UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: April 30, 2007
or
o TRANSITION REPORT PURSUANT TO SECTION 13 0R 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 000-51308
( (Exact name of small business issuer as specified in its charter)
Nevada | 98-0427221 |
(State or Other jurisdiction of Incorporation or organization) | (IRS Employer Identification No.) |
20710 Lassen Street Chatsworth CA | 91311 |
(Address of Principal Executive Offices) | (Zip Code) |
(818) 341-9200
(Issuer's telephone number including area code)
Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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.
Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes o No x
State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
As of June 1, 2007, the issuer had 31,250,000 shares of common stock, $0.00001 par value, issued and outstanding:
Transitional Small Business Disclosure Format: Yes o No x
CHATSWORTH DATA SOLUTIONS, INC.
INDEX TO FORM 10-QSB
PAGE | |||
PART I | FINANCIAL INFORMATION | 1 | |
Item 1. | Condensed Consolidated Financial Statements | 1 | |
Condensed consolidated balance sheet as of April 30, 2007 (unaudited) and January 31, 2007 | 1 | ||
Condensed consolidated statements of operations for the three months ended April 30, 2007 (Successor) and for the three months ended March 31, 2006 (Predecessor) - unaudited | 2 | ||
Condensed consolidated statement of changes in stockholders' equity for the three months ended April 30, 2007 - unaudited | 3 | ||
Condensed consolidated statements of cash flows for the three months ended April 30, 2007 (Successor) and for the three months ended March 31, 2006 (Predecessor) - unaudited | 4 | ||
Notes to condensed consolidated financial statements - unaudited | 5 | ||
Item 2. | Management's Discussion and Analysis or Plan of Operations | 15 | |
Item 3. | Controls and Procedures | 21 | |
PART II | OTHER INFORMATION | 21 | |
Item 1. | Legal Proceedings | 21 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 21 | |
Item 3. | Defaults Upon Senior Securities | 21 | |
Item 4. | Submission of Matters to a Vote of Security Holders | 21 | |
Item 5. | Other Information | 21 | |
Item 6. | Exhibits | 22 | |
SIGNATURES | 22 |
i
Part I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHATSWORTH DATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
April 30, 2007 (unaudited) and January 31, 2007
April 30, 2007 | January 31, 2007 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
Current Assets | |||||||
Cash | $ | 139,950 | $ | 341,676 | |||
Accounts receivable, less allowance for doubtful accounts of $25,894 and $22,978 | 991,058 | 647,786 | |||||
Inventories | 1,140,067 | 1,072,208 | |||||
Deferred tax assets, current | 501,310 | 362,433 | |||||
Prepaid expenses | 56,239 | 80,585 | |||||
Total current assets | 2,828,624 | 2,504,688 | |||||
Property and equipment, net | 340,466 | 279,190 | |||||
Goodwill | 3,926,643 | 3,926,643 | |||||
Intangible assets, net | 2,385,920 | 2,634,680 | |||||
Other assets | 44,409 | 41,671 | |||||
Total assets | $ | 9,526,062 | $ | 9,386,872 | |||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
Current Liabilities | |||||||
Accounts payable | $ | 895,799 | $ | 332,890 | |||
Accrued liabilities | 594,614 | 759,514 | |||||
Accrued registration payment penalty | 383,000 | 383,000 | |||||
Borrowings under line of credit | 200,000 | - | |||||
Current portion of notes payable | 1,000,000 | 1,000,000 | |||||
Total current liabilities | 3,073,413 | 2,475,404 | |||||
Notes payable, long term | 1,000,000 | 1,000,000 | |||||
Deferred tax liability, long term | 791,227 | 913,988 | |||||
Total liabilities | 4,864,640 | 4,389,392 | |||||
Commitments and contingencies | |||||||
Stockholders' Equity: | |||||||
Preferred stock, par value $0.00001 per share, 5,000,000 shares authorized, none issued and outstanding | - | - | |||||
Common stock, par value $0.00001 per share, 100,000,000 shares authorized, 31,250,000 shares issued and outstanding | 312 | 312 | |||||
Additional paid-in capital | 6,338,249 | 6,278,564 | |||||
Accumulated deficit | (1,677,139 | ) | (1,281,396 | ) | |||
Total stockholders' equity | 4,661,422 | 4,997,480 | |||||
Total liabilities and stockholders' equity | $ | 9,526,062 | $ | 9,386,872 |
See accompanying notes to condensed consolidated financial statements.
