UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB/A QUARTERLY REPORT
x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended August 31, 2005
o Transition Report pursuant to 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 000-31090
SYSTEMS EVOLUTION INC.
(Exact name of Small Business Issuer as specified in its charter)
Idaho | 82-0291029 |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
10777 Westheimer Road, Suite 810
(Address of principal executive offices)
713-979-1600
Issuer's telephone number
None
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 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.
(1) x Yes o No
(2) x Yes o No
The number of shares of issuer's Common Stock outstanding as of October 27, 2005:
94,253,114 shares
SYSTEMS EVOLUTION INC.
INDEX
QUARTERLY REPORT ON FORM 10-QSB/A
FOR QUARTERLY PERIOD ENDED August 31, 2005
PART I. FINANCIAL INFORMATION
ITEM 1 - Unaudited Consolidated Financial Statements
a. | Consolidated Balance Sheet as of August 31, 2005 (Unaudited) and May 31, 2005 |
b. | Consolidated Statements of Operations for the Three Months Ended August 31, 2005 and 2004 (Unaudited) |
c. | Consolidated Statements of Cash Flows for the Three Months Ended August 31, 2005 and 2004 (Unaudited) |
ITEM 2 - Management's Discussion and Analysis
ITEM 3 - Controls and Procedures
PART II. OTHER INFORMATION
ITEM 6 - Exhibits
SIGNATURES
This amendment to the Form 10-QSB for the period ended August 31, 2005, as previously filed on October 27, 2005 includes restated financial statements to properly reflect derivative accounting for warrants issued to consultants, the conversion features of the convertible notes payable and associated warrants.
Warrants issued to consultants and the warrants associated with the Convertible Notes payable have been accounted for as freestanding derivative liabilities instead of equity as was originally filed. Additionally, the embedded conversion options of the convertible notes payable have been bifurcated from the debt and accounted for separately as derivative liabilities instead of equity as was originally filed. We have added notes 6 and 7 further explaining the derivative liabilities and provided information on subsequent changes.
We are required to record the fair value of the embedded conversion options and the warrants on our balance sheet with changes in the values of these derivatives reflected in the consolidated statement of operations as “Gain (loss) on derivative liabilities.” The effect on our consolidated statement of operations for the quarter ended August 31, 2005, was a decrease in our net loss of $70,779. The cumulative effect on our consolidated balance sheet as of August 31, 2005 was an additional liability of $5,345,527 and a decrease in stockholders' equity of $3,789,178.
In all other material respects, this Amended Quarterly Report on Form 10-QSB/A is unchanged from the Quarterly Report on Form 10-QSB previously filed by the Company. This amendment should also be read in conjunction with our amended Annual Report on Form 10-KSB/A for the fiscal year ended May 31, 2005.
PART I. FINANCIAL INFORMATION
SYSTEMS EVOLUTION, INC.
August 31, 2005 and May 31, 2005
August 31, 2005 | May 31, | ||||||
(Unaudited) | 2005 | ||||||
(Restated) | |||||||
ASSETS | |||||||
Current Assets | |||||||
Cash | $6,300 | $66,060 | |||||
Accounts receivable, net of allowance for doubtful accounts of $23,341 | 379,445 | 319,612 | |||||
Unbilled revenue | 455,935 | 476,541 | |||||
Prepaid expenses and other current assets | 60,406 | 71,580 | |||||
Total Current Assets | 902,086 | 933,793 | |||||
Unamortized debt issue costs | 5,298,540 | 5,331,382 | |||||
Other assets | 14,694 | 8,971 | |||||
Furniture and equipment, net of accumulated depreciation of $147,649 and $132,361, respectively | 127,926 | 127,330 | |||||
Goodwill | 1,231,648 | 1,231,648 | |||||
Intangibles, net of $830,556 and $650,847 amortization and impairment, respectively | 1,481,955 | 1,661,664 | |||||
TOTAL ASSETS | $9,056,849 | $9,294,788 | |||||
LIABILITIES AND STOCKHOLDERS' DEFICIT | |||||||
Current Liabilities | |||||||
Accounts payable | $401,236 | $281,702 | |||||
Accrued expenses | 345,742 | 242,345 | |||||
Deferred revenue | 5,342 | 15,509 | |||||
Notes payable | 60,490 | 50,096 | |||||
Notes payable - related parties | 10,000 | - | |||||
Derivative liability | 6,392,293 | 5,731,053 | |||||
Total Current Liabilities | 7,215,103 | 6,320,705 | |||||
Convertible notes, net of unamortized discount of $3,031,003 | 43,997 | 23,544 | |||||
Long-term debt - related parties | 134,494 | 133,599 | |||||
Total Liabilities | 7,393,594 | 6,477,848 | |||||
STOCKHOLDERS' EQUITY | |||||||
Common stock, no par value, 750,000,000 shares authorized, 89,133,114 and 82,471,423 shares issued and outstanding, respectively | 7,469,086 | 7,297,683 | |||||
Accumulated deficit | (5,805,831 | ) | (4,480,743 | ) | |||
Total Stockholders' Equity | 1,663,255 | 2,816,940 | |||||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $9,056,849 | $9,294,788 |
SYSTEMS EVOLUTION, INC.
