As filed with the Securities and Exchange Commission on November 30, 2004
Registration No. 333-115243
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 2 to
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
CONVERSION SERVICES INTERNATIONAL, INC.
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(Name of small business issuer in its charter)
Delaware 7379 20-1010495
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(State or jurisdiction of (Primary Standard Industrial (I.R.S Employer
incorporation or organization) Classification Code Number) Identification No.)
100 Eagle Rock Avenue
East Hanover, New Jersey 07936
Phone: (973) 560-9400
Fax: (973) 560-9500
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(Address and telephone number of principal executive office)
Scott Newman
President and Chief Executive Officer
Conversion Services International, Inc.
100 Eagle Rock Avenue
East Hanover, New Jersey 07936
Phone: (973) 560-9400
Fax: (973) 560-9500
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(Name, address and telephone number of agent for service)
Copies to:
Douglas S. Ellenoff, Esq.
Ellenoff Grossman & Schole LLP
370 Lexington Avenue, 19th floor
New York, New York 10017
Phone: (212) 370-1300
Fax: (212) 370-7889
Approximate date of proposed sale to the public: As soon as practicable after
the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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TITLE OF EACH PROPOSED MAXIMUM
CLASS OF SECURITIES OFFERING PRICE AMOUNT OF
TO BE REGISTERED AMOUNT TO BE REGISTERED PER UNIT REGISTRATION FEE
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shares of common stock, par value $0.001 per share 453,140,492 (1) $0.21 (2) $12,085.98
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shares of common stock, par value $0.001 per share, 89,249,999 (1) $0.14 (2) $1,583.12
underlying convertible notes
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shares of common stock, par value $0.001 per share, 6,000,000 (1) $0.29 (2) $220.46
underlying warrants
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shares of common stock, par value $0.001 per share, 3,000,000 (1) $0.31 (2) $117.83
underlying warrants
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shares of common stock, par value $0.001 per share, 3,000,000 (1) $0.35 (2) $133.04
underlying warrants
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shares of common stock, par value $0.001 per share, 4,166,666 $0.105 (2) $55.43
underlying warrants
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shares of common stock, par value $0.001 per share, 6,000,000 (1) $0.14 (2) $106.43
underlying warrants
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TOTAL 564,557,157 $14,302.29 (3)
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(1) Also registered hereby are such additional and indeterminable number of
shares as may be issuable due to adjustments for changes resulting from stock
dividends, stock splits and similar changes as well as anti-dilution provisions
applicable to the convertible notes and warrants.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933.
(3) Previously paid.
The securities registered hereby will be made on a continuous or delayed basis
in the future in accordance with Rule 415 under the Securities Act.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
Subject to Completion
Preliminary Prospectus dated November 30, 2004
564,557,157 SHARES OF COMMON STOCK
OF
CONVERSION SERVICES INTERNATIONAL, INC.
This prospectus relates to the offering for resale of shares of our common
stock by certain selling stockholders who received shares in both LCS Group,
Inc. (hereinafter referred to as LCS) and Conversion Services International,
Inc. (hereinafter referred to as CSI) in private financing transactions and
acquisitions.
We will bear all expenses, other than selling commissions and fees of the
selling stockholders, in connection with the registration and sale of the shares
being offered by this prospectus.
Our common stock is traded on the Over The Counter Bulletin Board under
the symbol "CSII." The closing price of our common stock on November 26, 2004,
was $0.17.
In this prospectus, the terms "CSI," "we," or "us" each refer to
Conversion Services International, Inc., which was formerly known as LCS Group,
Inc. In January 2004, we merged with and into a wholly owned subsidiary of LCS.
In connection with this transaction, among other things, LCS changed its name to
"Conversion Services International, Inc."
The selling stockholders who wish to sell their shares of our common stock
may offer and sell such shares on a continuous or delayed basis in the future.
These sales may be conducted in the open market or in privately negotiated
transactions and at market prices, fixed prices or negotiated prices. We will
not receive any of the proceeds from the sale of the shares of common stock
owned by the selling stockholders.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. YOU SHOULD REVIEW CAREFULLY
AND CONSIDER THE INFORMATION DESCRIBED UNDER THE HEADING "RISK FACTORS"
BEGINNING ON PAGE 4.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Subject to Completion, dated ____ __, 2004
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE
SELLING STOCKHOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
TABLE OF CONTENTS
PAGE
----
PROSPECTUS SUMMARY..................................................................................1
RISK FACTORS........................................................................................4
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS..................................................16
BUSINESS...........................................................................................17
MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATIONS........................................30
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........44
USE OF PROCEEDS....................................................................................44
SELLING STOCKHOLDERS...............................................................................45
PLAN OF DISTRIBUTION...............................................................................47
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.......................................49
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.....................................56
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS...............................................57
DESCRIPTION OF SECURITIES..........................................................................60
SHARES ELIGIBLE FOR FUTURE SALE....................................................................63
EXPERTS............................................................................................63
LEGAL MATTERS......................................................................................63
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES................63
FINANCIAL STATEMENTS..............................................................................F-1
Any prospective investor should not rely on any information not contained
in this document. We have not authorized anyone to provide any other information
to the contrary. This document may only be used where it is legal to sell these
securities. The information in this document may only be accurate as of and on
the date of this document.
PROSPECTUS SUMMARY
The following summary contains basic information about us and this
prospectus. Because it is a summary, it does not contain all of the information
that you should consider before investing in our common stock. For a more
complete understanding of our company, our business and a possible investment in
our common stock, you should read the entire prospectus carefully, including the
Risk Factors starting on page 4.
OVERVIEW OF OUR BUSINESS
Conversion Services International, Inc. is a technology and software firm
providing professional services to the Global 2000 as well as mid-market
clientele. Our core competency areas include strategic consulting, data
warehousing, business intelligence and data management consulting. By leveraging
best practices and methodologies, we help organizations set strategy to reach
their goals and deliver them via best practices implementations. Our business
and technology offerings help clients improve performance and maximize returns
on technology investments. Our capabilities include benchmarking, tool
selection, business intelligence, data warehousing, analytics, process
improvement and application development and support.
OUR SERVICES
As a full service data warehousing, business intelligence and strategy
consulting firm, we offer services in the following solution categories:
STRATEGIC CONSULTING
o Project Management (PMO)
o Data Warehousing and Business Intelligence Strategic Planning
o Business Technology Alignment
o Tool Analysis and Recommendation
o Integration Management, M&A
o Compliance (HIPAA, Basel II, Sarbanes-Oxley)
o Process Improvement (Lean, Six Sigma)
o Organizational Analysis and Assessment (M&A)
o Methodology, process, procedures
o Acquisition Readiness
o Information, Process and Infrastructure (IPI) Diagrams
o RFP creation and responses
o Training and Education
BUSINESS INTELLIGENCE
o Architecture and Implementation
o Ad-Hoc Query and Analysis
o Enterprise Reporting Solutions
o Online Analytical Processing
o Analytics and Dashboards
o Business Performance Management
o Business Intelligence Competency Center
o Proof of Concepts and Prototypes
o BI Strategy
o Data Mining
1
DATA WAREHOUSING
o DW Design, Development and Implementation
o Departmental Data Warehousing
o Federated Data Warehousing
o Conforming Facts/Dimensions
o Proof of Concepts and Prototypes
o Data Mart Delivery
o Outsourcing
o Data Architecture / Database
o Extract, Transformation and Loading
o Data Warehouse Framework
DATA MANAGEMENT
o Data Quality Center of Excellence
o Data Profiling
o Data Quality / Cleansing
o Data Transformation
o Data Migrations and Conversions
o Metadata Management
o Enterprise Information Integration (EII)
o Integration Management
o Enterprise Information Architecture
o Quality Assurance Testing (Verification, Validation,
Certification)
See Business on page 17 for a detailed description of these offerings.
During the nine month period ended September 30, 2004, two of our clients,
Leading Edge Communications Corporation (17.9%) and Bank of America (13.4%),
accounted collectively for approximately 31% of total revenues (unaudited).
During the nine month period ended September 30, 2003 (unaudited), one of our
clients, Verizon Wireless, accounted for approximately 30% of total revenues.
For the year ended December 31, 2003, two of our clients, Morgan Stanley (11.2%)
and Verizon Wireless (29.2%), accounted collectively for approximately 41% of
our total revenues. During the fiscal year ended December 31, 2002, two of our
clients, Morgan Stanley (27.4%) and Verizon Wireless (31.6%), accounted
collectively for approximately 59% of our total revenues. With the recent
acquisition of new businesses and our objective of acquiring more over the next
year, we believe that our reliance on these clients will continue to decline
this year and in the future. Nevertheless, the loss of any of our largest
clients could have a material adverse effect on our business.
PURPOSE OF THIS PROSPECTUS
This prospectus relates to the resale of shares of our common stock owned
by, or issuable upon conversion of notes or exercise of warrants by, certain
selling stockholders who will use this prospectus to resell their shares of
common stock. We will not receive any proceeds from sales by the selling
stockholders. However, we will receive proceeds, to be used for working capital
purposes, upon the exercise of warrants held by certain selling stockholders.
For further information about the selling stockholders, see "Selling
Stockholders."
2
OUR CORPORATE INFORMATION
Our offices are located at 100 Eagle Rock Avenue, East Hanover, New Jersey
07936, and our telephone number is (973) 560-9400.
THE OFFERING
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COMMON STOCK OFFERED: The selling stockholders are offering up
to 564,557,157 shares of our common
stock. The selling stockholders will
determine when they will sell their
shares.
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COMMON STOCK OUTSTANDING: We have 772,082,096 shares of common
stock issued and outstanding as of
November 26, 2004.
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USE OF PROCEEDS: We will not receive any of the proceeds
from the sale of shares of common stock
offered by the selling stockholders.
However, we will receive proceeds, to be
used for working capital purposes, upon
the exercise of warrants held by certain
selling stockholders.
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TRADING MARKET: Our common stock is currently listed on
the OTC Bulletin Board under the trading
symbol "CSII."
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RISK FACTORS: Investment in our common stock involves
a high degree of risk. You should
carefully consider the information set
forth in the "Risk Factors" section of
this prospectus as well as other
information set forth in this
prospectus, including our financial
statements and related notes.
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3
RISK FACTORS
An investment in our securities is extremely risky. You should carefully
consider the following risks, in addition to the other information presented in
this prospectus, before deciding to buy our securities. If any of the following
risks actually materialize, our business and prospects could be seriously
harmed, the price and value of our securities could decline and you could lose
all or part of your investment. The risks and uncertainties described below are
intended to be the material risks that are specific to us and to our industry.
RISKS RELATING TO OUR BUSINESS
BECAUSE WE DEPEND ON A SMALL NUMBER OF KEY CLIENTS, NON-RECURRING REVENUE AND
CONTRACTS TERMINABLE ON SHORT NOTICE, OUR BUSINESS COULD BE ADVERSELY AFFECTED
IF WE FAIL TO RETAIN THESE CLIENTS AND/OR OBTAIN NEW CLIENTS AT A LEVEL
SUFFICIENT TO SUPPORT OUR OPERATIONS AND/OR BROADEN OUR CLIENT BASE.
During the nine month period ended September 30, 2004, two of our clients,
Leading Edge Communications Corporation (17.9%) and Bank of America (13.4%),
accounted collectively for approximately 31% of total revenues (unaudited).
During the nine month period ended September 30, 2003 (unaudited), one of our
clients, Verizon Wireless, accounted for approximately 30% of total revenues.
For the year ended December 31, 2003, two of our clients, Morgan Stanley (11.2%)
and Verizon Wireless (29.2%), accounted collectively for approximately 41% of
our total revenues. During the fiscal year ended December 31, 2002, two of our
clients, Morgan Stanley (27.4%) and Verizon Wireless (31.6%), accounted
collectively for approximately 59% of our total revenues. Further, the majority
of our current assets consist of accounts receivable, and as of December 31,
2003, two customers, Morgan Stanley and Verizon Wireless, accounted for 19% and
15% of our accounts receivable balance, respectively. With the recent
acquisition of new businesses and our objective of acquiring more over the next
year, we believe that our reliance on these clients will continue to decline
this year and in the future. The loss of any of our largest clients could have a
material adverse effect on our business. In addition, our contracts provide that
our services are terminable upon short notice, typically not more than 30 days.
Non-renewal or termination of contracts with these or other clients without
adequate replacements could have a material and adverse effect upon our
business. In addition, a large portion of our revenues are derived from
information technology consulting services that are generally non-recurring in
nature. There can be no assurance that we will:
o obtain additional contracts for projects similar in scope to those
previously obtained from our clients;
o be able to retain existing clients or attract new clients;
o provide services in a manner acceptable to clients;
o offer pricing for services which is acceptable to clients; or
o broaden our client base so that we will not remain largely dependent
upon a limited number of clients that will continue to account for a
substantial portion of our revenues.
4
CERTAIN CLIENT-RELATED COMPLICATIONS MAY MATERIALLY ADVERSELY AFFECT OUR
BUSINESS.
We may be subject to additional risks relating to our clients that could
materially adversely affect our business, such as delays in clients paying their
outstanding invoices, lengthy client review processes for awarding contracts,
delay, termination, reduction or modification of contracts in the event of
changes in client policies or as a result of budgetary constraints, and/or
increased or unexpected costs resulting in losses under fixed-fee contracts,
which factors could also adversely affect our business.
WE HAVE A HISTORY OF LOSSES AND WE COULD INCUR LOSSES IN THE FUTURE.
During the fiscal year ended December 31, 2003, we had a decrease in
revenues and gross profits, and we sustained an operating loss and cannot be
sure that we will operate profitably in the future.
During the fiscal year ended December 31, 2003, our revenues decreased by
$1.8 million from $16.2 million for the year ended December 31, 2002 to $14.4
million for the year ended December 31, 2003. In addition, our gross profits
decreased by approximately 5.8%. Accordingly, we sustained a net loss in the
approximate amount of ($307,000).
During the nine month period ended September 30, 2004, our revenues
increased by $8.0 million (unaudited) from $10.6 million for the nine month
period ended September 30, 2003 (unaudited) to $18.7 million for the nine month
period ended September 30, 2004. In addition, our gross profits increased by 2.5
percentage points, from 28.8% for the nine month period ended September 30, 2003
(unaudited) to 31.3% (unaudited) for the nine month period ended September 30,
2004. However, we sustained a net loss for the nine month period ended September
30, 2004 of ($4.3 million)(unaudited), a decrease of ($4.2 million) as compared
to net income of $68,000 for the nine month period ended September 30, 2003
(unaudited).
WE HAVE A SIGNIFICANT AMOUNT OF DEBT, WHICH, IN THE EVENT OF A DEFAULT, COULD
HAVE MATERIAL ADVERSE CONSEQUENCES UPON US.
On August 16, 2004, we entered into a security agreement with Laurus
Master Fund, Ltd., pursuant to which we have borrowed $3,200,000 as of November
26, 2004. Our total debt is $10,451,000, as described below in Management's
Discussion and Analysis or Plan of Operation - Liquidity and Capital Resources.
Such loan is collateralized and secured by all of our corporate assets. The
degree to which we are leveraged could have important consequences to us,
including the following:
o A portion of our cash flow must be used to pay interest on our
indebtedness and therefore is not available for use in our business;
o Our indebtedness increases our vulnerability to changes in general
economic and industry conditions;
o Our ability to obtain additional financing for working capital,
capital expenditures, general corporate purposes or other purposes
could be impaired; and
o Our failure to comply with restrictions contained in the terms of
our borrowings could lead to a default which could cause all or a
significant portion of our debt to become immediately payable.
o If we default, the loans will become due and we may not have the
funds to repay the loans, and we could discontinue our business and
investors could lose all their money.
In addition, certain terms of such loan require the prior consent of
Laurus Master Fund, Ltd. on many corporate actions including, but not limited
to, mergers and acquisitions--which is part of our ongoing business strategy.
5
OUR REVENUES ARE DIFFICULT TO FORECAST.
We may increase our general and administrative expenses in the event that
we increase our business and/or acquire other businesses, while our operating
expenses for sales and marketing and costs of services for technical personnel
to provide and support our services also increases. Additionally, although most
of our clients are large, creditworthy entities, at any given point in time, we
may have significant accounts receivable balances with clients that expose us to
credit risks if such clients either delay or elect not to pay or are unable to
pay such obligations. If we have an unexpected shortfall in revenues in relation
to our expenses, or significant bad debt experience, our business could be
materially and adversely affected.
OUR PROFITABILITY WILL SUFFER IF WE ARE NOT ABLE TO MAINTAIN OUR PRICING,
UTILIZATION OF PERSONNEL AND CONTROL OUR COSTS. A CONTINUATION OF CURRENT
PRICING PRESSURES COULD RESULT IN PERMANENT CHANGES IN PRICING POLICIES AND
DELIVERY CAPABILITIES.
Our gross profit margin is largely a function of the rates we are able to
charge for our information technology services. Accordingly, if we are not able
to maintain the pricing for our services or an appropriate utilization of our
professionals without corresponding cost reductions, our margins will suffer.
The rates we are able to charge for our services are affected by a number of
factors, including:
o our clients' perceptions of our ability to add value through our
services;
o pricing policies of our competitors;
o our ability to accurately estimate, attain and sustain engagement
revenues, margins and cash flows over increasingly longer contract
periods;
o the use of globally sourced, lower-cost service delivery
capabilities by our competitors and our clients; and
o general economic and political conditions.
Our gross margins are also a function of our ability to control our costs
and improve our efficiency. If the continuation of current pricing pressures
persists it could result in permanent changes in pricing policies and delivery
capabilities and we must continuously improve our management of costs.
UNEXPECTED COSTS OR DELAYS COULD MAKE OUR CONTRACTS UNPROFITABLE.
In the future, we may have many types of contracts, including
time-and-materials contracts, fixed-price contracts and contracts with features
of both of these contract types. Any increased or unexpected costs or
unanticipated delays in connection with the performance of these engagements,
including delays caused by factors outside our control, could make these
contracts less profitable or unprofitable, which would have an adverse effect on
all of our margins and potential net income.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE FAIL TO ADAPT TO EMERGING AND
EVOLVING MARKETS.
The markets for our services are changing rapidly and evolving and,
therefore, the ultimate level of demand for our services is subject to
substantial uncertainty. Most of our historic revenue was generated from
providing information technology services only. During the last several years,
we have focused our efforts on providing data warehousing services in particular
since we believe that there is going to be an increased need in this area. Any
significant decline in demand for programming, applications development,
information technology or data warehousing consulting services could materially
and adversely affect our business and prospects.
6
Our ability to achieve growth targets is dependent in part on maintaining
existing clients and continually attracting and retaining new clients to replace
those who have not renewed their contracts. Our ability to achieve market
acceptance, including for data warehousing, will require substantial efforts and
expenditures on our part to create awareness of our services.
IF WE SHOULD EXPERIENCE RAPID GROWTH, SUCH GROWTH COULD STRAIN OUR MANAGERIAL
AND OPERATIONAL RESOURCES, WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
Any rapid growth that we may experience would most likely place a
significant strain on our managerial and operational resources. If we continue
to acquire other companies, we will be required to manage multiple relationships
with various clients, strategic partners and other third parties. Further growth
(organic or by acquisition) or an increase in the number of strategic
relationships may increase this strain on existing managerial and operational
resources, inhibiting our ability to achieve the rapid execution necessary to
implement our growth strategy without incurring additional corporate expenses.
WE FACE INTENSE COMPETITION AND OUR FAILURE TO MEET THIS COMPETITION COULD
ADVERSELY AFFECT OUR BUSINESS.
Competition for our information technology consulting services, including
data warehousing, is significant and we expect that this competition will
continue to intensify due to the low barriers to entry. We may not have the
financial resources, technical expertise, sales and marketing or support
capabilities to adequately meet this competition. We compete against numerous
large companies, including, among others, multi-national and other major
consulting firms. These firms have substantially greater market presence, longer
operating histories, more significant client bases and greater financial,
technical, facilities, marketing, capital and other resources than we have. If
we are unable to compete against such competitors, our business will be
adversely affected.
Our competitors may respond more quickly than us to new or emerging
technologies and changes in client requirements. Our competitors may also devote
greater resources than we can to the development, promotion and sales of our
services. If one or more of our competitors develops and implements
methodologies that result in superior productivity and price reductions without
adversely affecting their profit margins, our business could suffer. Competitors
may also:
o engage in more extensive research and development;
o undertake more extensive marketing campaigns;
o adopt more aggressive pricing policies; and
o make more attractive offers to our existing and potential employees
and strategic partners.
In addition, current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties that
could be detrimental to our business.
7
New competitors, including large computer hardware, software, professional
services and other technology companies, may enter our markets and rapidly
acquire significant market share. As a result of increased competition and
vertical and horizontal integration in the industry, we could encounter
significant pricing pressures. These pricing pressures could result in
substantially lower average selling prices for our services. We may not be able
to offset the effects of any price reductions with an increase in the number of
clients, higher revenue from consulting services, cost reductions or otherwise.
In addition, professional services businesses are likely to encounter
consolidation in the near future, which could result in decreased pricing and
other competition.
IF WE FAIL TO ADAPT TO THE RAPID TECHNOLOGICAL CHANGE CONSTANTLY OCCURRING IN
THE AREAS IN WHICH WE PROVIDE SERVICES, INCLUDING DATA WAREHOUSING, OUR BUSINESS
COULD BE ADVERSELY AFFECTED.
The market for information technology consulting services and data
warehousing is rapidly evolving. Significant technological changes could render
our existing services obsolete. We must adapt to this rapidly changing market by
continually improving the responsiveness, functionality and features of our
services to meet clients' needs. If we are unable to respond to technological
advances and conform to emerging industry standards in a cost-effective and
timely manner, our business could be materially and adversely affected.
WE DEPEND ON OUR MANAGEMENT. IF WE FAIL TO RETAIN KEY PERSONNEL, OUR BUSINESS
COULD BE ADVERSELY AFFECTED.
There is intense competition for qualified personnel in the areas in which
we operate. The loss of existing personnel or the failure to recruit additional
qualified managerial, technical and sales personnel, as well as expenses in
connection with hiring and retaining personnel, particularly in the emerging
area of data warehousing, could adversely affect our business. We also depend
upon the performance of our executive officers and key employees in particular,
Messrs. Scott Newman and Glenn Peipert. Although we have entered into employment
agreements with Messrs. Newman and Peipert, the loss of either of these
individuals could have a material adverse effect upon us. In addition, we have
not obtained "key man" life insurance on the lives of either Messrs. Newman or
Peipert.
We will need to attract, train and retain more employees for management,
engineering, programming, sales and marketing, and client service and support
positions. As noted above, competition for qualified employees, particularly
engineers, programmers and consultants, continues to be intense. Consequently,
we may not be able to attract, train and retain the personnel we need to
continue to offer solutions and services to current and future clients in a cost
effective manner, if at all.
IF WE FAIL TO RAISE CAPITAL THAT WE MAY NEED TO SUPPORT AND INCREASE OUR
OPERATIONS, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Our future capital uses and requirements will depend on numerous factors,
including:
o the extent to which our solutions and services gain market
acceptance;
o the level of revenues from current and future solutions and
services;
o the expansion of operations;
o the costs and timing of product and service developments and sales
and marketing activities;
8
o the costs related to acquisitions of technology or businesses; and
o competitive developments.
We may require additional capital in order to continue to support and
increase our sales and marketing efforts, continue to expand and enhance the
solutions and services we are able to offer to current and future clients and
fund potential acquisitions. This capital may not be available on terms
acceptable to us, if at all. In addition, we may be required to spend
greater-than-anticipated funds if unforeseen difficulties arise in the course of
these or other aspects of our business. As a consequence, we will be required to
raise additional capital through public or private equity or debt financings,
collaborative relationships, bank facilities or other arrangements. We cannot
assure you that such additional capital will be available on terms acceptable to
us, if at all. Any additional equity financing is expected to be dilutive to our
stockholders, and debt financing, if available, may involve restrictive
covenants and increased interest costs. Our inability to obtain sufficient
financing may require us to delay, scale back or eliminate some or all of our
expansion programs or to limit the marketing of our services. This could have a
material and adverse effect on our business.
WE COULD HAVE POTENTIAL LIABILITY FOR INTELLECTUAL PROPERTY INFRINGEMENT,
PERSONAL INJURY, PROPERTY DAMAGE OR BREACH OF CONTRACT TO OUR CLIENTS THAT COULD
ADVERSELY AFFECT OUR BUSINESS.
Our services involve development and implementation of computer systems
and computer software that are critical to the operations of our clients'
businesses. If we fail or are unable to satisfy a client's expectations in the
performance of our services, our business reputation could be harmed or we could
be subject to a claim for substantial damages, regardless of our responsibility
for such failure or inability. In addition, in the course of performing
services, our personnel often gain access to technologies and content which
include confidential or proprietary client information. Although we have
implemented policies to prevent such client information from being disclosed to
unauthorized parties or used inappropriately, any such unauthorized disclosure
or use could result in a claim for substantial damages. Our business could be
adversely affected if one or more large claims are asserted against us that are
uninsured, exceed available insurance coverage or result in changes to our
insurance policies, including premium increases or the imposition of a large
deductible or co-insurance requirements. Although we maintain general liability
insurance coverage, including coverage for errors and omissions, there can be no
assurance that such coverage will continue to be available on reasonable terms
or will be available in sufficient amounts to cover one or more large claims.
WE DO NOT INTEND TO PAY DIVIDENDS ON SHARES OF OUR COMMON STOCK IN THE
FORESEEABLE FUTURE.
We have never paid cash dividends on our common stock other than
distributions resulting from our past tax status as a Subchapter S corporation.
Our current Board of Directors does not anticipate that we will pay cash
dividends in the foreseeable future. Instead, we intend to retain future
earnings for reinvestment in our business and/or to fund future acquisitions. In
addition, the security agreement with Laurus Master Fund, Ltd. requires that we
obtain their consent prior to paying any dividends.
9
OUR MANAGEMENT GROUP OWNS OR CONTROLS A SIGNIFICANT NUMBER OF THE OUTSTANDING
SHARES OF OUR COMMON STOCK AND WILL CONTINUE TO HAVE SIGNIFICANT OWNERSHIP OF
OUR VOTING SECURITIES FOR THE FORESEEABLE FUTURE.
Scott Newman and Glenn Peipert, our principal stockholders and our
executive officers and two of our directors, beneficially own approximately
39.2% and 19.6%, respectively, of our outstanding common stock. Robert C.
DeLeeuw, our Senior Vice President and President of our wholly owned subsidiary,
DeLeeuw Associates, LLC, owns approximately 10.4% of our outstanding common
stock. As a result, these persons will have the ability, acting as a group, to
effectively control our affairs and business, including the election of
directors and subject to certain limitations, approval or preclusion of
fundamental corporate transactions. This concentration of ownership of our
common stock may:
o delay or prevent a change in the control;
o impede a merger, consolidation, takeover or other transaction
involving us; or
o discourage a potential acquirer from making a tender offer or
otherwise attempting to obtain control of us.
THE AUTHORIZATION AND ISSUANCE OF "BLANK CHECK" PREFERRED STOCK COULD HAVE AN
ANTI-TAKEOVER EFFECT DETRIMENTAL TO THE INTERESTS OF OUR STOCKHOLDERS.
Our certificate of incorporation allows the Board of Directors to issue
preferred stock with rights and preferences set by our board without further
stockholder approval. The issuance of shares of this "blank check preferred"
under particular circumstances could have an anti-takeover effect. For example,
in the event of a hostile takeover attempt, it may be possible for management
and the board to endeavor to impede the attempt by issuing shares of blank check
preferred, thereby diluting or impairing the voting power of the other
outstanding shares of common stock and increasing the potential costs to acquire
control of us. Our Board of Directors has the right to issue blank check
preferred without first offering them to holders of our common stock, as the
holders of our common stock have no preemptive rights.
WE MAY NOT BE ABLE TO COMPLY WITH THE SARBANES-OXLEY ACT.
The enactment of the Sarbanes-Oxley Act in July 2002 created a significant
number of new corporate governance requirements and additional requirements may
be enacted in the future. Since our common stock is currently quoted on the Over
The Counter Bulletin Board (OTCBB), we are not currently subject to such
governance requirements. Although we expect to implement the requisite changes
to become compliant with existing and new requirements when they do apply to us,
we may not be able to do so, or to do so in a timely manner .
OUR SERVICES OR SOLUTIONS MAY INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF
OTHERS.
We cannot be sure that our services and solutions, or the solutions of
others that we offer to our clients, do not infringe on the intellectual
property rights of third parties, and we may have infringement claims asserted
against us or against our clients. These claims may harm our reputation, cost us
money and prevent us from offering some services or solutions. In some
instances, the amount of these expenses may be greater than the revenues we
receive from the client. Any claims or litigation in this area, whether we
ultimately win or lose, could be time-consuming and costly, injure our
reputation or require us to enter into royalty or licensing arrangements. We may
not be able to enter into these royalty or licensing arrangements on acceptable
terms. To the best of our knowledge, we have never infringed upon the
intellectual property rights of another individual or entity.
10
WE COULD BE SUBJECT TO SYSTEMS FAILURES THAT COULD ADVERSELY AFFECT OUR
BUSINESS.
Our business depends on the efficient and uninterrupted operation of our
computer and communications hardware systems and infrastructure. We currently
maintain our computer systems in our facilities at our offices in New Jersey and
Texas. We do not have complete redundancy in our systems and therefore any
damage or destruction to our systems would significantly harm our business.
Although we have taken precautions against systems failure, interruptions could
result from natural disasters as well as power losses, telecommunications
failures and similar events. Our systems are also subject to human error,
security breaches, computer viruses, break-ins, "denial of service" attacks,
sabotage, intentional acts of vandalism and tampering designed to disrupt our
computer systems. We also lease telecommunications lines from local and regional
carriers, whose service may be interrupted. Any damage or failure that
interrupts or delays network operations could materially and adversely affect
our business.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE FAIL TO ADEQUATELY ADDRESS
SECURITY ISSUES.
We have taken measures to protect the integrity of our technology
infrastructure and the privacy of confidential information. Nonetheless, our
technology infrastructure is potentially vulnerable to physical or electronic
break-ins, viruses or similar problems. If a person or entity circumvents its
security measures, they could jeopardize the security of confidential
information stored on our systems, misappropriate proprietary information or
cause interruptions in our operations. We may be required to make substantial
additional investments and efforts to protect against or remedy security
breaches. Security breaches that result in access to confidential information
could damage our reputation and expose us to a risk of loss or liability.
RISKS RELATING TO ACQUISITIONS
WE FACE INTENSE COMPETITION FOR ACQUISITION CANDIDATES, AND WE MAY HAVE LIMITED
CASH AVAILABLE FOR SUCH ACQUISITIONS.
There is a high degree of competition among companies seeking to acquire
interests in information technology service companies such as those we may
target for acquisition. We are expected to continue to be an active participant
in the business of seeking business relationships with, and acquisitions of
interests in, such companies. A large number of established and well-financed
entities, including venture capital firms, are active in acquiring interests in
companies that we may find to be desirable acquisition candidates. Many of these
investment-oriented entities have significantly greater financial resources,
technical expertise and managerial capabilities than we do. Consequently, we may
be at a competitive disadvantage in negotiating and executing possible
investments in these entities as many competitors generally have easier access
to capital, on which entrepreneur-founders of privately-held information
technology service companies generally place greater emphasis than obtaining the
management skills and networking services that we can provide. Even if we are
able to compete with these venture capital entities, this competition may affect
the terms and conditions of potential acquisitions and, as a result, we may pay
more than expected for targeted acquisitions. If we cannot acquire interests in
attractive companies on reasonable terms, our strategy to build our business
through acquisitions may be inhibited. Pursuant to a secured convertible term
note dated August 16, 2004 with Laurus Master Fund, Ltd., as of November 26,
2004, the Company has $4,251,000 in restricted cash available that may be used
for acquisition targets only upon the approval of Laurus. As a result, our
ability to fund acquisitions may be hindered further.
WE WILL ENCOUNTER DIFFICULTIES IN IDENTIFYING SUITABLE ACQUISITION CANDIDATES
AND INTEGRATING NEW ACQUISITIONS.
A key element of our expansion strategy is to grow through acquisitions.
If we identify suitable candidates, we may not be able to make investments or
acquisitions on commercially acceptable terms. Acquisitions may cause a
disruption in our ongoing business, distract management, require other resources
and make it difficult to maintain our standards, controls and procedures. We may
not be able to retain key employees of the acquired companies or maintain good
relations with their clients or suppliers. It may be required to incur
additional debt and to issue equity securities, which may be dilutive to
existing stockholders, to effect and/or fund acquisitions.
11
WE CANNOT ASSURE YOU THAT ANY ACQUISITIONS WE MAKE WILL ENHANCE OUR BUSINESS.
We cannot assure you that any completed acquisition will enhance our
business. Since we anticipate that acquisitions could be made with both cash and
our common stock, if we consummate one or more significant acquisitions, the
potential impacts are:
o a substantial portion of our available cash could be used to
consummate the acquisitions and/or we could incur or assume
significant amounts of indebtedness;
o losses resulting from the on going operations of these acquisitions
could adversely affect our cash flow; and
o our stockholders could suffer significant dilution of their interest
in our common stock.
Also, we are required to account for acquisitions under the purchase
method, which would likely result in our recording significant amounts of
goodwill. The inability of a subsidiary to sustain profitability may result in
an impairment loss in the value of long-lived assets, principally goodwill and
other tangible and intangible assets, which would adversely affect our financial
statements.
RISKS RELATING TO OUR COMMON STOCK
OUR RELATIONSHIP WITH OUR MAJORITY STOCKHOLDERS PRESENTS POTENTIAL CONFLICTS OF
INTEREST, WHICH MAY RESULT IN DECISIONS THAT FAVOR THEM OVER OUR OTHER
STOCKHOLDERS.
Our principal beneficial owners, Scott Newman and Glenn Peipert, provide
management and financial assistance to us. When their personal investment
interests diverge from our interests, they and their affiliates may exercise
their influence in their own best interests. Some decisions concerning our
operations or finances may present conflicts of interest between us and these
stockholders and their affiliated entities. Given that our Board of Directors
only has one independent member, our ability to comply with state corporate law
and/or the requirements of the Sarbanes-Oxley Act of 2002 may be impaired.
THE LIMITED PRIOR PUBLIC MARKET AND TRADING MARKET MAY CAUSE POSSIBLE VOLATILITY
IN OUR STOCK PRICE.
There has only been a limited public market for our securities and there
can be no assurance that an active trading market in our securities will be
maintained. The Over The Counter Bulletin Board (OTCBB) is an unorganized,
inter-dealer, over-the-counter market which provides significantly less
liquidity than NASDAQ and the national securities exchange, and quotes for
securities quoted on the OTCBB are not listed in the financial sections of
newspapers as are those for NASDAQ and the national securities exchange. In
addition, the overall market for securities in recent years has experienced
extreme price and volume fluctuations that have particularly affected the market
prices of many smaller companies. The trading price of our common stock is
expected to be subject to significant fluctuations including, but not limited
to, the following:
o quarterly variations in operating results and achievement of key
business metrics;
o changes in earnings estimates by securities analysts, if any;
12
o any differences between reported results and securities analysts'
published or unpublished expectations;
o announcements of new contracts or service offerings by us or our
competitors;
o market reaction to any acquisitions, joint ventures or strategic
investments announced by us or our competitors;
o demand for our services and products;
o shares being sold pursuant to Rule 144 or upon exercise of warrants;
and
o general economic or stock market conditions unrelated to our
operating performance.
These fluctuations, as well as general economic and market conditions, may
have a material or adverse effect on the market price of our common stock.
THERE ARE LIMITATIONS IN CONNECTION WITH THE AVAILABILITY OF QUOTES AND ORDER
INFORMATION ON THE OTCBB.
Trades and quotations on the OTCBB involve a manual process and the market
information for such securities cannot be guaranteed. In addition, quote
information, or even firm quotes, may not be available. The manual execution
process may delay order processing and intervening price fluctuations may result
in the failure of a limit order to execute or the execution of a market order at
a significantly different price. Execution of trades, execution reporting and
the delivery of legal trade confirmation may be delayed significantly.
Consequently, one may not able to sell shares of our common stock at the optimum
trading prices.
THERE ARE DELAYS IN ORDER COMMUNICATION ON THE OTCBB.
Electronic processing of orders is not available for securities traded on
the OTCBB and high order volume and communication risks may prevent or delay the
execution of one's OTCBB trading orders. This lack of automated order processing
may affect the timeliness of order execution reporting and the availability of
firm quotes for shares of our common stock. Heavy market volume may lead to a
delay in the processing of OTCBB security orders for shares of our common stock,
due to the manual nature of the market. Consequently, one may not able to sell
shares of our common stock at the optimum trading prices.
PENNY STOCK REGULATIONS MAY IMPOSE CERTAIN RESTRICTIONS ON MARKETABILITY OF OUR
SECURITIES.
The SEC has adopted regulations which generally define a "penny stock" to
be any equity security that has a market price (as defined) of less than $5.00
per share or an exercise price of less than $5.00 per share, subject to certain
exceptions. As a result, our shares of common stock are subject to rules that
impose additional sales practice requirements on broker-dealers who sell such
securities to persons other than established clients and "accredited investors".
For transactions covered by these rules, the broker-dealer must make a special
suitability determination for the purchase of such securities and have received
the purchaser's written consent to the transaction prior to the purchase.
Additionally, for any transaction involving a penny stock, unless exempt, the
rules require the delivery, prior to the transaction, of a risk disclosure
document mandated by the SEC relating to the penny stock market. The
broker-dealer must also disclose the commission payable to both the
broker-dealer and the registered representative, current quotations for the
securities and, if the broker-dealer is the sole market maker, the broker-dealer
must disclose this fact and the broker-dealer's presumed control over the
market. Finally, monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks. Consequently, the "penny stock" rules may
restrict the ability of broker-dealers to sell our shares of common stock and
may affect the ability of investors to sell such shares of common stock in the
secondary market and the price at which such investors can sell any of such
shares.
13
Investors should be aware that, according to the SEC, the market for penny
stocks has suffered in recent years from patterns of fraud and abuse. Such
patterns include:
o control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer;
o manipulation of prices through prearranged matching of purchases and
sales and false and misleading press releases;
o "boiler room" practices involving high pressure sales tactics and
unrealistic price projections by inexperienced sales persons;
o excessive and undisclosed bid-ask differentials and markups by
selling broker-dealers; and
o the wholesale dumping of the same securities by promoters and
broker-dealers after prices have been manipulated to a desired
level, along with the inevitable collapse of those prices with
consequent investor losses.