1
CHATSWORTH DATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended April 30, 2007 (Successor)
and the three months ended March 31, 2006 (Predecessor)
(unaudited)
Successor | Predecessor | ||||||
For the three months ended April 30, 2007 | For the three months ended March 31, 2006 | ||||||
Net sales | $ | 2,218,753 | $ | 1,515,896 | |||
Cost of sales | 1,493,328 | 1,181,196 | |||||
Gross profit | 725,425 | 334,700 | |||||
Operating expenses: | |||||||
General and administrative | 1,074,992 | 271,366 | |||||
Depreciation | 26,195 | 4,329 | |||||
Amortization of intangible assets | 248,760 | - | |||||
Income (loss) from operations | (624,522 | ) | 59,005 | ||||
Other income (expense) | |||||||
Interest expense | (35,752 | ) | - | ||||
Interest income | 2,893 | 4,366 | |||||
Other income (expense), net | (32,859 | ) | 4,366 | ||||
Income (loss) before income taxes | (657,381 | ) | 63,371 | ||||
Income tax benefit | 261,638 | - | |||||
Net income (loss) | $ | (395,743 | ) | $ | 63,371 | ||
Net loss per share - basic and diluted | $ | (0.01 | ) | ||||
Weighted average shares outstanding | 31,250,000 |
See accompanying notes to condensed consolidated financial statements
2
CHATSWORTH DATA SOLUTIONS, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the three months ended April 30, 2007
(unaudited)
Common Stock | ||||||||||||||||
Number of Shares | Amount | Additional Paid-in Capital | Accumulated Deficit | Total | ||||||||||||
Successor | ||||||||||||||||
Balance, February 1, 2007 | 31,250,000 | $ | 312 | $ | 6,278,564 | $ | (1,281,396 | ) | $ | 4,997,480 | ||||||
Net loss | - | - | - | (395,743 | ) | (395,743 | ) | |||||||||
Fair value of vested options | - | - | 59,685 | - | 59,685 | |||||||||||
Balance, April 30, 2007 | 31,250,000 | $ | 312 | $ | 6,338,249 | $ | (1,677,139 | ) | $ | 4,661,422 |
See accompanying notes to condensed consolidated financial statements
3
CHATSWORTH DATA SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended April 30, 2007 (Successor)
and the three months ended March 31, 2006 (Predecessor)
(unaudited)
Successor | Predecessor | ||||||
For the three months ended April 30, 2007 | For the three months ended March 31, 2006 | ||||||
Cash Flows from Operating Activities | |||||||
Net income (loss) for the period | $ | (395,743 | ) | $ | 63,371 | ||
Adjustments to reconcile net income (loss) to net cash used in operating activities: | |||||||
Depreciation and amortization | 274,955 | 4,329 | |||||
Fair value of vested options | 59,685 | ||||||
Income tax benefit | (261,638 | ) | |||||
Changes in operating assets and liabilities: | |||||||
Accounts receivable | (343,272 | ) | (86,659 | ) | |||
Inventories | (67,859 | ) | (179,516 | ) | |||
Deposits | (2,738 | ) | - | ||||
Prepaid expenses | 24,346 | (38,114 | ) | ||||
Accounts payable | 562,909 | (25,646 | ) | ||||
Accrued liabilities | (164,900 | ) | 1,926 | ||||
Income taxes payable | - | (46,025 | ) | ||||
Net cash used in operating activities | (314,255 | ) | (306,334 | ) | |||
Cash Flows from Investing Activities | |||||||
Purchase of property and equipment | (87,471 | ) | (702 | ) | |||
Net cash used in investing activities | (87,471 | ) | (702 | ) | |||
Cash Flows from Financing Activities | |||||||
Net borrowings on line of credit | 200,000 | - | |||||
Net cash provided by financing activities | 200,000 | - | |||||
Decrease in cash | (201,726 | ) | (307,036 | ) | |||
Cash and cash equivalents, beginning of period | 341,676 | 859,460 | |||||
Cash and cash equivalents, end of period | $ | 139,950 | $ | 552,424 | |||
Supplemental cash flow information | |||||||
Cash paid for income taxes | $ | - | $ | - | |||
Cash paid for interest | $ | 34,294 | - |
See accompanying notes to condensed consolidated financial statements
4
CHATSWORTH DATA SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended April 30, 2007 (Successor)
and the three months ended March 31, 2006 (Predecessor)
(unaudited)
NOTE 1 - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business
Chatsworth Data Solutions, Inc. (the Company), through its wholly owned subsidiary Chatsworth Data Corporation (CDC), manufactures equipment for optical readers and read heads, impact recorders and indicators, and cable test equipment. The Company's fiscal year-end is January 31.
On August 7, 2006, the Company completed the acquisition of CDC for $7,246,531 including transaction costs. The acquisition was deemed effective August 1, 2006, and was accounted for as purchase in accordance with Statement of Financial Accounting Standards (SFAS) No. 141 Business Combinations. The assets acquired and liabilities assumed were recorded at their fair values at the date of acquisition.