Three Months Ended August 31, 2005 and 2004
(unaudited)
Three Months Ending August 31, | |||||||
2005 (Restated) | 2004 | ||||||
Revenues | $1,355,388 | $232,629 | |||||
Cost of Goods Sold | 498,240 | - | |||||
Gross Profit | 857,148 | 232,629 | |||||
Operating Expenses: | |||||||
Payroll and related costs | 1,009,826 | 303,865 | |||||
General, administrative, and selling | 160,294 | 1,655,631 | |||||
Depreciation & amortization | 194,996 | 28,150 | |||||
Operating loss | (507,968 | ) | (1,755,017 | ) | |||
Interest income | 1,111 | ||||||
Interest expense | (156,621 | ) | (11,947 | ) | |||
Other costs | (370 | ) | - | ||||
Gain (loss) on derivative liabilities | (661,240 | ) | - | ||||
Net loss | $(1,325,088 | ) | $(1,766,964 | ) | |||
Basic and diluted loss per share | $(0.02 | ) | $(0.03 | ) | |||
Basic and diluted weighted average shares outstanding | 86,381,546 | 54,637,571 |
SYSTEMS EVOLUTION, INC.
For the Three Months Ended August 31, 2005 and 2004
(unaudited)
2005 (Restated) | 2004 | |||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||
Net loss | $ | (1,325,088) | $ | (1,766,964) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||
Derivative gain / (loss) | 661,240 | - | ||||
Depreciation and amortization | 194,996 | 28,150 | ||||
Amortization of discount on notes payable | 20,453 | |||||
Amortization of deferred financing costs | 32,842 | |||||
Shares issued for services | 165,403 | 137,000 | ||||
Stock options and warrant expense | - | 1,387,550 | ||||
Bad debt expense | - | 13,627 | ||||
Changes in: | ||||||
Accounts receivable | (59,833) | (20,210) | ||||
Prepaid expenses and current assets | 31,780 | (22,684) | ||||
Other assets | (5,723) | - | ||||
Accounts payable | 125,534 | 226,558 | ||||
Accrued expenses | 104,292 | (26,136) | ||||
Accrued expenses | (10,167) | - | ||||
NET CASH USED IN OPERATING ACTIVITIES | (64,271) | (43,079) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||
Cash received in CMS acquisition, net of $10,000 paid | - | 3,723 | ||||
Purchase of equipment | (2,500) | - | ||||
NET CASH PROVIDED BY INVESTING ACTIVITIES | (2,500) | 3,723 | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||
Proceeds from notes payable and long-term debt - related parties | 17,011 | |||||
Payments on notes payable and long-term debt | (10,000) | (14,943) | ||||
Proceeds from notes payable and long-term debt | - | 22,527 | ||||
Common stock issued for cash | - | 12,250 | ||||
NET CASH PROVIDED BY FINANCING ACTIVITIES | 7,011 | 19,834 | ||||
NET CHANGE IN CASH | (59,760) | (19,522) | ||||
- Cash, beginning of period | $ | 66,060 | (19,522) | |||
- Cash, end of period | $ | 6,300 | $ | - | ||
SUPPLEMENTAL CASH FLOW INFORMATION: | ||||||
Interest paid | $ | - | $ | 11,947 | ||
Income Taxes paid | - | - | ||||
NON-CASH INVESTING AND FINANCING ACTIVITIES: | ||||||
Common stock issued for acquisition of CMS | $ | - | $ | 104,000 | ||
Common stock issued for computer equipment | - | 52,070 | ||||
SYSTEMS EVOLUTION INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2005
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited interim financial statements of Systems Evolution Inc. ("SEVI") have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission ("SEC"), and should be read in conjunction with the audited financial statements and notes thereto contained in the SEVI's Annual Report filed with the SEC on Form 10-KSB. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited financial statements for fiscal 2005 as reported in the 10-KSB have been omitted.
