As filed with the Securities and Exchange Commission on May 13, 2005
Registration No. 333-124587
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 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 (Primary Standard Industrial (I.R.S. Employer
of incorporation or Classification Code Number) Identification No.)
organization)
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 AMOUNT TO BE OFFERING PRICE AMOUNT OF
TO BE REGISTERED REGISTERED (1) PER UNIT REGISTRATION FEE
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shares of common stock, par value $0.001 103,034,789 $0.25 (2) $3,031.80
per share
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shares of common stock, par value $0.001 39,256,872 $0.25 (3) $1,155.13
per share, underlying convertible notes
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shares of common stock, par value $0.001 6,000,000 $0.29 (4) $204.80
per share, underlying warrants
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shares of common stock, par value $0.001 3,000,000 $0.31 (4) $109.46
per share, underlying warrants
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shares of common stock, par value $0.001 3,000,000 $0.35 (4) $123.59
per share, underlying warrants
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shares of common stock, par value $0.001 4,166,666 $0.25 (4) $122.60
per share, underlying warrants
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shares of common stock, par value $0.001 6,000,000 $0.25 (4) $176.55
per share, underlying warrants
TOTAL 164,458,327 $4,923.93 (5)
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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) Represents the higher of: (i) the conversion prices of the notes and (ii)
the offering price of securities of the same class as the common stock
underlying the notes calculated in accordance with Rule 457(c) under the
Securities Act, for the purpose of calculating the registration fee pursuant to
Rule 457(g) under the Securities Act.
(4) Represents the higher of: (i) the conversion prices of the warrants and (ii)
the offering price of securities of the same class as the common stock
underlying the warrants calculated in accordance with Rule 457(c) under the
Securities Act, for the purpose of calculating the registration fee pursuant to
Rule 457(g) under the Securities Act.
(5) 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 May 13, 2005
164,458,327 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 Conversion Services
International, Inc. (hereinafter referred to as CSI) in private financing
transactions and acquisitions. These shares include 103,034,789 shares of
outstanding common stock, up to 39,256,872 shares of common stock issuable upon
the conversion of notes and up to 22,166,666 shares of common stock issuable
upon the exercise of warrants.
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 May 12, 2005, was
$0.22.
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. However, we will receive proceeds, to be used
for working capital purposes, upon the exercise of certain warrants held by
certain 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 ____ __, 2005
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
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PROSPECTUS SUMMARY.............................................................................1
RISK FACTORS...................................................................................4
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................................18
BUSINESS......................................................................................19
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.....................................33
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE........................................................................49
USE OF PROCEEDS...............................................................................49
SELLING STOCKHOLDERS..........................................................................50
PLAN OF DISTRIBUTION..........................................................................51
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS..................................53
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................60
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS..........................................61
DESCRIPTION OF SECURITIES.....................................................................64
SHARES ELIGIBLE FOR FUTURE SALE...............................................................67
EXPERTS.......................................................................................67
LEGAL MATTERS.................................................................................67
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES...........67
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 firm providing
professional services to the Global 2000 as well as mid-market clientele. Our
core competency areas include strategic consulting, data warehousing, business
intelligence and data management consulting. Our clients are primarily in the
financial services, pharmaceutical, healthcare and telecommunications
industries, although we do have clients in other industries. Our clients are
primarily located in the northeastern United States. We enable organizations to
leverage their corporate information assets by providing strategy, process,
methodology, data warehousing, business intelligence, enterprise reporting and
analytic solutions. Our organization delivers value to our clients, utilizing a
combination of business acumen, technical proficiency, experience and a proven
set of "best practices" methodologies to deliver cost effective services 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.
OUR SERVICES
As a full service strategic consulting, business intelligence, data
warehousing and data management 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, Mergers and Acquisitions
o Regulatory Compliance (The Health Insurance Portability and
Accountability Act of 1996, Basel II, Sarbanes-Oxley)
o Process Improvement (Lean, Six Sigma)
o Organizational Analysis and Assessment (mergers and
acquisitions)
o Acquisition Readiness
o Information, Process and Infrastructure (IPI) Diagrams
o Request For Proposal creation and responses
o Training and Education
o Change Management Consulting
BUSINESS INTELLIGENCE
o Architecture and Implementation
o Ad-Hoc Query and Analysis
o Enterprise Reporting Solutions
o Online Analytical Processing
o Analytics and Dashboards
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o Business Performance Management
o Business Intelligence Competency Center
o Proof of Concepts and Prototypes
o Business Intelligence Strategy
o Data Mining
DATA WAREHOUSING
o Data Warehousing 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 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)
o Infrastructure Management and Support
o Application Development
See Business on page 17 for a detailed description of these offerings.
During the year ended December 31, 2004, two of our clients, Leading Edge
Communications Corporation, a related party (15.2%), and Bank of America
(15.9%), accounted collectively for approximately 31% 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. Further, the majority of our current assets consist of accounts
receivable, and as of December 31, 2004, 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. Nevertheless, the loss of
any of our largest clients could have a material adverse effect on our business.
2
PURPOSE OF THIS PROSPECTUS
This prospectus relates to the resale of shares of our common stock owned,
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."
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.
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
164,458,327 shares of our common stock. The
selling stockholders will determine when
they will sell their shares. These shares
include 103,034,789 shares of outstanding
common stock, up to 39,256,872 shares of
common stock issuable upon the conversion of
notes and up to 22,166,666 shares of common
stock issuable upon the exercise of
warrants.
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COMMON STOCK OUTSTANDING: We have 788,474,038 shares of common stock
issued and outstanding as of May 12, 2005.
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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 year ended December 31, 2004, two of our clients, Leading Edge
Communications Corporation (LEC), a related party (15.2%), and Bank of America
(15.9%), accounted collectively for approximately 31% 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. Further, the majority of our current assets consist of accounts
receivable, and as of December 31, 2004, one customer, LEC, accounted for 15.6%
of our accounts receivable balance. 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 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.
OUR INTERNAL CONTROLS AND PROCEDURES HAVE BEEN MATERIALLY DEFICIENT, AND WE ARE
IN THE PROCESS OF CORRECTING INTERNAL CONTROL DEFICIENCIES.
In the first quarter of 2005, resulting from comments related to the
Company's Registration Statement on Form SB-2/A, the Company and its independent
registered public accounting firm recognized that our internal controls had
material weaknesses. We have restated our results of operations for the
Company's quarterly results for the quarters ended March 31, 2004, June 30, 2004
and September 30, 2004. For further information concerning our internal
controls, see Management's Discussion and Analysis or Plan of Operation.
4
If we cannot rectify these material weaknesses through remedial measures
and improvements to our systems and procedures, management may encounter
difficulties in timely assessing business performance and identifying incipient
strategic and oversight issues. Management is currently focused on remedying
internal control deficiencies, and this focus will require management from time
to time to devote its attention away from other planning, oversight and
performance functions.
We cannot provide assurances as to the timing of the completion of these
efforts. We cannot be certain that the measures we take will ensure that we
implement and maintain adequate internal controls in the future. Any failure to
implement required new or improved controls, or difficulties encountered in
their implementation, could harm our operating results or cause us to fail to
meet our reporting obligations.
THE COMPANY MAY HAVE LIABILITY IN CONNECTION WITH ITS RECENT SECURITIES
OFFERINGS.
We have completed various financings of which approximately $10,951,000 is
outstanding through the issuance of our common stock, as well as the issuance of
notes and warrants convertible into our common stock, while another Registration
Statement on Form SB-2 was on file with the SEC but had not yet been declared
effective (those transactions were with certain investors of Taurus Advisory
Group, LLC, Laurus Master Fund, Ltd. and three entities affiliated with Sands
Brothers International Limited). We also issued our common stock in connection
with the acquisition of Evoke Software Corporation during this time. Even though
all stockholders, noteholders and warrantholders have been advised of their
rights to rescind those financing transactions and they each have waived their
rights to rescind those transactions, there is a remote possibility that each of
those transactions could be reversed and the consideration received by us may
have to be repaid. In such an event, our business could be adversely affected
and we may have an obligation to fund such rescissions.
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 years ended December 31, 2004 and December 31, 2003, we
sustained operating losses and cannot be sure that we will operate profitably in
the future. During the fiscal year ended December 31, 2004, we sustained a net
loss in the approximate amount of ($32.9 million). $23.3 million of the loss
resulted from impairment of goodwill and intangibles for the year ended December
31, 2004 as a result of our annual impairment review for the DeLeeuw Associates
and Evoke acquisitions (and goodwill recorded for other assets) (see
Management's Discussion and Analysis or Plan of Operation - Goodwill
Impairment). During the fiscal year ended December 31, 2003, we sustained a net
loss in the approximate amount of ($307,000). If we do not become profitable, we
could have difficulty obtaining funds to continue our operations. We have
incurred net losses since our merger with LCS Group, Inc. We may continue to
generate losses from the ongoing business prior to returning the Company to
profitability..
5
WE HAVE A SIGNIFICANT AMOUNT OF DEBT, WHICH, IN THE EVENT OF A DEFAULT, COULD
HAVE MATERIAL ADVERSE CONSEQUENCES UPON US.
Our total debt as of May 12, 2005 is $11,502,000, as described below in
Management's Discussion and Analysis or Plan of Operation - Liquidity and
Capital Resources. 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;
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; and
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 loans require the prior consent of
Laurus Master Fund, Ltd. on many corporate actions including, but not limited
to, mergers and acquisitions--which is part of our ongoing business strategy.
OUR OPERATING RESULTS ARE DIFFICULT TO FORECAST.
We may increase our general and administrative expenses in the event that
we increase our business and/or acquire other businesses, while our operating
expenses for sales and marketing and costs of services for technical personnel
to provide and support our services also increases. Additionally, although 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, IF ANY, 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;
6
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.
Our ability to achieve growth targets is dependent in part on maintaining
existing clients and continually attracting and retaining new clients to replace
those who have not renewed their contracts. Our ability to achieve market
acceptance, including for data warehousing, will require substantial efforts and
expenditures on our part to create awareness of our services.
IF WE SHOULD EXPERIENCE RAPID GROWTH, SUCH GROWTH COULD STRAIN OUR MANAGERIAL
AND OPERATIONAL RESOURCES, WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
Any rapid growth that we may experience would most likely place a
significant strain on our managerial and operational resources. If we continue
to acquire other companies, we will be required to manage multiple relationships
with various clients, strategic partners and other third parties. Further growth
(organic or by acquisition) or an increase in the number of strategic
relationships may increase this strain on existing managerial and operational
resources, inhibiting our ability to achieve the rapid execution necessary to
implement our growth strategy without incurring additional corporate expenses.
LACK OF DETAILED WRITTEN CONTRACTS COULD IMPAIR OUR ABILITY TO COLLECT FEES,
PROTECT OUR INTELLECTUAL PROPERTY AND PROTECT OURSELVES FROM LIABILITY TO
OTHERS.
We try to protect ourselves by entering into detailed written contracts
with our clients covering the terms and contingencies of the client engagement.
In some cases, however, consistent with what we believe to be industry practice,
work is performed for clients on the basis of a limited statement of work or
verbal agreements before a detailed written contact can be finalized. To the
extent that we fail to have detailed written contracts in place, our ability to
collect fees, protect our intellectual property and protect ourselves from
liability from others may be impaired.
7
FAILURE TO ACHIEVE AND MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH
SECTION 404 OF THE SARBANES-OXLEY ACT COULD HAVE A MATERIAL ADVERSE EFFECT ON
OUR BUSINESS AND OPERATING RESULTS. IN ADDITION, CURRENT AND POTENTIAL
STOCKHOLDERS COULD LOSE CONFIDENCE IN OUR FINANCIAL REPORTING, WHICH COULD HAVE
A MATERIAL ADVERSE EFFECT ON OUR STOCK PRICE.
Effective internal controls are necessary for us to provide reliable
financial reports and effectively prevent fraud. If we cannot provide reliable
financial reports or prevent fraud, our operating results could be harmed.
Commencing July 15, 2006, we will be required to document and test our
internal control procedures in order to satisfy the requirements of Section 404
of the Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of our internal controls over financial reporting and a report by
our independent registered public accounting firm addressing these assessments.
During the course of our testing, we may identify deficiencies which we may not
be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley
Act for compliance with the requirements of Section 404. In addition, if we fail
to maintain the adequacy of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal
control environment could also cause investors to lose confidence in our
reported financial information, which could have a material adverse effect on
our stock price.
COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.
Changing laws, regulations and standards relating to corporate governance
and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC
regulations and exchange rules (although not, as of the date of this
Registration Statement, applicable to us), are creating uncertainty for
companies such as ours. These new or changed laws, regulations and standards are
subject to varying interpretations in many cases due to their lack of
specificity, and as a result, their application in practice may evolve over time
as new guidance is provided by regulatory and governing bodies, which could
result in continuing uncertainty regarding compliance matters and higher costs
necessitated by ongoing revisions to disclosure and governance practices. We are
committed to maintaining high standards of corporate governance and public
disclosure. As a result, our efforts to comply with evolving laws, regulations
and standards have resulted in, and are likely to continue to result in,
increased general and administrative expenses and a diversion of management time
and attention from revenue-generating activities to compliance activities. In
particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of
2002 and the related regulations regarding our required assessment of our
internal controls over financial reporting and our independent registered public
accounting firm's audit of that assessment will require the commitment of
significant financial and managerial resources. We expect these efforts to
require the continued commitment of significant resources. Further, our board
members, chief executive officer and chief financial officer could face an
increased risk of personal liability in connection with the performance of their
duties. As a result, we may have difficulty attracting and retaining qualified
board members and executive officers, which could harm our business. If our
efforts to comply with new or changed laws, regulations and standards differ
from the activities intended by regulatory or governing bodies due to
ambiguities related to practice, our reputation may be harmed.
8
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.
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.
9
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, Glenn Peipert and Robert C. DeLeeuw. Although we have
entered into employment agreements with Messrs. Newman, Peipert and DeLeeuw, the
loss of any of these individuals could have a material adverse effect upon us.
In addition, we have not obtained "key man" life insurance on the lives of
Messrs. Newman, Peipert or DeLeeuw.
We will need to attract, train and retain more employees for management,
engineering, programming, sales and marketing, and client service and support
positions. As noted above, competition for qualified employees, particularly
engineers, programmers and consultants, continues to be intense. Consequently,
we may not be able to attract, train and retain the personnel we need to
continue to offer solutions and services to current and future clients in a cost
effective manner, if at all.
IF WE FAIL TO RAISE CAPITAL THAT WE MAY NEED TO SUPPORT AND INCREASE OUR
OPERATIONS, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Our future capital uses and requirements will depend on several factors,
including:
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;
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. Further, if we raise capital though an equity or debt financing
at reduced exercise or conversion price, it could trigger certain anti-dilution
provisions with other investors. Any additional equity financing is expected to
be dilutive to our stockholders, and debt financing, if available, may involve
restrictive covenants and increased interest costs. Our inability to obtain
sufficient financing may require us to delay, scale back or eliminate some or
all of our expansion programs or to limit the marketing of our services. This
could have a material and adverse effect on our business.
10
WE COULD HAVE POTENTIAL LIABILITY FOR INTELLECTUAL PROPERTY INFRINGEMENT,
PERSONAL INJURY, PROPERTY DAMAGE OR BREACH OF CONTRACT TO OUR CLIENTS THAT COULD
ADVERSELY AFFECT OUR BUSINESS.
Our services involve development and implementation of computer systems
and computer software that are critical to the operations of our clients'
businesses. If we fail or are unable to satisfy a client's expectations in the
performance of our services, our business reputation could be harmed or we could
be subject to a claim for substantial damages, regardless of our responsibility
for such failure or inability. In addition, in the course of performing
services, our personnel often gain access to technologies and content which
include confidential or proprietary client information. Although we have
implemented policies to prevent such client information from being disclosed to
unauthorized parties or used inappropriately, any such unauthorized disclosure
or use could result in a claim for substantial damages. Our business could be
adversely affected if one or more large claims are asserted against us that are
uninsured, exceed available insurance coverage or result in changes to our
insurance policies, including premium increases or the imposition of large
deductible or co-insurance requirements. Although we maintain general liability
insurance coverage, including coverage for errors and omissions, there can be no
assurance that such coverage will continue to be available on reasonable terms
or will be available in sufficient amounts to cover one or more large claims.
WE DO NOT INTEND TO PAY DIVIDENDS ON SHARES OF OUR COMMON STOCK IN THE
FORESEEABLE FUTURE.
We have never paid cash dividends on our common stock 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.
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
37.3% and 19.0%, 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 10.1% 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.
11
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.
OUR SERVICES OR SOLUTIONS MAY INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF
OTHERS.
We cannot be sure that our services and solutions, or the solutions of
others that we offer to our clients, do not infringe on the intellectual
property rights of third parties, and we may have infringement claims asserted
against us or against our clients. These claims may harm our reputation, cost us
money and prevent us from offering some services or solutions. In some
instances, the amount of these expenses may be greater than the revenues we
receive from the client. Any claims or litigation in this area, whether we
ultimately win or lose, could be time-consuming and costly, injure our
reputation or require us to enter into royalty or licensing arrangements. We may
not be able to enter into these royalty or licensing arrangements on acceptable
terms. To the best of our knowledge, we have never infringed upon the
intellectual property rights of another individual or entity.
WE COULD BE SUBJECT TO SYSTEMS FAILURES THAT COULD ADVERSELY AFFECT OUR
BUSINESS.
Our business depends on the efficient and uninterrupted operation of our
computer and communications hardware systems and infrastructure. We currently
maintain our computer systems in our facilities at our offices in New Jersey and
elsewhere. We do not have complete redundancy in our systems and therefore any
damage or destruction to our systems would significantly harm our business.
Although we have taken precautions against systems failure, interruptions could
result from natural disasters as well as power losses, telecommunications
failures and similar events. Our systems are also subject to human error,
security breaches, computer viruses, break-ins, "denial of service" attacks,
sabotage, intentional acts of vandalism and tampering designed to disrupt our
computer systems. We also lease telecommunications lines from local and regional
carriers, whose service may be interrupted. Any damage or failure that
interrupts or delays network operations could materially and adversely affect
our business.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE FAIL TO ADEQUATELY ADDRESS
SECURITY ISSUES.
We have taken measures to protect the integrity of our technology
infrastructure and the privacy of confidential information. Nonetheless, our
technology infrastructure is potentially vulnerable to physical or electronic
break-ins, viruses or similar problems. If a person or entity circumvents 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.
12
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 May 12, 2005,
the Company has approximately $4.3 million 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. We may be required to incur
additional debt and to issue equity securities, which may be dilutive to
existing stockholders, to effect and/or fund acquisitions.
WE CANNOT ASSURE YOU THAT ANY ACQUISITIONS WE MAKE WILL ENHANCE OUR BUSINESS.
We cannot assure you that any completed acquisition will enhance our
business. Since we anticipate that acquisitions could be made with both cash and
our common stock, if we consummate one or more significant acquisitions, the
potential impacts are:
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. Additionally, we could choose to divest any acquisition that is not
profitable.
13
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, Glenn Peipert and Robert C.
DeLeeuw, provide management and financial assistance to us. When their personal
investment interests diverge from our interests, they and their affiliates may
exercise their influence in their own best interests. Some decisions concerning
our operations or finances may present conflicts of interest between us and
these stockholders and their affiliated entities.
THE LIMITED PRIOR PUBLIC MARKET AND TRADING MARKET MAY CAUSE POSSIBLE VOLATILITY
IN OUR STOCK PRICE.
There has only been a limited public market for our securities and there
can be no assurance that an active trading market in our securities will be
maintained. The 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;
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, divestitures, 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.
14
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.
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
15
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.
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 billion shares of our common stock. As of
May 12, 2005, there were 788,474,038 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 May 12, 2005, we had
108,297,618 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 May 12, 2005, we had outstanding stock
options and warrants to purchase approximately 63,432,647 shares of our common
stock, the exercise price of which range between $0.055 and $0.35 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 50 million shares
are currently reserved for issuance in connection with our 2003 Incentive Plan,
of which options to purchase an aggregate of 41,265,981 shares have been issued
under the plan. A significant number of such options and warrants contain
provisions for broker-assisted 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.
