ITEM 1. BUSINESS
General
EpicEdge, Inc. is a leading
information technology consulting firm, primarily focused on serving state and
local government agencies, commercial and utility market customers. We help our clients to meet their business
goals through implementation and support of client/server and Internet-enabled
enterprise software packages, custom Web application development, and strategic
consulting. We deliver successful IT project-based services by combining the
elements of market-leading, third-party products such as PeopleSoft, highly
skilled technical personnel and proven project methodologies. Our focused and
comprehensive approach to technology is driven by our clients' business needs,
and helps our clients maximize return on their software investment and lower
their total cost of ownership. The majority of our revenues are associated with
providing project management, consulting services, and software implementation
to state and local governments. We believe our strengths are technical
expertise, marketplace relationships, vendor alliances, customer service
orientation, strong consulting methodology, and ability to hire and retain skilled
professionals.
History
We are a publicly held Texas
corporation listed on the American Stock Exchange under the symbol “EDG.” We were originally incorporated under the
name Loch Exploration, Inc. in June 1979.
In April 1989, Loch Exploration filed for Chapter 11 bankruptcy, and was
reorganized in connection with its Plan of Reorganization, effective November
17, 1989. In December 1998, Loch
Exploration, Inc. transferred all of its assets and liabilities to Loch Energy,
Inc., in exchange for shares of Loch Energy, Inc. common stock, whereby Loch
Energy became a subsidiary of Loch Exploration. In January 1999, Loch Exploration acquired all of the issued and
outstanding capital stock of Design Automation Systems, Inc., a private
company, in exchange for shares of common stock. In April 1999, Design Automation was merged into Loch
Exploration, and Loch Exploration changed its name to Design Automation Systems
Incorporated. In March 2000, we changed
our name to EpicEdge, Inc. During the
quarter ended September 30, 2000, we irrevocably transferred all of the shares
of Loch Energy to a designated trustee.
Business Strategy
We
have successfully transformed ourselves from a pure systems integrator into a
leading edge project-based professional services firm specializing in
enterprise software and Internet technologies.
This was accomplished via an aggressive acquisition strategy of
‘best-of-breed’ consulting firms. This
acquisition process was completed in fiscal year 2000. Although significant
difficulties were experienced in integrating these acquisitions as more fully
discussed elsewhere in this Form 10-K, we believe that the net effect of these
acquisitions has culminated in an improved organization with an experienced and
dedicated management team, a reputation for client satisfaction and a superior
professional consulting staff. We have
also scaled back our infrastructure, sales and marketing, and operations to
align us for profitability in the coming years. Management intends to execute on the following strategies: gain
market share through a reputation for excellence, acquire new revenues through
successful marketing efforts and reduce our overall costs.
Marketing and Sales
Generally, our marketing efforts
are designed to generate qualified leads for our services and to continually
improve our reputation in the marketplace by performing quality work. A key component of our strategy is to
successfully execute on the current contracts of our existing business
lines. We intend to deliver excellent
service and results on current engagements.
Our goal is to grow internally, through replacing or renewing completed
engagements and expanding the scope of current contracts. We intend to continue to leverage our
significant government ERP and custom Web application development clients. In addition, we intend to leverage our core
competencies to find and win new long term engagements in the verticals where we
have a strong market presence, specifically, state and local governments,
utilities, and technology companies.
Our external communications efforts
involve sharing client success stories, new alliance partnerships and accolades
in addition to significant and material corporate news. We expect to continue to build momentum in
our national sales efforts to generate new business in 2002. Our business development professionals
secure new business through a combination of qualified lead generation and
targeted direct marketing efforts.
However, we may not be able to generate new clients, leverage our
existing clients or increase revenues.
We have a seasoned proposal
development team. State and local
government agencies award contracts to information technology vendors through a
lengthy and complicated bidding and proposal process. We are also experienced in assembling the large amounts of
information required to submit detailed proposals in response to Requests for
Proposals (RFPs) in a timely manner. In addition, the expertise and experience
of our managers and employees helps us to more accurately estimate project
costs and productivity levels.
We win many of our consulting
services and systems solutions contracts for state and local agencies by
responding to RFPs. We have developed and implemented an RFP tracking system
that provides us with real-time information about the status of existing RFPs
and our actions to date with respect to those RFPs. Our public affairs consultants provide introductions to
government personnel and provide information to us regarding the status of
legislative initiatives and executive decision-making. Following the issuance
of an RFP, we participate in formal discussions, if any, between the
contracting government agency and the group of potential service providers
seeking to modify the RFP and prepare the proposal. Upon the award of a
government operations contract, our representatives may
help
us negotiate the contract with representatives of the government authority
until an agreement is reached. We
generate leads for contracts by tracking bid notices, employing marketing
consultants, maintaining relationships with government personnel, communicating
directly with current and prospective clients. We participate in professional
associations of government administrators and industry seminars which from time
to time feature presentations by our executives and employees. Senior executives develop leads through
on-site presentations to decision makers.
A portion of our new consulting business results from prior client
engagements.
We were recently named an Approved
Consulting Services Alliance Partner with PeopleSoft. We are hopeful that this newly acquired status with PeopleSoft
will help us obtain new clients. We
believe this provides greater credibility with our existing client base and
prospects. This status may also
strengthen our current market positions and give us a greater competitive
advantage in contested procurements against our competitors who are not also
partners with PeopleSoft. However, even
with this status, we may not be able to gain any additional clients or maintain
our present clients.
Expense Reduction and Achieving
Operational Efficiencies.
We intend to continue our cost
reduction strategy, which includes reduction in sales and marketing,
administration, and creative design operations. We also intend to increase the gross margins of our business
lines through cost reductions and efficient hiring. All cost reductions are intended to bring expenses in line with
the revenues expected with the execution of current contracts.
Recent
Mergers and Acquisitions and Goodwill Impairment Losses
In March 1999, we acquired all of
the issued and outstanding stock of COAD Solutions, Inc. (“COAD”), an
information technology consulting firm, in exchange for (1) 600,000 shares of
our common stock valued at $2,625,000; (2) $200,000 cash, payable $100,000 at
closing, and $100,000 payable in quarterly installments of $25,000 beginning 90
days from the closing date. Goodwill of $3,000,000 was recorded related to this
transaction and was fully amortized as of December 31, 2001.
In May 1999, we acquired all of the
issued and outstanding stock of Dynamic Professional Services, LLC (“Dynamic”),
an information technology consulting firm, in exchange for (1) 524,000 shares
of our common stock valued at $2,695,600; (2) $200,000 cash, payable $100,000
at closing and $100,000 payable in quarterly installments of $25,000 beginning
90 days from the closing date; and (3) additional stock consideration if, on
June 1, 2000, the closing price for our common stock for the prior 15 business
days was less than $5.15 per share in an amount equal to 5,340 shares for each
$0.01 below $5.15. No additional
consideration was paid during 2000.
Goodwill of $2,732,000 was recorded related to this acquisition. Accumulated amortization of $2,472,000 had
been recorded related to this goodwill through December 31, 2001.
In July 1999, we acquired all of
the issued and outstanding stock of Connected Software Solutions, Inc.
(“Connected”), an electronic-business consulting and training firm, in
exchange for (1) 300,000 shares of our common stock valued at $1,545,000; (2)
$300,000 cash payable in six quarterly installments of $50,000 beginning 90
days from the closing date; and (3) additional stock consideration if, on
August 1, 2000, the closing price for our common stock for the prior 15
business days is less than $5.15 per share in an amount equal to 3,000 shares
for each $0.01 below $5.15. No additional consideration was paid in 2000.
Goodwill of $1,800,000 was recorded related to this acquisition and was fully
amortized as of December 31, 2001.
In November 1999, we acquired
substantially all of the assets of NET Information Systems, Inc. (“NET”), an e-Business
solutions provider, in exchange for (1) 350,000 shares of our common stock
valued at $1,093,750; (2) $180,000 cash; (3) a one-year promissory note
in the amount of $50,000 payable quarterly, with the first payment due 90 days
after closing; and (4) the assumption of NET’s Wells Fargo debt not to exceed
$220,000. Goodwill of $1,500,000
was
recorded related to this acquisition. Accumulated amortization of $1,300,000
had been recorded related to this goodwill through December 31, 2001.
In March 2000, we acquired all the
outstanding common shares of The Growth Strategy Group, Inc. (“Growth
Strategy”), an e-marketing and strategy-consulting firm, for 277,000
unregistered shares of our common stock valued at $6,076,800 and $375,000 in
cash. Goodwill of $6,100,000 was recorded related to this acquisition,
accumulated amortization of $643,000 had been recorded related to this goodwill
through December 31, 2000. As a result
of a review by Management of the carrying value and recoverability of this
goodwill, Management wrote off the unamortized balance of Growth Strategy’s
goodwill of $5,457,000 as of December 31, 2000.
In June 2000, we acquired all of
the issued and outstanding stock of IPS Associates, Inc. (“IPS”), a project
management firm, for $3,000,000 in cash, 1,472,586 unregistered shares of our
common stock, options to purchase 1,082,060 shares of our common stock and the
assumption of net liabilities of $2,940,000. The aggregate value of the shares
and stock options issued in connection with the transaction was $36,405,000. We
also assumed an employee stock ownership plan (“ESOP”) from IPS and 607,023 of
the 1,472,586 shares of common stock related to the transaction were issued to
the ESOP. We recorded unearned compensation of $9,445,000 related to 493,220
shares of common stock issued to the ESOP but not yet committed to be released
by the ESOP’s trustee. This amount was to be amortized over a period of
approximately three to five years as the shares were committed to be released.
In connection with the assumption of the ESOP, we assumed a note payable to a
financial institution for ESOP financing of approximately $5,000,000. The note is secured by the accounts
receivable, investments, and property and equipment of IPS. Goodwill of
$34,240,000 was recorded related to this acquisition. Accumulated amortization
of $2,558,000 had been recorded related to this goodwill through December 31,
2000. In connection with the purchase
transaction, we paid a commission to an organization that facilitated the
execution of the transaction of $300,000 in cash and issued 25,065 unregistered
shares of our common stock valued at $576,000 and recorded as part of the cost
of the IPS acquisition. As discussed
more fully under Recent Disposition below, IPS was sold effective January 1,
2001, at a substantial loss.
In July 2000, we acquired
substantially all of the assets of Tumble Interactive Media, Inc. (“Tumble”), a
creative and design firm, for 250,000 unregistered shares of our common stock
valued at $4,937,500, and $325,000 in cash. Goodwill of $5,300,000 was recorded
related to this acquisition. Accumulated amortization of $307,000 had been
recorded related to this goodwill through December 31, 2000. As a result of a review by Management of the
carrying value and recoverability of this goodwill, Management wrote off the
unamortized balance of Tumble’s goodwill of $5,125,901 as of December 31, 2000.
All of these acquisitions were
accounted for under purchase accounting, with the resulting goodwill being
originally amortized over eight years until the goodwill impairment loss was
recognized as of December 31, 2000. Beginning January 1, 2001, the original
amortization period was decreased to 32 months. The operations of each acquired entity are included in our
operations from their respective acquisition date.
In view of the sale of IPS, at a
substantial loss, effective January 1, 2001, management concluded that goodwill
related to IPS as of December 31, 2000, was impaired and wrote it down to the
amount recoverable in the sale, which was $7,643,000; accordingly, $24,040,000
was written off. Management also concluded that the entire amount of goodwill
related to the Tumble and Growth Strategy acquisitions and a portion of the
goodwill related to the COAD and Connected acquisitions, as of December 31,
2000, was impaired based on evaluations of the related estimated future
undiscounted cash flows and the lack of continuity of the related key employees;
accordingly, $12,400,000 was also written off, with a remaining goodwill of
$5,434,000 related to COAD, Dynamic, Connected and NET. The total of these goodwill impairment write-offs
of $36,440,000 was reported as an operating expense in 2000. Goodwill of $460,000 at December 31, 2001,
relates to Dynamic ($260,000) and NET ($200,000).
Recent
Disposition
Effective January 1, 2001 with a
closing date of February 5, 2001, we sold all of the issued and outstanding
stock of IPS to Red & Blue, Inc., a Delaware corporation and to the IPS
Associates, Inc. Stock Ownership Plan. The consideration for the sale was: (1)
the return of an aggregate 740,260 shares of our common stock, (2) $5,700,000
in cash, and (3) the transfer of the IPS employee stock ownership plan (ESOP)
along with the note payable to a financial institution for the ESOP financing.
The Stock Purchase Agreement provides that 143,323 shares of the 740,260 shares
of our common stock be held in escrow until the earlier of: (1) the completion
of audited financial statements of IPS for the year ended December 31, 2000, or
(2) six months from the date of closing. In the event that the net equity,
revenues or net earnings of IPS differs by more than $500,000 from the
financial statements disclosed in the Agreement, Red & Blue had the right
to set-off the difference against the shares held in escrow at a value based
upon the closing price of our common stock on the day before the set-off. In the
event of a set-off, we agreed to immediately register the set-off shares. Based
on the audited financial results of IPS, no such set-off occurred and no claim
for a set-off has been made by the acquirer.
The sale of IPS resulted in write-offs of goodwill and deferred
compensation with a non-cash charge to income of approximately $24 million in
the fourth quarter ended December 31, 2000. IPS was included in the results of
our operations since its acquisition in June 2000. The disposition of IPS has
been deemed “significant”; accordingly, pro forma results of operations for the
second, third and fourth quarters, respectively in 2000, as though the
disposition occurred in June 2000, are summarized later.
Clients,
Products and Services
Our client base encompasses state
and local government agencies, small- and mid-size companies and Fortune 1,000
companies. They are geographically
located in the Continental United States, primarily in Texas, New York and
Washington. While our clients span various industries, most of our clients are
in state and local government, utilities, and technology companies. The State of Texas is a significant
client. We have executed contracts with
several agencies of that state for which we are performing services. During 2001, approximately 48% of our
revenue was derived from these agencies, one of which represented over
27%. These contracts, for the most
part, are multi-year and run through 2005.
Northrup Grumman is also a significant client. We have a staff augmentation contract with that organization
which represented approximately 24% of our 2001 revenue. This contract is also a multi-year
engagement through 2007.
We provide services in two core
areas of competency: Enterprise
Software Consulting and Implementation, and E-Business Strategy and
Solutions. Our business strategy is to
combine the elements of market-leading products and highly skilled technical
personnel to deliver comprehensive information technology solutions within these
core competencies, to both new and existing clients. We believe this single-source solution reduces risk, increases
realized productivity, reduces consulting engagement duration, and promotes
tight alignment with the client’s overall business goals.
Enterprise Software Consulting and Implementation.
We are a total solution provider
managing all aspects of our clients’ enterprise applications, specifically
implementation, ongoing support, and outsourcing. We are an Approved Consulting Services Alliance Partner with
PeopleSoft, Inc. We also provide
business process consulting, allowing the client to automate and streamline
business operations focusing on Human Resources and Financial systems. We offer expertise in the following:
professional services for implementation; business process consulting;
integration with the Internet; data conversion and analysis; fit/gap analysis;
production support and outsourcing for entire financial and human resource
systems. We specialize in large-scale
government projects utilizing our implementation methodology. This helps our clients streamline business
processes and gain efficiencies throughout the organization thus maximizing
their return on investment with the software.
Over the last three years, this service provided 77.5%, 19.5%, and 2.5%
of total revenue for 2001, 2000, and 1999, respectively.
E-Business Strategy and Solutions.
We provide consulting services that
help companies visualize the Internet as an integrated part of their operations
and provide the planning framework for the critical building and managing
phases of the engagement. We also design and build systems that become the
infrastructure for Internet-based management of information and transactions. We believe this is the most crucial part of
client engagements. With technology
changing rapidly, we believe it is imperative that we maintain personnel who
have thorough and deep knowledge of existing and emerging technologies and have
the ability to train our clients in these technologies. We implement total project solutions for
custom web applications that are mission critical to our clients. We employ a multidisciplinary approach
utilizing cutting edge technologies, including IBM, SUN, and Microsoft. We
offer expertise in the following:
assessing viability and fit of latest proven technologies; architecture
and network-systems design; application development; integration with legacy
systems; integration with intranet, extranet, and Internet applications; and
training in these technologies. Over
the last three years, this service provided 18.7%, 7.9%, and 1.4% of total
revenue for 2001, 2000, and 1999, respectively. Many of our contracts are
terminable by the client following limited notice and without significant
penalty. The cancellation of contracts by clients, especially large contracts,
after we have staffed and committed resources to fulfilling the services
required by such contract, can have a negative impact on our business and can
cause us to incur high fixed costs. In
addition, approximately 53% of our contracts are with government
agencies. Substantially all of our
contracts with government agencies could be renegotiated or terminated at the
election of the applicable government agency.
Competition
The markets for the services we
provide are highly competitive. We believe that we currently compete
principally with large accounting and consulting firms and systems consulting
and implementation firms. We compete to a lesser extent with specialized
e-business consulting firms, strategy consulting firms, other package
technology vendors, and our clients’ own internal information systems groups.
Some of our competitors have significantly greater financial, technical and
marketing resources, generate greater revenues and have greater name
recognition than we do. Other of our competitors have experienced serious
financial difficulties in recent periods, which may result in those companies
much more aggressively pursuing business opportunities and reducing their
pricing substantially to obtain those opportunities. We believe that the major competitive factors in our market
relate to a company’s distinctive technical capabilities, successful past
contract performance, reputation for quality and pricing. We anticipate that we may face increased
competition in the future as new companies enter the market. Increased competition may result in price
reductions, fewer client projects, underutilization of our personnel, reduced
operating margins and loss of market share, any of which could have a material
adverse effect on our business, operating results and financial condition
Personnel
Our people are very important to
the success of our business. Our
collaborative culture is the hallmark of our delivery approach. The key values that we strive to attain are
teamwork, character and excellence. To
encourage the achievement of these values, we reward teamwork and promote
individuals who demonstrate these values.
As of March 31, 2002, we employed 106 persons, of whom 27 were engaged
in providing our e-solution services and training, 59 were Enterprise Resource
Planning consultants, and 20 were engaged in finance, administration, marketing
and management functions. None of our
employees is covered by a collective bargaining agreement. There is increasing competition for
experienced technical professionals. We
consider relations with our employees to be good.
Intellectual Property Rights
We rely upon a combination of trade
secret, nondisclosure and other contractual arrangements, and copyrights to
protect our proprietary rights. We
currently do not have any registered trademarks. We enter into confidentiality agreements with certain of our key
employees; generally require that our consultants and clients enter into such
agreements; and limit access to and distribution of our proprietary
information. There can be no assurance
that the steps taken by us in this regard will be adequate to deter
misappropriation of our proprietary information or that we will be able to
detect unauthorized use and take appropriate steps to enforce our intellectual
property rights.
A portion of our business involves
the development of software applications for specific client engagements. Ownership of client-specific software is
generally retained by the client, but we usually retain some rights to
applications, processes and intellectual property developed in connection with
client engagements.
ITEM 2.
ITEM 2. PROPERTIES
Our headquarters and principal
administrative, accounting, selling and marketing operations are located in
approximately 10,000 square feet of leased office space in Austin, Texas at a
current monthly rate of approximately $23,133.
We also lease office space of approximately 3,600 square feet in St.
Louis, Missouri and 11,725 square feet in Seattle, Washington.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We understand that the Securities
and Exchange Commission is conducting an investigation into the trading
activity of certain individuals and entities in our securities and the
securities of other companies during the period between 1999 and 2000. We are cooperating and will continue to
cooperate with the SEC to the extent it requests information.
On or about November 20, 2001 a
former employee, Mr. David Launey, brought suit against us, a former executive
officer, our former corporate counsel, Brewer and Pritchard, P.C., and an
individual attorney employed by Brewer and Pritchard in the District Court of
Travis County, Texas. Mr. Launey
alleges that we, through the acts and omissions of the named parties,
prohibited him from selling stock of the Company. The complaint seeks damages in the amount of $2,715,630. These proceedings are in the very early
stages of the case. Discovery has not yet occurred and no depositions have been
taken. We intend to defend ourselves vigorously and we believe we have good and
meritorious defenses. While the outcome of this litigation cannot be predicted
with certainty, we believe that it will not have a material adverse effect on
our financial statements. However, an
unfavorable outcome of this litigation could have a material adverse effect.
On or about May 31, 2001, we
brought suit against Reliant Energy in the District Court of Harris County,
Texas for breach of contract. We are
seeking damages in the amount of $973,804, plus costs and attorney’s fees. Reliant filed a counter-claim for an
unspecified amount of damages for breach of contract. We intend to defend the
counter-claim vigorously, but there are inherent uncertainties
involved in litigation. An unfavorable
outcome of this litigation could have a material adverse impact on our
business, financial condition and results of operations. Reliant is seeking unspecified
damages for the inability to review EpicEdge’s financial information after the
suit was filed. From time to time, we become involved in litigation
incidental to the conduct of our business.
Other than as disclosed above, we are not currently party to any legal
proceedings that we expect to have a material adverse impact on our business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote
of security holders of the Company during the fourth quarter of the fiscal year
covered by this Report.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
(a) Market Price of Common Stock
Our common stock was previously
quoted on the OTC Bulletin Board. On December 1, 1999, we began trading on The
American Stock Exchange under the symbol “EDG.” The following table sets forth
for the periods indicated the high and low sale prices for our common stock.
On April 12, 2002, the most recent
practicable date prior to the filing of this Form 10-K, the closing sale price
of a share of our common stock was $0.21 per share. As of April 12, 2002, there were approximately 3,186 holders of
record of the common stock. We did not
declare or pay any cash dividends on our common stock in 2000 or 2001 and do
not intend to pay any cash dividends in the foreseeable future. We plan to retain any future earnings to
finance the development and growth of our business.
On April 12, 2001, our stock was
halted from trading by the AMEX due to the delayed filing of our Form 10-KSB
for 2000 and the first and second quarter filings on Form 10-Q for 2001. These forms were subsequently filed and the
AMEX reinstated our trading status on August 31, 2001.