Impairment of Long-Lived Assets - SEVI reviews the carrying value of its long-lived assets annually or whenever events or changes in circumstances indicate that the historical cost-carrying value of an asset may no longer be appropriate. SEVI assesses recoverability of the carrying value of the asset by estimating the future net cash flows expected to result from the asset, including eventual disposition. If the future net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and fair value.
Reclassifications. Certain prior year amounts have been reclassified to conform with the current year presentation.
NOTE 2 - STOCK BASED COMPENSATION
SEVI accounts for stock-based compensation under the intrinsic value method. Under this method, SEVI recognizes no compensation expense for stock options granted when the number of underlying shares is known and exercise price of the option is greater than or equal to the fair market value of the stock on the date of grant. The following table illustrates the effect on net loss and net loss per share if SEVI had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three months ended August 31, 2005 and 2004:
Three Months Ending August 31, | |||||||
2005 | 2004 | ||||||
(Restated) | |||||||
Net loss as reported | $(1,325,088 | ) | $(1,766,964 | ) | |||
Add: intrinsic value expense recorded | - | 277,550 | |||||
Deduct: total stock-based employee compensation expense determined under fair value based method | - | (426,568 | ) | ||||
Pro forma net loss | $(1,325,088 | ) | $(1,915,982 | ) | |||
Basic and diluted net loss per common share: | |||||||
As reported | $(0.02 | ) | $(0.03 | ) | |||
Pro forma | (0.02 | ) | (0.04 | ) |
The fair value of each option granted is estimated on the date of grant using the Cox-Ross-Rubenstein option-pricing model with the following weighted average assumptions: (1) 1.5% risk-free interest rate, (2) expected option life is the actual remaining life of the options as of each year end, (3) expected volatility is from 181% to 781% and (4) zero expected dividends.
NOTE 3 - CONVERTIBLE NOTES
During 2005, SEVI issued a total of $3,075,000 in convertible promissory notes pursuant to private placements. Promissory notes for $1,825,000 are onvertible at the holder’s option into SEVI common stock at $0.05 per share, accrue interest at 8% per annum, and have 36,500,000 warrants attached to them. These warrants were denominated as Series A, B, C, and D warrants. The folloing table summarizes each series.
Series | Number of Shares | Exercise Price | Expiration |
A | 9,125,000 | $0.06 | 90 days from registration of underlying common shares |
B | 9,125,000 | $0.07 | 180 days from registration of underlying common shares |
C | 9,125,000 | $0.08 | 270 days from registration of underlying common shares |
D | 9,125,000 | $0.15 | August 31, 2009 |
36,500,000 |
Promissory notes for $1,500,000 are convertible ar the holders’ option into SEVI common stock at the lesser of 50% of the average of the three lowest trading prices 20 days prior to one day before the holder sends the conversion notice to SEVI or $0.13 per share, accrue interest at 8% per annum, and have 4,500,000 warrants attached to them. The exercise price of the warrants is $0.08 per share. The warrants are exercisable for 5 years. Accrued interest and principal are due at maturity. $500,000 matures on December 30, 2006, $500,000 matures on January 14, 2007, and $250,000 matures on April 28, 2007.