16
The exercise of the outstanding convertible securities will reduce the
percentage of common stock held by our stockholders. Further, the terms on which
we could obtain additional capital during the life of the convertible securities
may be adversely affected, and it should be expected that the holders of the
convertible securities would exercise them at a time when we would be able to
obtain equity capital on terms more favorable than those provided for by such
convertible securities. As a result, any issuance of additional shares of common
stock may cause our current stockholders to suffer significant dilution which
may adversely affect the market.
In addition to the above-referenced shares of common stock which may be
issued without stockholder approval, we have 20 million shares of authorized
preferred stock, the terms of which may be fixed by our Board of Directors. 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.
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.
17
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis or 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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18
BUSINESS
Conversion Services International, Inc. is a technology firm providing
professional services to the Global 2000 as well as mid-market clientele. Our
core competency areas include strategic consulting, data warehousing, business
intelligence and data management consulting. Our clients are primarily in the
financial services, pharmaceutical, healthcare and telecommunications
industries, although we do have clients in other industries. Our clients are
primarily located in the northeastern United States. We enable organizations to
leverage their corporate information assets by providing strategy, process,
methodology, data warehousing, business intelligence, enterprise reporting and
analytic solutions. Our organization delivers value to our clients, utilizing a
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 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.
19
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 75.9% of the outstanding shares of our common stock at that time
(due to subsequent events, that percentage of ownership has decreased), and
(iii) we changed our name to "Conversion Services International, Inc." The
acquisition was accounted for as a reverse acquisition. Please see Note 1
Accounting Policies of the Notes to Consolidated Financial Statements for
further discussion on this transaction.
Our offices are located at 100 Eagle Rock Avenue, East Hanover, New Jersey
07936, and our telephone number is (973) 560-9400.
OUR SERVICES
As a full service strategic consulting, business intelligence, data
warehousing and data management firm, we offer services in the following
solution categories:
STRATEGIC CONSULTING: - Involves planning and assessing both process and
technology, performing gap analysis, making recommendations regarding technology
and process improvements to help our clients realize their business goals and
maximize their investments in people and technology.
o Project Management (PMO) - Setting up an internal office at a
client location, staffed with senior/certified project
managers that act in accordance with the policies and
procedures identified in CSI Best Practices for Project
Management.
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
the user and technology 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, extract, transform and
load processes (ETL), data profiling, database and data
modeling.
o Integration Management, Mergers and Acquisitions - Work with
clients to implement best practices for mergers and
acquisitions. Support all aspects of the integration process
from initial assessment through implementation support.
o Regulatory Compliance (The Health Insurance Portability and
Accountability Act of 1996, Basel II, Sarbanes-Oxley) - Work
with clients to analyze, design and implement operational
control and procedures that will align the organization to
meet new regulatory requirements.
20
o Process Improvement (Lean, Six Sigma) - Provide a full array
of products and services in support of Lean and Six Sigma,
including training, process improvement, project management
and implementation support.
o Organizational Analysis and Assessment (mergers and
acquisitions) - Work with clients to implement best practices
for mergers and acquisitions. Support all aspects of the
integration process from initial assessment through
implementation support.
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.
o Information, Process and Infrastructure (IPI) Diagrams - A
blueprinting process and service that facilitates and
accelerates the strategic planning process.
o Request For Proposal creation and responses - Gather user and
technical requirements and develop Requests For Proposals
(RFP) on behalf of our clients. Respond to client RFPs with
detailed project plans, solutions and cost.
o Training and Education - Provide formal classroom training for
Business Objects software products. Provide training in data
warehousing and business intelligence methodologies and best
practices, as well as technology tool training, including
business intelligence tools such as Cognos and MicroStrategy.
o Change Management Consulting - Assist clients with
implementing project management governance and best practices
for large scale change initiatives, including consolidations,
conversions, integration of new business processes and systems
applications.
BUSINESS INTELLIGENCE: A category of applications and technologies for
gathering, storing, analyzing and providing access to data to help enterprise
users make better and quicker business decisions.
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
tools, 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 analytical tools, 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 monitor and manage
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.
21
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 Business Intelligence 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 extract
implicit, previously unknown, and potentially useful
information from data. These tools typically use statistical
and visualization techniques to discover and present knowledge
in a form which is easily comprehensible to humans. Business
intelligence tools will answer questions based on information
that has already been captured (history), data mining tools
will discover information and project information based on
historic information.
DATA WAREHOUSING: A consolidated view of enterprise data, making it
simpler and more efficient to run queries over data that originally came from
different sources.
o Data Warehousing Design, Development and Implementation - Design,
development and implementation of custom data warehouse solutions.
These solutions are based on our methodology and best practices.
o Departmental Data Warehousing - Design, development 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 data 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 data 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
data 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 is called a Proof of
Concept. The Proof of Concept will validate the technology and/or
business case, as well as "sell" the concept of data warehousing to
management.
o Data Mart Delivery - Design, development 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 utilized
in a data warehouse implementation.
22
DATA MANAGEMENT: Innovative solutions for moving data (information)
throughout an enterprise (services include data conversions, system migrations
and data warehousing).
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, development and
implementation of custom data migrations. These solutions are based
on our methodology and best practices.
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 trustworthy.
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.
23
The following illustrates the percentage of revenues provided by each
category of services as a percentage of overall revenues:
Category of Services Percentage of Revenues for the year ended
December 31,
2004 2003
---- ----
Strategic Consulting 34.1% 17.3%
Business Intelligence 21.6% 22.2%
Data Warehousing 15.9% 14.8%
Data Management 22.7% 45.7%
Software 5.4% 0.0%
Other 0.3% 0.0%
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 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.
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 an Acquisition Agreement by and between CSI, DeLeeuw Associates 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, $1.9 million; and (ii) issued 80,000,000 shares of our common stock
to Mr. DeLeeuw. DeLeeuw Sub changed its name to "DeLeeuw Associates, LLC."
Please see Notes 1 and 3 of our Notes To Consolidated Financial Statements for
further discussion on this transaction.
Integration of DeLeeuw's Change Management Consulting practices with CSI's
Data Warehousing and Business Intelligence core competency "The Center for Data
Warehousing" was completed in 2004. The Change Management, Six Sigma and Lean
methodology have been introduced to our clients along with our innovative
Information, Process and Infrastructure (IPI) Diagrams, which provide detailed
blueprints of our client's information, business processes and infrastructure on
a single highly detailed diagram. These diagrams can be utilized for risk
management, compliance, validation, planning and budgeting requirements. 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 in 2004, which will be the focus of our marketing and
communications programs for 2005. A QMO offering is a combination of
methodologies, best practices and automated techniques leveraged to establish
and enforce standards and procedures as it relates to elevating the quality of
executive information in an efficient and effective manner. We believe that
these offerings will drive greater understanding and demand for both data
warehousing and business intelligence implementations by delivering best
practices methodologies, tools and techniques to reduce risk, time to market and
total cost of ownership of these engagements. One component of our business
strategy is to continue to enhance and expand our offerings which include best
practices, process improvement, methodologies, advisory services and
implementation expertise.
24
In May 2004, CSI acquired 49% of all issued and outstanding shares of
common stock of LEC. The acquisition was completed through a Stock Purchase
Agreement between CSI and 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 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 an 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 approximately $0.5 million in deferred
compensation (approximately $0.2 million 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" and Evoke changed its name to
WHRT I Corp. Before the merger, certain investors of Evoke invested $0.55
million in Evoke, which investment was converted into approximately 5,500,000
shares of our common stock upon effectuation of the merger. Those approximately
5,500,000 shares issued to WHRT I Corp. are subject to a lock-up period after a
Registration Statement on Form SB-2 is declared effective by the Securities and
Exchange Commission, in which such shares shall be released and freely tradable
one month following the effective date of our Registration Statement. The
remainder of the shares issued to WHRT I Corp. are subject to a lock-up period
after the Registration Statement is effective as follows (the following assumes
the Registration Statement has been declared effective by the SEC): (i) 60%
shall be released and freely tradable when a Registration Statement is declared
effective (such Registration Statement is presently pending); (ii) 20% shall be
released and freely tradable on July 1, 2005; and (iii) 20% shall be released
and freely tradable on October 1, 2005. Please see Note 3 of our Notes to
Consolidated Financial Statements for further discussion on this transaction.
Evoke is managed and operated as a majority-owned subsidiary company, but
its integration is limited to infrastructure and back office operations. CSI has
a license to use Evoke software products and has a multi-year record of
leveraging the Evoke suite of products, which will continue under a Value Added
Reseller and Systems Integration partnership. 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.
25
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 positioned to expand our
client base by delivering 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. CSI, with the assistance of Evoke
Axio, is well positioned to support the increasing industry emphasis on data
quality and the use of automation to reduce the costs associated with data
warehouse and business intelligence projects, data migrations and conversions,
as well as packaged application implementations such as Enterprise Resource
Planning (ERP), Customer Relationship Management (CRM) and Supply Chain
Management (SCM) by leveraging the automation and validation gained by the use
of data profiling technology.
RECENT FINANCINGS
In May 2004, pursuant to the complete conversion of a $2.0 million
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. The
shares of common stock and the shares underlying the warrant of presently
outstanding debt are being registered in this registration statement of which
this prospectus forms a part. 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 $3.0 million 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 $6.0 million based upon
eligible accounts receivable. A portion of Laurus's revolving line of credit was
used to pay off all outstanding borrowings from North Fork Bank. 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 matures in three years. We
have no obligation to meet financial covenants under the $2.0 million
convertible minimum borrowing note or the $4.0 million revolving note. 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 $2.0
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 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.
26
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 $5.0 million to be used for acquisitions.
We have no obligation to meet financial covenants under the $5.0 million secured
convertible term note. 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. We issued Laurus a common stock purchase warrant
that provides Laurus with the right to purchase 12.0 million shares of our
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 15, 2011. We paid $0.75 million
in brokerage and transaction closing related costs. These costs were deducted
from the $5.0 million restricted cash balance being provided to us by Laurus. 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. An early termination fee is due to Laurus in an
amount equal to five percent (5%) of the total investment amount if such
termination occurs prior to the first anniversary of the closing, four percent
(4%) if such termination occurs after the first anniversary but prior to the
second anniversary, and three percent (3%) if after the second anniversary.
The fair value of the 12.0 million warrants was determined to be $2.0
million using the Black-Scholes option pricing model. The assumptions used in
the fair value calculation were as follows: stock prices of $0.21, exercise
prices of $0.29, $0.31 and $0.35 (as applicable), term of seven years,
volatility (annual) of 150.65%, annual rate of quarterly dividends of 0%, a risk
free rate of 1.33%, and the fair value per share of the warrants was accordingly
calculated to be $0.20. The Company will amortize this relative fair value of
the warrants to interest expense over the three-year life of the debt agreement.
Under the Laurus agreement, the Company was obligated to ensure that the
shares provided for issuance under the agreement were properly registered by
December 19, 2004. As a result of the Company's Registration Statement not being
declared effective prior to this date, the Company is incurring liquidated
damages to Laurus in an amount equal to 1% for each thirty day period (prorated
for partial periods) on a daily basis of the sum of (x) the original aggregate
principal amount of the term note plus (y) the original principal amount of each
applicable minimum borrowing note. While such event continues, such liquidated
damages shall be paid not less often than each thirty days. Any unpaid
liquidated damages as of the date when an event has been cured by the Company
shall be paid within three days following the date on which such event has been
cured by the Company. As a result, the Company has recorded a charge in December
2004 for approximately $44,000.
As of May 12, 2005, $1,003,666 is owed to Laurus under the $2,000,000
minimum borrowing note, $2,741,705 is owed to Laurus under the $4,000,000
revolving note and $750,591 is owed to Laurus under the $5,000,000 secured
convertible term note, equaling 32,114,014 shares of common stock underlying
those three notes. Therefore, the 7,142,857 shares of common stock owned by
Laurus, pursuant to a conversion in May 2005 by Laurus, the 32,114,014 shares
underlying the notes and the 12,000,000 shares of common stock underlying the
warrant of presently outstanding debt are being registered in this registration
statement of which this prospectus forms a part.
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 $1.0 million (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005, in exchange for $1,000,000, minus fees. 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 $5.0 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 than 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 6.0 million 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. The shares of common stock underlying the notes and the warrants of
presently outstanding debt are being registered in this registration statement
of which this prospectus forms a part.Finally, we engaged Sands Brothers
International Limited as our non-exclusive financial advisor at $6,000 per month
for a period of one year.
27
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 12.5 million shares of common
stock for a purchase price of $1.75 million. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for $0.5
million, and it was required to purchase the remaining 8,928,572 shares of
Common Stock for $1.25 million by December 31, 2004. As of March 17, 2005,
CMKX-treme, Inc. remitted final payment for the remaining 8,928,572 shares.These
shares of common stock are being registered in this registration statement of
which this prospectus forms a part.
CLIENTS
For 15 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 year ended December 31, 2004, two of our
clients, Leading Edge Communications Corporation, a related party, (15.2%) and
Bank of America (15.9%), accounted collectively for approximately 31% 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. As we continue to pursue and consummate
acquisitions, our dependence on these customers should be less significant. We
do not have long-term contracts with any of these customers. The loss of any of
our largest customers could have a material adverse effect on our business. We
have not had any collections problems with any of these customers to date.
MARKETING
We currently market our services through our director of marketing and
corporate communications, public relations firm, and our sales force comprised
of 10 employees, and we also receive new business through client referrals. We
are using 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
participated as Gold Level Sponsor for DCI's Business Intelligence
and Data Warehouse Conference in Boston in September 2004.
28
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 experts in
individual product areas.
o Vendor Relations: We are continually identifying key vendor
relationships. With the ability to leverage our 15 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.
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.
29
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.
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 continually updating our
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, of which every employee receives and
acknowledges, mandates that it is strictly prohibited for employees to disclose
client information to third parties. Our handbook further mandates that
disciplinary action be taken against those who violate such policy, including
possible termination. Our outside consultants sign non-disclosure agreements
prohibiting disclosure of client information to third parties, among other
things, and we perform background checks on employees and outside consultants.
INTELLECTUAL PROPERTY
Our trademark registration applications for the marks "TECH SMART BUSINESS
WISE", "QUALITY MANAGEMENT OFFICE", "QMO", DQXPRESS AND DQROI 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.
30
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 our 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
o Answerthink
EMPLOYEES
As of December 31, 2004, we had 39 outside consultants, 105 consultants on
the payroll and 66 non-consultant employees. Outside consultants are not our
employees, and as such, do not receive benefits or have taxes withheld. These
consultants are members or employees of separate corporations, they are
responsible for providing us with a current certificate of insurance and they
are responsible for filing and payment of their own taxes. We maintain
relationships with these consultants and their status is updated in a
proprietary data base application that we have built. Consultants on the payroll
are our 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.
31
PROPERTY
The Company's corporate headquarters are located at 100 Eagle Rock Avenue,
East Hanover, New Jersey 07936, where it operates under an amended lease
agreement expiring December 31, 2010. In addition to minimum rentals, the
Company is liable for its proportionate share of real estate taxes and operating
expenses, as defined. DeLeeuw Associates, 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.
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,
respectively.
Rent expense totaled approximately $0.6 million and $0.3 million in 2004
and 2003, respectively. The Company is committed under several operating leases
for automobiles that expire during 2007.
See Note 18 to the Notes to Consolidated Financial Statements.
LEGAL PROCEEDINGS
As of the date of this Prospectus, we are not involved in any legal
proceedings.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OVERVIEW OF OUR BUSINESS
Management's Discussion and Analysis contains statements that are
forward-looking. These statements are based on current expectations and
assumptions that are subject to risks and uncertainties. Actual results could
differ materially because of factors discussed in "Risk Factors" and elsewhere
in this report. The Company undertakes no duty to update any forward-looking
statement to conform the statement to actual results or changes in the Company's
expectations.
Conversion Services International, Inc. provides professional services to
the Global 2000 as well as mid-market clientele relating to strategic
consulting, data warehousing, business intelligence and data management and, 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 services based clients are
primarily in the financial services, pharmaceutical, healthcare and
telecommunications industries, although it has clients in other industries as
well. The Company's clients are primarily located in the northeastern United
States. The Company delivers value to its clients, utilizing a combination of
business acumen, technical proficiency, experience and a proven set of "best
practices" methodologies to deliver cost effective services. The Company is
committed to being a leader in data warehousing and business intelligence
consulting, enabling it to be a valuable asset and trusted advisor to its
customers. See Item 1 - Business for a full description of our services and
offerings.
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.
Revenues for the Company are categorized by strategic consulting, business
intelligence, data warehousing, data management and software. They are reflected
in the chart below as a percentage of overall revenues:
Category of Services Percentage of Revenues for the year ended
December 31,
2004 2003
---- ----
Strategic Consulting 34.1% 17.3%
Business Intelligence 21.6% 22.2%
Data Warehousing 15.9% 14.8%
Data Management 22.7% 45.7%
Software 5.4% 0.0%
Other 0.3% 0.0%
33
Strategic consulting revenues increased from 17.3% to 34.1% of total
revenues for the years ended December 31, 2003 and 2004, respectively. This is
primarily attributable to the $5.4 million, or 62.8% of strategic consulting
revenues, derived from DeLeeuw Associates which was acquired by the Company in
March 2004. Excluding DeLeeuw Associates, strategic consulting revenues as a
percent of total revenue for the year ended December 31, 2004 were 16.1%, a
decrease of 1.2% from the 17.3% in the comparable prior year period. During
2004, the Company obtained new business and increased existing client business
in this segment by 4.1% of total 2004 revenues, however, due to the acquisition
of a new software business segment in 2004 which resulted in a larger revenue
base attributable to a new business segment, the overall percentage of
comparable year-to-year revenues (excluding the 2004 impact of the DeLeeuw
Associates acquisition) declined.
Business intelligence services revenues were 21.6% of total revenues for
the year ended December 31, 2004, declining by 0.6% of revenues as compared to
22.2% for the comparable prior year period. While the percentage of total
revenues attributable to this category declined in 2004 as compared to the prior
year, the decline is primarily due to the acquisition of DeLeeuw Associates
which substantially increased revenues in the strategic consulting line of
business and the acquisition of Evoke which increased the Company's revenues in
the software line of business. On an absolute dollar basis, revenues in this
category of $5.4 million for the year ended December 31, 2004 increased by $2.2
million, or 68.8%, from $3.2 million for the year ended December 31, 2003.
Data warehousing revenues represented 15.9% of total revenues for the year
ended December 31, 2004, increasing by 1.1% of total revenues from 14.8% for the
year ended December 31, 2003. While the percentage of total revenues
attributable to this category remained constant in 2004 as compared to the prior
year, this is primarily due to the acquisition of DeLeeuw Associates which
substantially increased revenues in the strategic consulting line of business
and the acquisition of Evoke which increased the Company's revenues in the
software line of business. On an absolute dollar basis, however, revenues in
this category of $4.0 million for the year ended December 31, 2004 increased by
$1.8 million, or 81.8%, from $2.2 million for the year ended December 31, 2003.
Data management revenues decreased as a percentage of total revenues by
23.0% of revenues, from 45.7% for the year ended December 31, 2003 to 22.7% for
the year ended December 31, 2004. While the percentage of total revenues
attributable to this category declined in 2004 as compared to the prior year,
15.4% of the decline is due to the acquisition of DeLeeuw Associates which
substantially increased revenues in the strategic consulting line of business
and the acquisition of Evoke which increased the Company's revenues in the
software line of business and 5.4% of the decline is due to a shift in the mix
of the Company's business from the data management line of business to the
strategic consulting, business intelligence and data warehousing lines of
business in 2004. In absolute dollars, 2004 revenues in the data management line
of business of $5.7 million, decreased by $0.9 million, or 13.6%, from $6.6
million for the year ended December 31, 2003.
Software revenues increased from zero for the year ended December 31, 2003
to 5.4% of revenues for the year ended December 31, 2004. This is attributable
to revenues from Evoke Software which was acquired by the Company in June 2004.
