the deferred compensation for this stock grant for the years ended December 31, 2003 and 2002, respectively.
VECTOR GLOBAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003
A summary of the activity under the Plan is as follows for the years ended December 31, 2003 and 2002:
The following table summarizes information concerning currently outstanding and exercisable options as of December 31, 2003:
The weighted-average fair value of the options granted at grant date was $0.02 and $0.80 per share for 2003 and 2002, respectively. The exercise price for all of the options granted in 2003 and 2002 was equal to the estimated fair value of the underlying common stock. The fair value of each option grant is estimated on the date of grant using the minimum value option pricing model with the following weighted-average assumptions: no dividend yield for all periods, risk-free interest rate of 3.36% in 2003 and 4.74% in 2002, and an expected useful life of seven years.
9. Employee Benefit Plan
The Company has a 401(k) plan (the “401k Plan”) which is available to all full-time Company employees who have completed at least six months of service. Participants are permitted, in accordance with the provisions of Section 401(k) of the Internal Revenue Code, to contribute up to 60% of their earnings into the 401k Plan. The Company matches 50% of employees’ contributions not to exceed 6% of employees’ eligible compensation. The contribution plans for the years ended December 31, 2003 and 2002, respectively.
10. Discontinued Operations
On May 30, 2002, due to poor operating performance, the Company decided to discontinue operations in Philadelphia. The assets and liabilities primarily As of December 31, 2002, the Company had liquidated all assets and liabilities for the Philadelphia operations. Due to the nature of the assets and their recent acquisition, the liquidation value on disposal approximated their carrying value. The revenues and pre-tax loss for the discontinued operations were as follows for the year ended December 31, 2002:
Included in the 2002 pretax loss from operations was approximately $11,965 of goodwill that has been written off.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
INFO SYSTEMS, INC.
We have audited the accompanying balance sheet of Info Systems, Inc. as of December 31, 2004 and 2003, and the related statements of operations, changes in stockholders' equity, and cash flows for the years then ended. These 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 auditing standards generally accepted in the United States of America. 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 financial position of Info Systems, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
GUNNIP & COMPANY LLP
Wilmington, Delaware
March 17, 2005
INFO SYSTEMS, INC.
BALANCE SHEET
December 31, 2004 and 2003
See accompanying notes to financial statements.
INFO SYSTEMS, INC.
STATEMENT OF OPERATIONS
For the Years Ended December 31, 2004 and 2003
See accompanying notes to financial statements.
INFO SYSTEMS, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2004 and 2003
See accompanying notes to financial statements.
INFO SYSTEMS, INC.
STATEMENT OF CASH FLOWS
For the Years Ended December 31, 2004 and 2003
See accompanying notes to financial statements.
INFO SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
Note 1. Summary of Company activities and significant accounting policies
Company Activities
Info Systems, Inc. (“the Company”) is an information technology management and consulting company. The business is to assess, design, integrate and manage technologies and resources that relate directly to the way voice, data, and video are distributed, stored, managed, and secured. Offerings include consulting, infrastructure solutions, managed services, staffing augmentation and telecommunications, as well as related equipment sales. The Company has offices located in Delaware, Pennsylvania and Maryland.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Inventories principally consist of computer hardware and software for resale, and computer parts and supplies. Inventories are stated net of an allowance for obsolete inventory of $40,512 and $53,529 in 2004 and 2003, respectively.
Property and Equipment
Property and equipment is recorded at cost. Depreciation, which includes amortization of assets under capital leases, is provided using a straight-line method over the estimated useful lives of the respective assets which are generally three to seven years.
Renewals and improvements are capitalized. Normal maintenance and repairs are charged to income as incurred.
Concentrations of Credit Risk and Major Customer
Credit Risk
Financial instruments which potentially subject the Company to significant concentrations of credit risk are principally cash and accounts receivable.
Cash deposits are maintained in a highly rated financial institution within the Company’s operating area. Management continually monitors the financial strength of the institution to minimize its risk. The maximum loss that would have resulted from that risk totaled $991,750 at December 31, 2004 and $0 at December 31, 2003, representing the excess of the deposit liabilities reported by the institution over the amounts that would have been covered by federal insurance.
Accounts receivable represent unsecured credit sales. Economic conditions in this industry have a direct effect on the Company’s operations. The collectibility of these accounts is periodically reviewed by management, and an allowance for doubtful accounts is maintained.
Major Customer
Financial instruments that potentially subject the Company to credit risk consist principally of accounts receivable. The Company performs ongoing credit evaluations of its customers and
INFO SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
generally does not require collateral. Revenues to one customer represented 22% of total revenues during 2004 and one customer represented 22% of total revenues during 2003. Accounts receivable from the customer represented 6% of the accounts receivable balance at December 31, 2004 and accounts receivable from the customer represented 15% of the accounts receivable balance at December 31, 2003.
Revenue Recognition
Revenue from sales of computer equipment and related software products is recognized upon shipment. Revenue from service contracts is recognized over the term of the respective contracts. Revenue from design and installation projects, which are usually of short-term duration, is recognized upon completion of the installation. Revenue from staff augmentation and consulting projects is recognized during the period the project is performed. Included in deferred revenue are amounts billed and received on staff augmentation, telecommunications and consulting projects which will be earned in subsequent periods. Deferred revenue also represents the unamortized portion of service contract revenue also recognized ratably over the term of the contract.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense was $62,464 and $23,657 during the years ended December 31, 2004 and 2003, respectively.
