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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: JUNE 30, 2004
Commission file number: 0-20824
INFOCROSSING, INC.
-------------------------------------------------------------
(Exact name of Registrant as specified in its Charter)
DELAWARE 13-3252333
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2 CHRISTIE HEIGHTS STREET, LEONIA, NJ 07605
-----------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (201) 840-4700
Check whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): [ ] Yes [X] No.
There were 18,551,262 shares of the registrant's Common Stock, $0.01 par value,
outstanding as of August 6, 2004.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE
AMOUNTS)
JUNE 30, DECEMBER 31,
2004 2003
----------------- -----------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 31,170 $ 10,073
Trade accounts receivable, net of allowances for
doubtful accounts of $676 and $570, respectively 8,384 3,592
Due from related parties 231 226
Prepaid license fees 664 945
Other current assets 4,212 1,780
-------------- -------------
44,661 16,616
-------------- -------------
PROPERTY and EQUIPMENT, net 22,388 18,249
-------------- -------------
OTHER ASSETS:
Deferred software, net 1,019 1,264
Goodwill 73,011 28,361
Other intangible assets, net 2,364 788
Security deposits and other non-current assets 2,958 1,384
-------------- -------------
79,352 31,797
-------------- -------------
TOTAL ASSETS $ 146,401 $ 66,662
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 6,093 $ 2,768
Current portion of long-term debt and capitalized lease obligations 3,401 2,559
Current portion of accrued loss on leased facilities 211 202
Accrued expenses 7,664 1,516
Deferred revenue 1,266 1,356
-------------- -------------
18,635 8,401
LONG-TERM LIABILITES:
Convertible notes 57,900 -
Other long-term debt and capitalized lease obligations 5,504 25,732
Accrued loss on leased facilities, net of current portion 620 732
Deferred revenue, net of current portion - 42
Other long-term liabilities 1,398 954
-------------- -------------
TOTAL LIABILITIES 84,057 35,861
-------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock; $0.01 par value; 3,000,000 shares authorized; none
issued - -
Common stock; $0.01 par value; 50,000,000 shares authorized; shares
issued of 18,945,959 and 15,732,038, respectively 189 157
Additional paid-in capital 140,850 109,565
Accumulated deficit (75,557) (76,070)
-------------- -------------
65,482 33,652
Less 618,969 and 594,990 shares, respectively,
of common stock held in treasury, at cost (3,138) (2,851)
-------------- -------------
TOTAL STOCKHOLDERS' EQUITY 62,344 30,801
-------------- -------------
TOTAL LIABILITES AND STOCKHOLDERS' EQUITY $ 146,401 $ 66,662
============== =============
See Notes to Consolidated Financial Statements.
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS,
EXCEPT SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ---------------------------------------
2004 2003 2004 2003
------------------ ------------------ ------------------ -----------------
(UNAUDITED) (UNAUDITED)
REVENUES $ 24,611 $ 13,582 $ 39,787 $ 26,711
--------------- --------------- --------------- --------------
COSTS and EXPENSES:
Costs of revenues, excluding
depreciation shown below 17,567 9,129 27,790 17,903
Selling and promotion costs 905 741 1,641 1,454
General and administrative expenses 1,881 1,506 3,258 2,869
Depreciation and amortization 2,117 1,473 3,710 2,889
--------------- --------------- --------------- --------------
22,470 12,849 36,399 25,115
--------------- --------------- --------------- --------------
INCOME FROM OPERATIONS 2,141 733 3,388 1,596
--------------- --------------- --------------- --------------
Interest income (37) (17) (80) (37)
Fees related to loans repaid 1,347 - 1,347 -
Interest expense 1,106 637 1814 1,230
--------------- --------------- --------------- --------------
2,416 620 3,081 1,193
--------------- --------------- --------------- --------------
INCOME (LOSS) (275) 113 307 403
BEFORE INCOME TAXES
Income tax (benefit) expense (13) 8 (206) 28
--------------- --------------- --------------- --------------
NET INCOME (LOSS) (262) 105 513 375
Accretion and dividends on redeemable
preferred stock - (2,501) - (4,949)
--------------- --------------- --------------- --------------
NET INCOME (LOSS) TO COMMON
STOCKHOLDERS $ (262) $ (2,396) $ 513 $ (4,574)
=============== =============== =============== ==============
BASIC INCOME (LOSS) PER SHARE:
Net income (loss) to common stockholders $ (0.01) $ (0.45) $ 0.03 $ (0.85)
=============== =============== =============== ==============
Weighted average number of common
shares outstanding 18,323,069 5,383,230 16,757,815 5,380,886
=============== =============== =============== ==============
DILUTED INCOME (LOSS) PER SHARE:
Net income (loss) to common stockholders $ (0.01) $ (0.45) $ 0.03 $ (0.85)
=============== =============== =============== ==============
Weighted average number of
common shares and share equivalents
outstanding 18,323,069 5,383,230 19,019,320 5,380,886
=============== =============== =============== ==============
See Notes to Consolidated Financial Statements.
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
(UNAUDITED, IN THOUSANDS)
COMMON ADDITIONAL ACCUMULATED TREASURY
SHARES PAR VALUE PAID IN CAPITAL DEFICIT STOCK AT COST TOTAL
------------ ------------- ---------------- ----------------- -------------- --------------
Balances,
December 31, 2003 15,732 $ 157 $ 109,565 $ (76,070) $ (2,851) $ 30,801
Exercises of stock options 34 1 342 - (287) 56
Issuance of a warrant - - 137 - - 137
Non- employee option
issued for services - - 30 - - 30
Shares issued in connection
with an acquisition 136 1 1,438 - - 1,439
Exercises of warrants 127 1 994 - - 995
Private placement of
common stock 2,917 29 28,344 - - 28,373
Net income - - - 513 - 513
------------ ---------- ------------ -------------- ----------- ------------
Balances,
June 30, 2004 18,946 $ 189 $ 140,850 $ (75,557) $ (3,138) $ 62,344
============ ========== ============ ============== =========== ============
See Notes to Consolidated Financial Statements.
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
-------------------------------------------
SIX MONTHS ENDED JUNE 30,
-------------------------------------------
2004 2003
-------------------- --------------------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 513 $ 375
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization 3,710 2,889
Accretion of discounted Debentures - 280
Unamortized fees related to loans repaid 1,097 -
Non-employee option and warrant issued 167 -
Interest on related party balances (5) (5)
Decrease (increase) in:
Trade accounts receivable (1,479) 1,550
Prepaid license fees and other current assets (732) (408)
Security deposits and other non-current assets (824) (111)
Increase (decrease) in:
Accounts payable 737 (355)
Income taxes payable 28 29
Accrued expenses (2,146) (274)
Payments on accrued loss on leased facilities (76) (74)
Deferred revenue and other liabilities (125) (195)
----------------- -----------------
Net cash provided by operating activities 865 3,701
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (748) (1,202)
Payment of purchase price and costs relating to acquisitions, net of cash acquired (39,087) (350)
Increase in deferred software costs (70) (61)
----------------- -----------------
Net cash used in investing activities (39,905) (1,613)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from a private equity placement 28,373 -
Proceeds from Term Loans 15,000 -
Proceeds from a private placement of convertible notes 57,900 -
Payment of costs related to the convertible notes and Term Loans (587) -
Repayment of Term Loans, other debt and capitalized leases (41,573) (1,049)
Exercises of stock options and warrants 1,051 44
----------------- -----------------
Net cash provided by (used in) financing activities 60,164 (1,005)
----------------- -----------------
Net cash provided by continuing operations 21,124 1,083
CASH FLOWS FROM DISCONTINUED OPERATIONS:
Payments on portion of accrued loss on leased facilities relating to
discontinued operations (27) (26)
----------------- -----------------
Net increase in cash and equivalents 21,097 1,057
Cash and equivalents, beginning of period 10,073 7,026
----------------- -----------------
Cash and equivalents, end of the period $ 31,170 $ 8,083
================= =================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 1,813 $ 220
================= =================
Income taxes $ 103 $ 103
================= =================
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITY:
Equipment acquired under capital leases $ 2,457 $ 1,512
================= =================
Common stock issued in connection with an acquisition $ 1,439 -
================= =================
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Treasury shares received in payment of a stock option exercise $ 287 $ -
================= =================
Additional Debentures issued in lieu of a cash payment of interest $ - $ 636
================= =================
See Notes to Consolidated Financial Statements.