The Company derives a majority of its revenue from professional services
engagements. Its revenue depends on the Company's ability to generate new
business, in addition to preserving present client engagements. The general
domestic economic conditions in the industries the Company serves, the pace of
technological change, and the business requirements and practices of its clients
and potential clients directly affect 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 rate per hour it is able
to charge 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 vertical markets, particularly in financial services.
34
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.
As the Company continues to see increases in client spending and
improvements in economic conditions, it 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, 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 offering services
complementary to the Company's lines of business 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 service industry is very fragmented, with a handful of
large international firms having data warehousing and/or business intelligence
divisions, and hundreds of regional boutiques throughout the United States.
These smaller firms do not have the financial wherewithal to scale their
businesses or compete with the larger players, and the Company believes that the
service 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 $4.3 million to fund acquisitions via its financing transaction
with Laurus Master Fund, Ltd., some of these acquisitions may hinge upon future
financings.
During the fiscal year ended December 31, 2004, two of the Company's
clients, Leading Edge Communications Corporation, a related party, (15.2%) and
Bank of America (15.9%), accounted for approximately 31% 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.
The Company's most significant costs are personnel expenses, which consist
of consultant fees, benefits and payroll-related expenses.
35
RESULTS OF OPERATIONS
The following table sets forth selected financial data for the periods
indicated:
Selected Statement of Operations Data for the Years
Ended December 31,
----------------------------------------------------
2004 2003
----------------------------------------------------
Net sales $ 25,166,517 $14,366,456
Gross profit 6,152,992 4,100,648
Net loss (32,861,194) (306,763)
Net loss per share:
Basic $ (0.05) $ (0.00)
Diluted $ (0.05) $ (0.00)
Selected Statement of Financial Position Data for
the Years Ended December 31,
----------------------------------------------------
2004
---------------------------
Working capital $ (2,996,682)
Total assets 27,305,321
Long-term debt 5,181,369
Total stockholders' equity 12,444,374
YEARS ENDED DECEMBER 31, 2004 AND 2003
REVENUE
The Company's revenues are primarily comprised of billings to clients for
consulting hours worked on client projects. Revenues for the year ended December
31, 2004 were $25.2 million, an increase of $10.8 million, or 75.2%, over
revenues of $14.4 million for the year ended December 31, 2003.
SERVICES
Revenues from services for the year ended December 31, 2004 were $19.9
million, an increase of $5.9 million, or 42.0%, over revenues of $14.0 million
for the year ended December 31, 2003. $5.4 million, or 27.1% of 2004 services
revenues relates to revenues derived from DeLeeuw Associates which was acquired
by the Company in March 2004. The remaining $0.5 million of increased 2004
revenue as compared to the prior year relates to an increase in the average
billing rates coupled with a reduction in hours billed. The Company experienced
a 15.9% increase in the average billing rate in 2004 as compared to the prior
year, exclusive of the impact of the DeLeeuw Associates acquisition. This is a
direct result of the increased revenues in the strategic consulting and business
intelligence segments, both of which command higher billing rates than the other
segments. Hours billed for time and material based work in 2004 were
approximately 16.2% less than hours billed in 2003. This decline is partially
due to resources that were utilized on a substantial fixed-price project that
was undertaken by the Company during 2004. Additionally, the Company experienced
some attrition in the consulting workforce coupled with increased nonbillable
time due to gaps in the completion of ongoing assignments versus the start dates
of new assignments.
RELATED PARTY SERVICES
Revenues from related parties for the year ended December 31, 2004 were
$3.8 million, an increase of $3.4 million over revenues of $0.4 million for the
year ended December 31, 2003. The increase in 2004 results from a full year of
invoicing to LEC during 2004, versus six weeks in the prior year, under the
independent contractor agreement executed by the Company and LEC in November
2003. Additionally, the average billing rate increased by 7.6% in 2004 as
compared to 2003 which is primarily due to the hiring of six higher level
consultants for a project obtained by this related party.
36
SOFTWARE
Software revenues are derived from the sale of software licenses
pertaining to the licensing of our Evoke Axio data profiling software. Evoke was
acquired by the Company in June 2004 and, as a result, the Company has only
included revenues for the second half of 2004. Revenues from software for the
year ended December 31, 2004 were $0.3 million as compared to zero in the prior
year. During 2004, the Company deferred approximately $0.3 million of license
revenue that is being recognized over the life of the support and maintenance
agreements.
SUPPORT AND MAINTENANCE
Revenues from support and maintenance for the year ended December 31, 2004
were $1.1 million as compared to zero in the prior year. This increase in
revenues is attributable to revenues derived from Evoke Software which was
acquired by the Company in June 2004.
COST OF REVENUE
Cost of revenue primarily includes payroll and benefits costs for the
Company's consultants as well as the cost of software that is sold or licensed
by the company. Cost of revenue was $19.0 million, or 75.6% of revenue for the
year ended December 31, 2004, compared to $10.3 million, or 71.5% of revenue for
the year ended December 31, 2003.
SERVICES
Cost of revenue for services was $15.5 million, or 77.7% of services
revenue for the year ended December 31, 2004, compared to $10.0 million, or
71.2% of services revenue for the year ended December 31, 2003. Cost of revenue
for DeLeeuw Associates, which was acquired by the Company on March 4, 2004, for
the period March 4, 2004 through December 31, 2004 were $3.7 million, or 18.6%
of services revenues. Additionally, during 2004, the Company recorded a
stock-based compensation charge of $1.4 million, or 7.0% of services revenues,
to cost of services revenues. Cost of services revenue for the Company
(excluding DeLeeuw Associates and the stock-based compensation charge) for the
year ended December 31, 2004 were $10.4 million, an increase of $0.4 million, or
4.0%, as compared to $10.0 million for the year ended December 31, 2003. This
increase is attributed to a 15.7% average increase in compensation cost, in
2004, for the Company's consulting force as compared to the prior year. This
increase is primarily attributable to hiring highly skilled consultants in the
strategic consulting, data warehousing and business intelligence lines of
business.
RELATED PARTY SERVICES
Cost of revenue for related party services was $3.3 million, or 87.2% of
related party services revenue for the year ended December 31, 2004, compared to
$0.3 million, or 82.5% of related party services revenue for the year ended
December 31, 2003. The increase in 2004 results from a full year of costs
related to the consultants which are providing services for this related party
in 2004, versus six weeks of cost incurred in the prior year. Further, the
increase in 2004 reflects the cost of six higher level consultants hired for
specialized work during the year and annual increases for the consulting force.
SOFTWARE
Cost of revenue for software was $0.2 million, or 63.3% of software
revenue for the year ended December 31, 2004, compared to zero for the year
ended December 31, 2003. In 2004, cost of software revenue related to both the
cost of the Evoke Software revenues.
SUPPORT AND MAINTENANCE
Cost of revenue for support and maintenance includes costs associated with
resolving customer inquiries. Cost of revenue for support and maintenance was
$31,000, or 2.9% of support and maintenance revenue for the year ended December
31, 2004, as compared to zero for the prior year. The increase in cost of
support and maintenance is entirely attributable to Evoke Software which was
acquired by the Company in June 2004.
37
GROSS PROFIT
Gross profit was $6.2 million, or 24.4% of revenue for the year ended
December 31, 2004, compared to $4.1 million, or 28.5% of revenue for the year
ended December 31, 2003.
As a percentage of total gross profit for the years ended December 31,
2004 and 2003, services contributed 72.1% and 98.4%, respectively, related party
services contributed 8.0% and 1.6%, respectively, software contributed 1.8% and
zero, respectively, and support and maintenance the remaining 17.0% and zero,
respectively.
The gross profit percentage for the year ended December 31, 2004, was
33.2%, 86.9% and 17.5% for DeLeeuw Associates, Evoke, and ongoing operations of
the Company, respectively. The Company's gross profit percentage for the year
ended December 31, 2003 was 28.5%. There is no comparable prior year amount for
DeLeeuw Associates or Evoke as they were both acquired by the Company in 2004.
SERVICES
Gross profit from services was $4.4 million, for the year ended December
31, 2004, an increase of $0.4 million, or 10.0%, as compared to $4.0 million for
the year ended December 31, 2003. As a percent of services revenues, gross
profit of 22.3% for the year ended December 31, 2004 represented a decrease of
6.5% points as compared to 28.8% of services revenues for the year ended
December 31, 2003. The Company recorded a $1.4 million stock-based compensation
charge during 2004 which reduced gross profit by 7.0% of services revenues.
Excluding this charge, the 2004 gross profit percentage would have been 29.3%,
an increase of 0.5% as compared to the prior year. This increase is the result
of the gross profit attributable to DeLeeuw Associates, which had a gross profit
percentage of 33.2% for the ten months ended December 31, 2004.
RELATED PARTY SERVICES
Gross profit for related party services was $0.5 million, or 12.8% of
related party services revenue for the year ended December 31, 2004, compared to
$64,000, or 17.5% of related party services revenue for the year ended December
31, 2003. The 4.7% point decline in the related party services gross profit
percentage relates to increased consultant costs in 2004 as compared to the
prior year without corresponding increases in the billing rates charged to the
client.
SOFTWARE
Gross profit resulting from software was $0.1 million, or 36.7% of
software revenue for the year ended December 31, 2004, compared to zero for the
year ended December 31, 2003. During 2004, the Company deferred approximately
$0.3 million of license revenue that is being recognized over the life of the
support and maintenance agreements.
SUPPORT AND MAINTENANCE
Gross profit for support and maintenance was $1.0 million, or 97.1% of
support and maintenance revenue for the year ended December 31, 2004, as
compared to zero in the prior year. The increased gross profit for support and
maintenance is attributable to the Company's acquisition of Evoke Software in
June 2004.
SELLING AND MARKETING
Selling and marketing expenses include payroll, employee benefits and
other headcount-related costs associated with sales and marketing personnel and
advertising, promotions, tradeshows, seminars and other programs. Selling and
marketing expenses were $4.1 million, or 16.2% of revenue for the year ended
December 31, 2004, compared to $1.6 million, or 10.8% of revenue for the year
ended December 31, 2003. $0.9 million and $0.4 million of the increase in
selling and marketing expenses during the year ended December 31, 2004 is
attributed to the costs related to operating Evoke and DeLeeuw Associates,
respectively, which were both acquired during 2004. $0.7 million of the increase
resulted from increased payroll and related costs associated with the increased
headcount in the Company's existing sales force. The remaining $0.5 million is
reflected in the addition of six additional employees and a Director of
Marketing and Corporate Communications both through new hires and retaining
existing employees of the acquired companies as part of our strategy to gain new
clients and increase revenue.
38
GENERAL AND ADMINISTRATIVE
General and administrative costs include payroll, employee benefits and
other headcount-related costs associated with the finance, legal, facilities,
certain human resources and other administrative headcount, and legal and other
professional and administrative fees. General and administrative costs were $6.8
million, or 27.1% of revenue for the year ended December 31, 2004 compared to
$2.7 million, or 18.8% of revenue for the year ended December 31, 2003. $0.6
million and $1.2 million of the increase in general and administrative expenses
during the year ended December 31, 2004 is attributed to the costs of operating
Evoke and DeLeeuw Associates subsequent to the acquisitions during 2004,
respectively. Additionally, $1.4 million is attributed to an increase in general
and administrative payroll costs 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. $0.5 million represents an increase in development
headcount by twelve employees during 2004, as compared to 2003, to support the
increased size of the business and the increased compliance requirements
inherent in becoming a public company. Professional fees related to legal and
accounting increased by $0.4 million primarily due to work related to the
Company's public filing requirements.
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 the Evoke Axio software
product.
Research and development costs were $0.5 million, or 2.1% of revenue compared to
zero for the comparative periods in the prior year. The research and development
department was obtained in association with the Evoke acquisition which was
completed during 2004.
GOODWILL AND INTANGIBLES IMPAIRMENT
Impairment of goodwill of $23.3 million for the year ended December 31,
2004 resulted from the Company's annual impairment review for the DeLeeuw
Associates and Evoke acquisitions which occurred in 2004. Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets", instructs the Company to test intangible assets for impairment
annually, or more frequently if events or changes in circumstances indicate that
the asset might be impaired. There were no specific events or changes in
circumstances in either of the two acquired companies that would have required
an interim impairment charge. The Company performed its annual impairment review
as of December 31, 2004 and determined that an impairment charge of $23.3
million was required consisting of $11.1 million related to the goodwill and
intangibles previously recorded for Evoke Software, an impairment of $11.5
million related to the goodwill and intangibles previously recorded for DeLeeuw
Associates, and $0.7 million related to goodwill recorded for other assets.
There were no goodwill impairment charges recorded during the year ended
December 31, 2003.
DEPRECIATION AND AMORTIZATION
Depreciation expense is recorded on the Company's property and equipment
which is generally depreciated over a period between three to seven years.
Amortization of leasehold improvements is taken over the shorter of the
estimated useful life of the asset or the remaining term of the lease. The
Company amortizes deferred financing costs utilizing the effective interest
method over the term of the related debt instrument. Acquired software is
amortized on a straight-line basis over an estimated useful life of three years.
Acquired contracts are amortized over a period of time that approximates the
estimated life of the contracts, based upon the estimated annual cash flows
obtained from those contracts, generally five to six years. Depreciation and
amortization expenses were $1.1 million for the year ended December 31, 2004
compared to $0.2 million for the year ended December 31, 2003. $0.6 million and
$0.1 million of the increase in depreciation and amortization during the year
ended December 31, 2004 is attributed to amortization of the acquired Evoke and
DeLeeuw Associates intangible assets, respectively.
39
INTEREST EXPENSE
The Company incurs interest expense on loans from financial institutions,
from capital lease obligations related to the acquisition of equipment used in
its business, and on the outstanding convertible line of credit notes.
Amortization of the discount on debt issued of $0.9 million is also recorded as
interest expense. Interest expense recorded was $3.1 million for the year ended
December 31, 2004 compared to $0.1 million for the year ended December 31, 2003.
This increase is primarily related to the Laurus and Sands financing
transactions described below in the liquidity and capital resources section.
OTHER INCOME (EXPENSE)
The Company recorded interest income of $22,000 and other income of
approximately $14,000 for the year ended December 31, 2004, compared to interest
income of $5,000 for the year ended December 31, 2003. The Company recorded
equity income in its investment in DeLeeuw International (Turkey) of
approximately $5,000 for the year ended December 31, 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 $11.5 million during the year ended December 31, 2004. This
allowance was recorded because, based on the weight of available evidence, it is
more likely than not that some, or all, of the deferred tax asset may not be
realized.
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 prior year would have been an income tax benefit of $0.2 million
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 $1.8 million
from $16.2 million for the year ended December 31, 2002 to $14.4 million for the
year ended December 31, 2003. Our revenues decreased by $4.4 million with an
offsetting increase of $2.6 million 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.
COST OF REVENUES
For the year ended December 31, 2003, revenues decreased by $0.4 million
from $10.7 million for the year ended December 31, 2002 to $10.3 million for the
year ended December 31, 2003. This is directly related to the decrease in
revenues.
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.
40
SELLING AND MARKETING EXPENSES
Selling and marketing expenses increased $0.5 million or 42% to $1.6
million 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
$0.3 million 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 $0.1 million.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased by 23.9% or $0.8 million, to
$2.7 million for the year ended December 31, 2003, from $3.5 million 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
$1.0 million. 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 $0.2 million in additional salaries to support the
acquisition. The reduction of rent expense by $0.1 million 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.
RESEARCH AND DEVELOPMENT
The Company had no research and development expense for the years ended
December 31, 2003 or 2002.
GOODWILL IMPAIRMENT
The Company had no goodwill impairment for the years ended December 31,
2003 or 2002.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses increased by $0.1 million 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 $0.1 million in interest expense during each of the fiscal
years ended December 31, 2003 and 2002, 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.
OTHER INCOME (EXPENSE)
We had no other income (expense) for the years ended December 31, 2003 or
2002.
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 deferred
tax benefit of $0.2 million during the year ended December 31, 2004.
No income tax expense or benefit was recorded in the prior year as the
Company was an "S" Corporation.
41
LIQUIDITY AND CAPITAL RESOURCES
Cash totaled $1.0 million as of December 31, 2004 compared to $0.4 million
as of December 31, 2003. The Company's cash balance is primarily derived from
customer remittances, bank borrowings and acquired cash and is used for general
working capital needs. The Company had $0.1 million on deposit with a financial
institution as collateral for a letter of credit and has classified this as
restricted cash on the accompanying consolidated balance sheet.
Working capital deficit is ($3.0 million) as of December 31, 2004 compared
to ($0.7 million) as of December 31, 2003. The Company's working capital
position has deteriorated during the current year 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 $1.9 million of additional
borrowings against the Company's line of credit, a $1.0 million loan on a short
term note payable, $0.5 million raised through the sale of Company common stock,
and $0.3 million of loans to the Company by the Chief Executive Officer and the
Chief Operating Officer of the Company.
Cash used by operations during the year ended December 31, 2004 was $4.4
million, an increase in cash used by operations of $3.9 million from the year
ended December 31, 2003. This increase in cash used by operations is primarily
due to a $4.0 million "cash-based" loss from operations, as determined by adding
the non-cash charges incurred of $28.9 million to the reported loss of $32.9
million for the year ended December 31, 2004, a $1.3 million increase in
accounts receivable, a $0.4 million increase in the related party receivables,
and a $0.1 million increase in prepaid expenses during the year, which was
partially offset by an increase in accounts payable and accrued expenses of $1.2
million, and an increase in deferred revenue of $0.1 million. Trade accounts
receivable increased primarily due to $0.9 million of receivables attributable
to DeLeeuw Associates which was acquired in March 2004 and $0.8 million for
Evoke, both of which were acquired during 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. Accounts payable and accrued expenses increased primarily due to
$0.4 million related to DeLeeuw Associates and $0.8 million related to Evoke.
Cash used by investing activities was $1.9 million during the year ended
December 31, 2004. This was due to payments of $2.1 million made primarily as
acquisition payments for DeLeeuw Associates and for the purchases of equipment
for the Company, partially offset by $0.3 million of cash received as part of
the Evoke acquisition.
Cash provided by financing activities was $6.9 million during the year
ended December 31, 2004. During 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, additional line of credit borrowings of $1.9 million
and $0.5 million was raised from the sale of Company common stock and $0.2
million was obtained from other sources. $0.9 million of principal payments on
long-term debt and on capital lease obligations were made by the Company during
this time period.
There are currently no material commitments for capital expenditures.
In order to expand its brand awareness and increase revenues, during 2005,
the Company expects to engage in new or expanded marketing and direct sales
initiatives. These initiatives, as discussed in Marketing on page 15, are
estimated to cost the Company an incremental $0.4 million in 2005 as compared to
the promotional expenditures incurred by the Company in 2004.
The Company also expects to incur costs, in 2005, of approximately
$125,000 in order to improve its internal controls surrounding financial
reporting and disclosure.
As of December 31, 2004 and 2003, the Company had accounts receivable due
from LEC of approximately $0.8 million and $0.4 million, respectively. There are
no known collections problems with respect to LEC.
For the years ended December 31, 2004 and 2003, we invoiced LEC $3.8
million and $0.4 million, respectively, for the services of consultants
subcontracted to LEC by us. The majority of its billing is derived from Fortune
100 clients. The collection process is slow as these clients require separate
approval on their own internal systems, which extends the payment cycle. We feel
confident in the collectibility of these accounts receivable as the majority of
the revenues from LEC derive from Fortune 100 clients.
42
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. Due to an adjustment in the conversion price in September 2004,
participating investors received an additional 2,380,953 shares of common stock.
As a result of the initial conversion and the adjustment, we recorded a
beneficial conversion charge of $1.2 million. 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. This note also contains beneficial conversion
features, and as a result, we recorded a beneficial conversion charge of $1.5
million which is being amortized into income over the life of the debt
instrument. Additionally, using the Black-Scholes option pricing model, we
determined the fair value of the warrant to be $0.5 million.
