UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------
FORM 10-QSB/A
Amendment No. 1
-----------------------------
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From to
Commission File Number 0-30420
-----------------------------
CONVERSION SERVICES INTERNATIONAL, INC.
(Exact name of small business user as specified in its charter)
-----------------------------
Delaware 20-1010495
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Eagle Rock Avenue, East Hanover, New Jersey 07936
(Address of principal executive office)
Issuer's telephone number: (973) 560-9400
-----------------------------
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes |X| No
|_|
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: as of August 20, 2004,
766,129,715 of common stock, par value $0.001, were outstanding.
Conversion Services International, Inc. and Subsidiaries
Form 10-QSB
Index
Part I. -- Financial Information Page
Item 1. Financial Statements
Consolidated Balance Sheet as of June 30, 2004 (unaudited) (restated).......1
Consolidated Statements of Operations for the three and six months ended
June 30, 2004 (restated) and 2003 (unaudited).............................2
Consolidated Statements of Cash Flows for the six months ended June 30,
2004 (restated) and 2003 (unaudited)......................................3
Notes to Consolidated Financial Statements (unaudited)......................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................................13
Item 3. Controls and Procedures..............................................19
Part II. Other Information
Item 1. Legal Proceedings....................................................19
Item 2. Changes in Securities................................................19
Item 5. Other Information....................................................19
Item 6. Exhibits and Reports on Form 8-K.....................................20
Signatures
Explanatory Note
This Amendment No. 1 to this Quarterly Report on Form 10-QSB for the quarter
ended June 30, 2004 was filed in order to restate the consolidated financial
statements as of and for the three and six months ended June 30, 2004 to revise
the accounting treatment related to the purchase accounting for the Company's
acquisitions of DeLeeuw Associates, Inc. and Evoke Software Corporation, to
revise the accounting for a deferred tax liability recorded in connection with
the DeLeeuw Associates acquisition, and certain merger costs associated with the
reverse merger with LCS Group, Inc. See Note 1, Restatement of Financial
Statements.
Part 1 has been amended herein to reflect this change. This amendment does not
otherwise update information in the original filing to reflect facts or events
occurring subsequent to the date of the original filing. All information
contained in this amendment and the original filing is subject to updating and
supplementing as provided in periodic reports subsequent to the original filing
date of this Form 10-QSB with the Securities and Exchange Commission.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JUNE 30,2004
(Unaudited)
(Restated)
ASSETS
CURRENT ASSETS
Cash $ 553,338
Restricted cash 83,375
Accounts receivable, net of allowance
for doubtful accounts of $140,375 3,989,165
Accounts receivable from related parties - See note 7 786,232
Prepaid expenses 255,674
Costs in excess of billings 26,428
Deferred tax asset 687,576
--------------
TOTAL CURRENT ASSETS 6,381,788
--------------
PROPERTY AND EQUIPMENT, at cost, net 627,959
--------------
OTHER ASSETS
Due from stockholders,
including accrued interest of $24,330 206,354
Goodwill 27,197,882
Intangible assets, net of
accumulated amortization of $184,991 5,503,823
Deferred financing costs 515,365
Equity investments 122,688
Other assets 13,420
--------------
33,559,532
--------------
Total Assets $ 40,569,279
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit $ 2,041,125
Current portion of long-term debt 68,137
Accounts payable and accrued expenses 3,632,446
Deferred revenue 1,303,287
--------------
TOTAL CURRENT LIABILITIES 7,044,995
LONG-TERM DEBT, net of current portion 2,099,618
DEFERRED TAXES 36,900
--------------
Total Liabilities 9,181,513
--------------
MINORITY INTEREST 199,400
--------------
COMMITMENTS AND CONTINGENCIES -
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value, 1,000,000,000 shares
authorized; 766,129,715 issued and outstanding 766,130
Additional paid in capital 32,158,114
Accumulated deficit (1,735,878)
--------------
Total Stockholders' Equity 31,188,366
--------------
Total Liabilities and Stockholders' Equity $ 40,569,279
==============
See Notes to Consolidated Financial Statements.
1
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Restated) (Restated)
REVENUE $ 6,516,028 $ 3,660,323 $ 11,778,065 $ 7,097,806
COST OF SERVICES 4,379,625 2,501,926 8,218,925 5,085,444
------------ ------------- ------------ ------------
GROSS PROFIT 2,136,403 1,158,397 3,559,140 2,012,362
------------ ------------- ------------ ------------
OPERATING EXPENSES
Selling and marketing 785,943 309,786 1,367,368 625,606
General and administrative 1,782,127 678,305 3,195,079 1,180,931
Depreciation and amortization 102,108 50,528 152,352 95,228
------------ ------------- ------------ ------------
2,670,178 1,038,619 4,714,799 1,901,765
------------ ------------- ------------ ------------
INCOME (LOSS) FROM OPERATIONS (533,775) 119,778 (1,155,659) 110,597
------------ ------------- ------------ ------------
OTHER INCOME (EXPENSE)
Equity in losses from investments (14,486) -- (16,088) --
Other income 455 -- 7,006 --
Interest income 1,429 -- 1,872 --
Interest expense (772,228) (50,551) (804,781) (80,717)
------------ ------------- ------------ ------------
(784,830) (50,551) (811,991) (80,717)
------------ ------------- ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (1,318,605) 69,227 (1,967,650) 29,880
INCOME TAXES (BENEFIT) (244,278) -- (459,878) --
------------ ------------- ------------ ------------
NET INCOME (LOSS) $ (1,074,327) $ 69,227 $ (1,507,772) $ 29,880
============ ============= ============ ============
UNAUDITED PRO FORMA DATA (Note 1):
Income before income taxes
(benefit) $ -- $ 69,227 $ -- $ 29,880
Income taxes (benefit) -- 27,691 -- 11,952
------------ ------------- ------------ ------------
Net income $ -- $ 41,536 $ -- $ 17,928
============ ============= ============ ============
Net income (loss) per share $ (0.00) $ 0.00 $ (0.00) $ 0.00
============ ============= ============ ============
Weighted average number of
common shares used in the actual
and pro forma net income (loss)
per share calculations 680,777,170 450,000,000 627,289,684 450,000,000
See Notes to Consolidated Financial Statements.