(b) Recent Sales
of Unregistered Securities
On July 31, 2001, we issued to Panna L. Sharma, one of our current
directors, a warrant to purchase 30,000 shares of Common Stock at an exercise
price of $.28 per share. We issued the
warrant in reliance upon the exemption from registration provided by Rule 506
of Regulation D of the Securities Act of 1933.
On July 31, 2001, we issued to Eric Loeffel, one of our former
directors, a warrant to purchase 30,000 shares of our Common Stock at an
exercise price of $.28 per share. We
issued the warrant in reliance upon the exemption from registration provided by
Rule 506 of Regulation D of the Securities Act of 1933.
On November 30, 2001, we issued to John A. Svahn, one of our current
directors, a warrant to purchase 30,000 shares of Common Stock at an exercise
price of $.28 per share. We issued the
warrant in reliance upon the exemption from registration provided by Rule 506
of Regulation D of the Securities Act of 1933.
On May 15, 2001, we issued to Brewer & Pritchard, P.C. a warrant to
purchase 177,700 shares of our Common Stock at an exercise price of $.20 per
share, in exchange for legal services.
We issued the warrant in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act of 1933.
On July 21, 2000, we issued Convertible Promissory Notes to each of
Edgewater Private Equity Fund III (“Edgewater”) in the principal amount of
$3,750,000 and Fleck T.I.M.E. Fund, L.P. (“Fleck”) in the principal amount of
$1,250,000. The principal and accrued interest on the notes were convertible,
at the option of Edgewater and Fleck, into shares of common stock, sold at a
financing of $7,000,000 or more, at conversion price equal to seventy-five
percent of the lowest price paid by any third party investor or at a price
equal to the price paid by Edgewater or Fleck, if they led the financing. If a financing of $7,000,000 did not occur
on or before December 29, 2000, then the conversion price was to be equal to
$5.00. On July 20, 2001, the Company
and each of Edgewater and Fleck entered into an amendment to such notes which,
among other things, extended the maturity date until August 1, 2002. The notes were further amended in a
transaction we completed in April, 2002, as described in “Liquidity and Capital Resources”. We issued
and amended the notes in reliance upon the exemption from registration provided
by Rule 506 of Regulation D of the Securities Act of 1933.
On November 1, 2000, we issued to Carl Rose, our current Chairman of
the Board, a Convertible Note in the principal amount of $500,000, convertible
into shares of Common Stock at conversion rate equal to $.50 of indebtedness
(including accrued interest) per share of Common Stock. On November 7, 2000, we issued a second
Convertible Note to Carl Rose in the principal amount of $400,000, convertible
into shares of Common Stock at a conversion rate equal to $.50 of indebtedness
(including accrued interest) per share of Common Stock. On August 31, 2001, the Company and Carl R.
Rose entered into amendments to, among other things, extend the maturity date
of the notes and change the conversion rate from $.50 per share to $1.00 per
share. In connection with the transaction
that we completed in April 2002, we amended such notes again to, among other
things, extend the maturity date and change the conversion rate to $.25 per
share. We issued and amended the notes
in reliance upon the exemption from registration provided by Rule 506 of
Regulation D of the Securities Act of 1933.
On June 21, 2001, we entered
into a Letter Agreement with Fleck, John Paul DeJoria and, as amended on
February 7, 2002, Patrick Loche, with an initial funding of $800,000. Upon the terms specified in the Letter
Agreement we borrowed $400,000 from Fleck, $400,000 from Mr. DeJoria, and
$250,000 from Mr. Loche. Therefore, the
total funding as of December 31, 2001 under this Letter Agreement was $1,050,000. Such notes were contemplated to convert into
shares of Series A Preferred Stock. The
notes were further amended in a transaction we completed in April, 2002, as
described in “Liquidity and Capital Resources”.
We issued and amended the notes in reliance upon the exemption from
registration provided by Rule 506 of Regulation D of the Securities Act of
1933.
On February 19, 2002, we issued a
Secured Promissory Note to Edgewater in the principal amount of $610,000. On March 5, 2002, we borrowed an additional
$250,000 from Edgewater and issued a Substitute Secured Promissory Note to
Edgewater for an aggregate principal amount of $860,000. The notes were amended in a transaction we
completed in April, 2002, as described in “Liquidity
and Capital Resources”. We
issued the notes in reliance upon the exemption from registration provided by
Rule 506 of Regulation D of the Securities Act of 1933.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial
data should be read in conjunction with our financial statements and related
notes and with “Management’s Discussion and Analysis of Financial Condition and
Results of Operations: included elsewhere herein. The selected financial data represented below under the captions
“Statement of Operations Data” and “Balance Sheet Data” for, and as of the end
of, each of the years in the five-year period ended December 31, 2001, are
derived from the financial statements of EpicEdge, Inc. The financial statements as of December 31,
2001 and 2000, and for each of the years in the three-year period ended
December 31, 2001, and the independent auditors’ report thereon, are included
elsewhere herein.
(1) Pursuant to an
Exchange Agreement, dated December 31, 1998, and amended on January 27, 1999,
the shareholders of Design Automation Systems, Inc. became beneficial owners of
82.14% of the issued and outstanding common stock of Loch Exploration,
Inc. Prior to the effectiveness of and
in connection with the Exchange Agreement, Loch Exploration, Inc. assigned all
of its assets and liabilities to Loch Energy, Inc. in return for 100% of the
issued and outstanding common stock of Loch Energy, Inc., whereby Loch Energy,
Inc. became a subsidiary of Loch Exploration, Inc. During the quarter ended September 30, 2000, EpicEdge irrevocably
transferred all of the shares of Loch Energy, Inc. to a designated
trustee. As a result of the Exchange
Agreement, the shareholders who had held 100% of the issued and outstanding
common stock of Loch Exploration, Inc.
immediately prior to the effectiveness of the Exchange Agreement consequently held
17.86% of the issued and outstanding common stock of Loch Exploration, Inc.
upon the effectiveness of the Exchange Agreement. Because of these fundamental changes in the control and in the
operations of Loch Exploration, Inc., the selected financial data shown above
for the years 1998 and 1997 are presented as if Design Automation Systems, Inc.
had acquired Loch Exploration, Inc.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The following discussion and
analysis of our financial condition and results of operations should be read in
conjunction with our financial statements and notes thereto appearing elsewhere
in this Form 10-K. This discussion and
analysis contains forward-looking statements that involve risks, uncertainties
and assumptions and, with respect to this section, the cautionary language
applicable to such forward-looking statements described above before Item 1 of
this Form 10-K is incorporated by reference into this Item 7. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth under “Risk Factors” and elsewhere in this Form 10-K.
Critical Accounting Policies And Estimates
Our discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to bad debts, income taxes and contingencies
and litigation. We base our estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances.
Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following are critical accounting policies and estimates
used in the preparation of our financial statements.
Revenue
Recognition - In 2001,
revenue was recognized from consulting, support and training services
(“professional services”), which we believed in 2000, and continue to believe,
to have the most future profit
potential. This is the business of enabling our clients
to meet their business goals through implementation and support of
client/server, ERP, financial and human resource systems, custom application
development of open source, object oriented internet applications, and
strategic marketing.
Our services currently include assisting clients in
dealing with issues during the entire software development life cycle of their
projects, including the following: strategic planning, business process
evaluation, integrated marketing and communications, brand structure and
design, system architecture and design, product acquisition, application
hosting, configuration and implementation, ongoing operational support, and
evolutions in technology. Our goal is
to provide solutions to complex information technology problems focusing on
enabling our clients to take advantage of the evolving Internet economy. The majority of our revenues were and are
expected to be associated with providing project management, consulting
services, and software implementation to state and local governments, including
the States of Texas, New York and Washington.
Professional services revenues are recognized as the
services are performed, primarily on a time-and-materials basis
using the number of hours worked by consultants at agreed-upon rates per
hour. Out-of-pocket expenses reimbursed by clients are included in
professional services revenues, and the expenses incurred by us are included in
cost of professional services revenues.
We use the percentage-of-completion method to account for
custom consulting contacts with revenues recognized as the work on the contract
progresses and defined milestones are reached.
Concentration of Credit
Risk - Our financial instruments that are exposed to concentrations of credit
risk consist primarily of trade receivables.
Concentrations of credit risk with respect to receivables are a result
of a limited number of customers and their significant percentage of accounts
receivable from them. We perform
periodic credit evaluations of our customers’ financial condition and generally
do not require collateral. Two
customers account for approximately 53% and 19% of total accounts receivable as
of December 31, 2001 and 2000, respectively.
No other single group or customer represents greater than 10% of total
accounts receivable.
Allowance
for Doubtful Accounts - We
maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
Management specifically analyzes accounts receivable and analyzes historical
bad debts, customer concentrations, customer credit-worthiness, current
economic trends and changes in our customer payment terms when evaluating the
adequacy of the allowance for doubtful accounts. Our accounts receivable
balance was $1,803,000, net of allowance for doubtful accounts of $505,000 as
of December 31, 2001, as compared to an accounts receivable balance of $5,345,000,
net of allowance for doubtful accounts of $767,000 as of December 31, 2000.
Property and Equipment - Property and Equipment is
stated at cost less accumulated depreciation and amortization. Depreciation and
amortization are provided using the straight-line method over the
following estimated useful lives: computer hardware and software, three to five
years; office furniture and fixtures, three to seven years; and leasehold
improvements, five years or the lease term if shorter.
Goodwill - Goodwill represents the
excess of cost over the estimated fair value of net assets acquired in business
combinations, less impairment write-offs. The remainder was being amortized on a straight-line basis
over 32 months and is stated net of accumulated amortization. The balance of goodwill of $460,000 at
December 31, 2001, will no longer be
amortized under SFAS No. 142. We will
perform periodic impairment tests beginning January 1, 2002.
Valuation Allowance
for Deferred Tax Assets - Deferred income taxes are recorded, in
accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109),
“Accounting for Income Taxes.” Under
SFAS 109,
deferred tax assets and liabilities are determined based on the differences
between financial reporting and the tax basis of assets and liabilities using
the tax rates and laws in effect when the differences are expected to reverse.
SFAS 109 provides for the recognition of deferred tax assets if realization of
such assets are more likely than not to occur. Realization of our net deferred
tax assets is dependent upon our generating sufficient taxable income in future
years in appropriate tax jurisdictions to realize benefit from the reversal of
temporary differences and from net operating loss carryforwards. Based on the
weight of the available evidence, we have provided a valuation allowance
against all of our net deferred tax asset. Management will continue to evaluate
the realizability of the deferred tax asset and its related valuation
allowance.
Stock
Based Compensation - Stock Based Compensation
arising from stock option grants to employees is accounted for by the intrinsic
value method under Accounting Principles Board (“APB”) Opinion No. 25. Statement of Financial Accounting Standards
(“SFAS”) No. 123 encourages (but does not require) the cost of stock-based
compensation arrangements with employees to be measured based on the fair value
of the equity instrument awarded. As permitted by SFAS No. 123, we apply APB
Opinion No. 25 to our stock-based compensation awards to employees and
disclose the required pro forma effect on net income and earnings per share.
Business
Combinations And Goodwill Impairment Losses
Our ability to successfully provide
professional services to our clients is dependent upon our ability to obtain
the necessary skills, resources and capabilities required to render such
professional services. During 2001, EpicEdge underwent a transformation it
its business strategy. The company
continued to downsize from a rapid buildup in 2000. Growth in professional services during 2001 came from hiring
additional consultants to service new and old clients. No acquisitions were completed in 2001
Effective
January 1, 2001, with a closing date of February 5, 2001, we sold all of the
issued and outstanding stock of IPS to Red & Blue, Inc., a Delaware
corporation and to the IPS Associates, Inc. Stock Ownership Plan, as described
under Recent Disposition. In view of the sale of IPS, at a substantial
loss, effective January 1, 2001, management concluded that goodwill
related to IPS as of December 31, 2000, was impaired and wrote it down to
the amount recoverable in the sale, which was $7,643,000; accordingly,
$24,040,000 was written off. Management
also concluded that the entire amount of goodwill related to the Tumble and
Growth Strategy acquisitions and a portion of the goodwill related to the COAD
and Connected acquisitions, as of December 31, 2000, was impaired based on
evaluations of the related estimated future undiscounted cash flows and the
lack of continuity of the related key employees; accordingly, $12,400,000 was
also written off, with a remaining goodwill of $5,434,000 related to
COAD, Dynamic, Connected and NET. The
total of these goodwill impairment write-offs of $36,440,000 was reported as an
operating expense in 2000. Goodwill of
$460,000 at December 31, 2001, relates to Dynamic ($260,000) and NET
($200,000).
Results of operations 2001, reflect our first full year after a
successful transition into a pure professional services company. Results of operations 2000 of Growth
Strategy, IPS and Tumble have been included in our financial statements
commencing on April 1, 2000, June 1, 2000, and July 1, 2000, respectively, the
effective dates of the transactions for accounting purposes. Although IPS was included in our
accompanying actual results of operations since IPS’s acquisition in June 2000,
the disposition of IPS has been deemed “significant”; accordingly, pro-forma
results of operations 2000 and 1999 listed below under the heading Pro-Forma Results exclude IPS. The results of operations of Tumble would
not have a material affect on the pro forma financial information presented and
unless otherwise noted, has also been excluded from the pro forma financial
information listed below under the heading Pro-Forma
Results.
Results Of Operations
The following table sets forth certain condensed
statement of operations data for the period indicated:
ACTUAL RESULTS
Year Ended December 31, 2001 Compared To
Year Ended December 31, 2000
Revenues
Total revenue decreased $18.1
million or 55.2% from $32.7 to $14.6 million for the year ended December
31, 2000 and 2001, respectively. During
2001, we completed the transition of our operations to a professional services
company and all of our current and future revenues are to be derived from
delivery professional services to our clients.
Professional
Services Revenues - Professional services revenues decreased $7.3
million or 33.2% from $21.9 million to $14.6 million for the year ended
December 31, 2000 and 2001, respectively.
Approximately $9.8 million of the 2000 professional services revenue is
due to IPS, which was sold in 2001 (see Pro-Forma
Results below). Professional
services revenue represented 67.0% and 100% of total revenue for the year ended
December 31, 2000 and 2001, respectively.
Technology
Integration Revenues - Technology integration revenue decreased
$10.8 million or 100% from $10.8 million to $0.0 million for the year ended
December 31, 2000 and 2001, respectively.
Technology integration revenues represented 33% and 0% of total revenues
for the year ended December 31, 2000 and 2001, respectively. This elimination of technology integration
revenues is reflective of our proactive strategy to phase out of our hardware
sales or value-added reseller (“VAR”) operations. We do not expect to generate substantial future revenues from our
historical VAR business.
Cost Of Revenues And Gross Profit
Total cost of revenues decreased $13.5 million or 57.3%
from $23.6 million to $10.1 million for the year ended December 31, 2000 and
2001, respectively. This was mainly due
to our transition out of the historical VAR business. Cost of professional services revenues consist primarily of
salaries and employee cost for personnel dedicated to client projects,
sub-contractor costs related to client projects, and direct expenses incurred
to complete projects that were not reimbursed by clients. Cost of professional services revenues
decreased $2.6 million or 20.5% from $12.7 million to $10.1 million for the year
ended December 31, 2000 and 2001, respectively.
Total gross profit decreased $4.6 million or 50.1% from
$9.2 million to $4.6 million for the year ended December 31, 2000 and 2001,
respectively. The total gross profit
percentage was 28.2% and 31.4% for the year ended December 31, 2000 and 2001,
respectively. Our goal is to maintain
this level of gross margin into the future as we continue to transition into
higher margin longer contracted professional services revenues.
Operating Expenses
Compensation
and Benefits - Compensation and benefit expenses decreased $7.6
million or 64% from $11.9 million to $4.3 million for the year ended December
31, 2000 and 2001, respectively. These
expenses represent 36.6% and 29.4% of total revenues in the respective periods. The decrease in compensation and benefit
expenses is due to planned staff reductions consistent with the company’s
reorganization plan. The majority of these staff reductions were in redundant
administrative support and salesmen. As
well, these reductions were in part due to the divestiture of IPS in 2001.
Selling, General and
Administrative - Selling, general and administrative expenses
(SG&A) decreased $8.4 million or 71.3% from $11.7 million to $3.3 million
for the year ended December 31, 2000 and 2001 respectively. These expenses
represent 35.8% and 22.9% of total revenues in the respective periods. The decrease in SG&A expenses reflect
the Company’s focus on cost cutting measures, reduction in the sales force, and
non-billable staff. This is consistent
with the Company’s restructuring goals, and is due in part to the IPS
divestiture, which was sold in 2001.
Depreciation
and Amortization- Depreciation and amortization increased $0.4 million
or 7.1% from $5.6 million to $6.0 million for the year ended December 31, 2000
and 2001 respectively. These expenses
represent 17.1% and 41.1% of total revenues in the respective periods. Depreciation and amortization increased
during the year ended December 30, 2001 due to an acceleration of amortization
of goodwill as a result of a review by management of the carrying value and
recoverability of the remaining goodwill of some of the previous acquisitions.
Stock Based
Compensation and Costs - Stock based compensation and costs decreased $8.9 million or 100% from $8.9 million to
$0.0 million for the year ended December 31, 2000 and 2001, respectively. In 2000, $8.9 million of various stock based
compensation awards were issued, see discussion below.
Goodwill and other impairment losses - Goodwill and other impairment losses
decreased $37.5 million or 100% from $37.5 million to $0.0 million for the year
ended December 31, 2000 and 2001, respectively. In 2000, $37.5 million of goodwill and other impairment losses we
incurred, see discussion below.
Other Expenses (Income)
Debt
Discount Amortization -In November 2000, our Chairman and principal
stockholder provided a $1,000,000 line of credit in the form of convertible
notes (the “November Notes”). As of
December 31, 2000, we had drawn $900,000 on the line of credit. The November Notes bear annual interest at
the rate of 8%, and originally were convertible at the lenders’ option at $.50
per share and matured on December 31, 2001.
The lender had the option to demand repayment of the November Notes
within 30 days after the IPS sale; however, the lender made no such
demand. In connection with the November
Notes, the lender was issued five-year warrants to purchase an aggregate of
2,000,000 shares of our common stock at $.01 per share, which resulted in a net
carrying value of zero for the November Notes.
We recorded debt discount amortization of $600,000 and $75,000 as
interest expense for the year ending December 31, 2001 and December 31, 2000, respectively. In April 2002, the terms of the November
Notes were renegotiated and the maturity date was extended to December,
2004. See “Liquidity and Capital
Resources” below.
In December 2000, we issued $1,500,000 in convertible
notes to two of our stockholders (the “December Notes’), both of which formerly
served on our Board of Directors. The
December Notes are convertible at the lenders’ option at $.50 per share. The December Notes bear interest at 8% per
annum and matured on December 31, 2001.
In connection with the December Notes, the lenders were issued five-year
warrants to purchase an aggregate of 3,000,000 shares of our common stock at
$.01 per share. We recorded debt
discount of $1,500,000 in connection with the issuance of the warrants, which
resulted in a net carrying value of zero for the December Notes. This discount was to be amortized into
interest expense over the original life of the December Notes. This debt discount is fully amortized as of
December 31, 2001 and amortization of $1,300,000 and $200,000 was recorded as
interest expense in 2001 and 2000, respectively. In April 2002, the terms of the November Notes were renegotiated
and the maturity date was extended to April, 2003. See “Liquidity and Capital Resources” below.
Discontinued Operations
Additional expenses of $10,000 relating to the disposal of
the remaining assets of Loch Exploration, Inc. in 2001 are included in
discontinued operations (see discussion below).
ACTUAL RESULTS
Year Ended December 31, 2000 Compared To
Year Ended December 31, 1999
Revenues
Total revenue increased $3.3
million or 11.2% from $29.4 million to $32.7 million for the year ended
December 31, 1999 and 2000, respectively.
During 2000, we completed the transition of our operations to a
professional services company and expect substantially all of our future
revenues to be derived from delivery professional services to our clients.
Professional
Services Revenues - Professional services revenues increased $17.9
million or 453.9% from $4.0 million to $21.9 million for the year ended
December 31, 1999 and 2000, respectively.
Approximately $9.8 million of this increase is due to IPS, which was sold
in 2001 (see Pro-Forma Results
below), and the remaining portion of this increase was a result of the other
acquisitions of professional services businesses as we executed our business
strategy of migrating from a value-added reseller (VAR) of hardware and
software to a professional services company.
Professional services revenue represented 13.5% and 67.0% of total
revenue for the year ended December 31, 1999 and 2000, respectively.
Technology
Integration Revenues - Technology integration revenue decreased
$14.7 million or 57.7% from $25.5 million to $10.8 million for the year ended
December 31, 1999 and 2000, respectively.
Technology integration revenues represented 86.5% and 33% of total
revenues for the year ended December 31, 1999 and 2000, respectively. This downward trend in technology integration
revenues is reflective of our proactive strategy to phase out of our VAR
operations. We do not expect to
generate substantial future revenues from our historical VAR business.
Cost Of Revenues And Gross Profit
Total cost of revenues decreased $2.8 million or 10.7%
from $26.3 million to $23.5 million for the year ended December 31, 1999 and
2000, respectively. This was due mainly
to the Company’s transition out of the cost intensive Technology integration
business, as well as an overall reduction in revenue.
Total gross profit increased $6.1 million or 197.6% from
$3.1 million to $9.2 million for the year ended December 31, 1999 and 2000,
respectively. The total gross profit
percentage was 10.5% and 28.2% for the year ended December 31, 1999 and 2000,
respectively. This was due mainly to
the Company’s transition into higher margin Professional Services revenue.