INFOCROSSING, INC. AND SUBSIDIAIRES
NOTES TO THE CONSOLIDATED INTERIM
FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Infocrossing, Inc.
and its wholly owned subsidiaries (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated.
The consolidated balance sheets as of June 30, 2004, the consolidated statements
of operations for the three and six months ended June 30, 2004 and 2003, the
consolidated statements of cash flows for the six months ended June 30, 2004 and
2003, and the consolidated statement of stockholders' equity for the six months
ended June 30, 2004 have not been audited. In the opinion of management, all
adjustments (consisting of only normal recurring adjustments) necessary to
present fairly the financial position, results of operations, and cash flows for
the periods indicated have been made. The results of operations and cash flows
for the period ended June 30, 2004 is not necessarily indicative of the
operating results for the full year.
Certain reclassifications have been made to the prior periods to conform to the
current presentation.
Certain disclosures normally included in financial statements prepared in
accordance with U.S. generally accepted accounting principles have been
condensed or omitted. These consolidated interim financial statements should be
read in conjunction with the Company's Annual Report on Form 10-K for the year
ended December 31, 2003, as amended.
2. ACQUISITIONS
On April 2, 2004, the Company acquired all of the outstanding capital stock of
ITO Acquisition Corporation, a California corporation doing business as Systems
Management Specialists ("SMS"), from ITO Holdings, LLC ("Holdings") for
$34,589,000, $1,441,000 in related acquisition costs and 135,892 shares of
common stock of the Company valued at approximately $1,439,000 (the "SMS
Acquisition"). The value of the 135,892 shares was determined using the average
market price of the Company's common stock two days before and after March 4,
2004, when the terms of the acquisition were determined and announced. The
acquisition was accounted for using the purchase method of accounting and,
accordingly, the purchase price was allocated to the tangible and intangible
assets acquired and the liabilities assumed on the basis of their respective
fair values. In connection with the preliminary allocation of the purchase
price, goodwill of $40,660,000 and an intangible asset subject to amortization
in the amount of $1,650,000, relating to customer contracts and relationships,
was recorded. The intangible asset has an estimated useful life of five years.
SMS, headquartered in Orange County, California, provides computing operations,
business process outsourcing and managed application services to clients
primarily located in the western United States. Subsequent to the SMS
Acquisition, SMS continues to operate its business as a wholly-owned subsidiary
of the Company. The results of SMS are included with that of the Company for the
period subsequent to the SMS Acquisition.
The following table summarizes the preliminary fair values of the assets
acquired and the liabilities assumed at the date of the SMS Acquisition. The
Company is in the process of finalizing the fair value of certain assets, thus
the allocation of the purchase price is subject to adjustment.
APRIL 2, 2004
(IN THOUSANDS)
Accounts receivable $ 3,313
Other current assets 1,447
------------------
Total current assets 4,760
Property and equipment 4,033
Intangible assets subject to amortization 1,650
Other assets acquired 793
Goodwill 40,660
------------------
Total assets acquired 51,896
------------------
Accrued expenses and accounts payable (8,148)
Current capital leases (1,529)
Other current liabilities (87)
------------------
Total current liabilities (9,764)
Non-current liabilities (4,663)
------------------
Total liabilities assumed (14,427)
------------------
Purchase price $ 37,469
==================
The following unaudited condensed combined pro forma Statements of Operations
for the six month periods ended June 30, 2004 and 2003 give effect to the SMS
Acquisition and to the acquisition of certain of the assets, rights, properties,
and assumed obligations of Acxiom Corporation by SMS on June 30, 2003 as if they
all had occurred on the first day of each of the periods presented (January 1,
2004 and 2003).
The pro forma Statements of Operations may not be indicative of the results that
actually would have occurred had the transactions been in effect on the dates
indicated, nor does it purport to indicate the results that may be obtained in
the future.
CONSOLIDATED CONDENSED PRO FORMA STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED JUNE 30,
----------------------------------------
2004 2003
----------------- ------------------
Revenues $ 48,177 $ 46,000
Net loss $ (1,449) $ (2,051)
Net loss to common stockholders $ (1,449) $ (7,000)
Basic loss to common
stockholders per common share $ (0.09) (1.27)
============= ===============
Diluted loss to common
stockholders per common
share and share equivalents $ (0.09) $ (1.27)
============= ===============
Additions to goodwill reflect the excess of purchase price of acquired
businesses over net assets acquired.
3. STOCK-BASED COMPENSATION
The Company accounts for stock options granted to employees and directors under
the Company's 2002 Stock Option and Stock Appreciation Rights Plan in accordance
with Accounting Principles Board Opinion No. 25 and related Interpretations. No
compensation cost is reflected in the net income (loss) with respect to options
granted with an exercise price equal to the market value of the underlying
common shares on the date of the grant. Had compensation cost been determined in
accordance with Statement of Financial Accounting Standards No. 123 "Accounting
for Stock-Based Compensation", the Company's income (loss) in thousands of
dollars and income (loss) per common share for the three and six months ended
June 30, 2004 and 2003 would have been as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ---------------------------------------
2004 2003 2004 2003
------------------ ------------------ ------------------ -----------------
Net income (loss) to common
stockholders as reported $ (262) $ (2,396) $ 513 $ (4,574)
Deduct stock-based
employee compensation
determined under the
fair value method for all
awards (1,091) (704) (1,859) (1,433)
--------------- --------------- --------------- --------------
Pro forma $ (1,353) $ (3,100) $ (1,346) $ (6,007)
=============== =============== =============== ==============
Net income (loss) to common
stockholders per share:
Basic and diluted as
reported $ (0.01) $ (0.45) $ 0.03 $ (0.85)
=============== =============== =============== ==============
Basic and diluted, pro
forma $ (0.07) $ (0.54) $ (0.08) $ (1.12)
=============== =============== =============== ==============
4. NOTES PAYABLE
TERM LOANS
On October 21, 2003, in connection with the redemption of the Company's
redeemable preferred stock, the Company issued $25,000,000 of senior secured
term loans maturing in October 2008. These term loans were held by the prior
holders of the redeemable preferred stock. On February 13, 2004, the term loans
were purchased by a financial institution. The terms and conditions of the term
loans were not materially altered.