2
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended June 30,
---------------------------
2004 2003
----------- ------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,507,772) $ 29,880
Adjustments to reconcile net income (loss)to net cash
used in operating activities:
Depreciation 43,652 34,362
Amortizaton of intangible assets and deferred financing costs 116,233 49,916
Deferred tax asset (459,879) --
Non-cash beneficial conversion feature charge 666,667 --
Compensation expense for stock options and stock issued 89,000 --
Allowance for doubtful accounts 65,368 36,000
Write-off deferred loan costs 24,862 --
Loss on disposal of equipment 35,496 --
Loss on equity investments 16,088 --
Changes in operating assets and liabilities:
Increase in accounts receivable (1,133,077) (618,242)
(Increase) decrease in prepaid expenses (63,339) 2,487
(Increase) in costs in excess of billings (26,428) --
(Increase) decrease in due from stockholders (2,731) 50,000
Decrease in other assets 14,721 --
Increase in accounts payable and accrued expenses 642,566 46,185
Increase in deferred revenue 49,244 --
----------- -----------
Net cash used in operating activities (1,429,329) (369,412)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (186,389) (19,351)
Investment in DeLeeuw Associates, net of cash acquired (2,010,266) --
Investment in Evoke Software Corp., net of cash acquired 466,583 --
Equity investment in Leading Edge Communications Corp. (83,000) --
----------- -----------
Net cash used in investing activities (1,813,072) (19,351)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft (51,900) --
Net advances under line of credit 2,041,125 949,863
Line of credit repayment (1,789,110) --
Issuance of convertible line of credit notes 4,000,000 225,000
Deferred loan costs in connection with line of credit (30,534) --
Principal payments on long-term debt (657,882) (291,875)
Principal payments on capital lease obligations (44,171) --
Distributions to stockholders -- (439,784)
Restricted cash (83,375) --
----------- -----------
Net cash provided by financing activities 3,384,153 443,204
----------- -----------
NET INCREASE IN CASH 141,752 54,441
CASH, beginning of period 411,586 --
----------- ------------
CASH, end of period $ 553,338 $ 54,441
=========== ============
See Notes to Consolidated Financial Statements.
3
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30,
----------------------------
2004 2003
----------- -----------
(Restated)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 60,046 $ 57,989
Cash paid for income taxes -- --
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
During 2004 and 2003, the Company entered into various
capital lease arrangements computer and trade show
equipment in the amount of $227,139 and $0, respectively.
During March 2004, the Company acquired substantially all
of the assets and liabilities of DeLeeuw Associates, Inc.
The components and allocations of the purchase price were based on the
fair value of assets and liabilities acquired as of the acquisition date.
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Cash payments $ 1,939 --
Acquisition costs 71 --
Value of Common Stock 15,840 --
------- -------
$ 17,850 --
ALLOCATION OF PURCHASE PRICE:
Approved vendor status (40 month life) (539) --
Accounts receivable (975) --
Tradename (indefinite life) (722) --
Goodwill (15,844) --
Other assets (56) --
Current liabilities assumed 286 --
------- -------
$ -- $ --
======= =======
During June 2004, the Company acquired substantially all
of the assets and liabilities of Evoke Software Corporation.
The components and allocations of the purchase price were based on the
fair value of assets and liabilities acquired as of the acquisition date.
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Value of Common Stock $ 12,384 $ --
Acquisition costs 31 --
------- -------
$ 12,415 --
ALLOCATION OF PURCHASE PRICE:
Customer contracts (Six year estimated life) (1,962) --
Computer software (Three year estimated life) (1,381) --
Goodwill (10,269) --
Trade name (indefinite life) (651) --
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 --
------- -------
$ -- $ --
======= =======
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 current period.
See Notes to Consolidated Financial Statements.
4
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Accounting Policies
Organization and Business
Conversion Services International, Inc. ("CSI" or the "Company") was
incorporated in the State of Delaware and has been conducting business since
1990. CSI is 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 the northeastern United States. On November 1, 2002, the Company
acquired the operations of Scosys, Inc. ("Scosys"). Scosys is engaged in the
information technology services industry. On January 30, 2004, CSI became a
public company through our merger with a wholly-owned subsidiary of LCS Group,
Inc. 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 CSI that is currently dormant.
Basis of Presentation
In the opinion of management, the accompanying consolidated balance sheet
and related interim consolidated statements of operations and cash flows include
all adjustments necessary for their fair presentation in conformity with
accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue and
expenses. Actual results and outcomes may differ from management's estimates and
assumptions.
Interim results are not necessarily indicative of results for a full year.