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. We have no obligation to
meet financial covenants under the $2.0 million convertible minimum borrowing
note or the $4.0 million revolving note. 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 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 $5.0 million to be used for
acquisitions. We have no obligation to meet financial covenants under the $5.0
million secured convertible term note. 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 December 31, 2004, $3.7 million
was outstanding under the revolving line of credit. The interest rate on the
revolving line and the acquisition note was 6.25% during December 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. 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. An
early termination fee is due to Laurus in an amount equal to five percent (5%)
of the total investment amount if such termination occurs prior to the first
anniversary of the closing, four percent (4%) if such termination occurs after
the first anniversary but prior to the second anniversary, and three percent
(3%) if after the second anniversary.
43
The fair value of the 12.0 million warrants was determined to be $2.0
million using the Black-Scholes option pricing model. The assumptions used in
the fair value calculation were as follows: stock prices of $0.21, exercise
prices of $0.29, $0.31 and $0.35 (as applicable), term of seven years,
volatility (annual) of 150.65%, annual rate of quarterly dividends of 0%, a risk
free rate of 1.33%, and the fair value per share of the warrants was accordingly
calculated to be $0.20. The Company will amortize this relative fair value of
the warrants to interest expense over the seven-year life of the debt agreement.
The note also includes a beneficial conversion feature and a discount on debt of
$5.6 million was recorded in September 2004 and will also be amortized over the
three-year life of the debt agreement.
Under the Laurus agreement, the Company was obligated to ensure that the
shares provided for issuance under the agreement were properly registered by
December 19, 2004. As a result of the Company's Registration statement not being
declared effective prior to this date, the Company is incurring liquidated
damages to Laurus an amount equal to 1% for each thirty day period (prorated for
partial periods) on a daily basis of the sum of (x) the original aggregate
principal amount of the Note plus (y) the original principal amount of each
applicable Minimum Borrowing Note. While such event continues, such liquidated
damages shall be paid not less often than each thirty days. Any unpaid
liquidated damages as of the date when an event has been cured by the Company
shall be paid within three days following the date on which such event has been
cured by the Company. As a result, the Company has recorded a charge in December
2004 for approximately $44,000.
As of May 12, 2005, $1,003,666 is owed to Laurus under the $2,000,000
minimum borrowing note, $2,741,705 is owed to Laurus under the $4,000,000
revolving note and $750,591 is owed to Laurus under the $5,000,000 secured
convertible term note, equaling 32,114,014 shares of common stock underlying
those three notes. Therefore, the 7,142,857 shares of common stock owned by
Laurus pursuant to a conversion in May 2005 by Laurus, the 32,114,014 shares
underlying the notes and the 12,000,000 shares of common stock underlying the
warrant of presently outstanding debt are being registered in this registration
statement of which this prospectus forms a part.
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 $1.0 million (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005 , in exchange for $1,000,000, minus fees. 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 6.0 million 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.
The shares of common stock underlying the notes and the warrants of presently
outstanding debt are being registered in this registration statement of which
this prospectus forms a part. Using the Black-Scholes option pricing model, we
determined the fair value of the warrant to be $0.5 million. 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. Finally, we engaged Sands Brothers
International Limited as our non-exclusive financial advisor at $6,000 per month
for a period of one year.
44
The following is a summary of the debt instruments outstanding as of May
12, 2005:
---------------------------------- ---------------------------- ---------------------------- -------------------------
Lender Type of facility Outstanding as of May 12, Remaining Availability
2005 (not including (if applicable)
interest) (all numbers
approximate)
---------------------------------- ---------------------------- ---------------------------- -------------------------
Laurus Master Fund, Ltd. Convertible Line of Credit $3,700,000 $0
---------------------------------- ---------------------------- ---------------------------- -------------------------
Laurus Master Fund, Ltd. Convertible Term note $4,251,000 $0
---------------------------------- ---------------------------- ---------------------------- -------------------------
Sands Brothers Venture Capital Convertible Promissory Note $50,000 $0
LLC
---------------------------------- ---------------------------- ---------------------------- -------------------------
Sands Brothers Venture Capital Convertible Promissory Note $850,000 $0
III LLC
---------------------------------- ---------------------------- ---------------------------- -------------------------
Sands Brothers Venture Capital Convertible Promissory Note $100,000 $0
IV LLC
---------------------------------- ---------------------------- ---------------------------- -------------------------
Taurus Advisory Group, LLC Convertible Promissory Note $2,000,000 $0
investors
---------------------------------- ---------------------------- ---------------------------- -------------------------
Scott Newman Promissory Note $177,000 $0
---------------------------------- ---------------------------- ---------------------------- -------------------------
Glenn Peipert Promissory Note $374,000 $0
---------------------------------- ---------------------------- ---------------------------- -------------------------
TOTAL $11,502,000 $0
---------------------------------- ---------------------------- ---------------------------- -------------------------
The Company has generated losses that have exceeded expectations during
2004. 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 12.5 million shares of common
stock for a purchase price of $1.75 million. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for $0.5
million, and it was required to purchase the remaining 8,928,572 shares of
common stock for $1.25 million by December 31, 2004. As of March 17, 2005,
CMKX-treme, Inc. remitted final payment for the remaining 8,928,572 shares.
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 $0.5
million. 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. As of December
14, 2004, Mr. Newman had loaned the Company $0.2 million, and Mr. Peipert had
loaned the Company $0.125 million. The unsecured loans by Mr. Newman and Mr.
Peipert each accrue interest at a simple rate of 3% per annum, and each has a
term expiring on January 1, 2006. As of May 12, 2005, approximately $0.177
million and $0.374 million remained outstanding to Messrs. Newman and Peipert,
respectively.
As of March 30, 2005, Messrs. Newman, Peipert and Robert C. DeLeeuw have
agreed to personally support our cash requirements to enable us to fulfill our
obligations through May 1, 2006, to the extent necessary, up to a maximum amount
of $2.5 million. Mr. Newman personally guaranties up to $1.4 million, Mr.
Peipert guaranties up to $0.7 million and Mr. DeLeeuw personally guaranties $0.4
million. We believe that our reliance on such commitment is reasonable and that
Messrs. Newman, Peipert and DeLeeuw have sufficient liquidity and net worth to
honor such commitment. We believe that this written commitment provides us with
the legal right to request and receive such advances. Any loan by Messrs.
Newman, Peipert and DeLeeuw to the Company would bear interest at 3% per annum.
45
The Company has completed various financing transactions through the
issuance of common stock, as well as the issuance of notes and warrants
convertible into our common stock, while another registration statement was on
file with the Securities and Exchange Commission but had not yet been declared
effective. Those transactions were with the following entities:
o Taurus Advisory Group, LLC $4.0 million
o Laurus Master Fund, Ltd. $11.0 million
o Sands Brothers International Ltd.
(3 affiliated entities) $1.0 million
Even though all stockholders, noteholders and warrantholders have been
advised of their rights to rescind those financing transactions and they each
have waived their rights to rescind those transactions, there is a remote
possibility that each of those transactions could be reversed. In such an event,
the Company could be adversely affected and may have an obligation to fund such
rescissions.
The Company believes existing cash, borrowing capacity under the line of
credit or alternative financing sources, the funding to be provided by the
principal stockholders', 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.
CONTRACTUAL OBLIGATIONS
At December 31, 2004, the Company had certain contractual cash obligations
and other commercial commitments, as set forth in the following table (amounts
in table are noted in millions):
-------------------------------------------------------------------------------------------------------------------
Contractual Obligations Total Less than 1 year 1-3 years 4-5 years
-------------------------------------------------------------------------------------------------------------------
Long-term debt $ 7.3 $-- $7.3 $ --
-------------------------------------------------------------------------------------------------------------------
Short-term note payable 1.0 1.0 0.0 0.0
-------------------------------------------------------------------------------------------------------------------
Capital lease obligations 0.2 0.1 0.1 --
-------------------------------------------------------------------------------------------------------------------
Operating leases 2.6 0.8 1.2 0.6
-------------------------------------------------------------------------------------------------------------------
Employment agreements 5.4 5.4 -- --
-------------------------------------------------------------------------------------------------------------------
Total $16.5 $7.3 $8.6 $0.6
-------------------------------------------------------------------------------------------------------------------
46
APPLICATION OF CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION
Our revenue recognition policy is significant because revenues are a key
component of our results from operations. In addition, revenue recognition
determines the timing of certain expenses, such as incentive compensation. We
follow very specific and detailed guidelines in measuring revenue; however,
certain judgments and estimates affect the application of the revenue policy.
Revenue results are difficult to predict and any shortfall in revenues or delay
in recognizing revenues could cause operating results to vary significantly from
quarter to quarter and could result in future operating losses or reduced net
income.
SERVICES
Revenue from consulting and professional services is recognized at the
time the services are performed on a project by project basis. For projects
charged on a time and materials basis, revenue is recognized based on the number
of hours worked by consultants at an agreed-upon rate per hour. For large
services projects where costs to complete the contract could reasonably be
estimated, the Company undertakes projects on a fixed-fee basis and recognizes
revenues on the percentage of completion method of accounting based on the
evaluation of actual costs incurred to date compared to total estimated costs.
Revenues recognized in excess of billings are recorded as costs in excess of
billings. Billings in excess of revenues recognized are recorded as deferred
revenues until revenue recognition criteria are met. Reimbursements, including
those relating to travel and other out-of-pocket expenses, are included in
revenues, and an equivalent amount of reimbursable expenses are included in cost
of services.
The percentage-of-completion method of accounting is not applicable for
the Company's software sales.
SOFTWARE
Revenue from software licensing and maintenance and support are 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 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.
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.
BUSINESS COMBINATIONS
We are required to allocate the purchase price of acquired companies to
the tangible and intangible assets acquired and liabilities assumed based on
their estimated fair values. Such a valuation requires us to make significant
estimates and assumptions, especially with respect to intangible assets.
Critical estimates in valuing certain intangible assets include, but are not
limited to, future expected cash flows from customer contracts, customer lists,
distribution agreements and acquired developed technologies, and estimating cash
flows from projects when completed and discount rates. Our estimates of fair
value are based upon assumptions believed to be reasonable, but which are
inherently uncertain and unpredictable and, as a result, actual results may
differ from estimates. These estimates may change as additional information
becomes available regarding the assets acquired and liabilities assumed.
Additionally, in accordance with EITF 99-12, the Company values an acquisition
based upon the market price of its common stock for a reasonable period before
and after the date the terms of the acquisition are agreed to and announced.
IMPAIRMENT OF GOODWILL, INTANGIBLE ASSETS AND OTHER LONG-LIVED ASSETS
We evaluate our identifiable goodwill, intangible assets, and other
long-lived assets for impairment on an annual basis and whenever events or
changes in circumstances indicate that the carrying value of an asset may not be
recoverable based on expected undiscounted cash flows attributable to that
asset. Future impairment evaluations could result in impairment charges, which
would result in an expense in the period of impairment and a reduction in the
carrying value of these assets.
47
ALLOWANCES FOR DOUBTFUL ACCOUNTS
We make judgments regarding our ability to collect outstanding receivables
and provide allowances for the portion of receivables when collection becomes
doubtful. Provisions are made based upon a specific review of all significant
outstanding invoices. For those invoices not specifically reviewed, provisions
are provided at differing rates, based upon the age of the receivable. In
determining these percentages, we analyze our historical collection experience
and current economic trends. If the historical data we use to calculate the
allowance provided for doubtful accounts does not reflect the future ability to
collect outstanding receivables, additional provisions for doubtful accounts may
be needed and our future results of operations could be materially affected.
During 2004, $114,785 of uncollectible accounts receivable were written off of
the accounts receivable against the allowance for doubtful accounts.
STOCK-BASED COMPENSATION
We issue stock options to our employees and provide our employees the
right to purchase ordinary shares under employee stock purchase plans. We
account for our stock-based compensation plans under the intrinsic value method
of accounting as defined by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations. For equity instruments under fixed plans, APB 25 does not
require that any amount of expense to be recorded in the statement of income;
however, SFAS No. 123, "Accounting for Stock-Based Compensation" does require
disclosure of these amounts in a pro forma table to the financial statements. In
determining this disclosure the value of an option is estimated using the Black
Scholes option valuation model. This model requires the input of highly
subjective assumptions and a change in our assumptions could materially affect
the fair value estimate, and thus the total calculated costs associated with the
grant of stock options or issuance of stock under employee stock purchase plans.
In addition, in disclosing the fair-value cost of stock-based compensation, we
estimate that we will be able to obtain a 40% tax benefit on these costs. There
is the potential that this tax benefit will not be obtained to this extent or at
all, which directly impacts the level of expenses associated with stock-based
compensation. We expect our accounting policies, regarding stock-based
compensation to be materially affected by our adoption of SFAS123R, which is
described under "Recent Pronouncements." We have not yet determined what the
impact of the adoption of SFAS123R will be on our compensation philosophy.
DEFERRED INCOME TAXES
Determining the consolidated provision for income tax expense, income tax
liabilities and deferred tax assets and liabilities involves judgment. We record
a valuation allowance to reduce our deferred tax assets to the amount of future
tax benefit that is more likely than not to be realized. We have considered
future taxable income and prudent and feasible tax planning strategies in
determining the need for a valuation allowance. A valuation allowance is
maintained by the Company due to the impact of the current years net operating
loss (NOL). In the event that we determine that we would not be able to realize
all or part of our net deferred tax assets, an adjustment to the deferred tax
assets would be charged to net income in the period such determination is made.
Likewise, if we later determine that it is more likely than not that the net
deferred tax assets would be realized, then the previously provided valuation
allowance would be reversed. Our current valuation allowance relates
predominately to benefits derived from the utilization of our NOL's.
RECENT PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 123R, "Share-Based
Payment, an Amendment of SFAS No. 123 and 95". This final standard replaces the
existing requirements under SFAS 123 and APB 25 and requires that all forms of
share-based payments to employees, including employee stock options and employee
stock purchase plans, be treated the same as other forms of compensation by
recognizing the related cost in the statements of income. SFAS 123R eliminates
the ability to account for stock-based compensation transactions using APB 25
and requires instead that such transactions be accounted for using a fair-value
based method. SFAS 123R is effective for interim or annual periods beginning
after June 15, 2005 and allows companies to restate the full year of 2005 to
reflect the impact of expensing under SFAS 123R as reported in the footnotes to
the financial statements for the first half of 2005. The transitional provisions
of SFAS 123R allow companies to select either a modified-prospective or
modified-retrospective transition method which effectively impacts in which
periods actual expense will be reported in the statements of income. We are in
the process of determining the transitional method we will apply. We have not
determined how SFAS123R will modify, if at all, our compensation philosophy in
general or for stock option grants in particular. We cannot currently estimate
the amount of stock-based compensation expense which will be related to stock
option grants or the issue of warrants in 2005 and thereafter.
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 our Annual Report on Form
10-KSB. Based on that evaluation, and as a result of comments received in the
first quarter of 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. and Evoke
Software Corporation, 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
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 $0.125 million,
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.
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 the
financial statements for the periods covered by our Annual Report on Form
10-KSB. 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. Based on the foregoing,
our chief executive officer and our chief financial officer concluded that our
disclosure controls and procedures were not yet effective at a reasonable
assurance level as of the date of our Annual Report on Form 10-KSB.
Management, including our chief executive officer and our chief financial
officer, does not expect that our disclosure controls and internal controls will
prevent all error or all fraud, even as the same are improved to address any
deficiencies and/or weaknesses. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control.
Changes in internal control over financial reporting.
Our company also maintains a system of internal controls. The term
"internal controls," as defined by the American Institute of Certified Public
Accountants' Codification of Statement on Auditing Standards, AU Section 319,
means controls and other procedures designed to provide reasonable assurance
regarding the achievement of objectives in the reliability of our financial
reporting, the effectiveness and efficiency of our operations and our compliance
with applicable laws and regulations. In connection with the preparation of 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;
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.
48
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. We will pay all the expenses incident to this
registration.
49
SELLING STOCKHOLDERS
This prospectus relates to the offering for resale of 164,458,327 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 May 12, 2005. 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.
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
NUMBER OF TOTAL NUMBER OF NUMBER OF SHARES
POSITION, NUMBER OF SHARES SHARES SHARES OF COMMON OF COMMON STOCK
OFFICE OR OF COMMON STOCK, REPRESENTED STOCK AND SHARES
OTHER NOT INCLUDING BY WARRANTS BENEFICIALLY REPRESENTED BY
MATERIAL WARRANTS, BENEFICIALLY OWNED (1) WARRANTS OFFERED
RELATIONSHIP BENEFICIALLY OWNED OWNED (1) BY SELLING
PRIOR TO THE STOCKHOLDER
SELLING STOCKHOLDER OFFERING (1)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
NUMBER
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Mathew and Kyle Szulik None 25,750,714 3,125,000 28,875,714 4,910,714 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Jermar Corp. None 22,986,190 206,250 23,192,440 324,440 (4)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Richard and Stacey Adelson None 2,561,904 50,000 2,611,904 278,571 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Edward and Nancy McSorley None 4,327,619 156,250 4,483,869 245,536 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Ronald Kertes None 1,666,668 0 1,666,668 1,666,668 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Andrew Holder None 1,881,429 212,500 2,093,929 1,183,929 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Steven and Wendi Levitt None 927,286 156,250 1,083,536 714,286 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Ardmore Blouses, Inc. Retirement None 485,714 106,250 591,964 591,964 (5)
Plan
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Patricia A. DeSalvo-Cavelius None 1,100,714 106,250 1,206,964 591,964 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
David Horowitz None 244,048 47,916 291,964 266,964 (3)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
WHRT I Corp. None 72,543,956 0 72,543,956 72,543,956 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
John Giglio None 659,341 0 659,341 659,341 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Donald Townsend None 961,538 0 961,538 961,538 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Lacy Edwards None 1,785,714 0 1,785,714 1,785,714 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Andy Galewsky None 55,500 0 55,500 55,500 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Lee Pointer None 55,500 0 55,500 55,500 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Jeff Millman None 55,500 0 55,500 55,500 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Steve McWhirter None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Richard Hasting None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Sterling Runion None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Terry Manning None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Tim Leslie None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Kimberly Livingston None 39,000 0 39,000 39,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Chris Buckley None 28,000 0 28,000 28,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Isabelle Knight None 28,000 0 28,000 28,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Eckhard Bogner None 28,000 0 28,000 28,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Alan Brignall None 28,000 0 28,000 28,000 (6)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Laurus Master Fund, Ltd. None 39,256,871 12,000,000 51,256,871 51,256,871 (7)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Sands Brothers Venture Capital None 357,143 300,000 657,143 657,143 (8)
LLC
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Sands Brothers Venture Capital None 6,071,429 5,100,000 11,171,429 11,171,429 (8)
III LLC
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Sands Brothers Venture Capital IV None 714,286 600,000 1,314,286 1,314,286 (8)
LLC
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Viant Capital LLC None 320,513 0 320,513 320,513 (9)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
UAJC 2005 Irrevocable Trust None 10,000,000 0 10,000,000 10,000,000 (10)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Cindy Dwyer None 1,250,000 0 1,250,000 1,250,000 (10)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
Wesley Casavant None 1,250,000 0 1,250,000 1,250,000 (10)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
TOTAL 197,615,577 22,166,666 219,782,243 164,458,327 (10)
----------------------------------- -------------- -------------------- --------------- ------------------- -------------------
----------------------------------- ------------------- ----------------
COMMON STOCK PERCENTAGE OF
BENEFICIALLY COMMON STOCK
OWNED AFTER THE BENEFICIALLY
OFFERING OWNED AFTER TO
SELLING STOCKHOLDER THE OFFERING
----------------------------------- ------------------- ----------------
NUMBER PERCENTAGE
----------------------------------- ------------------- ----------------
Mathew and Kyle Szulik 23,965,000 *
----------------------------------- ------------------- ----------------
Jermar Corp. 22,868,000 *
----------------------------------- ------------------- ----------------
Richard and Stacey Adelson 2,333,333 *
----------------------------------- ------------------- ----------------
Edward and Nancy McSorley 4,238,333 *
----------------------------------- ------------------- ----------------
Ronald Kertes 0 *
----------------------------------- ------------------- ----------------
Andrew Holder 910,000 *
----------------------------------- ------------------- ----------------
Steven and Wendi Levitt 369,250 *
----------------------------------- ------------------- ----------------
Ardmore Blouses, Inc. Retirement 0 *
Plan
----------------------------------- ------------------- ----------------
Patricia A. DeSalvo-Cavelius 615,000 *
----------------------------------- ------------------- ----------------
David Horowitz 25,000 *
----------------------------------- ------------------- ----------------
WHRT I Corp. 0 *
----------------------------------- ------------------- ----------------
John Giglio 0 *
----------------------------------- ------------------- ----------------
Donald Townsend 0 *
----------------------------------- ------------------- ----------------
Lacy Edwards 0 *
----------------------------------- ------------------- ----------------
Andy Galewsky 0 *
----------------------------------- ------------------- ----------------
Lee Pointer 0 *
----------------------------------- ------------------- ----------------
Jeff Millman 0 *
----------------------------------- ------------------- ----------------
Steve McWhirter 0 *
----------------------------------- ------------------- ----------------
Richard Hasting 0 *
----------------------------------- ------------------- ----------------
Sterling Runion 0 *
----------------------------------- ------------------- ----------------
Terry Manning 0 *
----------------------------------- ------------------- ----------------
Tim Leslie 0 *
----------------------------------- ------------------- ----------------
Kimberly Livingston 0 *
----------------------------------- ------------------- ----------------
Chris Buckley 0 *
----------------------------------- ------------------- ----------------
Isabelle Knight 0 *
----------------------------------- ------------------- ----------------
Eckhard Bogner 0 *
----------------------------------- ------------------- ----------------
Alan Brignall 0 *
----------------------------------- ------------------- ----------------
Laurus Master Fund, Ltd. 0 *
----------------------------------- ------------------- ----------------
Sands Brothers Venture Capital 0 *
LLC
----------------------------------- ------------------- ----------------
Sands Brothers Venture Capital 0 *
III LLC
----------------------------------- ------------------- ----------------
Sands Brothers Venture Capital IV 0 *
LLC
----------------------------------- ------------------- ----------------
Viant Capital LLC 0 *
----------------------------------- ------------------- ----------------
UAJC 2005 Irrevocable Trust 0 *
----------------------------------- ------------------- ----------------
Cindy Dwyer 0 *
----------------------------------- ------------------- ----------------
Wesley Casavant 0 *
----------------------------------- ------------------- ----------------
TOTAL 55,323,916
----------------------------------- ------------------- ----------------
50
* Less than 1%
(1) Consists (as applicable) of shares of outstanding common stock or common
stock to be issued upon conversion of notes.