On April 2, 2004, the Company and the financial institution amended and restated
the term loan agreement (the "Amended Term Loan Agreement") to provide a portion
of the funding for the SMS Acquisition. The Amended Term Loan Agreement provided
for a Term Loan A facility with a maximum borrowing capacity of $25 million and
a Term Loan B facility with a maximum borrowing capacity of $15 million. The
Company borrowed $15 million under the Term Loan B facility and, along with
approximately $20 million from the private placement of the Company's common
stock on March 30, 2004 (see Note 6), completed the SMS Acquisition. Term Loan B
bore interest at the prime rate plus 3% with a floor of 9% and matured along
with the Term Loan A on October 21, 2008. The term loans included monthly
payments of interest beginning May 1, 2004 and monthly principal payments of
$312,500 beginning in December 2004. The Amended Term Loan Agreement was
guaranteed by each of the Company's subsidiaries. The Amended Term Loan
Agreement was also secured by a pledge of substantially all of the assets of the
Company and all of its subsidiaries.
On June 30, 2004, the Company repaid Term Loan A and Term Loan B in full, plus
interest accrued, from the proceeds of the private placement of convertible debt
described below, and the unamortized balance of $1,097 of deferred financing
costs were written off.
CONVERTIBLE DEBT
On June 30, 2004, the Company completed a private offering of $60 million
aggregate principal amount of 4.0% Convertible Senior Notes due July 15, 2024
(the "Notes"). Approximately $40 million of the net proceeds from this offering
were used to repay the term loans described above. The remaining balance will be
used to fund potential acquisitions and for general corporate purposes. On July
6, 2004, the initial purchaser exercised its option in full to purchase an
additional $12 million of the Notes. Net proceeds to the Company after the
additional purchase, net of discount, costs, and fees were approximately $69
million. Interest on the Notes is payable semi-annually in arrears beginning on
January 15, 2005.
Neither the Notes nor the shares of the Company's common stock into which they
will be convertible were registered under the Securities Act of 1933, as
amended, or any state securities laws, and they may not be offered or sold in
the United States absent registration or an applicable exemption from
registration requirements. On July 13, 2004, the Company filed a registration
statement on Form S-3 covering the resale of the Notes and the shares of the
Company's common stock into which they may be converted (the "Registration
Statement"). This registration statement is not effective as of August 13, 2004.
The Notes are convertible, subject to certain conditions, at the option of the
holder prior to maturity, into shares of the Company's common stock at a
specified conversion price, subject to certain adjustments. Upon conversion, the
Company will have the right to deliver to the holders, at the Company's option,
cash, shares of the Company's common stock, or a combination thereof. The
conversion price will be adjusted to reflect stock dividends, stock splits,
issuances of rights to purchase shares of common stock and other events. At the
initial conversion price of $15.36, the $72 million of Notes would be
convertible into 4,687,500 common shares. After the effective date of the
Registration Statement and prior to the end of the 18th month thereafter, if the
market price of the Company's common stock is less than 68.23% ($10.48
initially, subject to adjustment) of the conversion price then in effect for at
least 20 trading days during any 30 consecutive trading day period, the
conversion price shall immediately be reduced by 17.38% (to $12.69 initially,
subject to adjustment); provided that (i) this adjustment shall only be
applicable to Notes that have been sold or otherwise distributed pursuant to the
registration statement referred to above or pursuant to Rule 144(k) under the
Securities Act (and such adjustment shall apply to all such Notes, regardless of
whether they are so sold or distributed before or after adjustment), and (ii)
there shall be no more than one such reduction of the conversion price during
the term of the Notes.
The holders may convert their Notes into shares of the Company's common stock,
initially at the conversion price of $15.36 per share, equal to a conversion
rate of approximately 65.1042 shares per $1,000 principal amount of Notes, prior
to the close of business on their stated maturity date under any of the
following circumstances: (a) during any fiscal quarter if the market price per
share of the Company's common stock for a period of at least 20 consecutive
trading days during the 30 consecutive trading day period ending on the last day
of the preceding fiscal quarter is more than 130% of the applicable conversion
price; (b) on or before July 15, 2019, during the five business-day period
following any 10 consecutive trading-day period in which the trading price for
the Notes during such ten-day period was less than 98% of the applicable
conversion value (as described in the prospectus) for the Notes during that
period, subject to certain limitations; (c) if the Notes have been called for
redemption; or (d) upon the occurrence of specified corporate transactions. The
specified transactions include: (a) certain distributions to the Company's
common stockholders of rights to acquire shares of the Company's common stock at
a discount; (b) certain distributions to the Company's common stockholders when
the distribution has a per share value in excess of 5% of the market price of
the Company's common stock; and (c) a consolidation, merger or binding share
exchange pursuant to which the Company's common stock will be converted into
cash, securities or other property. Upon a "change of control," as defined in
the indenture, the holders can require the Company to repurchase all or part of
the Notes. A consolidation, merger, or binding exchange noted above also may
constitute a "change of control" in certain instances. If the "change of
control" occurs prior to July 15, 2009, in certain instances, the Company may be
required to pay a "make whole premium" when repurchasing the Notes.
The Company has a call option, pursuant to which it may redeem the Notes, in
part or in whole, for cash at any time on or after July 15, 2007 at a price
equal to 100% of the principal amount of the Notes, plus accrued interest plus a
"premium" if the redemption is prior to July 15, 2009, provided, however, the
Notes are only redeemable prior to July 15, 2009 if the market price of the
Company's common stock has been at least 150% of the conversion price then in
effect for at least 20 trading days during any 30 consecutive trading day
period. The "premium" referred to in the preceding sentence shall be in an
amount equal to $173.83 per $1,000 principal amount of Notes less the amount of
any interest actually paid on such Notes prior to the redemption date.
The holders of the Notes may require the Company to repurchase for cash all or a
portion of the Notes on July 15, 2009, 2014, and 2019 at a repurchase price
equal to 100% of the principal amount of the Notes plus any accrued interest.
As of June 30, 2004, the Company incurred costs and fees totaling $400,000 in
connection with the issuance of the Notes. These costs will be amortized using
the effective interest method over the twenty-year term of the Notes. The
$2,520,000 discount ($2,100,000 at June 30, 2004) will be accreted to the book
value of the Notes using the effective interest method over the same term. The
unamortized costs are included in Other Assets on the consolidated balance
sheet.
5. BASIC AND DILUTED EARNINGS PER COMMON SHARE
Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS
128") requires the presentation of basic and diluted earnings per share ("EPS").
Basic EPS is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during each period. Diluted
EPS is computed using the weighted average number of common shares plus the
dilutive effect of common stock equivalents. Common stock equivalents that are
antidilutive are excluded from the computation of weighted average share
equivalents.
Certain common stock equivalents that are currently antidilutive may be dilutive
in the future. In determining the diluted loss per common share for the
three-month periods ended June 30, 2004 and 2003, common stock equivalents of
approximately 690,000 and 3,167,000, respectively, have been excluded and, for
the six-month periods ended June 30, 2004 and 2003, common stock equivalents of
approximately 741,000 and 3,198,000, respectively, have been excluded, since the
effect of including such equivalents would have been antidilutive.
At its June 30 - July 1, 2004 meeting, the Emerging Issues Task Force of the
Financial Accounting Standards Board reached a tentative conclusion on EITF
Issue No. 04-08, "The Effect of Contingently Convertible Debt on Diluted
Earnings Per Share," about the accounting for contingently convertible debt
instruments, commonly referred to as CoCos. CoCos combine the features of
contingently issuable shares with a convertible debt instrument. The Notes
issued by the Company on June 30, 2004 are CoCos. These instruments generally
become convertible into common stock only if one or more specified events
occurs, such as the underlying common stock achieving a specified price target.