The information included in this Form 10-QSB should be read in conjunction with
Management's Discussion and Analysis and financial statements and notes thereto
included in the Conversion Services International, Inc. Current Report on Form
8-K/A filed with the Securities and Exchange Commission on April 1, 2004.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
CSI 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 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, on a project by project basis. For projects
charged on a time and materials basis, revenue is recognized based on the number
of hours worked by consultants at an agreed-upon rate per hour. 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. 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.
5
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.
Property and equipment
Property and equipment are stated at cost and includes equipment held
under capital lease arrangements. Depreciation, which includes amortization of
leasehold improvements, 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. In conjuction with
the DeLeeuw acquisition an intangible asset (Approved Vendor Status) was
acquired which has been determined to have a 40 month life and is being
amortized over this period.
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 six months ended June 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 June 30, 2004, five customers comprised approximately 46% of the
Company's accounts receivable balance.
Advertising
The Company expenses advertising costs as incurred. Advertising costs
amounted to $54,000 and $68,000, and $600 and $2,300, for the three and six
month periods ended June 30, 2004 and 2003, respectively.
6
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.
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.
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 or on the subsequent reporting periods.
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.
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. The Company accounts for its share of the income (losses) of
this investment under the equity method.
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.
Restatement of Financial Statements (unaudited)
As a result of discussions with the Staff at the Securities and Exchange
Commission, the Company made the decision to restate its accounting for the
acquisitions of DeLeeuw Associates, Inc. and Evoke Software Corporation. The
original purchase accounting for these acquisitions was recorded by the Company
in the Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 for
the DeLeeuw acquisition and for the quarter ended June 30, 2004 for the Evoke
acquisition. Additionally, during this process, it was determined that a
deferred tax liability and the accounting for certain merger costs were
initially recorded incorrectly. These changes require restatement of the
Company's Quarterly Reports for the periods ending March 31, June 30 and
September 30 2004.
The restatement relates to the following accounting transactions:
o The cost of the common stock issued in the acquisition is being
recorded based upon the weighted average trading price of the
Company's stock on the OTC Bulletin Board for the four days before
and after the announcement of the transaction. The Company
previously used an alternative method for valuing the stock issued
by the Company in these transactions;
o The Company recorded an intangible asset as a result of the DeLeeuw
acquisition and initially classified this asset as having an
indefinite life. The Company has revised the classification of this
intangible asset and assigned a definitive life to the asset. As a
result of this change, approximately $15,000 and $40,000 of
additional amortization expense was recorded by the Company during
the quarters ended March 31, 2004 and June 30, 2004, respectively.
o The Company initially recorded $300,000 deferred tax liability as
part of the DeLeeuw Associates purchase accounting with the
corresponding offset to goodwill. This accounting was subsequently
determined to be incorrect and was reversed.
o The Company recorded certain merger costs associated with its
reverse merger in LCS Group as a reduction of additional paid in
capital. It was inadequately determined to be incorrect and this
item was recorded as additional expense.
A summary of the balance sheet and income statement effects of the
restatement for the three and six months ended June 30, 2004 is as follows:
As of June 30, 2004
---------------------------
As reported Restated
---------------------------
Goodwill 2,506,224 27,197,882
Intangible assets, net 6,275,095 5,503,823
Total assets 16,648,893 40,569,279
Deferred taxes (336,900) (36,900)
Accumulated deficit (1,586,319) (1,735,878)
Additional paid-in capital 7,788,169 32,158,114
Three months ended June 30, 2004 Six months ended June 30, 2004
-------------------------------- ------------------------------
As reported Restated As reported Restated
-------------------------------- ------------------------------
Depreciation and amortization 61,697 102,108 98,471 152,352
General and administration -- -- 3,162,907 3,195,079
Loss from operations (493,307) (533,775) (1,006,100) (1,155,659)
Loss before income taxes (1,278,137) (1,318,605) (1,818,092) (1,967,650)
Net loss (1,033,916) (1,074,327) (1,358,213) (1,507,772)
Loss per share (0.00) (0.00) (0.00) (0.00)
Reclassifications
Certain amounts have been reclassified to conform to the Company's current
presentations. The reclassifications have no effect on total revenue or net loss
for the period.
Note 2 - 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.
7
Exclusive of future contingent consideration, the components and
allocations of the purchase price was allocated to the various assets and
liabilities of Evoke as follows:
COMPONENTS OF PURCHASE PRICE:
-----------------------------
Value of Common Stock $12,384
Acquisition costs 21
-------
$12,405
ALLOCATION OF PURCHASE PRICE:
Customer contracts (1,962).....(Six year estimated life)
Computer software (1,381).....(Three year estimated life)
Goodwill (10,259)
Trade name (651).....(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
--------
$ --
========
The following unaudited statements of income and financial position
reflect the pro forma consolidated results as of June 30, 2004 and 2003 and for
the six month periods then ended. These statements present the consolidated
results of Conversion Services International, Inc., DeLeeuw Associates, LLC and
Evoke Software Corporation for the aforementioned periods as if the entities had
been consolidated for the entire six month periods in both years presented.