The notes have been discounted for the fair value of the embedded conversion options and freestanding warrants accounted for as derivatives. All discounts will be amortized over the life of the notes using the effective interest method. The fair values of the derivatives were calculated using the Cox-Ross-Rubestein model. See note 7 for more information on the derivatives. Variables used in the Cox-Ross-Rubenstein model include (1) 2.75% to 3.84% risk-free interest rate, (2) expected volatility of 125% and (3) zero expected dividends.
A summary of the convertible notes at August 31, 2005 and May 31, 2005 is as follows:
August 31, 2005 | May 31, 2005 | |||||
Gross proceeds from notes | $3,075,000 | $3,075,000 | ||||
Less: Value of derivatives | (3,075,000 | ) | (3,075,000 | ) | ||
Less: Retirement of debt for stock | - | - | ||||
Add: Amortization of discounts | 43,997 | 23,544 | ||||
Carrying value of note on August 31, 2005 | $43,997 | $23,544 | ||||
Less: Current portion | - | - | ||||
Long-term convertible notes, net | $43,997 | $23,544 |
NOTE 4 - COMMON STOCK
During the three months ending August 31, 2005, SEVI issued the following shares:
· | In July 2005, SEVI issued 6,361,691 shares per a board resolution to offer restricted SEVI shares in exchange for all vested options in a one for one exchange (one vested option for one restricted SEVI share) as of May 31, 2005 for those still employed by SEVI as of June 30th, 2005. SEVI received a signed agreement from all option holders in order to receive the Share Grant that stipulates the Holder agrees to give up all un-vested options; these agreements amended all employment contracts then in force as of May 31, 2005. |
· | In July 2005, SEVI issued 300,000 shares valued at $6,000 to directors of SEVI as of December 2004. |
During the three months ended August 31, 2004, SEVI issued the following shares:
· | 32,258 shares of common stock sold for proceeds totaling $10,000. |
· | 2,250,000 shares of common stock to H.C. Wainwright and 1st SB related to the exercise of warrants. The warrants were issued and exercised during the quarter at a exercise price of $.001 per share resulting in $1,110,000 of compensation expense being recorded based on the fair value of the warrants and cash received of $2,250. |
· | 200,000 shares of common stock to 8 consultants and 20,000 shares to an employee. The company recorded consulting expense totaling $137,000 based on the fair market value on the date issued (earned). Fair market value was determined by using the stock price on the date issued. |
· | 200,000 shares of common stock valued at $104,000 as consideration for the acquisition of CMS. |
· | 100,000 shares of common stock in exchange for equipment. The shares were valued at $52,070 using the stock price on the date that the equipment was acquired. |
Subsequent to August 31, 2005:
· | In September 2005, SEVI issued 5,120,000 shares in exchange for the conversion of a $250,000 of convertible promissory notes. |
NOTE 5 - ACQUISITIONS
Effective July 27, 2004, SEVI acquired all the issued and outstanding shares of Southwest CMS Technology Services, LP and its general partner CMS Associates, LLC ("CMS"), a San Antonio based network integration firm. Effective September 23, 2004, SEVI purchased all of the outstanding shares of Next Hire Consultants Inc. (“Next Hire”), a Houston based staffing and permanent placement firm. Effective September 24, 2004, SEVI acquired all the issued and outstanding shares of Duration Software, Inc. (“Duration”), an Austin based IT consulting firm.
The consolidated statements of operations in the accompanying financial statements includes the operations of the acquired companies beginning from their respective acquisition dates. The following are unaudited pro forma condensed statements of income for the three months ended August 31, 2004, as though each of the acquisitions had occurred as of the beginning of the period.
As reported | CMS | Next Hire | Duration | Pro forma | ||||||||||||
Revenues | $ 232,629 | $211,171 | $ 83,454 | $868,535 | $1,395,789 | |||||||||||
Net gain (loss) | (1,766,964 | ) | (11,863 | ) | 3,783 | 341,804 | (1,433,240 | ) | ||||||||
Loss per share | (0.03 | ) | (11.86 | ) | 1.08 | 341.80 | (0.03 | ) | ||||||||
Weighted shares outstanding | 54,637,571 | 1,000 | 3,500 | 1,000 | 54,643,071 |
NOTE 6 - SEGMENT INFORMATION
Reportable segments are based on internal organizational structure and are comprised of the Business & Technology division (“B&T”) or the Next Hire Consultants (“NHC”) division. The B&T division provides high-end, value-added software development services and the NHC division provides contract staff and permanent placement services.