Under current interpretations of FASB Statement No. 128, Earnings per Share,
issuers of CoCos exclude the potential common shares underlying the CoCos from
the calculation of diluted earnings per share until the market price or other
contingency is met. When the contingency is met, generally the if-converted
method is used to calculate the dilutive impact of the instrument. Under the
if-converted method, the instrument is considered converted, with the resulting
number of shares included in the denominator of the earnings per share
calculation and the interest expense (net of tax) added back to the numerator of
the earnings per share calculation. While a traditional convertible debt
instrument may dilute earnings per share right away (application of the
"if-converted' method is required even if the conversion option is out of the
money), current accounting practice for CoCos avoids this dilution until a
specified contingency is met. The Task Force reached a tentative conclusion that
the contingently issuable shares guidance in Statement 128 does not apply to
convertible debt. As a result, the dilutive affect of contingently convertible
debt should be included in the calculation of diluted earnings per share
immediately upon issuance of the instrument (generally using the if-converted
method). This represents a significant change in practice and will affect the
Company. The Task Force tentatively concluded that its conclusion would be
applied by retroactively restating earnings per share. The proposed effective
date for Issue 04-08 has not been determined. Because the conclusions reached by
the EITF on Issue 04-08 are tentative and subject to further discussion and
approval by the FASB, the Company is continuing to analyze its impact on the
reporting of its earnings per share.
6. PRIVATE OFFERING OF SHARES
On March 30, 2004, in a private placement, the Company issued 2,917,000 shares
of common stock in exchange for net proceeds of $28,373,000. The private
placement was made only to accredited investors in a transaction exempt from the
registration requirements of the Securities Act of 1933. Investors who
participated in the private placement received certain registration rights with
respect to the common stock issued in the private placement. Approximately $20
million of the proceeds of the private placement were used to fund the SMS
Acquisition discussed in Note 2. The remaining balance of the amount raised will
be used for the payment of fees and expenses of the offering and for working
capital purposes. A registration statement on Form S-3 covering the shares
issued in the private placement became effective on June 10, 2004.
7. INCOME TAXES
In the period ended June 30, 2004, the Company recorded a tax benefit of
$234,000 from the sale of New Jersey State net operating loss carryforwards
("NOLs"), offset by estimated state income tax expense of $28,000. At December
31, 2003, the Company had NOLs of approximately $37.3 million for federal income
tax purposes that begin to expire in 2019. As a result of a recapitalization of
the Company's capital structure on October 21, 2003, the timing and use of these
NOLs in future years is expected to be limited in any one year. The Company's
net deferred tax assets, including the benefit from the NOLs, have been fully
offset by a valuation allowance due to the uncertainty of realizing such tax
benefits.
8. RELATED PARTY TRANSACTIONS
The initial purchaser of the Notes, described in Note 4 above, received
$2,100,000, representing 3.5% of the $60,000,000 principal amount of the
securities. In addition, the initial purchaser received $420,000 on the purchase
of the additional $12,000,000 in July 2004. An affiliate of the initial
purchaser beneficially owned 2.5% of the Company's common stock prior to the
offering and such affiliate acquired Notes as part of the offering. Following
the completion of the offering, the affiliate beneficially owned 5.8% and the
initial purchaser beneficially owned 4.7% of the Company's outstanding common
stock . Both the affiliate and the initial purchaser share the same common
parent.
9. SUBSEQUENT EVENTS
In July 2004, the Company established a $25 million non-revolving loan facility,
available for use in connection with the acquisition of complementary
businesses. Advances can be made during the first three years of the term of the
facility and interest will be payable monthly in arrears at prime plus 3.0%. The
interest rate floor is 8.5%. Monthly principal payments equal to 2.5% of the
outstanding balance will commence at the conclusion of the draw period and
continue until March 2009 when any remaining balance will be due. Advances are
subject to satisfying certain acquisition criteria and the approval of the
lenders. The Company paid a 1.0% commitment fee at the closing of the loan and
will pay a monthly unused-facility fee at the rate of 0.75% per annum until the
Company borrows more than $10 million on a cumulative basis. The Company may
incur prepayment penalties if it terminates the facility during the first 18
months or prepays any advance before the one-year anniversary of the applicable
borrowing date. The Company has not requested any advances under this facility.
On August 1, 2004, the Company acquired MailWatch, a provider of outsourced
e-mail security services, from EasyLink Services Corporation for consideration
consisting of $3,500,000 in cash and approximately $1,500,000 in stock.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management believes that we are a leading provider of information technology, or
IT, and business process outsourcing services to enterprise clients. We deliver
a full suite of managed and outsourced solutions that enable clients to leverage
our infrastructure and process expertise to improve their efficiency and reduce
their operating costs. During our nearly twenty year history, we have developed
expertise in managing complex computing environments, beginning with traditional
data center outsourcing services and evolving to a comprehensive set of managed
solutions. We support a variety of clients, and assure the optimal performance,
security, reliability, and scalability of our clients' mainframes, distributed
servers, and networks, irrespective of where the systems' components are
located. Strategic acquisitions have contributed significantly to our historical
growth and remain an integral component of our long-term growth strategy.
On April 2, 2004, we acquired all of the outstanding capital stock of ITO
Acquisition Corporation, a California corporation doing business as Systems
Management Specialists ("SMS"), from ITO Holdings, LLC ("Holdings") for a total
purchase price of approximately $37,469,000 including related acquisition costs
of $1,441,000 and 135,892 shares of common stock of the Company valued at
$1,439,000 (the "SMS Acquisition).
SMS, headquartered in Orange County, California, provides computing operations,
business process outsourcing and managed application services to clients
primarily located in the western United States. The operations of SMS are
included in consolidated operations for the entire second quarter.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
Net income declined by $367,000 from income of $105,000 for the three months
ended June 30, 2003 (the "Prior Year Quarter") to a loss of $262,000 for the
three months ended June 30, 2004 (the "Current Quarter") on 81% higher revenues.
For the Current Quarter, the results of operations include SMS and a one-time
acceleration of a charge of $1,347,000 for fees related to loans repaid relating
to 9.0% term loans of approximately $40 million. We repaid the term loans with a
portion of the proceeds received from the issuance of 4.0% Convertible Senior
Notes due July 15, 2024 (the "Notes").
For the Current Quarter, revenues increased $11,029,000 (81%) to $24,611,000
from $13,582,000 for the Prior Year Quarter. Approximately 16% of this growth is
attributable to new and expanded customer contracts added during the past twelve
months. The remainder, approximately $8,907,000, is attributable to revenues
from clients added in the SMS Acquisition.
Costs of revenues increased $8,438,000 (92%) to $17,567,000 during the Current
Quarter compared with $9,129,000 for the Prior Year Quarter. SMS represented
$7,278,000 of this increase. The balance of $1,160,000 is attributable to costs
related to new customer contracts added during the past twelve months and
increased revenue from certain existing customer contracts.
Selling and promotion costs increased $164,000 (22%) to $905,000 in the Current
Quarter from $741,000 for the Prior Year Quarter. SMS represents $158,000 of
this increase.
General and administrative expenses increased $375,000 (25%) to $1,881,000 for
the Current Quarter from $1,506,000 for the Prior Year Quarter. Without the
addition of SMS, our general and administrative expenses would have declined by
$123,000.
Depreciation and amortization of fixed assets and other intangibles increased
$644,000 (44%), from $1,473,000 for the Prior Year Quarter to $2,117,000 for the
Current Quarter. Depreciation of equipment and other fixed assets and
amortization of the value of intangible customer lists at SMS totaled $417,000.
Despite these increases, depreciation and amortization declined as a percentage
of revenues, from 11% in the Prior Year Quarter to 9% for the Current Quarter as
a result of the 81% increase in revenues.