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2007, filed with the SEC on May 16, 2007. The results of operations for interim periods are not necessarily indicative of the results expected for a full year or for any future period. Certain prior year’s amounts have been reclassified to conform to the current period presentation.
The following provides a description of the basis of presentation for all periods presented.
Successor-Represents the consolidated financial position of the Company and its wholly owned subsidiary as of April 30, 2007, and the condensed consolidated results of operations and cash flows of the Company and its wholly owned subsidiary for the three months February 1, 2007 through April 30, 2007. Intercompany accounts and transactions have been eliminated in consolidation.
5
Predecessor-Represents the results of operations and cash flows of Chatsworth Data Corporation for the three months January 1, 2006 through March 31, 2006.
The results of operations for the three months ended April 30, 2007 (Successor) are compared to the three months ended March 31, 2006 (Predecessor), as the Successor has a January 31 fiscal year end and the Predecessor had a December 31 calendar year end.
Use of estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue recognition
The Company recognizes revenue when there is persuasive evidence that an arrangement exists, delivery of the product has occurred and title has passed, the selling price is both fixed and determinable, and collectibility is reasonably assured, all of which generally occurs upon shipment of the Company's product or delivery of the product to the destination specified by the customer.
Inventory
The Company uses a gross profit method to estimate cost of sales and inventory for interim periods based on historical results and other factors, such as sales mix and purchasing trends, affecting cost of sales during the reporting period.
Goodwill and other intangible assets
Goodwill and other intangible assets are related to the Company's acquisition of CDC in August 2006. Intangible assets with finite lives are amortized over their estimated useful lives, which are three years for customer relations and five years for propriety technology. In addition to amortization, intangible assets are tested at least annually for impairment.
Major customers
For the three months ended April 30, 2007 the Company had three customers which accounted for 20%, 13%, and 10%, respectively, of total sales. There were no other customers that accounted for over 10% of total sales. At April 30, 2007, one customer accounted for 45% of total accounts receivable. For the three months ended March 31, 2006, CDC had two customers which accounted for approximately 21% and 15%, respectively, of its total sales.
For the three months ended April 30, 2007, the Company had foreign revenue, comprised mostly of sales from Asia (17%) and Europe (16%), which accounted for approximately 34% of total sales. For the three months ended March 31, 2006, CDC had foreign revenue, comprised mostly of sales from Asia (15%), which accounted for approximately 16% of total sales.
6
Basic and diluted net income (loss) per share
Basic earnings (loss) per share are computed by dividing net income (loss) available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted earnings per share reflects the potential dilution that could occur if options or other securities or contracts entitling the holder to acquire shares of common stock were exercised or converted, resulting in the issuance of additional shares of common stock that would then share in earnings. However, diluted loss per share does not consider such dilution as its effect would be anti-dilutive.
At April 30, 2007, potentially dilutive securities entitling the holder thereof to acquire shares of common stock are summarized as follows:
2007 | ||||
Options to purchase common stock | 6,000,000 | |||
Warrants to purchase common stock | 12,103,000 |
For the three months ended April 30, 2007, these options and warrants were not included in the computation of diluted loss per share as their effects are anti-dilutive. There were no options or warrants outstanding during the three months ended March 31, 2006. Earnings per share information of the Predecessor are not presented since it was privately owned and its capital structure is not relevant to current Company stockholders.
Stock-based compensation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS 123R”). This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. Effective February 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective method. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption and all previously granted awards not yet vested as of the date of adoption. The Company had no share based payments prior to the adoption of SFAS No. 123R, and the initial adoption of this standard had no effect on the Company’s financial statements
Shares, warrants and options issued to non-employees for services are accounted for in accordance with SFAS 123(R) and Emerging Issues Task Force Issue No. 96-18 (“EITF 96-18”), “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or In Conjunction with Selling Goods or Services” whereby the fair value of such option and warrant grants is determined using the Black-Scholes Model at the earlier of the date at which the non-employee’s performance is completed or a performance commitment is reached.
7
Registration payment arrangements
The Company accounts for registration payment arrangements under Financial Accounting Standards board (FASB) Staff Position EITF 00-19-2, “Accounting for Registration Payment Arrangements” (FSP EITF 00-19-2). FSP EITF 00-19-2 specifies that the contingent obligation to make future payments under a registration payment arrangement should be separately recognized and measured in accordance with SFAS No. 5, Accounting for Contingencies. FSP EITF 00-19-2 was issued in December, 2006. Early adoption of FSP EITF 00-19-2 is permitted and the Company adopted FSP EITF 00-19-2 effective November 1, 2006. At January 31, 2007 and April 30, 2007, the Company had accrued an estimated penalty (see Note 7).
