UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _______ to __________
Commission File Number 000-09154
PARADIGM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
| NEVADA | 38-3813367 | |
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
9715 KEY WEST AVE., 3RD FLOOR ROCKVILLE, MARYLAND | 20850 | |
| (Address of principal executive offices) | (Zip Code) |
(301) 468-1200
(Registrant's telephone number, including area code)
None
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark 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 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer (do not check if a smaller reporting company) o | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o Nox
Shares of common stock issued and outstanding on August 9, 2011 were 47,663,701 including restricted shares of 2,625,000 and treasury share of 13,848,183.
PART I. FINANCIAL INFORMATION | ||
| Item 1. | 3 | |
| 3 | ||
| 4 | ||
| 5 | ||
| 7 | ||
| Item 2. | 27 | |
| Item 3. | 41 | |
| Item 4. | 41 | |
| PART II. OTHER INFORMATION | ||
| Item 1. | 42 | |
| Item 1A. | 42 | |
| Item 2. | 42 | |
| Item 3. | 42 | |
| Item 4. | 42 | |
| Item 5. | 42 | |
| Item 6. | 43 | |
2
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes and incorporates by reference forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include future events and our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.
These forward-looking statements are identified by their use of terms and phrases such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and similar terms and phrases, and may also include references to assumptions. These statements are contained in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of this Quarterly Report on Form 10-Q.
Such forward-looking statements include, but are not limited to:
| ● | Funded backlog; |
| ● | Estimated remaining contract value; |
| ● | Our expectations regarding the U.S. Federal Government’s procurement budgets and reliance on outsourcing of services; and |
| ● | Our financial condition and liquidity, as well as future cash flows and earnings. |
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, the reader should specifically consider various factors, including the following:
| ● | the failure to obtain, delays in obtaining or adverse conditions contained in any required approvals in connection with the Merger (as defined below); |
| ● | the failure to consummate or delay in consummating the Merger for any reason; |
| ● | the outcome of any legal proceedings that may be instituted against the Company and others related to the Merger Agreement; |
| ● | Changes in U.S. Federal Government procurement laws, regulations, policies and budgets; |
| ● | The number and type of contracts and task orders awarded to us; |
| ● | The integration of acquisitions without disruption to our other business activities; |
| ● | Changes in general economic and business conditions and continued uncertainty in the financial markets; |
| ● | Technological changes; |
| ● | The ability to attract and retain qualified personnel; |
| ● | Competition; |
| ● | Our ability to retain our contracts during any rebidding process; and |
| ● | The other factors outlined under “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2010 and in this Quarterly Report on Form 10-Q. |
If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, actual results may vary materially from those expected, estimated or projected. We do not undertake to update our forward-looking statements or risk factors to reflect future events or circumstances.
PARADIGM HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
| June 30, 2011 | December 31, 2010 | |||||||
| ASSETS | (unaudited) | |||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | -- | $ | 94,746 | ||||
| Accounts receivable - contracts, net | 6,157,705 | 5,333,319 | ||||||
| Costs and earnings in excess of billings on uncompleted contracts | 363,677 | 3,398,380 | ||||||
| Restricted cash | 4,000,000 | 4,000,000 | ||||||
| Prepaid expenses | 537,185 | 1,214,542 | ||||||
| Deferred income tax assets | 111,874 | 50,837 | ||||||
| Other current assets | 1,404,011 | 842,717 | ||||||
| Total current assets | 12,574,452 | 14,934,541 | ||||||
| Property and equipment, net | 74,586 | 102,838 | ||||||
| Goodwill | 3,991,605 | 3,991,605 | ||||||
| Intangible assets, net | 376,409 | 550,045 | ||||||
| Deferred financing costs, net | 245,419 | 444,252 | ||||||
| Deferred income tax assets, net of current portion | 770,545 | 693,720 | ||||||
| Other non-current assets | 82,035 | 266,778 | ||||||
| Total Assets | $ | 18,115,051 | $ | 20,983,779 | ||||
| LIABILITIES AND STOCKHOLDERS' DEFICIT | ||||||||
| Current liabilities | ||||||||
| Bank overdraft | $ | 74,082 | $ | -- | ||||
| Notes payable — line of credit | 2,780,270 | 3,084,681 | ||||||
| Notes payable — promissory note, net of issuance discount | 3,969,867 | 3,877,124 | ||||||
| Accounts payable and accrued expenses | 2,214,623 | 5,371,557 | ||||||
| Accrued salaries and related liabilities | 1,636,052 | 1,811,553 | ||||||
| Corporate income tax payable | 72,896 | 114,294 | ||||||
| Mandatorily redeemable preferred stock - $.01 par value, 10,000,000 shares of preferred stock authorized with 6,206 shares designated to Series A-1 Senior Preferred Stock, 6,031 shares issued and outstanding as of June 30, 2011 and 6,115 shares issued and outstanding as of December 31, 2010, respectively | 6,663,327 | 600,000 | ||||||
| Other current liabilities | 73,897 | 176,669 | ||||||
| Total current liabilities | 17,485,014 | 15,035,878 | ||||||
| Long-term liabilities | ||||||||
| Other non-current liabilities | 32,065 | 67,365 | ||||||
| Mandatorily redeemable preferred stock, noncurrent portion | -- | 5,517,263 | ||||||
| Put warrants | 3,157,996 | 402,606 | ||||||
| Total liabilities | 20,675,075 | 21,023,112 | ||||||
| Commitments and contingencies | ||||||||
| Stockholders’ deficit | ||||||||
| Common stock - $.01 par value, 250,000,000 shares authorized, 45,038,701 shares issued as of June 30, 2011 and 44,671,598 shares issued as of December 31, 2010, respectively, of which 13,848,183 shares are held in the treasury | 311,907 | 308,236 | ||||||
| Additional paid-in capital | 4,178,459 | 3,987,536 | ||||||
| Accumulated deficit | (7,050,390 | ) | (4,335,105 | ) | ||||
| Total stockholders’ deficit | (2,560,024 | ) | (39,333 | ) | ||||
| Total liabilities and stockholders’ deficit | $ | 18,115,051 | $ | 20,983,779 | ||||
The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these condensed consolidated financial statements.
PARADIGM HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, 2011 | June 30, 2010 | June 30, 2011 | June 30, 2010 | |||||||||||||
| Contract Revenue | ||||||||||||||||
| Service contracts | $ | 6,446,146 | $ | 5,852,058 | $ | 12,907,657 | $ | 11,324,918 | ||||||||
| Repair and maintenance contracts | 4,977,671 | 1,665,583 | 11,038,682 | 3,715,427 | ||||||||||||
| Total contract revenue | 11,423,817 | 7,517,641 | 23,946,339 | 15,040,345 | ||||||||||||
| Cost of revenue | ||||||||||||||||
| Service contracts | 4,717,698 | 4,557,611 | 9,573,291 | 8,770,977 | ||||||||||||
| Repair and maintenance contracts | 4,188,788 | 1,199,338 | 9,515,375 | 2,856,149 | ||||||||||||
| Total cost of revenue | 8,906,486 | 5,756,949 | 19,088,666 | 11,627,126 | ||||||||||||
| Gross margin | 2,517,331 | 1,760,692 | 4,857,673 | 3,413,219 | ||||||||||||
| Selling, general and administrative | 1,465,155 | 1,601,960 | 3,114,235 | 3,209,883 | ||||||||||||
| Income from operations | 1,052,176 | 158,732 | 1,743,438 | 203,336 | ||||||||||||
| Other income (expense) | ||||||||||||||||
| Interest income | 8,053 | 961 | 18,756 | 969 | ||||||||||||
| Change in fair value of put warrants | 20,070 | (1,371,746 | ) | (2,755,390 | ) | (1,358,554 | ) | |||||||||
| Interest expense – mandatorily redeemable preferred stock | (523,219 | ) | (453,474 | ) | (1,024,262 | ) | (899,517 | ) | ||||||||
| Interest expense - other | (257,817 | ) | (171,286 | ) | (536,730 | ) | (280,450 | ) | ||||||||
| Total other expense | (752,913 | ) | (1,995,545 | ) | (4,297,626 | ) | (2,537,552 | ) | ||||||||
| Income (loss) from operations before income taxes | 299,263 | (1,836,813 | ) | (2,554,188 | ) | (2,334,216 | ) | |||||||||
| Provision for income taxes | 216,291 | 158,759 | 161,097 | 201,634 | ||||||||||||
| Net income (loss) attributable to common shareholders | $ | 82,972 | $ | (1,995,572 | ) | $ | (2,715,285 | ) | $ | (2,535,850 | ) | |||||
| Weighted average number of common shares: | ||||||||||||||||
| Basic | 31,006,967 | 42,385,884 | 30,915,191 | 41,814,456 | ||||||||||||
| Diluted | 181,274,383 | 42,385,884 | 30,915,191 | 41,814,456 | ||||||||||||
| Net income (loss) per common share | ||||||||||||||||
| Basic | $ | -- | $ | (0.05 | ) | $ | (0.09 | ) | $ | (0.06 | ) | |||||
| Diluted | $ | -- | $ | (0.05 | ) | $ | (0.09 | ) | $ | (0.06 | ) | |||||
The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these condensed consolidated financial statements.
PARADIGM HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Six Months Ended June 30, | ||||||||
| 2011 | 2010 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net loss | $ | (2,715,285 | ) | $ | (2,535,850 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Share-based compensation | 139,530 | 164,488 | ||||||
| Depreciation and amortization | 207,119 | 212,273 | ||||||
| Amortization of deferred financing costs | 198,833 | 201,144 | ||||||
| Amortization of debt discount | 524,823 | 303,147 | ||||||
| Accretion of preferred stock | 269,048 | 253,374 | ||||||
| Change in fair value of put warrants | 2,755,390 | 1,358,554 | ||||||
| Deferred income taxes | (137,862 | ) | (180,944 | ) | ||||
| (Increase) Decrease in | ||||||||
| Accounts receivable - contracts, net | (824,386 | ) | (340,802 | ) | ||||
| Costs and earnings in excess of billings on uncompleted contracts | 3,034,703 | -- | ||||||
| Restricted cash | -- | (4,000,000 | ) | |||||
| Prepaid expenses | 677,357 | (14,548 | ) | |||||
| Other current assets | (561,294 | ) | 42,660 | |||||
| Other non-current assets | 184,743 | 175,617 | ||||||
| (Decrease) Increase in | ||||||||
| Accounts payable and accrued expenses | (3,156,934 | ) | (619,414 | ) | ||||
| Accrued salaries and related liabilities | (175,501 | ) | 110,913 | |||||
| Other current liabilities | (144,170 | ) | 269,540 | |||||
| Other non-current liabilities | (35,300 | ) | (27,790 | ) | ||||
| Net cash provided by (used in) operating activities | 240,814 | (4,627,638 | ) | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Purchase of property and equipment | (5,231 | ) | (21,531 | ) | ||||
| Net cash used in investing activities | (5,231 | ) | (21,531 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Bank overdraft | 74,082 | -- | ||||||
| Proceeds from notes payable | -- | 4,000,000 | ||||||
| Payments on mandatorily redeemable preferred stock | (100,000 | ) | -- | |||||
| Debt issuance costs | -- | (206,021 | ) | |||||
| Proceeds from line of credit | 22,934,135 | 20,571,197 | ||||||
| Payments on line of credit | (23,238,546 | ) | (20,600,666 | ) | ||||
| Net cash (used in) provided by financing activities | (330,329 | ) | 3,764,510 | |||||
| Net decrease in cash and cash equivalents | (94,746 | ) | (884,659 | ) | ||||
| Cash and equivalents, beginning of period | 94,746 | 895,711 | ||||||
| Cash and cash equivalents, end of period | $ | -- | $ | 11,052 | ||||
| For the six months ended June 30, | 2011 | 2010 | ||||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION | ||||||||
| Cash paid during the year: | ||||||||
| Cash paid for income taxes | $ | 340,356 | $ | 228,000 | ||||
| Cash paid for interest | $ | 489,836 | $ | 413,097 | ||||
| Non-cash financing activities: | ||||||||
| Issuance of 367,103 shares and 3,428,571 shares of common stock in lieu of cash payment on financing fee incurred on amendment or issuance of promissory note as of June 30, 2011 and 2010, respectively | $ | 55,064 | $ | 285,107 | ||||
| Debt issuance costs incurred but not paid | $ | -- | $ | 70,431 | ||||
The accompanying Notes to the Condensed Consolidated Financial Statements are an integral part of these condensed consolidated financial statements.
PARADIGM HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Paradigm Holdings, Inc. (the “Company” or “Paradigm”) is the parent of the wholly owned subsidiaries, Paradigm Solutions Corp., Trinity Information Management Services (“Trinity”) and Caldwell Technology Solutions, LLC (“CTS”). On December 14, 2010, the Company reincorporated from the State of Wyoming to the State of Nevada pursuant to the merger of Paradigm Holdings, Inc., a Wyoming corporation (“Paradigm Wyoming”), into its wholly-owned subsidiary, Paradigm Holdings, Inc., a Nevada corporation (“Paradigm Nevada”). References to the Company in this Quarterly Report on Form 10-Q relate to Paradigm Wyoming and/or Paradigm Nevada as the context requires. Reference is made to the Annual Report on Form 10-K for the Company for the year ended December 31, 2010 filed with the Securities and Exchange Commission (the “SEC”) for additional information on our corporate structure.
The interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Therefore, certain financial information and footnote disclosures accompanying annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) are omitted in this interim report. The interim condensed consolidated financial statements and notes thereto should be read in conjunction with the Annual Report on Form 10-K for the Company for the year ended December 31, 2010.
The accompanying unaudited condensed consolidated financial statements for the Company reflect all normal recurring adjustments that are necessary, in the opinion of management, to present fairly the results of operations in accordance with GAAP. All significant intercompany accounts and transactions have been eliminated in consolidation. The results for the interim periods are not necessarily indicative of the results to be expected for the fiscal year.
Liquidity
As of June 30, 2011, the Company had an accumulated deficit of approximately $7.1 million and working capital deficit of $4.9 million principally associated with the reclassification of the Company’s Series A-1 Senior Preferred Stock, par value $0.01 per share (the “Series A-1 Preferred Stock”), as a current liability. Additionally, the Company is highly dependent on a line-of-credit financing arrangement. As of June 30, 2011, the Company had $1.7 million available under the Company’s working capital line of credit with Silicon Valley Bank (“SVB”). Although there can be no assurances, based upon the current level of operations, we believe that cash flow from operations, together with borrowings that we expect to be available from our working capital line of credit with SVB, will be adequate to meet future liquidity needs for the next twelve months. Refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for a further discussion.
For a description of the Company’s accounting policies, refer to Note 1 of the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for Paradigm Holdings, Inc. for the year ended December 31, 2010.
Restricted Cash
Restricted cash, which restrictions are expected to be released within one year, consists principally of cash held in money market accounts securing an outstanding letter of credit issued by SVB to secure the Performance Bond (defined below) issued in favor of a federal agency. Refer to Note 15 of the Notes to Condensed Consolidated Financial Statements for a further discussion.
Revenue Recognition
Substantially all of the Company's revenue is derived from service and solutions provided to the federal government by Company employees and subcontractors.
The Company generates its revenue from three different types of contractual arrangements: (i) time and materials contracts, (ii) cost-plus reimbursement contracts, and (iii) fixed price contracts.