Segment financial information is summarized as follows:
B&T | NHC | Corporate and other (Restated) | Total | ||||||||||
Three Months ending August 31, 2005 (Restated) | |||||||||||||
Revenue | $1,109,943 | $ 244,135 | $ 1,310 | $1,355,388 | |||||||||
Depreciation and amortization | 10,094 | 5,193 | 179,709 | 194,996 | |||||||||
Interest expense | 1,278 | - | 155,343 | 156,621 | |||||||||
Net income (loss) | (14,286 | ) | 38,849 | (1,349,651 | ) | (1,325,088 | ) | ||||||
Total assets | 1,438,681 | 43,274 | 7,574,894 | 9,056,849 | |||||||||
Expenditures for long-lived assets | - | - | 15,884 | 15,884 | |||||||||
Three Months ending August 31, 2004 | |||||||||||||
Revenue | $ 232,629 | $ - | $ - | $232,629 | |||||||||
Depreciation and amortization | - | - | 28,150 | 28,150 | |||||||||
Interest expense | - | - | 11,947 | 11,947 | |||||||||
Net income (loss) | - | - | (1,766,964 | ) | (1,766,964 | ) | |||||||
Expenditures for long-lived assets | - | - | - | - |
NOTE 7 - DERIVATIVES
SEVI evaluated the application of SFAS 133 and EITF 00-19 for all of its financial instruments and identified the following financial instruments as derivatives:
1) | Embedded conversion option of Convertible Notes |
2) | Warrants to purchase common stock associated with the Convertible Notes |
3) | Warrants to purchase common stock issued with consulting agreements for two individuals (“Consulting Warrants”) |
Based on the guidance in SFAS 133 and EITF 00-19, SEVI bifurcated and separately accounted for the embedded conversion options of the Convertible Notes Payable because the conversion price was not fixed and was not convertible into a fixed number of shares.
Furthermore, SEVI concluded that the exercise price and the number of shares to be issued under the “Consulting Warrants” and the Convertible Notes Warrants are fixed. However, because the Convertible Notes might result in issuing an indeterminate number of shares, it cannot be concluded that SEVI has a sufficient number of authorized shares to settle either group of warrants. As such, the warrants were accounted for as derivative liabilities.
SEVI is required to record the fair value of the conversion options and the warrants on its balance sheet with changes in the values of these derivatives reflected in the consolidated statement of operations as “Gain (loss) on embedded derivative liability.” The derivative liabilities were not previously classified as such in SEVI's historical financial statements causing those financial statements to be restated. See Note 8 for details.
The impact of the application of SFAS 133 and EITF 00-19 on the balance sheet as of August 31, 2005 is as follows:
Embedded conversion option in Convertible Debenture | $ 5,318,167 |
Convertible Debenture warrants | 603,175 |
Consulting warrants | 470,951 |
Total | $ 6,392,293 |
And the impact on statements of operations for the three months ended August 31, 2005 is as follows:
Three months ended August 31, | ||
2005 | 2004 | |
Note Payable | $ (694,457) | - |
Convertible Debenture & warrants | 20,464 | - |
Consulting warrants | 12,753 | - |
Total gain (loss) on embedded derivative liabilities: | (661,240) | - |
NOTE 8 - RESTATEMENT
SEVI has restated its 2005 quarterly financial statements from amounts previously reported. SEVI has determined that certain financial instruments issued by SEVI contain features that require accounting for these features as derivative instruments. Accordingly, warrants issued to consultants, the conversion features of the Note Payable and Convertible Debentures and associated warrants were originally accounted for as equity and should have been accounted for as derivative liabilities. Note 7 was added to disclose the derivative instrument liabilities and provided information on subsequent changes. In addition, SEVI has modified the estimated volatility used in the Cox-Ross-Rubenstein option pricing model used to value the warrants issued to consultants, the warrants issued to the debentures holders and the conversion features embedded in the Note Payable and the Convertible Debentures. Additionally, SEVI has changes the amortization of the discount to be on the effective interest method instead of the straight-line method.