Cost of
Professional Cost of
professional services revenues consist primarily of salaries and employee cost
for personnel dedicated to client projects, sub-contractor costs related to
client projects, and direct expenses incurred to complete projects that were
not reimbursed by clients. Cost of
professional services revenues increased $9.7 million or 319.8% from $3.0
million to $12.7 million for the year ended December 31, 1999 and 2000,
respectively. These increases are a
result of the completion of several acquisitions of professional services
businesses and our being engaged on larger and more numerous client projects
during the year.
Gross profit from professional
services increased $8.3 million or 892.9% from $0.9 million to $9.2 million for
the year ended December 31, 1999 and 2000, respectively. The gross profit percentage from
professional services was 23.4% and 41.9% for the year ended December 31, 1999
and 2000, respectively. Approximately
$5.9 million of this increase was due to IPS, which was sold in 2001 (see Pro-Forma Results below).
Cost of
Technology Integration Cost
of technology integration revenues consist primarily of hardware and software
costs associated with product sales.
Cost of technology integration revenues decreased $12.5 million or 53.8%
from $23.3 million to $10.8 million for the year ended December 31, 1999 and
2000, respectively. The overall
decrease is a result of our strategy to migrate away from our historical VAR
operations. The changes in the cost of
technology integration revenues are a result of related increases or decreases
in product sales. Additionally, we
recorded a reserve for potentially excess and obsolete inventory during 2000 of
$700,000 as we have substantially transitioned out of the hardware and software
VAR business.
Gross profit from technology
integration revenues decreased $2.0 million or 90.7% from $2.2 million to $0.2
million for the year ended December 31, 1999 and 2000, respectively. The gross profit percentage from technology
integration revenues was 8.5% and 1.9% for the year ended December 31, 1999 and
2000, respectively.
Operating Expenses
Compensation
and Benefits - Compensation
and benefit expenses increased $9,216,000 or 333.4% from $2,764,000 to
$11,980,000 for the year ended December 31, 1999 and 2000, respectively. These expenses represent 9.4% and 36.6% of
total revenues in the respective periods.
The increase in compensation and benefit expenses reflect the
acquisition of certain businesses along with planned increases in both selling
and consulting personnel. These planned
additions to staff were in anticipation of staffing needs to support forecasted
revenues. These revenues have failed to
materialize and as a result we have undergone two significant reductions in
force in October 2000 and March 2001.
We have gone from a headcount of a high of 215 in 2000 to the current
level of 112 in the entire organization.
The majority of these staff reductions were in redundant administrative
support and virtually all salesmen.
Selling, General and Administrative - Selling, general and administrative expenses (SG&A) increased
$9,639,000 or 467.0% from $2,064,000 to $11,703,000 for the year ended December
31, 1999 and 2000 respectively. These expenses represent 7.0% and 35.8% of
total revenues in the respective periods.
The increase in SG&A expenses reflect the acquisition of certain
businesses that brought additional SG&A expenses to us. We also recorded a provision for doubtful
accounts of $700,000 during the year ended December 31, 2000, related primarily
to accounts receivable associated with the former hardware and software VAR
business. In addition to the sale of
IPS, as more fully described under Recent
Disposition, which represented approximately $2,000,000 or 20% of
the total SG&A expenses, we have instituted an ongoing strict expense
reduction and monitoring program which began in the fourth quarter of 2000.
Depreciation and Amortization - Depreciation and amortization increased $4,952,000 or 763.0% from
$649,000 to $5,601,000 for the year ended December 31, 1999 and 2000
respectively. These expenses represent
2.2 % and 17.1% of total revenues in the respective periods. Depreciation and amortization increased
during the year ended December 30, 2000 as a result of amortization of goodwill
recorded in connection with the acquisition of certain businesses.
Stock-based
Compensation and Costs - Stock-based
compensation and costs was $3,549,000 and $8,942,000 for the year ended
December 31, 1999 and 2000, respectively representing 12.1% and 27.3% of total
revenues in the respective periods.
During 1999, we granted 1,147,500 shares of common stock, valued at
approximately $3,549,000 in exchange for consulting services from various
consulting firms.
The stock-based compensation charges during year ended
December 31, 2000 were based on certain transactions as follows:
In November 1999, we reserved 190,000 unregistered shares
of our common stock to two of our board members as compensation for their
participation on our Board of Directors. The shares are issued to each board
member in equal installments
at the end of each quarter through the quarter ended September 30, 2000. We record the value of the shares issued
each quarter by multiplying the quoted market price of the stock on the
issuance date times the number of shares issued for that period. We recorded stock-based compensation related
to the shares issued of $2,936,400 for 142,500 shares issued to these board
members during the year ended December 31, 2000.
In March 2000, we issued warrants for the purchase of
40,000 shares of our common stock to two advisory board members for services to
be rendered from April 2000 to March 2002.
The warrants have an exercise price of $21.88 and are exercisable for
five years from the date of grant. One
third of the warrants vest upon grant, and the remaining two-thirds vest in
one-half increments on the first and second anniversary of the grant date. We recorded the initial value of these
warrants based on the Black-Scholes model, totaling $346,000, as unearned
compensation on the date of grant. We are amortizing this amount as
compensation expense over the consulting period, and will revalue the warrants
over the consulting period. We revalued
the warrants at December 31, 2000, and based on a lower stock price, it reduced
the amount of the unearned compensation to zero. As a result of the decrease in stock value over the period, we
recorded no stock-based compensation related to the warrants during 2000.
In April 2000, we issued to our client’s venture capital
affiliate a warrant to purchase 500,000 shares of our common stock at an
exercise price of $22.00 per share. The
warrant is exercisable at any time after the earlier of (i) 60 days after the
consummation of a registered public offering and (ii) October 3, 2001 (such
earlier date being the vesting date), through the third anniversary of the
vesting date. We determined the value
of the warrant to be $4,843,000 based on the Black-Scholes model. The warrant was issued contemporaneously
with the negotiation of a consulting agreement between us and the client, under
which we could receive estimated fees totaling $3.1 million over the next three
years. However, the agreement provides the client with the right of
cancellation for convenience. Therefore, at June 30, 2000 the end of the
quarter in which these warrants were issued, there was no assurance that the
client would continue to engage us under the agreement or would enter into any
additional agreements in the future.
Accordingly, we recorded the estimated value of the warrant as a
stock-based compensation and costs charge of $4,843,000 during the three months
ended June 30, 2000. The client
cancelled the consulting agreement in January 2001.
In June 2000, we entered into a severance agreement with
one of our employees that provided, among other things, for the modification of
the employee’s stock options allowing a cashless exercise of vested and
unexercised stock options. As a result,
we accounted for the stock options as variable options and recorded a
stock-based compensation charge on the exercise date during the three months
ended June 30, 2000 of $475,600 based on the difference between the exercise
price and the quoted market price of the underlying stock. We issued 22,353 shares of our common stock
to the former employee as a result of the cashless exercise.
In connection with the IPS acquisition in June 2000, we
assumed an ESOP from IPS and issued 607,000 shares of common stock to the ESOP
(“ESOP shares”). On the date of acquisition,
we recorded unearned compensation of $9,445,000 related to 493,220 ESOP shares
issued, but not yet committed to be released by the ESOP trustee. During the period from acquisition to
December 31, 2000, a total of $466,000 in compensation expense was recorded for
43,949 ESOP shares committed to be released at an average share price of $10.60
per share. ESOP shares not committed to
be released are not considered to be outstanding and are excluded in earnings
per share calculations. As a result of
the IPS sale (see Recent Disposition),
the ESOP shares were returned to us in February 2001.
In July 2000, we issued warrants for the purchase of
17,000 shares of our common stock to the management company that helped us
locate our new corporate headquarters.
The warrants have an exercise price of $22.75 per share and are
exercisable for five years from the date of grant. One-third of the warrants vest upon grant, and the remaining
two-thirds vest in one-half increments on the first and second anniversaries of
the grant date. We recorded the value
of these warrants based on the Black-Scholes model, totaling $154,000, as an
expense in the period the warrants were issued.
In December 2000, we granted 400,000 options to an
employee with a six (6) month vesting period.
These options had an exercise price of $0.125 per share and,
accordingly, we recorded unearned compensation of $400,000 based upon the
market price of the stock on the date of grant. In December, we recorded $67,000 of amortization of the unearned
compensation, and on January 4, 2001, the employee resigned his executive
position with us; therefore, in January 2001, we reversed the remaining
unearned compensation related to these options. After resigning, this ex-employee exercised his vested portion of
66,668 options.
Goodwill and other impairment losses - In view of
the sale of IPS effective January 1, 2001, at a substantial loss, management
has concluded that goodwill related to IPS as of December 31, 2000, was
impaired and was written down to the amount recoverable in the sale of
$7,643,000; accordingly, $24,040,000 was written off. Management has also
concluded that the entire remaining goodwill related to the Tumble and Growth
acquisitions and a portion of the goodwill related to the COAD and Connected
acquisitions, as of December 31, 2000, are impaired based on evaluations of the
related estimated future undiscounted cash flows and the lack of continuity of
the related key employees; accordingly, $12,400,000 was also written off, with
a remaining goodwill of $5,434,000
related to COAD, Dynamic, Connected and Net. The total of these goodwill
impairment write-offs of $36,440,000 is reported as an operating expense
in 2000.
In addition to the goodwill impairment losses, as more
fully described in the preceeding paragraph and in Recent Mergers and Acquisitions and Goodwill Impairment Losses
discussed above, in October 2000, we moved our corporate headquarters from
Houston, Texas to Austin, Texas. As a
result of this move, several fixed assets were no longer of use to us and were
considered impaired. The net value of
these impaired assets totaled approximately $277,000 and is included as an
operating expense in goodwill and other impairment losses. In December 2000, we abandoned our
implementation of a new software platform for our corporate headquarters. We wrote off approximately $805,000 of
capitalized costs associated with this project abandonment. These costs are also included in goodwill
and other impairment losses.
Debt
Discount Amortization - In addition to the following discussion,
see debt discount amortization discussion
above. In July 2000, we completed a $5,000,000 convertible debt offering
with certain private investors, who are also stockholders. The convertible debt bears annual interest
of 9.5%. Principal and interest was due
on the original maturity date of December 30, 2000. The Company reached an agreement on the extension of the original
maturity date of this convertible debt to August 1, 2002. The conversion terms were to be renegotiated
by August 15, 2001, otherwise a penalty of $500,000 would be assessed and
payable in February 2002. The principal
and accrued and unpaid interest was to be convertible at the option of the
holder into common stock of the Company at a 25% discount from the per-share
price of a Qualified Financing consummated prior to the maturity date. A Qualified Financing was defined as an
equity financing in which we raise at least $7,000,000. If a Qualified Financing is not consummated
prior to the maturity date, then the principal and accrued and unpaid interest
is convertible at the option of the holder into common stock of the Company at
a conversion price $5.00 per share. We
recorded an imputed debt discount of $5,000,000 related to the beneficial
conversion feature based on the quoted market price of our common stock of
$19.50 per share on the date of issuance.
At December 31, 2000, this debt was due on demand, and the imputed
discount was fully amortized to expense.
In April 2002, the terms of this convertible debt were
renegotiated. See “Liquidity and
Capital Resources” below.
Discontinued Operations
Effective January 1, 1999, Loch
Exploration (“Loch”), a public company, acquired all of the stock of the
Company in a “reverse merger,” whereby the Company is the acquirer for
accounting purposes. In connection with
the acquisition, Loch exchanges shares of common stock with our stockholders. The transaction was accounted for in a
manner
similar to a pooling of interests, whereby no goodwill resulted from this
transaction, and our equity interest in Loch’s net assets was recorded at
Loch’s historical cost basis. In 1999,
Loch’s net assets were transferred to a subsidiary, Loch Energy, Inc. (“LEI”),
and, as we intended to distribute the shares of LEI common stock owned by us to
our stockholders during 2000, our equity interest in Loch’s net assets and
operations was reported as discontinued operations.
During the quarter ended September
30, 2000, we irrevocably transferred all of the stock of LEI to a designated
trustee. Since we were unable to
achieve our original plan of distributing these shares as registered stock to
our shareholders who were former shareholders of Loch Exploration, Inc., we
have recorded an additional write-off of $383,885 related to the disposal of
the remaining assets of the discontinued operations related to Loch Energy as
of December 31, 2000.
Quarterly Results
We derived this information from
unaudited quarterly financial statements that include, in the opinion of our
management, all adjustments necessary for a fair presentation of the
information for such periods. You should read this information in conjunction
with the audited consolidated financial statements and notes thereto. Results
of operations for any fiscal quarter are not necessarily indicative of results
for any future period.
Our revenues and operating results
are subject to significant variation from quarter to quarter depending on a
number of factors, including:
• the progress of contracts;
• the revenues earned on contracts;
• the timing of revenues on performance-based contracts;
• the commencement and completion of contracts during any
particular quarter;
• the schedule of government agencies for awarding contracts;
and
• the term of each contract that we have been awarded.
We have occasionally experienced a
pattern in our results of operations pursuant to which we incur greater operating
expenses during the start-up and early stages of significant contracts prior to
receiving related revenues. As well we have noticed seasonality in our
revenues, in that due to holiday and vacation time there are not enough
billable hours available for high utilization of billable consultants. Our quarterly results may fluctuate, causing
a material adverse effect on our operating results and financial condition.
PRO-FORMA RESULTS
The following information reflects
the unaudited pro-forma statement of operations combining the historical
results of operations of EpicEdge and the 1999 and 2000 acquisitions, discussed
under the heading Recent Mergers and
Acquisitions and Goodwill Impairment Losses (except for IPS, which
was subsequently sold effective January 1, 2001, and for Tumble Interactive,
which would not have a material effect, and therefore has been excluded from
the pro-forma financial information), as if the acquisitions had occurred and
the related common shares had been issued as of January 1, 2000, and as though
the IPS acquisition and sale had occurred at that date (and, therefore, the IPS
results and goodwill impairment loss are excluded). Actual results may have materially differed from the results
indicated in the unaudited pro-forma financial information had the combinations
actually occurred as of the beginning of the periods presented. Additionally, the unaudited pro-forma
information should not be relied upon as being indicative of the future results
of operations of the combined entity.
PRO-FORMA RESULTS
Year Ended December 31, 2001 Compared To
Year Ended December 31, 2000 On A Pro-Forma Basis
Revenues
The increase in revenues from Professional
Services of $2.3 million or 18.5% from $12.4 million (pro-forma) to $14.6
million (actual) for the year ended December 31, 2000 and 2001, respectively,
is due principally to the effects of the growth in the company’s core services
areas. This growth has come in the form
of larger more long-term contracts in the public sector ERP practice group as
well as expansion of the e-solutions practice.
In view of the completion of management’s plan to completely transition
out of Technology Integration into Professional Services, management is
planning and expects to continue Professional Services growth at a similar
rate; however, no assurances can be made that this historical rate of growth
will continue.
Cost Of Revenues And Gross Profit
Although the cost of professional
services increased $1.1 million or 11.7% from $9.0 million (pro-forma) to $10.1
million (actual) for the year ended December 31, 2000 and 2001, respectively,
the cost of professional services as a percentage of the professional services
revenues decreased 4.3%, from 72.9% (pro-forma) to 68.6% (actual). This decrease in costs translates into a
$1.2 million or 36.8% increase gross profit from professional services, from
$3.3 million (pro-forma) to $4.6 million (actual) for the year ended December
31, 2000 and 2001, respectively. These
increases in gross margin can be attributed to increasing average billing rates
and stabilizing the cost of delivering services.
Operating Expenses
The decrease in selling, general
and administrative expenses, including compensation and benefits, of $12.3
million or 61.8% from $19.9 million (pro-forma) to $7.7 (actual) million for
the year ended December 31, 2000 and 2001, respectively, was due primarily to
payroll and payroll reductions as well as redundant administrative costs. The strategy in 2000 was to acquire
complementary business practices to be able to provide current and potential
clients the entire spectrum of e-services from planning and design to implementation
and maintenance. In anticipation of the
execution of this strategy, we hired additional staff even beyond that which
came to us through the acquired businesses.
These staff additions were made up of a sales force designed to capture
new business and expand our scope of work in existing clients. In addition, with the transition out of the
VAR business, we had excess administration personnel. Therefore, as we experienced the general economic downturn in our
industry segment during 2000 and as we transitioned away from the low-margin VAR
business. In the spring of 2001, a
strategy and plan of execution was adopted to stabilize the organization and
return to cash flow positive and eventually profitability. This strategy included a strict line-by-line
review and evaluation of non-compensation expenses as well as another 15%
reduction in our workforce in the Creative, Research and Sales
departments. In the fourth quarter 2000
and in the first quarter 2001, there was continuing additional non-recurring
expenses associated with these reductions in force. However, because of the eventual reductions in compensation and
benefits along with the results of the line-by-line review and evaluation of
non-compensation
expenses, we expect to be cash flow positive through the end of 2002; however,
no assurances can be made that these expense reductions will have the effect we
expect.
Year Ended December 31, 2000 Compared To
Year Ended December 31, 1999 On A Pro-Forma Basis
Revenues
The increase in pro-forma revenues
from Professional Services of $4.3 million or 52.9% from $8.1 million to $12.4
million for the year ended December 31, 1999 and 2000, respectively, is due
principally to the effects of the acquisition strategy and growth of this higher
gross margin business. This growth has
come in the form of larger more long-term contracts in the public sector ERP
practice group as well as expansion of the e-solutions practice
Cost Of Revenues And Gross Profit
Although the pro-forma cost of professional
services increased $3.0 million or 50.0% from $6.0 million to $9.0 million for
the year ended December 31, 1999 and 2000, respectively, the pro-forma cost of
professional services as a percentage of the pro-forma professional services
revenues decreased nearly 1%, from 73.8% to 72.9% for the year ended December
31, 1999 and 2000, respectively. This
decrease in pro-forma costs translates into a $1.2 million or 57.1% increase in
pro-forma gross profit from professional services, from $2.1 million to $3.3
million for the year ended December 31, 1999 and 2000, respectively. These increases in gross margin can be
attributed to increasing average billing rates and stabilizing the cost of
delivering services. We also engaged
larger more lucrative projects thus increasing incremental margins.
Operating Expenses
The increase in pro-forma selling,
general and administrative expenses, including compensation and benefits, of
$13.4 million or 206.2% from $6.5 million to $19.9 million for the year ended
December 31, 1999 and 2000, respectively, was due primarily to payroll and
payroll related costs as well as redundant administrative costs. The strategy in 2000 was to acquire
complementary business practices to be able to provide current and potential
clients the entire spectrum of e-services from planning and design to
implementation and maintenance. In
anticipation of the execution of this strategy, we hired additional staff even
beyond that which came to us through the acquired businesses. These staff additions were made up of a
sales force designed to capture new business and expand our scope of work in
existing clients. In addition, with the
transition out of the VAR business, we had excess administration personnel. Therefore, as we experienced the general
economic downturn in our industry segment during 2000 and as we transitioned
away from the low-margin VAR business, in October 2000 we reduced our workforce
by 43 full-time positions, or 14% of our workforce at that time.
PRO-FORMA
QUARTERLY RESULTS
The following information reflects
the unaudited pro-forma statement of operations of the historical results of
operations of EpicEdge for the second, third, and fourth quarters of 2000
excluding IPS, which was acquired in June 2000 and subsequently sold effective
January 1, 2001. Actual results may have materially differed from the results
indicated in the unaudited pro forma financial information below had the
purchase, and subsequent sale, of IPS never occurred. Additionally, the
unaudited pro forma information should not be relied upon as being indicative
of the future results of operations.
During the fourth quarter 2000, there were non-recurring operating
expense charges recorded by the Company. As more fully described elsewhere in
this Form 10-K, we wrote off $12,400,000 in goodwill (in addition to the IPS
goodwill write off of $24,040,000), $5,200,000 of debt discount amortization,
$805,000 from the abandoned internal software implementation, and $277,000 of
asset impairments as a result of the moving of our corporate headquarters to
Austin, Texas. These non-recurring items total $18.7 million. Excluding these
non-recurring items, the fourth quarter 2000 pro-forma operating and other
expenses would have been $7.7 million.
Liquidity
And Capital Resources
As of December 31, 2001, our primary sources of liquidity were cash and
cash equivalents of $256,000 and net accounts receivable of approximately
$1,803,000. In June 2001, we began
negotiations with certain existing shareholders and convertible debt holders
for additional funding. Although the
final documents were not executed until April 2002, we received $1,050,000 as
of December 31, 2001 as interim bridge financing in the form of convertible
promissory notes. We also received
additional funding of $860,000 under these promissory notes in February and
early March 2002. On April 16, 2002,
the terms were finalized on these convertible notes. The total amount to be received under these new convertible notes
(the "New Convertible Notes") is a minimum of $2,650,000, $1,910,000
of which we received in December 2001, and February and March 2002 as described
above. Under the terms of the Note and Preferred Stock Purchase Agreement (the
"Purchase Agreement"), the investors can invest up to an additional
$1,850,000 for a maximum investment under the Purchase Agreement of $4,500,000
at their discretion. The New Convertible Notes are for a term of one year and
are due April 2003, and have a stated interest rate of 8%. The New Convertible
Notes cannot be converted, pursuant to their terms, unless and until we receive
the requisite shareholder approvals. Upon such approval, all but $600,000 of
the outstanding balance on these New Convertible Notes, including any accrued
and unpaid interest, shall be converted into shares of Series B Convertible
Preferred Stock (the "Series B Preferred Stock"). The additional
$600,000 may be converted at the option of the holder. Under the Purchase
Agreement, an Event of Default will have occurred in the event we fail to obtain
shareholder approval on or before June 30, 2002. Upon such an Event of Default,
the investors in the New Convertible Notes would have the option of declaring
such notes due and payable immediately.
The Series B Preferred Stock has
the following terms: a conversion rate equal to one share of common stock for
each $.25 of stated value or a liquidation preference such that in the event of
any liquidation, dissolution or winding up of the Company, the holders thereof
shall be entitled to receive, at their option, either (a) in preference to the
holders of the common stock and on a pro-rated pari passu basis with the Series
A Preferred Stock (see below) an amount equal to 2.75 times the stated value if
a liquidation event occurs within 24 months.