Time and Materials (“T&M”). For T&M contracts, revenue is recognized based on direct labor hours expended in the performance of the contract by the contract billing rates and adding other billable direct costs.
Cost-Plus Reimbursement (“CP”). Under CP contracts, revenue is recognized as costs are incurred and include an estimate of applicable fees earned. For award based fees under CP contracts, the Company recognizes the relevant portion of the expected fee to be awarded by the client at the time such fee can be reasonably estimated and collection is reasonably assured based on factors such as prior award experience and communications with the client regarding performance.
Fixed Price (“FP”). The Company has two basic categories of FP contracts: (i) fixed price-level of effort (“FP-LOE”) and (ii) firm fixed price (“FFP”).
● | Under FP-LOE contracts, revenue is recognized based upon the number of units of labor actually delivered multiplied by the agreed rate for each unit of labor. Revenue on fixed unit price contracts, where specific units of output under service agreements are delivered, is recognized as units are delivered based on the specific price per unit. For FP maintenance contracts, revenue is recognized on a pro-rata basis over the life of the contract. |
● | Under FFP contracts, revenue is generally recognized subject to the provision of the SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” For those contracts that are within the scope of Accounting Standards Codification (“ASC”) 605-35, “Revenue Recognition; Construction-Type and Production-Type Contracts,” revenue is recognized on the percentage-of-completion method using costs incurred in relation to total estimated costs. |
In certain arrangements, the Company enters into contracts that include the delivery of a combination of two or more of its service offerings. Such contracts are divided into separate units of accounting. Revenue is recognized separately in accordance with the Company's revenue recognition policy for each element. Further, if an arrangement requires the delivery or performance of multiple deliveries or elements under a bundled sale, the Company determines whether the individual elements represent "separate units of accounting" under the requirements of ASC 605-25, “Revenue Recognition; Multiple Element Arrangements,” and allocates revenue to each element based on relative fair value.
Software revenue recognition for sales of OpsPlanner is in accordance with ASC 985-605, “Software Revenue Recognition.” Since the Company has not yet established vendor specific objective evidence of fair value for the multiple elements typically contained within an OpsPlanner sale, revenue from the sale of OpsPlanner is recognized ratably over the term of the contract.
In certain contracts, revenue includes third-party hardware and software purchased on behalf of clients. The level of hardware and software purchases made for clients may vary from period to period depending on specific contract and client requirements. The Company recognizes the gross revenue under ASC 605-45, “Revenue Recognition; Principal Agent Considerations,” for certain of its contracts which contain third-party products and services, because in those contracts, the Company is contractually bound to provide a complete solution which includes labor and additional services in which the Company maintains contractual, technical and delivery risks for all services and agreements provided to the customers, and the Company may be subject to financial penalties for non-delivery.
The Company is subject to audits from federal government agencies. The Company has reviewed its contracts and believes there is no material risk of any significant financial adjustments due to government audit. To date, the Company has not had any adjustments as a result of a government audit of its contracts.
Deferred revenue relates to contracts for which customers pay in advance for services to be performed at a future date. The Company recognizes deferred revenue attributable to its software and maintenance contracts over the related service periods.
Cost of Revenue
Cost of revenue for service contracts consists primarily of labor, consultant, subcontract, materials, travel expenses and an allocation of indirect costs attributable to the performance of the contract.
Cost of revenue for repair and maintenance contracts consist primarily of labor, consultant, subcontract, materials, travel expenses and an allocation of indirect costs attributable to the performance of the contract. Certain costs are deferred based on the recognition of revenue for the associated contracts.
Percentage-of-Completion Contracts
The Company records certain construction type contracts, primarily in its mission critical infrastructure area, under the percentage-of-completion method of accounting. Amounts recognized in revenues are calculated using the percentage of construction cost completed, generally on a cumulative cost to total cost basis. Cumulative revenues recognized may be less or greater than cumulative costs and profits billed at any point during a contract’s term. The resulting difference is recognized as “costs and earnings in excess of billings on uncompleted contracts” or “billings in excess of costs and earnings on uncompleted contracts.” When using the percentage-of-completion method, the Company must be able to accurately estimate the total costs it expects to incur on a project in order to record the amount of revenues for that period. The Company continually updates its estimates of costs and the status of each contract with its subcontractors. If it is determined that a loss will result from the performance of a contract, the entire amount of the loss is recognized when it is determined. The impact of revisions in contract estimates is recognized on a cumulative basis in the period in which the revisions are made.
Goodwill and Intangible Assets
Goodwill represents the excess of cost over the fair value of net assets acquired in business combinations. Pursuant to ASC 350, “Intangibles-Goodwill and Other,” goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment at least annually. ASC 350-30 also requires that identifiable intangible assets with estimable useful lives be amortized over their estimated useful lives, and reviewed for impairment in accordance with ASC 360-10, “Property, Plant, and Equipment.”
The Company conducts a review for impairment of goodwill at least annually. Additionally, on an interim basis, the Company assesses the impairment of goodwill and intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that the Company considers important which could trigger an impairment review include significant underperformance relative to historical or expected future operating results significant changes in the manner or use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends or a decline in the Company’s stock price for a sustained period. Goodwill and intangible assets are subject to impairment to the extent the Company’s operations experience significant negative results. These negative results can be the result of the Company’s individual operations or negative trends in the Company’s industry or in the general economy, which impact the Company. To the extent the Company’s goodwill and intangible assets are determined to be impaired then these balances are written down to their estimated fair value on the date of the determination. At June 30, 2011, there were no such factors indicating that the Company’s goodwill and intangible assets were impaired.
Share-based Compensation
The Company follows the provisions of ASC 718, “Compensation-Stock Compensation,” to account for share-based compensation. Option awards are valued at fair value based on the Black-Scholes option-pricing model and the fair value is recognized as an expense on a straight line basis over the requisite service period. Restricted common stock is valued at fair value based on the closing market price on the date of grant. Total share-based compensation expense included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations was $70 thousand and $81 thousand for the three months ended June 30, 2011 and 2010, respectively. Total share-based compensation expense was $140 thousand and $164 thousand for the six months ended June 30, 2011 and 2010, respectively. On February 15, 2011, the Board of Directors of the Company approved the grant of stock appreciation rights to certain employees of the Company. Each stock appreciation right is in the form of a SAR Warrant (as described further under Note 13). The SAR Warrants were classified as liabilities. The Company is required to reassess at each reporting date whether achievement of a certain performance condition (occurrence of the Liquidity Event) (as defined in the SAR Warrants)) is probable and the Company intends to begin recognizing compensation cost over the required service period if and when achievement of the performance condition became probable. Refer to Note 13 of the Notes to Condensed Consolidated Financial Statements for a further discussion.
Valuation of Warrants
The Company accounts for the issuance of common stock purchase warrants in accordance with the provisions of ASC 815-40. The Class A Warrants and Class B Warrants issued in connection with the sale of the Company’s Series A-1 Preferred Stock, contain a provision that could require cash settlement and that event is outside the control of the Company, and therefore are classified as a liability as of June 30, 2011. The Company assesses classification of put warrants at each reporting date to determine whether a change in classification is required. The Company values put warrants using the Black-Scholes valuation model. Put warrants are valued upon issuance, and re-valued at each financial statement reporting date. Any change in value is charged to other income or expense during the period.
Major Customers
Nearly all of the Company’s revenue is from federal agencies and 74% and 76% of total revenue was generated from four and three major customers during the three months ended June 30, 2011 and 2010, respectively. For the six months ended June 30, 2011 and 2010, 73% and 77% of total revenue was generated from these major customers, respectively. The Company’s accounts receivable related to these major customers was 72% and 66% of total accounts receivable at June 30, 2011 and at December 31, 2010, respectively. The Company defines major customer by agencies within the federal government.
A majority of the Company’s customer concentration is in the Mid-Atlantic states of the United States.
Segment Reporting
ASC 280, “Segment Reporting” establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that these enterprises report selected information about operating segments in interim financial reports. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers. Management has concluded that the Company operates in one segment based upon the information used by management in evaluating the performance of its business and allocating resources and capital.
Recent Accounting Pronouncements – Not Yet Adopted
In January 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-01, “Receivables (Topic 310): Deferral of the Effective Date of Disclosure about Troubled Debt Restructurings in Update No. 2010-20”. This ASU temporarily delays the effective date of the disclosures about troubled debt restructurings in Update No. 2010-20 for public entities. The standard is not expected to have a significant impact on the Company’s condensed consolidated financial statements.
In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination Whether a Restructuring Is a Troubled Debt Restructuring”. This ASU clarifies the guidance on a creditor’s evaluation of whether a restructuring constitutes a troubled debt restructuring. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 13, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company believes that the adoption of ASU 2011-02 will not have a material impact on the Company’s condensed consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. The amendments in this update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments in this update to result in a change in the application of the requirements in Topic 820. Some of the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. The Company believes that the adoption of ASU 2011-02 will not have a material impact on the Company’s condensed consolidated finance statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”. In this update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The entity is also required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15. 2011. The Company will adopt ASU 2011-05 on January 1, 2012 and will apply ASU 2011-05 to its future comprehensive income, if any.
Recent Accounting Pronouncements – Adopted
In December 2010, the FASB issued ASU 2010-28, “Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force)”. This ASU provides guidance on when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. The Company adopted ASU 2010-28 on January 1, 2011. The adoption of ASU 2010-28 did not materially impact the Company’s condensed consolidated financial statements.
In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force)”. This ASU specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The Company adopted ASU 2010-29 on January 1, 2011 and will apply ASU 2010-29 to its future acquisitions, if any.
2. FAIR VALUE MEASUREMENTS
In accordance with ASC 820, “Fair Value Measurements and Disclosures,” a fair value measurement is determined based on the assumptions that a market participant would use in pricing an asset or liability. ASC 820 also established a three-tiered hierarchy that draws a distinction between market participant assumptions based on (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than quoted prices in active markets that are observable either directly or indirectly (Level 2) and (iii) unobservable inputs that require the Company to use present value and other valuation techniques in the determination of fair value (Level 3).
The following table represents our financial assets and liabilities measured at fair value on a recurring basis and the basis for that measurement:
| Fair Value Measurement at June 30, 2011 Using: | ||||||||||||||||
Total Fair Value Measurement | Quoted Price in Active Markets | Significant Other | Significant Unobservable | |||||||||||||
| Put warrants at June 30, 2011 | $ | 3,157,996 | $ | -- | $ | 3,157,996 | $ | -- | ||||||||
| Put warrants at December 31, 2010 | $ | 402,606 | $ | -- | $ | 402,606 | $ | -- | ||||||||
The Company values the put warrants using the Black-Scholes model with the following assumptions:
| June 30, 2011 | December 31, 2010 | |||||||
| Exercise price | $0.078 & $0.0858 | $0.078 & $0.0858 | ||||||
| Underlying common stock price | $ | 0.15 | $ | 0.02 | ||||
| Volatility | 134.0 | % | 127.7 | % | ||||
| Contractual term | 4.66 years | 5.2 years | ||||||
| Risk free interest rate | 1.76 | % | 2.01 | % | ||||
| Common stock dividend rate | 0 | % | 0 | % | ||||
In accordance with ASC 815, the Company has classified the fair value of the warrants as a liability and changes in the fair value of the warrants are recognized in the earnings of the Company as long as the warrants remain classified as a liability.
The Company’s financial instruments also include cash and cash equivalents, accounts receivable, restricted cash, accounts payable, note payable - line of credit, note payable – promissory note and mandatorily redeemable preferred stock. The fair values of cash and cash equivalents, accounts receivable, restricted cash, accounts payable, note payable - line of credit and note payable – promissory note approximated the carrying values based on market interest rates and the time to maturity. The mandatorily redeemable preferred stock was initially valued using the discounted cash flow method based on the weighted average cost of capital of 29%, and subsequently accreted to the redemption amount using the effective interest method. At June 30, 2011, the estimated fair values and carrying amounts of the mandatorily redeemable preferred stock was $6.7 million.
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of billed and unbilled amounts under contracts in progress with governmental units, principally, the Office of the Comptroller of the Currency, the Department of State, and the Internal Revenue Service. The components of accounts receivable are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Billed receivables | $ | 3,245,465 | $ | 2,815,955 | ||||
| Unbilled receivables | 2,912,240 | 2,517,364 | ||||||
| Total accounts receivable – contracts, net | $ | 6,157,705 | $ | 5,333,319 | ||||
All receivables are expected to be collected within the next twelve months and are pledged to SVB as collateral for the Loan and Security Agreement with SVB. The Company's unbilled receivables are comprised of contract costs that cover the current service period and are normally billed in the following month and do not include the offset of any advances received. In general, for cost-plus and time and material contracts, invoicing of the unbilled receivables occurs when contractual obligations or milestones are met. Invoicing for firm fixed price contracts occurs on delivery and acceptance. The Company's unbilled receivables at June 30, 2011 do not contain retainage. All advance payments received, if any, are recorded as deferred revenue.
The Company establishes an allowance for doubtful accounts based upon factors surrounding the historical trends and other information of the government agencies it conducts business with. Such losses have been within management's expectations. The Company reserved $20,733 as an allowance for doubtful accounts related to certain customers at June 30, 2011 and December 31, 2010.
4. PREPAID EXPENSES
Prepaid expenses consist of the following:
| June 30, 2011 | December 31, 2010 | |||||||
| Prepaid insurance, rent and software maintenance agreements | $ | 131,393 | $ | 134,087 | ||||
| Contract-related prepaid expenses | 176,263 | 737,295 | ||||||
| Other prepaid expenses | 229,529 | 343,160 | ||||||
| Total prepaid expenses | $ | 537,185 | $ | 1,214,542 | ||||
5. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
The components of uncompleted contracts are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Costs incurred on contract in progress and estimated earnings | $ | 11,174,181 | $ | 4,397,376 | ||||
| Less billings to date | 10,810,504 | 998,996 | ||||||
| $ | 363,677 | $ | 3,398,380 | |||||
The components of contract in progress are reflected in the consolidated balance sheets as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Costs and earnings in excess of billings on uncompleted contracts | $ | 363,677 | $ | 3,398,380 | ||||
| Billings in excess of costs and earnings on uncompleted contracts | -- | -- | ||||||
| $ | 363,677 | $ | 3,398,380 | |||||
6. PROPERTY AND EQUIPMENT
Property and equipments are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Furniture and fixtures | $ | 92,411 | $ | 92,411 | ||||
| Equipment | 270,412 | 265,181 | ||||||
| Software | 331,618 | 331,618 | ||||||
| Leasehold improvement | 50,985 | 50,985 | ||||||
| Total property and equipment | 745,426 | 740,195 | ||||||
| Accumulated depreciation | (670,840 | ) | (637,357 | ) | ||||
| Property and equipment, net | $ | 74,586 | $ | 102,838 | ||||
Depreciation and amortization expense included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011 was $15,779 and $33,483, respectively, and depreciation and amortization expense for the three and six months ended June 30, 2010 was $20,899 and $38,637, respectively.