SEVI is required to record the fair value of the conversion features and the warrants on the balance sheet at fair value with changes in the values of these derivatives reflected in the consolidated statement of operations as “Gain (loss) on derivative instrument liabilities.”
Following is a summary of the restatement adjustments:
Balance Sheet August 31, 2005 | Balance Sheet May 31, 2005 | |||||||
As Reported | Adjustments | As Restated | As Reported | Adjustments | As Restated | |||
Current assets | $ 902,086 | $ 902,086 | $ 933,793 | $ 933,793 | ||||
Deferred financing costs | 3,742,191 | $ 1,556,349 | 5,298,540 | 4,236,848 | $ 1,094,534 | 5,331,382 | ||
Other long-term assets | 2,856,223 | 2,856,223 | 3,029,613 | 3,029,613 | ||||
Total assets | $ 7,500,500 | $ 1,556,349 | $ 9,056,849 | $ 8,200,254 | $ 1,094,534 | $ 9,294,788 | ||
Current liabilities | $ 822,810 | $ 822,810 | $ 589,652 | $ 589,652 | ||||
Current portion of convertible notes, net | - | - | - | - | ||||
Derivative liability | - | $ 6,392,293 | 6,392,293 | - | $ 5,731,053 | 5,731,053 | ||
Convertible note | 1,090,763 | (1,046,766) | 43,997 | 800,107 | (776,563) | 23,544 | ||
Long-term debt - related parties | 134,494 | 134,494 | 133,599 | 133,599 | ||||
Total liabilities | 2,048,067 | 5,345,527 | 7,393,594 | 1,523,358 | 4,954,490 | 6,477,848 | ||
Common stock | 15,656,465 | (8,187,379) | 7,469,086 | 15,485,062 | (8,187,379) | 7,297,683 | ||
Accumulated deficit | (10,204,032) | 4,398,201 | (5,805,831) | (8,808,166) | 4,327,423 | (4,480,743) | ||
Total equity | 5,452,433 | (3,789,178) | 1,663,255 | 6,676,896 | (3,859,956) | 2,816,940 | ||
Total Liabilities and Equity | $ 7,500,500 | $ 1,556,349 | $ 9,056,849 | $ 8,200,254 | $ 1,094,534 | $ 9,294,788 | ||
Three Months Ended August 31, | |||
As Reported | Adjustments | As Restated | |
Gross Profit | $ 857,148 | $ 857,148 | |
Operating Expenses: | |||
Payroll and related | 1,009,826 | 1,009,826 | |
General and administrative | 160,294 | 160,294 | |
Depreciation and amortization | 194,996 | 194,996 | |
Operating loss | (507,968) | (507,968) | |
Interest expense | (888,640) | $ 732,019 | (156,621) |
Other income | 1,111 | 1,111 | |
Other costs | (370) | (370) | |
Gain (loss) on derivative instrument liabilities | - | (661,240) | (661,240) |
Net loss | $ (1,395,867) | $ 70,779 | $(1,325,088) |
Basic and diluted loss per share | $ (0.02) | $ (0.02) |
NOTE 9 - SUBSEQUENT EVENT
SEVI discontinued the $1,500,000 factoring facility with Allied Capital Partners, LP on the anniversary of the facility as provided in the original agreement with no costs associated with its discontinuance. SEVI signed a term sheet with a lender to provide a $500,000 “Accounts Receivable Factoring Line of Credit” with a maximum of 75% of the current accounts receivable with an immediate advance of $50,000. Since SEVI has not been able to amend to the security agreement with previous Convertible Note holders to provide the lender with the first lien on accounts receivable in a timely fashion, SEVI has entered into a payment plan to re-pay the advance to the lender within 30 days.