If, however, a liquidation event occurs after 24 months, the preference
multiple becomes 3 times the stated value.
In addition, if the holders of the Series B Preferred Stock choose upon
a liquidation event to receive the liquidation preference multiple in effect at
the time of the event and there still remains undistributed net equity value
after any debt obligations and Series A Preferred Stock liquidating preference
payments, then the Series B Preferred Stock will participate in that additional
distribution on an as converted basis at a conversion rate equal to one share
of common stock for each $.75 of stated value.
A merger, acquisition or sale of all or substantially all of our assets
in which our shareholders do not own a majority of the outstanding shares of
the surviving corporation shall be deemed to be a liquidation.
On April 16, 2002, we received a commitment (the
"Commitment") in the form of a letter agreement with Edgewater
Private Equity Fund III, L.P. ("Edgewater") to invest up to an
additional $1,360,000 either pursuant to the terms of the Purchase Agreement or
pursuant to a new agreement for the purchase of secured promissory notes that
are convertible into a new preferred stock. This new preferred stock would have
a liquidation preference equal to 3 times its purchase price and would be
senior with respect to liquidation preference to the all other securities
described in the Purchase Agreement. Any additional financing pursuant to that
which is described above is contingent upon the following: (a) there being (i)
no material adverse change in our financial condition, business, operating
results, operations, business prospects or property, as measured against our
Board of Directors' current operating plan (a "Material Adverse
Change"), or (ii) no default or event of default under the Purchase
Agreement (a "Default"). To the extent that there is a Material
Adverse Change or a Default, prior to the financing described above, Edgewater
shall not be obligated to provide us with any of the amounts described above;
(b) Board approval in advance of the financing; and (c) the execution of
definitive documents, which shall contain in detail the terms described above
and shall also contain other rights, including, without limitation,
registration rights, protective provisions, information rights and events of
defaults and remedies on essentially the same terms described in the Purchase
Agreement. In the event we are not able to execute on our current operating
plan or a Material Adverse Change occurs as described in the Commitment, we may
not be able to get any additional funding from Edgewater.
As of December 31, 2000, we also relied on amounts available under
lines of credit totaling $3,434,000 with two financial institutions. There were no additional amounts available
under the lines of credit on December 31, 2000. We had three lines of credit totaling $6.5 million with three
financial institutions. We could draw
on the lines of credit based on a borrowing base that is 85% of eligible
accounts receivable. Amounts
outstanding under the lines of credit bear interest ranging from the prime rate
plus 0.5% to the prime rate plus 2.5%.
The lines of credit are secured by accounts receivables, inventory,
investments and property and equipment.
The outstanding balance on the lines of credit was $3,434,000. We also were the guarantor on a note payable
to a financial institution for a loan made to an Employee Stock Ownership Plan
sponsored by us (the “ESOP loan”). The
ESOP loan bears annual interest at 8.02% and is secured by accounts
receivables, inventory, investments, property and equipment, and the personal
guarantees of certain employees and stockholders of the Company. The outstanding balance of the ESOP loan at
December 31, 2000 was $4,861,000. We
were in technical default of our lines of credit and the ESOP loan and the
creditors had asserted the default under the loan agreements. The financial
institutions agreed to temporarily standstill and forbear accelerating the
outstanding
balances through approximately January 20, 2001 to allow us time to either
replace the lines of credit with new creditors or repay the outstanding
balances. In February 2001, $2,275,000
was paid in full by the use of a portion of the proceeds from the IPS sale (see
Recent Disposition above); the remaining $1,159,000 and entire ESOP loan were
assumed by the acquirer in the IPS sale transaction.
Net cash used in operating
activities was $6,504,000 for the year ended December 31, 2001 and is primarily
the result of the net loss of $11,772,000 incurred during the period less
depreciation and amortization of $7,990,000, plus decreases in accounts payable
and accrued expenses of $3,128,000. Net
cash used in operations was $13,597,700 for the year ended December 31, 2000
and is primarily the result of the net loss of $72,604,000 incurred during the
period, after giving consideration to the affect of $57,379,000 in non-cash
expenses, and a decrease in accounts receivable and accounts payable, partially
offset by decreases in prepaid and other assets and accrued expenses.
Net cash provided by investing
activities was $5,457,000 for the year ended December 31, 2001 and is the
result of cash obtained in the disposition of IPS (see Recent Disposition
above) as well as fixed asset acquisitions. well as net cash used in investing
activities was $7,527,000 for the year ended December 31, 2000 and is the
result of fixed asset acquisitions of $3,527,000 as well as cash used to
acquire certain businesses of $4,000,000.
Net cash used by financing activities was $132,000 for the year ended
December 31, 2001 and reflects the return and repurchase of stock , options and
warrants, and reflects net proceeds of the issuance debt and the repayment of
debt. Net cash provided by financing
activities was $21,042,700 for the year ended December 31, 2000 and reflects
primarily the proceeds from issuance of common stock of $12,947,000 and debt of
$8,493,700.
In February 2000, we sold 2,260,000
unregistered shares of our common stock to a group of private equity investors
for $11.3 million ($5.00 per share). The transaction resulted in certain
shareholder rights being granted to the investors including a right to request
registration of the shares at our expense.
In August 2000, the investor group exercised its right to request
registration of the shares. In
connection with the transaction, we paid a commission to Aspen Finance
Corporation that facilitated the execution of the transaction that consisted of
a cash payment of $395,000 and the issuance of 22,000 shares of our common
stock.
In March 2001, we negotiated new
terms for $1,933,000 of other notes payable, which extended repayment terms
into 2002.
In July 2000, we completed a
$5,000,000 convertible debt offering (“July Convertible Notes”) with Edgewater Private
Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. The July Convertible Notes bear annual
interest at 9.5%. Principal and
interest was originally due on December 31, 2000. On July 20, 2001, we reached an agreement related to the July
Convertible Notes, under which the maturity date was extended to August 1,
2002. Originally the conversion terms
were to be renegotiated by August 15, 2001; otherwise, a penalty of $500,000
would have been assessed and payable in February 2002. On April 16, 2002, with a closing date of
April 15, 2002, we completed these renegotiations. Under the new terms, subject to stockholder
approval, the principal and accrued interest ($685,000 at December 31, 2001) underlying
the July Convertible Notes are required to be exchanged into Series A
Convertible Preferred Stock (“Series A Preferred Stock”) with a stated par
value of approximately $5.8 million dollars.
These new terms also include a waiver of the $500,000 penalty.
The Series A Convertible Preferred
Stock has the following terms: a conversion rate equal to one share of common
stock for each $.75 of stated value or a liquidation preference such that in
the event we liquidate, dissolve or wind-up, the holders thereof shall be
entitled to receive, at their option, either (a) in preference to the holders
of the common stock and on a pro-rated pari passu basis with the Series B
Preferred Stock (see New Convertible Notes above) an amount equal to 2.75 times
the stated value, or (b) a ratable share of the distribution of assets and
property with the holders of the common stock, participating on an as converted
basis, if a liquidation event occurs within 24 months. If, however, a liquidation event occurs
after 24 months, the preference multiple becomes 3 times the stated value. A merger, acquisition or sale of all or
substantially all of our assets in which our shareholders do not own a majority
of the outstanding shares of the surviving corporation shall be deemed to be a
liquidation.
In September 2000, we
sold 2,000,000 shares of unregistered common stock to certain private equity
investors, as well as existing stockholders, for $2 million. The stock purchase agreement provides for
two additional board members to be appointed by the investors. Such appointments were made in September and
October 2000. The purchase agreement
also requires us to immediately register the shares of common stock that were
issued. The investors had agreed to a
six-month lock-up period that prevents them from selling the shares of common
stock acquired in this transaction during the lock-up period. In connection with the recent financing discussed
above, these stockholders agreed to the termination of their right to require
us to immediately register these shares.
In November 2000, our Chairman and principal
stockholder loaned $900,000 to us in the form of convertible notes (the
“November Notes”). The November Notes
bore annual interest at the rate of 8%, were convertible at the lenders’ option
at $.50 per share and was scheduled to mature on December 31, 2001. The lender had the option to demand
repayment of the November Notes within 30 days after the IPS sale; however, the
lender made no such demand. In
August 2001, we renegotiated the terms of the November Notes (the “Amended
November Notes”) that extended the maturity date to December 1, 2002 and
increased the conversion feature to $1.00 per share, convertible at the lender’s
option. Furthermore, if the Amended
November Notes were not paid at the new maturity date, the lender, at his sole
discretion, could have converted the notes at $0.50 per share, demanded payment
or further extended the maturity date until December 1, 2003. Finally, if the Amended November Notes were
not paid at the new extended maturity date, the lender, at his sole discretion,
could have converted the notes at $0.25 per share, demanded payment or further
extended the maturity date until December 1, 2004. In exchange for the extension, we agreed to
commence interest only payments to the lender based upon the principal and
accrued interest as of September 1, 2001.
On April 16, 2002, with a closing date of April 15, 2002, in
conjunction with the financing discussed in the New Convertible Notes above, we
renegotiated the terms such that the Amended November Notes still bears an
annual interest at the rate of 8%, is convertible at the lenders’ option into
our common stock at $.25 per share and matures on December 31, 2004.
In connection with the original issuance of the
November Notes in November 2000, the lender was issued five-year warrants
to purchase an aggregate of 2,000,000 shares of our common stock at $.01 per
share. We recorded debt discount of $900,000
in connection with the issuance of the warrants, which resulted in an initial
net carrying value of zero for the November Notes. This discount was being amortized into interest expense over the
life of the November Notes. In
connection with the renegotiation of the November Notes in 2001, the
shareholder forfeited his rights to the 2,000,000 warrants to purchase common
stock. Upon forfeiture of these
warrants the debt was brought to its full value of $900,000 with the remaining
unamortized portion of the debt discount of $225,000 being offset to additional
paid in capital. Debt discount
amortization totaling $600,000 and $75,000 was recorded as interest expense
related to these warrants in 2001 and 2000, respectively.
In December 2000, we issued $1,500,000 in convertible notes to two of
our stockholders (the “December Notes’), both of which formerly served on the
Company’s Board of Directors. The
December Notes are convertible at the lenders’ option at $.50 per share. The December Notes bear interest at 8% per
annum and originally matured on December 31, 2001. In connection with the December Notes, the
lenders were issued five-year warrants to purchase an aggregate of 3,000,000
shares of our common stock at $.01 per share.
We recorded debt discount of $1,500,000 in connection with the issuance
of the warrants, which resulted in a net carrying value of zero for the
December Notes. This discount was to be
amortized into interest expense over the original life of the December
Notes. This debt discount is fully
amortized as of December 31, 2001 and amortization of $1,300,000 and $200,000
was recorded as interest expense in 2001 and 2000, respectively. Of these December Notes, the holders of
$1,000,000 agreed in December 2001 to extend the maturity date to January 31,
2003. On April 16, 2002, the Company renegotiated this portion
of the December Notes so that it will convert into Series A Preferred Stock
upon receipt of the requisite shareholder approvals (see above). The holder of the remaining $500,000 had
demanded payment and, on April 12, 2002, we completed the renegotiations on
this remaining portion of the December Notes.
Under the new terms, we are to pay the note holder $300,000 in April
2002 and the remaining balance of $200,000 plus any accrued and unpaid interest
is to be paid on or before January 31, 2003.
Our contractual cash obligations at December 31, 2001,
are as follows:
(1) As more
fully described above and in the notes to the audited financial statements
contained in this Form 10-K, the maturity of these obligations will not require
all cash. Convertible notes payable are
classified as current or long-term based on the contractual maturities as
amended on April 16, 2002. Subject to
stockholder approval, $7,050,000 of the convertible notes are required to be
converted to Series A and B convertible preferred stock and $1,458,000 may
require cash payments over the next 3 years if not converted into common stock
at the note holders option.
At December 31, 2001, we had a working capital deficit of $8,513,000.
We believe that the expected cash flows from operations in 2002 and the
additional funds to be provided by our existing stockholders and investors,
including, most recently, the Commitment, will be sufficient to allow
management to continue to execute on our current operating plan. However, based
on our current forecasts, we believe that we may need to obtain additional
capital in early 2003. In addition, if our operating cash flows are inadequate
or if we are unable to raise sufficient financing through the Commitment or otherwise,
we may not be able to continue successfully funding our operations. We believe
that our success in obtaining the necessary financing will depend upon, among
other factors, successfully executing on our current operating plan. If we fail
to execute on our current operating plan or a Material Adverse Change occurs as
described under the Commitment, we may not be able to obtain any additional
funds from Edgewater under the Commitment. In that event, we may need to raise
additional funding from other sources prior to 2003. Sources of additional
financing may include bank debt or the public or private sale of equity or debt
securities. However, there can be no assurance that we will be successful in
arranging such additional financing at all or on terms commercially acceptable
to us.
In view of the execution of this current funding, our cost reduction
strategy, renegotiations of debt terms and subsequent financings discussed
above, management believes that the Company will continue as a going concern
through the remainder of 2002. There
can be no assurance that these events will provide the necessary working
capital to fulfill the Company’s needs; therefore, additional reductions or
additional sources of funds may be necessary in early 2003.
RISK FACTORS
The following important factors
could cause actual results to differ materially from those contained in
forward-looking statements made in this Annual Report on Form 10-K or presented
elsewhere by management from time to time.
Our clients may cancel or delay spending on business and technology
initiatives because of the current economic climate.
Since the second half of 2000, many
companies have experienced financial difficulties or uncertainty, and have
cancelled or delayed spending on business and technology consulting
initiatives. Additionally, the severe
financial difficulties that many start-up Internet companies have experienced
have reduced or eliminated competition and have further reduced the perceived urgency
by larger companies to begin or continue technology initiatives. Since some of our revenues are derived from
large companies, if large companies continue to cancel or delay their business
and technology consulting initiatives because of the current economic climate,
or for other reasons, our business, financial condition and results of
operations could be materially adversely affected.
Our revenues and operating results
are volatile and difficult to forecast, which may cause the market price of our
common stock to decline.
Our
revenues and operating results are subject to significant variation from
quarter to quarter due to a number of factors, including:
• the number, size and scope of projects in which we
are engaged;
• demand for our services generated by strategic
relationships and certain prime contractors;
• economic conditions in the
vertical and geographic markets we serve;
• our employee utilization
rates and the number of billable days in a particular
quarter;
• the contractual terms and
degree of completion of projects;
• any delays or costs
incurred in connection with project; or early
termination of, a project;
• the accuracy of estimates
of resources required to complete ongoing projects;
• our ability to staff projects
with salaried employees versus hourly employees, hourly
independent contractors and subcontractors;
• start-up costs including software license fees incurred in connection with the initiation of
large projects;
• the adequacy of provisions for losses.
The timing and realization of opportunities in our sales
pipeline make the timing and variability of revenues difficult to
forecast. Because of the variability of
our quarterly operating results, we believe that period-to-period comparisons
of our operating results are not necessarily meaningful, should not be relied
upon as indications of future performance and may result in volatility and
declines in the price of our common stock.
In addition, our operating results may from time to time be below the
expectations of analysts and investors.
If so, the market price of our common stock may decline significantly.
We depend on
government agencies for a majority of our revenues and the loss or decline of
existing or future government agency funding would adversely affect our
revenues and cash flows.
For the
fiscal year ended December 31, 2001, approximately 53% of our revenues
were derived from services provided to government agencies. These government agencies may be subject to
budget cuts, budgetary constraints, a reduction or discontinuation of funding
or changes in the political or regulatory environment that may cause government
agencies to divert funds. A significant
reduction in funds available for government agencies to purchase professional
services would significantly reduce our revenues and cash
flows. In addition, the loss of a major
government client, or any significant reduction or delay in orders by that
client, would also significantly reduce our revenues and cash flows.
Businesses may decrease or delay their use of advanced technologies as
a means for conducting commerce.
Our future success depends heavily
on the increased acceptance and use of advanced technologies as a means for
conducting commerce and streamlining operations. We focus our services on the
development and implementation of advanced technology strategies and solutions.
If use of these advanced technologies does not continue to grow, or grows more
slowly than expected, our revenue growth could slow or decline and our business,
financial condition and results of operations could be materially adversely
affected. Consumers and businesses may delay adoption of advanced technologies
for a number of reasons, including:
• inability to
implement and sustain profitable business models using advanced technologies;
• inadequate
network infrastructure or bandwidth;
• delays in the
development or adoption of new technical standards and protocols required to
handle increased levels of usage;
• delays in the
development of security and authentication technology necessary to effect
secure transmission of confidential information; and
• failure of
companies to meet their clients’ expectations in delivering goods and services
using advanced technologies.
If our marketing relationships with software vendors deteriorate, we
would lose their potential client referrals.
We currently have marketing
relationships with software vendors, including PeopleSoft, iPlanet, Siebel, and
Sun Microsystems. We estimate that we
derive nearly all of our revenues directly or indirectly from these
relationships. Although we have
historically received a number of business leads from these software vendors to
implement their products, they are not required to refer business to us, may
cease referring business to us and may further terminate these relationships at
any time. If our relationships with these software vendors deteriorate, we may
lose their client leads and our ability to develop new clients could be
negatively impacted. Any decrease in our ability to obtain new clients may
cause a reduction in our revenue growth.
We may report an operating loss in 2002 and may not achieve or sustain
future profitability.
Although
our core business is providing information technology services, our business
strategy continues to evolve. We have
reported an operating loss in each of the previous three fiscal years, and
expect to report a loss for the first quarter of 2002. Furthermore, our revenues have generally
been decreasing since the third quarter of fiscal 2000, and this trend is
expected to continue into at least the first portion of 2002. It is possible that we will continue to
incur losses, and that our revenues will continue to decline, for the remainder
of 2002. During the course of 2001, we
fundamentally restructured our business by consolidating office space, reducing
our workforce and reshaping our service offerings. To the extent that our restructuring plan does not generate the
cost savings or revenues that we anticipate, our results of operations and
liquidity could be materially and adversely affected. If we are unable to increase our revenues, or if our operating
expenses exceed our expectations, we may continue to incur losses and may not
achieve profitability. If we achieve
profitability in the future, we may not sustain it.
Our business is dependent on our ability to keep pace with the latest
technological changes.
Our market and the enabling
technologies used by our clients are characterized by rapid technological
change. Failure to respond successfully
to these technological developments, or to respond in a timely or
cost-effective way, will result in serious harm to our business and operating
results. We expect to derive a substantial
portion of our revenues from creating e-business systems that are based upon
today’s leading technologies and that are capable of adapting to future
technologies. As a result, our success
will depend, in part, on our ability to offer services that keep pace with
continuing changes in technology, evolving industry standards and changing
client preferences as well as being first to market new services in this
market. There can be no assurance that
we will be successful in addressing these developments on a timely basis or
that if addressed we will be successful in the marketplace. Our failure to address these developments
could have a material adverse effect on our business, financial condition and
results of operations.
If we do not attract and retain qualified
professional staff, we may not be able to adequately perform our client
engagements and could be limited in accepting new client engagements.
Our business is labor intensive and
our success will depend upon our ability to attract, retain, train and motivate
highly skilled employees. Although many
specialized e-business and other business and technology companies have reduced
their workforces or slowed their hiring efforts, and we reduced our workforce
in October 2000 and March 2001, intense competition still exists for certain
employees who have specialized skills or significant experience in business and
technology consulting. We may not be
successful in attracting a sufficient number of these highly skilled employees
in the future. Additionally, the
industry attrition rates for these types of employees are high, and we may not
be successful in retaining, training and motivating the employees we are able
to attract. Any inability to attract,
retain, train and motivate employees could impair our ability to adequately
manage and complete existing projects and to bid for or accept new client
engagements.
The trading price of our stock has been,
and is expected to be, highly volatile.
The price of our common stock is subject
to significant fluctuation.
In addition, the trading price of
our common stock could be subject to wide fluctuations in response to:
• general
economic or stock market conditions unrelated to our operating performance;
• quarterly
variations in operating results;
• changes in
earnings estimates by analysts;
• any differences
between reported results and analysts’ published or unpublished expectations;
• announcements
of new contracts or service offerings by us or our competitors; and
• other events or
factors.
We depend heavily on our principal clients.
We have derived, and believe that
we will continue to derive, a significant portion of our revenues from a
limited number of large clients. In
2001, our two largest clients, the Texas Department of Health and Northrup
Grumman, accounted for approximately 61% of our revenues. The
volume of work performed for specific clients is likely to vary from year to
year, and a major client in one year may not use our services in a subsequent
year. In addition, revenues from a
large client may constitute a significant portion of our total revenues in a
particular quarter. Most of our
contracts are terminable by the client following limited notice and without
significant penalty to the client. The
loss of any large client could have a material adverse effect on our business,
financial condition and results of operations.
We have significant fixed operating costs
and our operating results are subject to fluctuation.
A high percentage of our operating
expenses, approximately 40%, particularly personnel and rent, are fixed in
advance of any particular quarter. As a
result, unanticipated variations in the number, or progress toward completion,
of our projects or in employee utilization rates may cause significant
variations in operating results in any particular quarter and could result in
losses for such quarter.
An unanticipated termination of a
major project, a client’s decision not to proceed to the subsequent stage of a
project, or the completion during a quarter of several major client projects
could require us to maintain underutilized employees and could therefore have a
material adverse effect on our business, financial condition and results of
operations. Our revenues and earnings
may also fluctuate from quarter to quarter based on such factors as the
contractual terms and degree of completion of such projects, any delays
incurred in connection with projects, the accuracy of estimates of resources
required to complete ongoing projects, and general economic conditions.
We sometimes enter into fixed-price
contracts.
Some of our projects are based on
fixed-price, fixed-timeframe contracts, rather than contracts in which payment
to us is determined on a time and materials basis. For the fiscal year ended December 31, 2001, 3% of our projects
were fixed-price, fixed time frame contracts.