Six Months Ended June 30,
-------------------------------
2004 2003
---- ----
Revenues $ 15,263,889 $ 12,486,228
Net Loss $ (1,617,433) $ (1,232,942)
Net Loss per share $ (0.00) $ (0.00)
Note 3 - Property and equipment
Property and equipment consisted of the following:
June 30,
2004
-------------
Computer equipment $ 787,335
Furniture and fixtures 198,026
Automobiles 72,833
Leasehold improvements 216,306
-------------
1,274,500
Accumulated depreciation (646,541)
-------------
$ 627,959
=============
8
Note 4 - Intangible assets
Intangibles acquired have been assigned as follows:
June 30,
2004
-------------
Customer contracts $ 1,962,000
Approved vendor status 538,814
Computer software 1,381,000
Tradename 1,373,000
Customer lists and contracts 414,000
Proprietary rights and rights to the name of Scosys Inc. 20,000
-------------
5,688,814
Accumulated amortization (184,991)
-------------
$ 5,503,823
=============
Note 5 - 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 available 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. A portion of the Laurus line
of credit will be used to pay off all outstanding borrowings from North Fork
Bank under the line of credit agreement. See note 13 - subsequent events for
further discussion of this transaction.
9
Note 6 - Long term debt
Long-term debt consisted of the following: June 30,
2004
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 conversion price of the
shares of common stock is equal to 75% of the average
bid price for the prior ten trading days. In the
event of the Company's non-compliance with certain
requirements, the conversion price may permanently
adjust 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. This debt financing cost is being amortized
into income over the life of the note. $ 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. 167,755
-----------
2,167,755
Less: Current portion of long-term debt, including
obligations under capital leases of $68,137. (68,137)
-----------
$ 2,099,618
===========
Future annual payments of long-term debt is as follows:
Years Ending June 30,
---------------------
2005 $ 68,137
2006 71,631
2007 27,987
2008 --
2009 2,000,000
-----------
$ 2,167,755
===========
In May 2004, the conversion option in the unsecured convertible line of
credit note dated October 29, 2003 was exercised by the holder. As a result of
the exercise, 16,666,666 shares of the Company's common stock were issued at an
exercise price per share of $0.12, which price represents 75% of the fair market
value of the stock on the date of conversion. Since the conversion price was
less than the market value of the common stock, the Company recorded a $666,667
beneficial conversion charge that reduced earnings available to common
stockholders. The Company has reflected this beneficial conversion charge in the
accompanying consolidated statements of operations.
Note 7 - Related Party Transactions
In November 2003, the Company executed an Independent Contractor Agreement
with LEC, whereby CSI agreed to be a subcontractor for LEC, and to provide
consultants as required to LEC. In return for these services, CSI receives a fee
from LEC based on the hourly rates established for consultants subcontracted to
LEC.
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.
10
For the three and six months ended June 30, 2004, CSI invoiced LEC
$871,000 and $1,841,000, respectively, for the services of consultants
subcontracted to LEC by CSI. As of June 30, 2004, CSI had accounts receivable
due from LEC of approximately $786,000.
As of June 30, 2004, Scott Newman, Chief Executive Officer, and Glenn
Peipert, Chief Operating Officer, owed the Company an aggregate of approximately
$206,000, including accrued interest. These loans bear interest at 3% per annum
and are due and payable by December 31, 2005.
Note 8 - Obligations under capital leases
The Company has entered into various capital leases that are
collateralized by computer equipment and a trade show booth with an original
cost of approximately $227,139.
The following schedule lists future minimum lease payments under the
capital leases with their present value as of June 30, 2004:
Years Ending June 30,
---------------------
2005 $ 97,734
2006 85,186
2007 26,563
-----------
209,483
Less: Amount representing interest (41,728)
-----------
$ 167,755
===========
Note 9 - 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.
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 June 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.
11
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.
Six months ended
June 30, 2004
----------------
Reported net loss $ (1,507,772)
Pro-forma stock compensation, net of tax (139,238)
-------------
Pro forma net loss $ (1,647,010)
=============
Basic EPS:
As reported $ (0.00)
Pro-forma $ (0.00)
Diluted EPS:
As reported $ (0.00)
Pro-forma $ (0.00)
Weighted average fair value per option share granted $ 0.13
Weighted average assumptions used to value options granted:
Risk free interest rate 1.33%
Expected volatility 139%
Expected life (years) 3.00
Note 10 - 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.
The components of basic and diluted earnings per share are as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income (loss) available for common stockholders (A) $ (1,074,327) $ 69,227 $ (1,507,772) $ 29,880
Weighted average outstanding shares of common stock (B) 680,777,170 450,000,000 627,289,684 450,000,000
Common stock and common stock equivalents (C) 680,777,170 450,000,000 627,289,684 450,000,000
Earnings (loss) per share:
Basic (A/B) $ (0.00) $ 0.00 $ (0.00) $ 0.00
============ =========== ============= ===========
Diluted (A/C) $ (0.00) $ 0.00 $ (0.00) $ 0.00
============ =========== ============= ===========
For the three and six months ended June 30, 2004, 32,305,000 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 4,166,666
warrants which were issued on June 7, 2004 were excluded from the calculation of
diluted earnings per share for both the three and six months ended June 30, 2004
because the effect was antidilutive.
12
Note 11 - 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.
During the first six months of 2004, our effective tax rate was estimated
to be approximately 40%.
Note 12 - 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 August 20, 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.
Note 13 - Subsequent Events
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 stock or
derivatives convertible into Company 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 stock or derivatives convertible into Company stock
for a price less the fixed conversion price, then the fixed conversion price is
reset to the lower price. 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.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
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. We undertake no duty to update any forward-looking
statement to conform the statement to actual results or changes in our
expectations.