7. DEFERRED FINANCING COSTS
Deferred financing costs are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Financing costs | $ | 1,175,078 | $ | 1,175,078 | ||||
| Accumulated amortization | (929,659 | ) | (730,826 | ) | ||||
| Net carrying amount | $ | 245,419 | $ | 444,252 | ||||
Financing costs incurred are amortized over the life of the associated financing arrangements using the effective interest rate method. Amortization expense included in interest expense in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011 was $100,007 and $198,833, respectively, and amortization expense for the three and six months ended June 30, 2010 was $101,321 and $201,144, respectively. The Company estimates that it will incur the following amortization expense for the future periods indicated below.
| For the remaining six months ending December 31, 2011 | $ | 201,670 | ||
| For the year ending December 31, | ||||
| 2012 | 43,749 |
8. INTANGIBLE ASSETS
Intangible assets are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Contract backlog | $ | 1,810,000 | $ | 1,810,000 | ||||
| Accumulated amortization | (1,433,591 | ) | (1,259,955 | ) | ||||
| Net carrying amount | $ | 376,409 | $ | 550,045 | ||||
The Company recorded $1.8 million of intangible assets representing the fair value of contract backlog associated with the Trinity and CTS acquisitions in 2007. These intangible assets are being amortized over a period of five years and have no residual value at the end of their useful lives. Amortization expense included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011 was $86,818 and $173,636, respectively, and amortization expense for the three and six months ended June 30, 2010 was $86,818 and $173,636, respectively. The Company estimates that it will incur the following amortization expense for the future periods indicated below.
| For the remaining six months ending December 31, 2011 | $ | 173,636 | ||
| For the year ending December 31, 2012 | 202,773 |
9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Accounts payable | $ | 1,278,156 | $ | 4,829,421 | ||||
| Accrued expenses | 936,467 | 542,136 | ||||||
| Total accounts payable and accrued expenses | $ | 2,214,623 | $ | 5,371,557 | ||||
10. DEBTS
At June 30, 2011 and December 31, 2010, outstanding debts consisted of the following:
| June 30, 2011 | December 31, 2010 | |||||||
| Current debts: | ||||||||
| Notes payable – line of credit | $ | 2,780,270 | $ | 3,084,681 | ||||
| Notes payable – promissory note | 3,969,867 | 3,877,124 | ||||||
| Mandatorily redeemable preferred stock, current portion | 6,663,327 | 600,000 | ||||||
| Total current debt | $ | 13,413,464 | $ | 7,561,805 | ||||
| Long-term debts: | ||||||||
| Mandatorily redeemable preferred stock | $ | 6,206,000 | $ | 6,206,000 | ||||
| Add: Accretion preferred stock | 1,194,918 | 925,870 | ||||||
| Less: Redemption | (200,000 | ) | (100,000 | ) | ||||
| Stated value | 7,200,918 | 7,031,870 | ||||||
| Less: unamortized discount | (537,591 | ) | (914,607 | ) | ||||
| Carrying amount | 6,663,327 | 6,117,263 | ||||||
| Less: current portion | (6,663,327 | ) | (600,000 | ) | ||||
| Mandatorily redeemable preferred stock, net of current portion | $ | -- | $ | 5,517,263 | ||||
| Put warrants | $ | 3,157,996 | $ | 402,606 | ||||
| Total long-term debt, net of current portion | $ | 3,157,996 | $ | 5,919,869 | ||||
Notes Payable – Line of Credit
On March 13, 2007, the Company entered into two Loan and Security Agreements with SVB, one of which provided for a revolving credit facility of up to $10 million and the other of which provided for a working capital line of credit of up to $12 million. SVB and the Company have agreed that the revolving credit facility has no further force or effect. The Company continues to use the working capital line of credit to borrow funds for working capital and general corporate purposes. References to the Loan and Security Agreement in this description refer to the working capital line of credit agreement. The Loan and Security Agreement is secured by a first priority perfected security interest in any and all properties, rights and assets of the Company, wherever located, whether now owned or thereafter acquired or arising and all proceeds and products thereof as described in the Loan and Security Agreement.
Under the Loan and Security Agreement, the line of credit is due on demand and interest is payable monthly based on a floating per annum rate equal to the aggregate of the Prime Rate plus the applicable spread which ranges from 1.00% to 2.00%, as well as other fees and expenses as set forth more fully in the agreements. The Loan and Security Agreement requires the Company to maintain certain EBITDA covenants as specified in the Loan and Security Agreement. On March 18, 2009, the Company and SVB entered into a Second Loan Modification Agreement. This Second Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to May 12, 2009 and modify the funds available under the working capital line of credit facility to not exceed $4.5 million and the total funds available under the Loan and Security Agreement to a maximum amount of $5.625 million. The interest rates and EBITDA covenant were consistent with the previous agreement for the remainder of the extension period. On May 4, 2009, the Company and SVB entered into a Third Loan Modification Agreement. This Third Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to June 12, 2009. On July 2, 2009, the Company and SVB entered into a Fourth Loan Modification Agreement. This Fourth Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to June 11, 2010.
On June 11, 2010, the Company and SVB entered into a Fifth Loan Modification Agreement. This Fifth Loan Modification Agreement, among other things, (i) reduces the early termination fee payable by the Company from $100,000 to $45,000, (ii) modifies the finance charge and collateral handling fee payable by the Company, (iii) revises the Company’s financial covenants, (iv) waives the Company’s failure to comply with certain financial covenants for the three month periods ended February 28, 2010, March 31, 2010, April 30, 2010 and May 31, 2010, (v) revises the circumstances pursuant to which the Company may redeem shares of Series A-1 Senior Preferred Stock without the prior written consent of SVB, (vi) adds certain new definitions and amends the definitions of “Prime Rate”, “Eligible Accounts” and “Applicable Rate” and (vii) extends the maturity date to May 15, 2011. On May 16, 2011, the Company and SVB entered into a Sixth Loan and Modification Agreement to extend the maturity date to November 11, 2011. The Company was in compliance with the EBITDA covenant set forth in Section 6.7(b) of the Loan and Security Agreement as of the three and six month periods ended June 30, 2011. As of June 30, 2011, the Company had $2.8 million outstanding, and $1.7 million additional availability, under its working capital line of credit with SVB.
The Loan and Security Agreement contains events of default that include among other things, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, cross default to certain other indebtedness, bankruptcy and insolvency events, change of control and material judgments. Upon occurrence of an event of default, SVB is entitled to, among other things, accelerate all obligations of the Company and sell the Company's assets to satisfy the Company's obligations under the Loan and Security Agreement. As of June 30, 2011, no events of default had occurred.
On May 6, 2011, the Company, PSC, CTS, Trinity and SVB entered into an Assumption Agreement (the “Assumption Agreement”). Pursuant to the Assumption Agreement, the Company, among other things, agreed to substitute itself as “Borrower” under the Loan and Security Agreement and other related loan documents in lieu of Paradigm Wyoming and granted a security interest to SVB in certain specified collateral. The Assumption Agreement also amended the Loan and Security Agreement by adding and clarifying certain definitions.
In addition to the Assumption Agreement, on May 6, 2011, the Company and SVB entered into a Intellectual Property Security Agreement (the “Intellectual Property Security Agreement”) pursuant to which the Company granted SVB a security interest in the Company’s intellectual property and the Company, SVB, SVB Securities and Penson Financial Services, Inc. entered into a Securities Account Control Agreement with respect to, among other things, the Company’s securities accounts with SVB Securities (the “SACA”).
On May 26, 2010, Paradigm Wyoming, PSC, CTS, Trinity, SVB and the Purchasers as defined herein entered into a Subordination Agreement in connection with a loan transaction between Paradigm Wyoming and the Purchasers (the “Subordination Agreement”). On May 6, 2011, the Company, PSC, CTS, Trinity, SVB and the Purchasers entered into a Ratification of Subordination Agreement pursuant to which, among other things, (i) the Purchasers ratified the Subordination Agreement, consented to the Assumption Agreement and acknowledged that references to “Borrower” in the Subordination Agreement include the Company and (ii) Silicon Valley Bank ratified the Subordination Agreement, consented to the terms of the Purchaser Assumption Agreement (as defined below) and acknowledged that references to “Borrower” in the Subordination Agreement include the Company.
Notes Payable – Promissory Note
On May 26, 2010, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Hale Capital Partners, LP (“Hale Capital”) and EREF PARA, LLC (“EREF” and together with Hale Capital, the “Purchasers”) and consummated the issuance and sale of Senior Secured Subordinated Promissory Notes with an aggregate principal amount of $4,000,000 (the “Original Notes”) to the Purchasers, for an aggregate purchase price of $4,000,000. In addition, the Company issued 3,428,571 shares (the “Fee Shares”) of the Company’s common stock, to the Purchasers, at a purchase price of $0.086 per share, in lieu of a cash payment owed by the Company to the Purchasers with respect to the financing fee in connection with the transactions contemplated by the Securities Purchase Agreement. The Company used the net proceeds from the sale of the Original Notes as security for the issuance of a letter of credit to secure the Performance Bond. Refer to Note 15 of the Notes to Consolidated Financial Statements for a further discussion of the Performance Bond. The Notes were initially valued using the discounted cash flow method based on the weighted average cost of capital, and subsequently accreted to the face amount using the effective interest method. The common stock was valued based on the Company’s closing stock market price on the date of the issuance. The initial proceeds allocated to the Notes and the common stock were $3.7 million and $0.3 million, respectively. The Company also incurred $0.2 million of costs in relation to this transaction, which were recorded as deferred financing costs under the caption of other current assets on the balance sheet to be amortized over the term of the Notes.
As a replacement for the Senior Secured Subordinated Promissory Notes previously issued on May 26, 2010 to the Purchasers by Paradigm Wyoming, on May 6, 2011, the Company issued Senior Secured Subordinated Promissory Notes with an aggregate principal amount of $4,000,000 (the “Notes” or the “Senior Notes”) to the Purchasers. The Notes have substantially the same terms as the Original Notes.
On May 16, 2011, the Company and the Purchasers entered into an Amendment to Senior Secured Subordinated Notes (the “Amendment”) pursuant to which the Notes were amended to provide, among other things, (i) that the maturity date of the Notes will be November 25, 2011 and (ii) to provide that the Company will pay, on or before May 26, 2011, as a prepayment of principal on the Notes, $756,767 to Hale Capital and $743,233 to EREF PARA. In connection with the Amendment, the Company issued an aggregate of 367,103 shares of common stock to the Purchasers as additional interest on the Notes. The Purchasers waived the required $1.5 million principal prepayment via Preferred Stock, Warrant and Note Termination Agreement as part of the Agreement and Plan of Merger with CACI, Inc.—Federal and CACI Newco Corporation. Refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for a further discussion.
The Notes accrue interest at a rate of 6.00% per annum. The Notes mature on November 25, 2011 (the “Maturity Date”). The Purchasers may require the Company to redeem all or any portion of the Notes prior to the Maturity Date in connection with an “Event of Default,” “Change of Control” or “Sale” (each as defined in the Notes). From and after the incurrence of an “Event of Default” the interest rate under the Notes automatically increases to 18.00%. The Notes also contain, among other things, certain affirmative and negative covenants, including, without limitation, limitations on indebtedness, liens and restricted payments. If the Company fails to redeem the Notes to the extent required pursuant to the terms of the Notes, then each holder of the Notes may elect to convert such holder’s Notes into common stock at a conversion price of $0.086.
On May 6, 2011, the Company, PSC, CTS, Trinity and the Purchasers entered into an Assumption and Reaffirmation Agreement (the “Purchaser Assumption Agreement”) pursuant to which, among other things, (i) the Company agreed to substitute itself as the “Company” and “Parent” in the Securities Purchase Agreement and related transaction documents in lieu of Paradigm Wyoming, (ii) assumed and agreed to pay all principal, accrued and unpaid interest and late charges owing under the Securities Purchase Agreement and the related transaction documents, (iii) acknowledged certain liens and reaffirmed certain obligations of the Company, (iv) granted a security interest to the Purchasers in certain specified collateral and (v) consented to the Assumption Agreement, the Intellectual Property Security Agreement and the SACA.
Mandatorily Redeemable Preferred Stock and Warrants
On February 27, 2009, the Company completed a private placement to a group of investors led by Hale Capital Partners, LP (“the purchasers”) pursuant to a Preferred Stock Purchase Agreement the (“Preferred Stock Purchase Agreement”) for gross proceeds of $6.2 million. The Company issued 6,206 shares of Series A-1 Preferred Stock, which bear an annual dividend of 12.5%. Each share of Series A-1 Preferred Stock has an initial stated value of $1,000 per share (the “Stated Value”). The private placement included 7-year Class A Warrants to purchase an aggregate of 79,602,604 shares of Common Stock at an exercise price of $0.0780 per share and 7-year Class B Warrants to purchase an aggregate of 69,062,248 shares of Common Stock at an exercise price of $0.0858 per share (collectively, the “Warrants”). We refer to the Class A Warrants, the Class B Warrants and the Series A-1 Preferred Stock collectively as the “Securities”. Except for the exercise price and number of shares of Common Stock subject to the Warrants, the terms of the Class A Warrants and the Class B Warrants are substantially similar. In addition, the Class A Warrants are subject to extension for an additional seven years if the Company has not met certain milestones. The Warrants may be exercised for cash or on a cashless exercise basis. The Warrants are subject to full ratchet anti-dilution provisions and other customary anti-dilution provisions as described therein. The Warrants further provide that in the event of certain fundamental transactions or the occurrence of an event of default under the Certificate of Designations that the holder of the Warrants may cause the Company to repurchase such Warrants for the purchase price specified therein.
Voting
The holders of Series A-1 Preferred Shares are entitled to vote together with the common stock on all matters and in the same manner. Each share of the Series A-1 Preferred Stock shall entitle the holder to such number of votes as shall equal the quotient of (x) the total number of shares of Common Stock issuable upon exercise of all Class A Warrants then outstanding, divided by (y) the total number of shares of Series A-1 Preferred Stock then outstanding.
Dividends
The holders of the Series A-1 Preferred Stock are entitled to receive cumulative dividends at the rate of 12.5% per annum, accruing on a daily basis and compounding monthly, with 40% of such dividends payable in cash and 60% of such dividends payable by adding such amount to the Stated Value per share of the Series A-1 Preferred Stock. The dividend shall be paid on a monthly basis to the holders of Series A-1 Preferred Stock entitled to receive such dividends.
Liquidation
Upon the occurrence of a liquidation event (including certain fundamental transactions), the holders of the Series A-1 Preferred Stock are entitled to receive prior and in preference to the payment of any amounts to the holders of any other equity securities of the Company (the “Junior Securities”) (i) 125% of the Stated Value of the outstanding shares of Series A-1 Preferred Stock, (ii) all accrued but unpaid cash dividends with respect to such shares of Series A-1 Preferred Stock and the (iii) specified repurchase prices with respect to all Warrants held by such holders.
Redemption
The Certificate of Designations of the Series A-1 Preferred Stock provides that any shares of Series A-1 Preferred Stock outstanding as of February 9, 2012 are to be redeemed by the Company for their Stated Value plus all accrued but unpaid cash dividends on such shares (the “Redemption Price”). In addition, on the last day of each calendar month beginning February 2009 through and including February 2010, the Company is required to redeem the number of shares of Series A-1 Preferred Stock obtained by dividing 100% of all Excess Cash Flow (as defined in the Certificate of Designations) with respect to such month by the Redemption Price applicable to the shares to be redeemed. Further, on the last day of each month beginning March 2010 through and including January 2012, the Company shall redeem the number of shares of Series A-1 Preferred Stock obtained by dividing the sum of $50,000 plus 50% of the Excess Cash Flow with respect to such month by the Redemption Price applicable to the shares to be redeemed. At anytime prior to February 9, 2012, the Company may redeem shares of Series A-1 Preferred Stock for 125% of the Stated Value of such shares plus all accrued but unpaid cash dividends for such shares. As of June 30, 2011, the Company had redeemed approximately 175 shares of Series A-1 Preferred Stock and no redemptions with respect to any Excess Cash Flow had been made in accordance with restrictions placed by SVB with respect to such redemptions and/or the Company’s lack of Excess Cash Flow. If at anytime a Purchaser realizes cash proceeds with respect to the Securities or common stock received upon exercise of the Warrants equal to or greater than the aggregate amount paid by the Purchaser for the Securities plus 200% of such amount then the Company has the option to repurchase all outstanding shares of Series A-1 Preferred Stock (other than certain excluded shares of Series A-1 Preferred Stock) held by that Purchaser for no additional consideration.