(2) Consists (as applicable) of shares of outstanding common stock or common
stock to be issued upon conversion of notes or exercise of warrants.
(3) Consists of shares obtained via private investments in CSI in October 2003
and May 2004 via Taurus Advisory Group, LLC.
(4) Consists of shares obtained via private investments in CSI 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 CSI 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.
(6) Consists of shares issued pursuant to CSI'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.
(7) Consists of shares underlying notes and warrants issued to Laurus Master
Fund, Ltd. in August 2004. David 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.
(8) 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.
(9) Consists of shares issued pursuant to an agreement among CSI and Viant
Capital LLC. Michael O'Leary is the natural person having investment
and/or voting control over the shares.
(10) Consists of shares issued pursuant to that certain stock purchase
agreement among CMKX-treme, Inc. and CSI and later transferred. Urban
Casavant is the natural person having investment and/or voting control
over the shares held by UAJC 2005 Irrevocable Trust.
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.
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:
51
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. The maximum amount of
compensation to be received by any NASD member or independent broker-dealer for
the sale of any securities registered under this prospectus will not be greater
than 8.0% of the gross proceeds from the sale of such securities.
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.
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.
52
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 AGE POSITION(S) HELD
AN OFFICER OR DIRECTOR
------------------------ ----------------------- ------- -----------------------------------------------
Scott Newman 2004 45 President, Chief Executive Officer and
Chairman
------------------------ ----------------------- ------- -----------------------------------------------
Glenn Peipert 2004 44 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 49 Senior Vice President and President of
DeLeeuw Associates, LLC
------------------------ ----------------------- ------- -----------------------------------------------
Joseph Santiso 2005 60 Director
------------------------ ----------------------- ------- -----------------------------------------------
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.
53
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.
JOSEPH SANTISO has been a Director of our company since May 2005. Mr.
Santiso founded and is President of The BCI Group, which consists of
Breakthrough Concepts Inc., BCI Systems Inc. and BCI Knowledge Inc., since 1991.
Prior to founding BCI, Mr. Santiso was the Chief Accounting Officer for Citibank
Stock Transfer Services Division, a Financial Analyst in the Comptrollers
Department of the Operational Services Division at Irving Trust and a Professor
of Accounting at Jersey City State College. Mr. Santiso received his B.S. from
Pace University in 1973 with a major in Accounting and Finance.
54
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, 2004, 2003 and 2002: (i)
individuals who served as, or acted in the capacity of, our principal executive
officer for the fiscal year ended December 31, 2004; 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
$100,000 with respect to the fiscal year ended December 31, 2004 and who were
employed at the end of fiscal year 2004.
SUMMARY COMPENSATION TABLE*
LONG TERM COMPENSATION
----------------------
ANNUAL COMPENSATION(1) AWARDS PAYOUTS
-------------------------------- ------------------------- -------------------------
NAME AND YEAR SALARY BONUS OTHER ANNUAL RESTRICTED SECURITIES LTIP ALL OTHER
PRINCIPAL COMPENSATION STOCK UNDERLYING PAYOUTS COMPENSATION
POSITION AWARD(S) OPTIONS/SARS
------------------------------------------------------------------------------------------------------------------------------------
($) ($) ($) ($) (#) ($) ($)
------------------------------------------------------------------------------------------------------------------------------------
Scott Newman 2004 487,270 -- -- -- -- -- 14,054 (2)
President, Chief Executive 2003 244,452 -- -- -- -- -- 206,686 (3)
Officer and Chairman 2002 143,750 -- -- -- -- -- 259,418 (3)
Glenn Peipert 2004 362,180 -- -- -- -- -- 14,054 (2)
Executive Vice President, 2003 223,016 -- -- -- -- -- 171,309 (4)
Chief Operating Officer and 2002 143,750 -- -- -- -- -- 199,166 (4)
Director
Mitchell Peipert, Vice 2004 193,524 -- -- -- 4,500,000 -- 14,413 (2)
President, Chief Financial 2003 10,000 -- -- -- -- -- 1,133 (2)
Officer, Treasurer and 2002 138,750 -- -- -- -- -- 13,591 (2)
Secretary
Robert C. DeLeeuw, Senior Vice 2004 329,400 -- -- -- -- -- 592 (5)
President and President of
DeLeeuw Associates, LLC
Steven Huber, Vice President 2004 273,168 -- -- -- 4,500,000 -- 6,686 (2)
and General Manager 2003 170,042 -- -- -- -- -- 6,971 (2)
-------------------------
* 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,
unless otherwise stated above.
55
(2) Amounts shown reflect payments related to medical, dental and life
insurance.
(3) Amounts shown reflect distributions resulting from the operating entity's
past tax status as a Subchapter S corporation of $209,020 in 2002 and
$153,738 in 2003, as well as $50,398 in 2002 and $66,262 in 2003 of
expenses, which include auto, travel and equipment purchases paid for by
the Company.
(4) Amounts shown reflect distributions resulting from the operating entity's
past tax status as a Subchapter S corporation of $134,252 in 2002 and
$101,988 in 2003, as well as $64,914 in 2002 and $63,645 in 2003 of
expenses, which include auto, travel and equipment purchases paid for by
the Company.
(5) Amounts shown reflect payment related to life insurance.
OPTION/SAR GRANTS AS OF DECEMBER 31, 2004
-------------------------- ---------------------- --------------------- -------------- ----------------------
Name Number of securities Percent of total Exercise or Expiration Date
underlying options/SARs base price
options/SARs granted granted to ($/Sh)
(#) (1) employees in
fiscal year
-------------------------- ---------------------- --------------------- -------------- ----------------------
Mitchell Peipert 4,500,000 13.2% $0.165 March 28, 2014
-------------------------- ---------------------- --------------------- -------------- ----------------------
(1) All options were granted under the Company's 2003 Incentive Plan. Mr.
Peipert's options were granted on March 29, 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.
AGGREGATE OPTIONS EXERCISABLE IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at December 31, 2004 (1) at December 31, 2004 (1)
-------------------------------- ------------------------
Name and Principal Position Exercisable Unexercisable Exercisable Unexercisable
--------------------------- ----------- ------------- ----------- -------------
Mitchell Peipert 0 4,500,000 0 $990,000
Vice President, Chief Financial
Officer, Secretary and Treasurer
-----------------
(1) As of December 30, 2004 the market value of a share of common stock was
$0.22. No shares were exercised by executive officers or directors in fiscal
year ended December 31, 2004.
56
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 million
shares of common stock for issuance upon exercise of options, of which we have
reserved 75 million shares. 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.
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.
57
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 of 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 or by broker
assisted exercise.
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.
58
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.
As of December 31, 2004, options to purchase a total of 41,265,981 shares
of common stock were outstanding at an exercise prices ranging from $0.055 to
$0.23 per share. Generally, 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. However,
8,900,981 options granted during 2004 were immediately vested upon grant and had
a below fair-market value exercise price of $0.055 per share. The Company
recorded $1.4 million of compensation expense with respect to this option grant
during 2004. All 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 above.
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 lump sum payment of the longer of (1) three
year's base salary or (2) the period from the date of termination through the
expiration date.
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 lump sum payment of the longer of (1)
three year's base salary or (2) the period from the date of termination through
the expiration date.
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 lump sum payment of the longer of
(1) three year's base salary or (2) the period from the date of termination
through the expiration date.
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 lump sum payment of the longer of
(1) one year's base salary or (2) the period from the date of termination
through the expiration date.
59
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 May 12, 2005, based on 788,474,038 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) 294,195,833 37.3%
-------------------------------------------- ------------------------------- --------------------------------------------
Glenn Peipert(4) 150,000,000 19.0%
-------------------------------------------- ------------------------------- --------------------------------------------
Mitchell Peipert(5) 1,500,000 *
-------------------------------------------- ------------------------------- --------------------------------------------
Robert C. DeLeeuw(6) 80,000,000 10.1%
-------------------------------------------- ------------------------------- --------------------------------------------
Lawrence K. Reisman(7) 150,000 *
-------------------------------------------- ------------------------------- --------------------------------------------
Joseph Santiso 0 *
-------------------------------------------- ------------------------------- --------------------------------------------
WHRT I Corp. (8) 72,543,956 9.2%
-------------------------------------------- ------------------------------- --------------------------------------------
All directors and officers as a group (5
persons) 525,845,833 66.7%
-------------------------------------------- ------------------------------- --------------------------------------------
---------------------------
* 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. Consists of an option to purchase
1,500,000 shares of common stock granted on March 29, 2004 at an exercise
price of $0.165 per share. Does not include an option to purchase
3,000,000 shares of common stock granted on March 29, 2004 at an exercise
price of $0.165 per share, of which 1,500,000 shares vest on March 29,
2006 and 1,500,000 shares vest on March 29, 2007. 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. Consists of an option to purchase 150,000
shares of common stock granted on May 28, 2004 at an exercise price of
$0.20 per share. Does not include an option to purchase 300,000 shares of
common stock granted on May 28, 2004 at an exercise price of $0.20 per
share, of which 150,000 shares vest on May 28, 2006 and 150,000 shares
vest on May 28, 2007. 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.
60
EQUITY COMPENSATION PLAN DISCLOSURE
The following table sets forth certain information as of December 31, 2004
regarding securities:
Number of securities
Number of securities to Weighted-average remaining available for
be issued upon exercise exercise price of future issuance under
of outstanding options, outstanding options, equity compensation
Plan Category warrants and rights warrants and rights plans
---------------------- ------------------------ ---------------------- -------------------------
Equity Compensation
Plans Approved by
Security Holders 41,265,981 $ 0.15 8,734,019
Equity Compensation
Plans Not Approved by
Security Holders -- -- --
------------------------ ---------------------- -------------------------
Total 41,265,981 $ 0.15 8,734,019
======================== ====================== =========================
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
In November 2003, the Company executed an Independent Contractor Agreement
with LEC, whereby the Company agreed to be a subcontractor for LEC, and to
provide consultants as required to LEC. In return for these services, the
Company receives a fee from LEC based on the hourly rates established for
consultants subcontracted to LEC. In May 2004, the Company acquired 49% of all
issued and outstanding shares of common stock of LEC. The acquisition was
completed through a Stock Purchase Agreement between the Company and the sole
stockholder of LEC. In connection with the acquisition, the Company (i) repaid a
bank loan on behalf of the seller in the amount of $35,000; (ii) repaid an LEC
bank loan in the amount of $38,000; and (iii) satisfied an LEC obligation for
$10,000 of prior compensation to an employee. For the year ended December 31,
2004, the Company invoiced LEC $3.8 million for the services of consultants
subcontracted to LEC by the Company. As of December 31, 2004, the Company had
accounts receivable due from LEC of approximately $0.8 million. There are no
known collection problems with respect to LEC. The majority of their billing is
derived from Fortune 1000 clients. The collection process is slow as these
clients require separate approval on their own internal systems, which extends
the payment cycle. The Company feels confident in the collectibility of these
accounts receivable as the majority of the revenues from LEC derive from Fortune
1000 clients.
On November 8, 2004, Mr. Newman entered into a stock purchase agreement
with a private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 2,833,333 shares of common stock for a purchase price of
$250,000. As of May 12, 2005, the shares have not been issued to CMKX-treme,
Inc. because it has not yet remitted payment for the shares.
On November 8, 2004, Mr. Peipert entered into a stock purchase agreement
with a private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 5,666,667 shares of common stock for a purchase price of
$500,000. As of May 12, 2005, the shares have not been issued to CMKX-treme,
Inc. because it has not yet remitted payment for the shares.
61
On November 10, 2004, the Company and Dr. Michael Mitchell, the former
President, Chief Executive Officer and sole director of LCS, executed a one-year
consulting agreement whereby Dr. Mitchell would perform certain consulting
services on behalf of the Company. Dr. Mitchell will receive an aggregate amount
of $0.25 million as compensation for services provided to the Company. During
2004, an aggregate amount of $50,000 was paid to Mr. Mitchell for services
provided under this consulting agreement.
As of November 16, 2004, Mr. Newman and Mr. Peipert repaid in full to the
Company loans in the aggregate of approximately $0.2 million, including accrued
interest. These loans bore interest at 3% per annum and were due and payable by
December 31, 2005.
As of 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 $0.5 million. 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 December 14, 2004, Scott Newman, our President, Chief
Executive Officer and Chairman, loaned the Company $0.2 million, and Glenn
Peipert, our Executive Vice President, Chief Operating Officer and Director,
loaned the Company $0.125 million. The unsecured loans by Mr. Newman and Mr.
Peipert each accrue interest at a simple rate of 3% per annum, and each has a
term expiring on January 1, 2006. As of May 12, 2005, approximately $0.177
million and $0.374 million remained outstanding to Messrs. Newman and Peipert,
respectively.
As of March 30, 2005, Messrs. Newman, Peipert and Robert C. DeLeeuw have
agreed to personally support our cash requirements to enable us to fulfill our
obligations through May 1, 2006, to the extent necessary, up to a maximum amount
of $2.5 million. Mr. Newman personally guaranties up to $1.4 million, Mr.
Peipert guaranties up to $0.7 million and Mr. DeLeeuw personally guaranties
approximately $0.4 million. We believe that our reliance on such commitment is
reasonable and that Messrs. Newman, Peipert and DeLeeuw have sufficient
liquidity and net worth to honor such commitment. We believe that this written
commitment provides us with the legal right to request and receive such
advances. Any loan by Messrs. Newman, Peipert and DeLeeuw to the Company would
bear interest at 3% per annum.
Dr. Michael Mitchell, the former President, Chief Executive Officer and
sole director of LCS, had loaned an aggregate of $0.93 million to us. This loan
was converted into shares of our common stock at the closing of the merger of
LCS and CSI.
Other than those described above, during the last two fiscal years, we
have no material transactions which involved or are planned to involve a direct
or indirect interest of a director, executive officer, greater than 5%
stockholder or any family of such parties.
62
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) 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, 2003 through March 31, 2005. Such prices represent
quotations between dealers, without dealer markup, markdown or commissions, and
may not represent actual transactions.
HIGH LOW
---- ---
2003 BY QUARTER
January 1 - March 31 $0.031 $0.012
April 1 - June 30 $ 0.09 $0.027
July 1 - September 30 $0.185 $ 0.08
October 1 - December 31 $ 0.17 $ 0.09
2004 BY QUARTER
January 1 - March 31 $ 0.25 $ 0.12
April 1 - June 30 $0.265 $ 0.11
July 1 - September 30 $ 0.31 $ 0.18
October 1 - December 31 $ 0.25 $ 0.16
2005 BY QUARTER
January 1 - March 31 $0.255 $0.145
We are listed on the OTC Bulletin Board. On May 12, 2005, the high and low
bid prices for shares of our common stock in the over-the-counter market, as
reported by NASD OTCBB, were $0.225 and $0.21, 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. The additional registration of our common stock and the sale of
substantial amounts of our common stock in the public market could adversely
affect the prevailing market price of our common stock.
(b) RECORD HOLDERS. As of May 12, 2005, there were 487 registered holders of
our common stock, including shares held in street name. As of May 12, 2005,
there were 788,474,038 shares of common stock issued and outstanding.
(c) DIVIDENDS. We have not paid dividends on our common stock in the past and do
not anticipate doing so in the foreseeable future. We currently intend to retain
future earnings, if any, to fund the development and growth of our business. In
addition, the security agreement with Laurus Master Fund, Ltd. requires that we
obtain their consent prior to paying any dividends.
63
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 April 28, 2005, there were 781,331,181
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 April 28, 2005,
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.
64
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 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 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. As of May 12, 2005, $1,003,666 is owed to Laurus
under the $2,000,000 minimum borrowing note, $2,741,705 is owed to Laurus under
the $4,000,000 revolving note and $750,591 is owed to Laurus under the
$5,000,000 secured convertible term note, equaling 32,114,014 shares of common
stock underlying those three notes. The 32,114,014 shares of common stock
underlying the notes of presently outstanding debt are being registered in this
registration statement of which this prospectus forms a part.
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, in exchange for $1,000,000, minus fees. 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.The
shares of common stock underlying the notes of presently outstanding debt are
being registered in this registration statement of which this prospectus forms a
part.
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 and are being registered in this registration statement of which this
prospectus forms a part.
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 and are being registered in this registration
statement of which this prospectus forms a part.
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
and are being registered in this registration statement of which this prospectus
forms a part.
65
OPTIONS
The only executive officers or directors to receive options as of December
31, 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 December 31, 2004, options to purchase a total of 41,265,981 shares
of common stock were granted by our Board of Directors at an exercise prices
ranging from $0.055 to $0.23 per share. Generally, 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. However, 8,900,981 options granted during 2004 were immediately
vested upon grant and had a below fair-market value exercise price of $0.055 per
share. The Company recorded $1.4 million of compensation expense with respect to
this option grant during 2004. All options expire on the ten year anniversary of
their grant date.
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.
66
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 164,458,327
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 7,884,740
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, 2004 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.
67
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. To request such
materials, please send an email to Mitchell Peipert, our Chief Financial
Officer, at our address as set forth above or at (973) 560-9400.
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.