Our management is aware of the abuses that have occurred historically in
the penny stock market.
THERE IS A RISK OF MARKET FRAUD.
OTCBB securities are frequent targets of fraud or market manipulation. Not
only because of their generally low price, but also because the OTCBB reporting
requirements for these securities are less stringent than for listed or NASDAQ
traded securities, and no exchange requirements are imposed. Dealers may
dominate the market and set prices that are not based on competitive forces.
Individuals or groups may create fraudulent markets and control the sudden,
sharp increase of price and trading volume and the equally sudden collapse of
the market price for shares of our common stock.
THERE IS LIMITED LIQUIDITY ON THE OTCBB.
When fewer shares of a security are being traded on the OTCBB, volatility
of prices may increase and price movement may outpace the ability to deliver
accurate quote information. Due to lower trading volumes in shares of our common
stock, there may be a lower likelihood of one's orders for shares of our common
stock being executed, and current prices may differ significantly from the price
one was quoted by the OTCBB at the time of one's order entry.
14
THERE IS A LIMITATION IN CONNECTION WITH THE EDITING AND CANCELING OF ORDERS ON
THE OTCBB.
Orders for OTCBB securities may be canceled or edited like orders for
other securities. All requests to change or cancel an order must be submitted
to, received and processed by the OTCBB. Due to the manual order processing
involved in handling OTCBB trades, order processing and reporting may be
delayed, and one may not be able to cancel or edit one's order. Consequently,
one may not able to sell shares of our common stock at the optimum trading
prices.
INCREASED DEALER COMPENSATION COULD ADVERSELY AFFECT THE STOCK PRICE.
The dealer's spread (the difference between the bid and ask prices) may be
large and may result in substantial losses to the seller of shares of our common
stock on the OTCBB if the stock must be sold immediately. Further, purchasers of
shares of our common stock may incur an immediate "paper" loss due to the price
spread. Moreover, dealers trading on the OTCBB may not have a bid price for
shares of our common stock on the OTCBB. Due to the foregoing, demand for shares
of our common stock on the OTCBB may be decreased or eliminated.
ADDITIONAL AUTHORIZED SHARES OF OUR COMMON STOCK AND PREFERRED STOCK AVAILABLE
FOR ISSUANCE MAY ADVERSELY AFFECT THE MARKET.
We are authorized to issue 1,000,000,000 shares of our common stock. As of
November 26, 2004, there were 772,082,096 shares of common stock issued and
outstanding. However, the total number of shares of our common stock issued and
outstanding does not include shares reserved in anticipation of the conversion
of notes or the exercise of options or warrants. As of November 26, 2004, we had
89,249,999 shares of common stock underlying convertible notes, and we have
reserved shares of our common stock for issuance in connection with the
potential conversion thereof. As of November 26, 2004, we had outstanding stock
options and warrants to purchase approximately 54,471,666 shares of our common
stock, the exercise price of which range between $0.105 and $0.20 per share, and
we have reserved shares of our common stock for issuance in connection with the
potential exercise thereof. Of the reserved shares, a total of 100,000,000
shares are currently reserved for issuance in connection with our 2003 Incentive
Plan, of which options to purchase an aggregate of 34,060,000 shares have been
issued under the plan. A significant number of such options and warrants contain
provisions for cashless exercise. To the extent such options or warrants are
exercised, the holders of our common stock will experience further dilution. In
addition, in the event that any future financing should be in the form of, be
convertible into or exchangeable for, equity securities, and upon the exercise
of options and warrants, investors may experience additional dilution.
The exercise of the outstanding convertible securities will reduce the
percentage of common stock held by our stockholders. Further, the terms on which
we could obtain additional capital during the life of the convertible securities
may be adversely affected, and it should be expected that the holders of the
convertible securities would exercise them at a time when we would be able to
obtain equity capital on terms more favorable than those provided for by such
convertible securities. As a result, any issuance of additional shares of common
stock may cause our current stockholders to suffer significant dilution which
may adversely affect the market.
In addition to the above-referenced shares of common stock which may be
issued without stockholder approval, we have 20,000,000 shares of authorized
preferred stock, the terms of which may be fixed by our Board of Directors. We
presently have no issued and outstanding shares of preferred stock and while we
have no present plans to issue any shares of preferred stock, our Board of
Directors has the authority, without stockholder approval, to create and issue
one or more series of such preferred stock and to determine the voting, dividend
and other rights of holders of such preferred stock. The issuance of any of such
series of preferred stock may have an adverse effect on the holders of common
stock.
15
SHARES ELIGIBLE FOR FUTURE SALE MAY ADVERSELY AFFECT THE MARKET.
From time to time, certain of our stockholders may be eligible to sell all
or some of their shares of common stock by means of ordinary brokerage
transactions in the open market pursuant to Rule 144, promulgated under the
Securities Act of 1933 (Securities Act), subject to certain limitations. In
general, pursuant to Rule 144, a stockholder (or stockholders whose shares are
aggregated) who has satisfied a one-year holding period may, under certain
circumstances, sell within any three-month period a number of securities which
does not exceed the greater of 1% of the then outstanding shares of common stock
or the average weekly trading volume of the class during the four calendar weeks
prior to such sale. Rule 144 also permits, under certain circumstances, the sale
of securities, without any limitation, by our stockholders that are
non-affiliates that have satisfied a two-year holding period. Any substantial
sale of our common stock pursuant to Rule 144 or pursuant to any resale
prospectus may have material adverse effect on the market price of our
securities.
DIRECTOR AND OFFICER LIABILITY IS LIMITED.
As permitted by Delaware law, our certificate of incorporation limits the
liability of our directors for monetary damages for breach of a director's
fiduciary duty except for liability in certain instances. As a result of our
charter provision and Delaware law, stockholders may have limited rights to
recover against directors for breach of fiduciary duty. In addition, our
certificate of incorporation provides that we shall indemnify our directors and
officers to the fullest extent permitted by law.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Plan of
Operation," and "Description of Business" in this prospectus are forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance, or achievements expressed or implied
by forward-looking statements. Such factors include, among other things, those
listed under "Risk Factors" and elsewhere in this prospectus.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," "proposed," "intended," or "continue" or
the negative of these terms or other comparable terminology. You should read
statements that contain these words carefully, because they discuss our
expectations about our future operating results or our future financial
condition or state other "forward-looking" information. There may be events in
the future that we are not able to accurately predict or control. Before you
invest in our securities, you should be aware that the occurrence of any of the
events described in these risk factors and elsewhere in this prospectus could
substantially harm our business, results of operations and financial condition,
and that upon the occurrence of any of these events, the trading price of our
securities could decline and you could lose all or part of your investment.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, growth rates,
levels of activity, performance or achievements. We are under no duty to update
any of the forward-looking statements after the date of this prospectus to
conform these statements to actual results.
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16
BUSINESS
Conversion Services International, Inc. is a technology and software firm
providing professional services to the Global 2000 as well as mid-market
clientele. Our core competency areas include strategic consulting, data
warehousing, business intelligence and data management consulting. Our clients
are primarily in the financial services, pharmaceutical, healthcare and
telecommunications industries, although we do have clients in other industries.
Our clients are primarily located in the northeastern United States. We enable
organizations to leverage their corporate information assets by providing
strategy, process, methodology, data warehousing, business intelligence,
enterprise reporting and analytic solutions. Our organization delivers value to
our clients, utilizing a unique combination of business acumen, technical
proficiency, experience and a proven set of "best practices" methodologies to
deliver cost effective services through either fixed price or time and material
engagements. We are committed to being a leader in data warehousing and business
intelligence consulting, allowing us to be a valuable asset and trusted advisor
to our customers.
We believe that our primary strengths that distinguish us from our
competitors are our:
o understanding of data management solutions;
o ability to provide solutions that integrate people, improve process
and integrate technologies;
o extensive service offerings as it relates to data warehousing,
business intelligence, strategy and data quality;
o our perspective regarding the accuracy of data and our data
purification process,
o best practices methodology, process and procedures;
o experience in architecting, recommending and implementing large and
complex data warehousing and business intelligence solutions; and
o ability to establish centers of excellence within client
organizations to address data quality and business intelligence.
Our goal is to be the premier provider of data warehousing, business
intelligence and related strategic consulting services, as well as data quality
products for organizations seeking to leverage and improve the quality of their
corporate information. In support of this goal we intend to:
o enhance our brand and mindshare;
o continue growth both organically and via acquisition;
o increase our geographic coverage;
o expand our client relationships;
o continue to enhance and expand the capabilities of the Evoke
Software Corporation software product;
o introduce new and creative service offerings; and
o leverage our strategic alliances.
We are committed to being a leader in data warehousing and business
intelligence consulting. As a data warehousing and business intelligence
specialist, we approach business intelligence from a strategic perspective,
providing integrated data warehousing and business intelligence strategy and
technology implementation services to clients that are attempting to leverage
their enterprise information. Our matrix of services includes strategy
consulting, data warehousing and business intelligence architecture and
implementation solutions, data quality solutions and data management solutions.
We have developed a methodology which provides a framework for each stage of a
client engagement, from helping the client conceive its strategy, to
architecting, engineering and extending its information. We believe that our
integrated methodology allows us to deliver reliable, robust, scalable, secure
and extensible business intelligence solutions in rapid timeframes based on
accurate information.
17
We are a Delaware corporation formerly named LCS Group, Inc. In January
2004, a privately held company named Conversion Services International, Inc.
("Old CSI") merged with and into our wholly owned subsidiary, LCS Acquisition
Corp. In connection with such transaction: (i) a 14-year old information
technology business became our operating business, (ii) the former stockholders
of Old CSI assumed control of our Board of Directors and were issued
approximately 84.3% of the outstanding shares of our common stock at that time
(due to subsequent events, that percentage of ownership has decreased), and
(iii) we changed our name to "Conversion Services International, Inc."
OUR SERVICES
As a full service data warehousing, business intelligence and strategy
consulting firm, we offer services in the following solution categories:
STRATEGIC CONSULTING
o Project Management (PMO) - Setting up internal office at a
client location, staffed with senior/certified project
managers that act in accordance with the policies and
procedures identified in CSI Best Practices for Project
Management.
o Data Warehousing and Business Intelligence Strategic Planning
- Helping clients develop a strategic roadmap to align with a
data warehouse or business intelligence implementation. These
engagements are focused on six strategic domains that have
been identified and documented by CSI: Business Case, Program
Formulation, Organizational Design, Program Methodologies,
Architecture and Operations and Servicing.
o Business Technology Alignment - A strategic offering that
consists of a series of interviews including both the business
and technology constituents. The purpose is to collect
information regarding user satisfaction, user requirements and
expectations, as well as the technology groups understanding
of needs and current and future deliverables. The result is a
document that outlines recommendations that will better align
both groups and deliver more perceived value.
o Tool Analysis and Recommendation - Gather business and
technical requirements and measure those requirements against
the capabilities of available tools in the current
marketplace. Tools evaluated and recommended include
reporting, ad-hoc query, analytics, ETL, data profiling,
database and data modeling.
o Integration Management, M&A - Work with clients to implement
best practices for mergers and acquisitions. Support all
aspects of the integration process from initial assessment
through implementation support.
o Compliance (HIPAA, Basel II, Sarbanes-Oxley) - Work with
clients to analyze, design and implement operational control
and procedures that will align organization with new
regulatory requirements.
o Process Improvement (Lean, Six Sigma) - Provide a full array
of product and service in support of Lean and Six Sigma,
including training, process improvement, project management
and implementation support.
o Organizational Analysis and Assessment (M&A) - Work with
clients to implement best practices for mergers and
acquisitions. Support all aspects of the integration process
from initial assessment through implementation support.
o Acquisition Readiness - Work with clients to better prepare
them for large scale acquisitions in the financial services
domain. This includes building best practices, mapping and
gapping and implementing a strategic roadmap to integrate
multiple companies.
18
o Information, Process and Infrastructure (IPI) Diagrams - A
blueprinting process and service that facilitates and
accelerates the strategic planning process.
o RFP creation and responses - Gather user and technical
requirements and develop a Request For Proposal (RFP) on
behalf of our clients. Respond to client RFPs with detailed
project plans, solutions and cost.
o Training and Education - Provide formal classroom training for
Business Objects and Evoke. Provide mentoring in data
warehousing and business intelligence methodologies and best
practices as well as technology tool training including
business intelligence tools such as Cognos, MicroStrategy and
Evoke.
BUSINESS INTELLIGENCE
o Architecture and Implementation - Develop architecture plans
and install all tools required to implement a business
intelligence solution. Develop the business intelligence
solution in tools such as Cognos, Business Objects,
MicroStrategy, Crystal Reports and Spotfire.
o Ad-Hoc Query and Analysis - Identify and document ad-hoc query
requirements, architect a supporting database structure to
support the identified hierarchies, implement an ad-hoc query
tool, provide training and education.
o Enterprise Reporting Solutions - Identify and document
reporting requirements, architect a supporting database
structure to support the identified hierarchies, implement an
enterprise reporting tool, provide training and education.
o Online Analytical Processing - Identify and document analytic
requirements, architect a supporting database structure to
support the identified hierarchies, drill-downs and slice and
dice requirements, implement an analytical tool, provide
training and education.
o Analytics and Dashboards - Identify and document dashboard
requirements. These requirements are typically driven by Key
Performance Indicators (KPIs) identified by upper management.
Architect a supporting database structure to support the
identified hierarchies, drill-downs and slice and dice
requirements, implement a dashboard tool, provide training and
education.
o Business Performance Management - Leveraging a new or existing
business intelligence implementation to monitoring and
managing both business process and IT events through key
performance indicators.
o Business Intelligence Competency Center - Set up an internal
office at a client location, staffed with a mix of senior
business intelligence developers and business intelligence
architects that will implement best practices, policies,
procedures, standards and provide training and mentoring to
further increase the use of the data warehouse and facilitate
the business owners embracing of the Business Intelligence
solution.
o Proof of Concepts and Prototypes - Gather requirements, design
and implement a small scale business intelligence
implementation called a Proof of Concept. The Proof of Concept
will validate the technology and/or business case, as well as
"sell" the concept of business intelligence to management.
o BI Strategy - Helping clients develop a roadmap to leverage a
business intelligence platform throughout the enterprise
aligning the client with best practices.
o Data Mining - Implementing data mining tools that extraction
implicit, previously unknown, and potentially useful
information from data. These tools typically use statistical
and visualization techniques to discover and present knowledge
in a form which is easily comprehensible to humans. Business
intelligence tools will answer questions based on information
that has already been captured (history), data mining tools
will discover information and project information based on
historic information.
19
DATA WAREHOUSING
o DW Design, Development and Implementation - Design, develop
and implementation of custom data warehouse solutions. These
solutions are based on our methodology and best practices.
o Departmental Data Warehousing - Design, develop and
implementation of custom data mart solutions. Data mart
solutions typically encompass a subject area or department.
These solutions are based on our methodology and best
practices.
o Federated Data Warehousing - When implementing a federated
data warehouse environment, multiple data warehouses will be
implemented to support multiple functions within an
organization. Functional analysis will then be performed over
multiple warehouse environments.
o Conforming Facts/Dimensions - Conformed dimensions can be used
to analyze facts from two or more data marts. In a multi-data
mart environment, all marts require a "customer" dimension and
a "time" dimension. If they are the same dimension, then you
have conforming dimensions, allowing you to extract and
manipulate facts relating to a particular customer from
multiple marts. Conforming a fact is standardizing the
definitions of terms across individual marts. Often, different
divisions or departments use the same term in different ways.
This process leads a client to "the single version of the
truth".
o Proof of Concepts and Prototypes - Gather requirements,
design, and implement a small scale data warehouse that called
a Proof of Concept. The Proof of Concept will validate the
technology and/or business case, as well as "sell" the concept
of data warehousing to management.
o Data Mart Delivery - Design, develop and implementation of
custom data mart solutions. Data mart solutions typically
encompass a subject area or department. These solutions are
based on our methodology and best practices.
o Outsourcing - Implementing and supporting a client data
warehouse solution at a CSI location.
o Extract, Transformation and Loading - We have expertise and
best practices integrating ETL tools with other data warehouse
tools, as well as leveraging ETL tools for each specific
engagement.
o Data Warehouse Framework - A concept that is applied to a data
warehouse engagement whereby we will create an architecture
document and best practices surrounding the integration of all
tools leveraged in a data warehouse implementation.
DATA MANAGEMENT
o Data Quality Center of Excellence - Set up an internal office
at a client location, staffed with a mix of senior data
quality developers and data quality architects that will
implement best practices, policies, procedures, standards and
provide training and mentoring to further increase the level
of data quality throughout the enterprise and increase the
awareness and importance of data quality as it pertains to
decision making.
o Data Profiling - An automated data analysis process that
significantly accelerates the data analysis process.
o Data Quality / Cleansing - Leveraging our best practices to
identify data quality concerns and provide rules to cleanse
and purify the information.
o Data Transformation - CSI has expertise and best practices
performing data transformations. The tools typically include
data profiling, ETL and data cleansing tools.
o Data Migrations and Conversions - Design, develop and
implementation of custom data migrations. These solutions are
based on our methodology and best practices.
20
o Metadata Management - Based on our Data Warehouse Framework,
we will build a metadata repository that is integrated with
all tools used in a data warehouse implementation and will be
leveraged by the business intelligence environment.
o Enterprise Information Integration (EII) - Enterprise
Information Integration tools are used to integrate
information by providing a logical view of data without moving
any data. This is particularly useful when bridging a business
intelligence tool to multiple data marts or data warehouses.
o Integration Management - Creating a roadmap to integrate
information across the enterprise, applications or business
functions and implementing the roadmap.
o Enterprise Information Architecture - Leveraging our
Information, Process and Infrastructure (IPI) Diagrams to
create a "snapshot" of the current information flow and
desired implementation flow throughout the enterprise. The
result is a strategic roadmap with recommendations and
statements of work.
o Quality Assurance Testing (Verification, Validation,
Certification) - We have developed a quality assurance process
referred to as Verification, Validation, Certification (VVC)
of information. This is a repeatable process that will insure
that all data has been validated to be accurate, consistent
and trusted.
o Infrastructure Management and Support - An infrastructure must
be in place to support any data warehouse or data management
initiative. This may include servers, cables, disaster
recovery or any process and procedure needed to support these
types of initiatives.
o Application Development - Custom application development or
integration to support data management or data warehouse
initiatives. This may include modification of existing
enterprise applications to capture additional information
required in the warehouse or may be a standalone application
developed to facilitate improved integration of existing
information.
The following illustrates what percentage of revenues each category of
services comprises our overall revenues:
Category of Services Percentage of Revenues for the Percentage of Revenues for the
nine months ended September 30, three months ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Strategic Consulting 34.7% 11.1% 45.5% 10.0%
Business Intelligence 17.0% 25.2% 12.7% 36.3%
Data Warehousing 16.3% 11.1% 16.6% 9.4%
Data Management 32.0% 52.6% 25.2% 44.3%
RECENT ACQUISITIONS
We will also continue to pursue strategic acquisitions that strengthen our
ability to compete and extend our ability to provide clients with a core
comprehensive services offering. In February 2004, we added personnel of the
business intelligence consulting division of Software Forces, LLC, an award
winning partner of Crystal Decisions.
21
In November 2003, the Company executed an Independent Contractor Agreement
with Leading Edge Communications Corporation (LEC), whereby CSI agreed to be a
subcontractor for LEC, and to provide consultants as required to LEC. In return
for these services, CSI receives a fee from LEC based on the hourly rates
established for consultants subcontracted to LEC.
CSI acquired 49% of all issued and outstanding shares of common stock of
LEC as of May 1, 2004. The acquisition was completed through a Stock Purchase
Agreement between CSI and Mary Ferrara, the sole stockholder of LEC. In
connection with the acquisition, CSI (i) repaid a bank loan on behalf of the
seller in the amount of $35,000; (ii) repaid an LEC bank loan in the amount of
$38,000; and (iii) satisfied an LEC obligation for $10,000 of prior compensation
to an employee.
In March 2004, through our subsidiary DeLeeuw Conversion LLC ("DeLeeuw
Sub"), we acquired DeLeeuw Associates, Inc. ("DeLeeuw Associates"), a management
consulting firm in the information technology sector with core competency in
delivering Change Management Consulting, including both Six Sigma and Lean
domain expertise to enhance service delivery, with proven process methodologies
resulting in time to market improvements within the financial services and
banking industries. The acquisition (the "DeLeeuw Acquisition") was completed
pursuant to that certain Acquisition Agreement by and between CSI, DeLeeuw and
Robert C. DeLeeuw (the "Acquisition Agreement"). In connection with the DeLeeuw
Acquisition, we: (i) paid Mr. DeLeeuw, as the sole stockholder of DeLeeuw
Associates, $1,900,000, $500,000 of which has been deposited into an escrow
account for a period of one year and may be reduced based upon claims for
indemnification that may be made pursuant to the Acquisition Agreement; (ii)
issued 80,000,000 shares of our common stock to Mr. DeLeeuw, 7,200,000 of which
have been deposited into an escrow account for a period of one-year and may be
reduced based upon claims for indemnification that may be made pursuant to the
Acquisition Agreement; and (iii) issued options to purchase 2,000,000 shares of
our common stock to certain employees of DeLeeuw Associates. DeLeeuw Sub changed
its name to "DeLeeuw Associates, LLC."
In June 2004, through our subsidiary Evoke Asset Purchase Corp.
("Acquisition Sub"), we acquired substantially all of the assets and assumed
substantially all of the liabilities of Evoke Software Corporation, a
privately-held California corporation ("Evoke") which designs, develops, markets
and supports software programs for data analysis, data profiling and database
migration applications and provides related support and consulting services. The
acquisition (the "Evoke Acquisition") was completed pursuant to that certain
Asset Purchase Agreement (the "Asset Purchase Agreement") by and between CSI,
Acquisition Sub and Evoke. In connection with the Evoke Acquisition, we: (i)
issued 72,543,956 shares of our common stock to Evoke, 7,150,000 of which have
been deposited into an escrow account for a period of one-year and may be
reduced based upon claims for indemnification that may be made pursuant to the
Asset Purchase Agreement; (ii) issued 5% of the outstanding shares of
Acquisition Sub to Evoke; (iii) issued 3,919,093 shares of our common stock to
certain executives of Evoke as a severance payment and to certain employees as
retention shares; (iv) agreed to pay $448,154 in deferred compensation ($189,583
to be paid over a seven month period and the remainder to be paid over a twelve
month period) to certain employees of Evoke; and (v) assumed substantially all
of Evoke's liabilities. Acquisition Sub changed its name to "Evoke Software
Corporation." Approximately 5,500,000 shares issued to WHRT I Corp. are subject
to a lock-up period after the Registration Statement is effective, in which such
shares shall be released and freely tradable one month following the effective
date of this Registration Statement. The remainder of the shares issued to WHRT
I Corp. are subject to a lock-up period after this Registration Statement is
effective as follows (the following assumes the Registration Statement has been
declared effective by the SEC): (i) 20% shall be released and freely tradable on
October 1, 2004; (ii) 20% shall be released and freely tradable on January 1,
2005; (iii) 20% shall be released and freely tradable on April 1, 2005; (iv) 20%
shall be released and freely tradable on July 1, 2005; and (v) 20% shall be
released and freely tradable on October 1, 2005.
22
Integration of DeLeeuw's Change Management Consulting practices with CSI's
Data Warehousing and Business Intelligence core competency "The Center for Data
Warehousing" will continue throughout 2004. The Change Management, Six Sigma and
Lean methodology have been introduced to our clients along with our innovative
Information, Process and Infrastructure (IPI) Diagrams, which provide detailed
blueprints of our client's information, business processes and infrastructure on
a single highly detailed diagram. These diagrams can be leveraged for risk
management, compliance, validation, planning and budgeting requirements. The IPI
diagram offering, launched in the first quarter of 2004, continues to receive
favorable reaction from our clients. In addition, we expanded our Data Warehouse
Assessment, Business Technology Alignment (BTA) and Quality Management Offering
(QMO) related offerings will be the focus of our marketing and communications
programs for 2004. A QMO offering is a combination of methodologies, best
practices and automated techniques leveraged to establish and enforce standards
and procedures as it relates to elevating the quality of executive information
in an efficient and effective manner. We believe that these offerings will drive
greater understanding and demand for both data warehousing and business
intelligence implementations by delivering best practices methodologies, tools
and techniques to reduce risk, time to market and total cost of ownership of
these engagements. Our business strategy is to continue to enhance and expand
our offerings which include best practices, process improvement, methodologies,
advisory services and implementation expertise.
Evoke is managed and operated as a subsidiary company, but its integration
is limited to infrastructure and back office operations. CSI has a multi-year
record of leveraging the Evoke suite of products, which will continue under a
Value Added Reseller and Systems Integration partnership. In addition to the
existing Evoke field and engineering personnel, a number of business development
and support resources are being transitioned into Evoke to bolster the
organizational infrastructure required to advance the companies growth plans.
The data analysis and profiling technology developed and marketed by Evoke is
receiving economic and development assistance from CSI to enhance and extend the
current technology platform. As a result, Evoke released a new version of Axio
in September 2004. The major emphasis will be on automating many of the project
related tasks associated with data proofing, as well as the introduction of a
workflow driving user interface to reduce the learning curve and increase time
to proficiency. Evoke is planning to include data cleansing and operational data
quality monitoring, as well as quality scorecard modules, to the existing data
quality platform. The combined expertise and synergy between CSI and Evoke has
also resulted in the introduction of value based services offerings. These
offerings include: Best Practices Methodology, Quality Improvement Programs
(QIP) and Quick Start Services Programs to accelerate Return on Investment and
knowledge transfer.
We believe that as new opportunities are created, Global 2000 companies
will continue the trend of expanding the utilization of external consulting
expertise to support corporate initiatives focused on maximizing Return On
Investment (ROI), leveraging existing technology infrastructure though
optimizations and best practices and will continue to leverage and derive value
from corporate information assets such as data warehousing, business
intelligence and analytics. We believe that we are uniquely positioned to expand
our client foot print by delivering unique business value resulting from our 15
years of domain expertise, proven best practices, methodologies, processes and
automation within data warehousing architecture and implementation. Our ability
to apply Six Sigma and Lean core competency to client processes and
implementation strategies further strengthens our competitive standing. With our
recently acquired subsidiary Evoke, CSI is well positioned to support the
increasing industry emphasis on data quality and the use of automation to reduce
the costs associated with data warehouse and business intelligence projects,
data migrations and conversions, as well as packaged application implementations
such as Enterprise Resource Planning (ERP), Customer Relationship Management
(CRM) and Supply Chain Management (SCM) by leveraging the automation and
validation gained by the use of data profiling technology.
23
RECENT FINANCINGS
In May 2004, pursuant to the complete conversion of a $2,000,000 unsecured
convertible line of credit note issued in October 2003 at $0.12 per share,
Taurus Advisory Group, LLC ("Taurus") received 16,666,666 shares of our common
stock, plus interest paid in cash. Because we failed to perform a private
investment in public equity transaction by September 1, 2004, the conversion
price on the October 2003 note was adjusted to a fixed conversion price of
$0.105 per share, and 2,380,953 additional shares of common stock were issued to
Taurus. No additional proceeds were received by us. In addition, Taurus received
a warrant to purchase 4,166,666 shares of our common stock, which has an
exercise price of $0.105 per share. This warrant expires in June 2009. Further
in May 2004, we raised an additional $2.0 million pursuant to a new five-year
unsecured promissory note with Taurus. In June 2004, we replaced the May 2004
note by issuing a five-year $2.0 million unsecured convertible line of credit
note with Taurus. The note accrues interest at an annual rate of 7%, and the
conversion price of the shares of common stock issuable under the note is equal
to $0.105 per share.
In August 2004, we replaced our $3,000,000 line of credit with North Fork
Bank with a revolving line of credit with Laurus Master Fund, Ltd. ("Laurus"),
whereby we have access to borrow up to $6,000,000 based upon eligible accounts
receivable. This revolving line, effectuated through a $2,000,000 convertible
minimum borrowing note and a $4,000,000 revolving note, provides for advances at
an advance rate of 90% against eligible accounts receivable, with an annual
interest rate of prime rate (as reported in the Wall Street Journal) plus 1%,
and maturing in three years. The interest rate on these notes will be decreased
by 1.0% for every 25% increase in our stock price above the fixed conversion
price prior to an effective registration statement and 2.0% thereafter up to a
minimum of 0.0%. This line of credit is secured by substantially all the
corporate assets. Both the $2,000,000 convertible minimum borrowing note and the
$4,000,000 revolving note provide for conversion at the option of the holder of
the amounts outstanding into our common stock at a fixed conversion price of
$0.14 per share. In the event that we issue common stock or derivatives
convertible into our common stock for a price less than the aforementioned fixed
conversion price, then the fixed conversion price is reset using a weighted
average dilution calculation. Additionally, in exchange for a secured
convertible term note bearing interest at prime rate (as reported in the Wall
Street Journal) plus 1%, Laurus has made available to us an additional
$5,000,000 to be used for acquisitions. This note is convertible into our common
stock at a fixed conversion price of $0.14 per share. In the event that we issue
common stock or derivatives convertible into our common stock for a price less
than the fixed conversion price, then the fixed conversion price is reset to the
lower price on a full-ratchet basis. This note matures in three years. The
proceeds of this loan are restricted for use for approved acquisition targets
identified by us that are approved by Laurus. A portion of Laurus's revolving
line of credit were used to pay off all outstanding borrowings from North Fork
Bank. We issued Laurus a common stock purchase warrant that provides Laurus with
the right to purchase 12,000,000 shares of our common stock. The exercise price
for the first 6,000,000 shares acquired under the warrant is $0.29 per share,
the exercise price for the next 3,000,000 shares acquired under the warrant is
$0.31 per share, and the exercise price for the final 3,000,000 shares acquired
under the warrant is $0.35 per share. The common stock purchase warrant expires
on August 15, 2011. We paid $749,000 in brokerage and transaction closing
related costs. These costs were deducted from the $5,000,000 restricted cash
balance being provided to us by Laurus.
24
In September 2004, we issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, "Sands") three subordinated secured convertible promissory notes
equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, subordinate to Laurus. The Notes are convertible into shares
of our common stock at the election of Sands at any time following the
consummation of a convertible debt or equity financing with gross proceeds of $5
million or greater (a "Qualified Financing"). The conversion price of the shares
of our common stock issuable upon conversion of the Notes shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to convert the
Notes at a fixed conversion price of $0.14 per share. In the event that we issue
stock or derivatives convertible into our stock for a price less the
aforementioned fixed conversion price, then the fixed conversion price is reset
using a weighted average dilution calculation. We also issued Sands three common
stock purchase warrants (the "Warrants") providing Sands with the right to
purchase 6,000,000 shares of our common stock. The exercise price of the shares
of our common stock issuable upon exercise of the Warrants shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to exercise the
Warrants at a fixed conversion price of $0.14 per share. The latest that the
Warrants may expire is September 8, 2008. Finally, we engaged Sands Brothers
International Limited as our non-exclusive financial advisor at $6,000 per month
for a period of one year.
On November 8, 2004, we entered into a Stock Purchase Agreement (the
"Agreement") with a private investor, CMKX-treme, Inc. Pursuant to the
Agreement, CMKX-treme, Inc. agreed to purchase 12,500,000 shares of common stock
for a purchase price of $1,750,000. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for
$500,000, and it is required to purchase the remaining 8,928,572 shares of
Common Stock for $1,250,000 by December 31, 2004.
CLIENTS
For more than 14 years, we have helped our clients develop strategies and
implement technology solutions to help them leverage corporate information.
Our clients are primarily in the financial services, pharmaceutical,
healthcare and telecommunications industries and are primarily located in the
northeastern United States. During the nine month period ended September 30,
2004, two of our clients, Leading Edge Communications Corporation (17.9%) and
Bank of America (13.4%), accounted collectively for approximately 31% of total
revenues (unaudited). During the nine month period ended September 30, 2003
(unaudited), one of our clients, Verizon Wireless, accounted for approximately
30% of total revenues. For the year ended December 31, 2003, two of our clients,
Morgan Stanley (11.2%) and Verizon Wireless (29.2%), accounted collectively for
approximately 41% of our total revenues. During the fiscal year ended December
31, 2002, two of our clients, Morgan Stanley (27.4%) and Verizon Wireless
(31.6%), accounted collectively for approximately 59% of our total revenues. As
we continue to pursue and consummate acquisitions, our dependence on these
customers should be less significant. We do not have long-term contracts with
any of these customers. The loss of any of our largest customers could have a
material adverse effect on our business. We have not had any collections
problems with any of these customers to date.
25
MARKETING
We currently market our services through our Director of Marketing and
Corporate Communications, investors relations firm and public relations firm,
and our sales force comprised of 10 employees, and we also receive new business
through client referrals. We are planning to use the investor relations firm and
the public relations firm in order to expand our brand awareness, and are
further engaging, or expect to engage, in the following sales related programs
and activities:
o Web Site Promotion: Our website (WWW.CSIWHQ.COM) has recently been
reformatted to reflect our vision and business plan. We are
currently promoting our website through various internet search
engines.
o Trade Show Participation: We expect that exposure in trade shows
should further solidify our position in our industry. In the proper
setting, the trade show can be viewed as a mobile mini-showroom
concept to demonstrate our services. There are a number of
significant trade show events within our target industry that
provide significant exposure to prospective customers in major
metropolitan markets, media and press exposure and collaborative
networking with technology partners. As with most trade show events,
the higher level of sponsorship, the greater exposure and benefits
received, such as the location of our booth, banner and advertising
space. We participated as a Gold Level Sponsor for the Digital
Consulting Institute (DCI) Customer Relationship Management
Conference and Technology Showcase in New York in May 2004, and we
enrolled as Gold Level Sponsor for DCI's Business Intelligence and
Data Warehouse Conference in Boston in September 2004.
o Seminars with Vendors: We expect that joint seminars with leading
software vendors should also stimulate new business lead
generations. We also expect to enhance our perception as an expert
in individual product areas.
o Vendor Relations: We are identifying key vendor relationships. With
the ability to leverage our fourteen year history, we intend to
continue to forge and maintain relationships with technical, service
and industry vendors. We have solidified and continue to develop
strategic relationships with technology vendors in the data
warehousing and business intelligence arena. These relationships
designate our status as a systems integration and/or reseller which
authorizes us to provide consulting services and to resell select
vendor software. We employ certified consultants in our vendor
partner technology platforms. We currently maintain relationships
with the following:
DATABASE VENDORS:
IBM- We are an Indirect Passport Advantage
Reseller Partner which enables us to
resell IBM software products. We also
employ consulting staff trained and
certified in IBM technology.
ORACLE- We are part of the Oracle Partner
Program (OPP) as a Certified Solution
Provider (CSP). We also employ certified
Oracle professionals and our partnership
allows us to utilize Oracle support
channels for technical advisement.
MICROSOFT- We are a Microsoft Certified Solution
Provider. We maintain the required
number of Microsoft certified
professionals to hold this designation.
SYBASE- We have a Systems Integration Agreement
and employ professionals trained in the
vendor's technology.
BUSINESS INTELLIGENCE VENDORS:
BUSINESS OBJECTS- We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology. In
addition, we are a Certified Onsite
Education Partner, which allows us to
directly market and provide a certified
training partner, which enables us to
provide onsite training classes in the
respective vendor technology.
26
COGNOS - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
MICROSTRATEGY - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
SPOTFIRE - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
DATA WAREHOUSING VENDORS:
INFORMATICA - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
ASCENTIAL
SOFTWARE - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
EVOKE SOFTWARE - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology.
COMPUTER
ASSOCIATES - We are an affiliate partner. We employ
and maintain a staff of professionals
that are certified in the vendor's
technology.
SIMILARITY
SYSTEMS - We are a Systems Integration and
Reseller Partner. We employ and maintain
a staff of professionals that are
certified in the vendor's technology. In
addition, Evoke Software, our majority
owned subsidiary, is a Reseller for
Similarity Systems and Similarity
Systems is a reseller of Evoke Axio.
o Expanded Direct Sales Activities: We are developing a campaign for
our sales personnel that will include lead generation, cross selling
and up-selling. We conduct direct sales activities, such as cold
call, networking and attending partnership functions to generate
leads for direct sales opportunities. We have developed marketing
campaigns, both in collaboration as well as independently, such as
email blasts, seminars and direct mail campaigns. In addition, we
have developed a number of best practices service offerings which
encompass selection, deployment, implementation, maintenance and
knowledge transfer. In some cases, these service offerings include
methodologies and best practices for integrating several vendor
technology platforms resulting in cross selling and up selling
opportunities when applicable. We maintain vendor independence by
consistently evaluating the respective vendors technology in our lab
located at our headquarters in East Hanover New Jersey. We regularly
attend vendor partnership events, including partner summits and user
group meetings, in support of our partnership programs.
PROTECTION AGAINST DISCLOSURE OF CLIENT INFORMATION
As our core business relates to the storage and use of client information,
which is often confidential, we have implemented policies to prevent client
information from being disclosed to unauthorized parties or used
inappropriately. Our employee handbook, which every employee receives and signs
an acknowledgement of, mandates that it is strictly prohibited for employees to
disclose client information to third parties. Our handbook further mandates that
disciplinary action be taken against those who violate such policy, including
possible termination. Our outside consultants sign non-disclosure agreements
prohibiting disclosure of client information to third parties, among other
things, and we perform background checks on employees and outside consultants.
27
INTELLECTUAL PROPERTY
Our trademark registration applications for the marks "TECH SMART BUSINESS
WISE", "QUALITY MANAGEMENT OFFICE" AND "QMO" are presently pending before the
United States Patent and Trademark Office. Further, we have over 30 domestic and
foreign trademarks relating to Evoke Software Corporation and its products. We
use non-disclosure agreements with our employees, independent contractors and
clients to protect information which we believe are proprietary or constitute
trade secrets.
COMPETITION
To our knowledge, there are no publicly-traded competitors that focus
solely on data warehousing and business intelligence consulting and strategy.
However, we have numerous competitors in the general marketplace, including data
warehouse and business intelligence practices within large international,
national and regional consulting and implementation firms, as well as smaller
boutique technology firms. Many of our competitors are large companies that have
substantially greater market presence, longer operating histories, more
significant client bases, and financial, technical, facilities, marketing,
capital and other resources than we have. We believe that we compete with these
firms on the basis of the quality of its services, industry reputation and
price. We believe our competitors include firms such as:
o Accenture,
o Cap Gemini Ernst & Young,
o IBM Global Services,
o Keane,
o Bearing Point, and
o Answerthink.