Net interest expense of $2,416,000 was recorded for the Current Quarter compared
with $620,000 for the Prior Year Quarter. As a result of the repayment of the
term loans of approximately $40 million, discussed in Liquidity and Capital
Resources below, the unamortized balance of costs and expenses of $1,347,000
relating to the term loans was expensed at June 30, 2004. The remainder of the
net increase of $449,000 reflects an increase of $469,000 in interest expense,
due to a larger average outstanding debt balance than in the Prior Year Quarter,
offset by an increase in interest income of $20,000.
In the Current Quarter, we recorded an estimated state income tax benefit of
$13,000, compared with state income tax expense of $8,000 recorded in the Prior
Year Quarter. At December 31, 2003, we had Federal NOLs of approximately $37.3
million for federal income tax purposes that begin to expire in 2019. As a
result of our recapitalization on October 21, 2003, the timing and use of these
NOLs in future years is expected to be limited in any one year. The carrying
value of our net deferred tax assets, including the benefit from the NOLs, has
been fully offset by a valuation allowance due to the uncertainty of realizing
such tax benefits.
We had a net loss of $262,000 for the Current Quarter compared with income of
$105,000 for the Prior Year Quarter. The net loss for the Current Quarter
reflects the one-time acceleration of a charge of $1,347,000 for the unamortized
balance of costs and expenses relating to the 9.0% term loans of approximately
$40 million that were repaid during the Current Quarter. Net loss to common
stockholders after accretion and accrued dividends on preferred stock was
$2,396,000 for the Prior Year Quarter. On October 21, 2003, we redeemed all
outstanding preferred stock; therefore no accretion and dividends were recorded
in the Current Quarter. We had a loss per common share of $0.01 on both a basic
and diluted basis, compared with a loss of $0.45 per share for the Prior Year
Quarter, also on both a basic and diluted basis. The number of weighted average
shares increased from 5.4 million shares for the Prior Year Quarter to 18.3
million shares in the Current Quarter largely because of the issuance of 136,000
shares for the acquisition of SMS and private placements of (a) 9,739,111shares
of common stock and warrants to purchase 3,408,689 shares of common stock in
October 2003 and (b) 2,917,000 shares of common stock in March 2004. Common
stock equivalents are excluded in determining the net income or loss per share
when the inclusion of such equivalents would be antidilutive.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Net income improved by $138,000 from $375,000 for the six months ended June 30,
2003 (the "Prior Period") to income of $513,000 for the six months ended June
30, 2004 (the "Current Period") on 49% higher revenues. For the Current Period,
the results of operations include SMS from April 1, 2004 through June 30, 2004
and a one-time charge of $1,347,000 for fees related to loans repaid relating to
9.0% term loans of approximately $40 million. We repaid the term loans with a
portion of the proceeds received from the issuance of the Notes.
For the Current Period, revenues increased $13,076,000 (49%) to $39,787,000 from
$26,711,000 for the Prior Period. Approximately 16% of this growth is
attributable to new customer contracts added during the past twelve months and
increased revenue from certain existing customer contracts. The remainder,
approximately $8,907,000, is attributable to revenues from clients added in the
SMS Acquisition.
Costs of revenues increased $9,887,000 (55%) to $27,790,000 during the Current
Period compared with $17,903,000 for the Prior Period. SMS represented
$7,278,000 of this increase. The balance of $2,609,000 is attributable to
organic growth.
Selling and promotion costs increased $187,000 (13%) to $1,641,000 in the
Current Period from $1,454,000 for the Prior Period. SMS represents $158,000 of
this increase.
General and administrative expenses increased $389,000 (14%) to $3,258,000 for
the Current Period from $2,869,000 for the Prior Period. Without the addition of
SMS, our general and administrative expenses would have declined by $109,000.
Depreciation and amortization of fixed assets and other intangibles increased
$821,000 (28%) from $2,889,000 for the Prior Period to $3,710,000 for the
Current Period. Depreciation of equipment and other fixed assets and
amortization of the value of intangible customer lists at SMS totaled $417,000.
Despite these increases, depreciation and amortization declined as a percentage
of revenues, from 11% in the Prior Period to 9% for the Current Period as a
result of the 49% increase in revenues.
Net interest expense of $3,081,000 was recorded for the Current Period compared
with $1,193,000 for the Prior Period. As a result of the repayment of the term
loans of approximately $40 million, discussed in Liquidity and Capital Resources
below, the unamortized balance of costs and expenses of $1,347,000 relating to
the term loans was expensed during the Current Period. The remainder of the net
increase of $541,000 reflects an increase of $584,000 in interest expense, due
to a larger average outstanding debt balance than in the Prior Period, offset by
an increase in interest income of $43,000.
In the Current Period, we recorded a tax benefit of $234,000 from the sale of
New Jersey State net operating loss carryforwards ("NOLs"), offset by estimated
state income tax expense of $28,000, compared with state income tax expense of
$28,000 recorded in the Prior Period. At December 31, 2003, we had Federal NOLs
of approximately $37.3 million for federal income tax purposes that begin to
expire in 2019. As a result of our recapitalization on October 21, 2003, the
timing and use of these NOLs in future years is expected to be limited in any
one year. The carrying value of our net deferred tax assets, including the
benefit from the NOLs, has been fully offset by a valuation allowance due to the
uncertainty of realizing such tax benefits.
We had net income of $513,000 for the Current Period compared with $375,000 for
the Prior Period. Net income for the Current Period is after the one-time
acceleration of a charge of $1,347,000 for the unamortized balance of costs and
expenses relating to the 9.0% term loans of approximately $40 million that were
repaid during the Current Period. Net loss to common stockholders after
accretion and accrued dividends on preferred stock was $4,574,000 for the Prior
Period. On October 21, 2003, we redeemed all outstanding preferred stock;
therefore no accretion and dividends were recorded in the Current Period. We had
income per common share of $0.03 on both a basic and diluted basis, compared
with a loss of $0.85 per share for the Prior Period, also on both a basic and
diluted basis. The number of weighted average shares increased from 5.4 million
shares for the Prior Period to 16.8 million shares in the Current Quarter
largely because of the issuance of 136,000 shares for the acquisition of SMS and
private placements of (a) 9,739,111shares of common stock and warrants to
purchase 3,408,689 shares of common stock in October 2003 and (b) 2,917,000
shares of common stock in March 2004. The weighted average number of shares and
share equivalents was 19.0 million in the Current Period compared with 5.4
million shares in the Prior Period. Common stock equivalents are excluded in
determining the net income or loss per share when the inclusion of such
equivalents would be antidilutive.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was approximately $865,000 for the six
months ended June 30, 2004. During the Current Period, we had $513,000 of net
income, $3,710,000 of depreciation and amortization, and a charge of $1,097,000
to expense the unamortized balance of costs and expenses relating to the
repayment of approximately $40 million of 9.0% term loans. Significant working
capital uses during the Current Period include the payment of of accrued
expenses and accounts payable assumed in the SMS Acquisition, an increase of
$595,000 in prepaid expenses net of amortization, the recognition of deferred
revenue of $125,000, and $824,000 of costs relating to certain new clients that
are being amortized over the various contract terms. Uses of working capital
also include an increase in accounts receivable of $1,479,000. We expect our
balance of accounts receivable to increase as our revenues increase.