68
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Conversion Services International, Inc. and Subsidiaries
East Hanover, New Jersey
We have audited the accompanying consolidated balance sheet of Conversion
Services International, Inc. and Subsidiaries as of December 31, 2004, and the
related consolidated statements of operations, stockholders' deficit, and cash
flows for the years ended December 31, 2004 and 2003. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Conversion Services
International, Inc. and Subsidiaries as of December 31, 2004, and the results of
its operations and its cash flows for the years ended December 31, 2004 and
2003, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Friedman LLP
------------------------
East Hanover, New Jersey
April 8, 2005
F-1
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2004
ASSETS
CURRENT ASSETS
Cash $ 1,028,146
Restricted cash 83,375
Accounts receivable, net of allowance for
doubtful accounts of $209,582 4,349,229
Accounts receivable from related parties; (Note 19) 781,100
Prepaid expenses 309,459
------------
TOTAL CURRENT ASSETS 6,551,309
------------
PROPERTY AND EQUIPMENT, at cost, net; (Note 4) 587,575
------------
OTHER ASSETS
Restricted cash 4,269,377
Goodwill 4,690,972
Intangible assets, net of accumulated
amortization of $911,142; (Note 5) 3,627,096
Deferred financing costs, net of accumulated
amortization of $126,767; (Note 6) 766,542
Discount on debt issued, net of accumulated amortization of
$921,605; (Note 7) 6,654,570
Equity investments 144,460
Other assets 13,420
------------
20,166,437
------------
Total Assets $ 27,305,321
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit; (Note 8) $ 3,733,403
Current portion of long-term debt 120,834
Accounts payable and accrued expenses 3,777,941
Short term note payable, (Note 9) 588,591
Deferred revenue 1,327,222
------------
TOTAL CURRENT LIABILITIES 9,547,991
LONG-TERM DEBT, net of current portion, (Note 10) 5,181,369
------------
Total Liabilities 14,729,360
------------
MINORITY INTEREST 131,587
------------
COMMITMENTS AND CONTINGENCIES; (Note 18) --
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value, 1,000,000,000 shares authorized;
772,082,096 issued and outstanding 772,082
Additional paid in capital 44,756,294
Accumulated deficit (33,089,300)
Accumulated other comprehensive income 5,298
------------
Total Stockholders' Equity 12,444,374
------------
Total Liabilities and Stockholders' Equity $ 27,305,321
============
See Notes to Consolidated Financial Statements.
F-2
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
2004 2003
------------- -------------
REVENUE:
Services $ 19,888,205 $ 14,000,998
Related party services 3,837,065 365,458
Software 293,504 --
Support and maintenance 1,074,933 --
Other 72,810 --
------------- -------------
25,166,517 14,366,456
COST OF REVENUE:
Services (inclusive of stock-based compensation of $1.4
million at December 31, 2004) 15,451,392 9,964,234
Related party services 3,345,318 301,574
Software 185,688
Support and maintenance 31,127 --
Other -- --
------------- -------------
19,013,525 10,265,808
------------- -------------
GROSS PROFIT 6,152,992 4,100,648
------------- -------------
OPERATING EXPENSES
Selling and marketing 4,087,617 1,552,766
General and administrative (inclusive of stock-based
compensation of $0.1 million at December 31, 2004) 6,819,039 2,701,934
Research and development 516,425 --
Goodwill and intangibles impairment 23,298,810 --
Depreciation and amortization 1,117,209 213,158
------------- -------------
35,839,100 4,467,858
------------- -------------
LOSS FROM OPERATIONS (29,686,108) (367,210)
------------- -------------
OTHER INCOME (EXPENSE)
Equity in earnings from investments 5,684 --
Other income 8,531 --
Interest income 22,388 5,400
Interest expense (3,088,702) (135,753)
------------- -------------
(3,052,099) (130,353)
------------- -------------
LOSS BEFORE INCOME TAXES (BENEFIT) AND MINORITY INTEREST (32,738,207) (497,563)
INCOME TAXES (BENEFIT) 190,800 (190,800)
------------- -------------
LOSS BEFORE MINORITY INTEREST (32,929,007) (306,763)
MINORITY INTEREST 67,813 --
------------- -------------
NET LOSS $ (32,861,194) $ (306,763)
============= =============
UNAUDITED PRO FORMA DATA (Note 1):
Loss before income taxes (benefit) $ -- $ (497,563)
Income taxes (benefit) -- (198,727)
------------- -------------
Net loss $ (32,861,194) $ (298,836)
============= =============
Net loss per share:
Basic $ (0.05) $ (0.00)
Diluted $ (0.05) $ (0.00)
Shares used to compute net loss per share:
Basic 698,220,972 450,000,000
Diluted 698,220,972 450,000,000
See Notes to Consolidated Financial Statements.
F-3
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Additional Retained Other
Common Capital Paid-in Earnings Comprehensive
Shares Stock Capital (Deficit) Income
----------- ------------ ------------ ------------ ------------
Balance, December 31, 2002, as restated 900,000 $ 900 $ 140,800 $ 629,237 $ --
Net loss -- -- -- (306,763) --
Issuance of Common Stock 100,000 100 1,522,338 -- --
Distributions to stockholders -- -- (216,888) (550,580) --
----------- ------------ ------------ ------------ ------------
Balance, December 31, 2003 1,000,000 $ 1,000 $ 1,446,250 $ (228,106) $ --
Net loss -- -- -- (32,861,194)
Foreign currency translation -- -- -- -- 5,298
Effect of Conversion Services
International recapitalization (1,000,000) (1,000) 1,000 -- --
Relative fair value of warrants issued -- -- 3,086,665 -- --
Issuance of Common Stock in
connection with the reverse
merger into LCS Golf 593,000,000 593,000 (593,000) -- --
Issuance of Common Stock in
connection with the acquisition
of DeLeeuw Associates, Inc. 80,000,000 80,000 15,760,000 -- --
Issuance of Common Stock in connection
with the conversion of debt
into Company stock 19,047,619 19,048 1,980,952 -- --
Issuance of Common Stock in
connection with the acquisition
of Evoke Software Corporation 76,463,049 76,463 12,307,635 -- --
Issuance of Common Stock in connection
with a stock purchase agreement 3,571,428 3,571 496,429 -- --
Compensation expense for stock
and stock option grants -- -- 1,479,902 -- --
Discount on debt issued -- -- 7,576,175 -- --
Unsecured convertible line of
credit beneficial conversion feature -- -- 1,214,286 -- --
Total comprehensive loss -- -- -- -- --
----------- ------------ ------------ ------------ ------------
Balance, December 31, 2004 772,082,096 $ 772,082 $ 44,756,294 $(33,089,300) $ 5,298
=========== ============ ============ ============ ============
Total
Stockholders' Comprehensive
Equity Loss
------------ -------------
Balance, December 31, 2002, as restated $ 770,937
Net loss (306,763) (306,763)
Issuance of Common Stock 1,522,438
Distributions to stockholders (767,468)
------------ -------------
Balance, December 31, 2003 $ 1,219,144 (306,763)
=============
Net loss (32,861,194) (32,861,194)
Foreign currency translation 5,298 5,298
Effect of Conversion Services
International recapitalization --
Relative fair value of warrants issued 3,086,665
Issuance of Common Stock in
connection with the reverse
merger into LCS Golf --
Issuance of Common Stock in
connection with the acquisition
of DeLeeuw Associates, Inc. 15,840,000
Issuance of Common Stock in connection
with the conversion of debt
into Company stock 2,000,000
Issuance of Common Stock in
connection with the acquisition
of Evoke Software Corporation 12,384,098
Issuance of Common Stock in connection
with a stock purchase agreement 500,000
Compensation expense for stock
and stock option grants 1,479,902
Discount on debt issued 7,576,175
Unsecured convertible line of
credit beneficial conversion feature 1,214,286
-----------
Total comprehensive loss -- (32,855,896)
===========
------------
Balance, December 31, 2004 $ 12,444,374
============
See Notes to Consolidated Financial Statements.
F-4
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(32,861,194) $ (306,763)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of
leasehold improvements 180,001 95,837
Amortizaton of intangible assets 821,432 82,800
Amortization of discount on debt 921,605 --
Amortization of relative fair value of warrants issued 449,848 --
Amortization of deferred financing costs 134,402 34,521
Beneficial conversion feature associated with convertible debt
instruments 1,214,286 --
Deferred taxes 190,800 (190,800)
Goodwill and intangibles impairment 23,298,810 --
Compensation expense for stock options and stock issued 1,479,902 --
Allowance for doubtful accounts 117,582 42,000
Conversion of accrued interest to additional paid-in capital -- 22,438
Write-off deferred loan costs 45,213 --
Loss on disposal of equipment 88,190 --
Income from equity investments (5,684) --
Minority interest in Evoke Software Corporation (67,813) --
Changes in operating assets and liabilities:
Increase in accounts receivable (1,252,116) (268,325)
Increase in accounts receivable from related parties (388,100) --
Increase in prepaid expenses (120,092) (50,611)
(Increase) decrease in other assets 14,721 (2,070)
Increase (decrease) in accounts payable and accrued expenses 1,217,749 (327)
Increase in deferred revenue 73,179 --
------------ ------------
Net cash used in operating activities (4,447,279) (541,300)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (147,833) (93,640)
Investment in DeLeeuw Associates, net of cash acquired (2,010,266) --
Investment in Evoke Software Corp., net of cash acquired 334,073 --
Collection of note receivable -- 2,100
Acquisition of intangible assets and goodwill -- (11,951)
Equity investment in Leading Edge Communications Corp. (83,000) --
------------ ------------
Net cash used in investing activities (1,907,026) (103,491)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft -- (5,661)
Net advances under line of credit 1,950,704 1,112,863
Issuance of convertible line of credit notes -- 1,500,000
Issuance of short-term note payable 1,000,000 --
Issuance of long-term note payable 4,730,623 --
Deferred loan costs in connection with line of credit (893,309) --
Principal payments on long-term debt (665,085) (777,957)
Proceeds from sale of Company common stock 500,000 --
Principal payments on capital lease obligations (85,595) --
Distributions to stockholders -- (767,468)
Due from stockholders -- (5,400)
Proceeds from repayment of stockholder loans 203,623 --
Long-term note payable to shareholders 307,981 --
Restricted cash (83,375) --
------------ ------------
Net cash provided by financing activities 6,965,567 1,056,377
------------ ------------
Effect of exchange rate changes on cash and cash equivalents 5,298 --
NET INCREASE IN CASH 616,560 411,586
CASH, beginning of year 411,586 --
------------ ------------
CASH, end of year $ 1,028,146 $ 411,586
============ ============
F-5
CONVERSION SERVICES INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
2004 2003
----------------- -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 276,680 $ 89,630
Cash paid for income taxes -- 28,258
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
During 2004 and 2003, the Company entered into various capital lease
arrangements for computer and trade show equipment in the amount of
$249,241 and $23,556, respectively.
During June 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 651,000 --
Acquired computer software 1,381,000 --
Acquired goodwill 9,901,000 --
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 (802,000) --
Minority interest (199,400) --
On March 4, 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 538,814 --
Acquired tradename 722,000 --
Acquired goodwill 15,844,000 --
Acquired investment in limited liability company 55,776 --
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 per share 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 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 the Laurus Master Fund ("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 September quarter 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 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 footnote 8 -- 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 stock and include beneficial conversion priviliges. As a result, the
Company has recorded a discount on debt relating to this transaction in the
amount of $454,500 in the September 2004 quarter 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 6,000,000 warrants 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 - Accounting Policies
Organization and Business
Conversion Services International, Inc. ("CSI") was incorporated in the
State of Delaware and has been conducting business since 1990. CSI and its
wholly owned subsidiaries (together the "Company") are principally engaged in
the information technology services industry in the following areas: strategic
consulting, business intelligence, data warehousing, and data management, on
credit, to its customers principally located in the northeastern United States.
o On November 1, 2002, the Company acquired the operations of Scosys,
Inc. ("Scosys"). Scosys is engaged in the information technology
services industry.
o On January 30, 2004, the Company became a public company through its
merger with a wholly owned subsidiary of LCS Group, Inc. Although
LCS Group, Inc. (now known as Conversion Services International,
Inc.) was the legal survivor in the merger and remains the
Registrant with the Securities and Exchange Commission, the merger
was accounted for as a reverse acquisition, whereby the Company was
considered the "acquirer" of LCS Group, Inc. for financial reporting
purposes, as the Company's stockholders controlled approximately 76%
of the post transaction combined company. Among other matters,
reverse merger accounting requires LCS Group, Inc. to present in all
financial statements and other public filings, prior historical and
other information of the Company, and a retroactive restatement of
the Company's historical stockholders' equity. The retroactive
restatement took place subsequent to the merger on January 30, 2004.
o On March 4, 2004, the Company acquired DeLeeuw Associates, Inc. and
merged the company into DeLeeuw Associates, LLC ("DeLeeuw"), a
subsidiary of CSI. DeLeeuw is a management consulting firm
specializing in integration, reengineering and project management.
o 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.
o On June 28, 2004, the Company acquired substantially all the assets
of Evoke Software Corporation and the stock of Evoke's foreign
subsidiaries ("Evoke"), a provider of data discovery, profiling and
quality management software.
o Doorways, Inc. is a wholly owned subsidiary of the Company that is
currently dormant.
o LEC Corporation of NJ is a wholly owned subsidiary of the Company
that incurs an insignificant amount of payroll expense and has no
other operations.
o CSI Sub Corp. (DE) is a wholly owned subsidiary of the Company and
is the primary operating entity for the Company.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries, Doorways, Inc., DeLeeuw, and Evoke Software
Corporation (formerly known as Evoke Asset Purchase Corp.), LEC Corporation of
NJ, and CSI Sub Corp. (DE). 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
F-7
Services
Revenue from consulting and professional services is recognized at the time the
services are performed on a project by project basis. For projects charged on a
time and materials basis, revenue is recognized based on the number of hours
worked by consultants at an agreed-upon rate per hour. For large services
projects where costs to complete the contract could reasonably be estimated, the
Company undertakes projects on a fixed-fee basis and recognizes revenues on the
percentage of completion method of accounting based on the evaluation of actual
costs incurred to date compared to total estimated costs. Revenues recognized in
excess of billings are recorded as costs in excess of billings. Billings in
excess of revenues recognized are recorded as deferred revenues until revenue
recognition criteria are met. Reimbursements, including those relating to travel
and other out-of-pocket expenses, are included in revenues, and an equivalent
amount of reimbursable expenses are included in cost of services and are
immaterial.
Software
Revenue from software licensing and maintenance and support are 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 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. The
Company recognizes net license revenues based upon the residual method after all
licensed software product has been delivered as prescribed by Statement of
Position 98-9, "Modification of SOP No. 97-2 with Respect to Certain
Transactions." The Company recognizes maintenance revenues over the term of the
maintenance contract. The maintenance rates for both license agreements with and
without stated renewal rates are based upon the price when sold separately.
Vendor-specific objective evidence of the fair value of maintenance for license
agreements that do not include stated renewal rates is determined by reference
to the price paid by the Company's customers when maintenance is sold separately
(i.e. the prices paid by customers in connection with renewals).
The percentage-of-completion method of accounting is not applicable for the
Company's software sales.
Business Combinations
Business combinations are accounted for in accordance with SFAS No. 141,
"Business Combinations" ("SFAS 141"), which requires the purchase method of
accounting for business combinations be followed and in accordance with EITF No.
99-12 "Determination of the Measurement Date for the Market Price of Acquirer
Securities Issued in a Purchase Business Combination" ("EITF 99-12"). In
accordance with SFAS 141, the Company determines the recognition of intangible
assets based on the following criteria: (i) the intangible asset arises from
contractual or other rights; or (ii) the intangible is separable or divisible
from the acquired entity and capable of being sold, transferred, licensed,
returned or exchanged. In accordance with SFAS 141, the Company allocates the
purchase price of its business combinations to the tangible assets, liabilities
and intangible assets acquired based on their estimated fair values. The excess
purchase price over those fair values is recorded as goodwill. Additionally, in
accordance with EITF 99-12, the Company values an acquisition based upon the
market price of its common stock for a reasonable period before and after the
date the terms of the acquisition are agreed to and announced.
Research and development costs
The Company incurs research and development costs related to software
upgrades and the development of new versions of its Evoke Axio software product.
Research and development costs are charged to expense as incurred. Such costs
amounted to $516,425 and $0 in 2004 and 2003, respectively.
F-8
Accounts receivable
The Company carries its accounts receivable at cost less an allowance for
doubtful accounts. On a periodic basis, the Company evaluates its accounts
receivable and adjusts the allowance for doubtful accounts, when deemed
necessary, based upon its history of past write-offs and collections,
contractual terms and current credit conditions. During 2004, $114,785 of
uncollectible accounts receivable were written off against the allowance for
doubtful accounts.
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. Leasehold improvements are amortized over the shorter of the asset
life or the remaining lease term on a straight-line basis. When assets are sold
or retired, the cost and accumulated depreciation are removed from the accounts
and any gain or loss is included in operations.
Expenditures for maintenance and repairs have been charged to operations.
Major renewals and betterments have been capitalized.
Goodwill and intangible assets
Goodwill and intangible assets are accounted for in accordance with SFAS
No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142,
goodwill and indefinite lived intangible assets are not amortized but instead
are reviewed annually for impairment, or more frequently if impairment
indicators arise. Separable intangible assets that are not deemed to have an
indefinite life will continue to be amortized over their estimated useful lives.
The Company tests for impairment whenever events or changes in circumstances
indicate that the carrying amount of goodwill or other intangible assets may not
be recoverable, or at least annually at December 31 of each year. These tests
are performed at the reporting unit level using a two-step, fair-value based
approach. The first step compares the fair value of the reporting unit with its
carrying amount, including goodwill. If the fair value of the reporting unit is
less than its carrying amount, a second step is performed to measure the amount
of impairment loss. The second step allocates the fair value of the reporting
unit to the Company's tangible and intangible assets and liabilities. This
derives an implied fair value for the reporting unit's goodwill. If the carrying
amount of the reporting unit's goodwill exceeds the implied fair value of that
goodwill, an impairment loss is recognized equal to that excess. In the event
that the Company determines that the value of goodwill or other intangible
assets have become impaired, the Company will incur a charge for the amount of
the impairment during the fiscal quarter in which the determination is made.
Goodwill represents the amounts paid in connection with the acquisitions
of Scosys, DeLeeuw and Evoke and also in connection with a settlement agreement
with the Elligent Consulting Group to re-acquire the ownership rights to the
Company in 1998. Additionally, as part of the Scosys, DeLeeuw and Evoke
acquisitions, the Company acquired identifiable intangible assets. The Company's
goodwill and intangible assets were evaluated and deemed not to be impaired at
December 31, 2003. The Company has performed its annual impairment review as of
December 31, 2004 and has determined that goodwill and certain intangible assets
were impaired at that date and, accordingly, has recorded an impairment charge
of $23,298,810.
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.
The approved vendor status intangible asset is being amortized over an estimated
life of forty months.
Deferred financing costs
The Company capitalizes costs associated with the issuance of debt
instruments. These costs are amortized on a straight-line basis over the term of
the related debt instruments, which currently range from one to three years.
F-9
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.
Stock compensation
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 APB 25, 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 650,000 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.
Had the Company determined compensation cost based upon the fair value at
the grant date for its stock options under SFAS No. 123, the Company's net loss
would have changed to the pro forma amounts indicated below:
Year ended
December 31, 2004
--------------------
Net loss:
As reported $ (32,861,194)
Add: Stock based compensation expense recorded 1,466,777
Less: Compensation expense per SFAS 123 (2,998,232)
----------------
Pro forma $ (34,392,649)
================
Net loss per share:
As reported
Basic $ (0.05)
Diluted (0.05)
Pro forma
Basic $ (0.05)
Diluted (0.05)
================
$13,125 of compensation expense related to options granted to non-employees is
included in the reported loss and has not been added back and fair valued in the
above calculation.
F-10
There were no options granted prior to 2004. The per share weighted average fair
value of stock options granted during 2004 was $0.16 per share on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions:
Expected dividend yield 0.0%
Risk-free interest rate 2.5%
Expected volatility 148.0%
Expected option life (years) 3.0
Pro forma information regarding net loss and net loss per share is
required by SFAS 123, as amended by SFAS 148, and has been determined as if the
Company had accounted for its employee stock options under the fair-value
method. The Black-Scholes option pricing model used in this valuation was
developed for use in estimating the fair value of traded options, which have no
vesting restrictions and are fully transferable. Option valuation models require
the input of highly subjective assumptions. The Company's stock-based
compensation has characteristics significantly different from those of traded
options, and changes in the assumptions used can materially affect the fair
value estimate.