EMPLOYEES
As of September 30, 2004, we had 44 outside consultants, 124 consultants
on the payroll and 57 non-consultant employees. Outside consultants are not our
employees, and as such, do not receive benefits or have taxes withheld. These
consultants are members or employees of separate corporations, they are
responsible for providing us with a current certificate of insurance and they
are responsible for filing their own taxes. We maintain relationships with these
consultants and their status is updated in a proprietary data base application
that we have built. Consultants on the payroll are our full time employees who
are consultants. Such consultants are billable to clients, and they receive full
benefits and have taxes withheld similar to other employees.
None of our employees are represented by a labor union or subject to a
collective bargaining agreement. We have never experienced a work stoppage and
we believe that our relations with employees are good.
LEGAL PROCEEDINGS
On June 29, 2004, Viant Capital LLC commenced legal action against us in
the United States District Court for the Southern District of New York. Through
an agreement with Viant, Viant had the exclusive right to obtain private equity
transactions on our behalf from February 18 to May 17, 2004. Viant alleges that
it is owed a fee of approximately $450,000 relating to our loan from a private
investor in May 2004. Management believes that this loan does not qualify as a
private equity transaction and we intend to vigorously defend this action. As of
November 26, 2004, there have been no material developments in the suit. The
Company has estimated the probable loss related to this suit to be the agreed
upon contract signing fee of $75,000 and has recorded a liability for this
amount.
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DESCRIPTION OF PROPERTY
The Company's corporate headquarters are located at 100 Eagle Rock Avenue,
East Hanover, New Jersey 07936, where it operates under an amended lease
agreement expiring December 31, 2010. Our monthly rent with respect to our East
Hanover, New Jersey facility is $24,965. In addition to minimum rentals, the
Company is liable for its proportionate share of real estate taxes and operating
expenses, as defined. DeLeeuw Associates, LLC has an office at Suite 1460,
Charlotte Plaza, 201 South College Street, Charlotte, North Carolina 28244.
DeLeeuw leases this space which has a stated expiration date of December 31,
2005. Our monthly rent with respect to our Charlotte, North Carolina facility is
$2,831.
Evoke leases offices in the following locations: Riata Corporate Park
Building VII, 12357-III Riata Trace Parkway, Austin, Texas; 1900 13th Street,
Boulder, Colorado; and Am Soldnermoos 17, D-85399 Hallbergmoos, Germany. The
expiration dates for these leases are July 2006, July 2006 and May 2005. Monthly
rentals for these offices are $22,872, $5,284 and $2,000, respectively.
Rent expense, including automobile rentals, totaled approximately
$1,152,000 and $1,239,000 in 2003 and 2002, respectively. The Company is
committed under several operating leases for automobiles that expire during
2007.
See Notes 8 and 13 to Consolidated Financial Statements.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OVERVIEW OF OUR BUSINESS
Management's Discussion and Analysis contains statements that are
forward-looking. These statements are based on current expectations and
assumptions that are subject to risks and uncertainties. Actual results could
differ materially because of factors discussed in "Issues and Uncertainties" and
elsewhere in this report. The Company undertakes no duty to update any
forward-looking statement to conform the statement to actual results or changes
in the Company's expectations.
Conversion Services International, Inc. provides professional services to
the Global 2000 as well as mid-market clientele relating to strategic
consulting, data warehousing, business intelligence and data management
consulting, and, as a result of its acquisition of Evoke Software Corporation,
the sale of software which is used to survey and quantify the quality of data.
This software is a tool that is used to identify problems with company data
prior to being transferred into a data warehouse. The Company's clients are
primarily in the financial services, pharmaceutical and telecommunications
industries, although it has clients in other industries as well. The Company's
clients are primarily located in the northeastern United States. The Company
enables organizations to leverage their corporate information assets by
providing strategy, process and methodology, best practices data warehousing,
business intelligence, enterprise reporting and analytic solutions. The
Company's business and technology offerings help clients improve performance and
maximize returns on technology investments.
The Company began operations in 1990. Its services were originally focused
on e-business solutions and data warehousing. In the late 1990s, the Company
strategically repositioned itself to capitalize on its data warehousing
expertise in the fast growing business intelligence/data warehousing space. The
Company became a public company via its merger with a wholly owned subsidiary of
LCS Group, Inc., effective January 30, 2004.
The Company's core strategy includes capitalizing on the already
established in-house business intelligence/data warehousing ("BI/DW") technical
expertise and its seasoned sales force. This is expected to result in organic
growth through the addition of new customers. In addition, this foundation will
be leveraged as the Company pursues targeted strategic acquisitions.
The Company derives a substantial portion of its revenue from professional
services engagements. Its revenue depends on the Company's ability to generate
new business, in addition to preserving present client activities. The general
domestic economic conditions in the industries the Company serves, the pace of
technological change, and the business requirements and practices of its clients
and potential clients directly affect this. When economic conditions decline,
companies generally decrease their technology budgets and reduce the amount of
spending on the type of information technology (IT) consulting the Company
provides. The Company's revenue is also impacted by the prices it obtains for
its services and by the size and chargeability, or utilization rate, of its
professional workforce. During periods of economic decline and reduced client
spending, competition for new engagements increases, and it becomes more
difficult to maintain its billing rates and sustain appropriate utilization
rates. If the Company is unable to maintain its billing rates or sustain
appropriate utilization rates for its professionals, its overall profitability
may decline. The Company is beginning to see improvements in economic
conditions, which have recently led to increased spending on consulting services
in certain verticals, particularly in financial services.
30
Although the Company is beginning to experience the benefits of some
positive economic indicators, it continues to experience pricing pressures as
competition for new engagements remains strong and as movements toward the use
of lower-cost service delivery personnel continue to grow within its industry.
Despite strong pricing pressures, the Company has improved its consolidated
billing rates in 2004 when compared to the prior year. The Company's growing
national presence and experienced, highly skilled workforce have enabled it to
successfully differentiate its value and capabilities from those of its
competitors, in effect, lessening the impact of current market pricing
pressures. Billing rates for the Company's operations improved 8.3% for the
three months ended September 30, 2004 when compared to the three months ended
June 30, 2004.
As the Company continues to see increases in client spending and
improvements in economic conditions, the Company will continue to focus on a
variety of growth initiatives in order to improve its market share and increase
revenue. Moreover, as the Company achieves top line growth and gains market
share, the Company will concentrate its efforts on improving margins and driving
earnings to the bottom line. The Company intends to improve margins by limiting
its use of outside consultants, complementing its service offerings with higher
level management consulting opportunities, continuously evaluating the size of
its workforce in order to balance the Company's skill base with the market
demand for services.
In addition to the conditions described above for growing the Company's
current business, the Company will continue to grow through acquisition. One of
the Company's objectives is to make acquisitions of companies in the BI/DW
industry that will accelerate the Company's business plan at lower costs than it
would generate internally and also improve its competitive positioning and
expand the Company's offerings in a larger geographic area. The industry is very
fragmented, with a handful of large international firms having data warehousing
and/or business intelligence divisions, and hundreds of regional boutiques
throughout the United States. These smaller firms do not have the financial
wherewithal to scale their businesses or compete with the larger players, and
the Company believes that the BI/DW industry as a whole is ready for
consolidation. The Company will continue to aggressively pursue these firms,
adding new geographies, areas of expertise and verticals to its current
business. These acquisitions will likely be consummated with a combination of
cash and stock. Although the Company has approximately $4.2 million to fund
acquisitions via its financing transaction with Laurus Master Fund, Ltd., some
of these acquisitions may hinge upon future financings.
Revenue from consulting and professional services is recognized at the
time the services are performed, evidence of an arrangement exists, the fee is
fixed or determinable and collectibility is reasonably assured. Reimbursements,
including those relating to travel and other out-of-pocket expenses, are
included in revenues, and an equivalent amount of reimbursable expenses are
included in cost of services. Revenues for large services projects are
recognized using the percentage of completion method for long-term construction
type contracts where costs to complete the contract could reasonably be
estimated. Revenues recognized in excess of billings are recorded as costs in
excess of billings. Billings in excess of revenues recognized are recorded as
deferred revenues until revenue recognition criteria are met. The
percentage-of-completion method is not applicable for the Company's software
sales. The relationship of costs incurred to date compared to estimated total
costs at completion is used to determine the percentage of completion on the
project. This percentage is applied to the total revenue to be earned on the
project and that portion of revenue is recognized in the current period.
31
Revenue from software licensing and maintenance and support are also
recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, and collectibility is reasonably
assured. The Evoke software is delivered directly by the Company either directly
to the customer or to a distributor on an order by order basis. The software is
not sold with any right of return privileges and, as a result, a returns reserve
is not applicable. License fee revenue is recognized by the Company in the
period in which delivery occurs. Maintenance and support revenue is recorded in
revenue on a pro rata basis over the term of the maintenance and support
agreement. Deferred revenue is recorded when customers are invoiced for software
maintenance and support. The revenue is recognized over the term of the
maintenance and support agreement. Additionally, billings in excess of revenue
recognized on projects being accounted for using the percentage-of-completion
method are recorded as deferred revenues. The Company licenses software and
provides a maintenance and support agreement to customers. These items are
invoiced as separate items and vendor-specific objective evidence is determined
for the maintenance and support, generally by identifying in the contract the
cost of the maintenance and support to the customer in subsequent renewal
periods.
During the nine month period ended September 30, 2004, two of the
Company's clients, Leading Edge Communications Corporation (17.9%) and Bank of
America (13.4%), accounted for approximately 31% of total revenues (unaudited).
During the nine month period ended September 30, 2003 (unaudited), one client,
Verizon Wireless, accounted collectively for approximately 30% of total
revenues.
The Company's most significant costs are personnel expenses, which consist
of consultant fees, benefits and payroll-related expenses, and outside
consultants.
RESULTS OF OPERATIONS
THE FOLLOWING TABLE SETS FORTH CERTAIN STATEMENT OF OPERATIONS DATA FOR
THE PERIODS INDICATED EXPRESSED AS A PERCENTAGE OF TOTAL REVENUES:
32
YEARS ENDED DECEMBER 31, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------
2002 2003 2003 2004
----------------------------------------------------------
(restated) (unaudited) (unaudited)
REVENUE 100.0% 100.0% 100.0% 100.0%
COST OF SALES 65.7 71.5 71.1 68.6
----------------------------------------------------------
GROSS PROFIT 34.3 28.5 28.9 31.4
----------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 6.7 10.8 10.0 14.7
General and administrative 21.9 18.8 17.2 26.1
Research and development -- -- -- 1.4
Depreciation and amortization 0.9 1.5 1.4 2.8
----------------------------------------------------------
29.5 31.1 28.6 45.0
----------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS 4.8 (2.6) 0.2 (13.6)
----------------------------------------------------------
OTHER INCOME (EXPENSE)
Equity in losses from investments -- -- -- (0.1)
Other income -- -- -- 0
Interest income -- -- -- 0
Interest expense (0.9) (0.9) (0.8) (3.4)
----------------------------------------------------------
(0.9) (0.9) (0.9) (3.5)
----------------------------------------------------------
LOSS BEFORE TAXES 3.9 (3.5) (0.6) (17.1)
----------------------------------------------------------
INCOME TAXES (BENEFIT)
Current 0.6 -- -- (0.7)
Deferred (0.5) (1.3) 0.0 0.0
----------------------------------------------------------
0.1 (1.3) 0.0 (0.7)
MINORITY INTEREST -- -- -- (0.2)
0.0 --
----------------------------------------------------------
NET INCOME (LOSS) 3.8 (2.2) (0.6) (16.2)
----------------------------------------------------------
UNSECURED CONVERTIBLE LINE OF CREDIT
BENEFICIAL CONVERSION FEATURE -- -- -- 6.5
NET INCOME (LOSS) ATTRIBUTABLE TO
----------------------------------------------------------
COMMON STOCKHOLDERS 3.8% (2.2) % (0.6)% (22.7)%
==========================================================
PROFORMA DATA:
Income before taxes (benefit) -- % -- % (0.6)% -- %
Income taxes (benefit) -- -- (0.3) --
----------------------------------------------------------
Net income (loss) -- % -- % (0.4)% -- %
----------------------------------------------------------
33
Nine Months Ended September 30, 2004 and 2003 (unaudited)
Revenue. Our revenues are primarily comprised of billings to clients for
consulting hours worked on client projects. Revenues for nine months ended
September 30, 2004 were $18.7 million (unaudited), an increase of 75.9% over the
nine months ended September 30, 2003 (unaudited). This increase was primarily
attributable to projects obtained in the fourth quarter of 2003 that are still
ongoing or have developed into new projects. The project design and
infrastructure projects obtained in the fourth quarter of 2003 are recognized at
the time that the services are performed as these are not related to fixed price
projects requiring percentage of completion accounting. These projects were
completed during 2004 and newly defined projects arose from these relationships.
The project design and infrastructure projects are based upon time and materials
and are billed and recognized at the time that the services are performed as
these are not related to fixed price projects. Additionally, $0.8 million, or
4.2% of revenues, and $3.4 million, or 18.0% of revenues, is attributable to the
Evoke and DeLeeuw acquisitions which were completed in 2004.
There has been an increase in hourly rates charged for services. The
average rate for the three months ended September 30, 2004 increased by 8.3%
over the three month ended June 30, 2004. This is substantially attributable to
the acquisition of DeLeeuw Associates, whose billing rates are higher than CSI's
traditional billing rates. DeLeeuw Associates' focus is more highly concentrated
on management consulting, which is generally associated with higher billing
rates. Revenues for the three month ended September 30, 2004 increased 5.6% over
the three months ended June 30, 2004. If the average rates had not increased,
revenues would have decreased by 2.4% for the same period.
Cost of services. Cost of services primarily includes payroll and benefits
costs for our consultants. Cost of services was $12.8 million, or 68.6% of
revenue for the nine months ended September 30, 2004 (unaudited), compared to
$7.5 million, or 71.1% of revenue for the nine months ended September 30, 2003
(unaudited) due to $2.3 million of cost to operate the DeLeeuw and Evoke
companies which were both acquired in 2004, and $3.0 million of cost associated
with producing the increased revenues and a shift in the consulting force to
higher paid consultants. This is directly correlated to the increase in billing
rates discussed above in the analysis of revenue.
Cost of Services for DeLeeuw for the period of March 1, 2004 through
September 30, 2004 were $2.2 million (unaudited). Cost of services for the
Company (excluding DeLeeuw and Evoke) for the nine months ended September 30,
2004 were $10.4 million (unaudited), an increase of 37.9% over the nine months
ended September 30, 2003 (unaudited).
Gross profit. Our gross profit percentage increased to $5.9 million, or
31.4% of revenues, for the nine months ended September 30, 2004 (unaudited)from
$3.1 million, or 28.8%, for the nine months ended September 30, 2003
(unaudited). The DeLeeuw acquisition contributed gross profit of $1.2 million,
or 6.2% of revenues for the nine months ended September 30, 2004(unaudited) and
the Evoke acquisition contributed gross profit of $0.7 million, or 3.6% of
revenues, for the nine months ended September 30, 2004 (unaudited). Gross profit
attributed to ongoing CSI operations was $4.0 million, or 21.5% of revenues, and
68.5% of total gross profit, for the nine months ended September 30, 2004. As a
percentage of total gross profit for the nine months ended September 30, 2004,
DeLeeuw contributed 19.8% of total gross profit, Evoke contributed 11.7% of
total gross profit, and ongoing Company operations contributed the remaining
68.5% of total gross profit. The gross profit percentage for the nine months
ended September 30, 2004, was 34.5%, 87.3% and 27.6% for DeLeeuw, Evoke, and
ongoing Company operations, respectively.
Selling and marketing. Selling and marketing expenses include payroll,
employee benefits and other headcount-related costs associated with sales and
marketing personnel and advertising, promotions, tradeshows, seminars and other
programs. Selling and marketing expenses were $2.7 million, or 14.7% of revenue,
for the nine months ended September 30, 2004 (unaudited), compared to $1.1
million, or 10.0% of revenue, for the nine months ended September 30, 2003
(unaudited). We have added six additional salespeople and a Director of
Marketing and Corporate Communications through new hires and retaining staffs of
acquired companies as part of our strategy to gain new clients and increase our
revenue. For the nine months ended September 30, 2004, $0.5 million and $0.2
million of the increase is attributed to the operations of the Evoke and DeLeeuw
acquisitions, respectively. Payroll expense and commissions increased by $0.6
million for the nine months ended September 30, 2004 as compared with the same
period in the prior year due to the additional headcount discussed above.
34
General and administrative. General and administrative costs include
payroll, employee benefits and other headcount-related costs associated with the
finance, legal, facilities, certain human resources and other administrative
headcount, and legal and other professional and administrative fees. General and
administrative costs were $4.9 million, or 26.1% of revenue, for the nine months
ended September 30, 2004 (unaudited), compared to $1.8 million, or 17.2% of
revenue, for the nine months ended September 30, 2003 (unaudited). $0.7 million
and $0.5 million of the increase in general and administrative expenses during
the three months ended September 30, 2004 is attributed to the costs of
operating the Evoke and DeLeeuw companies subsequent to the acquisitions during
2004, respectively. Additionally, $0.2 million is attributed to an increase in
officer's salaries as the result of hiring a chief financial officer during the
fourth quarter of 2003 and increasing the salaries of other Company officers to
compensate them competitively with other public companies the size of the
Company. We increased general and administrative and development headcount by
twelve employees during 2004, as compared to 2003, to support the increased size
of the business which resulted in an increase in salaries of $0.2 million in
comparing the nine months ended September 30, 2004 versus the same period in
2003. For the nine months ended September 2004, an increase of $0.2 million was
incurred as the result of legal and accounting fees associated with becoming a
public company and higher insurance premiums due to the growth of the Company.
For the nine months ended September 30, 2004, general and administrative expense
increased, as compared to the same period in the prior year, due to the
increased headcount of 15 and 43 and payroll costs of $0.8 million and $0.6
million for the acquisitions of Evoke and DeLeeuw, respectively, in 2004.
Research and Development. Research and development costs primarily include
the payroll, employee benefits and other headcount-related costs associated with
the employees working on the development of upgrades and new versions of our
Evoke Axio software product. Research and development costs were $0.3 million,
or 1.5% of revenue for the nine months ended September 30, 2004 (unaudited)
compared to zero for the comparative period in the prior year. The research and
development department was obtained in association with the Evoke acquisition
which was completed during 2004.
Depreciation and amortization. Depreciation expense is recorded on our
property and equipment which is generally depreciated over a period between
three to seven years. The Company amortizes deferred financing costs utilizing
the effective interest method over the term of the related debt instrument.
Acquired software is amortized on a straight-line basis over an estimated useful
life of three years. Acquired contracts are amortized over a period of time that
approximates the estimated life of the contracts, based upon the estimated
annual cash flows obtained from those contracts, generally five to six years.
Depreciation and amortization expenses were $0.5 million for the nine months
ended September 30, 2004 (unaudited), compared to $0.1 million for the nine
months ended September 30, 2003 (unaudited). $0.3 million of the increase in
depreciation and amortization during the nine months ended September 30, 2004 is
attributed to amortization of the acquired Evoke intangible assets.
Other income (expense). We incur interest expense on loans from financial
institutions, from capital lease obligations related to the acquisition of
equipment used in our business, and on the outstanding convertible line of
credit notes. Amortization of the discount of debt issued $0.3 million is also
recorded as interest expense. Interest expense recorded was $0.6 million for the
nine months ended September 30, 2004 (unaudited), compared to $0.1 million for
the nine months ended September 30, 2003 (unaudited). This is directly related
to the August and September financings described below in the liquidity and
capital resources section. We recorded equity income in our investment in
DeLeeuw International (Turkey) of $11,000 for the nine months ended September
30, 2004, and an equity loss in our investment in LEC of $36,000 for the nine
months ended September 30, 2004.
Income taxes. The Company evaluates the amount of deferred tax assets that
are recorded against expected taxable income over its forecasting cycle which is
currently two years. As a result of this evaluation, the Company has recorded a
valuation allowance of $1.2 million in the quarter ending September 2004
(unaudited). This allowance was recorded because, based on the weight of
available evidence, it is more likely than not that some portion of the deferred
tax asset may not be realized.
35
No income tax expense or benefit was recorded in the prior year as the
Company was an "S" Corporation through September 30, 2003 (unaudited). Pro forma
income taxes for the comparable nine month period in the prior year would have
been an income tax provision of $27,000 using the effective tax rate of 40%.
YEARS ENDED DECEMBER 31, 2003 AND 2002
Revenue. For the year ended December 31, 2003, revenues decreased by
$1,800,000 from $16,200,000 for the year ended December 31, 2002 to $14,400,000
for the year ended December 31, 2003. Our revenues decreased by $4,400,000 with
an offsetting increase of $2,600,000 from those accounts acquired pursuant to
our acquisition of Scosys, Inc. The decrease was attributable primarily to the
soft market in information technology consulting services that existed in 2003,
generally.
Gross profit. Our gross profit percentage decreased to 28.5% of revenues
for the year ended December 31, 2003 from 34.3% for the year ended December 31,
2002. The decrease in gross profit percentage was due to a combination of higher
personnel costs and lower rates realized for billable consultants as a result of
the softer market. We expect that the gross profit margins will rise in future
quarters, as we begin to hire consultants on payroll, which we anticipate will
translate into higher margins.
Selling and marketing expenses. Selling and marketing expenses increased
$458,000 or 42% to $1,553,000 for the year ended December 31, 2003, and
increased as a percentage of revenue from 6.7% to 10.8%, respectively. The
increase in selling and marketing expenses was related primarily to our
strategic decision to capitalize on the projected upturn in information
technology consulting services. We hired a seasoned Vice President of Sales and
additional experienced sales executives. These expenses had the effect of
increasing sales salaries and commissions by $302,000 for the year ended
December 31, 2003 compared with the year ended December 31, 2002. Accordingly,
sales travel and entertainment, benefits and payroll taxes increased by
$103,000.
General and administrative expenses. General and administrative expenses
decreased by 23.9% or $847,000, to $2,702,000 for the year ended December 31,
2003, from $3,549,000 for the year ended December 31, 2002, and decreased as a
percentage of revenue to 18.8% from 21.8%, respectively. The decrease in general
and administrative expenses was related primarily to the reduction of in-house
developers salaries totaling $997,000. The reduction represents a combination of
developers that were terminated as part of a cost cutting movement and the
change in status of our in house development manager in 2002 (non-billable
status) to an on site customer project in 2003 (billable status). In connection
with the Scosys, Inc. acquisition, we incurred $159,000 in additional salaries
to support the acquisition. The reduction of rent expense by $106,000 was
another factor. We were able to negotiate a temporary reduction in rent as space
requirements diminished as a result of the termination of in-house developers.
Depreciation and amortization. Depreciation and amortization expenses
increased by $64,000 for the fiscal year ended December 31, 2003, compared to
the same period in 2002. Depreciation is computed principally by an accelerated
method and is based on the estimated useful lives of the various assets ranging
from three to seven years. The increase in amortization expense is attributable
to the increase in identifiable intangibles from the acquisition of Scosys, Inc.
Interest expense. We incurred $136,000 and $139,000 in interest expense
during the fiscal years ended December 31, 2003 and 2002, respectively, related
primarily to borrowings under our line of credit. Borrowings under the line of
credit were used to fund operating activities, to make payments under the
obligation in connection with the Scosys acquisition and for distributions to
stockholders. The decrease in interest expense reflects the increased average
outstanding borrowings and at a lower variable rate of interest charged in 2003.
36
LIQUIDITY AND CAPITAL RESOURCES
Cash totaled $0.9 million as of September 30, 2004 (unaudited) compared to
$0.4 million as of December 31, 2003. Our cash balance is primarily derived from
customer remittances, bank borrowings, equity and debt financing, and cash
obtained from acquired businesses, and is used for general working capital
needs. We had $83,000 on deposit with a financial institution as collateral for
a letter of credit and have classified this as restricted cash on our
consolidated balance sheet.
Working capital is ($2.3 million) at September 30, 2004 (unaudited)
compared to ($0.7 million) at December 31, 2003. The Company's working capital
position has deteriorated during the nine month period ended September 30, 2004
primarily due to losses incurred by the Company and liabilities assumed as a
result of the acquisition of Evoke. The losses generated by the Company and the
payments in settlement of Evoke's obligations have resulted in the need for $1.4
million of additional borrowings against the Company's line of credit and a $1.0
million loan on a short term note payable. As of December 31, 2003, the Company
had negative working capital primarily due to the operating losses of $0.3
million sustained by the Company during 2003 and the liabilities incurred in
connection with the acquisition of Scosys, Inc. of $0.2 million at December 31,
2003.
Net cash used by operations for the year ended December 31, 2003 of $0.5
million increased by $0.5 million from $52,000 for the year ended December 31,
2002. This increase in cash usage was due to a $0.1 million increase in accounts
receivable, a $0.1 million increase in the deferred tax benefit, and a $0.3
million net loss. Cash used by operations during the nine months ended September
30, 2004 was $3.0 million (unaudited), an increase of $2.7 million from the nine
months ended September 30, 2003 (unaudited). This increase in cash used by
operations is primarily due to a $2.0 million loss from operations (adjusted for
non-cash charges), a $1.1 million increase in accounts receivable, a $0.5
million increase in the related party receivables, and a $0.2 million reduction
in deferred revenue during the nine month period, which was partially offset by
an increase in accounts payable and accrued expenses of $0.9 million. Trade
accounts receivable increased primarily due to $0.9 million of receivables for
DeLeeuw which was acquired in March 2004 and $0.5 million for Evoke, which was
acquired in June 2004. The increase in the related party receivables is due to
billings to LEC for work performed under a subcontractor agreement beginning in
December 2003. The Company acquired 49% of LEC in 2004. Deferred revenue
declined as a result of recognition of the revenue as it was earned during 2004.
Accounts payable and accrued expenses increased primarily due to $0.3 million
related to DeLeeuw and $1.3 million related to Evoke, both of which were
acquired during 2004.
Cash provided by (used by) investing activities consists primarily of
investments in acquired companies, equity investments in companies, and
purchases of property and equipment. Net cash provided by investing activities
was $0.1 million during the year ended December 31, 2002 and net cash used in
investing activities was $0.1 million for the year ended December 31, 2003. Net
cash provided by investing activities for the year ended December 31, 2002 of
$0.1 million was due to a collection of a $0.2 million note receivable. Cash
used by investing activities was $1.8 million during the nine months ended
September 30, 2004 (unaudited). This was due to payments of $2.1 million made
primarily as acquisition payments for DeLeeuw and for the purchases of equipment
for the Company, partially offset by $0.3 million of cash acquired as part of
the Evoke acquisition.
Cash provided by financing activities consists primarily of borrowings
under line of credit facilities, issuances of debt instruments, issuances of
equity instruments, and repayments of debt. Cash used in financing activities
was $0.1 million for the year ended December 31, 2002 and cash provided by
financing activities was $1.0 million for the year ended December 31, 2003. Cash
provided by financing activities was $5.2 million during the nine months ended
September 30, 2004 (unaudited). During the first nine months of 2004, $4.0
million was raised from the issuance of line of credit notes and $1.0 million
was raised from the issuance of a short-term note payable and additional line of
credit borrowings of $1.4 million. $0.8 million of principal payments on
long-term debt and on capital lease obligations were made by the Company during
this time period.
37
There are currently no material commitments for capital expenditures.
For the year ended December 31, 2003 and the nine months ended September
30, 2004 (unaudited), we invoiced LEC $393,000 and $1,727,200, respectively, for
the services of consultants subcontracted to LEC by us. As of December 31, 2003
and September 30, 2004, we had accounts receivable due from LEC of approximately
$393,000 and $901,000, respectively, and we have provided LEC with extended
payment terms. There are no known collections problems with respect to LEC. The
majority of its billing is derived from Fortune 100 clients. The collection
process is slow as these clients require separate approval on their own internal
systems, which extends the payment cycle. We feel confident in the
collectibility of these accounts receivable as the majority of the revenues from
LEC derive from Fortune 100 clients.
In February 2004, we obtained $2.0 million in financing pursuant to an
October 2003 unsecured convertible line of credit note. In May 2004, pursuant to
the complete conversion of this unsecured convertible line of credit note, the
participating investor received 16,666,666 shares of our common stock, plus
interest. Further in May 2004, we raised an additional $2.0 million pursuant to
a new five-year unsecured promissory note with the same investor. In June 2004,
we replaced the May 2004 note by issuing a five-year $2.0 million unsecured
convertible line of credit note with the same investor. The note accrues at an
annual interest rate of 7%, and the conversion price of the shares of common
stock issuable under the note is equal to $0.105 per share. In addition, such
investor received a warrant to purchase 4,166,666 shares of our common stock at
an exercise price of $0.105 per share. This warrant expires in June 2009.
In March 2004, all outstanding amounts under our previous line of credit
and notes payable agreements with Fleet Bank, totaling $2.3 million, were repaid
and $2.5 million was borrowed from a new $3.0 million line of credit with North
Fork Bank (formerly TrustCompany Bank). The terms of this note with North Fork
Bank provided for interest accruing on advances at seven eighths of one percent
(7/8%) over the institution's prime rate. The line of credit agreement with
North Fork Bank contained both financial and non-financial covenants.
In August 2004, the Company replaced its $3.0 million line of credit with
North Fork Bank with a revolving line of credit with Laurus Master Fund, Ltd.
("Laurus"), whereby the Company has access to borrow up to $6.0 million based
upon eligible accounts receivable. This revolving line, effectuated through a
$2.0 million convertible minimum borrowing note and a $4.0 million revolving
note, provides for advances at an advance rate of 90% against eligible accounts
receivable, with an annual interest rate of prime rate (as reported in the Wall
Street Journal) plus 1%, and maturing in three years. These notes will be
decreased by 1.0% for every 25% increase above the fixed conversion price prior
to an effective registration statement and 2.0% thereafter up to a minimum of
0.0%. This line of credit is secured by substantially all the corporate assets.
Both the $2.0 million convertible minimum borrowing note and the $4.0 million
revolving note provide for conversion at the option of the holder of the amounts
outstanding into the Company's common stock at a fixed conversion price of $0.14
per share. In the event that the Company issues common stock or derivatives
convertible into Company common stock for a price less the aforementioned fixed
conversion price, then the fixed conversion price is reset using a weighted
average dilution calculation. Additionally, in exchange for a secured
convertible term note bearing interest at prime rate (as reported in the Wall
Street Journal) plus 1%, Laurus has made available to the Company an additional
$5.0 million to be used for acquisitions. This note is convertible into Company
common stock at a fixed conversion price of $0.14 per share. In the event that
the Company issues Company common stock or derivatives convertible into Company
common stock for a price less the fixed conversion price, then the fixed
conversion price is reset to the lower price on a full-ratchet basis. This note
matures in three years. This cash will be restricted for use until approved
acquisition targets identified by the Company are approved by Laurus. A portion
of Laurus's revolving line of credit will be used to pay off all outstanding
borrowings from North Fork Bank. The Company issued Laurus a common stock
purchase warrant that provides Laurus with the right to purchase 12.0 million
shares of the Company's common stock. The exercise price for the first 6.0
million shares acquired under the warrant is $0.29 per share, the exercise price
for the next 3.0 million shares acquired under the warrant is $0.31 per share,
and the exercise price for the final 3.0 million shares acquired under the
warrant is $0.35 per share. The common stock purchase warrant expires on August
16, 2011. The Company paid $0.75 million in brokerage and transaction closing
related costs. These costs were deducted from the $5.0 million restricted cash
balance provided to the Company by Laurus. As of September 30, 2004, $3.2
million was outstanding under the revolving line of credit. The interest rate on
the revolving line and the acquisition note was 5.75% during September 2004. As
a result of the beneficial conversion feature, a discount on debt issued of $5.6
million was recorded and is being amortized to interest expense over the three
year life of the debt agreement.
38
In September 2004, we issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, "Sands") three subordinated secured convertible promissory notes
equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, subordinate to Laurus. The Notes are convertible into shares
of our common stock at the election of Sands at any time following the
consummation of a convertible debt or equity financing with gross proceeds of $5
million or greater (a "Qualified Financing"). The conversion price of the shares
of our common stock issuable upon conversion of the Notes shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to convert the
Notes at a fixed conversion price of $0.14 per share. In the event that we issue
stock or derivatives convertible into our stock for a price less the
aforementioned fixed conversion price, then the fixed conversion price is reset
using a weighted average dilution calculation. We also issued Sands three common
stock purchase warrants (the "Warrants") providing Sands with the right to
purchase 6,000,000 shares of our common stock. The exercise price of the shares
of our common stock issuable upon exercise of the Warrants shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to exercise the
Warrants at a fixed conversion price of $0.14 per share. The latest that the
Warrants may expire is September 8, 2008. Finally, we engaged Sands Brothers
International Limited as our non-exclusive financial advisor at $6,000 per month
for a period of one year. As a result of the beneficial conversion feature, a
discount on debt issued of $0.5 million was recorded in September 2004 and is
being amortized to interest expense over the one year life of the debt
instrument.
The following is a summary of the debt investments outstanding as of November
26, 2004:
------------------------------------------------------------------------------------------------------------------------------
Lender Type of facility Outstanding as of Remaining Availability
November 26, 2004
(not including interest)
------------------------------------------------------------------------------------------------------------------------------
Laurus Master Fund, Ltd. Convertible Line of Credit $3,200,000 $0
------------------------------------------------------------------------------------------------------------------------------
Laurus Master Fund, Ltd. Convertible Term note $4,251,000 $0
------------------------------------------------------------------------------------------------------------------------------
Sands Brothers Venture Capital LLC Convertible Promissory Note $50,000 $0
------------------------------------------------------------------------------------------------------------------------------
Sands Brothers Venture Capital III LLC Convertible Promissory Note $850,000 $0
------------------------------------------------------------------------------------------------------------------------------
Sands Brothers Venture Capital IV LLC Convertible Promissory Note $100,000 $0
------------------------------------------------------------------------------------------------------------------------------
Taurus Advisory Group, LLC investors Convertible Promissory Note $2,000,000 $0
------------------------------------------------------------------------------------------------------------------------------
TOTAL $10,451,000 $0
------------------------------------------------------------------------------------------------------------------------------
39
Cash generating revenues from Evoke have been approximately 40% below
expectations during the three months ended September 30, 2004. The Company
expects the Evoke revenues to increase over the next several quarters as its
sales force has been actively soliciting business in the marketplace.
Additionally, the Company has continued to generate losses that have exceeded
expectations. To that extent, the Company has experienced continued negative
cash flow which has created a liquidity issue for the Company that it currently
believes to be short-term. To address this issue, the following financings were
effectuated:
In November 2004, the Company entered into a Stock Purchase Agreement (the
"Agreement") with a private investor, CMKX-treme, Inc. Pursuant to the
Agreement, CMKX-treme, Inc. agreed to purchase 12,500,000 shares of common stock
for a purchase price of $1,750,000. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for
$500,000, and it is required to purchase the remaining 8,928,572 shares of
common stock for $1,250,000 by December 31, 2004.
On November 16, 2004, Scott Newman, President and Chief Executive Officer
of the Company, paid to the Company $188,520, the outstanding balance of Mr.
Newman's stockholder loan. Glenn Peipert, Executive Vice President and Chief
Operating Officer of the Company, paid to the Company $19,806, the outstanding
balance of Mr. Peipert's stockholder loan.
Additionally, as of November 17, 2004, Mr. Newman has agreed to personally
support the Company's cash requirements to enable it to fulfill its obligations
through March 31, 2005, to the extent necessary, up to a maximum amount of
$500,000. The Company believes that its reliance on such commitment is
reasonable and that Mr. Newman has sufficient liquidity and net worth to honor
such commitment. The Company believes that Mr. Newman's written commitment
provides the Company with the legal right to request and receive such advances.
Any loan by Mr. Newman to the Company would bear interest at 3% per annum.
The Company expects the aforementioned transactions to occur within the
contracted time periods. In the event that they do not materialize, the Company
may be required to seek additional sources of financing in the near future. If
the Company is unsuccessful in obtaining additional sources of financing, it
could experience difficulty meeting its current obligations as they become due.
The Company believes existing cash, borrowing capacity under the line of
credit or alternative financing sources, and funds generated from operations
should be sufficient to meet operating requirements over the upcoming twelve
month period. We may raise additional funds through debt or equity transactions
in order to fund expansion, to develop new or enhanced products and services, to
respond to competitive pressures, or to acquire complementary businesses or
technologies. There is no assurance, however, that additional financing will be
available, or if available, will be available on acceptable terms. Any decision
or ability to obtain additional financing through debt or equity investment will
depend on various factors, including, among others, revenues, financial market
conditions, strategic acquisition and investment opportunities, and developments
in the Company's markets. The sale of additional equity securities or future
conversion of convertible debt would result in additional dilution to the
Company's stockholders.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any transactions, agreements or other
contractual arrangements that constitute off-balance sheet arrangements.
40
APPLICATION OF CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION
PROFESSIONAL SERVICES
Revenue from consulting and professional services is recognized at the
time the services are performed, evidence of an arrangement exists, the fee is
fixed or determinable and collectibility is reasonably assured. Reimbursements,
including those relating to travel and other out-of-pocket expenses, are
included in revenues, and an equivalent amount of reimbursable expenses are
included in cost of services.
Revenues for large services projects are recognized using the percentage
of completion method for long-term construction type contracts where costs to
complete the contract could reasonably be estimated. Revenues recognized in
excess of billings are recorded as costs in excess of billings. Billings in
excess of revenues recognized are recorded as deferred revenues until revenue
recognition criteria are met. The relationship of costs incurred to date
compared to estimated total costs at completion is used to determine the
percentage of completion on the project. This percentage is applied to the total
revenue to be earned on the project and that portion of revenue is recognized in
the current period. Additionally, billings in excess of revenue recognized on
projects being accounted for using the percentage-of-completion method are
recorded as deferred revenues. The percentage-of-completion method is not
applicable for the Company's software sales.
SOFTWARE
Revenue from software licensing and maintenance and support are also
recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, and collectibility is reasonably
assured. The Evoke software is delivered directly by the Company either directly
to the customer or to a distributor on an order by order basis. The software is
not sold with any right of return privileges and, as a result, a returns reserve
is not applicable. License fee revenue is recognized by the Company in the
period in which delivery occurs. Maintenance and support revenue is recorded in
revenue on a pro rata basis over the term of the maintenance and support
agreement. Deferred revenue is recorded when customers are invoiced for software
maintenance and support. The revenue is recognized over the term of the
maintenance and support agreement.