On May 16, 2011, the Purchasers and the Company entered into a letter agreement pursuant to which the Purchasers agreed that if the Company fails to redeem the Company’s outstanding Series A-1 Preferred Stock on February 9, 2012 (the “Maturity Date”) pursuant to the mandatory redemption provision (the “Mandatory Redemption Requirement”) of the Certificate of Designations that the Purchasers waive the Company’s compliance with such requirement on February 9, 2012 and the Company and the Purchasers agreed that the Maturity Date would thereafter be extended until May 9, 2012. If the Company fails to redeem the Series A-1 Preferred Stock either (i) on May 9, 2012 pursuant to the revised Mandatory Redemption Requirement or (ii) as otherwise required under the Certificate of Designations, such failure would constitute an Event of Default pursuant to the Certificate of Designations.
Notwithstanding the above, each holder of Series A-1 Preferred Stock retains the right to hold one share of Series A-1 Preferred Stock without regard to any rights of the Company to redeem, repurchase or repay any shares of Series A-1 Preferred Stock pursuant to any provision contained in the Certificate of Designations of the Series A-1 Preferred Stock; provided, that in the event that a Holder holds only one share of Series A-1 Preferred Stock then that share would only entitle the holder to certain voting rights with respect to such share and shall not entitle the holder to any other rights under the Certificate of Designations of Series A-1 Preferred Stock except for rights accruing to such holder as a result of such holder’s ownership of Warrants or shares of common stock issuable upon exercise of Warrants. In the event that all Class A Warrants are no longer exercisable to purchase shares of common stock, then the Company may redeem such share of Series A-1 Preferred Stock for the liquidation price with respect to such share.
Covenants
The Preferred Stock Purchase Agreement and the Certificate of Designations also contain certain affirmative and negative covenants. The negative covenants require the prior approval of Hale Capital, for so long as (i) an aggregate of not less than 15% of the shares of Series A-1 Preferred Stock purchased on February 27, 2009 are outstanding, (ii) Warrants to purchase an aggregate of not less than 20% of the shares issuable pursuant to the Warrants on February 27, 2009 are outstanding or (iii) the Holders, in the aggregate, own not less than 15% of the common stock issuable upon exercise of all Warrants on February 27, 2009 (we refer to (i), (ii) and (iii) as the “Ownership Threshold”) in order for the Company to take certain actions, including, among others, (i) amending the Company’s Articles of Incorporation or other charter documents, (ii) liquidating, dissolving or winding-up the Company, (iii) merging with, consolidating with or acquiring or being acquired by, or selling all or substantially all of its assets to, any person, (iv) selling, licensing or transferring any capital stock or assets with a value, individually or in the aggregate, of $100,000 or more, (v) undergoing certain fundamental transactions, (vi) certain issuances of capital stock, (vii) certain redemptions or dividend payments, (viii) the creation, incurrence or assumption of certain types of indebtedness or liens, (ix) increasing or decreasing the size of the Company’s Board of Directors and (x) appointing, hiring, suspending or terminating the employment or materially modifying the compensation of any executive officer.
The Company accounts for its preferred stock based upon the guidance enumerated in ASC 480, “Distinguishing Liabilities from Equity.” The Series A-1 Preferred Stock is mandatorily redeemable on February 9, 2012 and therefore is classified as a liability instrument on the date of issuance. The mandatorily redeemable preferred stock was initially valued using the discounted cash flow method based on the weighted average cost of capital of 29%, and subsequently accreted to the redemption amount using the effective interest method. Interest expense related to the mandatorily redeemable preferred stock included in other expense in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011 was $0.5 million and $1.2 million, respectively, and interest expense related to the mandatorily redeemable preferred stock for the three and six months ended June 30, 2010 was $0.5 million and $0.9 million, respectively. The Warrants issued in connection with the Series A-1 Preferred Stock provide that the holders of the Warrants may cause the Company to repurchase such Warrants for the purchase price in the event of certain fundamental transactions or the occurrence of an event of default. The Company evaluated the Warrants pursuant to ASC 815-40 and determined that the Warrants should be classified as liabilities because they contain a provision that could require cash settlement and that event is outside the control of the Company. The warrants should be measured at fair value, with changes in fair value reported in earnings as long as the warrants remain classified as a liability.
The Company is amortizing the warrant discount using the effective interest rate method over the three year term of the Series A-1 Preferred Stock. Although the stated interest rate of the Series A-1 Preferred Stock is 12.5%, as a result of the discount recorded for the warrants, the effective interest rate is 26% as of June 30, 2011. The Company also incurred $1,175,078 of costs in relation to this transaction, which were recorded as deferred financing costs to be amortized over the term of the Series A-1 Preferred Stock.
The Company calculated the fair value of the warrants using the Black-Scholes option pricing model. This change of fair value of the Warrants was reflected as a component of other expense within the statement of operations. For the three and six months ended June 30, 2011, the change of fair value of the Warrants was $20 thousand and $2.8 million, respectively. For the three and six months ended June 30, 2010, the change of fair value of the Warrants was $1.4 million.
On May 26, 2010, the Purchasers and the Company, entered into the Consent and Amendment (the “Consent and Amendment”) to the Preferred Stock Purchase Agreement, dated February 27, 2009, by and among the Company and the Purchasers (the “Preferred Stock Agreement”), to, among other things: (i) grant registration rights to the Purchasers with respect to the Fee Shares; (ii) exclude the Notes and Fee Shares from certain participation rights granted to the purchasers of securities under to the Preferred Stock Agreement ; and (iii) amend the Company’s existing right to repurchase Series A-1 Preferred Stock for no additional consideration following the occurrence of certain events as provided in the Preferred Stock Purchase Agreement to exclude certain “Excluded Shares” (as defined in the Consent and Amendment) from such provision.
11. INCOME TAXES
The Company accounts for income taxes in accordance with ASC 740, “Income Taxes.” Under ASC 740, the Company recognizes deferred income taxes for all temporary differences between the financial statement basis and the tax basis of assets and liabilities at currently enacted income tax rates.
Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable earnings. Valuation allowances are established when necessary to reduce deferred tax assets to the amount more likely than not to be realized.
ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company concluded that there are no significant uncertain tax positions requiring recognition in the financial statements based on an evaluation performed for the tax years ended December 31, 2007, 2008, 2009 and 2010, the tax years which remain subject to examination by major tax jurisdictions as of June 30, 2011.
The Company may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been immaterial to the financial results. As of June 30, 2011, the Company had recorded immaterial interest and penalties associated with the filing of previous tax returns and no unrecognized tax benefits that would have an effect on the effective tax rate. The Company elected to continue to report interest and penalties as income taxes.
12. NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the reported period. Common shares issued during the period and common shares reacquired during the period are weighted for the portion of the period in which the shares were outstanding. Diluted net income (loss) per common share has been computed in a manner consistent with that of basic net income (loss) per common share while giving effect to all potentially dilutive common shares that were outstanding during each period. The following table reflects the computation of the Company's basic and diluted net income (loss) per common share for the three and six months ended June 30, 2011 and 2010.
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Basic net income (loss) per common share: | ||||||||||||||||
| Net income (loss) attributable to common stockholders | $ | 82,972 | $ | (1,995,572 | ) | $ | (2,715,285 | ) | $ | (2,535,850 | ) | |||||
| Change in fair value of put warrants, net of income tax | (20,070 | ) | -- | -- | -- | |||||||||||
| Net income (loss) attributable to common stockholders - diluted | $ | 62,902 | $ | (1,995,572 | ) | $ | (2,715,285 | ) | $ | (2,535,850 | ) | |||||
Weighted average common shares outstanding - basic | 31,006,967 | 42,385,884 | 30,915,191 | 41,814,456 | ||||||||||||
| Treasury effect of common stock equivalents | 150,267,416 | -- | -- | -- | ||||||||||||
Total weighted average common shares outstanding – diluted | 181,274,383 | 42,385,884 | 30,915,191 | 41,814,456 | ||||||||||||
| Basic net income (loss) per common share | $ | -- | $ | (0.05 | ) | $ | (0.09 | ) | $ | (0.06 | ) | |||||
| Diluted net income (loss) per common share | $ | -- | $ | (0.05 | ) | $ | (0.09 | ) | $ | (0.06 | ) | |||||
Common stock equivalents of 4,328,066 and 154,595,482 were not included in the computation of diluted net loss per common share for the three and six months ended June 30, 2011, respectively, and common stock equivalents of 154,638,817 and 154,648,808 were not included in the computation of diluted net loss per common share for the three and six months ended June 30, 2010, respectively, as these common stock equivalents are not “in-the-money” or the inclusion of these common stock equivalents would be anti-dilutive due to the Company’s net loss position and including such shares would reduce the net loss per common share in those periods.
13. STOCK INCENTIVE PLAN
On August 3, 2006, the Board of Directors and stockholders approved the 2006 Stock Incentive Plan (the “Plan”). A total of 2,500,000 shares of common stock were initially reserved for issuance under the Plan. At June 30, 2011, 4,918,546 shares of common stock were reserved for issuance under the Plan. The shares of common stock reserved for issuance under the Plan are in addition to approximately 1,000,000 shares of common stock which have been reserved for issuance related to standalone stock options that were granted by the Company to employees and directors on December 15, 2005 and May 15, 2006. As of June 30, 2011, 2,925,000 shares of restricted common stock and options to purchase 467,000 shares of common stock have been issued under the Plan and options to purchase 2,622,000 shares of common stock have been granted outside of the Plan. Individual awards under the Plan may take the form of incentive stock options and nonqualified stock options. To date, only nonqualified stock options have been granted under the Plan. These awards generally vest over three years of continuous service.
The Compensation Committee administers the Plan, selects the individuals who will receive awards and establishes the terms and conditions of those awards. Shares of common stock subject to awards that have expired, terminated, or been canceled or forfeited are available for issuance or use in connection with future awards.
Stock Options
The following table summarizes the Company's stock option activity.
Number of Options | Weighted Average | Aggregate Intrinsic | Weighted Average | |||||||||||||
| (in years) | ||||||||||||||||
| Outstanding at January 1, 2011 | 1,477,000 | $ | 0.29 | $ | -- | 5.6 | ||||||||||
| Granted | -- | -- | ||||||||||||||
| Exercised | -- | -- | ||||||||||||||
| Canceled | (10,000 | ) | 0.20 | |||||||||||||
| Outstanding at June 30, 2011 | 1,467,000 | $ | 0.29 | $ | -- | 5.1 | ||||||||||
| Exercisable at January 1, 2011 | 1,442,000 | $ | 0.30 | $ | -- | 5.6 | ||||||||||
| Exercisable at June 30, 2011 | 1,435,333 | $ | 0.30 | $ | -- | 5.1 | ||||||||||
Share-based compensation expense included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2011 was $1 thousand and $3 thousand, respectively and share-based compensation for the three and six months ended June 30, 2010 was $12 thousand and $28 thousand, respectively.
The Company did not grant any stock options for the three and six months ended June 30, 2011 and 2010. As of June 30, 2011, the Company had $2 thousand of total unrecognized option compensation costs, which will be recognized over a weighted average period of 0.25 years.
Restricted Common Stock
On May 3, 2007, the Board of Directors of the Company granted restricted shares of common stock, par value $0.01 per share, to certain individuals. The restricted shares will vest on January 2, 2012, unless vesting is accelerated, and have no interim vesting periods. On October 21, 2008, the Board of Directors of the Company granted restricted shares of common stock, par value $0.01 per share, to certain individuals. The restricted shares will vest on January 2, 2013, unless vesting is accelerated, and have no interim vesting periods. The restricted shares were issued from the Plan with the intent of providing a longer-term employment retention mechanism to key management and board members.
The following table summarizes the Company's restricted common stock activity.
Number of Restricted | Aggregate Fair Value | Weighted Average | Weighted Average | |||||||
| (in years) | (in years) | |||||||||
| Outstanding at January 1, 2011 | 2,625,000 | $ | 1,245,000 | 4.4 | 1.6 | |||||
| Granted | -- | |||||||||
| Outstanding at June 30, 2011 | 2,625,000 | $ | 1,245,000 | 4.4 | 1.1 | |||||
Share-based compensation expense for the restricted stock was included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations. The compensation expense recognized for the three and six months ended June 30, 2011 was $68 thousand and $137 thousand, respectively, and the compensation expense recognized for the three and six months ended June 30, 2010 was $68 thousand and $137 thousand, respectively.
The Company did not grant any restricted common stock for the three and six months ended June 30, 2011 and 2010. As of June 30, 2011, the unrecognized compensation costs related to the remaining nonvested shares of restricted stock was $0.2 million, which will be recognized over a weighted average period of 1.1 years.
Stock Appreciation Rights
On February 15, 2011, the Board of Directors of the Company approved the grant of stock appreciation rights to certain employees of the Company. Each stock appreciation right is in the form a SAR Warrant (the “SAR Warrants” or “Company SARs”) that is exercised automatically upon the occurrence of a Liquidity Event (as defined in the SAR Warrants), with respect to that number of shares that would equal a specified percentage of the shares of common stock of the Company, that are outstanding as of the Liquidity Date (as defined in the SAR Warrants) (the “Target Shareholding Percentage”), subject to the terms and conditions set forth in the SAR Warrants.
The aggregate Target Shareholding Percentages for the SAR Warrants is 15%, with each of Peter B. LaMontagne (President and Chief Executive Officer), Richard Sawchak (Senior Vice President Finance and Chief Financial Officer), Anthony Verna (Senior Vice President Business Strategy and Business Development) and Robert Boakai (Vice President, Enterprise IT Solution) having Target Shareholding Percentages of 6.5%, 2.5%, 1.83% and 1.83%, respectively. The remaining 2.34% has been granted to certain other officers and senior employees of the Company.
The aggregate number of shares of common stock for which the SAR Warrants will be vested and automatically exercised on the Liquidity Date is equal to: (a) in the event the 1X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 50% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “1X Threshold Shares”) plus (b) solely in the event the 2X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.65% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “2X Threshold Shares”); plus (c) solely in the event the 3X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.65% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “3X Threshold Shares”); plus (d) solely in the event the 4X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.7% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “4X Threshold Shares”). If the 1X Threshold has not been achieved on or prior to the Liquidity Date, the SAR Warrants will automatically be cancelled effective as of the Liquidity Date, and thereafter the grantees will not be entitled to any right, benefit or entitlement with respect to the SAR Warrants. For purposes of the above description: (a) “1X Threshold” means the cumulative receipt by Investor (as defined in the SAR Warrants) with respect to the aggregate Investor Investment (as defined in the SAR Warrants) of an amount equal to the Investor Return (as defined in the SAR Warrants), (b) “2X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to two (2) times the Investor Return, (c) “3X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to three (3) times the Investor Return and (d) “4X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to four (4) times the Investor Return.