On April 2, 2004, we acquired all of the outstanding capital stock of ITO
Acquisition Corporation, a California corporation doing business as Systems
Management Specialists ("SMS"), from ITO Holdings, LLC ("Holdings") for
approximately $36 million in cash and costs and 135,892 shares of our common
stock. As described below, the cash portion of the purchase price was funded
with proceeds from a term loan and the issuance of common stock in a private
placement.
Other investing activities during the six months ended June 30, 2004 include
$748,000 for the purchase of property and equipment. During the Current Period,
we also entered into capital leases on equipment having an aggregate carrying
value of approximately $2,457,000.
In March 2004 we issued 2,917,000 shares of common stock in exchange for
$28,373,000 net of fees and expenses. The shares were issued in a private
placement to accredited investors in a transaction exempt from the registration
requirements of the Securities Act of 1933. Approximately $20 million of the
proceeds of the private placement were used to fund the acquisition of SMS,
discussed above. The remainder of the amount raised will be used for working
capital purposes. A registration statement on Form S-3 covering the resale of
the shares issued in the private placement became effective on June 10, 2004.
On October 21, 2003, in connection with the redemption of our redeemable
preferred stock, we issued $25 million of senior secured term loans maturing in
October 2008. These term loans were held by the prior holders of the redeemable
preferred stock. On February 13, 2004, the term loans were purchased by a
financial institution. The terms and conditions of the term loans were not
materially altered. On April 2, 2004, the term loan agreement was amended and
restated to provide a portion of the funding for the acquisition of SMS. On June
30, 2004, we repaid the outstanding balance on the term loans.
On June 30, 2004, we completed a private offering of $60 million aggregate
principal amount of 4.0% Convertible Senior Notes due July 15, 2024 (the
"Notes"). Approximately $40 million of the net proceeds from this offering were
used to repay the 9.0% term loans described above. The remaining balance will be
used to fund potential acquisitions and for general corporate purposes. On July
6, 2004, the initial purchaser exercised its option in full to purchase an
additional $12 million of the Notes. Net proceeds after discount, costs, and
fees were approximately $69 million. Interest on the Notes is payable
semi-annually in arrears beginning on January 15, 2005.
Offers and sales of the Notes were made only in the United States to qualified
institutional buyers in transactions exempt from the registration requirements
of the Securities Act of 1933, as amended. Neither the Notes nor the shares of
our common stock into which they will be convertible were registered under the
Securities Act of 1933, as amended, or any state securities laws, and they may
not be offered or sold in the United States absent registration or an applicable
exemption from registration requirements. On July 13, 2004, we filed a
registration statement on Form S-3 covering the resale of the Notes and the
shares of our common stock into which they may be converted (the "Registration
Statement"). This registration statement is not yet effective as of August 9,
2004.
The Notes are convertible, subject to certain conditions, at the option of the
holder prior to maturity, into shares of our common stock at a specified
conversion price, subject to certain adjustments. The conversion price will be
adjusted to reflect stock dividends, stock splits, issuances of rights to
purchase shares of common stock and other events. Upon conversion, we will have
the right to deliver to the holders, at our option, cash, shares of our common
stock, or a combination thereof. At the initial conversion price of $15.36, the
$72 million of Notes would be convertible into 4,687,500 common shares. After
the effective date of the Registration Statement and prior to the end of the
18th month thereafter, if the market price of our common stock is less than
68.23% ($10.48 initially, subject to adjustment) of the conversion price then in
effect for at least 20 trading days during any 30 consecutive trading day
period, the conversion price shall immediately be reduced by 17.38% (to $12.69
initially, subject to adjustment); provided that (i) this adjustment shall only
be applicable to Notes that have been sold or otherwise distributed pursuant to
the registration statement referred to above or pursuant to Rule 144(k) under
the Securities Act (and such adjustment shall apply to all such Notes,
regardless of whether they are so sold or distributed before or after
adjustment), and (ii) there shall be no more than one such reduction of the
conversion price during the term of the Notes.
The holders may convert their Notes into shares of our common stock, initially
at the conversion price of $15.36 per share, equal to a conversion rate of
approximately 65.1042 shares per $1,000 principal amount of Notes, prior to the
close of business on their stated maturity date under any of the following
circumstances: (1) during any fiscal quarter if the market price per share of
our common stock for a period of at least 20 consecutive trading days during the
30 consecutive trading day period ending on the last day of the preceding fiscal
quarter is more than 130% of the applicable conversion price; (2) on or before
July 15, 2019, during the five business-day period following any 10 consecutive
trading-day period in which the trading price for the Notes during such ten-day
period was less than 98% of the applicable conversion value for the Notes during
that period, subject to certain limitations; (3) if the Notes have been called
for redemption; or (4) upon the occurrence of specified corporate transactions.
The specified transactions include: (1) certain distributions to our common
stockholders of rights to acquire shares of our common stock at a discount; (2)
certain distributions to our common stockholders when the distribution has a per
share value in excess of 5% of the market price of our common stock; and (3) a
consolidation, merger or binding share exchange pursuant to which our common
stock will be converted into cash, securities or other property. Upon a "change
of control," as defined in the indenture, the holders can require us to
repurchase all or part of the Notes. A consolidation, merger, or binding
exchange described in (3) above also may constitute a "change of control" in
certain instances. If the "change of control" occurs prior to July 15, 2009, in
certain instances, we may be required to pay a "make whole premium" when
repurchasing the Notes. The amount of the "make whole premium" is set forth in
the indenture.
We have a call option, pursuant to which we may redeem the Notes, in part or in
whole, for cash at any time on or after July 15, 2007 at a price equal to 100%
of the principal amount of the Notes, plus accrued interest plus a "premium" if
the redemption is prior to July 15, 2009, provided, however, the Notes are only
redeemable prior to July 15, 2009 if the market price of our common stock has
been at least 150% of the conversion price then in effect for at least 20
trading days during any 30 consecutive trading day period. The "premium"
referred to in the preceding sentence shall be in an amount equal to $173.83 per
$1,000 principal amount of Notes, less the amount of any interest actually paid
on such Notes prior to the redemption date.
The holders of the Notes may require that we purchase for cash all or a portion
of the Notes on July 15, 2009, 2014, and 2019 at a repurchase price equal to
100% of the principal amount of the Notes plus any accrued interest.
Other financing activities during the Current Period included $1,409,000 in
payments of principal with respect to other debt and capital lease obligations
and the receipt of $1,051,000 from exercises of options and warrants.
In July 2004, we established a $25 million, non-revolving loan facility,
available for use in connection with the acquisition of complementary
businesses. Advances can be made during the first three years of the term of the
facility and interest will be payable monthly in arrears at prime plus 3.0%. The
interest rate floor is 8.5%. Monthly principal payments equal to 2.5% of the
outstanding balance will commence at the conclusion of the draw period and
continue until March 2009 when any remaining balance will be due. Advances are
subject to satisfying certain acquisition criteria and the approval of the
lenders. We paid a 1.0% commitment fee at the closing of the loan and will pay
an unused facility fee at the rate of 0.75% per annum until we borrow more than
$10 million on a cumulative basis. We may incur prepayment penalties if we
terminate the facility during the first 18 months or prepay any advance prior to
the prior to the one year anniversary of the applicable borrowing date. We have
not requested any advances under this facility.
On August 1, 2004, we acquired MailWatch, a provider of outsourced e-mail
security services, from EasyLink Services Corporation for consideration
consisting of $3,500,000 in cash and approximately $1,500,000 in stock.