We license software and provide a maintenance and support agreement to
customers. These items are invoiced as separate items and vendor-specific
objective evidence (VSOE) is determined for the maintenance and support,
generally by identifying in the contract the cost of the maintenance and support
to the customer in subsequent renewal periods.
ACCOUNTS RECEIVABLE
The Company carries its accounts receivable at cost less an allowance for
doubtful accounts. On a periodic basis, the Company evaluates its accounts
receivable and adjusts the allowance for doubtful accounts, when deemed
necessary, based upon its history of past write-offs and collections,
contractual terms and current credit conditions.
41
AMORTIZATION
The Company amortizes deferred financing costs utilizing the effective
interest method over the term of the related debt instrument. Acquired contracts
are amortized over over a period that approximates the estimated life of the
contracts, based upon the estimated annual cash flows obtained from those
contracts, generally five to six years.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the amounts paid in connection with a settlement
agreement with the Elligent Consulting Group to re-acquire the ownership rights
to the Company in 1998 and in connection with the acquisitions of Scosys,
DeLeeuw and Evoke. Additionally, as part of the Scosys, DeLeeuw and Evoke
acquisitions, the Company acquired intangible assets. FASB Statement 142 was
adopted as of January 1, 2002 for all goodwill recognized in the Company's
balance sheet as of December 31, 2001. This statement changed the accounting for
goodwill from an amortization method to an impairment-only approach, and
introduced a new model for determining impairment charges.
Goodwill and intangible assets are reviewed for impairment whenever events
or circumstances indicate impairment might exist, or at least annually. The
Company assesses the recoverability of its assets, in accordance with SFAS No.
142 "Goodwill and Other Intangible Assets," comparing projected undiscounted
cash flows associated with those assets against their respective carrying
amounts. Impairment, if any, is based on the excess of the carrying amount over
the fair value of those assets. The Company's goodwill and intangible assets
were evaluated and deemed not to be impaired at December 31, 2003. There have
been no events or circumstances that would indicate that there has been any
impairment during the nine months ended September 30, 2004.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and accounts receivable arising from its
normal business activities. The Company routinely assesses the financial
strength of its customers, based upon factors surrounding their credit risk,
establishes an allowance for doubtful accounts, and as a consequence believes
that its accounts receivable credit risk exposure beyond such allowances is
limited. At September 30, 2004, one customer, LEC, a related party company,
comprised approximately 17.6% of the Company's accounts receivable balance.
INCOME TAXES
The Company accounts for income taxes under an asset and liability
approach that requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been recognized in
the Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.
On January 1, 2001, CSI elected to be an "S" Corporation, whereby the
stockholders account for their share of CSI's earnings, losses, deductions and
credits on their federal and various state income tax returns. CSI is subject to
New York City and various state income taxes. On September 30, 2003, CSI's "S"
Corporation status was revoked in connection with the conversion of convertible
subordinated debt into shares of common stock.
42
The Company evaluates the amount of deferred tax assets that are recorded
against expected taxable income over its forecasting cycle which is currently
two years. As a result of this evaluation, the Company has recorded a valuation
allowance of approximately $1.2 million in the third quarter of 2004. This
allowance was recorded because, based on the weight of available evidence, it is
more likely than not that some portion of the deferred tax asset may not be
realized.
For informational purposes, the accompanying statements of operations
include an unaudited pro-forma adjustment for income taxes which would have been
recorded if CSI had not been an "S" Corporation. During the first nine months of
2004, the Company's effective tax rate was estimated to be approximately 40%.
This rate is based upon the statutory federal income tax rate of 34% plus a
blended rate for the various states in which the Company incurs income tax
liabilities, net of the federal income tax benefit for state taxes paid, of 6%.
Since the Company was an "S" corporation for the majority of 2003, the pro
forma rate is based on the Company's estimated income tax rate for 2004 and is
not based upon the prior year's effective tax rate.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
For the ten months ended December 31, 2003, we changed our independent
auditor and certifying accountant to Ehrenkrantz Sterling & Co. LLC
("Ehrenkrantz"). Prior thereto, we had engaged Eisner LLP as our independent
auditor and certifying accountant. There have been no disagreements with Eisner
LLP on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedures, which disagreements if not resolved
to the satisfaction of Eisner LLP would have caused them to make reference
thereto in their report.
On June 1, 2004, Ehrenkrantz merged with the firm of Friedman Alpren &
Green LLP. The new entity, Friedman LLP ("Friedman"), was retained by us, and
our Board of Directors approved this decision on June 7, 2004. For the period
since Ehrenkrantz's appointment through June 7, 2004, there have been no
disagreements with Ehrenkrantz on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of Ehrenkrantz would have
caused them to make reference thereto in their report. In addition, for the
period since Ehrenkrantz's appointment through June 7, 2004, we did not consult
with Friedman regarding any matter that was the subject of a "disagreement" with
Ehrenkrantz, as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and
the related instructions to Item 304 of Regulation S-K, or with regard to any
"reportable event," as that term is defined in Item 304(a)(1)(v) of Regulation
S-K, except as such consultations as may have been made with former employees of
Ehrenkrantz who are now employees of Friedman.
USE OF PROCEEDS
We will not receive any of the proceeds from the offering of common stock
for sale by the selling stockholders. However, we will receive proceeds, to be
used for working capital purposes, upon the exercise of warrants held by certain
selling stockholders.
43
SELLING STOCKHOLDERS
This prospectus relates to the offering for resale of 564,557,157 shares
of our common stock by certain selling stockholders who received shares in both
LCS and CSI in private financing transactions and acquisitions. The following
table sets forth each stockholder who is offering shares of our common stock for
sale under this prospectus, any position, office or other material relationship
which such selling stockholder has had with us within the past three years, the
amount of shares owned by such stockholder prior to this offering, the amount to
be offered for such stockholder's account, the amount of be owned by such
stockholders following completion of the offering and (if one percent or more)
the percentage of the class to be owned by such stockholder after the offering
is complete. The prior-to-offering figures are as of November 26, 2004. All
share numbers are based on information that these stockholders supplied to us.
The table assumes that each stockholder will sell all of its shares available
for sale during the effectiveness of the registration statement that includes
this prospectus. Stockholders are not required to sell their shares. Beneficial
ownership is determined in accordance with SEC rules and regulations and
includes voting or investment power with respect to the securities.
The percentage interset of each selling stockholder is based on the
beneficial ownership of such selling stockholder divided by the sum of the
current outstanding shares of common stock plus the additional shares, if any,
which would be issued to such selling stockholder (but not any other selling
stockholder) when converting notes, exercising warrants or other rights in the
future.
44
---------------------------------------- -------------------- --------------------- ------------------
NUMBER OF SHARES
POSITION, OFFICE NUMBER OF SHARES OF REPRESENTED BY
OR OTHER MATERIAL COMMON STOCK, NOT WARRANTS
RELATIONSHIP INCLUDING WARRANTS, BENEFICIALLY
BENEFICIALLY OWNED OWNED (1)
PRIOR TO THE
SELLING STOCKHOLDER OFFERING (1)
---------------------------------------- -------------------- --------------------- ------------------
NUMBER
---------------------------------------- -------------------- --------------------- ------------------
Mathew and Kyle Szulik (2) None 23,035,714 3,125,000
---------------------------------------- -------------------- --------------------- ------------------
Jermar Corp. (3) None 22,526,190 206,250
---------------------------------------- -------------------- --------------------- ------------------
Redec & Associates LLC (4) None 17,750,000 0
---------------------------------------- -------------------- --------------------- ------------------
Trust FBO Claire S. Adelson (5) None 5,666,666 0
---------------------------------------- -------------------- --------------------- ------------------
Lawrence D. Share (2) None 9,666,667 0
---------------------------------------- -------------------- --------------------- ------------------
Richard and Stacey Adelson (2) None 2,561,904 50,000
---------------------------------------- -------------------- --------------------- ------------------
Alisa Farber Revocable Trust (6) None 1,000,000 0
---------------------------------------- -------------------- --------------------- ------------------
Edward and Nancy McSorley (2) None 4,047,619 156,250
---------------------------------------- -------------------- --------------------- ------------------
Ronald Kertes (2) None 1,666,668 0
---------------------------------------- -------------------- --------------------- ------------------
Andrew Holder (2) None 971,429 212,500
---------------------------------------- -------------------- --------------------- ------------------
Steven and Wendi Levitt (2) None 714,286 156,250
---------------------------------------- -------------------- --------------------- ------------------
Ardmore Blouses, Inc. Retirement Plan None 485,714 106,250
(7)
---------------------------------------- -------------------- --------------------- ------------------
Patricia A. DeSalvo-Cavelius (2) None 485,714 106,250
---------------------------------------- -------------------- --------------------- ------------------
David Horowitz (2) None 219,048 47,916
---------------------------------------- -------------------- --------------------- ------------------
Michael D. Mitchell, MD (8) Former Chief
Executive Officer
and Director 18,154,824 0
---------------------------------------- -------------------- --------------------- ------------------
Alex Bruni (9) Former Chief
Financial Officer 1,000,000 0
---------------------------------------- -------------------- --------------------- ------------------
Gene R. Kazlow, Esq. (10) None 500,000 0
---------------------------------------- -------------------- --------------------- ------------------
Janet M. Portelly (11) None 500,000 0
---------------------------------------- -------------------- --------------------- ------------------
Lawrence J. Slavin (12) None 200,000 0
---------------------------------------- -------------------- --------------------- ------------------
Roger Jones (13) None 125,000 0
---------------------------------------- -------------------- --------------------- ------------------
J.T. Shulman & Company, P.C. (14) None 100,000 0
---------------------------------------- -------------------- --------------------- ------------------
Traffix, Inc. (15) None 250,000 0
---------------------------------------- -------------------- --------------------- ------------------
WHRT I Corp. (16) None 72,543,956 0
---------------------------------------- -------------------- --------------------- ------------------
John Giglio (16) None 659,341 0
---------------------------------------- -------------------- --------------------- ------------------
Donald Townsend (16) None 961,538 0
---------------------------------------- -------------------- --------------------- ------------------
Lacy Edwards (16) None 1,785,714 0
---------------------------------------- -------------------- --------------------- ------------------
Andy Galewsky (16) None 55,500 0
---------------------------------------- -------------------- --------------------- ------------------
Lee Pointer (16) None 55,500 0
---------------------------------------- -------------------- --------------------- ------------------
Jeff Millman (16) None 55,500 0
---------------------------------------- -------------------- --------------------- ------------------
Steve McWhirter (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Richard Hasting (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Sterling Runion (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Terry Manning (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Tim Leslie (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Kimberly Livingston (16) None 39,000 0
---------------------------------------- -------------------- --------------------- ------------------
Chris Buckley (16) None 28,000 0
---------------------------------------- -------------------- --------------------- ------------------
Isabelle Knight (16) None 28,000 0
---------------------------------------- -------------------- --------------------- ------------------
Eckhard Bogner (16) None 28,000 0
---------------------------------------- -------------------- --------------------- ------------------
Alan Brignall (16) None 28,000 0
---------------------------------------- -------------------- --------------------- ------------------
Scott Newman (17) President, Chief 150,050,000 0
Executive Officer
and Chairman
---------------------------------------- -------------------- --------------------- ------------------
Glenn Peipert (18) Executive Vice 75,000,000 0
President, Chief
Operating Officer
and Director
---------------------------------------- -------------------- --------------------- ------------------
Robert C. DeLeeuw (19) Senior Vice 40,000,000 0
President
---------------------------------------- -------------------- --------------------- ------------------
Laurus Master Fund, Ltd. (20) None 82,107,141 12,000,000
---------------------------------------- -------------------- --------------------- ------------------
Sands Brothers Venture Capital LLC (21) None 357,143 300,000
---------------------------------------- -------------------- --------------------- ------------------
Sands Brothers Venture Capital III LLC None 6,071,429 5,100,000
(21)
---------------------------------------- -------------------- --------------------- ------------------
Sands Brothers Venture Capital IV LLC None 714,286 600,000
(21)
---------------------------------------- -------------------- --------------------- ------------------
TOTAL 542,390,491
---------------------------------------- -------------------- --------------------- ------------------
---------------------------------------- ---- ---------------------- ---------------------- --------------------
TOTAL NUMBER OF COMMON STOCK PERCENTAGE OF
SHARES OF COMMON BENEFICIALLY OWNED COMMON STOCK
STOCK BENEFICIALLY AFTER THE OFFERING BENEFICIALLY OWNED
OWNED (1) AFTER TO THE
SELLING STOCKHOLDER OFFERING
---------------------------------------- ---- ---------------------- ---------------------- --------------------
NUMBER PERCENTAGE
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Mathew and Kyle Szulik (2) 26,225,714 65,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Jermar Corp. (3) 23,522,440 790,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Redec & Associates LLC (4) 19,395,000 1,645,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Trust FBO Claire S. Adelson (5) 6,071,666 405,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Lawrence D. Share (2) 9,666,667 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Richard and Stacey Adelson (2) 2,611,904 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Alisa Farber Revocable Trust (6) 1,230,000 230,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Edward and Nancy McSorley (2) 4,533,869 330,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Ronald Kertes (2) 1,666,668 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Andrew Holder (2) 2,093,929 910,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Steven and Wendi Levitt (2) 1,083,536 213,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Ardmore Blouses, Inc. Retirement Plan 591,964 0 *
(7)
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Patricia A. DeSalvo-Cavelius (2) 1,206,964 615,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
David Horowitz (2) 291,964 25,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Michael D. Mitchell, MD (8) 21,754,824 3,600,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Alex Bruni (9) 1,900,000 900,000 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Gene R. Kazlow, Esq. (10) 500,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Janet M. Portelly (11) 500,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Lawrence J. Slavin (12) 200,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Roger Jones (13) 125,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
J.T. Shulman & Company, P.C. (14) 100,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Traffix, Inc. (15) 250,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
WHRT I Corp. (16) 72,543,956 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
John Giglio (16) 659,341 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Donald Townsend (16) 961,538 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Lacy Edwards (16) 1,785,714 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Andy Galewsky (16) 55,500 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Lee Pointer (16) 55,500 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Jeff Millman (16) 55,500 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Steve McWhirter (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Richard Hasting (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Sterling Runion (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Terry Manning (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Tim Leslie (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Kimberly Livingston (16) 39,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Chris Buckley (16) 28,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Isabelle Knight (16) 28,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Eckhard Bogner (16) 28,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Alan Brignall (16) 28,000 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Scott Newman (17) 295,050,000 145,000,000 18.8%
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Glenn Peipert (18) 150,000,000 75,000,000 9.8%
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Robert C. DeLeeuw (19) 80,000,000 40,000,000 5.2%
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Laurus Master Fund, Ltd. (20) 94,107,141 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Sands Brothers Venture Capital LLC (21) 657,143 0 *
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Sands Brothers Venture Capital III LLC 11,171,429 0 *
(21)
---------------------------------------- ---- ---------------------- ---------------------- --------------------
Sands Brothers Venture Capital IV LLC 1,314,286 0 *
(21)
---------------------------------------- ---- ---------------------- ---------------------- --------------------
TOTAL 22,166,666 834,285,157 269,728,000
---------------------------------------- ---- ---------------------- ---------------------- --------------------
45
* Less than 1%
(1) Consists (as applicable) of shares of common stock that may be acquired
upon the conversion of outstanding notes and exercise of warrants.
(2) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC.
(3) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC. Jerry Z. Ceder
is the natural person having investment and/or voting control over the
shares.
(4) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC. Jerry Z. Ceder
is the natural person having investment and/or voting control over the
shares.
(5) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC. Claire Adelson
and Shirley Moss are the natural persons having investment and/or voting
control over the shares.
(6) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC. Alisa and Allan
Farber are the natural persons having investment and/or voting control
over the shares.
(7) Consists of shares obtained via private investments in the Company in
October 2003 and May 2004 via Taurus Advisory Group, LLC. Michael and Alan
Wolf are the natural persons having investment and/or voting control over
the shares.
(8) Consists of shares issued to Mr. Mitchell in January 2004 in consideration
for a loan made to the Company.
(9) Consists of shares issued to Mr. Bruni in January 2004 in consideration
for a loan made to the Company.
(10) Consists of shares issued to Mr. Kazlow in December 2003 in consideration
for performed legal services to the Company.
(11) Consists of shares issued in December 2003 in consideration for performed
legal services to the Company by Ms. Portelly's husband, Mr. Barry Feiner.
(12) Consists of shares issued to Mr. Slavin in December 2003 in consideration
for performed consulting services to the Company.
(13) Consists of shares issued to Mr. Jones in December 2003 in consideration
for a loan made to a former subsidiary of the Company.
(14) Consists of shares issued to J.T. Shulman & Company, P.C. in November 2003
in consideration for performed accounting services to the Company. Jay T.
Shulman is the natural person having investment and/or voting control over
the shares.
(15) Consists of shares issued to Traffix, Inc. in January 2004 in
consideration for a loan made to the Company. Jeffrey L. Schwartz is the
natural person having investment and/or voting control over the shares.
(16) Consists of shares issued pursuant to the Company's acquisition in June
2004 of Evoke Software Corporation ("Evoke") to Evoke (now known as WHRT I
Corp.) and its employees. Lacy Edwards is the natural person having
investment and/or voting control over the shares held by WHRT I Corp.
(17) Consists of shares issued to Mr. Newman in January 2004 pursuant to the
merger of privately-held Conversion Services International, Inc. into the
Company's wholly owned subsidiary, LCS Acquisition Corp.
(18) Consists of shares issued to Mr. Peipert in January 2004 pursuant to the
merger of privately-held Conversion Services International, Inc. into the
Company's wholly owned subsidiary, LCS Acquisition Corp.
(19) Consists of shares issued to Mr. DeLeeuw in March 2004 pursuant to the
acquisition of DeLeeuw Associates, Inc.
(20) Consists of shares underlying notes and warrants issued to Laurus Master
Fund, Ltd. in August 2004. David Grin and Eugene Grin are the natural
persons having investment and/or voting control over Laurus Capital
Management, LLC, which is the entity that exercises investment and voting
power over Laurus Master Fund, Ltd. and the shares.
(21) Consists of shares underlying notes and warrants issued in September 2004
pursuant to $1,000,000 financing. Steven Sands is the natural person
having investment and/or voting control over the shares.
Because the selling stockholders may, under this prospectus, sell all or
some portion of their common stock, only an estimate can be given as to the
amount of common stock that will be held by the selling stockholders upon
completion of the offering. In addition, the selling stockholders identified
above may have sold, transferred or otherwise disposed of all or a portion of
their common stock after the date on which they provided information regarding
their stockholdings.
46
PLAN OF DISTRIBUTION
Selling stockholders may offer and sell, from time to time, the shares of
our common stock covered by this prospectus. The term selling stockholders
includes donees, pledgees, transferees or other successors-in-interest selling
securities received after the date of this prospectus from a selling stockholder
as a gift, pledge, partnership distribution or other non-sale related transfer.
The selling stockholders will act independently of us in making decisions with
respect to the timing, manner and size of each sale. Sales may be made on one or
more exchanges or in the over-the-counter market or otherwise, at prices and
under terms then prevailing or at prices related to the then current market
price or in negotiated transactions. The selling stockholders may sell their
securities by one or more of, or a combination of, the following methods:
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its own account pursuant to this prospectus;
o ordinary brokerage transactions and transactions in which the broker
solicits purchasers;
o block trades in which the broker-dealer so engaged will attempt to
sell the securities as agent but may position and resell a portion
of the block as principal to facilitate the transaction;
o an over-the-counter distribution in accordance with the rules of the
NASDAQ National Market;
o in privately negotiated transactions; and,
o in options transactions.
To the extent required, we may amend or supplement this prospectus to
describe a specific plan of distribution. In connection with distributions of
the securities or otherwise, the selling stockholders may enter into hedging
transactions with broker-dealers or other financial institutions. In connection
with those transactions, broker-dealers or other financial institutions may
engage in short sales of shares of our common stock in the course of hedging the
positions they assume with selling stockholders. The selling stockholders may
also sell shares of our common stock short and redeliver the securities to close
out their short positions. The selling stockholders may also enter into option
or other transactions with broker-dealers or other financial institutions that
require the delivery to the broker-dealer or other financial institution of
securities offered by this prospectus, which securities the broker-dealer or
other financial institution may resell pursuant to this prospectus, as
supplemented or amended to reflect the transaction. The selling stockholders may
also pledge securities to a broker-dealer or other financial institution, and,
upon a default, the broker-dealer or other financial institution, may affect
sales of the pledged securities pursuant to this prospectus, as supplemented or
amended to reflect the transaction.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this prospectus. In effecting
sales, broker-dealers or agents engaged by the selling stockholders may arrange
for other broker-dealers to participate. Broker-dealers or agents may receive
commissions, discounts or concessions from the selling stockholders in amounts
to be negotiated immediately prior to the sale.
In offering the securities covered by this prospectus, the selling
stockholders and any broker-dealers who execute sales for the selling
stockholders may be treated as "underwriters" within the meaning of the
Securities Act in connection with sales. Any profits realized by the selling
stockholders and the compensation of any broker-dealer may be treated as
underwriting discounts and commissions.
47
The selling stockholders and any other person participating in a
distribution will be subject to the Securities Exchange Act of 1934 (Exchange
Act). The Exchange Act rules include, without limitation, Regulation M, which
may limit the timing of purchases and sales of any of the securities by the
selling stockholders and other participating persons. In addition, Regulation M
may restrict the ability of any person engaged in the distribution of the
securities to engage in market-making activities with respect to the particular
security being distributed for a period of up to five business days prior to the
commencement of the distribution. This may affect the marketability of the
securities and the ability of any person or entity to engage in market-making
activities with respect to the securities. We have informed the selling
stockholders that the anti-manipulation rules of the SEC, including Regulation M
promulgated under the Exchange Act, may apply to their sales in the market.
We will make copies of this prospectus available to the selling
stockholders for the purpose of satisfying the prospectus delivery requirements
of the Securities Act. The selling stockholders may indemnify any broker-dealer
that participates in transactions involving the sale of the securities against
certain liabilities, including liabilities arising under the Securities Act.
At the time a particular offer of securities is made, if required, a
prospectus supplement will be distributed that will set forth the number of
securities being offered and the terms of the offering, including the name of
any underwriter, dealer or agent, the purchase price paid by any underwriter,
any discount, commission and other item constituting compensation, any discount,
commission or concession allowed or re-allowed or paid to any dealer, and the
proposed selling price to the public.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following table sets forth the names and ages our current directors
and executive officers, the principal offices and positions with us held by each
person and the date such person became a director or executive officer. Our
Board of Directors elects our executive officers annually. Each year the
stockholders elect the members of our Board of Directors.
Our directors and executive officers are as follows:
------------------------------------------------------------- -------- --------------------------------------------------------
NAME YEAR FIRST ELECTED AS AN AGE POSITION(S) HELD
OFFICER OR DIRECTOR
------------------------------------------------------------- -------- --------------------------------------------------------
Scott Newman 2004 45 President, Chief Executive Officer and Chairman
------------------------------------------------------------- -------- --------------------------------------------------------
Glenn Peipert 2004 43 Executive Vice President, Chief Operating Officer and
Director
------------------------------------------------------------- -------- --------------------------------------------------------
Mitchell Peipert 2004 46 Vice President, Chief Financial Officer, Secretary and
Treasurer
------------------------------------------------------------- -------- --------------------------------------------------------
Lawrence K. Reisman 2004 45 Director
------------------------------------------------------------- -------- --------------------------------------------------------
Robert C. DeLeeuw 2004 47 Senior Vice President and President of DeLeeuw
Associates, LLC
------------------------------------------------------------- -------- --------------------------------------------------------
SCOTT NEWMAN has been our President, Chief Executive Officer and Chairman
since January 2004. Mr. Newman founded the former Conversion Services
International, Inc. in 1990 (before its merger with and into the LCS) and is our
largest stockholder. He has over twenty years of experience providing technology
solutions to major companies internationally. Mr. Newman has direct experience
in strategic planning, analysis, design, testing and implementation of complex
big-data solutions. He possesses a wide range of software and hardware
architecture/discipline experience, including, client/server, data discovery,
distributed systems, data warehousing, mainframe, scaleable solutions and
e-business. Mr. Newman has been the architect and lead designer of several
commercial software products used by Chase, Citibank, Merrill Lynch and Jaguar
Cars. Mr. Newman advises and reviews data warehousing and business intelligence
strategy on behalf of our Global 2000 clients, including AT&T Capital, Jaguar
Cars, Cytec and Chase. Mr. Newman is a member of the Young Presidents
Organization, a leadership organization that promotes the exchange of ideas,
pursuit of learning and sharing strategies to achieve personal and professional
growth and success. Mr. Newman received his B.S. from Brooklyn College in 1980.
48
GLENN PEIPERT has been our Executive Vice President, Chief Operating
Officer and Director since January 2004. Mr. Peipert held the same positions
with the former Conversion Services International, Inc. since its inception in
1990. Mr. Peipert has over two decades of experience consulting to major
organizations about leveraging technology to enable strategic change. He has
advised clients representing a broad cross-section of rapid growth industries
worldwide. Mr. Peipert has hands on experience with the leading data warehousing
products. His skills include architecture design, development and project
management. He routinely participates in architecture reviews and
recommendations for our Global 2000 clients. Mr. Peipert has managed major
technology initiatives at Chase, Tiffany, Morgan Stanley, Cytec and the United
States Tennis Association. He speaks nationally on applying data warehousing
technologies to enhance business effectiveness and has authored multiple white
papers regarding business intelligence. Mr. Peipert is a member of the Institute
of Management Consultants, as well as TEC International, a leadership
organization whose mission is to increase the effectiveness and enhance the
lives of chief executives and those they influence. Mr. Peipert is the brother
of Mitchell Peipert, our Vice President, Chief Financial Officer, Secretary and
Treasurer. Mr. Peipert received his B.S. from Brooklyn College in 1982.
MITCHELL PEIPERT has been our Vice President, Chief Financial Officer,
Secretary and Treasurer since January 2004. Mr. Peipert is a Certified Public
Accountant who held the same positions with the former Conversion Services
International, Inc. from January 2001 to September 2002. From September 2002 to
December 2003, Mr. Peipert was Senior Sales Executive for NIA Group and
President of E3 Management Advisors. From April 1992 until January 2001, Mr.
Peipert served as Senior Vice President of Operations and Controller of TSR
Wireless LLC, where he directed the accounting, operations and human resources
functions. He also assisted the chief executive officer in strategic planning,
capital raising and acquisitions. Prior to his employment by TSR, he held
various managerial roles for Anchin, Block & Anchin, certified public
accountants, Merrill Lynch and Grant Thornton. Mr. Peipert is the brother of
Glenn Peipert, our Executive Vice President, Chief Operating Officer and
Director. Mr. Peipert received his B.S. from Brooklyn College in 1980 and
received his M.B.A. in Finance from Pace University in 1986.
LAWRENCE K. REISMAN has been a Director of our company since February
2004. Mr. Reisman is a Certified Public Accountant who has been the principal of
his own firm, The Accounting Offices of L.K. Reisman, since 1986. Prior to
forming his company, Mr. Reisman was a tax manager at Coopers & Lybrand and Peat
Marwick Mitchell. He routinely provides accounting services to small and
medium-sized companies, which services include auditing, review and compilation
of financial statements, corporate, partnership and individual taxation,
designing accounting systems and management consulting services. Mr. Reisman
received his B.S. and M.B.A. in Finance from St. John's University in 1981 and
1985, respectively.
ROBERT C. DELEEUW has been our Senior Vice President and the President of
our wholly owned subsidiary, DeLeeuw Associates, LLC, since March 2004. Mr.
DeLeeuw founded DeLeeuw Associates, LLC, formerly known as DeLeeuw Associates,
Inc., in 1991. Mr. DeLeeuw has over twenty-five years experience in banking and
consulting. During this time, he has managed and supported some of the largest
merger projects in the history of the financial services industry and has
implemented numerous large-scale business and process change programs for his
clients. He has been published in American Banker, Mortgage Banking Magazine,
The Journal of Consumer Lending and Bank Technology News where he has also
served as a member of the Editorial Advisory Board. Mr. DeLeeuw received his
B.S. from Rider University in 1979 and received his M.S. in Management from
Stevens Institute of Technology in 1986.
49
Directors do not receive compensation for their duties as directors.
CODE OF CONDUCT AND ETHICS
Our Board of Directors has adopted a Code of Conduct and Ethics which is
applicable to all our directors, officers, employees, agents and
representatives, including our principal executive officer and principal
financial officer, principal accounting officer or controller, or other persons
performing similar functions.
EXECUTIVE COMPENSATION
The following table sets forth, for the fiscal years indicated, all
compensation awarded to, paid to or earned by the following type of executive
officers for the fiscal years ended December 31, 2001, 2002 and 2003: (i)
individuals who served as, or acted in the capacity of, our principal executive
officer for the fiscal year ended December 31, 2003; and (ii) our other most
highly compensated executive officer, who together with the principal executive
officer are our most highly compensated officers whose salary and bonus exceeded
$100,000 with respect to the fiscal year ended December 31, 2003 and who were
employed at the end of fiscal year 2003.
SUMMARY COMPENSATION TABLE*
LONG TERM COMPENSATION
----------------------
ANNUAL COMPENSATION(1) AWARDS PAYOUTS
---------------------- ------ -------
NAME AND YEAR SALARY BONUS OTHER ANNUAL RESTRICTED SECURITIES LTIP ALL OTHER
PRINCIPAL COMPENSATION STOCK UNDERLYING PAYOUTS COMPENSATION
POSITION AWARD(S) OPTIONS/SARS
-----------------------------------------------------------------------------------------------------------------------------------
($) ($) ($) ($) (#) ($) ($)
Scott Newman 2003 244,452 -- -- -- -- -- 206,686 (2)
President, Chief
Executive Officer
and Chairman 2002 143,750 -- -- -- -- -- 259,418 (2)
2001 250,000 -- -- -- -- -- 220,000 (2)
Glenn Peipert 2003 223,016 -- -- -- -- -- 171,309 (3)
Executive Vice
President, Chief
Operating Officer
and Director
2002 143,750 -- -- -- -- -- 199,166 (3)
2001 187,500 -- -- -- -- -- 165,633 (3)
--------------------
* Salary reflects total compensation paid to these executives (both before and
after the merger described in Item 1).
(1) The annual amount of perquisites and other personal benefits, if any, did
not exceed the lesser of $50,000 or 10% of the total annual salary
reported for each named executive officer and has therefore been omitted.
(2) Amounts shown reflect distributions resulting from our past tax status as
a Subchapter S corporation of $150,000 in 2001, $209,020 in 2002, and
$153,738 in 2003, as well as $56,686 in 2001, $50,398 in 2002 and $66,262
in 2003 of expenses, which include auto, travel and equipment purchases
paid for by the Company.
(3) Amounts shown reflect distributions resulting from our past tax status as
a Subchapter S corporation of $115,200 in 2001, $134,252 in 2002, and
$101,988 in 2003, as well as $56,109 in 2001, $64,914 in 2002 and $63,645
in 2003 of expenses, which include auto, travel and equipment purchases
paid for by the Company.
50
OPTION GRANTS AS OF SEPTEMBER 30, 2004
--------------------------------- ---------------------------- ------------------------------- -------------------- ----------------
Name Number of Securities Percent of total options Exercise price Expiration Date
underlying options granted granted to employees in
(1) fiscal year
--------------------------------- ---------------------------- ------------------------------- -------------------- ----------------
Mitchell Peipert 4,500,000 13.2% $0.165 March 28, 2014
--------------------------------- ---------------------------- ------------------------------- -------------------- ----------------
Lawrence K. Reisman 450,000 1.3% $0.20 May 27, 2014
--------------------------------- ---------------------------- ------------------------------- -------------------- ----------------
(1) All options were granted under the Company's 2003 Incentive Plan. Mr.
Peipert's options were granted on March 29, 2004, and Mr. Reisman's options were
granted on May 28, 2004. One-third of such options vest upon the first
anniversary of the grant date, one-third vest on the second anniversary of the
grant date, and one-third vest on the third anniversary of the grant date.
As of September 30, 2004, options to purchase a total of 34,060,000 shares
of common stock were granted by our Board of Directors at an exercise prices
ranging from $0.165 to $0.23 per share. One-third of the options granted vest on
the first anniversary, one-third of the options granted vest on the second
anniversary and one-third of the options granted vest on the third anniversary.
The options expire on the ten year anniversary of their grant date.
All options described above have been issued pursuant to the 2003
Incentive Plan described below.
2003 INCENTIVE PLAN
General
The 2003 Incentive Plan was approved at a special meeting of our
stockholders on January 23, 2004. The Plan authorizes us to issue 100,000,000
shares of common stock for issuance upon exercise of options. It also authorizes
the issuance of stock appreciation rights, referred to herein as SARs. The Plan
authorizes us to grant:
o incentive stock options to purchase shares of our common stock,
o non-qualified stock options to purchase shares of common stock, and
o SARs and shares of restricted common stock.
The Plan may be amended, terminated or modified by our Board at any time,
subject to stockholder approval as required by law, rule or regulation. No such
termination, modification or amendment may affect the rights of an optionee
under an outstanding option or the grantee of an award.
Objectives
The objective of the Plan is to provide incentives to our officers, other
key employees, consultants, professionals and non-employee directors to achieve
financial results aimed at increasing stockholder value and attracting talented
individuals to CSI. Persons eligible to be granted incentive stock options under
the Plan will be those employees, consultants, professionals and non-employee
directors whose performance, in the judgment of a committee of our Board of
Directors, can have a significant effect on our success.
51
Oversight
The Board, acting as a whole, or a committee thereof appointed by our
Board, will administer the Plan by making determinations regarding the persons
to whom options should be granted and the amount, terms, conditions and
restrictions of the awards. The Board or such committee also has the authority
to interpret the provisions of the Plan and to establish and amend rules for its
administration subject to the Plan's limitations.
Types of grants
The Plan allows us to grant incentive stock options, non-qualified stock
options, shares of restricted stock, SARs in connections with options and
independent SARs. The Plan does not specify what portion of the awards may be in
the form of any of the foregoing. Incentive stock options awarded to our
employees are qualified stock options under the Internal Revenue Code.
Eligibility
Under the Plan, we may grant incentive stock options only to our officers
and employees, and we may grant non-qualified options to officers and employees,
as well as our directors, independent contractors and agents.
Statutory Conditions on Stock Options
Exercise Price. To the extent that Options designated as incentive stock
options become exercisable by an optionee for the first time during any calendar
year for common stock having a fair market value greater than One Hundred
Thousand Dollars ($100,000), the portions of such options which exceed such
amount shall be treated as nonqualified stock options. Incentive stock options
granted to any person who owns, immediately after the grant, stock possessing
more than 10% of the combined voting power of all classes of our stock, or of
any parent or subsidiary of ours, must have an exercise price at least equal to
110% of the fair market value of common stock on the date of grant and the term
of the option may not be longer than five years.
Expiration Date. Any option granted under the Plan will expire at the time
fixed by the Board or its committee, which cannot be more than ten (10) years
after the date it is granted or, in the case of any person who owns more than
10% of the combined voting power of all classes of our stock or of any parent or
subsidiary corporation, not more than five years after the date of grant.
Exerciseability. The Board or its committee may also specify when all or
part of an option becomes exercisable, but in the absence by such specification,
the option will ordinarily be exercisable in whole or part at any time during
its term. However, the Board or its committee may accelerate the exerciseability
of any option at its discretion.
Assignability. Options granted under the Plan are not assignable, except
by the laws of descent and distribution or as may be otherwise provided by the
Board or its committee.
Payment Upon Exercise Of Options
Payment of the exercise price for any option may be in cash, by withheld
shares that, upon exercise, have a fair market value at the time the option is
exercised equal to the option price, plus applicable withholding tax, or in the
form of shares of our common stock.
52
Stock Appreciation Rights
A Stock Appreciation Right is the right to benefit from appreciation in
the value of common stock. A SAR holder, on exercise of the SAR, is entitled to
receive from us in cash or common stock an amount equal to the excess of: (a)
the fair market value of common stock covered by the exercised portion of the
SAR, as of the date of such exercise, over (b) the fair market value of common
stock covered by the exercised portion of the SAR as of the date on which the
SAR was granted.
The Board or its committee may grant SARs in connection with all or any
part of an option granted under the Plan, either concurrently with the grant of
the option or at any time thereafter, and may also grant SARs independently of
options.
Tax Consequences
An employee or director will not recognize income on the awarding of
incentive stock options and nonstatutory options under the Plan.
An optionee will recognize ordinary income as the result of the exercise
of a nonstatutory stock option in the amount of the excess of the fair market
value of the stock on the day of exercise over the option exercise price.
An employee will not recognize income on the exercise of an incentive
stock option, unless the option exercise price is paid with stock acquired on
the exercise of an incentive stock option and the following holding period for
such stock has not been satisfied. The employee will recognize long-term capital
gain or loss on a sale of the shares acquired on exercise, provided the shares
acquired are not sold or otherwise disposed of before the earlier of:
(i) two years from the date of award of the option, or
(ii) one year from the date of exercise.
If the shares are not held for the required period of time, the employee
will recognize ordinary income to the extent the fair market value of the stock
at the time the option is exercised exceeds the option price, but limited to the
gain recognized on sale. The balance of any such gain will be a short-term
capital gain. Exercise of an option with previously owned stock is not a taxable
disposition of such stock. An employee generally must include in alternative
minimum taxable income the amount by which the price such employee paid for an
incentive stock option is exceeded by the option's fair market value at the time
his or her rights to the stock are freely transferable or are not subject to a
substantial risk of forfeiture.
EMPLOYMENT AGREEMENTS
Scott Newman, our President and Chief Executive Officer, agreed to a
five-year employment agreement dated as of March 26, 2004. The agreement
provides for an annual salary to Mr. Newman of $500,000 and an annual bonus to
be awarded by our to-be-appointed Compensation Committee. The agreement also
provides for health, life and disability insurance, as well as a monthly car
allowance. In the event that Mr. Newman's employment is terminated other than
with good cause, he will receive a payment of three year's base salary.
Glenn Peipert, Executive Vice President and Chief Operating Officer,
agreed to a five-year employment agreement dated as of March 26, 2004. The
agreement provides for an annual salary to Mr. Peipert of $375,000 and an annual
bonus to be awarded by our to-be-appointed Compensation Committee. The agreement
also provides for health, life and disability insurance, as well as a monthly
car allowance. In the event that Mr. Peipert's employment is terminated other
than with good cause, he will receive a payment of three year's base salary.