Adoption of New Accounting Policy
Effective February 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”) —an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of April 30, 2007, the Company does not have a liability for unrecognized tax benefits.
The Company files income tax returns in the U.S. federal jurisdiction and the state of California. The Company is subject to U.S. federal or state income tax examinations by tax authorities. During the periods open to examination, the Company has net operating loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these NOLs and tax credit carry forwards may be utilized in future periods, they remain subject to examination.
The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of April 30, 2007, the Company has no accrued interest or penalties related to uncertain tax positions.
Recent accounting pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently evaluating the effect that the adoption of SFAS No. 157 will have on its financial position and results of operations.
8
In February 2007, the FASB issued SFAS 159 The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 159 permits the measurement of certain financial instruments at fair value. Entities may choose to measure eligible items at fair value at specified election dates, reporting unrealized gains and losses on such items at each subsequent reporting period. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company has not evaluated the potential impact of the fair value option.
NOTE 2 - INVENTORIES
Inventories consist of the following:
April 30, 2007 | ||||
Raw materials | $ | 1,004,326 | ||
Work in process | 113,791 | |||
Finished goods | 36,950 | |||
Inventory reserve | (15,000 | ) | ||
$ | 1,140,067 |
As a result of the acquisition of CDC, intangible assets having finite lives consist of the following:
April 30, 2007 | ||||
Customer Relations | $ | 2,764,500 | ||
Propriety Technology | 367,700 | |||
3,132,200 | ||||
Less accumulated amortization | (746,280 | ) | ||
$ | 2,385,920 |
Amortization of intangible assets was $248,760 for the three months ended April 30, 2007. There was no amortization for the three months ended March 31, 2006.
Amortization expense is estimated to be for the twelve months ended April 30:
2008 | $ | 995,040 | ||
2009 | 995,040 | |||
2010 | 303,915 | |||
2011 | 73,540 | |||
2012 | 18,385 |
9
NOTE 4 - NOTES PAYABLE
Notes payable consist of seven unsecured notes that are payable to the predecessor shareholders of CDC in connection with the acquisition of CDC. Interest is at 6.54% per annum; $1,000,000 is due August 6, 2007, and $1,000,000 is due August 6, 2008. Included in the notes payable is a promissory note of $615,384 issued to an individual who serves as a director of the Company of which $307,692 is due on August 6, 2007 and $307,692 is due on August 6, 2008.
April 30, 2007 | ||||
Total notes payable | $ | 2,000,000 | ||
Less current portion | (1,000,000 | ) | ||
Long-term portion | $ | 1,000,000 |
NOTE 5 - LINE OF CREDIT
On December 1, 2006, CDC entered into a revolving credit agreement with a financial institution. The credit agreement provides for borrowings of up to $3 million or the maximum available based on specific percentages of accounts receivable and inventory, as determined by the financial institution, whichever is less. At April 30, 2007, $200,000 had been advanced and $789,482 was available to CDC under the credit agreement. The outstanding advances under the credit agreement bear interest at an annual rate equal to the prime rate (8.25 % at April 30, 2007) plus a margin initially set at 0.50%. The credit agreement expires on November 30, 2007, and is secured by all the personal property of CDC, including its equipment, accounts receivable and inventory. There are certain covenants and restrictions placed on CDC under the credit agreement, including, but not limited to, quarterly financial covenants, which commenced with the quarter ended April 30, 2007, specifying a funded debt to EBITDA (as defined) ratio, a minimum fixed-charge (as defined) coverage ratio, and restrictions or limitations on issuance of additional debt, mergers, leases, guaranties, transactions with affiliates, or change in control. CDC determined it is in compliance with all covenants as of April 30, 2007. The Company has guaranteed the obligations of CDC under the credit agreement.
NOTE 6 - INCOME TAXES
The components of the condensed consolidated income tax benefit are as follow:
April 30, 2007 | ||||
Federal: | ||||
Current | $ | - | ||
Deferred | 223,510 | |||
State: | ||||
Current | - | |||
Deferred | 38,128 | |||
Total | $ | 261,638 |
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Significant components of the Company's deferred income tax liability at April 30, 2007:
April 30,2007 | ||||
Deferred tax assets: | ||||
Net operating loss carry forward | $ | 396,669 | ||
Deferred taxes due to change from Sub S to C corporation | 80,000 | |||
Inventory | 24,641 | |||
Share-based compensation | 159,160 | |||
Total deferred tax assets | 660,470 | |||
Deferred tax liability: | ||||
Intangible assets | (950,387 | ) | ||
Net deferred income tax liability | $ | (289,917 | ) |
The deferred tax is presented on the accompanying balance sheet as $501,310 deferred tax assets, current, and $791,227 deferred tax liability, long term.