EBITDA
EBITDA represents net income before interest, taxes, depreciation and
amortization. We present EBITDA because we consider such information an
important supplemental measure of our performance and believe it is frequently
used by securities analysts, investors and other interested parties in the
evaluation of companies with comparable market capitalization to us, many of
which present EBITDA when reporting their results. We also use EBITDA as one of
the factors used to determine the total amount of bonuses available to be
awarded to executive officers and other employees. Our credit agreement uses
EBITDA (with additional adjustments) to measure compliance with covenants such
as interest coverage and debt incurrence. EBITDA is also used by prospective and
current lessors as well as potential lenders to evaluate potential transactions
with us. In addition, EBITDA is also widely used by the Company and other buyers
to evaluate and price potential acquisition candidates.
For the three and six months ended June 30, 2004, our EBITDA was $4,258,000 and
$7,098,000, respectively, compared with $2,206,000 and $4,485,000 for the three
and six-month periods ended June 30, 2003, respectively.
EBITDA has limitations as an analytical tool, and you should not consider it in
isolation, or as a substitute for analysis of our results as reported under U.S.
Generally Accepted Accounting Principles ("GAAP"). Some of these limitations
are: (a) EBITDA does not reflect changes in, or cash requirements for, our
working capital needs; (b) EBITDA does not reflect the significant interest
expense, or the cash requirements necessary to service interest or principal
payments, on our debts; and (c) Although depreciation and amortization are
non-cash charges, the assets being depreciated and amortized may have to be
replaced in the future, and EBITDA does not reflect any cash requirements for
such capital expenditures. Because of these limitations, EBITDA should not be
considered as a principal indicator of our performance. We compensate for these
limitations by relying primarily on our GAAP results and using EBITDA only
supplementally.
The reconciliation of EBITDA with net income for the three and six-month periods
ended June 30, 2004 and 2003 is as follows (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
--------------- -------------- -------------- --------------
NET INCOME (LOSS) $ (262) $ 105 $ 513 $ 375
Add (deduct):
Income tax provision (benefit) (13) 8 (206) 28
Net interest expense 2,416 620 3,081 1,193
Depreciation and amortization 2,117 1,473 3,710 2,889
------------ ----------- ----------- -----------
EBITDA $ 4,258 $ 2,206 $ 7,098 $ 4,485
============ =========== =========== ===========
EBITDA is a measure of our performance that is not required by, or presented in
accordance with, GAAP. EBITDA is not a measurement of our financial performance
under GAAP and should not be considered as an alternative to net income, income
(loss) from operating activities or any other performance measures derived in
accordance with GAAP.
As of June 30, 2004, we had cash and equivalents of $31,170,000. We believe that
our cash and equivalents, current assets, and cash generated from future
operating activities will provide adequate resources to fund our ongoing
operating requirements for at least the next twelve months. We may need to
obtain additional financing to fund significant acquisitions or other
substantial investments.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
Our Consolidated Financial Statements are prepared in accordance with accounting
principles generally accepted in the United States, which require the selection
and application of significant accounting policies, and which require management
to make significant estimates and assumptions. We believe that the following are
some of the more critical judgment areas in the application of our accounting
policies.
Revenue Recognition
Our services are provided under a combination of fixed monthly fees and time and
materials billings. Contracts with customers typically range from one to five
years. Revenue is recognized (1) after we have obtained an executed service
contract from the customer; (2) as the services are rendered; (3) when the price
is fixed as per the service contract; and (4) when we believe that
collectibility is reasonably assured based on our credit risk policies and
procedures that we employ.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
Tangible and Intangible Assets
We have significant tangible and intangible assets on our balance sheet,
primarily property and equipment, deferred software costs, and intangible
assets, primarily goodwill, related to acquisitions. The assignment of useful
lives to these assets and the valuation and classification of intangible assets
involves significant judgments and the use of estimates. The testing of these
tangible and intangibles under established accounting guidelines for impairment
also requires significant use of judgment and assumptions. Our assets are tested
and reviewed for impairment on an ongoing basis under the established accounting
guidelines. Changes in business conditions or changes in the decisions of
management as to how assets will be deployed in our operations could potentially
require future adjustments to asset valuations.
Deferred Taxes
A tax valuation allowance is established, as needed, to reduce net deferred tax
assets to the amount for which recovery is probable. As of June 30, 2004, we
have established a full valuation allowance against our net deferred tax assets
because of our history of operating losses. Depending on the amount and timing
of taxable income we may generate in the future, as well as other factors
including limitations that may arise from changes in our ownership, we could
recognize no benefit from our deferred tax assets, or we could recognize some or
all of their full value.
Earnings per Share
At its June 30 - July 1, 2004 meeting, the Emerging Issues Task Force of the
Financial Accounting Standards Board reached a tentative conclusion on EITF
Issue No. 04-08, "The Effect of Contingently Convertible Debt on Diluted
Earnings Per Share," about the accounting for contingently convertible debt
instruments, commonly referred to as CoCos. CoCos combine the features of
contingently issuable shares with a convertible debt instrument. The Notes
issued by the Company on June 30, 2004 are CoCos. These instruments generally
become convertible into common stock only if one or more specified events
occurs, such as the underlying common stock achieving a specified price target.
Under current interpretations of FASB Statement No. 128, Earnings per Share,
issuers of CoCos exclude the potential common shares underlying the CoCos from
the calculation of diluted earnings per share until the market price or other
contingency is met. When the contingency is met, generally the if-converted
method is used to calculate the dilutive impact of the instrument. Under the
if-converted method, the instrument is considered converted, with the resulting
number of shares included in the denominator of the earnings per share
calculation and the interest expense (net of tax) added back to the numerator of
the earnings per share calculation.
While a traditional convertible debt instrument may dilute earnings per share
right away (application of the "if-converted' method is required even if the
conversion option is out of the money), current accounting practice for CoCos
avoids this dilution until a specified contingency is met. The Task Force
reached a tentative conclusion that the contingently issuable shares guidance in
Statement 128 does not apply to convertible debt. As a result, the dilutive
affect of contingently convertible debt should be included in the calculation of
diluted earnings per share immediately upon issuance of the instrument
(generally using the if-converted method). This represents a significant change
in practice and will affect the Company. The Task Force tentatively concluded
that its conclusion would be applied by retroactively restating earnings per
share.
The proposed effective date for Issue 04-08 has not been determined. Because the
conclusions reached by the EITF on Issue 04-08 are tentative and subject to
further discussion and approval by the FASB, the Company is continuing to
analyze its impact on the reporting of earnings per share.
FORWARD-LOOKING STATEMENTS
Statements made in this Report, including the foregoing financial statements and
notes, other than statements of historical fact, are forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, that involve risks and uncertainties. These statements relate to future
events or our future financial performance, including statements relating to
products, customers, suppliers, business prospects and effects of acquisitions.
In some cases, forward-looking statements can be identified by terminology such
as "may," "will," "should," "expect," "anticipate," "intend," "plan," "believe,"
"estimate," "potential," or "continue," the negative of these terms or other
comparable terminology. These statements involve a number of risks and
uncertainties and as such, final results could differ from estimates or
expectations due to a number of factors including, without limitation:
incomplete or preliminary information; changes in government regulations and
policies; continued acceptance of our products and services in the marketplace;
competitive factors; new products; technological changes; our dependence on
third party suppliers; intellectual property rights; difficulties with the
integration of ITO Acquisition Corporation, d/b/a Systems Management
Specialists; and other risks and uncertainties including those set forth in this
Report that could cause actual events or results to differ materially from any
forward-looking statement. For any of these factors, we claim the protection of
the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995, as amended.