53
Mitchell Peipert, Vice President, Chief Financial Officer, Treasurer and
Secretary, agreed to a three-year employment agreement dated as of March 26,
2004. The agreement provides for an annual salary to Mr. Peipert of $200,000 and
an annual bonus to be awarded by our to-be-appointed Compensation Committee. The
agreement also provides for health, life and disability insurance, as well as a
monthly car allowance. In the event that Mr. Peipert's employment is terminated
other than with good cause, he will receive a payment of three year's base
salary.
Robert C. DeLeeuw, Senior Vice President and President of our wholly owned
subsidiary, DeLeeuw Associates, LLC, agreed to a three-year employment agreement
dated as of February 27, 2004. The agreement provides for an annual salary to
Mr. DeLeeuw of $350,000 and an annual bonus to be awarded by our to-be-appointed
Compensation Committee. The agreement also provides for health, life and
disability insurance. In the event that Mr. DeLeeuw's employment is terminated
other than with good cause, he will receive a payment of one year's base salary.
54
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of our common stock, our only class of outstanding voting
securities as of November 26, 2004, based on 772,082,096 aggregate shares of
common stock outstanding as of such date, by: (i) each person who is known by us
to own beneficially more than 5% of our outstanding common stock with the
address of each such person, (ii) each of our present directors and officers,
and (iii) all officers and directors as a group:
------------------------------------------------------------------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT OF COMMON STOCK PERCENTAGE OF OUTSTANDING COMMON STOCK
BENEFICIAL OWNER(1)(2) BENEFICIALLY OWNED BENEFICIALLY OWNED
------------------------------------------------------------------------------------------------------------------------------------
Scott Newman(3) 295,050,000 38.2%
------------------------------------------------------------------------------------------------------------------------------------
Glenn Peipert(4) 150,000,000 19.4%
------------------------------------------------------------------------------------------------------------------------------------
Mitchell Peipert(5) * *
------------------------------------------------------------------------------------------------------------------------------------
Robert C. DeLeeuw(6) 80,000,000 10.4%
------------------------------------------------------------------------------------------------------------------------------------
Lawrence K. Reisman(7) * *
------------------------------------------------------------------------------------------------------------------------------------
WHRT I Corp. (8) 72,543,956 9.4%
------------------------------------------------------------------------------------------------------------------------------------
All directors and officers as a group
(5 persons) 525,050,000 68.0%
------------------------------------------------------------------------------------------------------------------------------------
-----------------------
* Represents less than 1% of the issued and outstanding Common Stock.
(1) Each stockholder, director and executive officer has sole voting power and
sole dispositive power with respect to all shares beneficially owned by
him, unless otherwise indicated.
(2) All addresses except for WHRT I Corp. are c/o Conversion Services
International, Inc., 100 Eagle Rock Avenue, East Hanover, New Jersey
07936.
(3) Mr. Newman is the Company's President, Chief Executive Officer and
Chairman of the Board.
(4) Mr. Glenn Peipert is the Company's Executive Vice President, Chief
Operating Officer and Director.
(5) Mr. Mitchell Peipert is the Company's Vice President, Chief Financial
Officer, Secretary and Treasurer. Does not include an option to purchase
4,500,000 shares of common stock granted on March 29, 2004 at an exercise
price of $0.165 per share.
One-third of the options granted vest on the first anniversary, one-third
of the options granted vest on the second anniversary and one-third of the
options granted vest on the third anniversary. The option grant expires on
March 28, 2014.
(6) Mr. DeLeeuw is the Company's Senior Vice President and the President of
the Company's wholly owned subsidiary, DeLeeuw Associates, LLC.
(7) Mr. Reisman is a Director. Does not include an option to purchase 450,000
shares of common stock granted on May 28, 2004 at an exercise price of
$0.20 per share. One-third of the options granted vest on the first
anniversary, one-third of the options granted vest on the second
anniversary and one-third of the options granted vest on the third
anniversary. The option grant expires on May 27, 2014.
(8) Based on a Schedule 13G filed with the Securities Exchange Commission on
July 8, 2004. WHRT I Corp.'s address is c/o Tudor Ventures, 50 Rowes
Wharf, 6th Floor, Boston, Massachusetts 02420.
55
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
As of November 17, 2004, Mr. Newman has agreed to personally support our
cash requirements to enable us to fulfill our obligations through March 31,
2005, to the extent necessary, up to a maximum amount of $500,000. We believe
that our reliance on such commitment is reasonable and that Mr. Newman has
sufficient liquidity and net worth to honor such commitment. We believe that Mr.
Newman's written commitment provides us with the legal right to request and
receive such advances. Any loan by Mr. Newman to the Company would bear interest
at 3% per annum.
As of September 30, 2004, Scott Newman and Glenn Peipert owed us an
aggregate of approximately $207,000, including accrued interest. These loans
bear at 3% per annum and are due and payable by December 31, 2005. These loans
were repaid in full as of November 16, 2004.
Dr. Michael Mitchell, the former President, Chief Executive Officer and
sole director of LCS, had loaned an aggregate of $930,707 to us. This loan was
converted into shares of our common stock at the closing of the merger of LCS
and CSI. Dr. Mitchell is a selling stockholder hereunder.
On March 22, 2002, we issued 500,000 shares of our common stock to two of
our former directors, which we valued at $0.04 per share.
During our fiscal year ended February 28, 2003, A&J Marketing, Inc., a
company owned by Alex Bruni, acquired the Golfpromo.net and PlayGolfNow.com
domain names after we had lost our right to these names because we were unable
to pay the fees needed to retain these rights. A&J Marketing subsequently opened
websites using these names and is now operating these websites.
Other than those described above, we have no material transactions which
involved or are planned to involve a direct or indirect interest of a director,
executive officer, greater than 5% stockholder or any family of such parties.
56
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information. Our common stock traded on the OTC Bulletin Board,
except as indicated below, and/or the Pink Sheets LLC under the symbol "LCSG"
from mid-1998 through July 16, 2003 and "LCSI" through February 2, 2004.
Beginning February 3, 2004, our common stock has traded on the OTC Bulletin
Board under the symbol "CSII."
The following chart sets forth the high and low bid prices for each
quarter from January 1, 2002 through September 30, 2004. Such prices represent
quotations between dealers, without dealer markup, markdown or commissions, and
may not represent actual transactions.
HIGH LOW
---- ---
2002 BY QUARTER
January 1 - March 31 $0.37 $0.03
April 1 - June 30 $0.51 $0.04
July 1 - September 30 $0.10 $0.04
October 1 - December 31 $0.05 $0.01
2003 BY QUARTER
January 1 - March 31 $0.04 $0.01
April 1 - June 30 $0.09 $0.08
July 1 - September 30 $0.19 $0.06
October 1 - December 31 $0.19 $0.06
2004 BY QUARTER
January 1 - March 31 $0.25 $0.13
April 1 - June 30 $0.26 $0.12
July 1 - September 30 $0.32 $0.19
We are listed on the OTC Bulletin Board. On November 26, 2004, the high
and low bid prices for shares of our common stock in the over-the-counter
market, as reported by NASD OTCBB, were $0.21 and $0.17, respectively.
On April 21, 2004, we filed an application to list our common stock on the
American Stock Exchange. We are presently responding to the requests of the
American Stock Exchange for further information and documentation. There can be
no assurance, however, that such application will be approved.
No prediction can be made as to the effect, if any, that future sales of
shares of our common stock or the availability of our common stock for future
sale will have on the market price of our common stock prevailing from
time-to-time. Sales of substantial amounts of our common stock in the public
market could adversely affect the prevailing market price of our common stock.
Record Holders. As of November 26, 2004, there were 480 registered holders
of our common stock, including shares held in street name. As of November 26,
2004, there were 772,082,096 shares of common stock issued and outstanding.
Dividends. We have not paid dividends on our common stock in the past and
do not anticipate doing so in the foreseeable future. We currently intend to
retain future earnings, if any, to fund the development and growth of our
business. In addition, the security agreement with Laurus Master Fund, Ltd.
requires that we obtain their consent prior to paying any dividends.
57
DESCRIPTION OF SECURITIES
The following description of our capital stock is a summary and is
qualified in its entirety by the provisions of our Certificate of Incorporation,
as amended. We are authorized to issue up to 1,000,000,000 shares of common
stock, par value $.001 per share. As of November 26, 2004, there were
772,082,096 shares of common stock issued and outstanding. We are authorized to
issue up to 20,000,000 shares of preferred stock, par value $.001. As of
November 26, 2004, there were 0 shares of preferred stock issued and
outstanding.
COMMON STOCK
The holders of common stock are entitled to one vote for each share held
of record on all matters to be voted on by the stockholders. The holders of
common stock are entitled to receive dividends ratably, when, as and if declared
by the Board of Directors, out of funds legally available. In the event of a
liquidation, dissolution or winding-up of us, the holders of common stock are
entitled to share equally and ratably in all assets remaining available for
distribution after payment of liabilities and after provision is made for each
class of stock, if any, having preference over the common stock. The holders of
shares of common stock, as such, have no conversion, preemptive, or other
subscription rights and there are no redemption provisions applicable to the
common stock. All of the outstanding shares of common stock are validly issued,
fully-paid and nonassessable.
PREFERRED STOCK
The shares of preferred stock may be issued in series, and shall have such
voting powers, full or limited, or no voting powers, and such designations,
preferences and relative participating, optional or other special rights, and
qualifications, limitations or restrictions thereof, as shall be stated and
expressed in the resolution or resolutions providing for the issuance of such
stock adopted from time to time by our Board of Directors. Our Board of
Directors is expressly vested with the authority to determine and fix in the
resolution or resolutions providing for the issuances of preferred stock the
voting powers, designations, preferences and rights, and the qualifications,
limitations or restrictions thereof, of each such series to the full extent now
or hereafter permitted by the laws of the State of Delaware.
CONVERTIBLE NOTES
In June 2004, we issued a five-year $2.0 million unsecured convertible
line of credit note with a private investor. The note accrues interest at an
annual rate of 7%, and the conversion price of the shares of common stock
issuable under the note is equal to $0.105.
In August 2004, we replaced our $3,000,000 line of credit with North Fork
Bank with a revolving line of credit with Laurus Master Fund, Ltd. ("Laurus"),
whereby we will have the ability to borrow up to $6,000,000 based upon eligible
accounts receivable. This revolving line, effectuated through a $2,000,000
convertible minimum borrowing note and a $4,000,000 revolving note, provides for
advances at an advance rate of 90% against eligible accounts receivable, with an
annual interest rate of prime rate (as reported in the Wall Street Journal) plus
1%, and maturing in three years. The interest rate on these notes will be
decreased by 1.0% for every 25% increase in our stock price above the fixed
conversion price prior to an effective registration statement and 2.0%
thereafter up to a minimum of 0.0%. This line of credit is secured by
substantially all the corporate assets. Both the $2,000,000 convertible minimum
borrowing note and the $4,000,000 revolving note provide for conversion at the
option of the holder of the amounts outstanding into our common stock at a fixed
conversion price of $0.14 per share. In the event that we issue stock or
derivatives convertible into our stock for a price less the aforementioned fixed
conversion price, then the fixed conversion price is reset using a weighted
average dilution calculation.
58
In September 2004, we issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, "Sands") three subordinated secured convertible promissory notes
equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, subordinate to Laurus. The Notes are convertible into shares
of our common stock at the election of Sands at any time following the
consummation of a convertible debt or equity financing with gross proceeds of $5
million or greater to us (a "Qualified Financing"). The conversion price of the
shares of our common stock issuable upon conversion of the Notes shall be equal
to a price per share of common stock equal to forty percent (40%) of the price
of the securities issued pursuant to a Qualified Financing. If no Qualified
Offering has been consummated by September 8, 2005, then Sands may elect to
convert the Notes at a fixed conversion price of $0.14 per share. In the event
that we issue stock or derivatives convertible into our stock for a price less
the aforementioned fixed conversion price, then the fixed conversion price is
reset using a weighted average dilution calculation.
WARRANTS
A private investor received a warrant to purchase 4,166,666 shares of our
common stock at $0.105 per share in June 2004. These warrants expire in June
2009.
Laurus received a warrant to purchase 12,000,000 shares of our common
stock. The exercise price for the first 6,000,000 shares acquired under the
warrant is $0.29 per share, the exercise price for the next 3,000,000 shares
acquired under the warrant is $0.31 per share, and the exercise price for the
final 3,000,000 shares acquired under the warrant is $0.35 per share. These
warrants expire in August 2011.
We issued Sands three common stock purchase warrants (the "Warrants")
providing Sands with the right to purchase 6,000,000 shares of our common stock.
The exercise price of the shares of our common stock issuable upon exercise of
the Warrants shall be equal to a price per share of common stock equal to forty
percent (40%) of the price of the securities issued pursuant to a Qualified
Financing. If no Qualified Offering has been consummated by September 8, 2005,
then Sands may elect to exercise the Warrants at a fixed conversion price of
$0.14 per share. The latest that the Warrants may expire is September 8, 2008.
OPTIONS
The only executive officers or directors to receive options as of
September 30, 2004 were Mitchell Peipert, who was granted an option to purchase
4,500,000 shares of common stock by our Board of Directors on March 29, 2004 at
an exercise price of $0.165 per share, and Lawrence K. Reisman, who was granted
an option to purchase 450,000 shares of common stock by our Board of Directors
on May 28, 2004 at an exercise price of $0.20 per share. One-third of the
options granted vest on the first anniversary, one-third of the options granted
vest on the second anniversary and one-third of the options granted vest on the
third anniversary. Mr. Peipert's option expires on March 28, 2014, and Mr.
Reisman's option expires on May 27, 2014.
As of September 30, 2004, options to purchase a total of 34,060,000 shares
of common stock were granted by our Board of Directors at an exercise prices
ranging from $0.165 to $0.23 per share. One-third of the options granted vest on
the first anniversary, one-third of the options granted vest on the second
anniversary and one-third of the options granted vest on the third anniversary.
The options expire on the ten year anniversary of their grant date
59
TRANSFER AGENT
Olde Monmouth Stock Transfer Co., Inc., 200 Memorial Parkway, Atlantic
Highlands, New Jersey 07716, is the transfer agent for our shares of common
stock.
60
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of our common stock in the public
market, or the perception that such sales may occur, could adversely affect the
prevailing market price of our common stock. This could adversely affect the
prevailing market price and our ability to raise equity capital in the future.
Subject to this Registration Statement being declared effective, all 564,557,157
shares of common stock sold in this offering will be freely transferable without
restriction or further registration under the Securities Act, except for any
shares that may be sold or purchased by our "affiliates." Shares purchased by
our affiliates will be subject to the volume and other limitations of Rule 144
of the Securities Act, or "Rule 144" described below. As defined in Rule 144, an
"affiliate" of an issuer is a person who, directly or indirectly, through one or
more intermediaries, controls, is controlled by or is under common control with
the issuer. These shares will be subject to the volume and other limitations of
Rule 144.
Under Rule 144 as currently in effect, beginning 90 days after the date of
this prospectus, a person who has beneficially owned restricted shares of common
stock for at least one year, including the holding period of any prior owner who
is not an affiliate, would be entitled to sell a number of the shares within any
three-month period equal to the greater of 1% of the then outstanding shares of
the common stock or the average weekly reported volume of trading of the common
stock (if such common stock is traded on NASDAQ or another exchange) during the
four calendar weeks preceding such sale. Immediately after the offering, 1% of
our outstanding shares of common stock would equal approximately 7,661,297
shares. Under Rule 144, restricted shares are subject to manner of sale and
notice requirements and requirements as to the availability of current public
information concerning us.
Under Rule 144(k), a person who is not deemed to have been an affiliate at
any time during the 90 days preceding a sale, and who has beneficially owned the
shares proposed to be sold for at least two years, including the holding period
of any prior owner who is not an affiliate, is entitled to sell such shares
without regard to the volume or other limitations of Rule 144 just described.
EXPERTS
The audited financial statements for our company as of the year ended
December 31, 2003 included in this prospectus are reliant on the reports of
Friedman LLP, Livingston, New Jersey, independent registered public accountants,
as stated in their reports therein, upon the authority of that firm as experts
in auditing and accounting. Prior to our engagement of Friedman LLP, we had
engaged Ehrenkrantz Sterling & Co. LLC and Eisner LLP as our independent
auditors and certifying accountants. See "Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure."
LEGAL MATTERS
The legality of this offering of shares of our common stock has been
passed upon on our behalf by Ellenoff Grossman & Schole LLP, New York, New York.
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES
We have indemnified each member of the Board of Directors and our
executive officers to the fullest extent authorized, permitted or allowed by
law. Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the small
business issuer pursuant to the foregoing provisions, or otherwise, the small
business issuer has been advised that in the opinion of the SEC such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
61
For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form SB-2 under the
Securities Act, and the rules and regulations promulgated thereunder, with
respect to the common stock offered hereby. This prospectus, which constitutes a
part of the registration statement, does not contain all of the information set
forth in the registration statement and the exhibits thereto. Statements
contained in this prospectus as to the contents of any contract or other
document that is filed as an exhibit to the registration statement are not
necessarily complete and each such statement is qualified in all respects by
reference to the full text of such contract or document. For further information
with respect to us and the common stock, reference is hereby made to the
registration statement and the exhibits thereto, which may be inspected and
copied at the principal office of the SEC, 450 Fifth Street, N.W., Washington,
D.C. 20549, and copies of all or any part thereof may be obtained at prescribed
rates from the Commission's Public Reference Section at such addresses. Also,
the SEC maintains a World Wide Web site on the Internet at http://www.sec.gov
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the SEC.
We are in compliance with the information and periodic reporting
requirements of the Exchange Act and, in accordance therewith, will file
periodic reports, proxy and information statements and other information with
the SEC. Such periodic reports, proxy and information statements and other
information will be available for inspection and copying at the principal
office, public reference facilities and Web site of the SEC referred to above.
62
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheet F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Changes in Stockholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Conversion Services International, Inc.
East Hanover, New Jersey
We have audited the accompanying consolidated balance sheet of Conversion
Services International, Inc. and subsidiary as of December 31, 2003, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the years ended December 31, 2003 and 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversite Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Conversion Services
International, Inc. and subsidiary as of December 31, 2003 and the consolidated
results of its operations and its cash flows for the years ended December 31,
2003 and 2002, in conformity with accounting principles generally accepted in
the United States of America.
/s/ Friedman L.L.P.
Livingston, New Jersey March 30, 2004, except for Notes 1 and 9, as to which the
date is May 4, 2004
F-1
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, September 30,
2003 2004
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 411,586 $ 882,986
Restricted cash -- 83,375
Accounts receivable, net of allowance for
doubtful accounts of $92,000 and $150,755 at
December 31, 2003 and September 30, 2004, respectively 2,052,343 4,216,357
Account receivable from related parties -- 900,942
Prepaid expenses 113,803 188,513
Costs in excess of billings -- 139,565
Deferred tax asset 36,700 63,938
------------ ------------
TOTAL CURRENT ASSETS 2,614,432 6,475,676
------------ ------------
PROPERTY AND EQUIPMENT, at cost, net 270,696 697,399
------------ ------------
OTHER ASSETS
Restricted cash -- 4,251,000
Due from stockholders, including accrued
interest of $21,600 and $25,696 at December 31, 2003
and September 30, 2004, respectively 203,623 207,719
Goodwill 1,094,206 2,506,224
Deferred loan costs, net of accumulated amortization
of $77,484 and $30,881 at December 31, 2003 and
September 30, 2004, respectively 24,862 850,539
Intangible assets, net of accumulated amortization of
$89,710 and $461,063 at December 31, 2003 and
September 30, 2004, respectively 344,290 6,079,679
Discount on debt issued, net of accumulated
amortization of $0 and $270,434 at December 31, 2003 and
September 30, 2004, respectively -- 7,305,741
Deferred tax asset 191,000 --
Equity investments -- 113,876
Security deposits 16,791 4,433
------------ ------------
1,874,772 21,319,211
------------ ------------
TOTAL ASSETS $ 4,759,900 $ 28,492,286
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Line of credit $ 1,782,699 $ 3,200,000
Current portion of long-term debt 461,981 110,622
Deferred revenue -- 1,057,533
Accounts payable and accrued expenses 1,025,248 3,947,987
Short-term note payable -- 454,545
------------ ------------
TOTAL CURRENT LIABILITIES 3,269,928 8,770,687
------------ ------------
LONG-TERM DEBT, net of current portion 233,928 4,714,026
------------ ------------
DEFERRED TAXES 36,900 36,900
------------ ------------
MINORITY INTEREST -- 157,104
------------ ------------
COMMITMENTS and CONTINGENCIES -- --
STOCKHOLDER'S EQUITY
Common stock, $.001 par value, 1,000,000 shares
authorized, issued and outstanding as of
December 31, 2003; 1,000,000,000 shares authorized,
768,510,668 issued and outstanding as of
September 30, 2004 1,000 768,511
Additional paid in capital 1,446,250 18,501,875
Foreign currency translation -- 4,053
Accumulated deficit (228,106) (4,460,870)
------------ ------------
TOTAL STOCKHOLDERS EQUITY 1,219,144 14,813,569
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ 4,759,900 $ 28,492,286
============ ============
See Notes to Consolidated Financial Statements.
F-2
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ----------------------------------
2002 2003 2003 2004
------------- ------------- ------------- -------------
(Restated) (UNAUDITED) (UNAUDITED)
REVENUE $ 16,244,790 $ 14,366,456 $ 10,607,502 $ 18,655,937
COST OF SERVICES 10,677,527 10,265,808 7,545,080 12,804,331
------------- ------------- ------------- -------------
GROSS PROFIT 5,567,263 4,100,648 3,062,422 5,851,606
------------- ------------- ------------- -------------
OPERATING EXPENSES
Selling and Marketing 1,095,072 1,552,766 1,064,951 2,745,801
General and administrative 3,549,423 2,701,934 1,826,501 4,860,995
Research and development -- 270,976
Depreciation & amortization 149,463 213,158 147,127 516,119
------------- ------------- ------------- -------------
TOTAL OPERATING EXPENSES 4,793,958 4,467,858 3,038,579 8,393,891
------------- ------------- ------------- -------------
INCOME (LOSS) FROM OPERATIONS 773,305 (367,210) 23,843 (2,542,285)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE)
Equity in losses from investments -- -- -- (24,900)
Other income -- -- -- 7,295
Interest income 5,400 5,400 -- 3,392
Interest expense (139,152) (135,753) (92,304) (636,494)
------------- ------------- ------------- -------------
(133,752) (130,353) (92,304) (650,707)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE TAXES 639,553 (497,563) (68,461) (3,192,992)
INCOME TAXES (BENEFIT)
Current 101,100 -- -- (136,271)
Deferred (78,700) (190,800) -- --
------------- ------------- ------------- -------------
22,400 (190,800) -- (136,271)
MINORITY INTEREST -- -- -- (42,296)
------------- ------------- ------------- -------------
NET INCOME (LOSS) 617,153 (306,763) (68,461) (3,014,425)
UNSECURED CONVERTIBLE LINE OF CREDIT
BENEFICIAL CONVERSION FEATURE -- -- -- 1,214,286
------------- ------------- ------------- -------------
NET INCOME (LOSS) ATTRIBUTABLE TO
COMMON STOCKHOLDERS $ 617,153 $ (306,763) $ (68,461) $ (4,228,711)
============= ============= ============= =============
UNAUDITED PRO FORMA DATA:
Income before income taxes (benefit) $ 617,153 $ (306,763) $ (68,461) $ --
Income taxes (benefit) 246,491 (122,521) (27,325) --
------------- ------------- ------------- -------------
Net income (loss) $ 370,662 $ (184,242) $ (41,136) $ --
============= ============= ============= =============
NET INCOME (LOSS) PER SHARE (Unaudited) $ 0.00 $ (0.00) $ (0.00) $ (0.01)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES USED IN THE ACTUAL AND PRO
FORMA NET INCOME (LOSS) PER SHARE
CALCULATION (Unaudited) 593,000,000 593,000,000 593,000,000 689,233,712
============= ============= ============= =============
See Notes to Consolidated Financial Statements.
F-3
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Retained Other Total
Capital Paid-in Earnings Comprehensive Stockholders'
Stock Capital (Deficit) Income Equity
------------ ------------ ------------ ------------ ------------
Balance, January 1, 2002, as restated $ 900 $ 140,800 $ 190,424 $ -- $ 332,124
Net income -- -- 617,153 617,153
Distributions to stockholders -- -- (178,340) (178,340)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2002, as restated 900 140,800 629,237 -- 770,937
Net loss -- -- (306,763) (306,763)
Issuance of 100,000 shares of
Common Stock of Conversion
Services International, Inc. 100 1,522,338 -- 1,522,438
Distributions to stockholders -- (216,888) (550,580) (767,468)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2003 $ 1,000 $ 1,446,250 $ (228,106) $ -- $ 1,219,144
Net loss -- -- (3,018,478) (3,018,478)
Foreign currency translation 4,053 4,053
Effect of Conversion Services
International recapitalization (1,000) 1,000 --
Relative fair value of warrants
issued -- 3,086,668 -- 3,086,668
Fair value of stock grants to
employees -- 87,125 -- 87,125
Costs incurred in connection with
LCS Golf merger -- (95,678) -- (95,678)
Issuance of 593,000,000 shares of
Common Stock of Conversion Services
International, Inc. in connection
with the reverse merger into LCS Golf. 593,000 (593,000) -- --
Issuance of 80,000,000 shares of
Common Stock of Conversion Services
International, Inc. in connection
with the acquisition of DeLeeuw
Associates, Inc. 80,000 2,078,246 -- 2,158,246
Issuance of 16,666,666 shares of
Common Stock of Conversion Services
International, Inc. in connection
with the conversion of debt into
Company stock. 16,667 1,983,333 -- 2,000,000
Issuance of 76,463,049 shares of
Common Stock of Conversion Services
International, Inc. in connection
with the acquisition of Evoke
Software Corporation. 76,463 1,712,351 -- 1,788,814
Issuance of 2,380,953 shares of
Common Stock of Conversion Services
International, Inc. in connection
with a stock purchase agreement. 2,381 (2,381) --
Compensation expense for stock
options issued to non-employees -- 7,500 -- 7,500
Discount on debt issued 7,576,175 7,576,175
Unsecured convertible line of credit
beneficial conversion feature -- 1,214,286 (1,214,286) --
------------ ------------ ------------ ------------ ------------
Balance, September 30, 2004 (Unaudited) $ 768,511 $ 18,501,875 $ (4,460,870) $ 4,053 $ 14,813,569
============ ============ ============ ============ ============
See Notes to Consolidated Financial Statements.
F-4
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------- -------------------------------
2002 2003 2003 2004
----------- ----------- ----------- -----------
(Restated) (UNAUDITED) (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 617,153 $ (306,763) $ (68,461) $(4,228,711)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Depreciation 108,890 95,837 56,622 104,211
Amortization of intangible assets and deferred loan costs and
discount on debt issued 40,573 117,321 83,595 803,580
Beneficial conversion feature associated with convertible
debt instruments -- -- -- 1,214,286
Deferred tax benefit (78,700) (190,800) -- (136,238)
Compensation expense for stock options and stock issued -- -- -- 94,625
Allowance for doubtful accounts (75,000) 42,000 54,000 75,748
Write-off deferred loan costs -- -- -- 45,215
Loss on disposal of equipment -- -- -- 35,496
Loss on equity investments -- -- -- 24,900
Minority interest in Evoke Software Corporation -- -- -- (42,296)
Conversion of accrued interest to additional paid-in capital -- 22,438 -- --
Changes in operating assets and liabilities:
Increase in accounts receivable (180,980) (268,325) (381,137) (1,059,936)
Increase in accounts receivable from related parties -- -- -- (507,984)
(Increase) decrease in prepaid expense 73,139 (50,611) (5,319) 3,824
(Increase) decrease in security deposits 1,250 (2,070) -- --
Increase in costs in excess of billings -- -- -- (139,565)
Increase in due from stockholders -- -- -- (4,096)
Decrease in other assets -- -- 57,313 14,721
Increase (decrease) in accounts payable and accrued expenses (548,661) (327) (91,906) 920,258
Increase (decrease) in other current liabilities -- -- (2,086) 8,987
Increase (decrease) in deferred revenue (10,000) -- -- (196,509)
----------- ----------- ----------- -----------
Net cash used in o perating activities (52,336) (541,300) (297,379) (2,969,484)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (41,050) (93,640) (20,759) (42,111)
Investment in DeLeeuw Associates, net of cash acquired -- -- -- (2,010,266)
Investment in Evoke Software Corp., net of cash acquired -- -- -- 346,073
Equity investment in Leading Edge Communications Corp. -- -- -- (83,000)
Collection (issuance) of note receivable 210,000 2,100 -- --
Acquisition of intangible assets and goodwill (82,277) (11,951) -- --
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities 86,673 (103,491) (20,759) (1,789,304)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft 5,661 (5,661) -- (51,900)
Net advances under line of credit 454,137 1,112,863 89,862 1,410,890
Principal payments on long-term debt (308,828) (777,957) (295,785) (729,028)
Deferred loan costs in connection with long-term debt (23,241) -- -- --
Deferred loan costs in connection with line of credit -- -- (95,436) (911,954)
Issuance of short-term note payable -- -- -- 1,000,000
Issuance of long-term note payable -- -- -- 5,000,000
Issuance of convertible debt -- 1,500,000 1,522,438 4,000,000
Principal payments on capital lease obligations -- -- -- (92,987)
Due from stockholders (5,400) (5,400) -- --
Distributions to stockholders (178,340) (767,468) (767,468) --
Restricted cash -- -- -- (4,334,375)
Costs incurred in connection with LCS merger -- -- -- (95,678)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities (56,011) 1,056,377 453,611 5,194,968
----------- ----------- ----------- -----------
Effect of exchange rate changes on cash and cash equivalents -- -- -- 4,312
NET INCREASE (DECREASE) IN CASH (21,674) 411,586 135,473 440,492
CASH, beginning of period 21,674 -- -- 442,494
----------- ----------- ----------- -----------
CASH, end of period $ -- $ 411,586 $ 135,473 $ 882,986
=========== =========== =========== ===========
See Notes to Consolidated Financial Statements.
F-5
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------- -------------------------------
2002 2003 2003 2004
----------- ----------- ----------- -----------
(Restated) (UNAUDITED) (UNAUDITED)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 135,066 $ 89,630 $ 84,860 $ 134,546
Cash paid for income taxes 229,007 28,258 -- --
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
During 2003 and 2002, the Company entered into
various capital lease arrangements for computer
equipment in the amount of $23,556
and $2,928, respectively
During 2002, the Company financed the acquisition
of certain intangibles through an obligation due
to a third party in the amount of $700,811
During 2004, the Company acquired substantially
all of the assets and liabilities of Evoke
Software Corporation. The following assets and
liabilities were obtained as a result of the
acquisition
Acquired cash -- -- -- 497,492
Acquired accounts receivable -- -- -- 579,839
Acquired customer contracts -- -- -- 1,962,000
Acquired tradename -- -- -- 444,775
Acquired computer software -- -- -- 1,381,000
Acquired prepaid expenses -- -- -- 78,533
Acquired other assets -- -- -- 11,350
Acquired furniture and equipment -- -- -- 183,717
Acquired deferred revenue -- -- -- (1,254,043)
Acquired deferred compensation -- -- -- (443,174)
Acquired liabilities -- -- -- (1,301,856)
Minority interest -- -- -- (199,400)
In March 2004, the Company acquired DeLeeuw Associates,
Inc. The following assets and liabilities were obtained
as a result of the acquisition
Acquired accounts receivable -- -- -- 975,513
Acquired approved vendor status -- -- -- 1,597,000
Acquired tradename -- -- -- 722,000
Acquired goodwill -- -- -- 1,403,875
Acquired investment in limited liability company -- -- -- 55,776
Acquired deferred tax liability -- -- -- (300,000)
Acquired liabilities -- -- -- (285,651)
On May 5, 2004, a $2,000,000 unsecured convertible line of credit note was
converted into 16,666,666 shares of Company common stock. The conversion price
was $0.12 per share, which represented 75% of the market price on the date of
conversion. The $666,667 effect of this beneficial conversion feature is
reflected in the Company's statement of operations for the June 2004 quarter.
The conversion price on the October 2003 note was adjusted to a fixed conversion
price of $0.105 on September 1, 2004, and 2,380,953 additional shares of common
stock were issued to the participating investor. Since the conversion price was
less than the market value of the common stock, the Company recorded a $547,619
discount on debt issued in September 2004 as a result of the realization of a
contingency that reduced earnings available to common stockholders. The Company
has reflected this beneficial conversion charge in the accompanying consolidated
statements of operations.
In June 2004, the Company signed an unsecured convertible line of credit note in
exchange for $2,000,000. The note bears interest at 7% per annum, is convertible
into shares of Company common stock, and expires on June 6, 2009. The conversion
price is 75% of the average bid price for the ten trading days prior to the date
of conversion . However, on September 1, 2004, the conversion price was reset to
a fixed conversion price of $0.105 per share. As a result of the discount on
debt issued, the Company recorded a charge of $1,500,000 in September 2004,
which will be amortized to interest expense over the five year life of the debt
agreement.
On August 16, 2004, the Company executed a revolving line of credit agreement
and a secured convertible term note with Laurus Master Fund, Ltd. ("Laurus"),
whereby the Company will have access to a $6,000,000 revolving line of credit
and an additional $5,000,000 cash to be used for acquisitions. These notes
provide beneficial conversion features to Laurus and, as a result, the Company
has recorded a $5,621,600 discount on debt in the third quarter of 2004 which
will be amortized to interest expense over the three year life of the debt
instrument. Additionally, warrants to purchase up to 12,000,000 shares of
Company common stock were issued as part of the above transaction. A relative
fair value of $2,041,200 was also ascribed to the warrants. This relative fair
value will also be amortized to interest expense over the life of the debt
instrument. See Note 6 - Line of Credit for further discussion surrounding this
transaction.
On September 22, 2004, the Company issued subordinated secured convertible
promissory notes in the amount of $1,000,000. These notes bear interest at 8%
per annum and expire September 22, 2005. These notes are convertible into shares
of Company common stock and include beneficial conversion privileges. As a
result, the Company has recorded a discount on debt relating to the transaction
in the amount of $454,500 in the third quarter of 2004 which will be amortized
to interest expense over the one year life of the debt instrument. A relative
fair value of $545,500 was ascribed to the warrants to purchase up to 6,000,000
shares of Company common stock which were issued as part of this transaction.
The relative fair value will be amortized to interest expense over the one year
life of the debt instrument.
See Notes to Consolidated Financial Statements.
F-6
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Conversion Services International, Inc. ("CSI") was incorporated in the State of
Delaware and has been conducting business since 1990. CSI and Doorways, Inc., a
wholly owned subsidiary of CSI, (together the "Company") are principally engaged
in the information technology services industry in the following areas: data
warehousing, business intelligence, management consulting and professional
services, on credit, to its customers principally located in New Jersey and New
York. In November 2002, the Company acquired the operations of Scosys, Inc. that
is engaged in the information technology services industry. Included in the
Company's results of operations related to Scosys were the following:
Years ended December 31,
---------------------------
2002 2003
---------- ----------
Revenues $ 456,000 $3,034,000
Cost of Services 335,000 2,169,000
---------- ----------
Gross Profit 121,000 865,000
General and Administrative 10,000 159,000
On January 30, 2004, the Company became a public company through its merger with
a wholly owned subsidiary of LCS Group, Inc. Although LCS Group, Inc. (now known
as Conversion Services International, Inc.) was the legal survivor in the merger
and remains the Registrant with the Securities and Exchange Commission, the
merger was accounted for as a reverse acquisition, whereby CSI was considered
the "acquirer" of LCS Group, Inc. for financial reporting purposes, as CSI's
stockholders control more than 50% of the post transaction combined company.
Among other matters, reverse merger accounting requires LCS Group, Inc. to
present in all financial statements and other public filings, prior historical
and other information of CSI, and a retroactive restatement of CSI's historical
stockholders' equity. The retroactive restatement took place subsequent to the
merger on January 30, 2004. On March 4, 2004, the Company acquired DeLeeuw
Associates, Inc. ("DeLeeuw"). DeLeeuw is a management consulting firm
specializing in integration, reengineering and project management. On May 1,
2004, the Company acquired a 49% interest in Leading Edge Communications
Corporation ("LEC"), a provider of enterprise software and services solutions
for technology infrastructure management. On June 28, 2004, the Company acquired
substantially all the assets of Evoke Software Corporation ("Evoke"), a provider
of data discovery, profiling and quality management software. Doorways, Inc. is
a wholly owned subsidiary of the Company that is currently dormant.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its subsidiaries, Doorways, Inc., DeLeeuw, and Evoke Software
Corporation (formerly known as Evoke Asset Purchase Corp.). All intercompany
transactions and balances have been eliminated in the consolidation. Investments
in business entities in which the Company does not have control, but has the
ability to exercise significant influence (generally 20-50% ownership), are
accounted for by the equity method.
REVENUE RECOGNITION
Revenue from consulting and professional services is recognized at the time the
services are performed, evidence of an arrangement exists, the fee is fixed or
determinable and collectibility is reasonably assured (in accordance with SOP
97-2 and SAB 101). Reimbursements, including those relating to travel and other
out-of-pocket expenses, are included in revenues, and an equivalent amount of
reimbursable expenses are included in cost of services.
Revenues for large services projects are recognized using the percentage of
completion method for long-term construction type contracts where costs to
complete the contract could reasonably be estimated. Revenues recognized in
excess of billings are recorded as costs in excess of billings. Billings in
excess of revenues recognized are recorded as deferred revenues until revenue
recognition criteria are met. The relationship of costs incurred to date
compared to estimated total costs at completion is used to determine the
percentage of completion on the project. This percentage is applied to the total
revenue to be earned on the project and that portion of revenue is recognized in
the current period. Additionally, billings in excess of revenue recognized on
projects being accounted for using the percentage-of-completion method are
recorded as deferred revenues. The percentage-of-completion method is not
applicable for the Company's software sales.
F-7
Revenue from software licensing and maintenance and support (not applicable for
the year ended December 31, 2003) are also recognized when persuasive evidence
of an arrangement exists, delivery has occurred, the fee is fixed or
determinable, and collectibility is reasonably assured. The Evoke software is
delivered directly by the Company either directly to the customer or to a
distributor on an order by order basis. The software is not sold with any right
of return privileges and, as a result, a FAS 48 reserve is not applicable.