Our failure to accurately estimate the resources required for a project
or our failure to complete our contractual obligations in a manner consistent
with the project plan upon which our fixed-price, fixed-timeframe contract was
based would adversely affect our overall profitability and could have a
material adverse effect on our business, financial condition and results of
operations. We have at times been
required to commit unanticipated additional resources to complete certain
projects, which has resulted in losses on certain contracts. We recognize that we may experience similar
situations in the future. In addition,
for certain projects we may fix the price before the design specifications are
finalized, which could result in a fixed price that turns out to be less than
our expenses on the project and therefore adversely affects our profitability.
We face significant competition in markets
that are new, intensely competitive and rapidly changing.
The markets for the services we provide are highly
competitive. We believe that we
currently compete principally with large accounting firms, strategy consulting
firms, Internet and e-business professional services providers, software
integration firms, application software vendors, and internal information
systems groups. Some of our competitors
are Accenture Ltd., Braun Consulting, Inc., CACI International, Inc., Maximus,
Inc., Lante Corporation, and KPMG, Consulting,Inc. Many of the companies that provide such services have
significantly greater financial, technical and marketing resources than we do
and generate greater revenues and have greater name recognition than we do.
These firms may attempt to gain a competitive advantage by offering large
pricing concessions. In addition, there
are relatively low barriers to entry into our markets and we have faced, and
expect to continue to face, additional competition from new entrants into our
markets. We believe that the principal
competitive factors in our markets include:
• Internet expertise and
talent;
• quality of service, price
and speed of delivery;
• ability to integrate
strategy, technology and creative design services;
• vertical industry knowledge;
and
• project management
capability.
We
believe that our ability to compete also depends in part on a number of
competitive factors outside our control, including:
• the ability of our
competitors to hire, retain and motivate their senior staff;
• the development by others of
Internet solutions or software that is competitive with our products and
services; and
• the extent of our
competitors’ responsiveness to client needs.
There
can be no assurance that we will be able to compete successfully with our
competitors.
Increasing government regulation could
affect our business.
We are subject not only to
regulations applicable to businesses generally, but also laws and regulations
directly applicable to electronic commerce.
Although there are currently few such laws and regulations, state,
federal and foreign governments may adopt a number of these laws and
regulations. Any such legislation or
regulation could dampen the growth of the Internet and decrease our acceptance
as a communications and commercial medium.
If such a decline occurs, companies may decide in the future not to use
our services to create an electronic business channel. This decrease in the demand for our services
would seriously harm our business and operating results.
Our business could be adversely affected if
we are unable to protect our proprietary technology.
Our success depends, in part, upon
our proprietary methodologies and other intellectual property rights. We rely upon a combination of trade secret,
nondisclosure and other contractual arrangements to protect our proprietary
rights. We enter into confidentiality
agreements with our employees; generally require that our consultants and clients
enter into such agreements, and limit access to and distribution of our
proprietary information. We currently
do not have any trademark or copyright protection on any of our intellectual
property. There can be no assurance
that the steps taken by us in this regard will be adequate to deter
misappropriation of our proprietary information or that we will be able to
detect unauthorized use and take appropriate steps to enforce our intellectual
property rights. In addition, although
we believe that our services and products do not infringe on the intellectual
property rights of others, there can be no
assurance
that such a claim will not be asserted against us in the future, or that if
asserted any such claim will be successfully defended. A successful claim against us could have
material adverse affect on our business, financial condition and results of
operations.
We may not have the right to resell or
reuse applications developed for specific clients.
A portion of our business involves
the development of Internet and software applications for specific client
engagements. Ownership of such software
is the subject of negotiation and is frequently assigned to the client,
although we may retain a license for certain uses. Issues relating to the ownership of and rights to use software
applications can be complicated and there can be no assurances that disputes
will not arise that affect our ability to resell or reuse such
applications. Any limitation on our
ability to resell or reuse an application could require us to incur additional
expenses to develop new applications for future projects.
We are dependent on a number of key
personnel.
Our success will depend in large
part upon the continued services of a number of key employees, including our
CEO, key consultants and practice leaders.
The loss of the services of any of these individuals or of one or more
of our other key personnel could have a material adverse effect on us. In addition, if one or more of our key
employees resigns to join a competitor or to form a competing company, the loss
of such personnel and any resulting loss of existing or potential clients to
any such competitor could have a material adverse effect on our business, financial
condition and results of operations. In
the event of the loss of any such personnel, there can be no assurance that we
would be able to prevent the unauthorized disclosure or use of our technical
knowledge, practices or procedures by such personnel.
Our business will
suffer if we are unable to attract, successfully integrate and retain qualified
personnel and key employees.
A critical component of our
business is the level of experience and technical proficiency of our
employees. If we are unable to attract,
retain, train, manage and motivate skilled employees, particularly project
managers and other senior technical personnel, our ability to adequately
manage and staff our existing projects and to bid for or obtain new
projects could be impaired, which would adversely affect our business and its
growth. The failure of our employees to
achieve expected levels of performance could adversely affect our
business. There is significant
competition for employees with the skills required to perform the services we
offer. In particular, qualified project
managers and senior technical and professional staff are in
great demand worldwide. In addition, we
require that many of our employees travel to client sites to perform services
on our behalf, which may make a position with us less attractive to
potential employees.
We may need to raise additional capital,
which may not be available.
On April 16, 2002, the terms were
finalized on an initial funding under the Purchase Agreement (see Liquidity and Capital Resources). The total
amount to be received under the Purchase Agreement is a minimum of $2,650,000,
$1,910,000 of which we received in December 2001, and February and March 2002
as described above. Under the terms of the Purchase Agreement, the investors
can invest up to an additional $1,850,000 for a maximum investment under the
Purchase Agreement of $4,500,000 at their discretion. We have also received a
commitment from one of our current shareholders, Edgewater, pursuant to the
Commitment to fund up to an additional $1,360,000 during the rest of 2002
subject to certain conditions. Management expects that our current available
funds, funds provided from current operations and the additional amounts to be
funded by Edgewater will be sufficient to satisfy our cash requirements through the end of 2002.
However, based on our current forecasts, we believe that we may need to obtain
additional capital in early 2003. If our operating cash flows are inadequate or
if we are unable to raise sufficient financing though the Commitment or
otherwise, we may not be able to continue successfully funding our operations.
We believe that our success in obtaining the necessary financing will depend
upon, among other factors, successfully executing on our current operating
plan. If we fail to execute on our current operating plan or a Material Adverse
Change occurs as described under the Commitment, we may not be able to obtain
any additional funds from Edgewater under the Commitment. In that event, we may
need to raise additional funding from other sources prior to 2003. Sources of
additional financing may include bank debt or the public or private sale of
equity or debt securities. However, there can be no assurance that we will be
successful in arranging such additional financing at all or on terms
commercially acceptable to us. In addition, the issuance of debt may require us
to agree to restrictive covenants that could hamper our business and
operations. These uncertainties could have a material adverse affect on us.
Our failure to
deliver error-free products and services could result in reduced payments,
significant financial liability or additional costs to us, as well as negative
publicity.
Many of our engagements involve
projects that are critical to the operations of our clients’ businesses and
provide benefits that may be difficult to quantify. The failure by us to meet a client’s expectations in the performance of the
engagement could damage our reputation and adversely affect our ability to
attract new business. We have
undertaken, and may in the future undertake, projects in which we guarantee
performance based upon defined operating
specifications
or guaranteed delivery dates. Unsatisfactory
performance or unanticipated difficulties or delays in completing such projects
may result in client dissatisfaction and a reduction in payment to us, payment of
penalties or damages by us as a result of litigation or otherwise. In addition, unanticipated
delays could necessitate the use of more resources than we initially budgeted
for a particular project, which could increase our costs for that project.
We could become
subject to lawsuits that could result in material liabilities to us or cause us to incur material costs.
We
have several lawsuits pending against us, one of which alleges damages in the
amount of approximately $2,700,000. We
believe we have good and meritorious defenses against these claims and plan to
defend ourselves vigorously. While the outcome of this litigation cannot be
predicted with certainty, we believe that it will not have a material adverse
effect on our financial statements. However, an unfavorable outcome of this
litigation could have a material adverse effect. In addition, any failure in a client’s system could result in a claim against us for
substantial damages, regardless of our responsibility for such failure. We cannot guarantee that the limitations of
liability set forth in our service contracts will be enforceable or will otherwise
protect us from liability for damages.
Our general liability insurance coverage, which includes coverage for
errors or omissions, may not continue to be available on reasonable terms or in
sufficient amounts to cover one or more claims, and the insurer may disclaim
coverage as to any future claim. The
successful assertion of one or more claims against us that exceed available
insurance coverage or changes in insurance policies, including premium
increases or the imposition of large deductible or co-insurance requirements,
would adversely affect our business.
Our common stock may be delisted from The
American Stock Exchange. If it is delisted, the market price of the common
stock could decline potentially to zero and you could lose your investment.
As a result of our delay in filing Form 10-KSB for 2000
and the first and second quarter 10-Q of 2001, AMEX suspended the trading of
our stock on the AMEX. Upon review of
these items they reinstated trading in our stock. Currently, however we are not in compliance with several AMEX
rules, including the requirement that we have three independent Board Members
on our Audit Committee and the requirement that we file and have approved any
additional issuance of shares of Common Stock prior to any issuance of such
stock.
AMEX may decide to delist our common stock based on our
non-compliance with AMEX rules or upon our financial condition. Although we
intend to take steps to maintain our listing, we can give no assurances that
our securities will not be delisted from trading by AMEX. If we lose our AMEX listing status, our
common stock would most likely trade in the over-the-counter market, which is
viewed by most investors as a less desirable and less liquid marketplace. In
that event, trading in shares of our common stock would likely decrease
substantially or cease altogether, and the market price of the common stock
would likely decline further, potentially to zero.
We could suffer
material losses if our systems or operations fail or are disrupted.
Any
system failure, including network, software or hardware failure, whether caused
by us, a third party service provider, unauthorized intruders and hackers, computer viruses,
natural disasters, power shortage or terrorist attacks, could cause
interruptions or delays in our business or loss of data. In addition, if our mail, communications or
utilities are disrupted or fail, our operations, including our transaction
processing, could be suspended or interrupted and our business could be
harmed. Our property insurance and
business interruption insurance may not be adequate to compensate us for all
losses that may occur as a result of any system failure or disruption.
Certain shareholders can control matters
requiring shareholder approval because they own a large percentage of our
common stock, and they may vote this common stock in a way with which other
shareholders may not agree.
Certain shareholders Edgewater
Private Equity Fund III and Fleck T.I.M.E. Fund, LP and affiliates of Fleck own
approximately 36% and 15%, respectively, of the outstanding shares of our
common stock. As a result, if these
persons act together, they will have the ability to exercise substantial
control over our affairs and corporate actions requiring shareholder approval,
including the election of directors, a sale of substantially all our asserts, a
merger with another entity or an amendment our certificate of
incorporation. The ownership position
of these shareholders could delay, deter or prevent a change in control and
could adversely affect the price that investors might be willing to pay in the
future for shares of our common stock.
Our issuance of
preferred stock could make it difficult for another company to acquire us, which could depress the price of our common
stock.
Our board of directors has the authority and, pursuant
to the Note and Preferred Stock Purchase Agreement, is obligated to issue
preferred stock upon receiving the requisite shareholder approval. The preferred stock, if issued, will be
issued with voting, liquidation, dividend and other rights superior to the
rights of our common stock. The
potential issuance of preferred stock may delay or prevent a change in control
of us, discourage bids for the commons tock at a premium over the market price
and adversely affect the market price and the voting and other rights of the
holders of our common stock.
ITEM 7A.
ITEM 7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our
operations result primarily from changes in interest rates as well as credit
risk concentrations. All of our
contracts are denominated in US$ and, therefore, we have no foreign currency
risk.
Interest Rate Risk
Our
exposure to market risk for changes in interest rates relates primarily in our
convertible debt obligations. These
obligations are currently all fixed rate instruments and therefore our risk is
related to our inability to lower the applicable interest rate in the event
interest rates decrease in the future.
In the event interest rates increase in the future, we may not be able
to secure additional debt obligations or may be required to pay substantially higher
interest rates than we currently pay.
Credit Risks
Our financial instruments that are
exposed to concentrations of credit risk consist primarily of trade
receivables. Concentrations of credit
risk with respect to receivables are a result of a limited number of clients
and their significant percentage of accounts receivable from them. We perform periodic credit evaluations of
our clients’ financial condition and generally do not require collateral. Two clients account for approximately 53%
and 19% of total accounts receivable as of December 31, 2001 and 2000,
respectively. No other related group or
client represents greater than 10% of total accounts receivable.
ITEM 8.
ITEM 8. FINANCIAL
STATEMENTS
The information required by this
item is included in the Financial Statements found within this Annual Report on
Form 10-K beginning on page
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
ITEM
10.
ITEM
10. DIRECTORS AND EXECUTIVE OFFICERS
OF THE REGISTRANT
Information concerning our
directors and executive officers will be set forth in the Proxy Statement to be
provided to shareholders in connection with our 2002 Annual Meeting of
Shareholders (the “Proxy Statement”) under the headings “Election of Directors”
and “Executive Officers,” which information is incorporated herein by
reference. Information concerning
compliance with Section 16 of the Securities Exchange Act of 1934, as amended,
by persons subject to such Section, will be set forth in the Proxy Statement
under the heading “Section 16(a) Beneficial Ownership Reporting Compliance,”
which information is incorporated herein by reference.
ITEM
11.
ITEM
11. EXECUTIVE COMPENSATION
Information concerning executive
compensation will be set forth in the Proxy Statement under the headings
“Executive Officer Compensation” and “Election of Directors,” which information
is incorporated herein by reference. Information contained in the Proxy
Statement under the caption “Organization and Compensation Committee Report on
Executive Compensation,” “Audit Committee Report and Disclosures” and “Stock
Performance Graph” is not incorporated herein by reference.
ITEM
12.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security
ownership of certain beneficial owners and management will be set forth in the
Proxy Statement under the heading “Security Ownership of Certain Beneficial
Owners and Management,” which information is incorporated herein by reference.
ITEM
13.
ITEM
13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS
Information concerning certain
relationships and related transactions will be set forth in the Proxy Statement
under the headings “Organization and Compensation Committee Interlocks and
Insider Participation” and “Certain Relationships and Related Transactions,”
which information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Upon
written request, we will provide, without charge, a copy of our Annual Report
on Form 10-K, including the financial statements and financial statement
schedules for our most recent fiscal year. All requests should be sent to:
EpicEdge,
Inc 5508 Two Ninety West Suite 300 Austin, Texas, 78735 Attention: Sam DiPaola Vice President
Investor Relations
(a) The following documents are filed as
part of this report:
1. Financial
Statements
Independent Auditors' Report
Balance Sheets at December 31, 2001 and 2000 Statements of Operations for
the years ended December 31, 2001, 2000 and 1999
Statements of Stockholders’
Equity for the years ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for
the years ended December 31, 2001, 2000 and 1999
Notes to Financial Statements
2. Financial Statement Schedule
Independent Auditors' Report Schedule II-Valuation and Qualifying Accounts
All other schedules are
omitted because they are either not required, not applicable or the required
information is otherwise included.
3. Exhibits
The following
exhibits are filed as part of, or incorporated by reference into, this Form
10-K.
Exhibit Number
Description
2.1
(1)
Exchange
Agreement, dated December 31, 1998, by and between Loch Exploration, Inc.,
Loch Energy, Inc., Design Automation Systems, Inc. and Carl Rose
2.2
(2)
Agreement
and Plan of Merger, dated March 31, 1999, by and between Loch Exploration,
Inc., the Shareholders of COAD Solutions, Inc. and COAD Solutions, Inc.
2.3
(2)
Purchase
Agreement, dated August 21, 1998, by and between Loch Exploration, Inc.,
KanMap, Inc. and Cherokee Methane Corporation
2.4
(2)
Articles
of Merger of Parent and Subsidiary between Loch Exploration, Inc. and Design
Automation Systems, Inc. filed with the Texas Secretary of State on April 12,
2.5
(6)
Agreement
and Plan of Merger, dated May 1999, by and between Design Automation Systems,
Inc., Dynamic Professional Services, L.L.C. and COAD Solutions, Inc.
2.6
(7)
Agreement
and Plan of Merger, dated July 30, 1999, by and between Design Automation
Systems, Inc., Connected Software Solutions, Inc., COAD Solutions, Inc.,
Roger Barnes and Lance Dunbar
2.7
(10)
Agreement
and Plan of Merger, dated February 29, 2000, by and between Design Automation
Systems, Inc., EACQ, LLC, The Growth Strategy Group, Inc., Peter Davis, Jean
Albert and Michael McCahey
2.8
(13)
Agreement
and Plan of Merger, dated June 6, 2000, by and between the Company, IPS
Associates, Inc., EDG Acquisition Corporation, William Kern, Isabelle Suares,
Peter Heinrich and William Johnson
2.9
(13)
Amendment
to Agreement and Plan of Merger, dated June 30, 2000, by and between the
Company, IPS Associates, Inc., EDG Acquisition Corporation, William Kern, Isabelle
Suares, Peter Heinrich and William Johnson
2.10
(14)
Asset
Purchase Agreement, dated July 19, 2000, by and between the Company, Tumble
Interactive Media, Inc. and Charles C. Vornberger
2.11
(15)
Stock
Purchase Agreement, dated January 1, 2001, by and between the Company, RED
& BLUE, INC. and IPS Associates, Inc. Employee Stock Ownership Plan for
the sale of all the outstanding stock of IPS Associates, Inc.
2.12
(16)
Amendment
to Exchange Agreement, dated January 27, 1999, effective December 31, 1998,
by and between Loch Exploration, Inc., Loch Energy, Inc., Design Automation
Systems, Inc., Carl Rose, Glen Loch, Southport Capital Corporation, Carl R.
Rose, Trustee, Charles Leaver and Kelly Knake
2.13(17)
Purchase
and Sale Agreement, dated October 29, 1999, by and between Design Automation
Systems, Inc., COAD Solutions, Inc. and Net Information Systems, Inc.
3.1
(#)
Articles
of Incorporation filed with the Texas Secretary of State on June 5, 1979
3.2
(#)
Articles
of Amendment to the Articles of Incorporation filed with the Texas Secretary
of State on December 7, 1989
3.3
(#)
Articles
of Amendment to the Articles of Incorporation filed with the Texas Secretary
of State on March 11, 1997
3.4
(4)
Articles
of Amendment to the Articles of Incorporation filed with the Texas Secretary
of State on April 12, 1999
3.5
(18)
Articles
of Amendment to the Articles of Incorporation filed with the Texas Secretary
of State on March 16, 2000
3.6
(20)
Articles
of Amendment to the Articles of Incorporation filed with the Texas Secretary
of State on June 30, 2000
3.7
(#)
Amended
and Restated Bylaws
4.1
(#)
Specimen
Stock Certificate
4.2
(19)
Registration
Agreement, dated February 18, 2000, by and between Design Automation Systems,
Inc., Edgewater Private Equity Fund III, L.P., Aspen Finance Investors I,
LLC, Fleck T.I.M.E. Fund, LP, Fleck Family Partnership II, LP, LJH Partners
LP, Wain Investment, LLC, Gerald C.
Allen, and John Paul DeJoria
4.3
(19)
Shareholders’
Agreement, dated February 18, 2000, by and between Design Automation Systems,
Inc., Carl Rose, Charles Leaver, Kelly Knake, Jeff Sexton, Edgewater Private
Equity Fund III, L.P., Aspen Finance Investors I, LLC, Fleck T.I.M.E. Fund,
LP, Fleck Family Partnership II, LP, LJH Partners LP, Wain Investment,
LLC, Gerald C. Allen, and John Paul
DeJoria
4.4
(11)
Shareholders’
Agreement, dated September 29, 2000, by and between the Company, Carl Rose,
Charles Leaver, Jeff Sexton, Edgewater Private Equity Fund III, L.P., Aspen
Finance Investors I, LLC, Fleck T.I.M.E. Fund, LP and Fleck Family
Partnership II, LP
4.5
(11)
Registration
Agreement, dated September 29, 2000, by and between the Company, Edgewater
Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, LP
4.6
(#)
Warrant
Certificate issued by Design Automation Systems, Inc. to Aspen Finance Group
on February 18, 2000
4.7
(#)
Form
of Warrant issued by Design Automation Systems, Inc. to Robert Maddocks for
25,000 shares of our Common Stock and to Robert Heller for 15,000 shares of
our Common Stock on March 20, 2000
4.8
(#)
Warrant
to Purchase Common Stock issued by the Company to Reliant Energy, Inc. on
April 30, 2000
4.9
(#)
Warrant
issued by the Company to Nicholas L. Reding on May 25, 2000
4.10
(#)
Form
of Warrant issued by the Company to Fleck T.I.M.E. Fund, LP for 2,000,000
shares of our Common Stock and to Bahram Nour-Omid for 1,000,000 shares of
our Common Stock
4.11(#)
Form
of Warrant issued by the Company to each of Carl Rose and Eric Loeffel, each
for 30,000 shares of our Common Stock, on July 31, 2001
4.12
(#)
Warrant
Agreement issued by the Company to Brewer & Pritchard, P.C. on May 15,
4.13
(#)
Form
of Convertible Note issued by the Company to Carl Rose on November 1, 2000
for a principal
amount
of $500,000 and on November 7, 2000 for a principal amount of $400,000
4.14
(#)
Form
of Amendments to Convertible Notes, dated August 31, 2001, by and between the
Company and Carl Rose, amending the notes issued by the Company to Carl Rose
on November 1, 2000 for a principal amount of $500,000 and on November 7,
2000 for a principal amount of $400,000
4.15
(#)
Form
of Convertible Note issued by the Company on December 1, 2000 to Bahram
Nour-Omid for a principal amount of $500,000 and to Fleck T.I.M.E. Fund, LP
for a principal amount of $1,000,000
4.16
(#)
June
21, 2001 Letter Agreement by and between the Company, John Paul DeJoria and
Patrick Loche, as amended on February 7, 2002
4.17
(#)
Secured
Promissory Note, dated February 19, 2002, issued by the Company to Edgewater
Private Equity Fund III, L.P.