Reconciliation of the effective income tax rate to the U.S. statutory rate for the six-month period ended April 30, 2007 is as follows:
Tax expense at the U.S. statutory income tax rate | 34.0 | % | ||
State tax net of federal tax benefit | 5.8 | % | ||
Effective income tax benefit rate | 39.8 | % |
NOTE 7 - CAPITAL STOCK
Common Stock
In August 2006, the Company completed a private placement financing consisting of 22,000,000 units at a price of $0.25 per unit for total cash proceeds of $5,500,000 ($4,790,172 net of financing costs). Each unit consisted of one share of common stock valued at $0.24 per share and one-half of one share purchase warrant valued at $0.01. A total of 22,000,000 shares of common stock and 11,000,000 warrants were issued. Each full warrant is exercisable into one share of common stock at a purchase price of $0.30 per share on or before July 31, 2011 (see Note 8). The Company entered into an investor rights agreement with the investors in the private placement which provides for penalties if the Company fails to file a registration statement with respect to the shares of common stock sold and the shares of common stock underlying the warrants as soon as possible following the closing of the private placement. In addition, the registration statement must be declared effective by the SEC within a specified period of time after the filing and must be kept effective thereafter for a specified period of time. The registration rights agreement requires the payment of liquidated damages to the investors of approximately $1,833 per day (which represents approximately 1% per month of the total proceeds of $5,500,000) until the Registration Statement is declared effective, payable at the option of the Company in either cash or the Company's common stock. The Company failed to meet these requirements. Accordingly, the Company had accrued an estimate of $383,000 as of January 31, 2007 and April 30, 2007, for these potential penalties until the expected effectiveness of the registration statement.
11
NOTE 8 - STOCK OPTIONS AND WARRANTS
Stock Options
On February 21, 2007, the Company entered into an employment agreement with an individual. As part of the agreement, the Company granted options to purchase 100,000 shares of common stock at $0.40 per share. The options vest one year from the date of grant with respect to 50% of the shares of common stock and the remaining options vest over the following three years and expire February 20, 2012. The options were valued at $38,223, the fair value of the stock options on the date granted determined using a Black-Scholes pricing model. The Company recognized $3,185 of compensation expense from the date the options were granted through April 30, 2007 related to the fair value of the vested options.
On March 16, 2007, the Company granted options to an employee to purchase 50,000 shares of common stock at $0.40 per share. The options vest one year from the date of grant with respect to 50% of the shares of common stock and the remaining options vest over the following three years and expire March 15, 2012. The options were valued at $10,675, the fair value of the stock options on the date granted determined using a Black-Scholes pricing model. The Company recognized $445 of compensation expense from the date the options were granted through April 30, 2007 related to the fair value of the vested options.
On February 21, 2007, the Company agreed with an individual to provide consulting services. As part of the agreement the Company granted the individual options to purchase 250,000 shares of common stock at $0.50 per share. The options vest equally over a twelve month period and expire on February 20, 2012. The fair value of these option grants is estimated on the date of grant using the Black-Scholes option-pricing model and is remeasured at each reporting date based on market price until vested. For the three months ended April 30, 2007 we recorded $10,239 of compensation expense related to non-employee stock options.
The fair value of grants issued in the three months ended April 30, 2007 were determined using a Black-Scholes option pricing model with the following assumptions: 4.65% average risk-free interest rate; 50% expected volatility; five to six year expected term, and 0% dividend yield.
12
At April 30, 2007, options outstanding are as follows:
Shares | Average Exercise Price | ||||||
Balance at February 1, 2007 | 5,600,000 | $ | .39 | ||||
Granted | 400,000 | .46 | |||||
Exercised | - | - | |||||
Cancelled | - | - | |||||
Balance at April 30, 2007 | 6,000,000 | $ | .39 |
Additional information regarding options outstanding as of April 30, 2007 is as follows:
Options Outstanding | Options Exercisable | |||||
Range of Exercise Price | Number of Shares Under Options | Weighted Average Remaining Contractual life (years) | Weighted Average Exercise Price | Shares Under Options | Weighted Exercise Price | |
$.30-$.65 | 6,000,000 | 6.68 | $0.39 | 3,687,083 | $0.37 |
The aggregate intrinsic value of the 6,000,000 options outstanding and 3,687,083 options exercisable as of April 30, 2007 was $815,000 and $571,875, respectively. The aggregate intrinsic value for the options is calculated as the difference between the price of the underlying awards and quoted price of the Company's common shares for the options that were in-the-money as of April 30, 2007.
A summary of the status of nonvested shares as of April 30, 2007 are as follows:
Shares | ||||
Nonvested at February 1, 2007 | 2,245,833 | |||
Granted | 400,000 | |||
Vested | (332,916 | ) | ||
Nonvested at April 30, 2007 | 2,312,917 |
The total value of options issued and vesting over the three months ended April 30, 2007, was $59,685 and has been reflected as compensation cost in the accompanying statement of operations.