Generally, payment in respect of the SAR Warrants if exercised on a Liquidity Date will be made in a cash and will equal an amount determined by multiplying (i) times (ii): (i) is the number of shares of common stock with respect to which the SAR Warrant is being exercised; and (ii) is the excess of (A) the Fair Market Value (as defined in the SAR Warrant) of one share of common stock on the date of exercise, over (B) the Exercise Price.
The exercise price (the “Exercise Price”) of the SAR Warrants with respect to the 1X Threshold Shares, the 2X Threshold Shares and the 3X Threshold Shares is $0.081586 per share of common stock and with respect to the 4X Threshold Shares is $0.163172 per share of common stock.
The SAR Warrants are classified as liabilities and the vesting condition is considered a performance condition based on the guidance of ASC 718, “Compensation – Stock Compensation.” Since the SAR Warrants do not vest until the performance condition is met and the performance condition (occurrence of the Liquidity Event) is not considered probable at the quarter ended June 30, 2011, no compensation expense has been recognized for the reporting period. The Company is required to reassess at each reporting date whether achievement of the performance condition is probable and the Company intends to begin recognizing compensation cost over the required service period if and when achievement of the performance condition become probable. The compensation cost recognized in the financial statements will be based on the fair value of the award coincident with the time when performance condition becomes probable.
Shares Reserved for Future Issuance
At June 30, 2011, future issuances of the Company’s common stock are as follows:
| June 30, 2011 | December 31, 2010 | |||||||
| Exercise of Class A and B warrants | 148,664,851 | 148,664,851 | ||||||
| Exercise of common stock purchased warrants | 1,602,565 | 1,602,565 | ||||||
| Exercise of common stock purchased warrants | 232,733 | 232,733 | ||||||
| Exercise of stock options | 1,467,000 | 1,477,000 | ||||||
| 151,976,149 | 151,977,149 | |||||||
14. CONTRACT STATUS
Provisional Indirect Cost Rates
Billings under cost-plus government contracts are calculated using provisional rates which permit recovery of indirect costs. These rates are subject to audit on an annual basis by governmental audit agencies. The cost audits will result in the negotiation and determination of the final indirect cost rates which the Company may use for the period(s) audited. The final rates, if different from the provisional, may create an additional receivable or liability.
As of June 30, 2011, the Company has had no final settlements on indirect rates. The Company periodically reviews its cost estimates and experience rates and adjustments, if needed, are made and reflected in the period in which the estimates are revised. In the opinion of management, redetermination of any cost-based contracts for the open years will not have any material effect on the Company's financial position or results of operations.
The Company has authorized but uncompleted contracts on which work is in progress at June 30, 2011 approximately, as follows:
| Total contract prices of initial contract awards, including exercised options and approved change orders (modifications) | $ | 166,666,807 | ||
| Completed to date | 145,194,289 | |||
| Authorized backlog | $ | 21,472,518 |
The foregoing contracts contain unfunded and unexercised options not reflected in the above amounts of approximately $42,800,000.
As of June 30, 2011, two of the Company's existing contracts are subject to renegotiation during the remainder of 2011.
15. COMMITMENT AND CONTINGENCY
Bond Commitment
The Company was required by a certain governmental agency to post performance and payment bonds for one of its contracts which was won in the second quarter of 2010. The bonds were obtained through the surety company Zurich NA and guarantee to the customer that the Company will perform under the terms of the contract and to pay vendors. If the Company fails to perform under the contract or to pay vendors, the customer may require that the insurer make payments or provide services under the bonds. The bonds were further secured by an irrevocable letter of credit of $4.0 million. At June 30, 2011, the Company had $13.0 million in performance and payment bonds outstanding.
Letter of Credit
On May 26, 2010, the Company caused SVB to issue an irrevocable standby letter of credit in the aggregate amount of $4.0 million to secure the Performance and Payment Bonds. The letter of credit was originally valid until May 31, 2011 originally. In May 2011, the letter of credit was extended to May 31, 2012. The Company used the net proceeds from the sale of the Notes as security for the letter of credit.
16. SUBSEQUENT EVENTS
Agreement and Plan of Merger
On July 25, 2011, the Company, CACI, Inc.—Federal, a Delaware corporation (“Parent”), and CACI Newco Corporation, a Nevada corporation and wholly-owned subsidiary of Parent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will merge with and into Paradigm, with Paradigm continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”).
The aggregate consideration to be paid by Parent and Merger Sub in the Merger for all of the outstanding equity interests of Paradigm, including securities convertible into shares of Paradigm’s common stock, par value $0.01 per share (the “Company Common Stock“), and the Senior Notes is $61,500,000, plus the aggregate amount of Closing Cash (as defined in the Merger Agreement), minus the sum of (i) the aggregate amount of outstanding Company Debt (as defined in the Merger Agreement) (excluding the Senior Notes) at the effective time of the Merger and (ii) the Company Transaction Expenses (as defined in the Merger Agreement) that are unpaid at the effective time of the Merger.
At the effective time of the Merger, each share of Company Common Stock issued and outstanding immediately prior to the effective time of the Merger, other than (i) shares held in the treasury of the Company and shares owned by Parent, Merger Sub, or any subsidiary of Parent or the Company (which shares will be cancelled) and (ii) shares in respect of which dissenter’s rights have been properly exercised under Chapter 92A of the Nevada Revised Statutes (the “NRS”), will be converted into the right to receive an amount in cash equal to the “Aggregate Common Merger Consideration” (which is defined below) divided by the number of shares of Company Common Stock issued and outstanding immediately prior to the effective time of the Merger (the “Common Merger Consideration”), without interest. As of the date of the Merger Agreement, the Common Merger Consideration was estimated to be equal to $0.2913 per share.
At the effective time of the Merger, each share of Paradigm Series A-1 Preferred Stock, or fraction thereof, issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive an amount per share of Series A-1 Preferred Stock (including a proportionate amount for any fractional share) equal to the Liquidation Price (as defined in the Certificate of Designations of the Series A-1 Senior Preferred Stock (the “Certificate of Designations”)) (the “Preferred Share Merger Consideration”).
Each option to purchase shares of Company Common Stock (the “Company Options”) which is outstanding and unexercised immediately prior to the effective time of the Merger will be cancelled as of the effective time of the Merger. The holder of each Company Option will be entitled only to the right to receive, without any interest thereon, an amount in cash payable at the time of cancellation of such Company Option equal to the product of (i) the excess, if any, of the Common Merger Consideration over the per share exercise price of such Company Option, and (ii) the number of shares of Company Common Stock covered by such Company Option (including both vested and unvested shares) as of immediately prior to the effective time of the Merger.
Each Company SAR which is outstanding immediately prior to the effective time of the Merger will be cancelled as of the effective time of the Merger. The holder of each Company SAR would be entitled only to the right to receive, without any interest thereon, an amount in cash payable at the time of cancellation of such Company SAR equal to the product of (i) the excess, if any, of the Common Merger Consideration over the per share exercise price of such Company SAR and (ii) the number of shares of Company Common Stock with respect to which such Company SAR is exercisable as of the effective time of the Merger.
At the effective time of the Merger, pursuant to the Termination Agreement (as defined below), each outstanding Class A Warrant will be cancelled in exchange for the payment to each holder of a Class A Warrant of an amount in cash equal to (x) the greater of (I) the Common Merger Consideration and (II) $0.2913 (the greater of (I) and (II) is referred to as the “Adjusted Common Merger Consideration”) multiplied by (y) the number of shares of Company Common Stock that would have been issuable upon a cashless exercise of such Class A Warrant immediately prior to the effective time of the Merger based on the Adjusted Common Merger Consideration (the “Series A Preferred Warrant Merger Consideration”).
At the effective time of the Merger, pursuant to the Termination Agreement, each outstanding Class B Warrant will be cancelled in exchange for the payment to each holder of a Class B Warrant of an amount in cash equal to (x) the Adjusted Common Merger Consideration multiplied by (y) the number of shares of Company Common Stock that would have been issuable upon a cashless exercise of such Class B Warrant immediately prior to the effective time of the Merger based on the Adjusted Common Merger Consideration (the “Series B Preferred Warrant Merger Consideration”). We refer to the Series A Preferred Warrant Merger Consideration and the Series B Preferred Warrant Merger Consideration together as the “Preferred Warrant Merger Consideration”.
The Merger Agreement provides that the Company will take the necessary actions to cause each outstanding warrant (excluding Company SARs, Class A Warrants and Class B Warrants) (the “Other Company Warrants”) which is issued and outstanding at the effective time of the Merger to be deemed exercised effective as of the effective time of the Merger, for cash, with such cash deemed paid via the Common Merger Consideration payable to such holders. Other Company Warrants that have an exercise price less than the Common Merger Consideration will be cancelled and terminated at the effective time of the Merger.
Each of the Company’s Senior Notes that are outstanding as of the effective time of the Merger will be cancelled and the Company will pay to each holder of a Senior Note cash in an amount equal to the sum of (x) the aggregate principal amount of the Senior Notes held by such holder then outstanding, together with any accrued and unpaid interest thereon through the effective time of the Merger (calculated at an interest rate of 6% per annum) and (y) the Present Value of Interest (as defined in the Senior Notes) with respect to such aggregate principal amount of the Senior Notes then outstanding (collectively, the “Senior Note Merger Consideration”).
At the effective time of the Merger, all outstanding restricted stock awards (“Company Restricted Shares”) will automatically become fully vested and will be paid in the same fashion as other shares of Company Common Stock.
The Merger Agreement defines “Aggregate Common Merger Consideration” as being equal to the amount determined by subtracting (i) the aggregate Preferred Share Merger Consideration, (ii) the aggregate Senior Note Merger Consideration, (iii) the aggregate amount to which the holders of Company Options, Company SARs, Other Company Warrants, the Class A Warrants, the Class B Warrants and Company Restricted Shares (collectively, the “Company Stock-Based Securities”) are entitled, (iv) the aggregate amount of Company Transaction Expenses that are unpaid at the effective time of the Merger, and (v) the aggregate amount of outstanding Company Debt (excluding the Senior Notes) at the effective time of the Merger, from the sum of (A) $61.5 million and (B) the aggregate amount of Closing Cash.
The completion of the Merger is subject to the satisfaction or waiver of certain conditions, including, among other things, the adoption of the Merger Agreement by the Company’s stockholders, which was effected on July 25, 2011 by the written consent of the holders of securities representing 104,829,858 votes, or approximately 92.43% of the votes entitled to be cast with respect to the adoption and approval of the Merger Agreement.
The Merger Agreement contains customary termination provisions, including, without limitation, that the Merger Agreement may be terminated by either the Company or Parent if the Merger has not been consummated by the close of business on November 10, 2011, other than due to the failure of the terminating party to fulfill its obligations under the Merger Agreement. The Merger Agreement requires the Company to pay a $1,537,500 termination fee to Parent under certain limited circumstances.
The Merger Agreement contains customary representations and warranties made by the Company, Parent and Merger Sub. In addition, the Company has agreed to various covenants in the Merger Agreement, including, among other things, covenants to continue to conduct its business in the ordinary course and in accordance with past practices and not to take certain actions prior to the closing of the Merger without the prior consent of Parent.
Termination Agreement
On July 25, 2011, in connection with the execution of the Merger Agreement, the Company, Parent and the Holders entered into the Preferred Stock, Warrant and Note Termination Agreement (the “Termination Agreement”). The Termination Agreement, among other things, (i) provides for the cancellation of the shares of Series A-1 Preferred Stock, Class A Warrants, Class B Warrants and Senior Notes held by the Holders in exchange for the right to receive the Preferred Share Merger Consideration, the Preferred Warrant Merger Consideration and the Senior Note Merger Consideration, respectively, and (ii) restricts the transfer of the Series A-1 Preferred Stock, Class A Warrants, Class B Warrants and Senior Notes except under certain limited circumstances. . Pursuant to the Termination Agreement, the Company remains obligated to make certain payments and redemptions pursuant to the terms of the Series A-1 Preferred Stock, the Class A Warrants, the Class B Warrants, the Senior Notes and Certificate of Designations until the effective time of the Merger.
The Preferred Share Merger Consideration, Preferred Warrant Merger Consideration and the Senior Note Merger Consideration are potentially less favorable to the Holders than what their rights would have been upon the Merger under the terms of the Series A-1 Preferred Stock, the Senior Notes, the Class A Warrants and the Class B Warrants. The Termination Agreement also provides that until the earlier of the effective time of the Merger or the termination of the Merger Agreement, that, and for so long as certain specified events do not occur, the Holders will refrain from exercising any of their rights or remedies that may exist as a result of any Event of Default (as such term is defined in the Senior Notes and the Certificate of Designations, as applicable). In consideration of these agreements by the Holders, the Termination Agreement provides that the Company will reimburse the Holders’ reasonable legal fees in connection with the contemplated transactions.
Martin Hale, a member of the Company’s Board of Directors, is the Chief Executive Officer of each of Hale Capital and Hale Fund Management, LLC, the managing member of EREF PARA.
Support Agreements
On July 25, 2011, the Company and Parent entered into Stockholder Support Agreements with each of the Holders, Raymond Huger, John Moore (together with his spouse), Peter LaMontagne, Richard Sawchak, Robert Boakai, Anthony Verna and Diane Moberg (the “Stockholder Support Agreements”). The Stockholder Support Agreements, among other things, (i) require the execution of the Merger Consent (as defined below) by the stockholder, (ii) require that in the event of a stockholder meeting such stockholder will vote in favor of the Merger, the Merger Agreement and the transactions contemplated by the Merger Agreement and against any adverse proposal, (iii) appoints Parent or its designee as such stockholder’s proxy and attorney-in-fact to vote such stockholder’s shares in favor of the Merger, the Merger Agreement and the transactions contemplated by the Merger Agreement and against any adverse proposal, (iv) restricts the transfer of such stockholder’s shares and (v) provides a general release, effective as of the Merger, of certain claims against the Company and certain other identified persons and entities.
Indemnification Agreements
On July 25, 2011, the Company entered into Indemnification Agreements (the “Indemnification Agreements”) with each of the current members of the Board of Directors of the Company and Richard Sawchak, the Company’s Senior Vice President and Chief Financial Officer. Among other things, the Indemnification Agreements require the Company to indemnify the directors and Mr. Sawchak in the event of certain proceedings and to advance expenses as provided in the Indemnification Agreements.
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS
This quarterly report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, readers can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “forecasts,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “see,” “target,” “projects,” “position,” or “continue” or the negative of such terms and other comparable terminology. These statements reflect our current expectations, estimates, and projections. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict. Actual events or results may differ materially from what is expressed or forecasted in these forward-looking statements. We disclaim any intention or obligation to update any forward-looking statement.
OVERVIEW
Paradigm Holdings, Inc. (the “Company” or “Paradigm”) provides information technology (“IT”), information assurance, and business continuity solutions, primarily to U.S. Federal Government customers. Headquartered in Rockville, Maryland, the Company was founded based upon strong commitment to high standards of performance, integrity, customer satisfaction, and employee development.
With an established core of experienced executives, the Company has grown from six employees in 1996 to 199 personnel (full time, part time, and consultants) at June 30, 2011. The 2011 annual run-rate of revenue is approximately $47.9 million, based on revenue for the six months ended June 30, 2011. The results for the interim periods are not necessarily indicative of the results to be expected for the fiscal year.