Impairment of Goodwill
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. In accordance with FAS No. 142, Goodwill and Other Intangible Assets, goodwill cannot be amortized, however, it must be tested annually for impairment. This impairment test is calculated at the operating unit level. The goodwill impairment test has two steps. The first identifies potential impairments by comparing the fair value of an operating unit with its book value, including goodwill. If the fair value of the operating unit exceeds the carrying amount, goodwill is not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied goodwill is less than the carrying amount, a write-down is recorded.
Based on the impairment tests performed, the value of goodwill recorded was deemed not impaired at December 31, 2004 and 2003.
Note 2. Amounts Due from Shareholders
Amounts due from shareholders represent unsecured, non-interest bearing advances, and are due on demand. Outstanding advances totaled $102,593 at December 31, 2004 ($95,565 in 2003).
INFO SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
Note 3. Property and Equipment
Property and equipment consist of the following:
Note 4. Short-term Borrowings
The Company has a credit facility with its bank that is effective through September 2005 and is renewable annually. This credit facility, as amended, has a maximum borrowing availability of $12,000,000. At December 31, 2004 and 2003, there were $0 and $56,584 outstanding on this facility. The available borrowings on this facility were reduced by a $6,000,000 irrevocable letter of credit related to the Company’s inventory credit facility. This agreement bears interest at the bank’s prime rate of 5.25% and 4.00% at December 31, 2004 and 2003, respectively. The credit facility is for working capital purposes and borrowings at any point in time are limited based on eligible assets of the Company. Borrowings under the credit facility are secured by substantially all of the assets of the Company. The credit facility is personally guaranteed by the majority stockholder of the Company.
The Company also has a $6,000,000 floor plan credit facility with another bank available for eligible inventory purchases (“inventory facility”) which extends the Company’s trade payment terms with certain vendors. At December 31, 2004 and 2003, accounts payable includes $1,827,544 and $2,045,863 related to these inventory purchases. The inventory facility is guaranteed by the letter of credit referenced above.
Note 5. Notes Payable
Notes payable are summarized as follows:
INFO SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
Principal repayments on long-term debt are summarized as follows:
Note 6. Income taxes
The components of the Company’s net deferred income tax asset are as follows:
The provision (benefit) for income taxes is as follows:
The provision for income taxes differs from the statutory U.S. Federal rate due to state income taxes and certain nondeductible items. A valuation allowance has not been established as management believes it is more likely than not the deferred tax asset will be realized.
Note 7. Commitments
The Company leases office and warehouse space from a partnership which is 83% owned by current and past shareholders of the Company which, based on its terms, is classified for financial statement purposes as an operating lease. The lease expires in April 2012, requires minimum annual rent payments and is subject to adjustment at the end of each lease year based on the consumer price index for the prior twelve-month period. Rent expense under this lease, including base rental adjustments, was $186,516 in 2004 and $172,879 in 2003.
The Company had leased equipment under capital lease obligations expiring through November 2003. The equipment is recorded at the present value of minimum lease payments and amortized over its estimated productive life.
INFO SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
Property and equipment includes the following amounts for capitalized leases:
The Company also leases office space, equipment, and vehicles under various noncancelable operating leases expiring through December 2012. Rent expense under these leases was $379,351 and $538,969 for the years ended December 31, 2004 and 2003, respectively.
Future minimum rental payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2004 are as follows:
Note 8. Employee Benefit Plan
The Company sponsors a defined contribution 401(k) plan (Plan) which covers substantially all employees. Employees become eligible upon attaining age 21 and completing six months of service. Employees may elect to contribute up to 15% of their annual compensation up to the maximum allowable under the Internal Revenue Code. The Company pays all administrative costs of the Plan and matches employee contributions up to fifty percent of the first six percent of employee contributions. The Company’s contributions to the Plan were $275,815 and $292,211 for the years ended December 31, 2004 and 2003, respectively.
Note 9. Equity
The Company has authorized the issuance of 1,500 shares of $1,000 par, 6% cumulative preferred stock, of which 600 shares are outstanding. Cumulative dividends in arrears at December 31, 2004 and 2003 were approximately $216,000 and $182,000, respectively. On March 8, 2005, the Board of Directors declared the dividends for payment.
Note 10. Subsequent Event
Subsequent to year end, a total of 7.71 shares of common stock were issued to certain employees of the Company as part of their compensation. The stock was issued out of Treasury stock. The total cost of compensation that will be recognized in 2005 for this transaction is $206,018, using the fair value method.
In 2004, the shareholders of the Company entered into an agreement to sell their stock in the Company to MTM Technologies, Inc. for $8,300,000 in cash plus shares in the acquiring entity valued at $3,200,000. Payment for the stock is subject to the terms of the Stock Purchase Agreement between the Company and MTM Technologies, Inc. The sale was completed on March 11, 2005.
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.
Pursuant to the requirements of the Securities Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
MTM TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
Fiscal Year Ended March 31, 2005
EXHIBIT INDEX