The total future compensation expense for the outstanding value of unvested stock options was $416,772 as of April 30, 2007, which will be recognized over a weighted average period of 33 months.
13
Warrants
Number of Shares under Warrants | Weighted Average Exercise Price | ||||||
Warrants outstanding at February 1, 2007 | 12,103,000 | $ | 0.30 | ||||
Warrants granted | - | - | |||||
Warrants expired | - | - | |||||
Warrants outstanding at April 30, 2007 | 12,103,000 | $ | 0.30 |
The following table summarizes information about warrants outstanding at April 30, 2007:
Warrants Outstanding and Exercisable | ||||||||||
Number of Shares Under Warrants | Exercise Price | Expiration Date | Weighted Average Exercise Price | |||||||
11,000,000 | $ | 0.30 | July 31, 2011 | $ | 0.30 | |||||
1,000,000 | $ | 0.30 | July 31, 2011 | $ | 0.30 | |||||
103,000 | $ | 0.01 | July 31, 2011 | $ | 0.01 | |||||
12,103,000 | $ | 0.01-$0.30 | $ | 0.30 |
NOTE 9 - RELATED PARTY TRANSACTIONS
On August 1, 2006, the Company entered into consulting agreements with two individuals to serve as chairman of the board of directors and the Company’s chief financial officer. During the three months ended April 30, 2007, the Company paid each individual $24,000. In addition, the Company paid a firm in which one of the consultants is a partner $5,411 for services.
Four individuals were the shareholders and executive managers of the CDC before they sold their stock to the Company. During the three months ended March 31, 2006, CDC paid salaries of $159,510 to the four individuals. Effective August 1, 2006, one of the individuals was appointed to the Company’s board of directors. On August 7, 2006, the Company issued notes payable totaling $2,000,000 to these individuals or their heirs in conjunction with the acquisition of CDC, including $615,384 to the current board member. For the three months ended April 30, 2007, the Company accrued $32,252 of interest on these notes, including $9,924 to the current board member.
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ITEM 2. Management’s Discussion and Analysis or Plan of Operation
This section of this report includes a number of forward- looking statements that reflect our current views with respect to future events and financial performance. Forward-looking statements are often identified by words like: believe, expect, estimate, anticipate, intend, project and similar expressions, or words which, by their nature, refer to future events. You should not place undue certainty on these forward-looking statements, which apply only as of the date of this report. These forward-looking states are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or out predictions.
Company Overview
Chatsworth Data Solutions (formerly Adera Mines Limited) was incorporated in the State of Nevada on December 30, 2003 and until August 2006 was an exploration stage corporation. An exploration stage corporation is one engaged in the search for mineral deposits (reserves) which are not in either the development or production stage. In August 2006, we purchased all of the outstanding shares of an operating data transfer business, Chatsworth Data Corporation (“CDC”).
Prior to August 2006, CDC was privately owned. It was acquired from Republic Corporation in 1971 by five Republic managers, four of whom managed the Company until the sale. CDC's corporate headquarters are in Chatsworth, California, thirty miles northwest of downtown Los Angeles. Its primary business has been the development and manufacture of optical mark readers. Over one hundred thousand readers and one hundred ten thousand optic head assemblies have been sold worldwide by CDC. The optical mark readers have been traditionally sold into four vertical market sectors: education, gaming and lottery, health care, and vote tabulation. The corporation also manufactures impact recording devices and cable testers. CDC prides itself on customer service; its engineering and design staff is able to understand client's technical problems and offer ready solutions to those problems. A customer hotline was installed over fifteen years ago to enable field problems to be handled quickly, efficiently and effectively. New products are designed and brought to market quickly in response to customer demand.
Acquisition
On August 7, 2006, the Company acquired 100 percent of the common stock of Chatsworth Data Corporation (CDC). The acquisition was effective August 1, 2006. CDC manufactures equipment for optical readers and read heads, impact recorders and indicators, and cable test equipment. The acquisition was accounted for as a purchase in accordance with Statement of Financial Accounting Standards No. 141 “Business Combinations.” As such, the results of CDC’s operations have been included in the consolidated financial statements since August 1, 2006.