13
We are in the business of supplying professional services relating to
information technology management consulting, data warehousing and business
intelligence, and, as a result of our 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. Our clients are primarily in
the financial services, pharmaceutical and telecommunications industries,
although we have clients in other industries as well. Our clients are primarily
located in the northeastern United States. We enable organizations to leverage
their corporate information assets by providing strategy, process and
methodology, best practices data warehousing, business intelligence, enterprise
reporting and analytic solutions.
Conversion Services International, Inc. began operations in 1990. Our
services were originally focused on e-business solutions and data warehousing.
In the late 1990s, we strategically repositioned ourselves to capitalize on our
data warehousing expertise in the fast growing business intelligence/data
warehousing space. We became a public company through our merger with a wholly
owned subsidiary of LCS Group, Inc., effective as of January 30, 2004.
Our core strategy includes capitalizing on the already established
in-house business intelligence/data warehousing ("BI/DW") technical expertise
and our seasoned sales force. This is expected to result in organic growth
through the acquisition of new customers. In addition, this foundation will be
leveraged as we pursue targeted strategic acquisitions. The BI/DW industry as a
whole is an extremely fragmented marketplace which we believe is ready for
consolidation.
One of our objectives is to make acquisitions of companies in the BI/DW
industry that will enable us to accelerate our business plan at lower costs than
we would generate internally and also improve our competitive positioning and
expand our offerings in a larger geographic area. We intend to seek acquisitions
of other consulting firms that have expertise and clients in strategic locations
or industries.
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 our ability to collect is reasonably assured. On
certain large service engagements, revenue is recognized using the percentage of
completion method for long-term construction type contracts where costs to
complete the engagement could reasonably be estimated. Our services range from
providing clients with a single consultant to multi-personnel full-scale
projects. Our contracts provide that its services are terminable upon relatively
short notice, typically not more than 30 days. There can be no assurance that
our clients will continue to enter into contracts with us or that existing
contracts will not be terminated. We provide our services directly to end-user
organizations, in most cases.
During the six month period ended June 30, 2004, five of our clients
accounted for approximately 52% of total revenues. During the six month period
ended June 30, 2003, four clients accounted collectively for approximately 55%
of total revenues.
Our most significant costs are personnel expenses, which consist of
consultant fees, benefits and payroll-related expenses, and outside consultants.
Results of Operations
Revenue
Our revenues are primarily comprised of billings to clients for consulting
hours worked on client projects. Revenues for the three and six months ended
June 30, 2004 were $6.5 million and $11.8 million, respectively, an increase of
78.0% and 65.9% over the three and six months ended June 30, 2003, respectively.
This increase was primarily attributable to project design and infrastructure
projects obtained in the fourth quarter of 2003 that are still ongoing, the
acquisition of several new clients, business attributed to DeLeeuw Associates,
LLC during 2004, and a general increase in consulting business as the overall
demand for IT services improves.
Cost of services
Cost of services primarily includes payroll and benefits costs for our
consultants. Cost of services was $4.4 million, or 67.2% of revenue, and $8.2
million, or 69.8% of revenue for the three and six months ended June 30, 2004,
respectively, compared to $2.5 million, or 68.4% of revenue, and $5.1 million,
or 71.6% of revenue for the three and six months ended June 30, 2003,
respectively. The increase in absolute dollars resulted primarily from costs
related to consultants on project design and infrastructure projects, the
acquisition of DeLeeuw Associates, Inc. in March 2004, and additional
consultants hired to staff projects for the new clients that we obtained. Cost
of services declined as a percentage of revenue due to a shift in the mix of
business to higher level projects that have increased hourly billing rates, and
higher gross margin percentages associated with them.
14
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 $0.8 million, or 12.1% of revenue, and $1.4 million, or
11.6% of revenue, for the three and six months ended June 30, 2004,
respectively, compared to $0.3 million, or 8.5% of revenue, and $0.6 million, or
8.8% of revenue, for the three and six months ended June 30, 2003, respectively.
Selling and marketing costs increased in absolute dollars primarily due to
increased payroll and related costs associated with the increased headcount in
our sales force. We have hired additional salespeople as part of our strategy to
gain new clients and increase our revenue.
General and administrative
General and administrative costs include payroll, employee benefits and
other headcount-related costs associated with the finance, legal, facilities,
certain human resources and other administrative headcount, and legal and other
professional and administrative fees. General and administrative costs were $1.8
million, or 27.3% of revenue, and $3.2 million, or 27.1% of revenue, for the
three and six months ended June 30, 2004, respectively, compared to $0.7
million, or 18.5% of revenue, and $1.2 million, or 16.6% of revenue, for the
three and six months ended June 30, 2003, respectively. General and
administrative costs primarily increased due to increased headcount resulting
from the acquisition of DeLeeuw Associates, Inc., increased salaries paid to our
officers due to hiring a chief financial officer during the fourth quarter of
2003 and increasing the salaries of our other company officers to compensate
them competitively with other public companies our size. We also increased
general and administrative headcount in the first quarter to support the
increased size of the business which increased overall salary expense, incurred
increased legal and accounting fees associated with becoming a public company
and higher insurance premiums due to the growth of the Company.
Depreciation and amortization
Depreciation expense is recorded on our property and equipment which is
generally depreciated over a period between three to seven years. Amortization
is recorded for acquired intangible assets that have a finite useful life and
for financing costs. Amortization of acquired intangible assets that have a
finite useful life is recorded over the estimated useful life of the asset.
Financing costs are amortized over the life of the related loans. Depreciation
and amortization expenses were $0.1 million and $0.2 million for the three and
six months ended June 30, 2004, respectively, compared to $51,000 and $95,000
for the three and six months ended June 30, 2003, respectively.