4.18
(#)
Subordination
Agreement, dated February 19, 2002, by and between Edgewater Private Equity
Fund III, L.P. and MRA Systems, Inc., d/b/a GE Access
4.19
(#)
Security
Agreement, dated February 19, 2002, by and between the Company and Edgewater
Private Equity Fund III, L.P.
4.20
(#)
Trademark
and License Security Agreement, dated February 19, 2002, by and between
the Company and Edgewater Private Equity Fund III, L.P.
4.21
(#)
Substitute
Secured Promissory Note, dated March 5, 2002, issued by the Company to
Edgewater Private Equity Fund III, L.P.
4.22
(#)
First
Amendment to Security Agreement, dated March 5, 2002, by and between the
Company and Edgewater Private Equity Fund III, L.P.
4.23
(#)
First
Amendment to Trademark and License Security Agreement, dated March 5, 2002,
by and between the Company and Edgewater Private Equity Fund III, L.P.
4.24
(#)
Amendment
No. 1 to Shareholders’ Agreement, dated June 21, 2000, by and between the
Company, Carl Rose, Charles Leaver, Jeff Sexton, Kelly Knake, Edgewater
Private Equity Fund III, L.P., Aspen Finance Investors I, LLC, Fleck T.I.M.E.
Fund LP, Fleck Family Partnership II, LP, LJH Partners LP, Wain Investment,
LLC, Gerald C. Allen, and John Paul DeJoria.
4.25
(#)
Form
of Convertible Promissory Note issued by the Company to Edgewater Private
Equity Fund III, L.P. for a principal sum of $3,750,000 and to Fleck T.I.M.E.
Fund, LP for a principal sum of $1,250,000 on July 21, 2000
4.26
(#)
Form
of Amendment to Convertible Promissory Note, dated July 20, 2001, by and
between each of Edgewater Private Equity Fund III and Fleck T.I.M.E. Fund, LP
4.27
(#)
Note
and Preferred Stock Purchase Agreement, dated April , 2002, by and between
the Company, Edgewater Private Equity Fund III, L.P., Fleck T.I.M.E. Fund,
LP, John Paul DeJoria and Patrick
Loche
4.28
(#)
Form
of Substitute Secured Convertible Promissory Note, dated April , 2002, issued by the Company to Edgewater
Private Equity Fund III, L.P. for a principal amount of $1,600,000, to John
Paul DeJoria for a principal amount of $400,000, to Patrick Loche for a
principal amount of $250,000 and to Fleck T.I.M.E. Fund, LP for a principal
amount of $400,000
4.29
(#)
Security
Agreement, dated April , 2002, by
and between the Company and Edgewater Private Equity Fund III, L.P., on
behalf of itself and certain other lenders
4.30
(#)
Subordination
Agreement, dated April , 2002, by
and between Edgewater Private Equity Fund III, L.P. and MRA Systems, Inc.,
d/b/a GE Access
4.31
(#)
Trademark
and License Security Agreement, dated April , 2002, by and between the Company and Edgewater Private
Equity Fund III, L.P., on behalf of itself and certain other lenders
4.32
(#)
Amendment
to Registration Agreement, dated April
, 2002, by and between the Company, Edgewater Private Equity Fund III,
L.P. and Fleck T.I.M.E. Fund, LP
4.33
(#)
Waiver
Letter, dated April , 2002, by and
between the Company, Edgewater Private Equity Fund III, L.P., Fleck T.I.M.E.
Fund, LP and certain other parties
4.34
(#)
Termination
Agreement, dated April , 2002, by
and between the Company, Carl Rose, Charles Leaver, Jeff Sexton, Edgewater
Private Equity Fund III, L.P., Aspen Finance Investors I, LLC, Fleck T.I.M.E.
Fund, LP, Fleck Family Partnership II, LP
4.35
(#)
Transaction
Agreement, dated April , 2002, by
and between the Company and Carl Rose
4.36
(#)
Transaction
Agreement, dated April , 2002, by
and between the Company and John Paul DeJoria
4.37
(#)
Transaction
Agreement, dated April , 2002, by
and between the Company and Patrick Loche
4.38
(#)
Transaction
Agreement, dated April , 2002, by
and between the Company and Fleck T.I.M.E. Fund, LP
4.39
(#)
Amendment
to Promissory Note, dated April ,
2002, by and between the Company and Carl Rose
4.40
(#)
Voting
Agreement, dated April , 2002, by
and between Carl Rose, Jenta Rose, Charles Leaver, Kelly Knake, Gerald Allen,
John Paul DeJoria, Edgewater Private Equity Fund III, L.P., and Fleck
T.I.M.E. Fund, LP
10.1
(4)
Stock Option Plan
10.2
(2)
Employment
Agreement, dated December 31, 1998, by and between Design Automation Systems,
Inc. and Carl Rose
10.3
(2)
Employment
Agreement, dated December 31, 1998, by and between Design Automation Systems,
Inc. and Charles Leaver
10.4
(5)
Employment
Agreement, dated December 31, 1998, by and between Design Automation Systems,
Inc. and Kelly Knake
10.5
(2)
Lease
Agreement, dated August 29, 1995, by and between MXM Mortgage L.P. d/b/a MPC
Mortgage L.P. and Design Automation Systems, Inc.
10.6
(2)
HP
Indirect Reseller Application, dated September 4, 1998, by and between Design
Automation Systems, Inc., Hewlett-Packard Company and Hall-Mark Computer
Products
10.7
(2)
HP
Distributor Authorized Reseller DAR Application Short Form, dated November
21, 1997, by and between Design Automation Systems, Inc., Hewlett-Packard
Company and Client Systems, Inc.
10.8
(2)
Indirect
Value Added Reseller Agreement, dated July 10, 1992, by and between Design
Automation Systems, Inc. and Sun Microsystems Computer Corporation
10.9
(2)
IBM
Business Partner Agreement for Solution Providers, dated October 6, 1998
10.10
(8)
Line of Credit with FINOVA Capital Corporation
10.11
(2)
Line
of Credit with FINOVA Capital Corporation, dated July 25, 1996
10.12
(9)
Agreement
for Services, dated October 5, 1999, by and between Design Automation
Systems, Inc. and Optimization Group, LLC
10.13
(12)
Microsystem
Products Purchase Agreement, dated February 29, 2000, by and between the
Company and MRA Systems, Inc., d/b/a GE Access
10.14
(12)
Sun
Channel Agreement Master Terms, dated February 1, 2000, by and between the
Company and Sun Microsystems, Inc.
10.15(12)
Lease,
dated December 7, 1998, by and between Ferrari Partners, L.P. and Connected
Software Solutions, LLC for office space in Franklin, Tennessee
10.16
(12)
Sun
Trademark and Logo Policies, dated August 1997
10.17
(12)
HP
Authorized Reseller Agreement
10.18
(12)
IBM
Business Partner/Solutions Provider Agreement
10.19
(12)
HP
Agreement for Authorized Solutions Direct Resellers
10.20
(12)
Lease
Agreement for Office Space, dated March 8, 2000, by and between John McArdle, Jr. and the Company for office
space in Austin
10.21
(12)
Texas
Association of Realtors Commercial Lease, dated January 1, 1999, by and
between COAD Solutions, Inc. and CONTI Building Ltd. for office space in
Lakeway, Texas
10.22
(12)
Assignment
and Assumption of Lessee’s Interest and Lessor’s Consent, dated December 9,
1999, by and between Bay West Design Center, LLC and the Company for office
space in Seattle
10.23
(12)
Standard
Office Lease for COAD Solutions, Inc., dated January 8, 1999, by and between
Clayton Investors Associates LLC and COAD Solutions, Inc. for office space in
St. Louis
10.24
(12)
Line
of Credit with FINOVA Capital Corporation, dated December 29, 1999
10.25
(14)
Convertible
Bridge Loan Agreement, dated July 21, 2000, by and between the Company,
Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, LP
10.26
(14)
Employment
Agreement, dated April 1, 1999, by and between COAD Solutions, Inc. and Jeff
Sexton
10.27
(14)
Common
Stock Warrant Purchase Agreement, dated December 29, 1999, by and between the
Company and FINOVA Capital Corporation
10.28
(15)
Form
of Convertible Note
10.29
(14)
Common
Stock Purchase Warrant issued by the Company to FINOVA Capital Corporation on
December 29, 1999
10.30
(15)
Form
of Warrant
10.31
(21)
Termination
of Employment Agreement, dated September 29, 2000, by and between the Company
and Charles Leaver
10.32
(2)
First
Amendment of Lease, dated June 16, 1998, by and between Transwestern
Westchase III, L.P., successor in interest to MXM Mortgage L.P. d/b/a MPC
Mortgage L.P. and Design Automation Systems, Inc.
10.33
(19)
Stock
Purchase Agreement, dated February 18, 2000, by and between Design Automation
Systems, Inc., Edgewater Private Equity Fund III, L.P., Aspen Finance
Investors I, LLC, Fleck T.I.M.E. Fund, LP, Fleck Family Partnership II, LP,
LJH Partners LP, Wain Investment, LLC,
Gerald C. Allen, and John Paul DeJoria
10.34
(20)
Employee Stock Purchase Plan
10.35
(11)
Stock
Purchase Agreement, dated September 29, 2000, by and between the Company,
Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, LP
10.36
(22)
Form
of Consent to Settlement of Claim
10.37
(23)
Share
Return Agreement, dated August 29, 2001, by and between the Company, Carl
Rose, Charles Leaver and Kelly Knake
10.38
(#)
Seattle
Design Center Lease, dated March 23, 2000, by and between the Company and Bay
West Design Center, LLC
10.39
(#)
Office
Lease Agreement, dated October 4, 2000, by and between the Company and ASC
Management, Inc., as revised on September 14, 2001 and as modified on
September 18, 2001 and again on March 28, 2002 for office space in Austin,
Texas
10.40
(#)
Form
of Letter Agreement terminating Tennessee Office Space Lease, dated March 26,
10.41
(#)
Second
Amendment to Lease, dated September 22, 2000, by and between the Company and
Transwestern Westchase III, L.P.
10.42
(#)
Employment
Agreement, dated June 1, 1999, by and between COAD Solutions, Inc. and
Richard Carter
10.43
(#)
Employment
Agreement, dated June 1, 1999, by and between COAD Solutions, Inc. and Robert
Cohan
10.44
(#)
Employment
Agreement, dated November 30, 1999, by and between COAD Solutions, Inc. and
Mark Slosberg
10.45
(#)
Employment
Agreement, dated April 15, 2000, by and between the Company and Sam Dipaola
10.46
(#)
Employment
Agreement, dated February 28, 2000, by and between Design Automation Systems,
Inc. and Peter Davis
21.1
(#)
List
of Subsidiaries of the Registrant
23.1
(#)
Independent
Auditors' Consent
(1) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 15, 1999 and incorporated herein by reference.
(2) Filed as an
exhibit to our Annual Report on Form 10-KSB for the year ended December 31,
1998 and incorporated herein by reference.
(3) Filed as an exhibit to the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 7, 1979 and incorporated herein by reference.
(4) Filed as an
exhibit to our Definitive Proxy Statement on Schedule 14C filed with the
Securities and Exchange Commission on March 9, 1999 and incorporated herein by
reference.
(5) Filed as an
exhibit to our Quarterly Report on Form 10-QSB for the quarter ended March 31,
1999 filed with the Securities and Exchange Commission on May 17, 1999 and
incorporated herein by reference.
(6) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on June 14, 1999 and incorporated herein by reference.
(7) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on August 11, 1999 and incorporated herein by reference.
(8) Filed as an
exhibit to our Quarterly Report on Form 10-QSB for the quarter ended June 30,
1999 filed with the Securities and Exchange Commission on August 16, 1999 and
incorporated herein by reference.
(9) Filed as an
exhibit to our Quarterly Report on Form 10-QSB for the quarter ended September
30, 1999 filed with the Securities and Exchange Commission on November 15, 1999
and incorporated herein by reference.
(10) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on March 15, 2000 and incorporated herein by reference.
(11) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on October 16, 2000 and incorporated herein by reference.
(12) Filed as an
exhibit to our Annual Report on Form 10-KSB for the year ended December 31,
1999 filed with the Securities and Exchange Commission on March 30, 2000 and
incorporated herein by reference.
(13) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on July 14, 2000 and incorporated herein by reference.
(14) Filed as an
exhibit to our Quarterly Report on Form 10-QSB for the quarter ended September
30,2000 filed with the Securities and Exchange Commission on November 21, 2000
and incorporated herein by reference.
(15) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on March 5, 2001 and incorporated herein by reference.
(16) Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on January 27, 1999 and incorporated herein by reference.
(17)
Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 14, 1999 and incorporated herein by reference.
(18) Filed as an
exhibit to our Definitive Proxy Statement on Schedule 14A filed with the
Securities and Exchange Commission on February 24, 2000 and incorporated herein
by reference.
(19)
Filed as an
exhibit to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on February 28, 2000 and incorporated herein by reference.
(20)
Filed as an
exhibit to our Definitive Proxy Statement on Schedule 14A filed with the Securities
and Exchange Commission on April 28, 2000 and incorporated herein by reference.
(21)
Filed as an
exhibit to our Annual Report on Form 10-KSB for the year ended December 31,
2000 filed with the Securities and Exchange Commission on July 23, 2001 and
incorporated herein by reference.
(22) Filed as an
exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30,2001
filed with the Securities and Exchange Commission on August 28, 2001 and
incorporated herein by reference.
(23)
Filed as an
exhibit to our Quarterly Report on Form 10-Q for the quarter ended September
30,2001 filed with the Securities and Exchange Commission on November 19, 2001
and incorporated herein by reference.
(#) Filed herewith
A copy of any exhibit will be
furnished (at a reasonable cost) to any of our shareholders upon receipt of a
written request. Such request should be sent to EpicEdge, Inc. 5508 Two Ninety
West Suite 300 Austin, Texas 78735 Attention: Sam DiPaola Vice President
Investor Relations.
(b) Reports on Form 8-K
During the quarter
ended December 31, 2001, EpicEdge filed the following Current Reports on Form
8-K with the Securities and Exchange Commission:
• Form 8-K filed on November
16, 2001 reporting that EpicEdge appointed a new Board member on October 11,
2001.
• Form 8-K filed on November
26, 2001 reporting that EpicEdge appointed a new Board member and also
announced the resignation of an existing Board member on November 20, 2001.
• Form 8-K filed on December
20, 2001 reporting that, on December 14, 2001, a founding shareholder of
EpicEdge returned 9,085,101 shares of Company stock as a condition to a
previously disclosed financing and also announced the resignation of an
existing Board member.
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.
EPICEDGE, Inc.
Dated
April 16, 2002
By:
/s/ RICHARD CARTER
RICHARD
CARTER
CEO
Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
EPICEDGE,
INC.
INDEX TO FINANCIAL STATEMENTS ITEM
8 IN FORM 10-K
INDEPENDENT
AUDITORS’ REPORT
FINANCIAL
STATEMENTS AND NOTES:
Balance Sheets as
of December 31, 2001 and 2000
Statements
of Operations for the Years Ended December 31, 2001, 2000 and 1999
Statements of
Stockholders’ Equity for the Years Ended December 31, 2001, 2000 and 1999
Statements
of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999
Notes to Financial
Statements
INDEPENDENT AUDITORS’ REPORT
To
the Directors and Stockholders of EpicEdge, Inc.:
We
have audited the accompanying balance sheets of EpicEdge, Inc. (the “Company”)
as of December 31, 2001 and 2000, and the related statements of operations,
stockholders’ equity (deficiency), and cash flows for each of the three years
in the period ended December 31, 2001. 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, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 2001 and 2000,
and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
/s/
Deloitte & Touche LLP
Dallas,
TX
March
29, 2002
(April
16, 2002, as to the effects of subsequent
financings in Notes 10 and 16)
EPICEDGE, INC.
BALANCE SHEETS
DECEMBER 31, 2001 and 2000
See
notes to financial statements.
EPICEDGE, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
See
notes to financial statements.
EPICEDGE, INC.
STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
See
notes to financial statements.
EPICEDGE, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
See
notes to financial statements.
EPICEDGE,
INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
1. BASIS OF PRESENTATION AND ACCOUNTING
POLICIES
Business - EpicEdge, Inc. (the “Company”) engages in the business of
advising and supporting companies through ERP financial and human resource
system implementation, developing custom web applications of object oriented
Internet applications and implementing strategic marketing plans. The Company’s
services include assisting clients through the entire software development life
cycle of a project, including strategic planning, business process evaluation,
integrated marketing and communication, brand structure and design, system
architecture and design, product acquisition, configuration and implementation
and ongoing operational support.
Financial Statements at December 31, 2000 and for the year then ended
include the accounts of the Company and its wholly owned subsidiary, IPS
Associates, Inc. (“IPS”) (referred to collectively as the “Company”), which was
acquired in June 2000 and sold in February 2001 (Notes 3 and 4). Significant intercompany balances and
transactions were eliminated.
Financial Statement Preparation requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingencies as of the date of the financial statements and
revenues and expenses for the period.
Differences from those estimates are recognized in the period they
become known.
Revenues
were generated from consulting, support and training services (“professional
services”). In 2000 and 1999, revenues
were also generated from the value-added reselling of hardware and software
products (“technology integration”). Professional
services revenues are recognized as the services are performed, primarily on a
time-and-materials basis using the number of hours worked by consultants at
agreed-upon rates per hour.
Out-of-pocket expenses reimbursed by clients are included in
professional services revenues, and the expenses incurred by the Company are
included in cost of professional services revenues. The Company uses the percentage-of-completion method to account
for custom consulting contracts, with revenues recognized as the work on the
contract progresses and defined milestones are reached. Technology integration revenues were
recognized upon receipt of an executed agreement and delivery of the products
to the customer, if there were no significant remaining vendor obligations and
collection of the receivable is probable.
Cash Equivalents represent highly liquid investments with original
maturities at the date of acquisition of three months or less.
Financial Instruments that potentially subject the Company to an interest
and credit risk consist of cash and cash equivalents, accounts receivable and
debt instruments. The fair market
values of these items at December 31, 2001, approximate their carrying
amounts.
Property and Equipment is stated at cost less accumulated depreciation
and amortization. Depreciation and
amortization are provided using the straight-line method over the following
estimated useful lives: computer
hardware and software, three to five years; office furniture and fixtures,
three to seven years; and leasehold improvements, five years or the lease term,
if shorter.
Goodwill represents the excess of cost over the estimated fair value of net
assets acquired in business combinations, less impairment write-offs in 2000
(Note 3). The remainder was being
amortized on a straight-line basis over 32 months and is stated net of
accumulated amortization of $7,654,000 and $1,731,000 at December 31, 2001
and 2000, respectively. The Company
will implement Financial Accounting Standard (“SFAS”) No. 142 “Goodwill and
Other Intangible Assets” on January 1, 2002, which will require the Company to
cease amortization of goodwill and perform periodic impairment tests of the
balance, beginning as of that date.
Stock-Based Compensation arising from stock option grants to employees is
accounted for by the intrinsic value method under Accounting Principles Board
(“APB”) Opinion No. 25. SFAS
No. 123
encourages (but does not require) the cost of
stock-based compensation arrangements with employees to be measured based on
the fair value of the equity instrument awarded. As permitted by SFAS No. 123, the Company applies APB Opinion No.
25 to its stock-based compensation awards to employees and discloses the
required pro forma effect on net income and earnings per share (Note 13).
Basic Net Loss per Share is computed by dividing the net loss by the
weighted average shares of common stock outstanding during the period,
excluding shares issued to the ESOP that have not yet been committed to be
released (0 and 449,271 shares at December 31, 2001 and 2000,
respectively, as discussed in Note 13).
The dilutive effect of the options and warrants to purchase common stock
and convertible notes are excluded from the computation of diluted net loss per
share, since their effect is antidilutive.
The antidilutive effects excluded from the diluted net loss per share
computation at December 31 were as follows:
New Accounting Standards - SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
as amended, establishes standards for measuring, classifying and reporting all
derivative financial instruments in the financial statements. SFAS No. 133 became effective for
the Company beginning the first quarter of fiscal year 2001. The Company currently does not use any
derivative financial products for hedging or speculative purposes and, as a
result, there was no impact on the financial statements on implementing this
standard.
In June 2001, SFAS No.141 (“SFAS 141”), “Business Combinations”, was issued. SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The adoption of SFAS 141 did not have an impact on the Company’s financial statements.
In June 2001, SFAS No. 142 (“SFAS
142”), “Goodwill and Other Intangible Assets”, was issued, which requires,
among other things, the discontinuance of goodwill amortization. SFAS 142 also
requires the Company to complete a transitional goodwill impairment test six
months from the date of adoption. The
Company adopted SFAS No. 142 on January 1, 2002, and is currently evaluating
the impact that the adoption of this standard will have on the financial
statements.
In August 2001, SFAS No. 144
(“SFAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets”,
was issued, which addresses the financial accounting and reporting for the
impairment of long-lived assets. This
statement supersedes SFAS No. 121, “Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”
and the accounting and reporting provisions of APB Opinion No. 30,
“Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions”, for the disposal of a segment of a business. The Company adopted SFAS No. 144 on January
1, 2002 and does not believe that the adoption of SFAS 144 will have a
significant impact on its financial statements.
Reclassifications of certain prior-year amounts have been made to
conform to the current-year presentation.