License fee revenue is recognized by the Company in the period in which delivery
occurs. Maintenance and support revenue is recorded in revenue on a pro rata
basis over the term of the maintenance and support agreement.
Deferred revenue (not applicable for the year ended December 31, 2003) is
recorded when customers are invoiced for software maintenance and support. The
revenue is recognized over the term of the maintenance and support agreement.
Additionally, billings in excess of revenue recognized on projects being
accounted for using the percentage-of-completion method are recorded as deferred
revenues.
The Company licenses software and provides a maintenance and support agreement
(not applicable for the year ended December 31, 2003) to customers. These items
are invoiced as separate items and VSOE is determined for the maintenance and
support, generally by identifying in the contract the cost of the maintenance
and support to the customer in subsequent renewal periods.
ACCOUNTS RECEIVABLE
The Company carries its accounts receivable at cost less an allowance for
doubtful accounts. On a periodic basis, the Company evaluates its accounts
receivable and changes the allowance for doubtful accounts, when deemed
necessary, based on its history of past write-offs and collections, contractual
terms and current credit conditions.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and includes equipment held under
capital lease agreements. Depreciation, which includes amortization of leased
equipment, is computed principally by an accelerated method and is based on the
estimated useful lives of the various assets ranging from three to seven years.
When assets are sold or retired, the cost and accumulated depreciation are
removed from the accounts and any gain or loss is included in operations.
Expenditures for maintenance and repairs have been charged to operations. Major
renewals and betterments have been capitalized.
AMORTIZATION
The Company amortizes deferred financing costs utilizing the effective interest
method over the term of the related debt instrument. Acquired software is
amortized on a straight-line basis over an estimated useful life of three years.
Acquired contracts are amortized over a period that approximates the estimated
life of the contracts, based upon the estimated annual cash flows obtained from
those contracts, generally five to six years.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the amounts paid in connection with a settlement agreement
with the Elligent Consulting Group to re-acquire the ownership rights to the
Company and in connection with the acquisition of Scosys, Inc. Additionally, as
part of Scosys, DeLeeuw and Evoke acquisitions, the Company acquired intangible
assets. The Company adopted FASB Statement 142 as of January 1, 2002 for all
goodwill recognized in the Company's balance sheet as of December 31, 2001. This
statement changed the accounting for goodwill from an amortization method to an
impairment-only approach, and introduced a new model for determining impairment
charges.
F-8
Goodwill and intangible assets are reviewed for impairment whenever events or
circumstances indicate impairment might exist or at least annually. The Company
assesses the recoverability of its assets, in accordance with SFAS No. 142
"Goodwill and Other Intangible Assets," comparing projected undiscounted cash
flows associated with those assets against their respective carrying amounts.
Impairment, if any, is based on the excess of the carrying amount over the fair
value of those assets. The Company's goodwill and intangible assets were not
impaired at December 31, 2003. There have been no events or circumstances that
would indicate that there has been any impairment during the nine months ended
September 30, 2004.
DEFERRED FINANCING COSTS
The Company capitalizes costs associated with the issuance of debt instruments.
These costs are amortized on a straight-line basis over the term of the related
debt instruments, which currently range from one to three years.
DISCOUNT ON DEBT
The Company has allocated the proceeds received from convertible debt
instruments between the underlying debt instrument and the detachable warrants
and has recorded the discount on the debt instrument due to a beneficial
conversion feature as a deferred charge. This deferred charge is being amortized
to interest expense over the life of the related debt instruments, which
currently range from one to five years.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk are cash and accounts receivable arising from its normal business
activities. The Company routinely assesses the financial strength of its
customers, based upon factors surrounding their credit risk, establishes an
allowance for doubtful accounts, and as a consequence believes that its accounts
receivable credit risk exposure beyond such allowances is limited. At December
31, 2003, one customer approximated 25% of the Company's accounts receivable
balance. At September 30, 2004, one customer, LEC, a related party company,
comprised approximately 17.6% of the Company's accounts receivable balance.
The Company maintains its cash with a high credit quality financial institution.
Each account is secured by the Federal Deposit Insurance Corporation up to
$100,000.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising costs amounted
to approximately $8,000 and $5,700 for the years ended December 31, 2003 and
2002, respectively. Advertising costs amounted to $132,300 and $2,700 for the
nine month periods ended September 30, 2004 and 2003, respectively (unaudited).
INCOME TAXES
The Company accounts for income taxes under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax consequences, the
Company generally considers all expected future events other than enactments of
changes in the tax laws or rates.
On January 1, 2001, CSI elected to be an "S" Corporation whereby, the
shareholders account for their share of CSI"s earnings, losses, deductions and
credits on their Federal and various state income tax returns. CSI is subject to
New York City and various state income taxes. On September 30, 2003, CSI's "S"
Corporation status was revoked in connection with the conversion of convertible
subordinated debt into common shares. Effective October 1, 2004, as a result of
the revocation, the Company's tax status reverts to a C Corporation and on a
prospective basis, the Company would expect to have an effective income tax rate
of approximately 40%.
The Company evaluates the amount of deferred tax assets that are recorded
against expected taxable income over its forecasting cycle which is currently
two years. As a result of this evaluation, the Company has recorded a valuation
allowance of $1,240,800 in the third quarter of 2004 (unaudited). This allowance
was recorded because, based on the weight of available evidence, it is more
likely than not that some portion of the deferred tax asset may not be
realizable.
For informational purposes, the accompanying statements of operations include an
unaudited pro forma adjustment for income taxes which would have been recorded
if the Company had not been an "S" Corporation. During the first nine months of
2004, the Company's effective tax rate was estimated to be approximately 40%.
This rate is based upon the statutory federal income tax rate of 34% plus a
blended rate for the various states in which the Company incurs income tax
liabilities, net of the federal income tax benefit for state taxes paid, of 6%.
Since the Company was an "S" corporation for the full year of 2003, the pro
forma rate is based on the Company's estimated income tax rate for 2004 and is
not based upon the prior year's effective tax rate.
F-9
DERIVATIVES
In September 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133 " Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"), which requires the recognition of all derivatives as either assets or
liabilities measured at fair value, with changes in value reflected as current
period income (loss) unless specific hedge accounting criteria are met. The
effective date of SFAS No. 133, as amended by SFAS No. 138, is for fiscal years
beginning after September 15, 2000. The Company adopted SFAS No. 133 as of
January 1, 2001, resulting in no material impact upon adoption. SFAS No. 133 did
not have a material impact on the financial results for the years ended December
31, 2003 and 2002.
EQUITY INVESTMENTS
In August 2003, DeLeeuw acquired a non-controlling interest in DeLeeuw
International (a company formed under the laws of Turkey). The Company is
accounting for its share of the income (losses) of this investment under the
equity method.
The Company acquired 49% of all issued and outstanding shares of common stock of
LEC as of May 1, 2004. The acquisition was completed through a Stock Purchase
Agreement between the Company and Mary Ferrara, the sole stockholder of LEC. In
connection with the acquisition, the Company (i) repaid a bank loan on behalf of
the seller in the amount of $35,000; (ii) repaid an LEC bank loan in the amount
of $38,000; and (iii) satisfied an LEC obligation for $10,000 of prior
compensation to an employee. The Company accounts for its share of the income
(losses) of this investment under the equity method.
FOREIGN CURRENCY TRANSLATION
Local currencies are the functional currencies for Evoke's foreign operations.
Assets and liabilities are translated using the exchange rates in effect at the
balance sheet date. Income and expenses are translated at the average exchange
rates during the period. Translation gains and losses not reflected in earnings
are reported as a component of stockholders' equity.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain amounts in prior periods have been reclassified to conform to the 2003
presentation.
RESTATEMENT OF FINANCIAL STATEMENTS
The following is a brief description of the differences between the Company's
original accounting treatment and the revised accounting treatment that it has
concluded is appropriate and has been reflected in the accompanying financial
statements for the respective periods.
Recognition of interest income on Due from Stockholders - Retained earnings at
January 1, 2002 has been adjusted to reflect interest income on loans receivable
due from stockholders. The Company's original accounting did not include any
adjustments to its financial statements for interest due on these loans. These
loans receivable bear interest at 3% per annum and are due and payable by
December 31, 2005. The revised accounting resulted in an increase to retained
earnings of $10,800 as of January 1, 2002. The Company also recorded an
additional $5,400 as interest income as a result of the correction of this error
for the year ended December 31, 2002.
Recognition of Additional Intangibles and Goodwill related to acquisition of
Scosys, Inc. - Retained earnings at December 31, 2002 has been reduced by
approximately $11,000 to reflect additional amortization expense on certain
acquired intangibles and interest expense on an obligation to a third party in
connection with the acquisition of Scosys, Inc. (See Note 5). The Company's
original accounting did not properly include the amount of intangibles acquired
in connection with the Scosys, Inc. acquisition in November 2002. In connection
with this acquisition, the Company recorded an additional $351,723 in intangible
assets and $349,088 in goodwill and a corresponding obligation of $700,811 to a
third party. (See Note 7)
Stockholders' Equity - Common stock has been reduced by $1,000 and Additional
paid in capital has been increased by $1,000 at January 1, 2002 to reflect the
consolidated results of the Company which were previously reported as affiliated
and combined entities.
NOTE 2: RECENT PRONOUNCEMENTS
On August 16, 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. Specifically, this standard
requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. The entity is
required to capitalize the cost by increasing the carrying amount of the related
long-lived asset. The capitalized cost is then depreciated over the useful life
of the related asset and the liability is accreted, with changes to the
operating expense, to the estimated settlement obligation amount. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss. The standard is effective for fiscal
years beginning after June 15, 2002. The Company adopted SFAS No. 143 as of as
of January 1, 2003 and this adoption had no material impact on the Company's
consolidated financial statements for the year ended December 31, 2003.
F-10
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144).
SFAS 144 supersedes Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and certain 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." SFAS 144 establishes standards for long-lived assets to be
disposed of, and redefines the valuation and presentation of discontinued
operations. SFAS 144 is effective for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years. The adoption of SFAS 144
did not have a material effect on the Company's consolidated financial position,
results of operations, and cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing or other exit or disposal activity. Previous accounting
guidance was provided by EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". SFAS No. 146 replaces EITF 94-3. SFAS 146
is to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The Company adopted SFAS No. 146 as of January 1, 2003 and
this adoption had no material impact on the Company's consolidated financial
statements for the year ended December 31, 2003.
In November 2002, the EITF reached consensus on EITF No. 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables". This consensus requires that
revenue arrangements with multiple deliverables be divided into separate units
of accounting if the deliverables in the arrangement meet specific criteria. In
addition, arrangement consideration must be allocated among the separate units
of accounting based on their relative fair values, with certain limitations. The
Company will be required to adopt the provisions of this consensus for revenue
arrangements entered into after June 30, 2003, and the Company has decided to
apply it on a prospective basis. The Company does not have any revenue
arrangements that would have a material impact on its financial statements with
respect to EITF No. 00-21.
In November 2002, the FASB issued FASB Interpretation, or FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. However, a liability does not have to be recognized for a
parent's guarantee of its subsidiary's debt to a third party or a subsidiary's
guarantee of the debt owed to a third party by either its parent or another
subsidiary of that parent. The initial recognition and measurement provisions of
FIN No. 45 are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002 irrespective of the guarantor's fiscal year
end. The disclosure requirements of FIN No. 45 are effective for financial
statements with annual periods ending after December 15, 2002. The Company does
not have any guarantees that would require disclosure under FIN No. 45.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation - Transition and Disclosure - an Amendment to SFAS No. 123". SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value-based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 for
public companies. This statement is effective for fiscal years beginning after
December 15, 2002. The Company adopted the disclosure requirements of SFAS No.
148 as of January 1, 2003 and plans to continue to follow the provisions of APB
Opinion No. 25 for accounting for stock based compensation.
F-11
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities -- An Interpretation of ARB No. 51", which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46 provides guidance related to identifying
variable interest entities (previously known generally as special purpose
entities, or SPEs) and determining whether such entities should be consolidated.
FIN No. 46 must be applied immediately to variable interest entities created or
interests in variable interest entities obtained, after January 31, 2003. For
those variable interest entities created or interests in variable interest
entities obtained on or before January 31, 2003, the guidance in FIN No. 46 must
be applied in the first fiscal year or interim period beginning after June 15,
2003. The Company adopted FIN No. 46 as of January 1, 2003 and this adoption had
no material impact on the Company's consolidated financial statements for the
year ended December 31, 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) because that financial instrument embodies the characteristics of
an obligation of the issuer. This standard is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The Company has determined that it did not have any financial instruments
that are impacted by SFAS No. 150.
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
December 31, September 30,
2003 2004
----------- -----------
(unaudited)
Computer equipment $ 609,968 $ 932,320
Furniture and fixtures 103,777 260,577
Automobiles 72,833 72,833
Leasehold improvements 87,546 216,307
----------- -----------
874,124 1,482,037
Accumulated depreciation (603,428) (784,638)
----------- -----------
$ 270,696 $ 697,399
=========== ===========
NOTE 4: RELATED PARTY TRANSACTIONS
Due from stockholders of $204,000 at December 31, 2003 consists of loans
receivable and accrued interest thereon from the majority stockholders /
officers of the Company. These loans bear interest at 3% per annum and are due
and payable by December 31, 2005. As of September 30, 2004, Scott Newman, Chief
Executive Officer, and Glenn Peipert, Chief Operating Officer, owed the Company
an aggregate of approximately $208,000, including accrued interest. These loans
were repaid in full as of November 16, 2004 (unaudited).
F-12
NOTE 5: INTANGIBLES
Intangibles acquired have been assigned as follows:
December 31, September 30,
2003 2004
----------- -----------
(unaudited)
Customer Contracts $ 414,000 $ 2,376,000
Approved vendor status -- 1,597,000
Computer software -- 1,381,000
Tradename -- 1,166,742
Proprietary rights and rights to the name of Scosys, Inc. 20,000 20,000
----------- -----------
434,000 6,540,742
Accumulated amortization (89,710) (461,063)
----------- -----------
$ 344,290 $ 6,079,679
=========== ===========
NOTE 6: LINE OF CREDIT
The credit facility provides for a maximum borrowing of $2,250,000, based on
eligible accounts receivable. The interest rate is at the bank's prime rate plus
one (5.0% at December 31, 2003). The line is collateralized by all corporate
assets, guaranteed by the Company's shareholders, and expires on June 30, 2004.
As of December 31, 2003, the Company is in violation of certain financial
covenants in connection with the credit facility and notes payable to a bank.
(See Note 14).
On October 29, 2003, the Company obtained an additional $2,000,000 Unsecured
Convertible Line of Credit Note. The terms of the note provide for interest
accruing at 7% per annum with a maturity date of October 28, 2008, unless
converted into Common Stock at the Company or the Noteholder's option. (See Note
14)
On March 30, 2004, the Company executed a $3,000,000 revolving line of credit
with North Fork Bank (formerly known as TrustCompany Bank) secured by
substantially all of the corporate assets. The terms of this note provided for
interest accruing on advances at seven eighths of one percent (7/8%) over the
institution's prime rate.
On August 16, 2004, the Company replaced its $3,000,000 line of credit with
North Fork Bank with a revolving line of credit with Laurus Master Fund, Ltd.
("Laurus"), whereby the Company will have access to borrow up to $6,000,000
based upon eligible accounts receivable. This revolving line, effectuated
through a $2,000,000 convertible minimum borrowing note and a $4,000,000
revolving note, provides for advances at an advance rate of 90% against eligible
accounts receivable, with an annual interest rate of prime rate (as reported in
the Wall Street Journal) plus 1%, and maturing in three years. These notes will
be decreased by 1.0% for every 25% increase above the fixed conversion price
prior to an effective registration statement and 2.0% thereafter up to a minimum
of 0.0%. This line of credit is secured by substantially all the corporate
assets. Both the $2,000,000 convertible minimum borrowing note and the
$4,000,000 revolving note provide for conversion at the option of the holder of
the amounts outstanding into the Company's common stock at a fixed conversion
price of $0.14 per share. In the event that the Company issues Company common
stock or derivatives convertible into Company common stock for a price less than
the aforementioned fixed conversion price, then the fixed conversion price is
reset using a weighted average dilution calculation. Additionally, in exchange
for a secured convertible term note bearing interest at prime rate (as reported
in the Wall Street Journal) plus 1%, Laurus has made available to the Company an
additional $5,000,000 to be used for acquisitions. This note is convertible into
Company common stock at a fixed conversion price of $0.14 per share. In the
event that the Company issues Company common stock or derivatives convertible
into Company common stock for a price less than the fixed conversion price, then
the fixed conversion price is reset to the lower price on a full-ratchet basis.
This note matures in three years. This cash will be restricted for use until
approved acquisition targets identified by the Company are approved by Laurus. A
portion of Laurus's revolving line of credit was used to pay off all outstanding
borrowings from North Fork Bank. The Company issued Laurus a common stock
purchase warrant that provides Laurus with the right to purchase 12,000,000
shares of the Company's common stock. The exercise price for the first 6,000,000
shares acquired under the warrant is $0.29 per share, the exercise price for the
next 3,000,000 shares acquired under the warrant is $0.31 per share, and the
exercise price for the final 3,000,000 shares acquired under the warrant is
$0.35 per share. The common stock purchase warrant expires on August 16, 2011.
The Company paid $749,000 in brokerage and transaction closing related costs.
These costs were deducted from the $5,000,000 restricted cash balance provided
to the Company by Laurus. As of September 30, 2004, $3,200,000 was outstanding
under the revolving line of credit. The interest rate on the revolving line and
the acquisition note was 5.75% during September 2004. As a result of the
beneficial conversion feature associated with the aforementioned notes payable,
a discount on debt issued was recorded by the Company in the amount of
$5,621,630 in the September 2004 quarter which will be amortized to interest
expense over the three year life of the debt agreement.
F-13
NOTE 7: LONG-TERM DEBT
Long term debt consists of the following:
December 31, September 30,
2003 2004
----------- -----------
(Unaudited)
Note payable to a bank requiring monthly installments of $8,333, plus interest
at the bank's prime rate plus 1/4% (4.25% at December 31, 2003), due November
2005. The note is collateralized by all corporate assets and is guaranteed by
the Company's stockholders $ 191,666 $ --
Note payable to a bank requiring monthly installments of $11,667, plus interest
at LIBOR plus 200 basis points, due November 2005. The note is collateralized by
all corporate assets, pledged securities of one of the stockholders, and is
guaranteed by the Company's stockholders. The LIBOR rate at December 31, 2003 was 1.46% 268,333 --
An obligation due to a third party in connection with an acquisition of Scosys, payable
through May 2004. The obligation has been present valued at the Company's implicit
borrowing rate at the time of the acquisition (5.25%) 213,533 --
Secured convertible term note with a maturity date of August 16, 2007 unless
converted into common stock at the note holder's option. The initial conversion
price is $0.14 per share. Interest accrues at a rate of prime plus one percent
See note 6 - Line of Credit for further description of this transaction -- 5,000,000
Convertible line of credit note with a maturity date of June 6, 2009 unless
converted into common stock at the Company or the note holder's option. Interest
accrues at 7% per annum. The original conversion price to shares of common stock
is equal to 75% of the average trading price for the prior ten trading days. In
September 2004, the price was reset to $0.105 per share. A warrant to purchase
4,166,666 shares of Company common stock was also issued. The exercise price of
the warrant is $0.14 per share and the warrant expires on June 6, 2009. An
allocation of the relative fair value of the warrant and the debt instrument was
performed. The relative fair value of the warrant was determined to be $500,000
and is being amortized to interest expense over the life of the note. A discount
on debt issued of $1,500,000 was recorded in September 2004 based on the reset
conversion terms -- 2,000,000
Notes payable under capital lease obligations payable to various finance companies
for equipment at varying rates of interest and maturity dates through 2007 22,377 239,142
----------- -----------
695,909 7,239,142
Relative fair values ascribed to warrants associated with the above debt
instruments. This amount is being accreted to the debt instrument over the term
of the related debt agreements, which range from three to five years -- (2,414,494)
Less: Current portion of long-term debt including obligations under capital leases
of $8,448 and $110,622 for 2003 and 2004, respectively (461,981) (110,622)
----------- -----------
$ 233,928 $ 4,714,026
----------- -----------
Future annual payments of long-term debt is as follows:
December 31, September 30,
Years Ending 2003 2004
------------ ------------ ----------
(unaudited)
2004 $461,981 $ --
2005 227,706 110,622
2006 6,222 103,875
2007 -- 5,024,645
2008 -- --
2009 -- 2,000,000
-----------------------------------------------------
$ 695,909 $ 7,239,142
-----------------------------------------------------
As a result of the Replacement Line of Credit described in Note 14, no long-term
portion of the Notes payable to the bank were reclassified to be reported as
currently due as a result of the Company's violation of existing covenants.
F-14
NOTE 8: OBLIGATIONS UNDER CAPITAL LEASES
The Company has entered into various capital leases that are collateralized by
computer equipment with an original cost of approximately $389,000 as of
December 31, 2003 and $338,000 as of September 30, 2004 (unaudited).
The following is a schedule of future minimum payments required under the leases
together with their present value as of December 31, 2003 and September 30,
2004 (unaudited):
Year ended
Year ended September 30, 2004
December 31, 2003 (unaudited)
------------------- ------------------
2004 $ 11,012 $ --
2005 9,219 154,878
2006 6,593 120,441
2007 -- 26,394
-------------------- ------------------
26,824 301,713
Less: Amount representing interest (4,447) (62,571)
-------------------- ------------------
$ 22,377 $ 239,142
==================== ===================
NOTE 9: STOCKHOLDERS' EQUITY
In July 2003, the Company issued $1,500,000 of 7% Convertible Promissory Notes
due January 1, 2006. On September 30, 2003, these notes were converted into
100,000 shares of CSI's common stock.
NOTE 10: INCOME TAXES
The Company provides for federal and state income taxes in accordance with
current rates applied to accounting income before taxes. The provision for
income taxes is as follows:
Years ended December 31,
---------------------------------- Nine months ended
2003 2002 September 30, 2004
--------- --------- ---------
(unaudited)
Current-Federal $ -- $ 63,300 $ --
Current-State -- 37,800 --
Deferred-Federal (147,800) (63,500) (49,532)
Deferred-State (43,000) (15,200) (14,406)
--------- --------- ---------
$(190,800) $ 22,400 $ (63,938)
========= ========= =========
Deferred tax benefit in 2002 consisted of the temporary difference caused by the
conversion of cash-basis tax accounting to accrual-basis tax accounting pursuant
to Internal Revenue Code section 481(a) which allows up to a 4 year spreading of
the income and expenses caused by the change in accounting method that completed
during 2002.
The Company has net operating loss carry-forwards for both Federal and State
purposes totaling approximately $413,000 that expire in 2023.
F-15
Deferred tax assets (liabilities) consisted of the following temporary
differences:
December 31, 2003 September 30, 2004
----------------- ------------------
(unaudited)
Net operating losses $ 164,900 $ 1,204,000
Accounts receivable 36,700 60,200
property and equipment 2,200 2,200
Ggoodwill (36,900) (60,500)
Intangible assets 23,900 98,800
----------- -----------
$ 190,800 1,304,700
===========
Valuation allowance (1,240,762)
-----------
$ 63,938
===========
The Company evaluates the amount of deferred tax assets that are recorded
against expected taxable income over its forecasting cycle which is currently
two years. As a result of this evaluation, the Company has recorded a valuation
allowance of approximately $1,240,800 in the third quarter of 2004. This
allowance was recorded because, based on the weight of available evidence, it is
more likely than not that some portion of the deferred tax asset may not be
realized.
NOTE 11: MAJOR CUSTOMERS
During 2003, the Company had sales to two major customers, Morgan Stanley
(approximately 11%) and Verizon Wireless (approximately 29%), which totaled
approximately $5,819,000. Amounts due from these customers included in accounts
receivable were approximately $729,000 at December 31, 2003. As of December 31,
2003, Morgan Stanley and Verizon Wireless accounted for approximately 19% and
15% of the Company's accounts receivable balance, respectively.
During 2002, the Company had sales to these same two major customers, Morgan
Stanley (approximately 27%) and Verizon Wireless (approximately 32%), which
totaled approximately $9,540,000. Amounts due from these customers included in
accounts receivable were approximately $726,000 at December 31, 2002. Further,
as of December 31, 2002, one customer, Verizon Wireless, accounted for
approximately 26% of the Company's accounts receivable balance.
During the nine month period ended September 30, 2004, two of our clients, LEC
(17.9%) and Bank of America (13.4%), accounted for approximately 31% of total
revenues. Amounts due from these customers included in accounts receivable were
$2,334,073 at September 30, 2004 (unaudited). Further, as of September 30, 2004
(unaudited), one customer, LEC, accounted for 17.6% of the Company's accounts
receivable balance.
NOTE 12: EMPLOYEE BENEFIT PLAN
The Company has a defined contribution profit sharing plan under Section 401(k)
of the Internal Revenue Code that covers substantially all employees. Eligible
employees may contribute on a tax deferred basis a percentage of compensation up
to the maximum allowable amount. Although the plan does not require a matching
contribution by the Company, the Company may make a contribution. The Company's
contributions to the plan for the years ended December 31, 2003 and 2002 was
approximately $24,000 and $20,000, respectively, and $28,000 for the nine months
ended September 30, 2004 (unaudited).
NOTE 13: COMMITMENTS
LEASE COMMITMENTS
The Company's corporate headquarters are located in East Hanover, New Jersey,
where it operates under an amended lease agreement expiring December 31, 2010.
In addition to minimum rentals, the Company is liable for its proportionate
share of real estate taxes and operating expenses, as defined.
Rent expense, including automobile rentals, totaled approximately $313,000 and
$416,000 in 2003 and 2002, respectively, and $296,353 for the nine months ended
September 30, 2004 (unaudited).
The Company is committed under several operating leases for automobiles that
expire during 2007.
Future minimum lease payments due under all operating lease agreements as of
December 31, 2003 and September 30, 2004 (unaudited) are as follows:
F-16
Years Ending December 31
OFFICE AUTOMOBILES TOTAL
---------- ---------- ----------
2004 $ 310,615 $ 33,013 $ 343,628
2005 299,575 30,785 330,360
2006 -- 30,785 30,785
2007 -- 7,696 7,696
---------- ---------- ----------
$ 610,190 $ 102,279 $ 712,469
========== ========== ==========
Years Ending September 30, (unaudited)
OFFICE AUTOMOBILES TOTAL
---------- ---------- ----------
2004 $ 316,325 $ 73,410 $ 389,735
2005 308,635 59,373 368,008
2006 297,595 52,893 350,488
2007 297,595 20,303 317,898
2008 297,595 -- 297,595
Thereafter 595,190 -- 595,190
---------- ---------- ----------
$2,112,934 $ 205,980 $2,318,914
========== ========== ==========
LETTER OF CREDIT
The Company is committed under an outstanding letter of credit with a bank to
secure the security deposit on the office space in the amount of $83,375 as of
September 30, 2004 (unaudited) and December 31, 2003 and $191,356 as of December
31, 2002.
AGREEMENTS
During 2002, the Company executed a twelve month employment agreement with one
of Scosys' senior management. This agreement expired in November 2003 and has
not been renewed.
NOTE 14: SUBSEQUENT EVENTS
Reverse Merger
On August 21, 2003, LCS Group, Inc., LCS Acquisition Corp., a wholly owned
subsidiary of LCS Group, Inc., CSI and CSI's executive officers and principal
stockholders, executed an Agreement and Plan of Reorganization to merge CSI into
LCS Acquisition Corp. This transaction was consummated on January 30, 2004, CSI
became the operating entity, LCS Group changed its name to CSl and the CSI
shareholders control approximately 84% of the shares of the Company.
In connection with this transaction, LCS Group, Inc. agreed to a.) increase the
number of common shares they were authorized to issue from 50,000,000 to
1,000,000,000; b.) authorized the right to issue up to 20,000,000 shares of
preferred stock; and c.) adopted the 2003 Stock Incentive Plan (the "2003 Stock
Option Plan").
The 2003 Stock Option Plan authorizes the issuance of up to 100,000,000 shares
of common stock for issuance upon exercise of options. It also authorizes the
issuance of stock appreciation rights. On March 29, 2004, the Company granted
19,200,000 options to purchase its common stock at an exercise price of $0.165.
The 19.2 million options granted on March 29, 2004 were granted to the following
company employees: Vice President and Chief Financial Officer, Vice President
and General Manager, Practice Director - The Center for Data Warehousing,
Director of Business Development, Vice President of Professional Services and
Vice President of Technology. The options have a ten year life and vest over a
three year period. There was no compensation expense recorded in the Company
income statement. The fair value of the options was determined using the
Black-Scholes option pricing model and the pro-forma impact on earnings was
disclosed in footnote form.
Although LCS Group, Inc. was the legal survivor in the merger and remains the
Registrant with the Securities and Exchange Commission, the merger was accounted
for as a reverse acquisition, whereby CSI was considered the "acquirer" of LCS
Group, Inc. for financial reporting purposes, as CSI's stockholders control more
than 50% of the post transaction combined company. Among other matters, reverse
merger accounting requires LCS Group, Inc. to present in all financial
statements and other public filings, prior historical and other information of
CSI, and a retroactive restatement of CSI's historical stockholders' equity. The
retroactive restatement took place subsequent to the merger on January 30, 2004.
F-17
PRO FORMA INFORMATION: For the nine months ended November 30, 2003, LCS Group
Inc. reported an unaudited loss from operations of approximately $561,000. The
loss from operations consisted of $487,000 of selling, general and
administrative expenses and $74,000 of interest expense. As part of the merger
with CSI, a condition precedent to closing the merger transaction, 100% of the
outstanding stock of LCS Golf, Inc. (a wholly-owned subsidiary of LCS Group,
Inc.) was required to be sold to a third-party. As the results noted above are
those of LCS Golf, Inc. which was sold prior to the merger, no pro-forma results
of operations are shown as there is no continuing impact or effect to results of
operations. As a result of the retroactive recapitalization, CSI would have had
593,000,000 and 592,900,000 shares of common stock outstanding as of December
31, 2003 and 2002, respectively.
Borrowings under the Unsecured Convertible Line of Credit Note
On October 29, 2003, the Company made arrangements to obtain a $2,000,000
Unsecured Convertible Line of Credit Note. The terms of this new note provide
for interest accruing on advances at 7% per annum with a maturity date of
October 28, 2008, unless converted into Common Stock at the Company's or the
Note holder's option. As of February 28, 2004, the Company has drawn down on the
facility and received advances totaling $2,000,000.
Replacement Line of Credit
On March 30, 2004, the Company executed a $3,000,000 revolving line of credit
secured by substantially all of the corporate assets with a new financial
institution. This credit facility was utilized to replace the existing Line of
Credit facility expiring in June 2004 and both Notes payable to a bank. The
terms of this new note provide for interest accruing on advances at seven
eighths of one percent (7/8%) over the institution's prime rate. This line of
credit contains certain financial covenants including but not limited to a.)
Debt Service Coverage ratios; b.) Minimum Tangible Capital Funds limits; and c.)
Current Ratio limits, as defined. The Company started to be measured quarterly
on these covenants beginning June 30, 2004.
DeLeeuw Acquisition
In March 2004, the Company formed a wholly-owned acquisition subsidiary, DeLeeuw
Conversion LLC ("DCL"), for the purpose of consummating a merger with DeLeeuw
Associates, Inc. a privately-held New Jersey corporation ("DAI"). On March 4,
2004, DCL completed the merger with DAI. At the closing of the merger, DAI was
merged with and into DCL, and Mr. DeLeeuw received $2,000,000 and 80,000,000
outstanding shares of common stock of CSI (approximately 11.9% of the
outstanding shares). On March 5, 2004, DCL changed its name to Deleeuw
Associates, LLC.
Employment Agreements
On February 27, 2004, Robert C. DeLeeuw, Senior Vice President and President of
our wholly owned subsidiary, DeLeeuw Associates, LLC, agreed to a three-year
employment agreement. The agreement provides for an annual salary to Mr. DeLeeuw
of $350,000 and an annual bonus to be awarded by our to-be-appointed
Compensation Committee. The agreement also provides for health, life and
disability insurance. In the event that Mr. DeLeeuw's employment is terminated
other than with good cause, he will receive a payment of one year's base salary.
On March 26, 2004, the Company entered into employment agreement with Scott
Newman , CSI's President and Chief Executive Officer, director and principal
stockholder. The agreement provides for an annual salary of $500,000 and an
annual bonus to be awarded by the Company's to-be-appointed Compensation
Committee. The agreement also provides for health, life and disability
insurance, as well as a monthly car allowance. In the event that Mr. Newman's
employment is terminated other than with good cause, he will receive a payment
of three year's base salary.
F-18
On March 26, 2004, the Company entered into employment agreement with Glenn
Peipert, CSI's Vice President and Chief Operating Officer, director and
principal stockholder. The agreement provides for an annual salary of $375,000
and an annual bonus to be awarded by the Company's to-be-appointed Compensation
Committee. The agreement also provides for health, life and disability
insurance, as well as a monthly car allowance. In the event that Mr. Peipert's
employment is terminated other than with good cause, he will receive a payment
of three year's base salary.
On March 26, 2004, the Company entered into employment agreement with Mitchell
Peipert, CSI's Vice President and Chief Financial Officer. The agreement
provides for an annual salary to of $200,000 and an annual bonus to be awarded
by the Company's to-be-appointed Compensation Committee. The agreement also
provides for health, life and disability insurance, as well as a monthly car
allowance. In the event that Mr. Peipert's employment is terminated other than
with good cause, he will receive a payment of three year's base salary.
NOTE 15: SUBSEQUENT EVENTS (UNAUDITED)
Acquisition of DeLeeuw Associates, Inc.
In February 2004, the Company formed a wholly owned acquisition
subsidiary, DeLeeuw Conversion LLC ("DCL"), for the purpose of consummating a
merger with DeLeeuw Associates, Inc. a privately-held New Jersey corporation
("DAI"). On March 4, 2004, DCL completed the merger with DAI, whereby DAI was
merged with and into DCL, and Robert C. DeLeeuw, the president and sole
stockholder of DAI, received $2,000,000 and 80,000,000 shares of common stock of
CSI (at the time, approximately 11.9% of the outstanding shares). On March 5,
2004, DCL changed its name to DeLeeuw Associates, LLC. The Company's
consolidated financial statements include DeLeeuw Associates results of
operations for the period subsequent to its acquisition on March 4, 2004.
Exclusive of future consideration, the purchase price was allocated to the
various assets of DeLeeuw Associates as follows:
The components and allocations of the purchase price were based on
independent third party valuations as of the acquisition date.
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Cash payments $ 1,939
Acquisition costs 71
Value of Common Stock 2,158
-------
$ 4,168
ALLOCATION OF PURCHASE PRICE:
Approved vendor status (a) (1,597)..........(indefinite life)
Accounts receivable (975)
Tradename (722)..........(indefinite life)
Goodwill (1,404)
Other assets (56)
Current liabilities assumed 286
Deferred tax liability assumed 300
-------
$ --
=======
================================================================================
An approved vendor is on an exclusive list to provide vendor services to a
specified client and has previously met established quality control standards of
that client.
F-19
No value has been ascribed to the property and equipment acquired in connection
with the acquisition of DeLeeuw Associates based upon independent third party
valuations as of the acquisition date.
Acquisition of Evoke Software Corporation
On June 28, 2004, CSI, through its subsidiary Evoke Asset Purchase Corp.,
acquired substantially all of the assets and assumed substantially all of the
liabilities of Evoke, a privately-held California corporation. The acquisition
was completed pursuant to an Asset Purchase Agreement between CSI, Evoke Asset
Purchase Corp. and Evoke. In connection with the acquisition, CSI (i) issued
72,543,956 shares of its common stock to Evoke, 7,150,000 of which have been
deposited into an escrow account for a period of one-year and may be reduced
based upon claims for indemnification that may be made pursuant to the
agreement; (ii) issued 5% of the outstanding shares of the Evoke Asset Purchase
Corp. to Evoke; (iii) issued 3,919,093 shares of its common stock to certain
executives of Evoke as a severance payment and to certain employees as retention
shares; and (iv) agreed to pay $448,154 in deferred compensation to certain
employees of Evoke. For accounting purposes, this transaction was deemed to have
occurred on June 30, 2004. Transaction volumes between June 28 and June 30, 2004
were de minimis.
To reflect the acquisition of assets and assumption of certain liabilities
of Evoke and the allocation of the purchase price on the basis of the fair value
of the assets received, liabilities assumed, and the fair values assigned to
identifiable intangible assets and to goodwill in June 2004, presented as if the
acquisition had occurred in December 2003 (in thousands), the purchase price was
allocated to the various assets and liabilities of Evoke as follows:
The components and allocations of the purchase price were based on
independent third party valuations as of the acquisition date.
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Value of Common Stock $ 1,789
Acquisition costs 151
-------
$ 1,940
ALLOCATION OF PURCHASE PRICE:
Customer contracts (1,962).........(Six year estimated life)
Computer software (1,381).........(Three year estimated life)
Trade name (445).........(indefinite life)
Accounts receivable (580)
Furniture and equipment (184)
Cash (497)
Prepaid expenses (78)
Other assets (11)
Deferred revenue 1,254
Deferred compensation 443
Other liabilities 1,302
Minority interest 199
-------
$ --
=======
In valuing the assets acquired and the liabilities assumed, the Company
retained an independent valuation firm. The fair value of Evoke was
independently determined by this firm.
The weighted average life of the identifiable intangible assets is 4.3
years.
7,150,000 shares of common stock of the Company have been withheld
pursuant to the Holdback Agreement among the Company, Evoke Asset Purchase Corp.
and Evoke Software Corporation, dated June 28, 2004, for a period of one year.
At the end of one year, if the Company is entitled to indemnification pursuant
to the Asset Purchase Agreement among the same parties, then the Company shall
retain all rights, title and interest in and to that portion of the holdback
shares necessary to satisfy the applicable amount of such indemnity obligation.
In the event that these shares are released pursuant to the Indemnification
Agreement within the specified period, this will be deemed additional
consideration in connection with this acquisition.
Pursuant to the Non-Competition Agreement among the Company and Lacy
Edwards, dated June 28, 2004, Mr. Edwards shall not directly or indirectly
compete with the Company or its subsidiaries. No allocation of purchase price
has been ascribed in connection with this agreement.
The severance payment in shares of common stock to three former Evoke
employees was part of the negotiated purchase price and reflected in "Components
of Purchase Price" above. Such severance payments were not allocated as part of
purchase price and have no continuing impact on subsequent proforma earnings.