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The components of the purchase price and the allocation of the purchase price are as follows:
Purchase price | ||||
Cash consideration | $ | 4,000,000 | ||
Notes payable issued | 2,000,000 | |||
Value of 250,000 shares issued at close | 60,000 | |||
Obligation for tax reimbursement | 200,000 | |||
Cash paid for services related to acquisition | 469,451 | |||
Fair value of 2,000,000 shares issued for services related to acquisition | 480,000 | |||
Fair value of 103,000 warrants issued for services related to acquisition | 37,080 | |||
Total | $ | 7,246,531 | ||
Purchase price allocation | ||||
Current assets, including cash of $438,690 | $ | 2,748,534 | ||
Property and equipment | 74,694 | |||
Intangible assets | 3,132,200 | |||
Goodwill | 3,926,643 | |||
Current liabilities | (1,387,932 | ) | ||
Deferred tax liability | (1,247,555 | ) | ||
Total purchase price | $ | 7,246,531 |
Of the $3,132,200 of acquired intangible assets, $2,764,500 was assigned to customer relations with an estimated life of 3 years and $367,700 was assigned to proprietary technology with an estimated life of 5 years.
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Results of operations - For the Three Months Ended April 30, 2007 (Successor) compared to the three months ended March 31, 2006 (Predecessor)
Net sales revenue totaled $2,218,753 for the three months ended April 30, 2007, compared to $1,515,896 for the three months ended March 31, 2006. Net sales for the three months ended March 31, 2006 were attributable to CDC (Predecessor) prior to its acquisition by the Company on August 7, 2006. The following table sets forth net sales revenue by vertical market for the respective periods indicated below for the Successor and Predecessor.
Successor | Predecessor | ||||||
Three months ended | |||||||
April 30, 2007 | March 31, 2006 | ||||||
Gaming | $ | 832,307 | $ | 682,883 | |||
Education | 4,999 | - | |||||
Voting | 468,832 | 224,592 | |||||
Medical | 81,595 | 68,207 | |||||
Others | 43,123 | 4,903 | |||||
Total optical mark readers | 1,430,856 | 980,585 | |||||
Impact recorders/indicators | 787,897 | 440,423 | |||||
Cable Testing | - | 94,888 | |||||
Total | $ | 2,218,753 | $ | 1,515,896 |
Cost of sales totaled $1,493,328 for the three months ended April 30, 2007, compared to $1,181,196 for the three months ended March 31, 2006. The cost of sales for the three months ended March 31, 2006 pertained to the revenues generated by the Predecessor from the acquisition of CDC. Gross margin percentage was 33% for the three months ended April 30, 2007, compared to 22% for the three months ended March 31, 2006. The increased gross margin percentage was in part due to an increase in the volume of business which allowed the Company to spread its indirect manufacturing overhead over a larger volume of sales.
General and administrative (G&A) expenses totaled $1,078,392 for the three months ended April 30, 2007, as compared to $271,366 for the three months ended March 31, 2006. Included in G&A for this quarter were accounting and legal fees totaling $151,233 incurred in connection with the audit of the Company and the registration of our common stock with the Securities and Exchange Commission. During this quarter, we also spent increased amounts on advertising and public relations, increasing from $0 in the March 31, 2006 quarter to $23,448 in the quarter ended April 30, 2007. We also increased the amount spent for insurance from $19,253 to $45,992. Our contribution to our 401(k) plan increased from $0 in the March 31, 2006 quarter to $12,423 in the quarter ended April 30, 2007. Travel increased from $0 in the quarter ended March 31, 2006 to $74,420 in the quarter ended April 30, 2007. Our expense for consulting and outside services increased from $31,186 to $236,941 as a result of the cost of trade shows, expenses of attending a conference of one our resellers held in Cairo, the expenses of updating our product materials and marketing and sales materials. Finally, in accordance with FASB 123(R), the Company recorded compensation expense of $59,685 related to stock options.
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The Company recorded a deferred tax benefit of $261,638 for the three months ended April 30, 2007. Our effective tax rate was estimated to be 40%.
The net loss for the three months ended April 30, 2007 was $359,743 compared to net income of $63,371 for the three months ended March 31, 2006 attributable to our Predecessor.
As shown in the financial statements for the three months ended April 30, 2007, the Company had cash of $139,950 compared to $341,676 as of January 31, 2007. The Company used $314,254 of cash in operating activities for the three months ended April 30, 2007 compared to $306,334 of cash used in operating activities for the three months ended March 31, 2006. We expect to fund our operations and capital expenditures from internally generated funds and from the use of our revolving credit line. We believe that our cash flow from operations and available credit line will be sufficient to meet our working capital, capital expenditure and investment requirements for at least the next 12 months. We may require additional funds for other purposes, such as acquisitions of complementary businesses, and may seek to raise such additional funds through public and private equity financings or from other sources. However, we cannot assure you that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to us or that any additional financing will not be dilutive.