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and accounts receivable arising from its
normal business activities. The Company routinely assesses the financial
strength of its customers, based upon factors surrounding their credit risk,
establishes an allowance for doubtful accounts, and as a consequence believes
that its accounts receivable credit risk exposure beyond such allowances is
limited. At December 31, 2004, LEC, and Bank of America accounted for
approximately 15.2% and 6.8% of the Company's accounts receivable balance,
respectively.
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 $162,000 and $8,000 for the years ended December 31,
2004 and 2003, respectively.
Income taxes
The Company accounts for income taxes, in accordance with SFAS No. 109,
"Accounting for Income Taxes" ("SFAS 109") and related interpretations, under an
asset and liability approach that requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been recognized in the Company's financial statements or tax returns. In
estimating future tax consequences, the Company generally considers all expected
future events other than enactments of changes in the tax laws or rates.
The Company records a valuation allowance to reduce the deferred tax
assets to the amount that is more likely than not to be realized. The Company's
current valuation allowance primarily relates to benefits from the Company's
NOL's.
On January 1, 2001, the Company elected to be an "S" Corporation, whereby
the stockholders account for their share of the Company's earnings, losses,
deductions and credits on their federal and various state income tax returns.
The Company is subject to New York City and various state income taxes. On
September 30, 2003, the Company's "S" Corporation status was revoked in
connection with the conversion of convertible subordinated debt into shares of
common stock. Effective October 1, 2003, as a result of the revocation, the
Company's tax status reverted to a "C" Corporation.
F-11
For informational purposes, the accompanying statements of operations for
2003 include a pro forma adjustment for income taxes which would have been
recorded if the Company had not been an "S" Corporation. For 2004, the Company's
effective tax rate is 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 first nine months 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.
Derivatives
The Company accounts for derivatives in accordance with SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and
related interpretations. SFAS 133, as amended, requires companies to recognize
all derivative instruments as either assets or liabilities in the balance sheet
at fair value. At December 31, 2004, the Company had not entered into any
transactions which were considered hedges under SFAS 133. The accounting for
changes in the fair value of a derivative instrument depends on: (i) whether the
derivative has been designated and qualifies as part of a hedging relationship,
and (ii) the type of hedging relationship. For those derivative instruments that
are designated and qualify as hedging instruments, a company must designate the
hedging instrument based upon the exposure being hedged as either a fair value
hedge, cash flow hedge or hedge of a net investment in a foreign operation.
Equity investments
Prior to the Company's acquisition of DeLeeuw in 2004, DeLeeuw had
acquired a non-controlling interest in DeLeeuw International (a company formed
under the laws of Turkey). The Company accounts for its share of the income
(losses) of this investment under the equity method.
The Company acquired 49% of all issued and outstanding shares of common
stock of LEC as of May 1, 2004. The acquisition was completed through a Stock
Purchase Agreement between the Company and the sole stockholder of LEC. In
connection with the acquisition, the Company (i) repaid a bank loan on behalf of
the seller in the amount of $35,000; (ii) repaid an LEC bank loan in the amount
of $38,000; and (iii) satisfied an LEC obligation for $10,000 of prior
compensation to an employee. The Company accounts for its share of the income
(losses) of this investment under the equity method.
Foreign Currency Translation
Local currencies are the functional currencies for Evoke's foreign
subsidiaries. Assets and liabilities are translated using the exchange rates in
effect at the balance sheet date. Income and expenses are translated at the
average exchange rates during the period. Translation gains and losses not
reflected in earnings are reported as a component of stockholders' equity.
Comprehensive Income
Accumulated other comprehensive income is comprised of foreign currency
translation gains and losses which have been excluded from net income. The
Company has reported the components of comprehensive income on the consolidated
statements of shareholders' equity.
Reclassification
Certain amounts in prior periods have been reclassified to conform to the
2004 financial statement presentation.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-12
Note 2: Recent Pronouncements
In October 2004, the Financial Accounting Standards Board ("FASB") ratified EITF
04-8, "Accounting Issues Related to Certain Features of Contingently Convertible
Debt and the Effect on Diluted Earnings Per Share." The new rules require
companies to include shares issuable upon conversion of contingently convertible
debt in their diluted earnings per share (EPS) calculations regardless of
whether the debt has a market price trigger that is above the current fair
market value of the company's common stock that makes the debt currently not
convertible. The new rules are effective for reporting periods ending on or
after December 15, 2004. At December 31, 2004, the Company had no contingently
convertible debt.
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities". In December 2003, the FASB issued
FIN No. 46 (Revised) ("FIN 46-R") to address certain FIN 46 implementation
issues. This interpretation requires that the assets, liabilities, and results
of activities of a Variable Interest Entity ("VIE") be consolidated into the
financial statements of the enterprise that has a controlling interest in the
VIE. FIN 46-R also requires additional disclosures by primary beneficiaries and
other significant variable interest holders. For entities acquired or created
before February 1, 2003, this interpretation is effective no later than the end
of the first interim or reporting period ending after March 15, 2004, except for
those VIE's that are considered to be special purpose entities, for which the
effective date is no later than the end of the first interim or annual reporting
period ending after December 15, 2003. For all entities that were acquired
subsequent to January 31, 2003, this interpretation is effective as of the first
interim or annual period ending after December 31, 2003. The adoption of the
provisions of this interpretation did not have a material effect on our
financial condition or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". This standard amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts,
collectively referred to as derivatives, and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Relationships." SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003
and for hedging relationships after June 30, 2003. The adoption of this
statement did not have a material impact on our results of operations or
financial condition.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
clarifies the accounting for certain financial instruments with characteristics
of both liabilities and equity and requires that those instruments be classified
as liabilities in statements of financial condition. Previously, many of those
financial instruments were classified as equity. SFAS No. 150 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 adoption the provisions of SFAS No. 150 did not have a material
effect on our results of operations or financial condition.
In December 2003, the SEC issued Staff Accounting Bulletin No. 104, "Revenue
Recognition" ("SAB 104"), which supersedes SAB 101, "Revenue Recognition in
Financial Statements." The primary purpose of SAB 104 is to rescind accounting
guidance contained in SAB 101 related to multiple element revenue arrangements,
which was superseded as a result of the issuance of EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables." While the wording of SAB 104
has changed to reflect the issuance of EITF 00-21, the revenue recognition
principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The
adoption of SAB 104 did not have a material impact on our financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based
Payment" ("SFAS No. 123R") that addresses the accounting for share-based payment
transactions in which a company receives employee services in exchange for (a)
equity instruments of the company or (b) liabilities that are based on the fair
value of the company's equity instruments or that may be settled by the issuance
of such equity instruments. SFAS No. 123R addresses all forms of share-based
payment awards, including shares issued under employee stock purchase plans,
stock options, restricted stock and stock appreciation rights. SFAS No. 123R
eliminates the ability to account for share-based compensation transactions
using APB Opinion No. 25, "Accounting for Stock Issued to Employees", that was
provided in Statement 123 as originally issued. Under SFAS No. 123R companies
are required to record compensation expense for all share based payment award
transactions measured at fair value. This statement is effective for quarters
ending after December 15, 2005. We have not yet determined the impact of
applying the various provisions of SFAS No. 123R.
F-13
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets
-- An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions
(SFAS 153). SFAS 153 eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an
exception for exchanges that do not have commercial substance. SFAS 153
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. SFAS 153 is effective for the fiscal periods beginning after June 15,
2005 and is required to be adopted by the Company in the third quarter of 2005.
The Company is currently evaluating the effect that the adoption of SFAS 153
will have on its consolidated results of operations and financial condition but
does not expect it to have a material impact.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs: an amendment
of ARB No. 43, Chapter 4," to clarify the accounting for abnormal amounts of
idle facility expense, freight, handling costs and wasted material. SFAS No. 151
is effective for inventory costs incurred during fiscal years beginning after
June 15, 2005. We do not believe the provisions of SFAS No. 151, when applied,
will have an impact on our financial position or results of operations.
Note 3 - Mergers and acquisitions
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 the president and sole stockholder of DAI,
received $2,000,000 and 80,000,000 shares of common stock of CSI (at the time,
approximately 11.9% of the outstanding shares). On March 5, 2004, DCL changed
its name to DeLeeuw Associates, LLC. The Company's consolidated financial
statements include DeLeeuw Associates, LLC's results of operations for the
period subsequent to its acquisition on March 4, 2004. The components and
allocations of the purchase price were based on the fair value of assets and
liabilities acquired as of the acquisition date ($'s in 000's):
F-14
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 (539) (40 month life)
Accounts receivable (975)
Tradename (722) (indefinite life)
Goodwill (15,844)
Other assets (56)
Current liabilities assumed 286
--------
$ --
--------
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.
The Company performed its annual goodwill impairment review in connection with
its year-end financial closing in December 2004 and has determined that the
recorded amount of the goodwill was impaired as of December 31, 2004. As a
result, the Company recorded a goodwill impairment charge with respect to the
DAI goodwill of approximately $11,500,000.
The DAI acquisition was structured to be a non-taxable transaction and, as a
result, the goodwill recorded with respect to this transaction is not deductible
for income tax purposes.
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 $448,154 in deferred compensation to certain
employees of Evoke. For accounting purposes, this transaction was deemed to have
occurred on June 30, 2004. Transaction volumes between June 28 and June 30, 2004
were de minimis.
The components and allocations of the purchase price were based on the
fair value of assets and liabilities acquired as of the acquisition date ($'s in
000's).
F-15
COMPONENTS OF PURCHASE PRICE:
Value of Common Stock $ 12,384
Acquisition costs 163
--------
$ 12,547
ALLOCATION OF PURCHASE PRICE:
Customer contracts (1,962) (six year estimated life)
Computer software (1,381) (three year estimated life)
Goodwill (9,901)
Tradename (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 802
Minority interest 199
--------
$ --
========
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.
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 pro forma earnings.
512,500 shares of common stock of the Company have been granted to certain
Evoke employees to retain their employment. A charge of $87,125 was included in
the Company's results of operations during 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 Company performed its annual impairment review in connection with its
year-end financial closing in December 2004 and has determined that the recorded
amount of the Evoke goodwill and certain intangibles was impaired as of December
31, 2004. As a result, the Company recorded an impairment charge with respect to
Evoke goodwill and certain intangibles of approximately $11,100,000. $9,901,000
relates to goodwill impairment, and the remaining $1,150,000 is attributable to
intangibles (customer contracts $500,000 and tradename $651,000).
F-16
In connection with the Company's acquisition of the assets of Evoke
Software, five percent (5%) of the outstanding common stock of Evoke Software
Corporation was issued to WHRT I Corporation.
The pro forma consolidated statements of operations for the years ended
December 31, 2003 and 2004, respectively, set forth below gives effect to the
acquisitions of DeLeeuw Associates, LLC and Evoke Software Corporation as if
they occurred on January 1, 2003.
Year ended Year ended
December 31, 2003 December 31, 2004
----------------------------------------
Revenues $ 22,422,859 $ 28,641,133
Net Loss $ (3,548,881) $(33,671,080)
Net Loss per share $ (0.01) $ (0.05)
Note 4 - Property and equipment
Property and equipment consisted of the following:
December 31,
2004
------------
Computer equipment $ 979,494
Furniture and fixtures 232,648
Leasehold improvements 216,306
------------
1,428,448
Accumulated depreciation (840,873)
------------
$ 587,575
============
Depreciation and amortization expense related to property and equipment totaled
$0.2 million and $0.1 million for 2004 and 2003, respectively.
Note 5 - Intangible assets
Intangibles acquired along with their assigned lives are as follows:
December 31, Amortization
2004 period
------------------------------
Customer contracts $ 1,876,424 5 - 6 years
Approved vendor status 538,814 40 months
Computer software 1,381,000 3 years
Tradename 722,000 Indefinite
Proprietary rights and rights to the name of Scosys, Inc. 20,000 Indefinite
-----------
4,538,238
Accumulated amortization (911,142)
-----------
$ 3,627,096
===========
F-17
The estimated amortization expense for the next five years related to other
finite-lived intangible assets is estimated to be as follows:
Amortization of
Intangible assets
----------------------
2005 $ 1,125,224
2006 957,045
2007 573,339
2008 127,962
2009 81,165
Thereafter 20,361
----------------------
$ 2,885,096
----------------------
In accordance with SFAS No. 142, the Company completed the annual impairment
review and concluded that a $1,150,376 impairment of intangibles existed at
December 31, 2004.
Note 6 - Deferred financing costs
The Company has incurred and capitalized financing costs in connection
with two financing transactions consummated during 2004. These costs were
deferred and are being amortized over the life of the related financing
agreement. The following illustrates the components of the deferred financing
costs:
Year Ended
December 31,
2004
--------------
Laurus Master Fund $ 766,270
Sands Brothers 127,039
--------------
$ 893,309
Accumulated amortization (126,767)
--------------
$ 766,542
==============
Note 7 - 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 and their applicable amortization period:
December 31,
2004 Amortization period
--------------------------------------
Laurus Master Fund $ 5,621,630 3 years
Sands Brothers 1,500,000 1 year
Taurus Advisory Group 454,545 5 years
-----------
7,576,175
Accumulated amortization (921,605)
-----------
$ 6,654,570
===========
F-18
Note 8 - 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 provided for
interest accruing on advances at seven eighths of one percent (7/8%) over the
institution's prime rate.
Laurus Transaction:
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. A portion of Laurus's revolving line of
credit was used to pay off all outstanding borrowings from North Fork Bank. 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, which was 5.25% as of
December 31, 2004) plus 1%, and maturing in three years. We have no obligation
to meet financial covenants under the $2,000,000 convertible minimum borrowing
note or the $4,000,000 revolving note. 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. We have no obligation to meet financial covenants under the
$5,000,000 secured convertible term note (See Note 10 to the Consolidated
Financial Statements). 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. An early termination fee is due to Laurus in an amount equal to
five percent (5%) of the total investment amount if such termination occurs
prior to the first anniversary of the closing, four percent (4%) if such
termination occurs after the first anniversary but prior to the second
anniversary, and three percent (3%) if after the second anniversary.
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 December 31, 2004, $3.7 million was outstanding under the
revolving line of credit. The interest rate on the revolving line and the
acquisition note was 6.25% during December 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. 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.
F-19
The fair value of the warrant to purchase 12.0 million common shares was
determined to be $2.0 million using the Black-Scholes option pricing model. The
assumptions used in the fair value calculation were as follows: stock prices of
$0.21, exercise prices of $0.29, $0.31 and $0.35 (as applicable), term of seven
years, volatility (annual) of 150.65%, annual rate of quarterly dividends of 0%,
a risk free rate of 1.33%, and the fair value per share of the warrants was
accordingly calculated to be $0.20. The Company will amortize this relative fair
value of the warrants to interest expense over the three-year life of the debt
agreement
Under the Laurus agreement, the Company was obligated to ensure that the
shares provided for issuance under the agreement were properly registered by
December 19, 2004. As a result of the Company's Registration statement not being
declared effective prior to this date, the Company is incurring liquidated
damages to Laurus an amount equal to 1% for each thirty day period (prorated for
partial periods) on a daily basis of the sum of (x) the original aggregate
principal amount of the Note plus (y) the original principal amount of each
applicable Minimum Borrowing Note. While such event continues, such liquidated
damages shall be paid not less often than each thirty days. Any unpaid
liquidated damages as of the date when an event has been cured by the Company
shall be paid within three days following the date on which such event has been
cured by the Company. As a result, the Company has recorded a charge in December
2004 for approximately $44,000.
Note 9 - Short Term Notes Payable
In September 2004, the Company issued to Sands Brothers Venture Capital
LLC, Sands Brothers Venture Capital III LLC and Sands Brothers Venture Capital
IV LLC (collectively, "Sands") three subordinated secured convertible promissory
notes equaling $1,000,000 (the "Notes"), each with an annual interest rate of 8%
expiring September 22, 2005. The Notes are secured by substantially all
corporate assets, but subordinate to Laurus. The Notes are convertible into
shares of the Company's common stock at the election of Sands at any time
following the consummation of a convertible debt or equity financing with gross
proceeds of $5 million or greater (a "Qualified Financing"). The conversion
price of the shares of the Company's 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 the Company issues stock or derivatives convertible
into the Company's 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. The Company also issued Sands three common stock
purchase warrants (the "Warrants") providing Sands with the right to purchase
6,000,000 shares of the Company's common stock. The exercise price of the shares
of the Company's common stock issuable upon exercise of the Warrants shall be
equal to a price per share of common stock equal to 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. 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.
F-20
Note 10 - Long Term Debt
Long-term debt consisted of the following:
December 31,
2004
--------------
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. As of December 31, 2004, the interest
rate on this note was 6.25%. See note 8 - Line of
credit, Laurus Transaction, 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
Unsecured loans to the Company by the Chief Executive
Officer, Mr. Newman, and the Chief Operating Officer,
Mr. Peipert, of the Company. These unsecured notes each
accrue interest at a simple rate of 3% per annum, and
each has a term expiring on January 1, 2006. 307,981
Notes payable under capital lease obligations payable to
various finance companies for equipment at varying rates
of interest, ranging from 18% to 32% as of December 31,
2004, and have maturity dates through 2007. 221,949
--------------
7,529,930
Relative fair values ascribed to warrants associated
with the above debt agreements. This amount is being
accreted to the debt instrument over the term of the
related debt agreements, which range from three to five
years. (2,227,727)
--------------
Subtotal 5,302,203
Less: Current portion of long-term debt, including
obligations under capital leases of $120,834. (120,834)
--------------
$ 5,181,369
==============
Future annual payments of long-term debt is as follows:
Years Ending December 31,
-------------------------
2005 $ 120,834
2006 395,534
2007 5,013,562
2008 --
2009 2,000,000
--------------
$ 7,529,930
==============
F-21
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 $355,000.
The following schedule lists future minimum lease payments under the
capital leases with their present value as of December 31, 2004:
Years Ending December 31,
-------------------------
2005 $ 160,231
2006 98,907
2007 14,233
---------
273,371
Less: Amount representing interest (51,422)
---------
$ 221,949
=========
During 2004, the Company recorded depreciation expense related to
equipment under capital leases of approximately $75,000.
On October 29, 2003, the Company made arrangements to obtain a $2,000,000
Unsecured Convertible Line of Credit Note. The terms of this 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. In February 2004, the Company borrowed the entire $2,000,000
available under this line of credit. 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. Due to
an adjustment in the conversion price in September 2004, participating investors
received an additional 2,380,953 shares of common stock. As a result of the
initial conversion and the adjustment, we recorded a beneficial conversion
charge of $1,200,000. Further in May 2004, we raised an additional $2,000,000
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 $2,000,000
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. This note also contains beneficial conversion features, and as a
result, we recorded a beneficial conversion charge of $1,500,000 which is being
amortized into income over the life of the debt instrument. Additionally, using
the Black-Scholes option pricing model, we determined the fair value of the
warrant to be $500,000. The Company valued the warrant in accordance with EITF
00-27 using the Black-Scholes option pricing model and the following
assumptions: contractual term of five years, an average risk free interest rate
of 1.33%, a dividend yield of 0%, and volatility of 138.62%. The relative fair
value attributed to the warrant issued is amortized over the note's maturity
period (60 months) as interest expense.
Note 11 - 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:
F-22
Years ended December 31,
-------------------------
2004 2003
-------------------------
Current - Federal $ -- $ --
Current - State -- --
Deferred - Federal 147,800 (147,800)
Deferred - State 43,000 (43,000)
-------------------------
$ 190,800 $(190,800)
=========================
The Company's provision for income taxes is based on estimated effective
annual income tax rates. The provision may differ from income taxes currently
payable because certain items of income and expense are recognized in different
periods for financial statement purposes than for tax return purposes.
The Company has net operating loss carry-forwards for both Federal and
State purposes totaling approximately $11,300,000 and $413,000 that expire in
2024 and 2023, respectively.