ITEM 2 - Management's Discussion and Analysis
FORWARD LOOKING STATEMENTS
This quarterly report contains forward-looking statements that involve risks and uncertainties. We use words such as anticipate, believe, plan, expect, future, intend and similar expressions to identify such forward-looking statements. You should not place too much reliance on these forward-looking statements. Our actual results are likely to differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described in this section.
The Company, previously known as Wallace Resources Inc., was organized in the State of Idaho on August 26, 1968. Systems Evolution Inc., our Texas operating company was acquired by the Company on September 9, 2003, and after the acquisition, the Company's current directors and management took control of the Company. We generate revenue from professional services performed for our end-user customers and the end-user customers of our software partners.
Revenue is derived primarily from professional services provided on a time and materials basis, with the remaining revenue provided from fixed fee engagements. For time and material contracts, revenue is recognized and billed by multiplying the number of hours expended by our professionals in the performance of the contract by the established billing rates. For fixed fee projects, revenue is generally recognized using the proportionate performance method. Provisions for estimated losses on uncompleted contracts are made on a contract-by-contract basis and are recognized in the period in which such losses are determined. Billings in excess of costs plus earnings are classified as deferred revenues. On many projects we are also reimbursed for out-of-pocket expenses such as airfare, lodging and meals. These reimbursements are included as a component of revenue.
Our revenue and operating results are subject to substantial variations based on our customers' expenditures and the frequency with which we are chosen to perform services for our customers. Revenue from any given customer will vary from period to period.
Our gross margins are affected by trends in the utilization rate of our professionals (defined as the percentage of our professionals' time billed to customers, divided by the total available hours in the respective period), the salaries we pay our consulting professionals, and the average rate we receive from our customers. If a project ends earlier than scheduled or we retain professionals in advance of receiving project assignments, our utilization rate will decline and adversely affect our gross margins.
Recent Developments
Subsequent to the period ending August 31, 2005 in October 2005, SEVI entered into a teaming agreement with The Project Group Inc. (“TPG”), a company currently in Chapter 11 Bankruptcy and publicly traded on the Pink Sheets with the symbol PJTGQ. TPG is world’s leading integrator of Microsoft Project software and a Microsoft Gold Partner. This teaming agreement provides SEVI and TPG the ability to increase market penetration by cross marketing our services (software development) to TPG clients and TPG’s services (Microsoft Project implementation) to our clients, increase operating efficiencies by integrating our physical Houston offices, and gain Microsoft Gold Partner status (achieved October 2005).
Furthermore, on October 4, 2005, SEVI and TPG entered into a non-binding term sheet that provides a plan of reorganization of TPG in bankruptcy court and the corporate integration of the two companies after TPG emerges from bankruptcy. “The entire transaction and relevant terms are subject to approval by the respective Board of Directors of SEVI and TPG, our respective shareholders as required, by the SEVI convertible note holders as required, by the creditors of TPG, and the Bankruptcy Court.”
SEVI discontinued the $1,500,000 factoring facility with Allied Capital Partners, LP on the anniversary of the facility as provided in the original agreement with no costs associated with its discontinuance. SEVI signed a term sheet with a lender to provide a $500,000 “Accounts Receivable Factoring Line of Credit” with a maximum of 75% of the current accounts receivable with an immediate advance of $50,000. Since we have not been able to amend to the security agreement with previous Convertible Note holders to provide the lender with the first lien on accounts receivable in a timely fashion, SEVI has entered into a payment plan to re-pay the advance to the lender within 30 days.
Results of Operations for the three month period ending August 31, 2005
Total gross revenue increased from $232,629 for the three month period ended August 31, 2004 to $1,355,388 for the three month period ended August 31, 2004, an increase of 443%. The increase in revenue resulted from the addition of CMS Technology, Duration Software, and Next Hire Consultants acquisitions.
Net loss from operations decreased from $1,755,017 for the three month period ended August 31, 2004 to $1,325,088 for the three month period ended August 31, 2005. The decrease in the loss is attributable to no consulting services paid by stock within the period as well as improved revenue generating capabilities provided by our two operating segments, offset by additional expenses from the change in value of derivatives..