At April 30, 2007, $200,000 was owed under CDC’s revolving credit agreement with a financial institution. Under this credit agreement, CDC may borrow the lesser of $3 million or its borrowing base, which is based on specific percentages of accounts receivable and inventory, as determined by the financial institution. The outstanding advances under the credit agreement bear interest of an annual rate equal to the prime rate (8.25% at April 30, 2007) plus a margin initially set at 0.50%. Interest is payable in arrears on a monthly basis. The credit agreement expires on November 30, 2007, and is secured by all the personal property of CDC, including its equipment, accounts receivable and inventory. The Company has guaranteed the obligations of CDC under the credit agreement.
The credit agreement, among other things, restricts CDC’s ability to (i) incur additional indebtedness, (ii) create or incur liens, (iii) enter into or assume certain leases, (iv) guarantee the indebtedness of any other person, (v) enter into any merger, consolidation or similar transaction or sell all or substantially all of its assets, or (vi) incur any ownership change. The credit agreement also requires CDC to maintain a minimum Fixed Charge Coverage Ratio and limits CDC’s maximum ratio of Funded Debt to EBITDA, each as defined in the credit agreement. At April 30, 2007, CDC has determined that it was in compliance with all the covenants of the credit agreement.
We owe $2,000,000 million to the CDC sellers; $1,000,000 million is payable August 6, 2007 (one year from the closing of the CDC purchase) and $1,000,000 million is payable August 6, 2008 (two years from the closing). Interest is payable quarterly. Interest accrued for this quarter was $32,969. We believe cash flow from operations and available credit line will be sufficient to repay the note.
On August 17, 2005, Chatsworth Data Corp. entered into a property leasing arrangement to lease approximately 14,500 square feet from an unrelated third party. The lease calls for minimum lease payments of $10,296 per month through August 31, 2007, and $10,605 per month thereafter until it expires in August 2008.
On March 13, 2007, the Company entered an arrangement to lease approximately 1,270 square feet of office space from an unrelated third party beginning May 1, 2007. The lease expires April 30, 2010. Both leases are classified as operating leases.
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The future minimum non-cancelable rental payments under all operating leases are as follows:
2008 | $ | 165,383 | ||
2009 | 81,781 | |||
2010 | 39,103 | |||
2011 | 4,402 | |||
2012 | - | |||
Thereafter | - |
Critical Accounting Policies
Revenue recognition
The Company recognizes revenue when there is persuasive evidence that an arrangement exists, delivery of the product has occurred and title has passed, the selling price is both fixed and determinable, and collectibility is reasonably assured, all of which generally occurs upon shipment of the Company’s product or delivery of the product to the destination specified by the customer.
Inventory
The Company uses a gross profit method to estimate cost of sales and inventory for interim periods based on historical results and other factors, such as sales mix and purchasing trends, affecting cost of sales during the reporting period.
Intangible assets
Intangible assets and goodwill are related to the Company's acquisition of CDC in August 2006. Intangible assets with finite lives are amortized over their estimated useful lives, which are three years for customer relations and five years for propriety technology. In addition to amortization, intangible assets are tested at least annually for impairment.
Stock-based compensation
Stock-based compensation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS 123R”). This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. Effective February 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective method. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption and all previously granted awards not yet vested as of the date of adoption. The Company had no share based payments prior to the adoption of SFAS No. 123R, and the initial adoption of this standard had no effect on the Company’s financial statements
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Shares, warrants and options issued to non-employees for services are accounted for in accordance with SFAS 123(R) and Emerging Issues Task Force Issue No. 96-18 (“EITF 96-18”), “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or In Conjunction with Selling Goods or Services” whereby the fair value of such option and warrant grants is determined using the Black-Scholes Model at the earlier of the date at which the non-employee’s performance is completed or a performance commitment is reached.
Adoption of New Accounting Policy
Effective February 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”) —an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of April 30, 2007, the Company does not have a liability for unrecognized tax benefits.
The Company files income tax returns in the U.S. federal jurisdiction and the state of California. The Company is subject to U.S. federal or state income tax examinations by tax authorities. During the periods open to examination, the Company has net operating loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these NOLs and tax credit carry forwards may be utilized in future periods, they remain subject to examination.
The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of April 30, 2007, the Company has no accrued interest or penalties related to uncertain tax positions.
Recent accounting pronouncements
In September 2006, the Financial Accounting Standard Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in U.S. generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently evaluating the effect that the adoption of SFAS No. 157 will have on its financial position and results of operations.
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In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS 159 to have a material effect on its financial statements and related disclosures.
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are adequate to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
(b) Changes in internal controls over financial reporting. There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
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(a) Exhibits
The exhibits listed in the Exhibit Index are filed as a part of this report.
In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CHATSWORTH DATA SOLUTIONS, INC. | ||
Date: June 12, 2007 | /s/ J. Stewart Asbury III | |
J. Stewart Asbury III Chief Executive Officer, President |
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Exhibit Number | Description |
31.1 | Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer. |
31.2 | Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer. |
32.1 | Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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