As of June 30, 2011, Paradigm had three wholly-owned subsidiaries, Paradigm Solutions Corp. (“PSC”), which was incorporated in 1996 to deliver IT services to federal agencies, Trinity Information Management Services (“Trinity”), which was acquired on April 9, 2007 to deliver cybersecurity solutions into the national security marketplace and Caldwell Technology Solutions, LLC (“CTS”) which was acquired on July 2, 2007 to provide advanced IT solutions in support of national security programs within the intelligence community.
We derive substantially all of our revenue from fees for information technology solutions and services. We generate these fees from contracts with various payment arrangements, including time and materials contracts, fixed-price contracts and cost-plus contracts. We typically issue invoices monthly to manage outstanding accounts receivable balances. We recognize revenue on time and materials contracts as the services are provided. For the quarter ended June 30, 2011, our business was comprised of 57% fixed price and 43% time and material contracts.
For the quarter ended June 30, 2011, contracts with the federal government and contracts with prime contractors of the federal government accounted for 100% of our revenue. During that same period, our four largest clients, all agencies within the federal government, generated approximately 74% of our revenue. In most of these engagements, we retain full responsibility for the end-client relationship and direct and manage the activities of our contract staff.
Our most significant expense is direct costs, which consist primarily of direct labor, subcontractors, materials, equipment, travel and an allocation of indirect costs including fringe benefits. The number of subcontract and consulting employees assigned to a project will vary according to the size, complexity, duration and demands of the project.
Selling, general and administrative expenses consist primarily of costs associated with our executive management, finance and administrative groups, human resources, marketing and business development resources, employee training, occupancy costs, depreciation and amortization, travel, and all other corporate costs.
Other income and expense consists primarily of interest income earned on cash and cash equivalents, interest payable on our revolving credit facility, interest expense related to the mandatorily redeemable preferred stock and the change in fair value of put warrants.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates including those related to contingent liabilities, revenue recognition, and other intangible assets. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable at the time the estimates are made. Actual results may differ from these estimates under different assumptions or conditions.
The following critical accounting policies require management’s judgment and estimation, where such estimates have a material effect on the condensed consolidated financial statements:
· accounting for revenue recognition
· accounting for cost of revenue
· accounting for goodwill and intangible assets
· accounting for impairment of long-lived assets
· accounting for share-based compensation
· accounting for valuation of put warrants
· accounting for income taxes
· accounting for segment reporting
For a description of these critical accounting policies, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Paradigm’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
RECENT ACCOUNTING PRONOUNCEMENTS
New accounting pronouncements that have a current or future potential impact on our consolidated financial statements are as follows:
Recent Accounting Pronouncements – Not Yet Adopted
In January 2011, the FASB issued ASU 2011-01, “Receivables (Topic 310): Deferral of the Effective Date of Disclosure about Troubled Debt Restructurings in Update No. 2010-20”. This ASU temporarily delays the effective date of the disclosures about troubled debt restructurings in Update No. 2010-20 for public entities. The standard is not expected to have a significant impact on the Company’s condensed consolidated financial statements.
In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination Whether a Restructuring Is a Troubled Debt Restructuring”. This ASU clarifies the guidance on a creditor’s evaluation of whether a restructuring constitutes a troubled debt restructuring. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 13, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company believes that the adoption of ASU 2011-02 will not have a material impact on the Company’s condensed consolidated finance statements.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. The amendments in this update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments in this update to result in a change in the application of the requirements in Topic 820. Some of the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. The Company believes that the adoption of ASU 2011-02 will not have a material impact on the Company’s condensed consolidated finance statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”. In this update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The entity is also required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15. 2011. The Company will adopt ASU 2011-05 on January 1, 2012 and will apply ASU 2011-05 to its future comprehensive income, if any.
Recent Accounting Pronouncements – Adopted
In December 2010, the FASB issued ASU 2010-28, “Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force)”. This ASU provides guidance on when to perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. The Company adopted ASU 2010-28 on January 1, 2011. The adoption of ASU 2010-28 did not materially impact the Company’s condensed consolidated financial statements.
In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force)”. This ASU specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The Company adopted ASU 2010-29 on January 1, 2011 and will apply ASU 2010-29 to its future acquisitions, if any.
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with Paradigm’s condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with Paradigm’s consolidated financial statements and the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in Paradigm’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
The following table sets forth certain items from our condensed consolidated statements of operations for the periods indicated.
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | ||||||||||||||||||||||||
| Revenue | $ | 11,424 | $ | 7,518 | 100.0 | % | 100.0 | % | $ | 23,946 | $ | 15,040 | 100.0 | % | 100.0 | % | ||||||||||||||||
| Cost of revenue | 8,907 | 5,757 | 78.0 | 76.6 | 19,088 | 11,627 | 79.7 | 77.3 | ||||||||||||||||||||||||
| Gross margin | 2,517 | 1,761 | 22.0 | 23.4 | 4,858 | 3,413 | 20.3 | 22.7 | ||||||||||||||||||||||||
| Selling, general & administrative | 1,465 | 1,602 | 12.8 | 21.3 | 3,114 | 3,210 | 13.0 | 21.3 | ||||||||||||||||||||||||
| Income from operations | 1,052 | 159 | 9.2 | 2.1 | 1,744 | 203 | 7.3 | 1.4 | ||||||||||||||||||||||||
| Other expense | (753 | ) | (1,996 | ) | (6.6 | ) | (26.5 | ) | (4,298 | ) | (2,537 | ) | (17.9 | ) | (16.9 | ) | ||||||||||||||||
| Provision for income taxes | 216 | 159 | 1.9 | 2.1 | 161 | 202 | 0.7 | 1.4 | ||||||||||||||||||||||||
| Net income (loss) | $ | 83 | $ | (1,996 | ) | 0.7 | % | (26.5 | %) | $ | (2,715 | ) | $ | (2,5364 | ) | (11.3 | %) | (16.9 | %) | |||||||||||||
The table below sets forth, for the periods indicated the service mix in revenue with related percentages of total revenue.
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||
| (Dollars in thousands) | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | ||||||||||||||||||||||||
| Federal service contracts | $ | 6,446 | $ | 5,852 | 56.4 | % | 77.8 | % | $ | 12,908 | $ | 11,325 | 53.9 | % | 75.3 | % | ||||||||||||||||
Federal repair & maintenance contracts | 4,978 | 1,666 | 43.6 | 22.2 | 11,038 | 3,715 | 46.1 | 24.7 | ||||||||||||||||||||||||
| Total revenue | $ | 11,424 | $ | 7,518 | 100.0 | % | 100.0 | % | $ | 23,946 | $ | 15,040 | 100.0 | % | 100.0 | % | ||||||||||||||||
The Company’s revenues and operating results may be subject to significant variation from quarter to quarter depending on a number of factors, including the progress of contracts, revenues earned on contracts, the number of billable days in a quarter, the timing of the pass-through of other direct costs, the commencement and completion of contracts during any particular quarter, the schedule of the government agencies for awarding contracts, the term of each contract that has been awarded and general economic conditions. Because a significant portion of total expenses, such as personnel and facilities costs, are fixed in the short term, successful contract performance and variation in the volume of activity as well as in the number of contracts commenced or completed during any quarter may cause significant variations in operating results from quarter to quarter.
The Federal Government’s fiscal year ends September 30. If a budget for the next fiscal year has not been approved by that date, the Company’s clients may have to suspend engagements that are in progress until a budget has been approved. Such suspensions may cause the Company to realize lower revenues in the fourth quarter of the year. Further, a change in presidential administrations, in senior government officials or budgetary policy may negatively affect the rate at which the Federal Government purchases technology.
As a result of the factors above, period-to-period comparisons of Paradigm’s revenues and operating results may not be meaningful. Readers should not rely on these comparisons as indicators of future performance as no assurances can be given that quarterly results will not fluctuate, causing a possible material adverse effect on Paradigm’s operating results and financial condition.
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2011 AND 2010
Revenue. For the three months ended June 30, 2011, revenue increased 52.0% to $11.4 million from $7.5 million for the same period in 2010. The increase in revenue is attributable to increase in our federal service and repair and maintenance contracts revenue of $0.6 million and $3.3 million, respectively. The increase in service contract revenue is attributable to the expansion of existing service contracts and recent contract wins in the Company’s cybersecurity practice area and the increase in repair and maintenance revenue is attributable to recent contract wins in mission critical infrastructure practice area.
Cost of Revenue. Cost of revenue includes direct labor, materials, subcontractors and an allocation for indirect costs. Generally, changes in cost of revenue correlate to fluctuations in revenue as resources are consumed in the production of that revenue. For the three months ended June 30, 2011, cost of revenue increased by 54.7% to $8.9 million from $5.8 million for the same period in 2010. The increase in cost of revenue was primarily attributable to the corresponding increase in revenue. As a percentage of revenue, cost of revenue was 78.0% for the three months ended June 30, 2011 as compared to 76.6% for the same period in 2010.
Gross Margin. For the three months ended June 30, 2011, gross margin increased 43.0% to $2.5 million from $1.8 million for the same period in 2010. Gross margin as it relates to our service contracts increased 33.5% to $1.7 million from $1.3 million for the same period in 2010. Gross margin, as it relates to our maintenance contracts, increased 69.2% to $0.8 million from $0.5 million for the same period in 2010. The increase in gross margin is directly attributable to the increase in revenue. Gross margin as a percentage of revenue decreased to 22.0% for the three months ended June 30, 2011 from 23.4% for the same period in 2010. The decrease in gross margin is attributable to lower profitability on one of the contracts in the mission critical infrastructure practice area which is partially offset by increases in the service gross margin.
Selling, General & Administrative Expenses. For the three months ended June 30, 2011, selling, general and administrative (“SG&A”) expenses decreased by 8.5% to $1.5 million from $1.6 million for the same period in 2010. As a percentage of revenue, SG&A expenses decreased to 12.8% for the three months ended June 30, 2011 from 21.3% for the same period in 2010. The decrease in percentage is primarily attributable to the increase in revenue.
Other Expense. For the three months ended June 30, 2011, other expense decreased 62.3% to $0.8 million from $2.0 million for the same period in 2010. As a percentage of revenue, other expense decreased to 6.6% for the three months ended June 30, 2011 from 26.5% for the same period in 2010. The decrease in other expense was primarily attributable to change in fair value of the put warrants.
Income Taxes. For the three months ended June 30, 2011, the Company recorded a tax expense of $216 thousand, or an annual effective tax rate of 79.88%, compared to a tax expense of $159 thousand, or an annual effective tax rate of 8.56%, for the same period in 2010. The change in estimated annual effective tax rate is due to the interest expense on the mandatorily redeemable preferred stock and change in fair value of warrants which are not deductible under applicable tax laws.
Net Loss. For the three months ended June 30, 2011, net income increased to $83 thousand from a net loss of $2.0 million for the same period in 2010. The increase in net income was due to improved income from operations and lower other expense as discussed above.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010
Revenue. For the six months ended June 30, 2011, revenue increased 59.2% to $23.9 million from $15.0 million for the same period in 2010. The increase in revenue is attributable to increase in our federal service and repair and maintenance contracts revenue of $1.6 million and $7.3 million, respectively. The increase in service contract revenue is attributable to the expansion of existing service contracts and recent contract wins in the Company’s cybersecurity practice area and the increase in repair and maintenance revenue is attributable to recent contract wins in mission critical infrastructure practice area which is partially offset by a reduction in revenue on a federal repair and maintenance contract.
Cost of Revenue. Cost of revenue includes direct labor, materials, subcontractors and an allocation for indirect costs. Generally, changes in cost of revenue correlate to fluctuations in revenue as resources are consumed in the production of that revenue. For the six months ended June 30, 2011, cost of revenue increased 64.2% to $19.1 million from $11.6 million for the same period in 2010. The increase in cost of revenue was primarily attributable to the corresponding increase in revenue. As a percentage of revenue, cost of revenue was 79.7% for the six months ended June 30, 2011 as compared to 77.3% for the same period in 2010.
Gross Margin. For the six months ended June 30, 2011, gross margin increased 42.3% to $4.9 million from $3.4 million for the same period in 2010. Gross margin as it relates to our service contracts increased 30.6% to $3.4 million from $2.6 million for the same period in 2010. Gross margin, as it relates to our maintenance contracts, increased 77.3% to $1.5 million from $0.8 million for the same period in 2010. The increase in gross margin is directly attributable to the increase in revenue. Gross margin as a percentage of revenue decreased to 20.3% for the six months ended June 30, 2011 from 22.7% for the same period in 2010. The decrease in gross margin is attributable to lower profitability on one of the contracts in the mission critical infrastructure practice area which is partially offset by increases in the service gross margin.
Selling, General & Administrative Expenses. For the six months ended June 30, 2011, SG&A expenses decreased 3.0% to $3.1 million from $3.2 million for the same period in 2010. As a percentage of revenue, SG&A expenses decreased to 13.0% for the six months ended June 30, 2011 from 21.3% for the same period in 2010. The decrease in percentage is directly attributable to the increase in revenue.
Other Expense. For the six months ended June 30, 2011, other expense increased 69.4% to $4.3 million from $2.5 million for the same period in 2010. As a percentage of revenue, other expense increased to 17.9% for the six months ended June 30, 2011 from 16.9% for the same period in 2010. The increase in other expense was primarily attributable to interest expense recorded on the promissory notes issued in May 2010 and change in fair value of the put warrants.
Income Taxes. For the six months ended June 30, 2011, the Company recorded a tax expense of $161 thousand, or an annual effective tax rate of 79.88%, compared to a tax expense of $202 thousand, or an annual effective tax rate of 8.56%, for the same period in 2010. The change in estimated annual effective tax rate is due to the non-deductibility of permanent items including interest expense on the mandatorily redeemable preferred stock and the expense associated with the change in the fair value of the warrant liability.
Net Loss. For the six months ended June 30, 2011, net loss increased to $2.7 million from $2.5 million for the same period in 2010. The increase in net loss was due to higher other expense as discussed above which was partially offset by improved income from operations.
Our primary liquidity needs are financing our cost of operations, capital expenditures, servicing our debt and paying dividends and redemption payments on our preferred stock. Our sources of liquidity are existing cash, cash generated from operations, and cash available from borrowings under our working capital line of credit. We have historically financed our operations through our existing cash, cash generated from operations and cash available from borrowings under our working capital line of credit. As of June 30, 2011, the Company had a working capital deficit of $4.9 million associated with the reclassification of Series A-1 Preferred Stock to a current liability. Although there can be no assurances, based upon the current level of operations, we believe that cash flow from operations, together with borrowings that we expect to be available from our working capital line of credit with SVB, will be adequate to meet future liquidity needs for the next twelve months.
For the six months ended June 30, 2011, the Company used $95 thousand in cash and cash equivalents compared to $885 thousand for the same period in 2010.
Net cash provided by operating activities was $0.2 million for the six months ended June 30, 2011 compared to $4.6 million of net cash used in for the same period in 2010. Net cash provided by operating activities increased due to change in fair value of put warrants, decrease in costs and earnings in excess of billings on uncompleted contracts and decrease in prepaid expenses which were partially offset by decrease in accounts payable and other accrued expenses and increase in accounts receivable and other current assets.
Net loss was $2.7 million for the six months ended June 30, 2011 compared to $2.5 million for the same period in 2010. The increase in net loss was primarily due to higher other expense as discussed above which was partially offset by improved income from operations.