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 deferred financing costs is also recorded as interest expense. Interest
expense recorded was $0.1 million and $0.1 million for the three and six months
ended June 30, 2004, respectively, compared to $51,000 and $81,000 for the three
and six months ended June 30, 2003, respectively. We earn interest income on
deposits with our financial institution. Interest income for the three and six
month periods ended June 30, 2004 was $1,400 and $1,900, respectively, compared
to zero for the three and six month periods in the prior year. We recorded
equity income in our investment in DeLeeuw, Turkey of $9,200 and $7,700 for the
three and six months ended June 30, 2004, respectively, and an equity loss in
our investment in LEC of $23,700 for the three and six months ended June 30,
2004, respectively.
15
Income Taxes
An income tax benefit of $0.2 million and $0.5 million was recorded for
the three and six months ended June 30, 2004, respectively. This benefit was
computed by multiplying our net loss by our estimated effective tax rate of 40%.
No income tax expense or benefit was recorded in the prior year as the Company
was an "S" Corporation through September 30, 2003. Pro forma income taxes for
the comparable three and six month periods in the prior year would have been an
income tax provision of $28,000 and $12,000, respectively, using the effective
tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES
Cash totaled $0.6 million as of June 30, 2004 compared to $0.4 million as
of December 31, 2003. Our cash balance is primarily derived from customer
remittances, bank borrowings and acquired cash 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
the accompanying consolidated balance sheet.
Cash used by operations during the six months ended June 30, 2004 was $1.4
million, an increase of $1.0 million from the six months ended June 30, 2003.
This increase in cash used by operations is primarily due to a $0.5 million
increase in accounts receivable, a $0.5 million increase in the deferred tax
asset during the six month period and the net loss of $0.7 million, which was
partially offset by an increase in accounts payable and accrued expenses of $0.6
million. The increase in accounts receivable is due to billings to new clients
and increased business with several established clients. Non-cash expenses
included depreciation, amortization, and the allowance for doubtful accounts.
Cash used by investing activities was $1.8 million during the six months
ended June 30, 2004. This was due to payments of $2.0 million made primarily as
acquisition payments for DeLeeuw Associates, Inc. and for the purchases of
equipment for the Company.
Cash provided by financing activities was $3.4 million during the six
months ended June 30, 2004. During the first six months of 2004, $4.0 million
was raised from the issuance of line of credit notes, all outstanding amounts
under our previous line of credit and notes payable agreements with Fleet Bank,
totaling $2.3 million, were repaid and $2.0 million was borrowed from our new
line of credit with North Fork Bank.
On August 16, 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 will have 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 Company stock or derivatives convertible into
Company 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 stock or derivatives convertible into Company stock for a price less the
fixed conversion price, then the fixed conversion price is reset to the lower
price. 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 will be deducted from the $5.0
million restricted cash balance being provided to the Company by Laurus.
16
In May 2004, pursuant to the complete conversion of an unsecured
convertible line of credit note issued in October 2003, 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 75% of the average bid price for the prior ten trading days
(prior to the date of conversion) of the common stock on the date of conversion.
Under certain circumstances, the conversion price may be adjusted to a fixed
conversion price of $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
$0.14 per share. This warrant expires in June 2009.
We believe 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 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
We do not have any transactions, agreements or other contractual
arrangements that constitute off-balance sheet arrangements.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2003, the FASB issued Interpretation 46R (FIN 46R), a revision
to Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN
46R clarifies some of the provisions of FIN 46 and exempts certain entities from
its requirements. FIN 46R is effective at the end of the first interim period
ending after March 15, 2004. Entities that have adopted FIN 46 prior to this
effective date can continue to apply the provisions of FIN 46 until the
effective date of FIN 46R. The Company adopted FIN 46 on January 1, 2004 and it
did not have a material impact on our financial statements.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Revenue recognition
Revenue from consulting and professional services is recognized at the
time the services are performed on a project by project basis. For projects
charged on a time and materials basis, revenue is recognized on the number of
hours worked by consultants at an agreed-upon rate per hour. 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.
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.
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.
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 five
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 these contracts, generally five to six years. In conjuction with
the DeLeeuw acquisition, an intangible asset (Approved Vendor Status) was
acquired which has been determined to have a 40 month life and is being
amortized over this period.
17
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. The Company
has determined during its preliminary annual impairment review that the goodwill
recorded for both the DeLeeuw and Evoke acquisitions is likely to be impaired.
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 June 30, 2004, five customers comprised approximately 46% 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.
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.
ISSUES AND UNCERTAINTIES
This Quarterly Report on Form 10-QSB 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 issues and uncertainties such as those referenced
below and elsewhere in this report, which, among others, should be considered in
evaluating our financial outlook.
For further information, refer to the business description and risk
factors sections included in our Form SB-2 filed with the SEC on May 6, 2004.
18
Item 3. Controls and Procedures
CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management,
including our chief executive officer and our chief financial officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Securities Exchange Act of 1934 Rule
13a-15(e) as of the end of the period covered by this report. Based on their
evaluation, our management concluded at the time of our original Form 10-QSB
filing that our disclosure controls and procedures were effective. As a result
of comments received in February 2005 from the Staff of the SEC pertaining to
our Registration Statement on Form SB-2/A, File No. 333-115243 (the
"Registration Statement"), our chief executive officer and our chief financial
officer have concluded that a material weakness exists with regard to the
valuation and purchase accounting of our recent acquisitions, including the
inability to prepare financial statements and footnotes in accordance with SEC
rules and regulations.