512,500 shares of common stock of the Company have been paid to certain
Evoke employees to retain their employment. A charge of $87,125 was included in
the Company's results of operations for the quarter ending June 30, 2004.
Deferred revenue acquired in conjunction with the purchase of Evoke
relates to maintenance contracts that the Company has assumed a contractual
obligation to fulfill. In accordance with EITF 01-3: "Accounting in a Business
Combination for Deferred Revenue of an Acquiree," this liability was recorded at
its fair value.
The unaudited pro forma consolidated statements of operations for the year
ended December 31, 2003 and the nine months ended September 30, 2004 set forth
below gives effect to the acquisitions of DeLeeuw Associates, LLC and Evoke
Software Corporation as if they occurred on January 1, 2003.
F-20
Year ended Nine months ended
December 31, 2003 September 30, 2004
------------ ------------
Revenues $ 25,422,859 $ 21,035,774
Net Loss $ (3,301,174) $ (4,985,292)
Net Loss per share $ (0.01) $ (0.01)
Line of credit
On March 30, 2004, the Company executed a $3,000,000 revolving line of
credit with North Fork Bank (formerly known as TrustCompany Bank) secured by
substantially all of the corporate assets. The terms of this note provide for
interest accruing on advances at seven eighths of one percent (7/8%) over the
institution's prime rate.
On August 16, 2004, the Company replaced its $3,000,000 line of credit
with North Fork Bank with a revolving line of credit with Laurus Master Fund,
Ltd. ("Laurus"), whereby the Company has access to borrow up to $6,000,000 based
upon eligible accounts receivable. This revolving line, effectuated through a
$2,000,000 convertible minimum borrowing note and a $4,000,000 revolving note,
provides for advances at an advance rate of 90% against eligible accounts
receivable, with an annual interest rate of prime rate (as reported in the Wall
Street Journal) plus 1%, and maturing in three years. These notes will be
decreased by 1.0% for every 25% increase above the fixed conversion price prior
to an effective registration statement and 2.0% thereafter up to a minimum of
0.0%. This line of credit is secured by substantially all the corporate assets.
Both the $2,000,000 convertible minimum borrowing note and the $4,000,000
revolving note provide for conversion at the option of the holder of the amounts
outstanding into the Company's common stock at a fixed conversion price of $0.14
per share. In the event that the Company issues common stock or derivatives
convertible into Company common stock for a price less the aforementioned fixed
conversion price, then the fixed conversion price is reset using a weighted
average dilution calculation. Additionally, in exchange for a secured
convertible term note bearing interest at prime rate (as reported in the Wall
Street Journal) plus 1%, Laurus has made available to the Company an additional
$5,000,000 to be used for acquisitions. This note is convertible into Company
common stock at a fixed conversion price of $0.14 per share. In the event that
the Company issues Company common stock or derivatives convertible into Company
common stock for a price less the fixed conversion price, then the fixed
conversion price is reset to the lower price on a full-ratchet basis. This note
matures in three years. This cash will be restricted for use until approved
acquisition targets identified by the Company are approved by Laurus. A portion
of Laurus's revolving line of credit will be used to pay off all outstanding
borrowings from North Fork Bank. The Company issued Laurus a common stock
purchase warrant that provides Laurus with the right to purchase 12,000,000
shares of the Company's common stock. The exercise price for the first 6,000,000
shares acquired under the warrant is $0.29 per share, the exercise price for the
next 3,000,000 shares acquired under the warrant is $0.31 per share, and the
exercise price for the final 3,000,000 shares acquired under the warrant is
$0.35 per share. The common stock purchase warrant expires on August 16, 2011.
The Company paid $749,000 in brokerage and transaction closing related costs.
These costs will be deducted from the $5,000,000 restricted cash balance being
provided to the Company by Laurus. As of September 30, 2004, $3,200,000 was
outstanding under the revolving line of credit. The interest rate on the
revolving line and the acquisition note was 5.75% during September 2004. As a
result of the beneficial conversion feature associated with the aforementioned
notes payable, a discount on debt issued was recorded by the Company in the
amount of $5,621,630 in the September 2004 quarter which will be amortized to
interest expense over the three year life of the debt agreement.
F-21
Short term notes payable
In September 2004, we issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, "Sands") three subordinated secured convertible promissory notes
equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, subordinate to Laurus. The Notes are convertible into shares
of our common stock at the election of Sands at any time following the
consummation of a convertible debt or equity financing with gross proceeds of $5
million or greater (a "Qualified Financing"). The conversion price of the shares
of our common stock issuable upon conversion of the Notes shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to convert the
Notes at a fixed conversion price of $0.14 per share. In the event that we issue
stock or derivatives convertible into our stock for a price less the
aforementioned fixed conversion price, then the fixed conversion price is reset
using a weighted average dilution calculation. We also issued Sands three common
stock purchase warrants (the "Warrants") providing Sands with the right to
purchase 6,000,000 shares of our common stock. The exercise price of the shares
of our common stock issuable upon exercise of the Warrants shall be equal to a
price per share of common stock equal to forty percent (40%) of the price of the
securities issued pursuant to a Qualified Financing. If no Qualified Offering
has been consummated by September 8, 2005, then Sands may elect to exercise the
Warrants at a fixed conversion price of $0.14 per share. The latest that the
Warrants may expire is September 8, 2008. Finally, we engaged Sands Brothers
International Limited as our non-exclusive financial advisor at $6,000 per month
for a period of one year.
The fair value of the 6,000,000 warrants was determined to be $545,000
using the Black-Scholes option pricing model. The assumptions used in the fair
market calculation were as follows: stock price of $0.22, exercise price of
$0.14, term of four years, volatility (annual) of 150.23%, annual rate of
quarterly dividends of 0%, and a risk free rate of 1.33%. The Company will
amortize this relative fair value of the warrants to interest expense over the
one-year life of the debt agreement. The note also includes a beneficial
conversion feature and a discount on debt of $454,500 was recorded in September
2004 and will also be amortized over the one-year life of the debt agreement.
DISCOUNT ON DEBT
The Company has allocated the proceeds received from convertible debt
instruments between the underlying debt instrument and the detachable warrants
and has recorded the discount on the debt instrument due to a beneficial
conversion feature as a deferred charge. This deferred charge is being amortized
to interest expense over the life of the related debt instruments, which
currently range from one to five years. The following illustrates the components
of the discount on debt:
September 30,
2004 Amortization period
----------------------------------
Laurus Master Fund $5,621,630 3 years
Sands Brothers 454,545 1 year
Taurus Advisory Group 1,500,000 5 years
----------
7,576,175
----------
Accumulated amortization $7,305,741
==========
Private Stock Sale
On November 8, 2004, the Company entered into a Stock Purchase Agreement
(the "Agreement") with a private investor, CMKX-treme, Inc. Pursuant to the
Agreement, CMKX-treme, Inc. agreed to purchase 12,500,000 shares of common stock
for a purchase price of $1,750,000. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for
$500,000, and it is required to purchase the remaining 8,928,572 shares of
common stock for $1,250,000 by December 31, 2004.
Repayment of Stockholder Loans
On November 16, 2004, Scott Newman, President and Chief Executive Officer
of the Company, paid to the Company $188,520, the outstanding balance of Mr.
Newman's stockholder loan. Glenn Peipert, Executive Vice President and Chief
Operating Officer of the Company, paid to the Company $19,806, the outstanding
balance of Mr. Peipert's stockholder loan.
F-22
Related party transactions
In November 2003, the Company executed an Independent Contractor Agreement
with Leading Edge Communications Corporation (LEC), whereby the Company agreed
to be a subcontractor for LEC, and to provide consultants as required to LEC. In
return for these services, the Company receives a fee from LEC based upon the
hourly rates established for consultants subcontracted to LEC.
The Company acquired 49% of all issued and outstanding shares of common
stock of LEC as of May 1, 2004. The Company accounts for its investment in LEC
under the equity method and does not exercise significant control over the
investee nor have control of LEC's Board of Directors. The acquisition was
completed through a Stock Purchase Agreement between the Company and Mary
Ferrara, the sole stockholder of LEC. In connection with the acquisition, the
Company (i) repaid a bank loan on behalf of the seller in the amount of $35,000;
(ii) repaid an LEC bank loan in the amount of $38,000; and (iii) satisfied an
LEC obligation for $10,000 of prior compensation to an employee.
For the year ended December 31, 2003 and the nine months ended September
30, 2004, the Company invoiced LEC $393,000 and $1,727,200, respectively, for
the services of consultants subcontracted to LEC by the Company. As of December
31, 2003 and September 30, 2004, the Company had accounts receivable due from
LEC of approximately $393,000 and $901,000, respectively, and the Company has
provided LEC with extended payment terms. There are no known collections
problems with respect to LEC. The majority of their billing is derived from
Fortune 100 clients. The collection process is slow as these clients require
separate approval on their own internal systems, which extends the payment
cycle. The Company feels confident in the collectibility of these accounts
receivable as the majority of the revenues from LEC derive from Fortune 100
clients.
Stock options
The 2003 Incentive Plan authorizes the issuance of up to 100,000,000
shares of common stock for issuance upon exercise of options. It also authorizes
the issuance of stock appreciation rights. On March 29, 2004 and April 12, 2004,
the Company granted a total of 19,950,000 options to purchase its common stock
at an exercise price of $0.165 per share. The options granted are a combination
of both incentive and nonqualified options, vest over a three year period from
the date of grant, and expire ten years from the date of grant. Between May and
June 2004, the Company granted 11,905,000 options to purchase its common stock
at an exercise price of $0.20 per share. The options granted are all incentive
options, vest over a three year period from the date of grant, and expire ten
years from the date of grant. Between July and September 2004, the Company
granted 1,755,000 options to purchase its common stock at an exercise price of
$0.23 per share. The options granted are all incentive options, vest over a
three year period from the date of grant, and expire ten years from the date of
grant.
The Company follows Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") in accounting for its
employee stock options. Under APB25, because the exercise of the Company's
employee stock option equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized in the Company's
consolidated statements of operations. The Company is required under Statement
of Financial Accounting Standards (SFAS) 123, "Accounting for Stock-Based
Compensation", which established a fair value based method of accounting for
stock compensation plans with employees and others to disclose pro-forma
financial information regarding option grants made to its employees.
The Company follows EITF No. 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services" ("EITF 96-18") in accounting for stock options
issued to non-employees. Under EITF 96-18, the equity instruments should be
measured at the fair value of the equity instrument issued. During the three
months ended September 30, 2004, the Company granted 450,000 stock options to
non-employee recipients. In compliance with EITF 96-18, the fair value of these
options was determined using the Black-Scholes option pricing model. The Company
is recording the fair value of these options as expense over the three year
vesting period of the options.
F-23
The following pro-forma net income and earnings per share (EPS) reflects
the difference between stock compensation costs charged to operations under the
APB 25 intrinsic value method and pro-forma stock compensation cost that would
have been recorded if the SFAS 123 fair value method had been applied. The
Black-Scholes option pricing model used in this valuation was developed for use
in estimating the fair value of traded options, which have no vesting
restrictions and are fully transferable. Option valuation models require the
input of highly subjective assumptions. CSI's stock-based compensation has
characteristics significantly different from those of traded options, and
changes in the assumptions used can materially affect the fair value estimate.
Year ended Nine months ended
December 31, September 30,
2003 2004
------------- -------------
(unaudited)
Reported net loss $ (307,000) $ (4,228,711)
Pro-forma stock compensation, net of tax -- (156,285)
------------- -------------
Pro forma net loss $ (307,000) $ (4,384,996)
============= =============
Basic EPS:
As re ported $ -- $ (0.01)
Pro-forma $ -- $ (0.01)
Diluted EPS:
As reported $ -- $ (0.01)
Pro-forma $ -- $ (0.01)
Weighted average fair value per option share granted N/A $ 0.13
Weighted average assumptions used to value options
Risk free interest rate N/A $ 0.01
Expected volatility N/A 138% - 151%
Expected life (years) N/A 300%
There were no options granted during the year ended December 31, 2003. As a
result, the assumptions pertaining to the option grants during 2003 were noted
as N/A in the above table.
Earnings per share
Basic earnings per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted earnings per share is computed on
the basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the "treasury stock" method.
F-24
Year Ended December 31, Nine Months Ended September 30,
2003 2004
------------- -------------
(unaudited)
Net loss available for common stockholders (A) $ (306,763) $ (4,228,711)
Weighted average outstanding shares of common stock (B) 593,000,000 689,233,712
Common stock and common stock equivalents (C) 593,000,000 689,233,712
Loss per share:
Basic (A/B) $ (0.00) $ (0.01)
============= =============
Diluted (A/C) $ (0.00) $ (0.01)
============= =============
For the nine months ended September 30, 2004, 34,060,000 shares
attributable to outstanding stock options were excluded from the calculation of
diluted earnings per share because the effect was antidilutive. There were no
stock options outstanding during 2003. Additionally, the effect of 22,166,666
warrants which were issued on June 7, 2004, August 16, 2004 and September 22,
2004 were excluded from the calculation of diluted earnings per share for both
the three and the nine months ended September 30, 2004 because the effect was
antidilutive.
Income taxes
Our provision for income taxes is based on estimated effective annual
income tax rates. The provision may differ from income taxes currently payable
because certain items of income and expense are recognized in different periods
for financial statement purposes than for tax return purposes.
The Company evaluates the amount of deferred tax assets that are recorded
against expected taxable income over its forecasting cycle which is currently
two years. As a result of this evaluation, the Company has recorded a valuation
allowance of $1,240,800 in the third quarter of 2004. This allowance was
recorded because, based on the weight of available evidence, it is more likely
than not that some portion of the deferred tax asset may not be realized.
During the first nine months of 2004, the Company's effective tax rate was
estimated to be approximately 40%. This rate is based upon the statutory federal
income tax rate of 34% plus a blended rate for the various states in which the
Company incurs income tax liabilities, net of the federal income tax benefit for
state taxes paid, of 6%. Since the Company was an "S" corporation for the
majority of 2003, the pro forma rate is based on the Company's estimated income
tax rate for 2004 and is not based upon the prior year's effective tax rate.
Commitments and contingencies
On June 29, 2004, Viant Capital LLC commenced legal action against us in
the United States District Court for the Southern District of New York. Through
an agreement with Viant, Viant had the exclusive right to obtain private equity
transactions on behalf of the company from February 18 to May 17, 2004. Viant
alleges that it is owed a fee of approximately $450,000 relating to our loan
from a private investor in May 2004. Management believes that this loan does not
qualify as a private equity transaction and we intend to vigorously defend the
company. As of November 26, 2004, there have been no material developments in
the suit. The Company has estimated the probable loss related to this suit to be
the agreed upon contract signing fee of $75,000 and has recorded a liability for
this amount.
Lease Commitments
In July 2004, the Company's lease agreement for its corporate headquarters
facility in East Hanover, New Jersey was amended. The lease term was extended to
December 31, 2010 from December 31, 2005, and an additional 3,500 square feet of
space was obtained.
F-25
EVOKE SOFTWARE CORPORATION
REPORT ON AUDITS OF FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2003
AND NINE MONTHS ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
Page
----
Report of Independent Registered Public Accounting Firm F-27
Consolidated Balance Sheets F-28
Consolidated Statements of Operations F-29
Consolidated Statements of Redeemable Convertible Preferred
Stock and Shareholders' Deficiency and Other Comprehensive Loss F-30
Consolidated Statements of Cash Flows F-31
Notes to Consolidated Financial Statements F-32
F-26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Evoke Software Corporation:
We have audited the accompanying consolidated balance sheets of Evoke Software
Corporation (a California Corporation) and Subsidiaries (together the "Company")
as of December 31, 2003 and 2002, and the related consolidated statements of
operations, consolidated statements of redeemable convertible preferred stock
and shareholders' deficiency and other comprehensive loss and cash flows for the
year ended December 31, 2003 and the nine months ended December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform an audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Evoke Software Corporation and
Subsidiaries as of December 31, 2003 and 2002 and the results of their
operations and their cash flows for the year ended December 31, 2003 and the
nine months ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Friedman LLP
------------------
Livingston, New Jersey
September 3, 2004
F-27
EVOKE SOFTWARE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
December 31,
----------------------------
2003 2002
------------ ------------
ASSETS
Current assets:
Cash $ 586 $ 1,862
Accounts receivable, net of allowance for
doubtful accounts of $0 in 2003 and $25 in 2002 999 2,784
Prepaid expenses and other current assets 161 293
------------ ------------
Total current assets 1,746 4,939
Furniture and equipment, net of accumulated depreciation of $1,086
in 2003 and $1,042 in 2002 350 852
Other assets 102 111
------------ ------------
Total assets $ 2,198 $ 5,902
============ ============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable and accrued liabilities $ 1,337 $ 1,224
Notes payable -- 92
Deferred revenue 1,970 2,450
------------ ------------
Total current liabilities 3,307 3,766
Deferred revenue, long term portion -- 336
------------ ------------
Total liabilities 3,307 4,102
------------ ------------
Commitments -- --
Redeemable convertible preferred stock:
Series AA, no par value, authorized, issued and outstanding, 44,265,578
shares at December 31, 2003 and 2002; aggregate liquidation preference of
$24,420 in 2003 and $22,660 in 2002 13,648 7,718
Shareholders' deficiency:
Common stock, no par value, 60,000,000 shares authorized; 3,703,723 shares issued
and outstanding in 2003 and 3,649,819 shares issued and outstanding in 2002 80,618 80,615
Accumulated deficit (95,073) (86,317)
Cumulative translation adjustment (302) (216)
------------ ------------
Total shareholders' deficiency (14,757) (5,918)
Total liabilities, redeemable convertible preferred stock ------------ ------------
and shareholders' deficiency $ 2,198 $ 5,902
============ ============
See Notes to Consolidated Financial Statements.
F-28
EVOKE SOFTWARE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Nine Months
Year Ended Ended
December 31, December 31,
2003 2002
------- -------
Revenues:
License fees $ 2,014 $ 1,675
Maintenance, product support and other
services 3,891 3,658
------- -------
Total revenues 5,905 5,333
Operating expenses:
Cost of license fees 41 12
Cost of maintenance, product support
and other services 340 337
Sales and marketing 4,661 2,471
Product development 2,000 1,792
General and administrative 1,648 2,366
Restructuring charge 40 1,451
------- -------
Total operating expenses 8,730 8,429
------- -------
Loss from operations (2,825) (3,096)
Other income (expense), net (1) 15
------- -------
Net loss $(2,826) $(3,081)
======= =======
See Notes to Consolidated Financial Statements
F-29
EVOKE SOFTWARE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS' DEFICIENCY AND OTHER COMPREHENSIVE LOSS FOR THE NINE
MONTHS ENDED DECEMBER 31, 2002 AND THE YEAR ENDED DECEMBER 31, 2003
(In thousands, except share amounts)
Shareholders' Deficiency
------------------------------
Redeemable
Convertible
Preferred Stock Common Stock
-----------------------------
Shares Amount Shares Amount
------------- ------------ ------------- ---------------
Balance at March 31, 2002 3,823,709 $ 74,534 744,253 $ 948
Issuance of Series AA preferred stock, less
issuance costs of $180 44,265,578 5,320
Accretion of Series D&E preferred stock -- 5,133 -- --
Preferred stock conversion to common stock (3,823,709) (79,667) 2,905,566 79,667
Accretion of Series AA preferred stock -- 2,398 -- --
Net loss
Foreign currency translation adjustment -- -- -- --
Comprehensive loss -- -- -- --
------------- ------------ ------------- ---------------
Balance at December 31, 2002 44,265,578 7,718 3,649,819 80,615
Exercise of stock options 53,904 3
Accretion of Series AA preferred stock -- 5,930 -- --
Net loss
Foreign currency translation adjustment
Comprehensive loss -- -- -- --
------------- ------------ ------------- ---------------
Balance at December 31, 2003 44,265,578 $13,648 3,703,723 $ 80,618
============= ============ ============= ===============
Shareholders' Deficiency
----------------------------------------------------
Other
Accumulated Comprehensive
Deficit Income Total
----------------- ---------------- ----------------
Balance at March 31, 2002 $ (75,705) $ (197) $ (74,954)
Issuance of Series AA preferred stock, less
issuance costs of $180
Accretion of Series D&E preferred stock (5,133) -- (5,133)
Preferred stock conversion to common stock -- -- 79,667
Accretion of Series AA preferred stock (2,398) -- (2,398)
Net loss (3,081) (3,081)
Foreign currency translation adjustment -- (19) (19)
----------------
Comprehensive loss -- -- (3,100)
----------------- ---------------- ----------------
Balance at December 31, 2002 (86,317) (216) (5,918)
Exercise of stock options 3
Accretion of Series AA preferred stock (5,930) -- (5,930)
Net loss (2,826) (2,826)
Foreign currency translation adjustment (86) (86)
----------------
Comprehensive loss -- -- (2,912)
----------------- ---------------- ----------------
Balance at December 31, 2003 $ (95,073) $ (302) $ (14,757)
================= ================ ================
See Notes to Consolidated Financial Statements
F-30
EVOKE SOFTWARE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Nine Months
Ended Ended
December 31, December 31,
2003 2002
------- -------
OPERATING ACTIVITIES
Net loss $(2,826) $(3,081)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 457 457
Impairment of furniture and equipment -- 837
(Gain) loss on disposals of furniture and equipment 32 (29)
Changes in operating assets and liabilities:
Restricted cash -- 426
Accounts receivable 1,785 (2,081)
Prepaid expenses and other current assets 132 (79)
Accounts payable and accrued liabilities 113 (916)
Deferred revenue (816) (462)
Other Assets 9 130
------- -------
Net cash used in operating activities (1,114) (4,798)
------- -------
INVESTING ACTIVITIES
Proceeds from dispositions of furniture and equipment 13 159
------- -------
FINANCING ACTIVITIES
Repayments of notes payable (92) (76)
Proceeds of preferred stock sale net of issuance costs -- 5,320
Proceeds from exercise of stock options 3 --
------- -------
Net cash provided by (used in) financing activities (89) 5,244
Effect of exchange rate differences on cash (86) (19)
------- -------
Increase (decrease) in cash (1,276) 586
CASH, at beginning of period 1,862 1,276
------- -------
CASH, at end of year $ 586 $ 1,862
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest $ 3 $ 2
======= =======
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
Accretion of Series D&E preferred stock $ 5,133 $ --
Preferred stock conversion to common stock 79,667 --
Accretion of Series AA preferred stock 2,398 5,930
See Notes to Consolidated Financial Statements
F-31
EVOKE SOFTWARE CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share amounts)
Note 1: THE COMPANY
Evoke Software Corporation (the "Company") designs, develops,
markets and supports technology that assists organizations in
managing large quantities of data. The Company's software products
allow its customers to better understand the content, quality and
structure of their data. In 2002, the Company changed its year end
from March 31 to Decmeber 31. The Company derives revenues from
sales to companies principally in North America and Europe.
Year Ended Nine Months Ended
December 31, 2003 December 31, 2002
--------------------------------------
North America $ 4,069 $ 4,017
Europe 1,836 1,316
--------------------------------------
$ 5,905 $ 5,333
======================================
Note 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its foreign subsidiaries. All significant intercompany
accounts and transactions have been eliminated. The asset and
liability accounts of the Company's foreign subsidiaries are
translated from their local currency at the rates in effect at the
balance sheet date. Revenue and expense items are translated at
average rates of exchange prevailing during the period. Translation
adjustments are accumulated and reported as a component of
shareholders' deficiency. Foreign currency transaction gains and
losses, which have not been material, are recorded in other income
and expense in the consolidated statement of operations.
USE OF ESTIMATES
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make certain estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported results of operations during
the reporting period. Actual results could differ from those
estimates.
CONCENTRATIONS OF CREDIT RISK AND CREDIT EVALUATIONS
Financial instruments that potentially subject the Company to
concentrations of risk include cash accounts receivable. Cash
consists principally of demand deposit and money market accounts
primarily held with financial institutions with high credit
standings. The Company has not experienced any significant losses
on its cash.
The Company performs ongoing credit evaluations of customers and
generally does not require collateral. Revenues from one customer
accounted for 15% and 21% of total revenues in the year ended
December 31, 2003 and the nine months ended December 31, 2002,
respectively.
At December 31, 2003, the Company was owed $457 from three
customers which represented approximately 45.9% of the outstanding
accounts receivable. At December 31, 2002, the Company was owed
$2,029 from two customers which represented approximately 70.2% of
the outstanding accounts receivable.
ACCOUNTS RECEIVABLE
The Company carries its accounts receivable at cost less an
allowance for doubtful accounts. On a periodic basis, the Company
evaluates its accounts receivable and changes the allowance for
doubtful accounts, when deemed necessary, based on its history of
past write-offs and collection, contractual terms and current
credit conditions.
F-32
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash, accounts receivable, accounts payable and accrued liabilities
are carried at cost, which approximates fair value due to the short
maturity of these instruments.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost, less accumulated
depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, which range
from two to five years.
SOFTWARE DEVELOPMENT COSTS
Software development costs have been accounted for in accordance
with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased
or Otherwise Marketed." Capitalization of software development
costs begins upon the establishment of technological feasibility,
subject to net realizable value considerations. To date, such
capitalizable costs have not been material. Accordingly, the
Company has charged all such costs to research and development
expense. Future capitalized costs, if any, will be amortized based
on the greater of the expense, as determined on a straight-line
basis over the estimated life of the products, or the ratio of
current revenue to the total of current and anticipated future
revenue.
REVENUE RECOGNITION
The Company licenses software under noncancellable license
agreements and provides services including maintenance, training,
installation, consulting and support services. License fee revenues
are generally recognized when a noncancellable license agreement
has been signed, the product has been shipped, there are no
uncertainties surrounding product acceptance, the fees are fixed or
determinable and collection is considered probable. The Company
allocates a portion of contractual license fees to post-contract
support activities covered under the contract, including first year
maintenance and product support services based on vendor specific
objective evidence of fair value. The Company's agreements with its
customers and resellers do not contain product return rights. For
license arrangements with resellers, the Company recognizes revenue
when the licenses are resold to the end user. Revenues from
maintenance agreements for maintaining, supporting and providing
periodic upgrades are recognized ratably over the maintenance
period, which in most instances is one year. Revenues for training,
installation, and consulting services are recognized as services
are performed.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement
of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109"), which requires the use of the liability method
in accounting for income taxes. Under this method, deferred tax
assets and liabilities are measured using enacted tax rates and
laws that will be in effect when the differences are expected to
reverse.
F-33
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") and has adopted the "disclosure
only" alternative described in SFAS No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"). Equity instruments issued to
non-employees are accounted for in accordance with the provisions
of FAS 123 and related interpretations.
PRO FORMA DISCLOSURES OF THE EFFECT OF STOCK-BASED COMPENSATION
The Company has elected to use the intrinsic value method in
accounting for its employee stock options because, the alternative
fair value accounting requires the use of option valuation models
that were not developed for use in valuing employee stock options.
Under the intrinsic value method, when the exercise price of the
Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.
The fair value of each option granted is estimated on the date of
grant using the Minimum value option-pricing valuation model, with
the following assumptions for options granted during the year ended
December 31, 2003 and nine months ended December 31, 2002:
2003 2002
----------------- --------------
Expected dividend yield -- --
Risk-free interest rate 3.3% 2.8%
Expected life 3 years 3 years
The Minimum Value option valuation model used was developed for use
in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective
assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of
its employee stock options.
For purposes of pro forma disclosure, the estimated fair value of
options is amortized to pro forma expense over the options' vesting
period. Pro forma information is as follows:
Nine months
Year Ended Ended
December 31 December 31
2003 2002
------------ ------------
Net loss:
As reported $ (2,826) $ (3,081)
------------ ------------
Pro forma $ (2,833) $ (3,087)
============ ============
The weighted-average fair value at grant date of options granted
during 2003 and 2002 was $ .05 and $.04.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", effective for fiscal
periods beginning after December 15, 2001 and interim periods
within those fiscal years. SFAS 144 establishes an accounting model
for impairment or disposal of long-lived assts to be disposed of by
sale. The Company adopted SFAS 144 on March 31, 2002.
F-34
In November 2001, the FASB issued an announcement on the topic of
"Income Statement Characterization of Reimbursements received for
Out-of-Pocket Expenses Incurred" (the "Announcement"). The
Announcement required companies to characterize reimbursements
billed for out-of-pocket expenses as revenue in the income
statement. The Announcement was applied in financial reporting
periods beginning after December 15, 2001. There were no netted
reimbursements received for 2003 and 2002 for out-of-pocket
expenses against the related expenses in the accompanying
consolidated statement of operations, respectively. Adoption of the
Announcement has no impact on gross profit or net loss but would
increase both services revenues and the cost of services revenues.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". The standard requires
companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Examples of costs covered
by the standard include lease termination costs and certain
employee severance costs that are associated with a restructuring,
discontinued operation, plant closing or other exit or disposal
activity. Previous accounting guidance was provided by EITF 94-3,
"Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)". SFAS No. 146 replaces EITF 94-3.
SFAS 146 is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company adopted
SFAS No. 146 as of January 1, 2003 and this adoption had no
material impact on the Company's financial position or results of
operations.
In November 2002, the FASB issued FASB Interpretation, or FIN No.
45,"Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others". FIN No. 45 elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also
clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. However, a
liability does not have to be recognized for a parent's guarantee
of its subsidiary's debt to a third party or a subsidiary's
guarantee of the debt owed to a third party by either its parent or
another subsidiary of that parent. The initial recognition and
measurement provisions of FIN No. 45 are applicable on a
prospective basis to guarantees issued or modified after December
31, 2002 irrespective of the guarantor's fiscal year end. The
disclosure requirements of FIN No. 45 are effective for financial
statements with annual periods ending after December 15, 2002. The
Company does not have any guarantees that would require disclosure
under FIN No. 45.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-based Compensation - Transition and Disclosure - an Amendment
to SFAS No. 123". SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value-based method of
accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 for
public companies. This statement is effective for fiscal years
beginning after December 15, 2002. The Company adopted the
disclosure requirements of SFAS No.148 as of January 1, 2003 and
plans to follow the provisions of APB Opinion No. 25 for accounting
for stock based compensation.
In January 2003, the FASB issued FIN No. 46, "Consolidation of
Variable Interest Entities -- An Interpretation of ARB No. 51",
which clarifies the application of Accounting Research Bulletin No.
51, "Consolidated Financial Statements," to certain entities in
which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN No. 46
provides guidance related to identifying variable interest entities
(previously known generally as special purpose entities, or SPEs)
and determining whether such entities should be consolidated. FIN
No. 46 must be applied immediately to variable interest entities
created or interests in variable interest entities obtained, after
January 31, 2003. For those variable interest entities created or
interests in variable interest entities obtained on or before
January 31, 2003, the guidance in FIN No. 46 must be applied in the
first fiscal year or interim period beginning after June 15, 2003.
The Company adopted FIN No. 46 as of January 1, 2003 and this
adoption had no impact on the Company's consolidated financial
statements.
F-35
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity". This statement establishes standards for how an issuer
classifies and measures in its statement of financial position
certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument
embodies the characteristics of an obligation of the issuer. This
standard is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15,
2003. The Company has adopted SFAS No. 150 in the applicable
reporting period and does not expect it will have a material impact
on the Company's Consolidated Financial Statements.
Note 3: FURNITURE AND EQUIPMENT
Furniture and equipment consist of the following:
December 31,
-------------------------------
2003 2002
-------------- --------------
Furniture $ 267 $ 434
Leasehold improvements 372 --
Equipment and related software 797 927
-------------- --------------
1,436 1,361
Less accumulated depreciation 1,086 1,042
-------------- --------------
$ 350 $ 852
============== ==============
Note 4: RESTRUCTURING AND ASSET IMPAIRMENT WRITE-DOWNS
For the nine months ended December 31, 2002, the Company continued
implementation of a plan approved by management to restructure
operations to better align its deployment of operating resources
with lower revenue and activity levels. In so doing, the Company
recorded asset impairment charges representing $837 for the
write-down of furniture and equipment related to excess office
space. Work force reductions mainly in the U.S. and the Company's
U.K. subsidiary were recorded with a total charge to operations for
severance and associated costs of $456. All affected employees had
been terminated as of December 31, 2002 and all termination
benefits had been paid to former employees. In addition, the
Company recorded $158 as a charge to operations principally in
conjunction with the closing of its offices in London and Paris.
Note 5: NOTES PAYABLE
Obligations due to an equipment vendor were fully paid in 2003.
Note 6: COMMITMENTS
The Company has entered into operating leases for certain office
space and equipment with original terms ranging from 12 to 60
months expiring through August 2006. The facility leases generally
contain renewal options and provisions adjusting the lease payments
based upon changes in operating costs of the facilities.
The Company had a twenty-three month lease with a server equipment
vendor under a capitalized lease obligation which required monthly
payments totaling $2. The obligation was fully paid in April 2003.
Future minimum lease payments under all operating leases as of
December 31, 2003 (in thousands) are as follows:
Year Ending December 31 Amount
----------------------- -----------------
2004 $ 492
2005 364
2006 215
-----------------
Total $ 1,071
=================
Rent expense from operating leases for the year ended December 31,
2003 and the nine months ended December 31, 2002 was $1,058 and
$883.
F-36
Note 7: SHAREHOLDERS' DEFICIENCY
PREFERRED STOCK FINANCING
In August 2002, the Company issued 44,265,578 shares of Series AA
preferred stock at $0.12425 per share, and received approximately
$5,500 in cash for the offering (before deducting issuing expenses
totaling $180). In connection with and effective upon the closing
of the financing, all shares of the Company's prior Series A, B, C,
D and E preferred stock automatically converted into Common Stock
on a one-for-one share basis, except that 1,948,569 shares of the
prior preferred stock converted into the Series AA preferred stock
upon participation in the financing. Accordingly, following the
closing of the financing, only common stock and Series AA preferred
stock remained issued and outstanding.
REVERSE STOCK SPLIT
Contemporaneous with and subject to the closing of the
aforementioned preferred stock financing, the Company completed a
ten-for-one reverse stock split of issued and outstanding preferred
and common stock. All preferred and common share prices and amounts
associated with rights, preferences, dividends, and privileges in
the accompanying financial statements were adjusted to reflect such
reverse split.
REDEEMABLE CONVERTIBLE PREFERRED STOCK
At December 31, 2003 and 2002, redeemable convertible preferred
stock consisted of 44,265,578 shares of Series AA shares
authorized, issued and outstanding. Aggregate liquidation
preference totaled $24,420 and $22,660 at December 31, 2003 and
2002.
DIVIDENDS
The holders of Series AA convertible preferred stock are entitled
to receive dividends when, as and if, declared by the Board of
Directors but only out of funds that are legally available at the
rate of $0.03976 per share per annum. These dividends are in
preference to any declaration or payment of any dividend on common
stock of the Company.
CONVERSION
Each share of Series AA convertible preferred stock, at the option
of the holder, is convertible into the number of fully paid and
non-assessable shares of common stock at the conversion rate of one
to one, subject to anti-dilution adjustments and the accrual of
dividends. Each share of Series AA convertible preferred stock will
automatically be converted into shares of common stock, based on
the then-effective conversion price, immediately upon the closing
of a firmly underwritten qualified public offering pursuant to an
effective registration statement under the Securities Act of 1933
for a total offering of not less than $30,000,000 prior to the
deduction of underwriting commissions and expenses and a per share
price (subject to adjustment for stock splits, stock dividends and
similar events) which is not less than $2.982; or the date
specified by written consent or agreement of the holders of 75% of
the then outstanding shares of said stock.
LIQUIDATION
In the event of any liquidation, dissolution or winding up of the
Company, including a merger, consolidation or other transaction in
which more than 50% voting control is transferred, whether
voluntary or involuntary, the holders of Series AA convertible
preferred stock are entitled to receive, prior and in preference to
any distribution of any of the assets of the Company to the holders
of common stock, an amount equal to the original purchase price
plus accrued but unpaid dividends, or $0.55245 and $0.51269 for
each share at December 31, 2003 and 2002, respectively. If the
assets of the Company legally available for distribution shall be
insufficient to permit the payment in full to the holders of the
Series AA convertible preferred stock the Series AA liquidation
preference, then the entire assets of the Company shall be
distributed ratably among the holders of Series AA convertible
stock in proportion to their ownership thereof.
F-37
VOTING
The holders of Series AA convertible preferred stock are entitled
to the number of votes equal to the number of shares of common
stock into which each share of convertible preferred stock could be
converted, and have voting rights and powers equal to the voting
rights and powers of the common stock.
REDEMPTION
At any time after August 9, 2006, the holders of greater than 50%
of the outstanding shares of Series AA preferred stock shall have
the right to request that the Company purchase all or any portion
of the shares of Series AA preferred stock held by such holders,
paying to such holders an amount in cash equal to the repurchase
price, defined as the Series AA liquidation preference, or the
original per share price plus all accrued but unpaid dividends.
COMMON STOCK
At December 31, 2003 the Company has reserved shares of common
stock for future issuance as follows:
Series AA redeemable convertible preferred stock 44,265,578
Common stock warrants 46,533
Options available for grant 2,121,636
Stock options outstanding 6,520,636
--------------
52,954,383
==============
COMMON STOCK WARRANTS
In connection with certain notes issued in 1999, and converted into
shares of series D redeemable convertible preferred stock, the
Company issued warrants for the purchase of 33,866 shares of Series
C redeemable convertible preferred shares. The warrants are
exercisable at $12.90 per share and expire in April 2004. The
Company valued these warrants using the Black-Scholes method with
an interest rate of 6%, a five year life, a volatility factor of
1.0 and no expected dividend yield. The Company deemed the fair
value of these warrants to be immaterial.
Throughout 2001 and 2000, the Company issued warrants to purchase
9,167 shares of common stock to a service provider. The Company
determined the fair value of these options using the Black-Scholes
method with a volatility factor of 1, an interest rate of 6%, a
dividend rate of 0% and a life of five years. The value recorded
for these warrants was approximately $59. The warrants expire
through October 2006.
F-38
In August of 2000, the Company issued warrants exercisable into
3,500 shares of common stock to a lender in connection with an
equipment loan, in which the Company made an early repayment of the
remaining outstanding balance during 2002. The Company determined
the fair value of these options using the Black-Scholes method with
a volatility factor of 1.0, an interest rate of 6.0%, a dividend
rate of 0% and a life of ten years. The value of these warrants,
approximately $24 was recorded by the Company as prepaid financing
costs and was being amortized to interest expense over 36 months.
The remaining prepaid financing balance was amortized in full at
the time of repayment. The warrants expire in August 2010.