Accounts receivable increased by $0.8 million for the six months ended June 30, 2011 compared to an increase of $0.3 million for the same period in 2010. The increase in the accounts receivable balance for the six months ended June 30, 2011 is attributable to increase in revenue and timing of collections on two of the Mission Critical Infrastructural contracts.
Restricted cash was unchanged for the six months ended June 30, 2011 compared to an increase of $4.0 million for the same period in 2010. Restricted cash consists principally of cash held in money market accounts securing an outstanding letter of credit issued by SVB to secure a performance bond issued in favor of a federal agency.
Costs and earnings in excess of billings on uncompleted contracts decreased by $3.0 million for the three months ended June 30, 2011 compared to a balance of zero for the same period in 2010. Costs and earnings in excess of billings on uncompleted contracts represent the amount unbilled on certain MCI contracts won in 2010 as of June 30, 2011.
Accounts payable and accrued expenses decreased by $3.2 million for the six months ended June 30, 2011 compared to $0.6 million for the same period in 2010. The decrease during the six months ended June 30, 2011 is primarily reflective of the timing of equipment deliverables on the uncompleted contracts discussed above.
Net cash used in investing activities was $5 thousand for the six months ended June 30, 2011 compared to $22 thousand for the same period in 2010. Cash used in investing activities in 2011 and 2010 was for purchases of property and equipment.
Net cash used in financing activities was $0.3 million for the six months ended June 30, 2011 compared to $3.8 million of net cash provided by financing activities for the same period in 2010. The decrease in net cash used in financing activities is due to payments made to pay down the Company’s line of credit with SVB and redemption payments on mandatorily redeemable preferred stock.
As of June 30, 2011, 34% of the Company’s total assets were in the form of accounts receivable. The Company depends on the collection of its receivables to generate cash flow, provide working capital, pay down debt and continue its business operations. As of June 30, 2011, the Company had unbilled receivables of $2.9 million included in the total accounts receivable for which it is awaiting authorization to invoice. If the federal government, any of the Company’s other clients or any prime contractor for whom the Company is a subcontractor does not authorize the Company to invoice or fails to pay or delays the payment of the Company’s outstanding invoices for any reason, the Company’s business and financial condition may be materially adversely affected. The government may fail to pay outstanding invoices for a number of reasons, including a reduction in appropriated funding, lack of appropriated funds or lack of an approved budget.
In the event cash flows are not sufficient to fund operations at the present level and the Company is unable to obtain additional financing, it would attempt to take appropriate actions to tailor its activities to its available financing, including reducing its business operations through additional cost cutting measures and revising its business strategy. However, there can be no assurances that the Company’s attempts to take such actions would be successful.
Private Placement
On February 27, 2009, the Company completed the sale, in a private placement transaction, of 6,206 shares of Series A-1 Senior Preferred Stock (the “Series A-1 Preferred Stock”), Class A Warrants to purchase up to an aggregate of approximately 79.6 million shares of common stock with an exercise price equal to $0.0780 per share (the “Class A Warrants”) and Class B Warrants to purchase up to an aggregate of approximately 69.1 million shares of common stock at an exercise price of $0.0858 per share (the “Class B Warrants” and together with the Class A Warrants and the Series A-1 Preferred Stock, the ”Securities”) to a group of investors, led by Hale Capital (the “Purchasers”). The Series A-1 Preferred Stock bears an annual dividend of 12.5%. Each share of Series A-1 Preferred Stock has an initial stated value of $1,000 per share (the “Stated Value”). Paradigm received gross proceeds of approximately $6.2 million from the private placement.
The annual dividend on the Series A-1 Preferred Stock accrues on a daily basis and compounds monthly, with 40% of such dividend payable in cash and 60% of such dividend payable by adding such amount to the Stated Value per share of the Series A-1 Preferred Stock. The Company is generally required to make cash dividend payments ranging from $26,000 to $29,000 a month. Based on the dividend accrued as of June 30, 2011, the Stated Value per share as of such date was $1,194.
Any shares of Series A-1 Preferred Stock outstanding as of February 9, 2012 are to be redeemed by the Company for their Stated Value plus all accrued but unpaid cash dividends on such shares (the “Redemption Price”). In addition, on the last day of each calendar month beginning February 2009 through and including February 2010, the Company is required to redeem the number of shares of Series A-1 Preferred Stock obtained by dividing 100% of all Excess Cash Flow (as defined in the Certificate of Designations of Series A-1 Senior Preferred Stock (the “Certificate of Designations”)) with respect to such month by the Redemption Price applicable to the shares to be redeemed. Further, on the last day of each month beginning March 2010 through and including January 2012, the Company shall redeem the number of shares of Series A-1 Preferred Stock obtained by dividing the sum of $50,000 plus 50% of the Excess Cash Flow with respect to such month by the Redemption Price applicable to the shares to be redeemed. As of June 30, 2011, the Company had redeemed approximately 175 shares of Series A-1 Preferred Stock and no redemptions with respect to any Excess Cash Flow had been made in accordance with restrictions placed by SVB with respect to such redemptions and/or the Company’s lack of Excess Cash Flow. If at anytime a Purchaser realizes cash proceeds with respect to the Securities or common stock received upon exercise of the Warrants equal to or greater than the aggregate amount paid by the Purchaser for the Securities plus 200% of such amount then the Company has the option to repurchase all outstanding shares of Series A-1 Preferred Stock (other than certain excluded shares of Series A-1 Preferred Stock) held by that Purchaser for no additional consideration.
For so long as (i) an aggregate of not less than 15% of the shares of Series A-1 Preferred Stock purchased on February 27, 2009 are outstanding, (ii) Warrants to purchase an aggregate of not less than 20% of the shares issuable pursuant to the Warrants on February 27, 2009 are outstanding or (iii) the Purchasers, in the aggregate, own not less than 15% of the common stock issuable upon exercise of all Warrants on February 27, 2009 (we refer to (i), (ii) and (iii) as the “Ownership Threshold”), the Preferred Stock Purchase Agreement between the Company and the Purchasers (the “Preferred Stock Purchase Agreement”) limits the Company’s ability to offer or sell certain evidences of indebtedness or equity or equity equivalent securities (other than certain excluded securities and permitted issuances) without the prior consent of Hale Capital. Other than with respect to the issuance of certain excluded securities by the Company, the Preferred Stock Purchase Agreement further grants the Purchasers a right of first refusal to purchase certain evidences of indebtedness, equity and equity equivalent securities sold by the Company. The Company is further required to use a portion of the proceeds it receives from a subsequent placement of its securities to repurchase shares of Series A-1 Preferred Stock, Warrants and/or shares of common stock from the Purchasers.
The Preferred Stock Purchase Agreement and the Certificate of Designations also contain certain affirmative and negative covenants. The affirmative covenants include certain financial covenants, including revenue, EBDITA, working capital and net cash covenants. The Company was in compliance with these financial covenants as of June 30, 2011.
The affirmative covenants also include a requirement that the Company file proxy materials with the SEC and hold a shareholder meeting to approve certain matters, including, among other things, the reincorporation of the Company into the State of Delaware or Nevada and the approval of certain rights of the holders of the Series A-1 Preferred Stock, no later than the dates specified in the Preferred Stock Purchase Agreement and the Certificate of Designations. The Company failed to file such proxy materials or to hold such meeting within the specified time period, however, the Company did file such proxy materials with the SEC on October 15, 2010 and the shareholder meeting was held on November 11, 2010 and the Company has reincorporated into the State of Nevada.
The negative covenants require the prior approval of Hale Capital, for so long as the Ownership Threshold is met, in order for the Company to take certain actions, including, among others, (i) amending the Company’s Articles of Incorporation or other charter documents, (ii) liquidating, dissolving or winding-up the Company, (iii) merging with, consolidating with or acquiring or being acquired by, or selling all or substantially all of its assets to, any person, (iv) selling, licensing or transferring any capital stock or assets with a value, individually or in the aggregate, of $100,000 or more, (v) undergoing certain fundamental transactions, (vi) certain issuances of capital stock, (vii) certain redemptions or dividend payments, (viii) the creation, incurrence or assumption of certain types of indebtedness or liens, (ix) increasing or decreasing the size of the Company’s Board of Directors and (x) appointing, hiring, suspending or terminating the employment or materially modifying the compensation of any executive officer.
The Certificate of Designations further provides that upon the occurrence of certain defined events of default each holder of Series A-1 Preferred Stock may elect to require the Company to repurchase any outstanding shares of Series A-1 Preferred Stock held by such holder for 125% of the Stated Value of such shares plus all accrued but unpaid cash dividends for such shares payable, at the holder’s election, in cash or Common Stock. In addition, upon the occurrence of such event of default, the number of directors constituting the Company’s Board of Directors will automatically increase by a number equal to the number of directors then constituting the Board of Directors plus one and the holders of the Series A-1 Preferred Stock are entitled to elect such additional directors.
The Warrants provide that in the event of certain fundamental transactions or the occurrence of an event of default, the holder of the Warrants may cause the Company to repurchase such Warrants for the purchase price specified therein (the “Repurchase Price”).
In addition, upon the occurrence of a liquidation event (including certain fundamental transactions), the holders of the Series A-1 Preferred Stock are entitled to receive prior and in preference to the payment of any amounts to the holders of any other equity securities of the Company (the “Junior Securities”) (i) 125% of the Stated Value of the outstanding shares of Series A-1 Preferred Stock, (ii) all accrued but unpaid cash dividends with respect to such shares of Series A-1 Preferred Stock and the (iii) Repurchase Price with respect to all Warrants held by such holders.
In connection with the private placement, the Company paid Noble International Investments, Inc. (“Noble”) $100,000 and issued Noble a warrant to purchase up to 1,602,565 shares of the Company’s common stock for an exercise price of $0.0780 per share.
The Company accounts for its preferred stock based upon the guidance enumerated in ASC 480, “Distinguishing Liabilities from Equity.” The Series A-1 Preferred Stock is mandatorily redeemable on February 9, 2012 and therefore is classified as a liability instrument on the date of issuance. The Warrants issued in connection with the sale of our Series A-1 Preferred Stock provide that the holders of the Warrants may cause the Company to repurchase such Warrants for the Repurchase Price in the event of certain fundamental transactions or the occurrence of an event of default. The Company evaluated the Warrants pursuant to ASC 815-40 and determined that the Warrants should be classified as liabilities because they contain a provision that could require cash settlement and that event is outside the control of the Company. The Warrants are required to be measured at fair value, with changes in fair value reported in earnings as long as the Warrants remain classified as liabilities.
The Company is amortizing the warrant discount using the effective interest rate method over the three year term of the Series A-1 Preferred Stock. Although the stated interest rate of the Series A-1 Preferred Stock is 12.5%, as a result of the discount recorded for the Warrants, the effective interest rate is 26% as of June 30, 2011. The Company also incurred approximately $1,175,000 of costs in relation to this transaction, which were recorded as deferred financing costs to be amortized over the term of the Series A-1 Preferred Stock.
The Company calculated the fair value of the Warrants at the date of issuance using the Black-Scholes option pricing model. The change in fair value of the Warrants issued in connection with the Series A-1 Preferred Stock from the date of issuance to June 30, 2011, was an increase of approximately $1.3 million from $1.9 million as of February 27, 2009 to $3.2 million as of June 30, 2011. This change of fair value of the Warrants was reflected as a component of other expense within the statement of operations. For the three and six months ended June 30, 2011, the change of fair value of the Warrants was $20 thousand and $2.8 million, respectively.
On May 26, 2010, the Purchasers and the Company, entered into the Consent and Amendment (the “Consent and Amendment”) to the Preferred Stock Purchase Agreement, dated February 27, 2009, by and among the Company and the Purchasers (the “Preferred Stock Agreement”), to, among other things: (i) grant registration rights to the Purchasers with respect to the Fee; (ii) exclude the Notes and Fee Shares from certain participation rights granted to the purchasers of securities under to the Preferred Stock Agreement ; and (iii) amend the Company’s existing right to repurchase Series A-1 Preferred Stock for no additional consideration following the occurrence of certain events as provided in the Preferred Stock Purchase Agreement to exclude certain “Excluded Shares” (as defined in the Consent and Amendment) from such provision.
At the Special Meeting of Shareholders of Paradigm Wyoming, on November 11, 2010, Paradigm Wyoming’s shareholders approved the proposed merger (the “Merger”) of Paradigm Wyoming with and into a wholly-owned subsidiary, Paradigm Nevada, for the purpose of changing the domicile of Paradigm Wyoming from Wyoming to Nevada in accordance with the terms of the Agreement and Plan of Merger dated May 5, 2010 between Paradigm Wyoming and Paradigm Nevada. Following the approval by the Paradigm Wyoming shareholders, the Merger was effected on December 14, 2010. As a result, Paradigm is now a Nevada corporation and has continued to be named “Paradigm Holdings, Inc.”
Upon the effective date of the Merger, by virtue of the Merger and without any action on the part of any holder thereof, each share of Paradigm Wyoming’s common stock, $0.01 par value per share, outstanding immediately prior thereto was changed and converted into one fully paid and non-assessable share of the common stock of Paradigm Nevada, par value $0.01 per share, with the rights and privileges thereto appertaining. Paradigm Wyoming’s outstanding options and warrants also were assumed by Paradigm Nevada and are exercisable for Paradigm Nevada common stock on the same terms (including, without limitation, the same exercise price) as existed prior to the Merger. In addition, upon the effective date of the Merger, by virtue of the Merger and without any action on the part of any holder thereof, each share of Paradigm Wyoming’s Series A-1 Senior Preferred Stock, $0.01 par value per share, outstanding immediately prior thereto was changed and converted into one fully paid and non-assessable share of the Series A-1 Senior Preferred Stock of Paradigm Nevada, par value $0.01 per share, with the rights and privileges thereto appertaining.
As a result of the Merger, the Amended and Restated Articles of Incorporation of Paradigm Nevada and the Bylaws of Paradigm Nevada became the Company's Articles of Incorporation and Bylaws following the Merger. The Amended and Restated Articles of Incorporation of Paradigm Nevada authorize 250,000,000 shares of common stock of Paradigm Nevada. As a result, the Class A Warrants are fully exercisable for 79,602,604 shares of Paradigm Nevada’s common stock and the Class B Warrants are fully exercisable for 69,062,248 shares of Paradigm Nevada’s common stock. The Merger did not result in any change in the Company’s current business, management, or location of the Company’s principal executive offices, assets, liabilities or net worth.
On May 16, 2011, the Purchasers and the Company entered into a letter agreement pursuant to which the Purchasers agreed that if the Company fails to redeem the Company’s outstanding Series A-1 Preferred Stock on February 9, 2012 (the “Maturity Date”) pursuant to the mandatory redemption provision (the “Mandatory Redemption Requirement”) of the Certificate of Designations that the Purchasers waive the Company’s compliance with such requirement on February 9, 2012 and the Company and the Purchasers agreed that the Maturity Date would thereafter be extended until May 9, 2012. If the Company fails to redeem the Series A-1 Preferred Stock either (i) on May 9, 2012 pursuant to the revised Mandatory Redemption Requirement or (ii) as otherwise required under the Certificate of Designations, such failure would constitute an Event of Default pursuant to the Certificate of Designations.