In connection with our acquisitions of DeLeeuw Associates, Inc. in March
2004 and Evoke Software Corporation in June 2004, we misapplied generally
accepted accounting principles whereby we did not value the acquisitions and
record the resulting purchase accounting in accordance with SFAS 141 and EITF
99-12. As a result, we were required in March 2005 to restate our financial
statements for the quarters ended March 31, 2004, June 30, 2004 and September
30, 2004. Management now believes and has determined that the disclosure
controls and procedures for these three quarters were not effective.
In light of the need for these restatements and the material weakness in
our valuation and purchase accounting for recent acquisitions, commencing in the
first quarter of our 2005 fiscal year, we are beginning to undertake a review of
our disclosure, financial information and internal controls and procedures
regarding these areas for future acquisitions. This review will include efforts
by our management and directors, as well as the use of additional outside
resources, as follows:
o Senior accounting personnel and our chief financial officer will
continue to review any future acquisition or divestiture in order to
evaluate, document and approve its accounting treatment in
accordance with SFAS 141 and EITF 99-12;
o We will augment, as necessary, such procedures by obtaining
concurrence with independent outside accounting experts prior to
finalizing financial reporting for such transactions; and
o We will incorporate the applicable parts of the action plan
described in the next paragraph.
In conjunction with the measures outlined below, we believe these actions will
strengthen our internal control over our valuation and purchase accounting of
future acquisitions, and this material weakness should be resolved. Management
does not anticipate any extra cost from this change in its valuation and
purchase accounting of future acquisitions.
In addition, we previously identified two internal control matters.
Neither relates to the subject matter of the material weakness described above,
yet combined with the above-referenced material weakness, constitute in the
aggregate a material weakness in our internal control over financial reporting.
These internal control matters, identified in October 2004 by Friedman LLP, our
independent registered public accounting firm, are summarized as follows:
o Lack of certain internal controls over period-end financial
reporting related to the identification of transactions, primarily
contractual, and accounting for them in the proper periods; and
19
o Accounting and reporting for our complex financing transactions
related to the beneficial conversion features and the determination
of the fair value of warrants in such transactions.
Management is establishing an action plan that it believes will correct
the aggregated material weaknesses described above. Our estimated costs related
to the correction of these material weaknesses is approximately $125,000, most
notably related to our conversion to the Great Plains accounting system during
the third quarter of 2004. The conversion to the Great Plains accounting system
required inconsequential modifications to our transaction processing systems.
The effect of the migration to this system has been to provide a better audit
trail than our previous system. The batch processing of transactions provides
the ability for review of transactions prior to being posted in the accounting
system. Further, the ability to close and lock periods to prevent changes to
prior periods provides greater reliability of the data and the financial
statements (resulting from the financial statements being prepared directly by
the accounting system as opposed to using spreadsheets, which have greater
potential for error). Finally, this system has the ability to provide
comparative financial statements to expectations, which drives variance
reporting. As a result of this system change, there were changes in our internal
control over financial reporting starting in the third quarter of 2004, as we
have redesigned the organization structure to drive more focus on our internal
control environment. Other measures included in our action plan are as follows:
o We have formed a Disclosure Committee consisting of our chief
executive officer, chief operating officer, senior vice president of
sales, general counsel and controller, chaired by our chief
financial officer. The Disclosure Committee is comprised of these
key members of senior management who have knowledge of significant
portions of our internal control system, as well as the business and
competitive environment in which we operate. One of the key
responsibilities of each Disclosure Committee member is to review
quarterly reports, annual reports and registration statements to be
filed with the SEC as each progress through the preparation process.
Open lines of communication to financial reporting management exist
for Disclosure Committee members to convey comments and suggestions;
o A process to be established whereby material agreements are reviewed
by the legal, accounting and sales departments and an executive
management member that includes determination of appropriate
accounting and disclosure;
o Our accounting and legal departments are now working more closely
and in conjunction to accurately account for period-end financial
reporting and complex financing transactions;
o We are constantly assessing our existing environment and continue to
make further changes, as appropriate, in our finance and accounting
organization to create clearer segregation of responsibilities and
supervision, and to increase the level of technical accounting
expertise including the use of outside accounting experts;
o There will be closer monitoring of the preparation of our monthly
and quarterly financial information. We are in the process of
instituting regular quarterly meetings to review each department's
significant activities and respective disclosure controls and
procedures and to have such in place by the end of the second
quarter of 2005;
o Department managers have been tasked with tracking relevant
non-financial operating metrics and other pertinent operating
information and communicating their findings to a member of the
Disclosure Committee; and
o We will conduct quarterly reviews of the effectiveness of our
disclosure controls and procedures, and we have enhanced our
quarterly close process to include detailed analysis in support of
the financial accounts, and improved supervision over the process.
20
We believe that we will satisfactorily address the control deficiencies and
material weakness relating to these matters by the end of the second quarter of
2005, although there can be no assurance that we will do so.
At the same time as we continue our efforts to improve our internal
control environment, management of the Company is still in the process of
implementing the above procedures and controls, including review and evaluation,
to mitigate recognized weaknesses specifically for the preparation of future
financial statements. Management believes that these procedures and controls are
not yet effective in ensuring the proper collection, evaluation and disclosure
of the financial information for the periods covered by this.