December 31,
------------------------------
2004 2003
------------------------------
Net operating losses $ 6,675,000 $ 164,900
Accounts receivable 84,000 36,700
Property and equipment (16,000) 2,200
Accounts payable and accrued expenses 32,000 --
Long-term debt 41,000 --
Goodwill 4,048,000 (36,900)
Intangible assets 620,000 23,900
------------------------------
11,484,000 190,800
Valuation allowance (11,484,000) --
------------------------------
$ -- $ 190,800
==============================
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 $11,484,000 and zero for the years ended December 31, 2004 and
2003, respectively, representing a current year change in the valuation
allowance of $11,484,000. This allowance was recorded because, based on the
weight of available evidence, it is more likely than not that some, or all, of
the deferred tax asset may not be realized.
Income taxes computed at the federal statutory rate differ from the
amounts provided as follows:
For the year ended December 31,
---------------------------------
2004 2003
--------------------------
Provision for Federal taxes at
statutory rate (34%) (34.0)% (34.0)%
State taxes, net of Federal benefit (2.9) (4.4)
Permanent difference due to
non-deductible items 17.1 --
Foreign income taxed at different rates 0.4 --
Valuation allowance applied against
income tax benefit 20.0 --
--------------------------
Income tax provision 0.6% (38.4)%
===========================
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.
F-23
Note 12 - Common Stock
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 was required to purchase the remaining 8,928,572 shares of
common stock for $1,250,000 by December 31, 2004. As of March 17, 2005,
CMKX-treme, Inc. remitted final payment for the remaining 8,928,572 shares.
Note 13 - Common Stock Warrants
On June 7, 2004, the Company granted a warrant to purchase 4,166,666
shares of the Company's common stock to the Taurus Advisory Group in connection
with the issuance of an unsecured convertible line of credit note at an exercise
price of $0.14 per share and an expiration date of June 6, 2009. See footnote 10
- Long Term Debt for further discussion of the related financing transaction.
On August 16, 2004, the Company granted a warrant to purchase an aggregate
of 12,000,000 shares of the Company's common stock to Laurus Master Fund, Ltd.
in connection with a secured convertible term note, a secured revolving note,
and a secured convertible minimum borrowing note. The first 6,000,000 shares
acquired under the warrant have an exercise price of $0.29 per share, the next
3,000,000 shares acquired have an exercise price of $0.31 per share, and the
final 3,000,000 shares acquired have an exercise price of $0.35 per share. The
expiration date of the warrant is August 16, 2011. See footnote 8 - Line of
Credit for further discussion of the Laurus transaction.
On September 22, 2004, the Company granted a warrant to purchase an
aggregate of 6,000,000 shares of the Company's common stock to three affiliates
of Sands Brothers Venture Capital. Sands Brothers Venture Capital III LLC
received a warrant to purchase 5,100,000 shares of Company common stock, Sands
Brothers Venture Capital LLC received a warrant to purchase 300,000 shares of
Company common stock, and Sands Brothers Venture Capital IV LLC received a
warrant to purchase 600,000 shares of Company common stock. Each warrant
provides for an exercise price equal to forty percent (40%) of the price per
share of Common Stock received by the Company in connection with the first
Qualified Financing occurring after the date of the warrant agreement. In the
event the Company does not consummate a Qualified Financing on or before
September 7, 2005, the exercise price adjusts to $0.14 per share. The warrants
expire on September 7, 2008. See footnote 9 - Short Term Notes Payable for
further discussion of the transaction.
Note 14 - Stock Based Compensation
The 2003 Incentive Plan ("2003 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. The options granted
may be a combination of both incentive and nonstatutory options, generally vest
over a three year period from the date of grant, and expire ten years from the
date of grant.
To the extent that CSI derives a tax benefit from options exercised by
employees, such benefit will be credited to additional paid-in capital when
realized on the Company's income tax return. There were no tax benefits realized
by the Company during 2004 or 2003.
F-24
The following summarizes the stock option transactions under the 2003 Plan
during 2004:
Weighted average
Shares exercise price
------------ -----------------
Options outstanding at December 31, 2003 -- $ --
Options granted 43,060,981 0.15
Options exercised -- --
Options canceled (1,795,000) 0.20
------------ -------------
Options outstanding at December 31, 2004 41,265,981 $ 0.15
============ =============
The following table summarizes information concerning outstanding and
exercisable Company common stock options at December 31, 2004:
Weighted Weighted average Weighted
Range of exercise Options average remaining Options average
prices outstanding exercise price contractual life exercisable exercise price
-------------------------------------------------------------------------------------------------------------
$0.055 8,900,981 $ 0.055 9.9 8,900,981 $ 0.055
$0.165 - $0.23 32,365,000 0.180 9.3 -- --
---------- ---------
41,265,981 8,900,981
========== =========
On October 18, 2004, options to purchase 8,900,981 shares of our common
stock were granted to several employees below fair market value at an exercise
price of $0.055 per share, when the fair market value on date of grant was
$0.21. These options are non-qualified stock options, are all immediately
vested, and expire ten years from the date of grant. As a result of this
issuance of stock options at a price below fair market value on the date of
grant, the Company has recorded a stock-based compensation charge of
approximately $1,380,000 during the fourth quarter of 2004.
Note 15 - Loss Per Share
Basic loss per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted loss per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options using the "treasury stock" method.
F-25
Basic and diluted loss per share were determined as follows:
For the years ended December 31,
--------------------------------
2004 2003
------------- -------------
Net loss available for common stockholders (A) $ (32,861,194) $ (306,763)
Weighted average outstanding shares of common stock (B) 698,220,972 450,000,000
Common stock and common stock equivalents (C) 698,220,972 450,000,000
Loss per share:
Basic (A/B) $ (0.05) $ (0.00)
============= =============
Diluted (A/C) $ (0.05) $ (0.00)
============= =============
For the year ended December 31, 2004, 41,265,981 shares attributable to
outstanding stock options were excluded from the calculation of diluted loss 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 loss per share for the year ended
December 31, 2004 because the effect was antidilutive.
Note 16 - Major Customers
During 2004, the Company had sales to two major customers, LEC, a related
party (15.2%) and Bank of America (15.9%), which totaled approximately
$7,828,000. Amounts due from these customers included in accounts receivable
were approximately $1,128,000 at December 31, 2004. As of December 31, 2004, LEC
and Bank of America accounted for approximately 15.2% and 6.8% of the Company's
accounts receivable balance, respectively.
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.
Note 17 - 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, 2004 and 2003 were approximately $81,000 and $24,000, respectively.
Note 18 - Commitments and Contingencies
Legal Proceedings
On June 29, 2004, Viant Capital LLC commenced legal action against the
Company 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
the Company's loan from a private investor in May 2004. Management believes that
this loan does not qualify as a private equity transaction and it intends to
vigorously defend the Company. As of April 8, 2005, 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.
F-26
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 lump sum payment of the longer of (1) three
year's base salary or (2) the period from the date of termination through the
expiration date.
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 lump sum payment of the longer of (1)
three year's base salary or (2) the period from the date of termination through
the expiration date.
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 lump sum payment of the longer of
(1) three year's base salary or (2) the period from the date of termination
through the expiration date.
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 lump sum payment of the longer of
(1) one year's base salary or (2) the period from the date of termination
through the expiration date.
Lease Commitments
The Company's corporate headquarters are located at 100 Eagle Rock Avenue,
East Hanover, New Jersey 07936, where it operates under an amended lease
agreement expiring December 31, 2010. Our monthly rent with respect to our East
Hanover, New Jersey facility is $26,290. In addition to minimum rentals, the
Company is liable for its proportionate share of real estate taxes and operating
expenses, as defined. DeLeeuw Associates, LLC has an office at Suite 1460,
Charlotte Plaza, 201 South College Street, Charlotte, North Carolina 28244.
DeLeeuw leases this space which 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 $629,000
and $313,000 in 2004 and 2003, respectively.
The Company is committed under several operating leases for automobiles
that expire during 2007.
F-27
Future minimum lease payments due under all operating lease agreements as
of December 31, 2004 are as follows:
Years Ending December 31 Office Automobiles Total
------------------------ ----------- ------------ -----------
2005 $ 697,984 $ 55,209 $ 753,193
2006 496,672 48,729 545,401
2007 299,580 17,161 316,741
2008 299,580 -- 299,580
2009 299,580 -- 299,580
Thereafter 299,580 -- 299,580
---------- ---------- ----------
$2,392,976 $ 121,099 $2,514,075
========== ========== ==========
The Company engaged Sands Brothers International Limited as its
non-exclusive financial advisor at $6,000 per month for a period of one year.
Note 19 - Related Party Transactions
In November 2003, the Company executed an Independent Contractor Agreement
with LEC, whereby the Company agreed to be a subcontractor for LEC, and to
provide consultants as required to LEC. In return for these services, the
Company receives a fee from LEC based on the hourly rates established for
consultants subcontracted to LEC. In May 2004, the Company acquired 49% of all
issued and outstanding shares of common stock of LEC. The acquisition was
completed through a Stock Purchase Agreement between the Company and the sole
stockholder of LEC. In connection with the acquisition, the Company (i) repaid a
bank loan on behalf of the seller in the amount of $35,000; (ii) repaid an LEC
bank loan in the amount of $38,000; and (iii) satisfied an LEC obligation for
$10,000 of prior compensation to an employee. For the years ended December 31,
2004 and 2003, the Company invoiced LEC $3,837,065 and $365,458, respectively,
for the services of consultants subcontracted to LEC by the Company. As of
December 31, 2004 and 2003, the Company had accounts receivable due from LEC of
approximately $781,000 and $393,000, respectively. There are no known
collection problems with respect to LEC. The majority of their billing is
derived from Fortune 1000 clients. The collection process is slow as these
clients require separate approval on their own internal systems, which extends
the payment cycle. The Company feels confident in the collectibility of these
accounts receivable as the majority of the revenues from LEC derive from Fortune
1000 clients.
On November 8, 2004, Mr. Newman entered into a stock purchase agreement
with a private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 2,833,333 shares of common stock for a purchase price of
$250,000. As of April 8, 2005, the shares have not been issued to CMKX-treme,
Inc. because it has not yet remitted payment for the shares.
On November 8, 2004, Mr. Peipert entered into a stock purchase agreement
with a private investor, CMKX-treme, Inc. Pursuant to the agreement, CMKX-treme,
Inc. agreed to purchase 5,666,667 shares of common stock for a purchase price of
$500,000. As of April 8, 2005, the shares have not been issued to CMKX-treme,
Inc. because it has not yet remitted payment for the shares.
On November 10, 2004, the Company and Dr. Michael Mitchell, the former
President, Chief Executive Officer and sole director of LCS, executed a one-year
consulting agreement whereby Dr. Mitchell would perform certain consulting
services on behalf of the Company. Dr. Mitchell will receive an aggregate amount
of $250,000 as compensation for services provided to the Company. During 2004,
an aggregate amount of $50,000 was paid to Dr. Mitchell for services provided
under this consulting agreement.
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. 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 December 14, 2004, Scott Newman, our President, Chief
Executive Officer and Chairman, had loaned the Company $200,000, and Glenn
Peipert, our Executive Vice President, Chief Operating Officer and Director, had
loaned the Company $125,000. The unsecured loans by Mr. Newman and Mr. Peipert
each accrue interest at a simple rate of 3% per annum, and each has a term
expiring on January 1, 2006. As of December 31, 2004, approximately $188,000 and
$125,000 remained outstanding to Messrs. Newman and Peipert, respectively.
F-28
See Note 21 to the Notes to Consolidated Financial Statements for
additional related party transactions.
Dr. Michael Mitchell, the former President, Chief Executive Officer and
sole director of LCS, had loaned an aggregate of $930,707 to the Company. This
loan was converted into shares of the Company's common stock at the closing of
the merger of LCS and CSI.
Note 20 - Segment Information
The Company has two reportable segments: services and software, which
includes support and maintenance. The services segment includes the Company's
information technology services offerings in the following areas: data
warehousing, business intelligence, management consulting and professional
services to its customers principally located in the northeastern United States.
The Company's acquisitions of Scosys, Inc., DeLeeuw Associates, Inc. and the
equity adjustment related to its equity investment in Leading Edge
Communications Corporation have all been included in the services business
segment. The Company maintains offices for its services business in East
Hanover, New Jersey and Charlotte, North Carolina.
The software segment resulted from the Company's acquisition of
substantially all the assets of Evoke Software Corporation ("Evoke") on June 28,
2004. Evoke is a provider of data discovery, profiling and quality management
software. Evoke's headquarters are in East Hanover, New Jersey and it maintains
development offices in Austin, Texas and Denver, Colorado. Additionally, Evoke
has sales offices in England and Germany.
The Company considers all revenues and expenses to be of an operating
nature and, accordingly, allocates them to industry segments regardless of the
profit center in which recorded. Corporate office expenses are allocated to
certain segments based on resources allocated. The accounting policies of the
reportable segments are the same as those described in the summary of
significant accounting policies.
The Company considers reportable segments as business units that offer
different products and are managed separately.
As of and for the years ended December 31,
---------------------------------------------------------------------------------------------------
2004 2003
----------------------------------------------- -----------------------------------------------
Services Software Consolidated Services Software Consolidated
------------ ------------ ------------ ------------ ------------ ------------
Net revenues from external
customers $ 23,798,080 $ 1,368,437 $ 25,166,517 $ 14,366,456 $ -- $ 14,366,456
Segment net loss (19,260,675) (13,600,519) (32,861,194) (306,763) -- (306,763)
Interest income 22,388 -- 22,388 5,400 -- 5,400
Interest expense 2,139,093 949,609 3,088,702 135,753 -- 135,753
Depreciation and
amortization 468,235 648,974 1,117,209 213,158 -- 213,158
Total segment assets 22,508,434 4,796,887 27,305,321 4,759,900 -- 4,759,900
F-29
Geographic Information
For the year ended December 31,
-------------------------------
2004 2003
----------- -----------
Revenues:
United States $24,925,008 $14,366,456
International 241,509 --
----------- -----------
$25,166,517 $14,366,456
=========== ===========
As of December 31,
-----------------------------
2004 2003
----------- -----------
Long-lived assets:
United States $ 585,019 $ 270,696
International 2,556 --
----------- -----------
$ 587,575 $ 270,696
=========== ===========
The software segment had one customer during 2004, Wellpoint that comprised
10.5% of segment revenues. There was no software segment in 2003.
Note 21 - Subsequent Events
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 12.5 million shares of common
stock for a purchase price of $1.75 million. Under the terms of the Agreement,
CMKX-treme, Inc. initially purchased 3,571,428 shares of common stock for $0.5
million, and it was required to purchase the remaining 8,928,572 shares of
common stock for $1.25 million by December 31, 2004. As of March 17, 2005,
CMKX-treme, Inc. remitted final payment for the remaining 8,928,572 shares.
As of March 30, 2005, Messrs. Newman, Peipert and Robert C. DeLeeuw have
agreed to personally support our cash requirements to enable us to fulfill our
obligations through May 1, 2006, to the extent necessary, up to a maximum amount
of $2,500,000. Mr. Newman personally guaranties up to $1,415,000, Mr. Peipert
guaranties up to $707,500 and Mr. DeLeeuw personally guaranties $377,500. We
believe that our reliance on such commitment is reasonable and that Messrs.
Newman, Peipert and DeLeeuw have sufficient liquidity and net worth to honor
such commitment. We believe that this written commitment provides us with the
legal right to request and receive such advances. Any loan by Messrs. Newman,
Peipert and DeLeeuw to the Company would bear interest at 3% per annum.
Note 22 - Subsequent Events (unaudited)
In April 2005, Glenn Peipert loaned $250,000 to the Company. Such loan
bears interest at 3% per annum and is due May 1, 2006.
On May 6, 2005, Joseph Santiso was elected to the Board of Directors of
the Company. Mr. Santiso founded and is President of The BCI Group. Mr. Santiso
and present director Lawrence K. Reisman will comprise the newly formed Audit
Committee, Compensation Committee and Nominating and Corporate Governance
Committee.
On May 9, 2005, Laurus Master Fund. Ltd. elected to convert $1,000,000 of
the principal amount outstanding under the minimum borrowing note dated August
16, 2004 into shares of common stock of the Company at a conversion price of
$0.14 per share. As a result of this conversion, the Company issued 7,142,857
shares of common stock to Laurus.
F-30
--------------------------------------------------------------------------------
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.
164,458,327 SHARES OF COMMON STOCK
-------------
PROSPECTUS
-------------
_______ __, 2005
--------------------------------------------------------------------------------
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 $ 6,189.40
Printing and engraving expenses $ 2,500.00*
Legal fees and expenses $ 10,000.00*
Accounting fees and expenses $ 10,000.00*
Transfer Agent and Registrar fees $ 2,000.00*
Miscellaneous fees and expenses $ 4,310.60*
-----------
Total $ 35,000.00*
* 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 May 2005, we issued 7,142,857 shares of common stock to Laurus Master
Fund, Ltd. pursuant to a conversion by Laurus of $1,000,000 under a minimum
borrowing note among Laurus and us.
In April 2005, we issued 320,513 shares of common stock to Viant Capital
LLC pursuant to an investment banking agreement executed in February 2004.
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 12.5 million shares of common stock for a purchase price of
$1.75 million. Under the terms of the Agreement, CMKX-treme, Inc. initially
purchased 3,571,428 shares of common stock for $0.5 million, and it was required
to purchase the remaining 8,928,572 shares of Common Stock for $1.25 million by
December 31, 2004. As of March 17, 2005, CMKX-treme, Inc. remitted final payment
for the remaining 8,928,572 shares
II-2
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, in exchange for $1,000,000, minus fees. 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.
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.
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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.
In March 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.
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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
Company, 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 Company, LCS Acquisition Corp., Conversion Services
International, Inc. and certain affiliated stockholders of Conversion Services
International, Inc. (filed as Appendix A on Schedule 14A on January 5, 2004).
2.3 Certificate of Merger, dated January 30, 2004, relating to the merger
of LCS Acquisition Corp. and Conversion Services International, Inc. (filed as
Exhibit 2.3 on Form 8-K on February 17, 2004).
2.4 Acquisition Agreement, dated February 27, 2004, among the Company,
DeLeeuw Associates, Inc. and Robert C. DeLeeuw (filed as Exhibit 2.1 on Form 8-K
on March 16, 2004).
2.5 Plan and Agreement of Merger and Reorganization, dated February 27,
2004, among the Company, 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 Company's Certificate of
incorporation, dated January 27, 2004, amending, among other things, the
authorized shares of common and preferred stock (filed as Exhibit 3.1 on Form
8-K on February 17, 2004).
3.3 Certificate of Amendment to the Company's Certificate of
Incorporation, dated January 30, 2004, changing the name of the Company from LCS
Group, Inc. to Conversion Services International, Inc. (filed as Exhibit 3.2 on
Form 8-K on February 17, 2004).
3.4 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).
4.2 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).
4.3 Common Stock Purchase Warrant, dated August 16, 2004, in favor of
Laurus Master Fund, Ltd. (filed as Exhibit 4.7 on Form 10-QSB on August 23,
2004).
4.4 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).
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4.5 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).
4.6 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).
4.7 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 the Company and Robert DeLeeuw, dated
March 26, 2004 (filed as Exhibit 10.4 on Form SB-2/A on September 30, 2004).
10.5 2003 Incentive Plan (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).
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).
II-6
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).
10.16 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).
10.17 Consulting Agreement with Morgan Stanley & Co., Incorporated (filed
as Exhibit 10.18 on Form SB-2/A on January 19, 2005).
10.18 Consulting Agreement with Cellco Partnership (now known as Verizon
Wireless) (filed as Exhibit 10.19 on Form SB-2/A on January 19, 2005).
21 Subsidiaries of the Company.*
23.1 Consent of Friedman LLP.**
--------------------
* Previously filed.
** 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 May 13, 2005.
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, Chairman
Scott Newman and Principal Executive Officer May 13, 2005
*
---------------------------------------- Executive Vice President, Chief Operating May 13, 2005
Glenn Peipert Officer and Director
* Vice President, Chief Financial Officer,
---------------------------------------- Secretary, Treasurer and Principal Accounting May 13, 2005
Mitchell Peipert Officer
*
---------------------------------------- Director May 13, 2005
Lawrence K. Reisman
*
---------------------------------------- Director May 13, 2005
Joseph Santiso
* By: /s/ Scott Newman
as attorney-in-fact
May 13, 2005
II-9