STOCK OPTIONS
On September 4, 2002, the Board of Directors of the Company
approved the amendment of the 2000 stock option plan under which
incentive stock options may be granted to employees, directors and
consultants of the Company to purchase up to 8,892,321 shares of
common stock.
The exercise price of stock options granted under the 2000 Plan is
equal to the then-current fair market value of the Company's common
stock at time of grant. In January of 2002, the Company, in
believing that the 2000 Plan exercise price was considerably higher
than what was considered to be the then current fair market value
of the Company's common stock, introduced an Exchange Program
allowing employees and directors, with options having an exercise
price of $0.75 per share or greater, the opportunity to cancel
existing stock options in exchange for new ones. This program was
intended to allow the exchange of existing options for the same
number of new options to be granted at least six months and one day
after the cancellation date of the old options, January 16, 2002,
at an exercise price equal to the fair market value of the
Company's stock on September 4, 2002, the grant date of the new
options.
Options granted under terms of both the existing 1997 plan and the
2000 plan generally have a maximum term of 10 years from the grant
date, are immediately exercisable and generally vest over a 4 year
period. The plan provides that the unvested shares are subject to
repurchase by the Company upon termination of employment at the
original price paid for the shares. The shares generally vest at
the rate of 25% after one year and ratably on a monthly basis for
three years thereafter. The number of shares that were subject to
repurchase totaled 4,772 and 4,835 as of December 31, 2003 and
2002, respectively.
F-39
A summary of the Company's stock option activity during 2003 and
2002 is as follows:
WEIGHTED-AVERAGE
EXERCISE PRICE PER
NUMBER OF SHARES SHARE
------------------ ---------------------
Outstanding at March 31, 2002 116,774 $ 6.40
Granted 6,449,821 0.05
Exercised -- --
Canceled (27,347) 7.50
-----------------
Outstanding at December 31, 2002 6,539,248 0.06
Granted 481,257 0.05
Exercised (53,904) 0.05
Canceled (445,965) 0.06
-----------------
Outstanding at December 31, 2003 6,520,636 0.06
==================
The following table summarizes the outstanding and exercisable
stock options at December 31, 2003:
OPTIONS OUTSTANDING & EXERCISABLE
----------------------------------------------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE
EXERCISE REMAINING CONTRACTUAL PRICE
PRICE PER LIFE (YEARS)
SHARE NUMBER OF SHARES
-------------------- -------------------------- --------------------------- ---------------------------
$0.05 6,431,451 8.70 $ 0.05
1.00 5,960 4.25 $ 1.00
1.10 3,250 3.59 $ 1.10
1.30 4,000 5.77 $ 1.30
7.50 75,975 6.79 $ 7.50
------------
6,520,636 8.67 $ 0.06
============
Options to purchase 2,121,636 shares of common stock were available
for future grant at December 31, 2003.
OPTIONS ISSUED TO NON-EMPLOYEES
During 2003 and 2002, there were no options or stock granted to
non-employees.
Note 8: INCOME TAXES
The Company had deferred tax assets of approximately $5,124 and
$3,954 as of December 31, 2003 and 2002, respectively. Realization
of the deferred tax assets is dependent upon future taxable income,
if any, the amount and timing of which are uncertain. Accordingly,
the net deferred tax assets have been fully offset by a valuation
allowance. The net valuation allowance increased by approximately $
1,170 during the year ended December 31, 2003 primarily relating to
net operating losses and tax credit carryforwards. In 2002, the
valuation allowance decreased by approximately $14,293 primarily as
a result of an August 2002 event which was triggered by a change in
control when the preferred shareholders converted their shares into
common shares. The difference between the statutory tax rates and
the Company's effective tax rate of zero percent is due to the 100
percent valuation allowance against net deferred tax assets. o The
Company had Federal and state operating loss carryforwards of
approximately $ 8,200 and $4,994 as of December 31, 2003 and 2002,
respectively. The net operating loss carryforwards will expire at
various dates through 2023.
Note 9: EMPLOYEE RETIREMENT AND BENEFIT PLAN
The Company has a deferred compensation plan for all eligible U.S.
employees, which qualifies under Section 401(k) of the Internal
Revenue Code. Under the terms of the 401(k) Plan, member employees
may contribute varying amounts of their annual compensation. The
Plan provides for discretionary employer contributions to the Plan.
There have been no employer contributions to the Plan in 2003 and
2002.
F-40
Note 10: SUBSEQUENT EVENT
On June 28, 2004, the Company sold substantially all of its net
assets to Conversion Services International, Inc. a public company
(CSI). The acquisition was completed pursuant to an Asset Purchase
agreement between CSI, Evoke Asset Purchase Corp., a subsidiary of
CSI, and the Company. In connection with the acquisition, CSI (i)
issued 72,543,956 shares of its common stock to the Company,
7,150,000 shares of which have been deposited into an escrow
account for a period of one-year and may be reduced based upon
claims for indemnification that may be made pursuant to the
agreement; (ii) issued 5% of the outstanding shares of the Evoke
Asset Purchase Corp. to the Company; (iii) issued 3,919,093 shares
of its common stock to certain executives of the Company as a
severance payment and to certain employees as retention shares; and
(iv) agreed to pay $448 in deferred compensation to certain
employees of the Company. For accounting purposes, this transaction
was deemed to have occurred on June 30, 2004.
F-41
Conversion Services International, Inc.
Notes to Pro Forma Condensed Financial Statements
PRO FORMA FINANCIAL INFORMATION
The following Pro Forma Financial Statements are based on the historical
financial statements of Conversion Services International, Inc. (the "Company")
and Evoke Software Corporation ("Evoke"), adjusted to give effect to the
acquisition of Evoke by the Company. The Balance Sheet assumes the acquisition
occurred as of June 30, 2004. For accounting purposes, the Evoke acquisition was
deemed to have occurred on June 30, 2004. Transaction volumes between June 28
and June 30, 2004 were de minimis. The Pro Forma Income Statements, for the year
ended December 31, 2003 and the six months ended June 30, 2004, assume the
acquisition occurred as of the first day of the applicable period.
The pro forma financial information does not reflect certain anticipated cost
savings resulting from the operation of Evoke by the Company. There can be no
assurance that the Company will be able to realize any anticipated cost savings.
The pro forma statements should be read in conjunction with the audited
consolidated financial statements of the Company and the related notes thereto
which are included in the Company's Amendment No. 2 to Form SB-2 filed with the
SEC on November 30, 2004.
F-42
CONVERSION SERVICES INTERNATIONAL, INC.
PRO FORMA CONDENSED BALANCE SHEET
JUNE 30, 2004 (IN THOUSANDS) (UNAUDITED)
CONVERSION
SERVICES, INT'L EVOKE SOFTWARE PRO FORMA PRO FORMA
(CONSOLIDATED) CORPORATION ADJUSTMENTS CONSOLIDATED
-------------- ----------- ----------- ------------
ASSETS
CURRENT ASSETS
Cash $ 56 $ 141 (1) $ 356(1) $ 553
Restricted cash 83 -- 83
Accounts receivable 3,475 580 (65) 3,990
Accounts receivable from related parties 786 -- -- 786
Prepaid expenses 177 78 -- 255
Costs in excess of billings 27 -- -- 27
Deferred tax asset 687 -- -- 687
-------- -------- -------- --------
TOTAL CURRENT ASSETS 5,291 799 291 6,381
-------- -------- -------- --------
PROPERTY AND EQUIPMENT, at cost, net 444 184 -- 628
-------- -------- -------- --------
OTHER ASSETS
Due from stockholders, including
accrued interest of $24 206 -- -- 206
Goodwill 2,506 -- -- 2,506
Deferred financing costs 515 -- -- 515
Intangible assets, net of
accumulated amortization of $137 2,616 -- 1,359(1), (3) 5,801
-- -- 1,381(1) --
-- -- 445(1) --
Equity investments 122 -- -- 122
Investment in Evoke 1,820 -- -- 1,820
Other assets 2 56 (45) 13
-------- -------- -------- --------
7,787 56 3,140 10,983
$ 13,522 $ 1,039 $ 3,431 $ 17,992
======== ======== ======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Line of credit $ 2,041 $ -- $ -- $ 2,041
Current portion of long-term debt 68 -- -- 68
Deferred compensation liability -- -- 443(1) 443
Deferred revenue 49 1,254 -- 1,303
Accounts payable and accrued expenses 1,960 1,302 (65) 3,197
-------- -------- -------- --------
TOTAL CURRENT LIABILITIES 4,118 2,556 378 7,052
-------- -------- -------- --------
LONG-TERM DEBT, net of current portion 2,100 -- -- 2,100
-------- -------- -------- --------
DEFERRED TAXES 337 -- -- 337
-------- -------- -------- --------
MINORITY INTEREST -- -- 199(1) 199
-------- -------- -------- --------
COMMITMENTS AND CONTINGENCIES -- -- -- --
STOCKHOLDER'S EQUITY
Common stock, $.001 par value, 1,000,000
shares authorized, issued and outstanding 766 80,619 80,619(1)(9) 766
Preferred Stock -- 13,649 13,649(1)(9) --
Additional paid in capital 7,788 -- 1,940(1) 9,728
Cumulative translation adjustment -- (415) 415(1) --
Accumulated deficit (1,587) (95,370) 94,767(1) (2,190)
-------- -------- -------- --------
6,967 (1,517) 2,854 8,304
-------- -------- -------- --------
$ 13,522 $ 1,039 $ 3,431 $ 17,992
======== ======== ======== ========
See Accompanying Notes to Pro Forma Financial Statements
F-43
CONVERSION SERVICES INTERNATIONAL, INC.
PRO FORMA STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2004
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
CONVERSION EVOKE
SERVICES INT'L SOFTWARE PRO FORMA PRO FORMA
(CONSOLIDATED) CORP. ADJUSTMENTS CONSOLIDATED
------------- ------------- ------------- -------------
REVENUE $ 11,778 $ 2,380 $ -- $ 14,158
COST OF SERVICES 8,154 90 -- 8,244
------------- ------------- ------------- -------------
GROSS PROFIT 3,624 2,290 -- 5,914
------------- ------------- ------------- -------------
Selling and Marketing 1,304 1,718 -- 3,022
G&A 3,163 481 -- 3,644
Produict Development -- 737 -- 737
Restructuing Charge -- 5 -- 5
Depreciation & amortization 98 129 603(3) 830
------------- ------------- ------------- -------------
OPERATING EXPENSES 4,565 3,070 603 8,238
------------- ------------- ------------- -------------
INCOME FROM OPERATIONS (941) (780) (603) (2,324)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE), net (145) 23 -- (122)
------------- ------------- ------------- -------------
LOSS BEFORE INCOME TAXES (1,086) (757) (603) (2,446)
------------- ------------- ------------- -------------
INCOME TAXES (BENEFIT) (460) -- (241)(5) (701)
241(6)
------------- ------------- ------------- -------------
(460) -- -- (701)
------------- ------------- ------------- -------------
NET LOSS (626) (757) (603) (1,745)
UNSECURED CONVERTIBLE LINE OF CREDIT
BENEFICIAL CONVERSION FEATURE 667 -- -- 667
------------- ------------- ------------- -------------
NET LOSS ATTRIBUTABLE TO COMMON
STOCKHOLDERS $ (1,293) $ (757) $ (603) $ (2,412)
============= ============= ============= =============
NET LOSS PER SHARE $ (0.00) N/A $ (0.01) $ (0.00)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES USED IN THE NET LOSS PER SHARE
CALCULATION 675,628,205 -- 76,463,049 752,091,254
============= ============= ============= =============
See Accompanying Notes to Pro Forma Financial Statements
F-44
CONVERSION SERVICES INTERNATIONAL, INC.
PRO FORMA STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONVERSION EVOKE
SERVICES INT'L SOFTWARE
(RESTATED) CORP. PRO FORMA PRO FORMA
(AUDITED) (AUDITED) ADJUSTMENTS CONSOLIDATED
------------- ------------- ------------- -------------
REVENUE $ 19,518 $ 5,905 $ -- $ 25,423
COST OF SERVICES 13,472 381 -- 13,853
------------- ------------- ------------- -------------
GROSS PROFIT 6,046 5,524 -- 11,570
------------- ------------- ------------- -------------
Selling and Marketing 1,639 4,661 -- 6,300
G&A 4,148 1,191 -- 5,339
Product Development -- 2,000 -- 2,000
Restructuing Charge -- 40 -- 40
Depreciation & amortization 224 457 1,206(4) 1,887
------------- ------------- ------------- -------------
OPERATING EXPENSES 6,011 8,349 1,206 15,566
------------- ------------- ------------- -------------
INCOME FROM OPERATIONS 35 (2,825) (1,206) (3,996)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE), net (211) (1) -- (212)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES (176) (2,826) (1,206) (4,208)
------------- ------------- ------------- -------------
INCOME TAXES (BENEFIT) (191) -- (482)(5) (673)
-- -- 482 (6) 482
------------- ------------- ------------- -------------
(191) -- -- (191)
------------- ------------- ------------- -------------
NET INCOME (LOSS) $ 15 $ (2,826) $ (1,206) $ (4,017)
============= ============= ============= =============
NET INCOME (LOSS) PER SHARE $ 0.00 N/A $ (0.02) $ (0.01)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
USED IN THE NET INCOME (LOSS) PER SHARE
CALCULATION 673,000,000 -- 76,463,049 749,463,049
============= ============= ============= =============
See Accompanying Notes to Pro Forma Financial Statements
F-45
CONVERSION SERVICES INTERNATIONAL, INC. Notes to Pro Forma Condensed Financial
Statements
NOTE A - The pro forma adjustments to the condensed consolidated balance sheet
are as follows:
1) To reflect the acquisition of assets and assumption of liabilities of
Evoke Software Corporation and the allocation of the purchase price on the
basis of the fair value of the assets received, liabilities assumed, and
the fair values assigned to identifiable intangible assets as of June 30,
2004 (in thousands)
The components and allocations of the purchase price were based on
independent third party valuations as of the acquisition date.
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Value of Common Stock $ 1,789
Acquisition costs 151
-------
$ 1,940
ALLOCATION OF PURCHASE PRICE:
-----------------------------
Customer contracts (1,962)...................(Six year estimated life)
Computer software (1,381)...................(Three year estimated life)
Trade name (445)...................(indefinite life)
Accounts receivable (580)
Furniture and equipment (184)
Cash (497)
Prepaid expenses (78)
Other assets (11)
Deferred revenue 1,254
Deferred compensation 443
Other liabilities 1,302
Minority interest 199
-------
$ --
=======
2) Elimination of intercompany accounts receivable and accounts payable.
NOTE B - The pro forma adjustments to the condensed consolidated statement of
operations are as follows:
3) To reflect the amortization of Evoke's identified intangible assets for
the six months ended June 30, 2004. Amortization of identified intangible
assets are as follows(in thousands): :
DESCRIPTION AMORTIZATION
----------- ------------
Computer software $230
Customer contracts 373
----
Total $603
====
4) To reflect the amortization of Evoke's intangible assets for the year
ended December 31, 2003. Amortization of identified intangible assets are
as follows(in thousands): :
DESCRIPTION AMORTIZATION
----------- ------------
Computer software $ 460
Customer contracts 746
------
Total $1,206
======
F-46
The weighted average life of the identifiable intangible assets is 4.3
years.
5) To reflect a provision for income taxes which includes an adjustment to
reflect the Company's pro forma income tax rate of 40.0%. This rate is
based upon the statutory federal income tax rate of 34% plus a blended
rate for the various states in which the Company incurs income tax
liabilities, net of the federal income tax benefit for state taxes paid,
of 6%. Since the Company was an "S" corporation for the majority of 2003,
the pro forma rate is based on the Company's estimated income tax rate for
2004 and is not based upon the prior year's effective tax
6) To reflect a valuation allowance for income tax benefit provided in
footnote 5.
NOTE C - Other Pro Forma Disclosures
7) 7,150,000 shares of common stock of the Company have been withheld
pursuant to the Holdback Agreement among the Company, Evoke Asset Purchase
Corp. and Evoke Software Corporation, dated June 28, 2004, for a period of
one year. At the end of one year, if the Company is entitled to
indemnification pursuant to the Asset Purchase Agreement among the same
parties, then the Company shall retain all rights, title and interest in
and to that portion of the holdback shares necessary to satisfy the
applicable amount of such indemnity obligation. In the event that these
shares are released pursuant to the Indemnification Agreement within the
specified period, this will be deemed additional consideration in
connection with this acquisition.
8) Pursuant to the Non-Competition Agreement among the Company and Lacy
Edwards, dated June 28, 2004, Mr. Edwards shall not directly or indirectly
compete with the Company or its subsidiaries. No allocation of purchase
price has been ascribed in connection with this agreement.
9) The severance payment in shares of common stock to three former Evoke
employees was part of the negotiated purchase price and reflected in
"Components of Purchase Price" above. Such severance payments were not
allocated as part of purchase price and have no continuing impact on
subsequent proforma earnings.
10) 512,500 shares of common stock of the Company have been paid to certain
Evoke employees to retain their employment. A charge of $87,125 was
included in the Company's results of operations for the quarter ending
June 30, 2004.
Deferred revenue acquired in conjunction with the purchase of Evoke relates to
maintenance contracts that the Company has assumed a contractual obligation to
fulfill. In accordance with EITF 01-3: "Accounting in a Business Combination for
Deferred Revenue of an Acquiree," this liability was recorded at its fair value.
F-47
--------------------------------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT. THIS
DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THE SECURITIES. THE
INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE ON THE DATE OF THIS DOCUMENT.
ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN OR THAT IS CURRENTLY
DEEMED IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. THE RISKS AND
UNCERTAINTIES DESCRIBED IN THIS DOCUMENT AND OTHER RISKS AND UNCERTAINTIES WHICH
WE MAY FACE IN THE FUTURE WILL HAVE A GREATER IMPACT UPON THOSE WHO PURCHASE OUR
COMMON STOCK. THESE PURCHASERS WILL PURCHASE OUR COMMON STOCK AT THE MARKET
PRICE OR AT A PRIVATELY NEGOTIATED PRICE AND WILL RUN THE RISK OF LOSING THEIR
ENTIRE INVESTMENT.
--------------------------------------------------------------------------------
CONVERSION SERVICES INTERNATIONAL, INC.
564,557,157 SHARES OF COMMON STOCK
---------------
PROSPECTUS
---------------
--------------------------------------------------------------------------------
_______ __, 2004
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The registrant's certificate of incorporation, as amended, currently
states that a director of the registrant shall have no personal liability to the
registrant or its stockholders for monetary damages for breach of fiduciary duty
as a director except to the extent that Section 102(b)(7) (or any successor
provision) of the Delaware General Corporation Law, as amended from time to
time, expressly provides that the liability of a director may not be eliminated
or limited. No amendment or repeal of this provision shall apply to or have any
effect on the liability or alleged liability of any director of the registrant
for or with respect to any acts or omissions of such director occurring prior to
such amendment or repeal.
The registrant's bylaws require the registrant to indemnify any person who
was or is a party or is threatened to be made a party to any threatened, pending
or completed action, suit or proceeding, whether civil, criminal, administrative
or investigative, by reason of the fact that such person is or was a director or
officer of the registrant, or is or was serving while a director or officer of
the registrant at its request as a director, officer, employee, agent, fiduciary
or other representative of another corporation, partnership, joint venture,
trust, employee benefit plan or other enterprise, against expenses (including
attorneys' fees), judgments, fines, excise taxes and amounts paid in settlement
actually and reasonably incurred by such person in connection with such action,
suit or proceeding to the full extent permissible under Delaware law. Any person
claiming indemnification as provided in the bylaws shall be entitled to advances
from the registrant for payment of the expenses of defending actions against
such person in the manner and to the full extent permissible under Delaware law.
On the request of any person requesting indemnification under such provisions,
the Board of Directors of the registrant or a committee thereof shall determine
whether such indemnification is permissible or such determination shall be made
by independent legal counsel if the board or committee so directs or if the
board or committee is not empowered by statute to make such determination.
The indemnification and advancement of expenses provided by the bylaws
shall not be deemed exclusive of any other rights to which those seeking
indemnification or advancement of expenses may be entitled under any insurance
or other agreement, vote of stockholders or disinterested directors or
otherwise, both as to actions in their official capacity and as to actions in
another capacity while holding an office, and shall continue as to a person who
has ceased to be a director or officer and shall inure to the benefit of the
heirs, executors and administrators of such person. The registrant shall have
the power to purchase and maintain insurance on behalf of any person who is or
was a director, officer, employee or agent of the registrant or is or was
serving at its request as a director, officer, employee, agent, fiduciary or
other representative of another corporation, partnership, joint venture, trust
or other enterprise, against any liability asserted against him and incurred by
him in any such capacity, or arising out of his status as such, whether or not
the registrant would have the power to indemnify him against such liability
under the provisions of the bylaws.
The duties of the registrant to indemnify and to advance expenses to a
director or officer provided in the bylaws shall be in the nature of a contract
between the registrant and each such director or officer, and no amendment or
repeal of any such provision of the bylaws shall alter, to the detriment of such
director or officer, the right of such person to the advancement of expenses or
indemnification related to a claim based on an act or failure to act which took
place prior to such amendment, repeal or termination.
II-1
Delaware law also permits indemnification in connection with a proceeding
brought by or in the right of the registrant to procure a judgment in its favor.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers or persons controlling the registrant
pursuant to the foregoing provisions, the registrant has been informed that in
the opinion of the SEC such indemnification is against public policy as
expressed in that Securities Act and is therefore unenforceable. The registrant
has directors and officers liability insurance.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is an estimate of the expenses that we expect to incur in
connection with this registration. We will pay all of these expenses, and the
selling stockholders will not pay any of them.
AMOUNT
TO BE PAID
-------------
SEC registration fee $ 14,302.29
Printing and engraving expenses $ 2,500.00*
Legal fees and expenses $ 40,000.00*
Accounting fees and expenses $ 20,000.00*
Transfer Agent and Registrar fees $ 2,000.00*
Miscellaneous fees and expenses $ 1,197.71*
-------------
Total $ 80,000.00*
* Estimate, and subject to future contingencies.
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
Set forth below is information regarding the issuance and sales of our
securities without registration during the last three years. No such sales
involved the use of an underwriter and no commissions were paid in connection
with the sale of any securities. Except as otherwise noted, all sales below were
made in reliance on Section 4(2) of the Securities Act of 1933, as amended (the
"Act").
In November 2004, we entered into a Stock Purchase Agreement (the
"Agreement") with a CMKX-treme, Inc. Pursuant to the Agreement, CMKX-treme, Inc.
agreed to purchase 12,500,000 shares of common stock for a purchase price of
$1,750,000. Under the terms of the Agreement, CMKX-treme, Inc. initially
purchased 3,571,428 shares of common stock for $500,000, and it is required to
purchase the remaining 8,928,572 shares of Common Stock for $1,250,000 by
December 31, 2004.
In September 2004, we issued to Sands Brothers Venture Capital LLC, Sands
Brothers Venture Capital III LLC and Sands Brothers Venture Capital IV LLC
(collectively, "Sands") three subordinated secured convertible promissory notes
equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, subordinate to Laurus. The Notes are convertible into shares
of our common stock at the election of Sands at any time following the
consummation of a convertible debt or equity financing with gross proceeds of $5
million or greater to us (a "Qualified Financing"). The conversion price of the
shares of our common stock issuable upon conversion of the Notes shall be equal
to a price per share of common stock equal to forty percent (40%) of the price
of the securities issued pursuant to a Qualified Financing. If no Qualified
Offering has been consummated by September 8, 2005, then Sands may elect to
convert the Notes at a fixed conversion price of $0.14 per share. In the event
that we issue stock or derivatives convertible into our stock for a price less
the aforementioned fixed conversion price, then the fixed conversion price is
reset using a weighted average dilution calculation. We also issued Sands three
common stock purchase warrants (the "Warrants") providing Sands with the right
to purchase 6,000,000 shares of our common stock. The exercise price of the
shares of our common stock issuable upon exercise of the Warrants shall be equal
to a price per share of common stock equal to forty percent (40%) of the price
of the securities issued pursuant to a Qualified Financing. If no Qualified
Offering has been consummated by September 8, 2005, then Sands may elect to
exercise the Warrants at a fixed conversion price of $0.14 per share. The latest
that the Warrants may expire is September 8, 2008.
II-2
In August 2004, we replaced our $3,000,000 line of credit with North Fork
Bank with a revolving line of credit with Laurus Master Fund, Ltd. ("Laurus"),
effectuated through a $2,000,000 convertible minimum borrowing note and a
$4,000,000 revolving note, with an annual interest rate of prime rate (as
reported in the Wall Street Journal) plus 1%, and maturing in three years. The
interest rate on these notes will be decreased by 1.0% for every 25% increase in
our stock price above the fixed conversion price prior to an effective
registration statement and 2.0% thereafter up to a minimum of 0.0%. Both the
$2,000,000 convertible minimum borrowing note and the $4,000,000 revolving note
provide for conversion at the option of the holder of the amounts outstanding
into our common stock at a fixed conversion price of $0.14 per share.
Additionally, in exchange for a secured convertible term note bearing interest
at prime rate (as reported in the Wall Street Journal) plus 1%, Laurus has made
available to us an additional $5,000,000 to be used for acquisitions. This note
is convertible into our common stock at a fixed conversion price of $0.14 per
share. In the event that we issue our stock or derivatives convertible into our
stock for a price less than the fixed conversion price, then the fixed
conversion price is reset to the lower price. This note matures in three years.
The proceeds of this loan will be restricted for use for approved acquisition
targets identified by us that are approved by Laurus. We issued Laurus a common
stock purchase warrant that provides Laurus with the right to purchase
12,000,000 shares of our common stock. The exercise price for the first
6,000,000 shares acquired under the warrant is $0.29 per share, the exercise
price for the next 3,000,000 shares acquired under the warrant is $0.31 per
share, and the exercise price for the final 3,000,000 shares acquired under the
warrant is $0.35 per share. The common stock purchase warrant expires on August
15, 2011. Fees to Laurus and Sands (who introduced us to Laurus) equaled
approximately $749,000.
Pursuant to the conversion of an unsecured convertible line of credit note
in May 2004, participating investors received 16,666,666 shares of our common
stock. These shares were issued in reliance on ss.3(a)(9) of the Act. Due to an
adjustment in the conversion price in September 2004, participating investors
received an additional 2,380,953 shares of common stock.
In June 2004, through our subsidiary Evoke Asset Purchase Corp., we
acquired substantially all of the assets and assumed substantially all of the
liabilities of Evoke Software Corporation, a privately-held California
corporation ("Evoke"). In connection with the acquisition, we issued 72,543,956
shares of our common stock to Evoke (7,150,000 of which have been deposited into
an escrow account for a period of one-year and may be reduced based upon claims
for indemnification that may be made pursuant to the Asset Purchase Agreement
among Evoke, Evoke Asset Purchase Corp. and us), and issued 3,919,093 shares of
our common stock to certain executives of Evoke as a severance payment and to
certain employees as retention shares.
In March 2004, Robert C. DeLeeuw was issued 80,000,000 shares of common
stock pursuant to our acquisition of DeLeeuw Associates, Inc. (7,200,000 of
which have been deposited into an escrow account for a period of one-year and
may be reduced based upon claims for indemnification that may be made pursuant
to the Plan and Agreement of Merger and Reorganization, dated February 27, 2004,
among DeLeeuw Associates, Inc., DeLeeuw Conversion LLC and us).
II-3
In January 2004, loans by Dr. Michael Mitchell, the former President,
Chief Executive Officer and sole director of LCS, and by Alex Bruni, the former
Vice President and Secretary of LCS, were converted into 18,313,157 and
1,000,000 shares of our common stock, respectively, at the closing of the merger
of privately-held Conversion Services International, Inc. ("Old CSI") with and
into LCS Acquisition Corp., whereby the former stockholders of Old CSI assumed
control of our company (the "Merger").
In January 2004, 500,000,000 shares of common stock were issued Scott
Newman, Glenn Peipert and certain accredited investors at the closing of the
Merger.
In December 2003, Gene R. Kazlow, Esq. was issued 500,000 shares of common
stock in consideration for performed legal services.
In December 2003, Barry Feiner, Esq. was issued 500,000 shares of common
stock in consideration for performed legal services.
In December 2003, Susan Erwin was issued 200,000 shares of common stock in
consideration for a loan made to a former subsidiary of the Company.
In December 2003, Lawrence Slavin was issued 100,000 shares of common
stock in consideration for performed consulting services.
In December 2003, Roger Jones was issued 125,000 shares of common stock in
consideration for a loan made to a former subsidiary of the Company.
In November 2003, J.T. Shulman & Company, P.C. was issued 125,000 shares
of common stock in consideration for performed accounting services.
In May 2003, Robert E. Morris was issued 1,100,000 shares of common stock
in consideration for a loan made to a former subsidiary of the Company.
On March 22, 2002, we issued 500,000 shares of our common stock to two of
our former directors.
Other than as specifically set forth above, all of the above offerings and
sales were deemed to be exempt under Section 4(2) of the Act. No advertising or
general solicitation was employed in offering the securities. In each instance,
the offerings and sales were made to a limited number of persons, who were
either (i) accredited investors, (ii) business associates of the Company (iii)
employees of the Company, or (iv) executive officers or directors of the
Company. In addition, the transfer of such securities were restricted by the
Company in accordance with the requirements of the Act. With respect to the
issuances to accredited investors, in addition to representations by them, we
have made independent determinations that they were accredited or sophisticated
investors, capable of analyzing the merits and risks of their investment, and
that they understood the speculative nature of their investment. With respect to
the business associates of the Company, employees of the Company and the
executive officers or directors of the Company, in addition to representations
by them, they were provided with detailed information and had access to all
material information about the Company, and we have made independent
determinations that that they were capable of analyzing the merits and risks of
their investment, and that they understood the speculative nature of their
investment. Furthermore, all of the above-referenced persons were provided with
access to our filings with the Securities and Exchange Commission.
II-4
ITEM 27. EXHIBITS
The following is a list of exhibits filed as a part of this registration
statement. Where so indicated by footnote, exhibits which were previously filed
are incorporated herein by reference. For exhibits incorporated by reference,
the location of the exhibit in the previous filing is indicated parenthetically
except for those situations where the exhibit number was the same as set forth
below.
2.1 Agreement and Plan of Reorganization, dated August 21, 2003, among the
Registrant, LCS Acquisition Corp., Conversion Services International, Inc.
and certain affiliated stockholders of Conversion Services International,
Inc. (filed as Appendix A on Schedule 14A on January 5, 2004).
2.2 First Amendment to Agreement and Plan of Reorganization, dated November
28, 2003, among the Registrant, LCS Acquisition Corp., Conversion Services
International, Inc. and certain affiliated stockholders of Conversion
Services International, Inc. (filed as Appendix A on Schedule 14A on
January 5, 2004).
2.3 Certificate of Merger, dated January 30, 2004, relating to the merger of
LCS Acquisition Corp. and Conversion Services International, Inc. (filed
as Exhibit 2.3 on Form 8-K on February 17, 2004).
2.4 Acquisition Agreement, dated February 27, 2004, among the Registrant,
DeLeeuw Associates, Inc. and Robert C. DeLeeuw (filed as Exhibit 2.1 on
Form 8-K on March 16, 2004).
2.5 Plan and Agreement of Merger and Reorganization, dated February 27, 2004,
among the Registrant, DeLeeuw Associates, Inc. and DeLeeuw Conversion LLC
(filed as Exhibit 2.1 on Form 8-K on March 16, 2004).
2.6 Asset Purchase Agreement, dated May 26, 2004, among the Registrant, Evoke
Asset Purchase Corp. and Evoke Software Corporation (filed as Exhibit 2.1
on Form 8-K on July 13, 2004).
3.1 Certificate of Incorporation, as amended (filed as Exhibit 3.1 on Form
10-SB on December 9, 1999).
3.2 Certificate of Amendment to the Registrant's Certificate of Incorporation,
dated January 27, 2004 (filed as Exhibit 3.1 on Form 8-K on February 17,
2004).
3.3 Certificate of Amendment to the Registrant's Certificate of Incorporation,
dated January 30, 2004 (filed as Exhibit 3.2 on Form 8-K on February 17,
2004).
3.4 Amended and Restated Bylaws (filed as Exhibit 3.3 on Form 8-K on February
17, 2004).
4.1 Securities Purchase Agreement, dated August 16, 2004, among the Registrant
and Laurus (filed as Exhibit 4.2 on Form 10-QSB on August 23, 2004).
4.3 Registration Rights Agreement, dated August 16, 2004, among the Registrant
and Laurus (filed as Exhibit 4.3 on Form 10-QSB on August 23, 2004).
4.4 Common Stock Purchase Warrant, dated August 16, 2004, in favor of Laurus
Master Fund, Ltd. (filed as Exhibit 4.7 on Form 10-QSB on August 23,
2004).
II-5
4.5 Common Stock Purchase Warrant, dated September 22, 2004, in favor of Sands
Brothers Venture Capital LLC (filed as Exhibit 4.1 on Form 8-K on
September 27, 2004).
4.6 Common Stock Purchase Warrant, dated September 22, 2004, in favor of Sands
Brothers Venture Capital III LLC (filed as Exhibit 4.2 on Form 8-K on
September 27, 2004).
4.7 Common Stock Purchase Warrant, dated September 22, 2004, in favor of Sands
Brothers Venture Capital IV LLC (filed as Exhibit 4.3 on Form 8-K on
September 27, 2004).
4.8 Registration Rights Agreement, dated September 22, 2004, among the
Company, Sands Brothers Venture Capital LLC, Sands Brothers Venture
Capital III LLC and Sands Brothers Venture Capital IV LLC (filed as
Exhibit 4.4 on Form 8-K on September 27, 2004).
5.1 Opinion of Ellenoff Grossman & Schole LLP.*
10.1 Employment Agreement among the Company and Scott Newman, dated March 26,
2004 (filed as Exhibit 10.1 on Form 8-K/A on April 1, 2004).
10.2 Employment Agreement among the Company and Glenn Peipert, dated March 26,
2004 (filed as Exhibit 10.2 on Form 8-K/A on April 1, 2004).
10.3 Employment Agreement among the Company and Mitchell Peipert, dated March
26, 2004 (filed as Exhibit 10.3 on Form 8-K/A on April 1, 2004).
10.4 Employment Agreement among DeLeeuw Associates, LLC (formerly known as
DeLeeuw Conversion LLC) and Robert C. DeLeeuw, dated February 27, 2004.**
10.5 2003 Incentive Plan (filed as Schedule B on Schedule 14A on January 5,
2004).
10.6 Security Agreement, dated August 16, 2004, among the Registrant, DeLeeuw
Associates, LLC, CSI Sub Corp. (DE), Evoke Software Corporation and Laurus
Master Fund, Ltd. ("Laurus") (filed as Exhibit 4.1 on Form 10-QSB on
August 23, 2004).
10.7 Secured Convertible Minimum Borrowing Note, dated August 16, 2004 (filed
as Exhibit 4.4 on Form 10-QSB on August 23, 2004).
10.8 Secured Revolving Note, dated August 16, 2004 (filed as Exhibit 4.5 on
Form 10-QSB on August 23, 2004).
10.9 Secured Convertible Term Note, dated August 16, 2004 (filed as Exhibit 4.6
on Form 10-QSB on August 23, 2004).
10.10 Stock Pledge Agreement, dated August 16, 2004, among the Registrant and
Laurus (filed as Exhibit 4.8 on Form 10-QSB on August 23, 2004).
10.11 Senior Subordinated Secured Convertible Promissory Note, dated September
22, 2004, in favor of Sands Brothers Venture Capital LLC (filed as Exhibit
10.1 on Form 8-K on September 27, 2004).
II-6
10.12 Senior Subordinated Secured Convertible Promissory Note, dated September
22, 2004, in favor of Sands Brothers Venture Capital III LLC (filed as
Exhibit 10.2 on Form 8-K on September 27, 2004).
10.13 Senior Subordinated Secured Convertible Promissory Note, dated September
22, 2004, in favor of Sands Brothers Venture Capital IV LLC (filed as
Exhibit 10.3 on Form 8-K on September 27, 2004).
10.14 Security Agreement, dated September 22, 2004, among the Registrant, Sands
Brothers Venture Capital LLC, Sands Brothers Venture Capital III LLC and
Sands Brothers Venture Capital IV LLC (filed as Exhibit 10.4 on Form 8-K
on September 27, 2004).
10.15 Subordination Agreement, dated September 22, 2004, among the Registrant,
Sands Brothers Venture Capital LLC, Sands Brothers Venture Capital III
LLC, Sands Brothers Venture Capital IV LLC and Laurus Master Fund, Ltd.
(filed as Exhibit 10.5 on Form 8-K on September 27, 2004).
10.17 Advisory Agreement, dated September 22, 2004, among the Registrant and
Sands Brothers International Limited (filed as Exhibit 10.6 on Form 8-K on
September 27, 2004).
14 Code of Conduct and Ethics**
21 Subsidiaries of the Company.
23.1 Consent of Friedman LLP.**
--------------------
* To be filed by amendment.
** Filed herewith.
ITEM 28. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 ("Securities Act") may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933.
II-7
(ii) To reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information in
the registration statement; and notwithstanding the forgoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any deviation
from the low or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in the volume and price represent no
more than a 20% change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the effective registration statement,
and
(iii) To include any additional or changed material information on
the plan of distribution.
(2) For purposes of determining liability under the Securities Act, to
treat each post-effective amendment as a new registration statement of the
securities offered, and the offering of the securities at that time to be the
initial bona fide offering.
(3) To file a post-effective amendment to remove from registration any of
the securities that remains unsold at the end of the offering.
II-8
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned in the city of East
Hanover, State of New Jersey, on November 30, 2004.
CONVERSION SERVICES INTERNATIONAL, INC.
By: /S/ SCOTT NEWMAN
---------------------------------------
Name: Scott Newman
Title: President and Chief Executive Officer
In accordance with the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates stated:
PERSON CAPACITY DATE
------ -------- ----
/s/ Scott Newman
---------------------------------------- President, Chief Executive Officer, November 30, 2004
Scott Newman Chairman and Principal Executive Officer
*
---------------------------------------- Executive Vice President, Chief Operating November 30, 2004
Glenn Peipert Officer and Director
*
---------------------------------------- Vice President, Chief Financial Officer, November 30, 2004
Mitchell Peipert Secretary, Treasurer and Principal
Accounting Officer
*
---------------------------------------- Director November 30, 2004
Lawrence K. Reisman
* By: /s/ Scott Newman
as attorney-in-fact
November 30, 2004