In connection with restating our financial statements as provided in this
report, our chief executive officer and our chief financial officer, with the
participation of other management, re-evaluated the effectiveness of our
disclosure controls and procedures for the quarter ended March 31, 2004 and
based on the re-evaluation by our chief executive officer and our chief
financial officer, they concluded that, as of March 31, 2004, there were certain
material weaknesses in our internal control procedures and in our valuation and
purchase accounting of our acquisitions in 2004, which has resulted in a
conclusion that such disclosure controls were not effective at a reasonable
assurance level.
Management, including our chief executive officer and our chief financial
officer, does not expect that our disclosure controls and internal controls will
prevent all error or all fraud, even as the same are improved to address any
deficiencies and/or weaknesses. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control.
Changes in internal control over financial reporting.
Our company also maintains a system of internal controls. The term
"internal controls," as defined by the American Institute of Certified Public
Accountants' Codification of Statement on Auditing Standards, AU Section 319,
means controls and other procedures designed to provide reasonable assurance
regarding the achievement of objectives in the reliability of our financial
reporting, the effectiveness and efficiency of our operations and our compliance
with applicable laws and regulations. During the first quarter of 2004, there
were no changes in our internal controls over financial reporting that have
materially affected or are reasonably likely to materially affect our internal
controls over financial reporting. Subsequent to the first quarter of 2004, in
connection with the preparation of the Registration Statement, our management
identified certain weaknesses in our internal control procedures and in our
valuation and purchase accounting of our acquisitions in 2004. Our management
and Board have adopted corrective measures as described in the third and fourth
paragraphs of this Controls and Procedures section above. The following measures
have materially affected our internal control over financial reporting since our
last Quarterly Report:
o Senior accounting personnel and our chief financial officer will
continue to review any future acquisition or divestiture in order to
evaluate, document and approve its accounting treatment in
accordance with SFAS 141 and EITF 99-12;
o We will augment, as necessary, such procedures by obtaining
concurrence with independent outside accounting experts prior to
finalizing financial reporting for such transactions;
21
o We have formed a Disclosure Committee consisting of our chief
executive officer, chief operating officer, senior vice president of
sales, general counsel and controller, chaired by our chief
financial officer. The Disclosure Committee is comprised of these
key members of senior management who have knowledge of significant
portions of our internal control system, as well as the business and
competitive environment in which we operate. One of the key
responsibilities of each Disclosure Committee member is to review
quarterly reports, annual reports and registration statements to be
filed with the SEC as each progress through the preparation process.
Open lines of communication to financial reporting management exist
for Disclosure Committee members to convey comments and suggestions;
o Our accounting and legal departments are now working more closely
and in conjunction to accurately account for period-end financial
reporting and complex financing transactions;
o There will be closer monitoring of the preparation of our monthly
and quarterly financial information. We are in the process of
instituting regular quarterly meetings to review each department's
significant activities and respective disclosure controls and
procedures and to have such in place by the end of the second
quarter of 2005; and
o Department managers have been tasked with tracking relevant
non-financial operating metrics and other pertinent operating
information and communicating their findings to a member of the
Disclosure Committee.
22
PART II. OTHER INFORMATION
Item 1. 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 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 August 20, 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.
Item 2. Changes in Securities.
On May 5, 2004, pursuant to the conversion of an unsecured convertible
line of credit note, participating investors received 16,666,666 shares of our
common stock and 4,166,666 warrants to purchase shares of our common stock at an
exercise price of $0.14 per share. These warrants expire in May 2009. See Item 2
to Part I.
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. See Note 2 to Financial Statements.
Item 5. Other Information
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 stock or
derivatives convertible into Company 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 stock or derivatives convertible into Company stock
for a price less the fixed conversion price, then the fixed conversion price is
reset to the lower price. 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.
23
Item 6. Exhibits and Reports on Form 8-K
(a) The following is a list of exhibits to this Form 10-QSB:
4.1* 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")
4.2* Securities Purchase Agreement, dated August 16, 2004, among the Registrant
and Laurus
4.3* Registration Rights Agreement, dated August 16, 2004, among the Registrant
and Laurus
4.4* Secured Convertible Minimum Borrowing Note, dated August 16, 2004
4.5* Secured Revolving Note, dated August 16, 2004
4.6* Secured Convertible Term Note, dated August 16, 2004
4.7* Common Stock Purchase Warrant, dated August 16, 2004
4.8* Stock Pledge Agreement, dated August 16, 2004, among the Registrant and
Laurus
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
32.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
Section 1350
32.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C.
Section 1350
* Previously filed.
(b) Reports on Form 8-K:
Five reports on Form 8-K were filed during the reporting period, as follows:
Form 8-K/A filed by the Company on April 1, 2004, pertaining to Item Nos. 1 and
7 regarding a change in control and financial statements.
Form 8-K/A filed by the Company on May 18, 2004, pertaining to Item No. 7
regarding financial statements of business acquired.
24
Form 8-K filed by the Company on May 27, 2004, pertaining to Item Nos. 4 and 7
regarding a change in certifying accountant.
Form 8-K filed by the Company on May 28, 2004, pertaining to Item Nos. 7 and 9
regarding FD disclosure.
Form 8-K filed by the Company on June 29, 2004, pertaining to Item Nos. 4 and 7
regarding a change in certifying accountant.
25
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONVERSION SERVICES INTERNATIONAL, INC.
By: /s/ Scott Newman
-------------------------------------
Name: Scott Newman
Title: President and Chief Executive Officer
(Principal Executive Officer and Duly Authorized
Officer)
April 12, 2005