Operating Expenses
Payroll and related costs make up the majority of our cost of revenue. Total payroll and related costs increased from $303,865 for the three month period ended August 31, 2004 to $1,009,826 for the three month period ended August 31, 2005, an increase of 232%. This increase is attributed to an increase in operations related staff in the acquisitions of CMS Technology, Duration Software, and Next Hire Consultants.
General and administrative expenses consist of salaries and benefits for sales, executive and administrative employees, training, marketing activities, investor relations, recruiting, non-reimbursable travel costs and expenses and miscellaneous expenses. General and administrative expenses decreased from $1,655,631 for three month period ended August 31, 2004 to $160,294 for the three month period ended August 31, 2005. This decrease is related to retaining a small administrative management team and little ongoing professional services.
Derivatives
The gain (loss) on derivative liabilities changed from $0 for the three month period ended August 31, 2004 to a loss of $661,240 for the three month period ended August 31, 2005. This change is the result of additional derivative liabilities and the negative change in the valuation of the derivative liabilities.
Liquidity and Capital Resources
Net cash used by operating activities was $64,271 for the three month period ended August 31, 2005 compared to $43,079 used by operating activities for the three month period ended August 31, 2004.
Net cash provided by financing activities was $7,011 for the three month period ended August 31, 2005 compared to $19,834 for three month period ended August 31, 2004.
On August 31, 2004, the Company executed a Purchase Agreement with certain institutional and accredited investors under which the Company agreed to sell and the purchasers agreed to purchase convertible promissory notes due August 31, 2007 (the "Notes") in the aggregate principal amount of up to $2,500,000 bearing interest at the rate of 8% per annum and convertible into shares of our Common Stock at a conversion price of $0.05 per share. On September 9, 2004, the Company completed the sale of an aggregate of $1,825,000 in Notes and accompanying Warrants under the Purchase Agreement which resulted in net proceeds to the Company of $1,542,417. The Notes are initially convertible into 36,500,000 shares of Common Stock, and an additional 36,500,000 shares of Common Stock are reserved for issuance upon exercise of the Warrants issued to the note holders.
On December 30, 2004, we executed a securities purchase agreement with certain institutional and accredited investors for the sale of 8% Callable Secured Promissory Notes and accompanying Warrants. Under this agreement, on December 30, 2004, we completed the sale of an aggregate of $500,000 of these Notes, which resulted in net proceeds to SEVI of $408,148; on January 14, 2005, completed the sale of an additional $500,000 of these Notes, with net proceeds to SEVI of $497,500; and on April 29, 2005 completed the sale of an additional $250,000 principal amount of these notes with net proceeds to SEVI of $230,000.
The Company estimates that our requirements for additional capital over the next 12 months will be approximately $260,000 or four times our net cash used in operating activities. There can be no assurance we will be able to raise this additional required capital on satisfactory terms, or at all. In the event we are unable to obtain such additional capital or to obtain it on acceptable terms or in sufficient amounts, the impact thereof would have a material adverse effect on our business, operating results, financial condition and may affect our ability to carry on as a Company.
Critical Accounting Policies
Consulting revenues are comprised of revenue from professional services fees recognized primarily on a time and materials basis as performed. For fixed fee engagements, revenue is recognized using the proportionate performance method (based on the ratio of hours expended to total estimated hours). Provisions for estimated losses on uncompleted contracts are made on a contract-by-contract basis and are recognized in the period in which such losses are determined. Billings in excess of costs plus earnings are classified as deferred revenues. Our normal payment terms are net 30 days. We record an expense for the expected losses on uncollectible accounts receivable each period based on known facts and circumstances for the respective period.
Deferred Financing Costs
Deferred financing costs relate to the cost incurred in the arrangement of Systems Evolution Inc.'s debt agreement and are being amortized using the effective interest method over the terms of the related debt.
ITEM 3 - Controls and Procedures
Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer has concluded that, as of the end of such period, the Company's disclosure controls and procedures were not effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and for late filing and derivative accounting and disclosures.
Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6 - Exhibits and Report on Form 10-QSB/A
(a) Exhibits.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Systems Evolution Inc.
Dated: June 15, 2006
/s/ Robert C. Rhodes
Robert C. Rhodes
Chief Executive Officer
and Chief Financial Officer