2. BUSINESS COMBINATION WITH PUBLIC
COMPANY AND DISCONTINUED OPERATIONS
Effective January 1,
1999, Loch Exploration, Inc. (“Loch”), a public company, acquired all of the
stock of the Company in a “reverse merger,” whereby the Company was the
acquirer for accounting purposes. In
connection with the acquisition, Loch exchanged shares of common stock with the
Company’s stockholders. The transaction
was accounted for in a manner similar to a pooling of interests, whereby no
goodwill resulted from this transaction, and the Company’s equity interest in
Loch’s net assets of $69,975 were recorded at Loch’s historical cost
basis. Loch’s net assets were
transferred to a subsidiary, Loch Energy, Inc. (“LEI”), which was in the oil
and gas business.
The Company’s 53% equity
interest in LEI’s operations is reported as discontinued operations in the
accompanying financial statements though September 2000. In September 2000, the Company irrevocably
transferred its investment in the remaining shares of LEI to a designated
trustee. Since the Company was unable
to achieve its original plan of distributing these shares as registered stock
to its stockholders who were former stockholders of Loch, the Company recorded
a write-off of $383,885 related to the disposal of its remaining equity
interest in LEI, which is included in discontinued operations in 2000. Related expenses in 2001 and 2000 are also
included in discontinued operations (see Note 13).
3. ACQUISITIONS AND GOODWILL IMPAIRMENT
LOSSES
In March 2000, the Company
acquired all the outstanding common shares of The Growth Strategy Group, Inc.
(“Growth Strategy”), an e-marketing and strategy consulting firm, for 277,000
unregistered shares of the Company’s common stock valued at $6,076,800 and
$375,000 in cash. Goodwill of
$6,100,000 was recorded related to this acquisition. Accumulated amortization of $643,000 had been recorded related to
this goodwill through December 31, 2000.
As a result of a review by Management of the carrying value and
recoverability of this goodwill, Management wrote off the unamortized balance
of Growth Strategy’s goodwill of $5,457,000 as of December 31, 2000.
In June 2000, the Company
acquired all of the issued and outstanding stock of IPS, a project management
firm, for $3,000,000 in cash, 1,472,586 unregistered shares of the Company’s
common stock, options to purchase 1,082,060 shares of the Company’s common
stock and the assumption of net liabilities of $2,940,000. The aggregate value of the shares and stock
options issued in connection with the transaction was $36,405,000. The Company also assumed an employee stock
ownership plan (“ESOP”) from IPS, and 607,023 of the 1,472,586 shares of common
stock related to the transaction were issued to the ESOP. The Company recorded unearned compensation
of $9,445,000 related to 493,220 shares of common stock issued to the ESOP, but
not yet committed to be released by the ESOP’s trustee. This amount was to be amortized over a
period of approximately three to five years as the shares were committed to be
released. In connection with the
assumption of the ESOP, the Company assumed a note payable to a financial
institution for ESOP financing of approximately $5,000,000 (Note 10). The note was secured by the accounts
receivable, investments, and property and equipment of IPS. Goodwill of $34,240,000 was recorded related
to this acquisition. Accumulated
amortization of $2,558,000 had been recorded related to this goodwill through
December 31, 2000. As discussed in
Note 4, IPS was sold effective January 1, 2001, at a substantial
loss. A goodwill impairment loss of
$24,040,000 was recorded in the financial statements as of December 31, 2000,
relating to the sale of IPS.
In connection with the
acquisition, the Company paid a commission of $300,000 in cash to an
organization that facilitated the execution of the transaction and issued
25,065 unregistered shares of the Company’s common stock valued at $576,000 and
recorded as part of the cost of the IPS acquisition.
In July 2000, the Company
acquired substantially all of the assets of Tumble Interactive Media, Inc.
(Tumble), a creative and design firm, for 250,000 unregistered shares of the
Company’s common stock valued at $4,937,500 and $325,000 in cash. The principal
selling stockholder entered into an employment agreement with the Company. The
agreement terminates in July 2003 and includes a non-compete provision for the
term of the agreement and one year thereafter.
The transaction was
accounted for under the
purchase method of accounting and resulted in the recognition of goodwill of
$5,432,901. Accumulated amortization of $307,000 had been recorded related to
this goodwill through December 31, 2000.
As a result of a review by Management of the carrying value and
recoverability of this goodwill, Management wrote off the unamortized balance
of Tumble’s goodwill of $5,125,901 as of December 31, 2000.
In March 1999, the
Company acquired all of the issued and outstanding stock of COAD Solutions,
Inc. (“COAD”), an information technology consulting firm, in exchange for (1)
600,000 shares of the Company’s common stock valued at $2,625,000; and (2)
$200,000 cash, payable $100,000 at closing, and $100,000 payable in quarterly
installments of $25,000 beginning 90 days from the closing date. Goodwill of $3,000,000 was recorded related
to this transaction and was fully amortized as of December 31, 2001.
In May 1999, the Company
acquired all of the issued and outstanding stock of Dynamic Professional
Services, LLC (“Dynamic”), an information technology consulting firm, in
exchange for (1) 524,000 shares of the Company’s common stock valued at
$2,695,600; and (2) $200,000 cash, payable $100,000 at closing and $100,000
payable in quarterly installments of $25,000 beginning 90 days from the closing
date; and (3) additional stock consideration if, on June 1, 2000, the
closing price for the Company’s common stock for the prior 15 business days was
less than $5.15 per share, in an amount equal to 5,340 shares for each $0.01
below $5.15. No additional
consideration was required during 2000.
Goodwill of $2,732,000 was recorded related to this acquisition. Accumulated amortization of $2,472,000 had
been recorded related to this goodwill as of December 31, 2001.
In July 1999, the Company
acquired all of the issued and outstanding stock of Connected Software
Solutions, Inc. (“Connected”), an electronic-business consulting and training
firm, in exchange for (1) 300,000 shares of the Company’s common stock
valued at $1,545,000; (2) $300,000 cash payable in six quarterly installments
of $50,000 beginning 90 days from the closing date; and (3) additional stock
consideration if, on August 1, 2000, the closing price for the Company’s
common stock for the prior 15 business days is less than $5.15 per share, in an
amount equal to 3,000 shares for each $0.01 below $5.15. No additional consideration was required in
2000. Goodwill of $1,800,000 was
recorded related to this acquisition and was fully amortized as of December 31,
2001.
In November 1999, the
Company acquired substantially all of the assets of NET Information Systems,
Inc. (“NET”), an e-Business solutions provider, in exchange for (1) 350,000
shares of the Company’s common stock valued at $1,093,750; (2) $180,000 cash;
(3) a one-year promissory note in the amount of $50,000 payable quarterly, with
the first payment due 90 days after closing; and (4) the assumption of NET’s
debt not to exceed $220,000. Goodwill
of $1,500,000 was recorded related to this acquisition. Accumulated amortization of $1,300,000 had
been recorded related to this goodwill through December 31, 2001.
All of these acquisitions
were accounted for under the purchase method, with the resulting goodwill
initially being amortized over eight years until the goodwill impairment loss
was recognized as of December 31, 2000. Beginning January 1, 2001, the original
amortization period was decreased to 32 months. The operations of each acquired entity are included in the
Company’s consolidated operations from their respective acquisition date.
The unaudited results of
operations for 2000 and 1999 on a pro forma basis are shown below as though the
above acquisitions (except for Tumble, which did not have a material effect on
the pro forma information, and IPS) were made and the related common
shares were issued as of January 1, 1999, and as though the IPS
acquisition and sale had occurred at that date (therefore, the IPS results and
related goodwill impairment loss are excluded).
In view of the sale of IPS,
at a substantial loss, effective January 1, 2001, management concluded
that goodwill related to IPS as of December 31, 2000, was impaired and
wrote it down to the amount recoverable in the sale, which was $7,643,000;
accordingly, $24,040,000 was written off.
Management also concluded that the entire amount of goodwill related to
the Tumble and Growth Strategy acquisitions and a portion of the goodwill
related to the COAD and Connected acquisitions, as of December 31, 2000,
was impaired based on evaluations of the related estimated future undiscounted
cash flows and the lack of continuity of the related key employees;
accordingly, $12,400,000 was also written off, with a remaining goodwill of
$5,434,000 related to COAD, Dynamic, Connected and NET. The total of these goodwill impairment
write-offs of $36,440,000 was reported as an operating expense in 2000. Goodwill of $460,000 at December 31, 2001,
relates to Dynamic ($260,000) and NET ($200,000).
4. SALE OF IPS
Effective January 1,
2001, with a closing date of February 5, 2001, the Company sold all of the
issued and outstanding stock of IPS to Red & Blue, Inc., a Delaware
corporation, and to the IPS Associates, Inc. Stock Ownership Plan. The consideration for the sale was
(1) the return of an aggregate 740,260 shares of the Company’s common
stock, including ESOP shares, (2) $5,700,000 in net proceeds and
(3) the transfer of the IPS ESOP plan, along with the note payable to a
financial institution for the ESOP financing of $4,861,000. The stock purchase agreement provided that
143,323 shares of the 740,260 shares of the Company’s common stock be held in
escrow until the earlier of (1) the completion of audited financial
statements of IPS for the year ended December 31, 2000, or (2) six
months from the date of closing. In the
event that the net equity, revenues or net earnings of IPS differed by more
than $500,000 from the financial statements disclosed in the purchase
agreement, Red & Blue, Inc. had the right to setoff the difference against
the shares held in escrow at a value based upon the closing price of the
Company’s common stock on the day before the setoff. In the event of a setoff, the Company has agreed to immediately
register the setoff shares. Based on
audited financial results of IPS, no such setoff occurred. As discussed in Note 3, the goodwill related
to IPS was written down as of December 31, 2000, to the amount recoverable in
the sale.
IPS was included in the
Company’s accompanying results of operations since IPS’s acquisition in June
2000. Pro forma results of
operations for 2000 and 1999 in Note 3 exclude IPS.
In the first quarter of
2001, the Company received the above-described proceeds, cancellation of the
inter-company payable and receivables with IPS, along with the return of
740,260 shares now in treasury stock, in exchange for the transfer of assets of
$6,085,000 and liabilities of $8,028,000.
In addition, with the return of the shares held by the ESOP, a reduction
in unearned compensation of $8,979,000 associated with these unreleased ESOP
shares was recorded as a charge against the additional paid in capital arising
from the IPS acquisition. The net
proceeds from the sale of IPS were used to pay off the secured debt for
$2,275,000 and the balance was used to fund working capital needs such as
payroll and current accounts payable.
5. GAIN
ON RESTRUCTURING OF PAYABLES
In February 2001, the
Company adopted a strategy and a plan of execution to reduce its workforce and
other costs in order to stabilize the organization. In February 2001, the Company hired a consulting group to assist
in designing and executing a repayment plan (the “Plan”) with its unsecured
creditors. This Plan, which was executed in June 2001, after achieving an
acceptable percentage of consents from the unsecured creditors, is designed to
repay this group over time either in-full for those creditors whose balance is
$5,000 or less, or
who are willing to accept
$5,000 as full payment, or up to 60% of $3,094,000, which represented the
original unsecured accounts payable amount as of February 1, 2001. The Plan further provided that, if
sufficient cash was available, the Company could pay a total of 30% of the
original unsecured accounts payable amount by December 31, 2001, and this total
amount would fully and completely satisfy the Company’s obligations to the
unsecured creditors. In June 2001, in
accordance with the Plan, the Company paid the initial installment to
consenting unsecured creditors under the Plan representing 18% of the original
obligation. In December 2001, the
Company made a second installment of 12% of the original obligation to fully satisfy
its obligations under the Plan as it relates to $2,045,000 of the original unsecured
accounts payable. The remaining balance
of $1,049,000 will be paid quarterly at four (4%) percent of the original
balance over the next two and one-half (2 ½) years, unless they agree to a
lesser amount over a shorter time.
Based upon the payables satisfied by payments made under the Plan, the
Company recognized an extraordinary gain from this restructuring of $1,329,000.
6. SIGNIFICANT CUSTOMERS
Accounts receivable and sales from significant customers as a
percentage of the Company’s accounts receivable and total revenues for are as
follows:
7. PROPERTY AND EQUIPMENT
Property and
equipment at December 31 consist of the following:
In October 2000, the
Company moved its corporate headquarters from Houston, Texas, to Austin,
Texas. As a result of this move,
several fixed assets were no longer of use to the Company and were considered
impaired. The net value of these
impaired assets totaled approximately $277,000 and was included as an operating
expense in goodwill and other impairment losses in 2000. In December 2000, the Company abandoned its
implementation of a new software package for its corporate headquarters, and
wrote off approximately $805,000 of capitalized costs associated with this
project abandonment. These costs were
also included in goodwill and other impairment losses.
8. RESTRICTED CASH AND OTHER ASSETS
Other assets at December 31
consist of the following:
9. ACCRUED EXPENSES AND OTHER CURRENT
LIABILITIES
Accrued expenses and other
current liabilities at December 31 consist of the following:
10. NOTES PAYABLE AND CONVERTIBLE DEBT
Convertible
notes payable to stockholders at December 31 consist of the following:
Convertible notes payable
are classified as current or long-term based on the contractual maturities as
amended on April 16, 2002, and as discussed in Note 16. The June, July and December convertible
notes are required to be converted to Series A and B convertible preferred
stock subject to stockholder approval, which management and the Board of
Directors expect to occur during the second quarter of 2002, as discussed below
and in Note 16.
Notes
payable at December 31 consist of the following:
Revolving lines of credit
and term note at December 31, 2000, consisted of the following and were
paid in 2001:
Convertible Notes Payable - On June 21, 2001 the Company
executed letter agreements and promissory notes (the “June Notes”) with certain
existing stockholders. The June Notes,
once fully funded, were to be for no less than $3,110,000. As of December
31, 2001 the Company had received $1,050,000 relating to these June Notes. The June Notes originally were for a term of
one year and have a stated interest rate of 8%. On April 16, 2002, the
June Notes were replaced with a substitute convertible secured promissory note
(the “June Convertible Notes”) that has a maturity date of April 2003. Subject to stockholder approval, the June
Convertible Notes required the outstanding balance, plus any accrued interest,
to be exchanged into shares of Series B Convertible Preferred Stock
(“Series B Preferred Stock”). The Series B Preferred Stock has the
following terms: a conversion rate equal to one share of common stock for each
$.25 of stated value or a liquidation preference such that in the event of any
liquidation, dissolution or winding up of the Company, the holders thereof
shall be entitled to receive, at their option, either (a) in preference to the
holders of the common stock and on a pro-rated pari passu basis with the Series
A Preferred Stock (see July Convertible Notes below) an amount equal to two and
three-quarters (2 ¾) times the stated value if a liquidation event occurs
within twenty-four (24) months. If,
however, a liquidation event occurs after twenty-four (24) months, the
preference multiple becomes three (3) times the stated value. In addition, if the holders of the Series B
Preferred Stock choose upon a liquidation event to receive the liquidation
preference multiple in effect at the time of the event and there still remains
undistributed net equity value after any debt obligations and Series A
Preferred Stock liquidating preference payments, then the Series B Preferred
Stock will participate in that additional distribution on an as converted basis
at a conversion rate equal to one share of common stock for each $.75 of stated
value. A merger, acquisition or sale of
all or substantially all of the assets of the Company in which the stockholders
of the Company do not own a majority of the outstanding shares of the surviving
corporation shall be deemed to be a liquidation. The terms of these June Convertible Notes were finalized on April
16, 2002 (see Note 16).
In July 2000, the Company completed a $5,000,000 convertible debt
offering (“July Convertible Notes”) with Edgewater Private Equity Fund III, L.P. and
Fleck T.I.M.E. Fund, L.P. The
July Convertible Notes bear annual interest at 9.5%. Originally, the principal and accrued and unpaid interest was convertible at the
option of the holder into common stock of the Company at a conversion price of
$5.00 per share. The Company recorded
an imputed debt discount of $5,000,000 related to the beneficial conversion
feature and based on the quoted market price of our common stock of $19.50 per
share on the date of issuance. At
December 31, 2000, this debt was due on demand, and the imputed discount
was fully amortized to expense.
On July 20, 2001, the Company
reached an agreement related
to the July Convertible Notes, under which the maturity date was extended to
August 1, 2002. Originally the conversion terms were to be renegotiated by
August 15, 2001; otherwise, a penalty of $500,000 would have been assessed and
payable in February 2002. On April 16,
2002, the Company completed these renegotiations (see Note 16). Under the new terms, subject to stockholder
approval, the principal and accrued interest ($685,000 at December 31, 2001)
underlying the July Convertible Notes are required to be exchanged into Series
A Convertible Preferred Stock (“Series A Preferred Stock”) with a stated par
value of approximately $5.8 million dollars.
These new terms also include a waiver of the $500,000 penalty. The Series A Convertible Preferred Stock has
the following terms: a conversion rate equal to one share of common stock for
each $.75 of stated value or a liquidation preference such that in the event of
any liquidation, dissolution or winding-up of the Company, the holders thereof
shall be entitled to receive, at their option, either (a) in preference to the
holders of the common stock and on a pro-rated pari passu basis with the Series
B Preferred Stock (see June Notes above) an amount equal to two and three-quarters
(2 ¾) times the stated value, or (b) a ratable share of the distribution of
assets and property with the holders of the common stock, participating on an
as converted basis, if a liquidation event occurs within twenty-four (24)
months. If, however, a liquidation
event occurs after twenty-four (24) months, the preference multiple becomes
three (3) times the stated value. A
merger, acquisition or sale of all or substantially all of the assets of the
Company in which the stockholders of the Company do not own a majority of the
outstanding shares of the surviving corporation shall be deemed to be a
liquidation.
In November 2000, the
Company’s Chairman and principal stockholder provided a $1,000,000 line of
credit to the Company in the form of a convertible note (the “November
Convertible Note”). The Company could draw upon the line of credit from
time to time as needed and had drawn $900,000 at December 31, 2001 and
2000. The November Convertible Note bore annual interest at the rate of 8%,
was convertible at the lenders’ option at $.50 per share and was scheduled to
mature on December 31, 2001. The lender had the option to demand
repayment of the November Convertible Note within 30 days after the IPS sale;
however, the lender made no such demand.
In August 2001, the Company
renegotiated the terms of the November Convertible Note (the “Amended November
Convertible Note”) that extended the maturity date to December 1, 2002 and
increased the conversion feature to $1.00 per share, convertible at the lender’s
option. Furthermore, if the Amended November Convertible Note was not paid at
the new maturity date, the lender, at his sole discretion, could have converted
the note at $0.50 per share, demanded payment or further extended the maturity
date until December 1, 2003. Finally, if the Amended November Convertible
Note was not paid at the new extended maturity date, the lender, at his sole
discretion, could have converted the note at $0.25 per share, demanded payment
or further extended the maturity date until December 1, 2004. In exchange, the Company agreed to commence
interest only payments to the lender based upon the principal and accrued
interest as of September 1, 2001.
In September 2001, the $100,000 unused balance of the November
Convertible Note was cancelled. On
April 16, 2002, in conjunction with the financing discussed in Note 16, the new
terms are that the Amended November Convertible Note still bears an annual
interest at the rate of 8%, is convertible at the lenders’ option into the Company’s
common stock at $.25 per share and matures on December 31, 2004.
In connection with the
November Convertible Note, the lender was issued in 2000 five-year warrants to
purchase an aggregate of 2,000,000 shares of our common stock at $.01 per
share. The Company recorded debt discount of $900,000 in connection with
the issuance of the warrants, which resulted in an initial net carrying value
of zero for the November Convertible Note. This discount was being
amortized into interest expense over the life of the November Convertible
Note. In connection with the renegotiation the November Convertible Note
in 2001, the stockholder forfeited his rights to the 2,000,000 warrants to
purchase common stock. Upon
forfeiture of these warrants the debt was brought to its full value of $900,000
with the remaining unamortized portion of the debt discount of $225,000 being
offset to additional paid in capital.
Debt discount amortization totaling
$600,000 and $75,000 was recorded as interest expense related to these
warrants in 2001 and 2000, respectively.
In December 2000, the
Company issued $1,500,000 in convertible notes to two of its stockholders (the
“December Convertible Notes’), both of which formerly served on the Company’s
Board of
Directors. The December
Convertible Notes are convertible at the lenders’ option at $.50 per
share. The December Convertible Notes
bear interest at 8% per annum and matured on December 31, 2001. In connection with the December Convertible
Notes, the lenders were issued five-year warrants to purchase an aggregate of
3,000,000 shares of the Company’s common stock at $.01 per share. The Company recorded debt discount of
$1,500,000 in connection with the issuance of the warrants, which resulted in a
net carrying value of zero for the December Convertible Notes. This discount was to be amortized into
interest expense over the original life of the December Convertible Notes. This debt discount is fully amortized as of
December 31, 2001 and amortization of $1,300,000 and $200,000 was recorded as
interest expense in 2001 and 2000, respectively. Of these convertible notes, the holders of $1,000,000 agreed in
December 2001 to extend the maturity date to January 31, 2003. On April 16, 2002, the Company renegotiated
this portion of the December Convertible Notes, which are required to be
exchanged into Series A Preferred Stock, subject to stockholder approval (see
Note 16). The Holder of the remaining
$500,000 has demanded payment and on April 16, 2002, the Company negotiated
with this individual to repay this note over an installment period through
January 31, 2003 (see Note 16).
Notes Payable - ESOP - As part of the IPS
acquisition (Note 3), the Company was the guarantor on a note payable to a
financial institution for a loan made to an ESOP sponsored by the Company (the
“ESOP Loan”). As a result of the IPS
sale (Note 4), the ESOP Loan of $4,861,000 at December 31, 2000, was transferred
to the acquirer effective January 1, 2001.
Notes Payable - Other - In March 2001, the Company
negotiated new terms for $1,933,000 of other notes payable. Under these new terms, the Company is
required to make equal bi-monthly payments of $25,000 through January 2002 and
bi-monthly payments of $35,000 from
January 2002 until October 2002 when the final balance is due and payable in
full.