You are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Report and are based on
information currently and reasonably known to us. Except as required by law, we
undertake no obligation to release any revisions to or update these
forward-looking statements to reflect events or circumstances that occur after
the date of this Report or to reflect the occurrence or effect of anticipated or
unanticipated events.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We are not exposed to material gains or losses related to the impact of interest
rate changes, foreign currency fluctuations, or changes in the market values of
our investments. We generally invest in fixed income securities - typically
commercial paper, certificates of deposit, and money market accounts issued only
by major corporations and financial institutions of recognized strength and
security - and hold all investments to maturity.
At June 30, 2004, our outstanding fixed rate debt was approximately $60,000,000
with interest payable semi-annually at 4%. If market rates decline, we run the
risk that the related required payments on the fixed rate debt will exceed those
that would be paid based on then current market rates.
Market Risk
Our accounts receivable are subject, in the normal course of business, to
collection risks. We regularly assess these risks and have policies and business
practices to mitigate the adverse effects of collection risks. As a result, we
do not anticipate any material losses in this area in excess of the recorded
allowance for doubtful accounts.
Foreign Currency Risks
We have no material foreign operations.
ITEM 4 - CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
our management, including the Chief Executive Officer and Senior Vice President
of Finance, of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on that evaluation, our management, including the Chief Executive Officer
and the Senior Vice President of Finance, concluded that our disclosure controls
and procedures were effective as of June 30, 2004. There have been no changes in
our internal control over financial reporting that occurred during our last
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY
SECURITIES
(c) Recent Issuances of Unregistered Securities
On April 2, 2004, in connection with the acquisition of ITO Acquisition
Corporation, doing business as Systems Management Specialists ("SMS"), from ITO
Holdings, LLC ("Holdings"), Holdings was issued 135,892 restricted shares of the
common stock of the Company as a portion of the purchase price. This transaction
is exempt from registration pursuant to Section 4(2) of the Securities Act of
1933.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders held on June 15, 2004, the stockholders
elected two directors for a three-year term. The votes were as follows:
FOR WITHHELD
Kathleen A. Perone 14,790,122 204,167
Michael B. Targoff 14,790,122 204,167
Messrs. Zach Lonstein, Robert B. Wallach, Patrick A. Dolan, and Howard L.
Waltman have terms expiring in 2005 and beyond and continue as directors of the
Company.
The stockholders also approved, by a vote of 10,965,397 for and 964,845 against
with 438 abstaining to increase the total number of shares of common stock for
which options may be granted under the Company's 2002 Stock Option and Stock
Appreciation Rights Plan from 1,000,000 to 3,000,000 shares.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
2 Stock Purchase Agreement between the Company and ITO Holdings, LLC,
dated as of March 3, 2004, incorporated by reference to Exhibit 2.1 to
a Current Report on Form 8-K filed April 7, 2004.
3.1A Restated Certificate of Incorporation, incorporated by reference to
Exhibit 3.1 to the Company's Form 10-KSB for the period ended October
31, 1999.
3.1B Certificate of Amendment to the Company's Certificate of
Incorporation, filed May 8, 2000, to increase the authorized shares
and to remove Article 11, incorporated by reference to the Company's
report on Form 10-Q for the period ended April 30, 2000.
3.1C Certificate of Amendment to the Company's Certificate of
Incorporation, filed as of June 5, 2000, to change the name of the
Company to Infocrossing, Inc., incorporated by reference to the
Company's report on Form 10-Q for the period ended April 30, 2000.
3.2 By-Laws, as amended, incorporated by reference to Exhibit 3.2 to the
Company's Form 10-Q/A filed May 17, 2004.
4.1 Securities Purchase Agreement, dated as of March 24, 2004, by and
among the Company and certain purchasers of the Company's common
stock, incorporated by reference to Exhibit 4.1 to a Current Report on
Form 8-K filed April 1, 2004.
4.2 Registration Rights Agreement, dated as of March 24, 2004, by and the
Company and certain purchasers of the Company's common stock,
incorporated by reference to Exhibit 4.2 to a Current Report on Form
8-K filed April 1, 2004.
4.3 Indenture, dated as of June 30, 2004, between the Company as issuer
and Wells Fargo Bank, National Association, as trustee; and form of
4.00% Convertible Senior Notes due 2024, incorporated by reference to
a Registration Statement on Form S-3 filed July 13, 2004.
4.4 Resale Rights Agreement, dated as of June 30, 2004, by and between the
Company and Lehman Brothers, Inc. regarding the Company's 4.00%
Convertible Senior Notes due 2024.
10.1 Amended and Restated Term Loan Agreement, dated as of April 2, 2004
between the lenders named therein and the Company, incorporated by
reference to Exhibit 10.1 to a Current Report on Form 8-K filed April
7, 2004.
10.2 Guaranty and Security Agreement, dated as of April 2, 2004, between
SMS and CapitalSource, incorporated by reference to Exhibit 10.2 to a
Current Report on Form 8-K filed April 7, 2004.
10.3 Amended and Restated Stock Pledge Agreement, dated as of April 2,
2004, among the Company, Amquest, Inc. and CapitalSource, incorporated
by reference to Exhibit 10.3 to a Current Report on Form 8-K filed
April 7, 2004.
10.4 Employment Agreement, dated as of April 2, 2004, by and between the
Company and Patrick A. Dolan, incorporated by reference to Exhibit
10.4 to a Current Report on Form 8-K filed April 7, 2004.
10.5 Employment Agreement, dated as of April 2, 2004, by and between the
Company and Jim Cortens, incorporated by reference to Exhibit 10.5 to
a Current Report on Form 8-K filed April 7, 2004.
10.6 Amendment to Amended and Restated Credit Agreement, dated as of June
30, 2004, between the lenders named therein and the Company,
incorporated by reference to a Registration Statement on Form S-3
filed July 13, 2004
(a) Exhibits (continued):
10.7 Acquisition Loan Agreement dated July 29, 2004 between the Company,
various Lenders and CapitalSource Finance LLC as Agent for the
Lenders.
10.8 Guarantee and Security Agreement dated as of July 29, 2004, between
the Company and certain of the Company's subsidiaries and
CapitalSource Finance LLC.
10.9 Stock Pledge Agreement Dated as of July 29, 2004, between the Company
and certain of the Company's subsidiaries and CapitalSource Finance
LLC.
14 Code of Ethics, incorporated by reference to the Company's definitive
Proxy Statement filed on April 29, 2004.
31 Certifications required by Rule 13a-14(a) to be filed.
32 Certifications required by Rule 13a-14(b) to be furnished but not
filed.
(b) Reports on Form 8-K
On April 1, 2004, the Company announced the closing of the $30.6 million
private placement of securities previously reported on March 26, 2004.
On April 7, 2004, the Company announced the closing of the acquisition of
ITO Acquisition Corporation previously reported on March 4, 2004.
On May 17, 2004, the Company released earnings for the first quarter of
2004.
On June 10, 2004, the Company amended the Form 8-K filed on April 7, 2004
to add financial statements and pro forma financial information.
On June 23, 2004, the Company announced guidance for the remainder of
2004 and for 2005.
On June 23, 2004, the Company announced a proposal to issue up to $72
million of Convertible Senior Notes due 2024.
On June 30, 2004, the Company announced the closing of $60 million of the
Convertible Senior Notes at 4%.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
INFOCROSSING, INC.
August 13, 2004 /s/ ZACH LONSTEIN
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Zach Lonstein
Chairman & Chief Executive Officer
August 13, 2004 /s/ WILLIAM J. McHALE
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William J. McHale
Senior Vice President of Finance