Revolving Lines of Credit and Term Loan
Facility - On August 10, 1999, the Company entered into
a Loan and Security Agreement (the “Agreement”) for a total credit facility of
up to $5,000,000, limited to the available borrowing base, which is based on
levels of eligible accounts receivable and inventory, as defined in the
Agreement, expiring August 10, 2001, with three one-year renewals at the
lender’s option. On December 29,
1999, the Company amended its Agreement to include a $1,000,000 term loan under
the total credit facility of $5,000,000.
In connection with this amendment, the Company entered into a warrant
purchase agreement with the lender and issued warrants to purchase 25,000
shares of the Company’s common stock (Note 13). The fair value assigned to these warrants of $115,000 was
accounted for as a debt discount and amortized over the period of the term loan. Amortization totaling $115,000 is included
in debt discount amortization expense as of December 31, 2000. At December 31, 2000, there was no
available unused balance under the Agreement.
In February 2001, the entire outstanding balance of the Agreement of
$2,275,000 was paid in full by the use of a portion of the proceeds from the
IPS sale (Note 4).
Debt Defaults - As
of December 31, 2001, the Company was in default on its $500,000 December
Convertible Note to a previous member of the Company’s Board of Directors. This creditor had demanded payment under the
loan agreement. However, as discussed
above, the Company has renegotiated the payment terms on this debt on April 16,
2002 (see Note 16).
11. INCOME TAXES
Prior to the reverse merger
in January 1999, the Company was an S Corporation for tax purposes. Based on C Corporation status for tax
purposes beginning in 1999, the Company has deferred income tax benefits total
approximately $12,500,000 and $10,000,000 at December 31, 2001 and 2000, respectively,
arising principally from the tax benefits of net operating loss carryforwards.
These tax benefits are fully reserved and will not be recognized on the
accompanying balance sheet until recoverability in the future is reasonably
assured.
12. COMMITMENTS AND CONTINGENCIES
Leases - The Company leases office space under a
noncancelable operating lease. Total
rent expense for 2001, 2000 and 1999, was approximately $1,180,000, $1,328,800
and $119,231, respectively. Minimum
future rental commitments under operating leases at December 31, 2001, are
as follows:
Employment Contracts - In
connection with the reverse merger (Note 2), the Board of Directors of the
Company had approved five-year employment agreements with three key
employees. As of December 2000, each of
these three employees had left the Company.
As a result, the Company recorded an accrued severance amount to reflect
the Company’s obligations to these former employees. The Company renegotiated these severance payments during 2001 and
paid in full the renegotiated amounts by the end of the year. The difference in the amount paid and the
amounts accrued of $316,000 was included in the extraordinary item.
In
connection with the acquisitions discussed in Note 3 and other agreements
with new senior management, the Company entered into various employment
agreements, some of which expire on various dates from November 2002 to
December 2004, and continue thereafter on a year-to-year basis. Generally, these agreements include a
noncompete provision for the term of the agreement and one year thereafter. These agreements also include severance
provisions, under which the Company was contingently liable as of
December 31, 2001 for a total of $753,000. In conjunction with the financing discussed in Note 16, the
Company renegotiated the severance portion of these agreements. As of March 31, 2002, the Company is
contingently liable for a total of $188,000, which would become payable if the
employees were terminated under certain conditions
Legal Proceedings - In November 2001, a
former employee brought suit against the Company and others. This former employee
alleges that the Company, through acts and omissions of the named parties,
prohibited the former employee from selling stock of the Company. The complaint
seeks damages of approximately $2.7 million. These proceedings are in the very
early stages of the case. Discovery has not yet occurred and no depositions
have been taken. The Company intends to defend itself vigorously and believes
it has good and meritorious defenses. While the outcome of this litigation
cannot be predicted with certainty, the Company believes that it will not have
a material adverse effect on its financial statements.
13. CAPITAL STOCK
Common Stock Transactions - During 1999,
the Company granted 1,147,500 shares of common stock, valued at $3,549,000 in
exchange for consulting services from various consulting firms, which was
recorded by the Company in its 1999 operating expenses. In 2000, the Company made a
claim for the return of a portion of these shares as one of these consulting
firms failed to fully execute on the original contractual arrangement as
agreed. In March 2001, this issue was
settled with the return and cancellation of 480,000 shares, which was recorded
at the estimated current value of the stock of $0.34 per share as of the return
date.
Also during 1999, 2,304,700
common shares valued at $726,000 were exchanged for consulting services
performed by various consulting firms for Loch Energy, Inc. in connection with
the reverse merger (Note 2). This
transaction resulted in the Company recording an additional investment in LEI of
$726,000. In July 2001, the Company
issued 496 shares out of treasury stock to stockholders of Loch for previously
unexchanged Loch shares. These original
Loch shares were issued prior to 1989 and were not presented for exchange at
the time of the reverse merger (Note 2).
The value of these shares was $10,000 and was charged to discontinued
operations in 2001.
In addition to the cancellation of the 2,000,000
warrants referred to below under Common Stock Warrants, as an additional condition precedent
to the Series A and Series B Preferred Stock financings discussed in Notes 10 and 16, the
Company entered into a share return agreement dated August 29, 2001, with three
original stockholders, one of which is the Chairman and principal stockholder,
for the return of 10,295,210 shares. In
the fourth quarter of 2001, these shares were
recorded as treasury stock and as a capital
contribution at the estimated current value of the stock of $2,883,000.
In February 2000, the Company sold 2,260,000
unregistered shares of its common stock to a group of private investors led by
Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. for
$11,300,000 ($5.00 per share). The
transaction resulted in certain stockholder rights being granted to the
investors, including a right to request registration of the shares at the Company’s expense. In August 2000, the investor group exercised
its right to request registration of the shares. In connection with the financing discussed in Note 16, these
private investors withdrew their request for the registration of these
shares. In connection with the
February 2000 transaction, the Company paid a commission to an organization
that facilitated the execution of the transaction that consisted of a cash
payment of $395,000 and a warrant to purchase 22,000 shares of the
Company’s
common stock at an exercise price of $15.00 per share. The warrants were valued at $22,000 based on
an independent valuation and are exercisable for a period of three years from
the date of issuance.
In June 2000, the Company
entered into a severance agreement with one of its employees that provided for,
among other things, the modification of the employee’s stock options allowing a
cashless exercise of vested and unexercised stock options. As a result, the Company accounted for the
stock options as variable options and recorded a stock-based compensation
charge on the exercise date during the three months ended June 30, 2000,
of $475,600 based on the difference between the exercise price and the quoted
market price of the underlying stock.
The Company issued 22,353 shares of its common stock to the former
employee as a result of the cashless exercise.
In September 2000, the Company
sold 2,000,000 shares of unregistered common stock to certain private equity
investors, Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund,
L.P., for $2,000,000 ($1.00 per share).
The stock purchase agreement provided for two additional board members
to be appointed by the investors. Such
appointments were made in September and October 2000. The purchase agreement also required the Company to immediately
register the shares of common stock that were issued. The investors had agreed to a six-month lockup period, which
prevented them from selling the shares of common stock acquired in this
transaction during that period. In connection with
the financing discussed in Note 16, these private investors terminated their
stock purchase agreement relating to these shares and thereby relinquished
their right to require the Company to immediately register these shares.
In November 1999, the
Company reserved 190,000 unregistered shares of its common stock for grants to
two of its board members for their participation on the Company’s Board of
Directors. The shares were issued to
each board member in equal installments at the end of each quarter through
December 31, 2000. The Company
recorded the value of the shares issued each quarter at the average quoted
market price of the stock for the period in which the stock was issued, which
resulted in stock-based compensation of $2,936,400 for 142,500 shares issued to
these board members during 2000.
ESOP Shares - In connection with the IPS
acquisition in June 2000, the Company assumed an ESOP from IPS and issued
607,000 shares of common stock to the ESOP (“ESOP shares”). On the date of acquisition, the Company
recorded unearned compensation of $9,445,000 related to 493,220 ESOP shares
issued, but not yet committed to be released by the ESOP’s trustee. During the period from acquisition to
December 31, 2000, a total of $466,000 in compensation expense was recorded for
43,949 ESOP shares committed to be released at an average share price of $10.60
per share. ESOP shares not committed to
be released are not considered to be outstanding and were excluded in earnings
per share calculations. As a result of
the IPS sale (Note 4), the ESOP shares were returned to the Company in February
2001, treasury stock increased by $232,000 and unearned compensation decreased
by $8,979,000 related to the unreleased ESOP shares.
Common Stock Warrants - In August 2001, the Company
issued warrants for
the purchase of 30,000 shares of its common stock to each of two new members of
the Board of Directors, and in November 2001, the Company issued warrants for
the purchase of 30,000 shares of its common stock to a third new member of the
Board of Directors. These warrants are for services
to be rendered for one year from the date of appointment to the Board. The warrants have an exercise
price of $0.28 and are
exercisable for five years from the date of grant. The warrants vest in twelve months from the date of grant. Since the warrants were issued to members
of the Board of Directors for services as a director, and the exercise price
equaled the fair market value of the common stock on the date of issuance, no
compensation expense was recorded related to these warrants.
In November 2001, the
Company issued warrants for the purchase of 177,700 shares of its common stock
in exchange for legal services totaling $35,540. The warrant have an exercise price of $.20 and are exercisable for
three years from the date of grant. The warrants were immediately vested. The Company valued these warrants at the
cost of the services received of $35,540 and recorded legal expense in the same
amount.
In November and December
2000, the Company issued in conjunction with November and December Convertible
Notes (Note 10) warrants for the purchase of 5,000,000 shares of its common
stock at an exercise price of $.01 per share.
The Company recorded the initial value of these warrants based on the
Black-Scholes model, totaling $2,400,000, as a discount to the Convertible
Notes. In August 2001, in connection
with the renegotiation of the $1,000,000 Convertible Note (Note 10), the holder
of the Convertible Note forfeited the right to 2,000,000 of these warrants and
the Company recorded the forfeiture of these warrants as additional paid in
capital of $675,000 and a reduction of unamortized debt discount of $225,000.
In March 2000, the Company
issued warrants for the purchase of 40,000 shares of its common stock to two
advisory board members for services to be rendered from April 2000 to March
2002. The warrants have an exercise
price of $21.88 and are exercisable for five years from the date of grant. The warrants vest over the service period as
follows: one-third of the warrants vest
upon grant, and the remaining two-thirds vest in one-half increments on the
first and second anniversaries of the grant date. The Company recorded the initial value of these warrants based on
the Black-Scholes model, totaling $346,000, as unearned compensation on the
date of grant. The Company originally
amortized this amount as compensation expense over the expected consulting
period. The Company revalued the
warrants at December 31, 2000, and based on a lower stock price, it
reduced the amount of the unearned compensation to zero. As a result of the decrease in stock value
over the period, the Company recorded no stock-based compensation related to
the warrants during 2000.
In May 2000, the Company
issued warrants for the purchase of 150,000 shares of its common stock to a
member of the Board of Directors for services to be rendered from May 2000 to
April 2002. The warrants have an
exercise price of $19.00 and are exercisable for five years from the date of
grant. The warrants vest over the
service period as follows: one-third of
the warrants vest upon grant, and the remaining two-thirds vest in one-half
increments on the first and second anniversaries of the grant date. Since the warrants were issued to a member
of the Board of Directors for services as a director, and the exercise price
equaled the fair market value of the common stock on the date of issuance, no
compensation expense was recorded related to these warrants.
In April 2000, the Company
issued to a client’s venture capital affiliate a warrant to purchase 500,000
shares of its common stock at an exercise price of $22.00 per share. The warrant is exercisable at any time after
the earlier of (i) 60 days after the consummation of a registered public offering
and (ii) October 3, 2001 (such earlier date being the vesting date), through
the third anniversary of the vesting date.
The Company determined the value of the warrant to be $4,843,000 based
on the Black-Scholes model. The warrant
was issued contemporaneously with the negotiation of a consulting agreement
between the Company and the client, under which the Company could receive
estimated fees totaling $3,100,000 over the next three years. However, the agreement provided the client
with the right of cancellation for convenience. At June 30, 2000, there was no assurance that the client would
continue to engage the Company under the agreement or would enter into any
additional agreements in the future; accordingly, the Company recorded the
estimated value of the warrant as stock-based compensation of $4,843,000 during
the three months ended June 30, 2000.
The client canceled the consulting agreement in January 2001.
In July 2000, the Company
issued warrants for the purchase of 17,000 shares of its common stock to the
management company that helped the Company locate its new corporate
headquarters. The warrants have an
exercise price of $22.75 per share and are exercisable for five years from the
date
of grant. One-third of the warrants vest upon grant,
and the remaining two-thirds vest in one-half increments on the first and
second anniversaries of the grant date.
The Company recorded the value of these warrants based on the
Black-Scholes model, totaling $154,000, as an expense in the period the
warrants were issued.
Warrants to purchase 25,000
common shares were granted in 1999 with the term loan (Note 10). The shares can be purchased any time prior
to March 31, 2005, at an exercise price of $11.70 per warrant share. A fair value of $115,000 was assigned to
these warrants at the date of grant.
Stock Options - In February 1999, the Board of Directors approved
the 1999 Employee Stock Option Plan (the “Plan”). The Board reserved 3,000,000 shares of common stock for issuance
under the Plan. Under the terms of the
Plan, options to purchase common stock may be granted at the discretion of the Company’s compensation
committee and may be subject to certain restrictions. In May 2000, this number
of shares reserved was increased to 7,500,000.
Options
generally vest over a three-year life, except for 420,000 options granted in
November 1999 to certain employees that had a one-year vesting period and
400,000 options granted to an employee in December 2000 that had a six-month
vesting period. The 400,000 options
granted in December 2000 were granted at an exercise price of $0.125 per share;
accordingly, the Company recorded unearned compensation of $400,000 based on
the market price of the common stock on the grant date. The Company recorded $67,000 of amortization
of the unearned compensation in December 2000.
On January 4, 2001, the employee left the Company; therefore, in
January 2001, the Company reversed the remaining unearned compensation related
to these options. This employee
exercised the vested portion of the options, which were 66,668 options in
January 2001. All other options granted
under the Plan were granted at prices equal to the fair value of the common
stock at the grant date. All options
expire 10 years after the date of grant.
At December 31, 2001 there were 1,891,582 options outstanding and
5,374,959 options available for grant and at December 31, 2000, there were
6,657,441 options outstanding and 798,474 options available for grant under the
Plan.
A summary of the Plan is as
follows:
The following table
summarizes information about stock options outstanding at December 31,
2001:
Pro Forma Stock-Based Compensation - The Company applies APB Opinion No. 25 and
related interpretations in accounting for its stock option plans. Compensation cost was recognized for the Company’s stock option
plans only when the options were granted to employees at an exercise price that
was below the fair value of the stock on the grant date. SFAS No. 123 prescribes a method to
record compensation cost for stock-based employee compensation plans at the
estimated fair value of the options at the grant date, but allows disclosure as
an alternative. The pro forma disclosure
as if the Company had adopted the cost recognition requirements under
SFAS No. 123 for options granted to employees in 2001, 2000 and 1999
is presented below. The pro forma
compensation cost may not be representative of that expected in future years.
In the pro forma
calculations, the weighted average fair value of options granted to employees
in 2001, 2000 and 1999 was estimated at $0.30, $8.85 and $2.00 per share,
respectively. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes pricing
model with the following assumptions:
(i) expected volatility computed using the monthly average of the
Company’s common stock market price as listed on the American Stock Exchange
for the period from April 1999 through December 2001, which market price
volatility averaged
146%, 223% and 78% in 2001, 2000 and 1999, respectively; (ii) expected dividend
yield of 0%; (iii) expected option term ranging from six months to three years;
and (iv) risk-free interest rate of
4.0%, 5.5% and 6.0% in 2001, 2000 and 1999, respectively.
IPS Options - In the IPS acquisition, the Company granted options
to purchase 1,082,060 shares of its common stock, which were valued as part of
the purchase price (Note 3) based on the Black-
Scholes model and, therefore, are not included in
the above pro forma amounts. In
the sale of IPS (Note 4), these options were canceled.
Preferred Stock - The Company has authorized 5,000,000 shares of
‘blank check” preferred stock, $.01 par value; no shares were issued at
December 31, 2001 or 2000. Subject
to stockholder approval at the next Annual Meeting, it is expected that Series
A and Series B convertible preferred shares will be reserved for potential
issuance in connection with the Convertible Notes Payable discussed in Notes 10
and 16.
Other - In the first quarter 2001, there was a reduction in
unearned compensation of $8,979,000 associated with unreleased ESOP shares and an increase
in treasury stock of $233,000 as a result of the sale of
IPS, as discussed in Note 4 and ESOP Shares above.
14. STOCK-BASED
COMPENSATION AND COSTS
Stock-based compensation and
costs in 2000 and 1999 are as follows:
15. EMPLOYEE BENEFIT PLAN
The Company has a profit sharing
plan under Section 401(k) of the Internal Revenue Code, which covers
substantially all employees. The
Company does not match employee contributions.
16. SUBSEQUENT FINANCININGS
In June 2001, the Company
began negotiations with certain existing stockholders and convertible debt
holders for additional funding to provide the ability to execute on the
unsecured creditor payment plan (see Note 5), pay or renegotiate legacy
expenses, and provide working capital to execute on the current operating plan of
the Company. Although the final
documents were not executed until 2002, the Company received $1,050,000 as of
December 31, 2001 as interim bridge financing in the form of convertible
promissory notes (see Note 10). The
Company received additional funding of $860,000 under the June Notes in
February and early March 2002. On April
16, 2002, the terms were finalized on these convertible notes, subject to
stockholder approval. The total amount
to be received under these new convertible notes is a minimum of $2,650,000 and
a maximum of $4,500,000. Until converted, these June Convertible Notes are for
a term of one year and are due April 2003, and have a stated interest rate of
8%. These notes, consisting of the outstanding
balance, plus any accrued interest, are required to be exchanged into shares of
Series B Convertible Preferred Stock (see Note 10).
Additional
features of the June Convertible Notes are that they are secured, until
converted, by all investments, accounts receivable, inventory and
property, subject only to a first lien (see Note 10) and they carry with them
demand registration rights.
Also on April 16, 2002, the
terms of $5,000,000 July Convertible Notes (see Note 10) with Edgewater Private
Equity Fund III, L.P. and Fleck T.I.M.E. Fund, L.P. were renegotiated, subject
to stockholder approval. Under
the new terms of the $5,000,000 July Convertible Notes, the principal and
accrued interest are required to be exchanged into Series A Convertible
Preferred Stock (see Note 10) with a stated par value of approximately $5.8
million.
Additionally, on April 16,
2002, the principal and accrued interest on $1,000,000 of the December
Convertible Notes (see Note 10) are also required to be converted into Series A
Preferred Stock, and 2,000,000 of the warrants issued along with the December
Convertible Notes are to be relinquished.
Also the holders of the $1,000,000 of the December Convertible Notes
waive any defaults and all events of default under that agreement.
In conjunction with and as
part of the conditions prior to executing the final documents, the June
Convertible Notes required that terms of the November Convertible Note (see
Note 10) be renegotiated. On April
16, 2002, the Company renegotiated the November Convertible Note, as amended,
such that the new terms are that the November Convertible Note bears an annual
interest at the rate of 8%, are convertible at the lenders’ option into the
Company’s common stock at $.25 per share and matures on December 31, 2004. In addition, the promissory notes required
that the note holder relinquish the 2,000,000 warrants that were issued along
with the November Convertible Note and that the Company enter into a share
return agreement with three original stockholders, one of which is the
Chairman, principal stockholder, and November Convertible Note holder, for the
return of 10,295,210 shares. Both of these additional requirements were
completed as of December 31, 2001.
Also on April 16, 2002, of
the remaining $500,000 under the December Convertible Notes, $300,000 is due
April 2002 and $200,000 plus any accrued and unpaid interest is to be paid by
January 31, 2003. The remaining
1,000,000 warrants that we issued in conjunction with this portion of the
December Convertible Notes are not relinquished and therefore remain in effect.
As discussed above, as part
of the transactions on April 16, 2002, there are convertible notes that are
required to be exchanged into Series A and Series B Convertible Preferred Stock
subject to stockholder approval. The
Company plans to submit this to the stockholders for their approval during the
second quarter 2002. Management and the
Board of Directors anticipate that the stockholders will approve this
transaction.
The following is a pro-forma
chart that depicts the effect on common stock outstanding on an as-converted
basis of the convertible notes payable at December 31:
In view of the
renegotiations of debt terms and subsequent financings discussed above,
management believes that the Company will continue as a going concern through
the remainder of 2002. There can be no assurance that these events will
provide the necessary working capital to fulfill the Company’s needs;
therefore, additional cost reductions or additional sources of funds may be
necessary in early 2003.
INDEPENDENT AUDITORS’ REPORT
To
the Directors and Stockholders of EpicEdge, Inc.:
We
have audited the financial statements of EpicEdge, Inc. (the “Company”) as of
December 31, 2001 and 2000, and for each of the three years in the period ended
December 31, 2001 and have issued our report thereon dated March 29, 2002
(April 16, 2002, as to the effects of subsequent financings in Notes 10 and 16)
appearing in this Annual Report on Form 10-K of EpicEdge, Inc. for the year
ended December 31, 2001. Our audits also included the financial statement
schedule of EpicEdge, Inc. listed in Item 14. This financial statement schedule
is the responsibility of the Company’s management. Our responsibility is to
express an opinion based on our audits. In our opinion, such financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/
Deloitte & Touche LLP
Dallas,
Texas
March
29, 2002
SCHEDULE II --- Valuation and Qualifying
Accounts
EpicEdge, Inc.
Allowance for Doubtful Accounts
Years Ended December 31, 2001, 2000, 1999
(1) Doubtful
accounts written off, net of recoveries.
(2) Includes
$47,000 of Allowance for Doubtful Accounts that was removed with the sale of
IPS as discussed more fully elsewhere in this Form 10-K.