Loan and Security Agreement
On March 13, 2007, the Company entered into two Loan and Security Agreements with SVB, one of which provided for a revolving credit facility of up to $10 million and the other of which provided for a working capital line of credit of up to $12 million. SVB and the Company have agreed that the revolving credit facility has no further force or effect. The Company continues to use the working capital line of credit to borrow funds for working capital and general corporate purposes. References to the Loan and Security Agreement in this description refer to the working capital line of credit agreement. The Loan and Security Agreement is secured by a first priority perfected security interest in any and all properties, rights and assets of the Company, wherever located, whether now owned or thereafter acquired or arising and all proceeds and products thereof as described in the Loan and Security Agreement.
Under the Loan and Security Agreement, the line of credit is due on demand and interest is payable monthly based on a floating per annum rate equal to the aggregate of the Prime Rate plus the applicable spread which ranges from 1.00% to 2.00%, as well as other fees and expenses as set forth more fully in the agreements. The Loan and Security Agreement requires the Company to maintain certain EBITDA covenants as specified in the Loan and Security Agreement. On March 18, 2009, the Company and SVB entered into a Second Loan Modification Agreement. This Second Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to May 12, 2009 and modify the funds available under the working capital line of credit facility to not exceed $4.5 million and the total funds available under the Loan and Security Agreement to a maximum amount of $5.625 million. The interest rates and EBITDA covenant were consistent with the previous agreement for the remainder of the extension period. On May 4, 2009, the Company and SVB entered into a Third Loan Modification Agreement. This Third Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to June 12, 2009. On July 2, 2009, the Company and SVB entered into a Fourth Loan Modification Agreement. This Fourth Loan Modification Agreement amended the Loan and Security Agreement to extend the maturity date to June 11, 2010.
On June 11, 2010, the Company and SVB entered into a Fifth Loan Modification Agreement. This Fifth Loan Modification Agreement, among other things, (i) reduces the early termination fee payable by the Company from $100,000 to $45,000, (ii) modifies the finance charge and collateral handling fee payable by the Company, (iii) revises the Company’s financial covenants, (iv) waives the Company’s failure to comply with certain financial covenants for the three month periods ended February 28, 2010, March 31, 2010, April 30, 2010 and May 31, 2010, (v) revises the circumstances pursuant to which the Company may redeem shares of Series A-1 Senior Preferred Stock without the prior written consent of SVB, (vi) adds certain new definitions and amends the definitions of “Prime Rate”, “Eligible Accounts” and “Applicable Rate” and (vii) extends the maturity date to May 15, 2011. On May 16, 2011, the Company and SVB entered into a Sixth Loan and Modification Agreement to extend the maturity date to November 11, 2011. The Company was in compliance with the EBITDA covenant set forth in Loan and Security Agreement as of the three month period ended June 30, 2011. As of June 30, 2011, the Company had $2.8 million outstanding, and $1.7 million additional availability, under its working capital line of credit with SVB.
Even though the Company was in compliance with the EBITDA covenant requirement as of June 30, 2011, it is reasonably possible that the Company may not be in compliance in future periods if the Company cannot maintain the same levels of profitability.
The Loan and Security Agreement contains events of default that include among other things, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, cross default to certain other indebtedness, bankruptcy and insolvency events, change of control and material judgments. Upon occurrence of an event of default, SVB is entitled to, among other things, accelerate all obligations of the Company and sell the Company’s assets to satisfy the Company’s obligations under the Loan and Security Agreement.
On May 6, 2011, the Company, PSC, CTS, Trinity and SVB entered into an Assumption Agreement (the “Assumption Agreement”). Pursuant to the Assumption Agreement, the Company, among other things, agreed to substitute itself as “Borrower” under the Loan and Security Agreement and other related loan documents in lieu of Paradigm Wyoming and granted a security interest to SVB in certain specified collateral. The Assumption Agreement also amended the Loan and Security Agreement by adding and clarifying certain definitions.
In addition to the Assumption Agreement, on May 6, 2011, the Company and SVB entered into a Intellectual Property Security Agreement (the “Intellectual Property Security Agreement”) pursuant to which the Company granted SVB a security interest in the Company’s intellectual property and the Company, SVB, SVB Securities and Penson Financial Services, Inc. entered into a Securities Account Control Agreement with respect to, among other things, the Company’s securities accounts with SVB Securities (the “SACA”).
On May 26, 2010, Paradigm Wyoming, PSC, CTS, Trinity, SVB and the Purchasers entered into a Subordination Agreement in connection with a loan transaction between Paradigm Wyoming and the Purchasers (the “Subordination Agreement”). On May 6, 2011, the Company, PSC, CTS, Trinity, SVB and the Purchasers entered into a Ratification of Subordination Agreement pursuant to which, among other things, (i) the Purchasers ratified the Subordination Agreement, consented to the Assumption Agreement and acknowledged that references to “Borrower” in the Subordination Agreement include the Company and (ii) Silicon Valley Bank ratified the Subordination Agreement, consented to the terms of the Purchaser Assumption Agreement (as defined below) and acknowledged that references to “Borrower” in the Subordination Agreement include the Company.
Notes Payable – Promissory Note
On May 26, 2010, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Hale Capital Partners, LP (“Hale Capital”) and EREF PARA, LLC (“EREF” and together with Hale Capital, the “Purchasers” or the “Holders”) and consummated the issuance and sale of Senior Secured Subordinated Promissory Notes with an aggregate principal amount of $4,000,000 (the “Original Notes”) to the Purchasers, for an aggregate purchase price of $4,000,000, pursuant to such agreement. In addition, the Company issued 3,428,571 shares (the “Fee Shares”) of the Company’s common stock to the Purchasers at a purchase price of $0.086 per share, in lieu of a cash payment owed by the Company to the Purchasers with respect to the financing fee in connection with the transactions contemplated by the Securities Purchase Agreement. The Company used the net proceeds from the sale of the Original Notes as security for the issuance of a letter of credit to secure the Performance Bond (as defined below). Refer to Note 15 of the Notes to Consolidated Financial Statements for a further discussion of the Performance Bond.
As a replacement for the Senior Secured Subordinated Promissory Notes previously issued on May 26, 2010 to the Purchasers by Paradigm Wyoming, on May 6, 2011, the Company issued Senior Secured Subordinated Promissory Notes with an aggregate principal amount of $4,000,000 (the “Notes” or the “Senior Notes”) to the Purchasers. The Notes have substantially the same terms as the Original Notes.
On May 16, 2011, the Company and the Purchasers entered into an Amendment to Senior Secured Subordinated Notes (the “Amendment”) pursuant to which the Notes were amended to provide, among other things, (i) that the maturity date of the Notes will be November 25, 2011 and (ii) to provide that the Company will pay, on or before May 26, 2011, as a prepayment of principal on the Notes, $756,767 to Hale Capital and $743,233 to EREF PARA. In connection with the Amendment, the Company issued an aggregate of 367,103 shares of common stock to the Purchasers as additional interest on the Notes. The Purchasers waived the required $1.5 million principal prepayment via Preferred Stock, Warrant and Note Termination Agreement as part of the Agreement and Plan of Merger with CACI, Inc.—Federal and CACI Newco Corporation.
The Notes accrue interest at a rate of 6.00% per annum. The Notes mature on November 25, 2011 (the “Maturity Date”). The Purchasers may require the Company to redeem all or any portion of the Notes prior to the Maturity Date in connection with an “Event of Default,” “Change of Control” or “Sale” (each as defined in the Notes). From and after the incurrence of an “Event of Default” the interest rate under the Notes automatically increases to 18.00%. The Notes also contain, among other things, certain affirmative and negative covenants, including, without limitation, limitations on indebtedness, liens and restricted payments. If the Company fails to redeem the Notes to the extent required pursuant to the terms of the Notes, then each holder of the Notes may elect to convert such holder’s Notes into common stock at a conversion price of $0.086.
The Notes were initially valued using the discounted cash flow method based on the weighted average cost of capital of 14%, and subsequently accreted to the face amount using the effective interest method. The common stock was valued based on the Company’s closing stock market price on the date of the issuance. The initial proceeds allocated to the Notes and the common stock were $3.7 million and $0.3 million, respectively. The Company also incurred $0.2 million of costs in relation to this transaction, which were recorded as deferred financing costs under the caption of other current assets on the balance sheet to be amortized over the term of the Notes.
On May 6, 2011, the Company, PSC, CTS, Trinity and the Purchasers entered into an Assumption and Reaffirmation Agreement (the “Purchaser Assumption Agreement”) pursuant to which, among other things, (i) the Company agreed to substitute itself as the “Company” and “Parent” in the Securities Purchase Agreement and related transaction documents in lieu of Paradigm Wyoming, (ii) assumed and agreed to pay all principal, accrued and unpaid interest and late charges owing under the Securities Purchase Agreement and the related transaction documents, (iii) acknowledged certain liens and reaffirmed certain obligations of the Company, (iv) granted a security interest to the Purchasers in certain specified collateral and (v) consented to the Assumption Agreement, the Intellectual Property Security Agreement and the SACA.
Bond Commitment
The Company was required by a certain governmental agency to post performance and payment bonds for one of its contracts which was won in the second quarter of 2010. The bonds were obtained through the surety company Zurich NA and guarantee to the customer that the Company will perform under the terms of the contract and to pay vendors. If the Company fails to perform under the contract or to pay vendors, the customer may require that the insurer make payments or provide services under the bonds. The bonds were further secured by an irrevocable letter of credit of $4.0 million. At June 30, 2011, the Company had $13.0 million in performance and payment bonds outstanding.
Letter of Credit
On May 26, 2010, the Company caused SVB to issue an irrevocable standby letter of credit in the aggregate amount of $4.0 million to secure the Performance and Payment Bonds. The letter of credit was originally valid until May 31, 2011 originally. In May 2011, the letter of credit was extended to May 31, 2012. The Company used the net proceeds from the sale of the Notes as security for the letter of credit.
Stock Appreciation Rights
On February 15, 2011, the Board of Directors of the Company approved the grant of stock appreciation rights to certain employees of the Company. Each stock appreciation right is in the form of a SAR Warrant (the “SAR Warrants” or “Company SARs”) that is exercised automatically upon the occurrence of a Liquidity Event (as defined in the SAR Warrants), with respect to that number of shares that would equal a specified percentage of the shares of common stock of the Company, that are outstanding as of the Liquidity Date (as defined in the SAR Warrants) (the “Target Shareholding Percentage”), subject to the terms and conditions set forth in the SAR Warrants.
The aggregate Target Shareholding Percentages for the SAR Warrants is 15%, with each of Peter B. LaMontagne (President and Chief Executive Officer), Richard Sawchak (Senior Vice President Finance and Chief Financial Officer), Anthony Verna (Senior Vice President Business Strategy and Business Development) and Robert Boakai (Vice President, Enterprise IT Solution) having Target Shareholding Percentages of 6.5%, 2.5%, 1.83% and 1.83%, respectively. The remaining 2.34% has been granted to certain other officers and senior employees of the Company.
The aggregate number of shares of common stock for which the SAR Warrants will be vested and automatically exercised on the Liquidity Date is equal to: (a) in the event the 1X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 50% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “1X Threshold Shares”) plus (b) solely in the event the 2X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.65% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “2X Threshold Shares”); plus (c) solely in the event the 3X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.65% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “3X Threshold Shares”); plus (d) solely in the event the 4X Threshold (as defined below) has been achieved on or prior to the Liquidity Date, such number of shares of common stock equal to the product of (i) 16.7% and (ii) the Target Shareholding Percentage of the shares of common stock as of the Exercise Date (such number of shares, the “4X Threshold Shares”). If the 1X Threshold has not been achieved on or prior to the Liquidity Date, the SAR Warrants will automatically be cancelled effective as of the Liquidity Date, and thereafter the grantees will not be entitled to any right, benefit or entitlement with respect to the SAR Warrants. For purposes of the above description: (a) “1X Threshold” means the cumulative receipt by Investor (as defined in the SAR Warrants) with respect to the aggregate Investor Investment (as defined in the SAR Warrants) of an amount equal to the Investor Return (as defined in the SAR Warrants), (b) “2X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to two (2) times the Investor Return, (c) “3X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to three (3) times the Investor Return and (d) “4X Threshold” means the cumulative receipt by Investor with respect to the aggregate Investor Investment of an amount equal to four (4) times the Investor Return.
Generally, payment in respect of the SAR Warrants if exercised on a Liquidity Date will be made in a cash and will equal an amount determined by multiplying (i) times (ii): (i) is the number of shares of common stock with respect to which the SAR Warrant is being exercised; and (ii) is the excess of (A) the Fair Market Value (as defined in the SAR Warrant) of one share of common stock on the date of exercise, over (B) the Exercise Price.
The exercise price (the “Exercise Price”) of the SAR Warrants with respect to the 1X Threshold Shares, the 2X Threshold Shares and the 3X Threshold Shares is $0.081586 per share of common stock and with respect to the 4X Threshold Shares is $0.163172 per share of common stock.
The SAR Warrants were classified as liabilities and the vesting condition was considered a performance condition based on the guidance of ASC 718, “Compensation – Stock Compensation.” Since the warrants do not vest until the performance condition is met and the performance condition (occurrence of the Liquidity Event) is not considered probable at the quarter ended June 30, 2011. No compensation expense is required for the reporting period. The Company is required to reassess at each reporting date whether achievement of the performance condition is probable and would begin recognizing compensation cost over the required service period if and when achievement of the performance condition became probable. The compensation cost recognized in the financial statements will be based on the fair value of the award coincide with the actual settlement.
Subsequent Events
Agreement and Plan of Merger
On July 25, 2011, the Company, CACI, Inc.—Federal, a Delaware corporation (“Parent”), and CACI Newco Corporation, a Nevada corporation and wholly-owned subsidiary of Parent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will merge with and into Paradigm, with Paradigm continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”).
The aggregate consideration to be paid by Parent and Merger Sub in the Merger for all of the outstanding equity interests of Paradigm, including securities convertible into shares of Paradigm’s common stock, par value $0.01 per share (the “Company Common Stock“), and the Senior Notes is $61,500,000, plus the aggregate amount of Closing Cash (as defined in the Merger Agreement), minus the sum of (i) the aggregate amount of outstanding Company Debt (as defined in the Merger Agreement) (excluding the Senior Notes) at the effective time of the Merger and (ii) the Company Transaction Expenses (as defined in the Merger Agreement) that are unpaid at the effective time of the Merger.
At the effective time of the Merger, each share of Company Common Stock issued and outstanding immediately prior to the effective time of the Merger, other than (i) shares held in the treasury of the Company and shares owned by Parent, Merger Sub, or any subsidiary of Parent or the Company (which shares will be cancelled) and (ii) shares in respect of which dissenter’s rights have been properly exercised under Chapter 92A of the Nevada Revised Statutes (the “NRS”), will be converted into the right to receive an amount in cash equal to the “Aggregate Common Merger Consideration” (which is defined below) divided by the number of shares of Company Common Stock issued and outstanding immediately prior to the effective time of the Merger (the “Common Merger Consideration”), without interest. As of the date of the Merger Agreement, the Common Merger Consideration was estimated to be equal to $0.2913 per share.
At the effective time of the Merger, each share of Paradigm Series A-1 Preferred Stock, or fraction thereof, issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive an amount per share of Series A-1 Preferred Stock (including a proportionate amount for any fractional share) equal to the Liquidation Price (as defined in the Certificate of Designations of the Series A-1 Senior Preferred Stock (the “Certificate of Designations”)) (the “Preferred Share Merger Consideration”).
Each option to purchase shares of Company Common Stock (the “Company Options”) which is outstanding and unexercised immediately prior to the effective time of the Merger will be cancelled as of the effective time of the Merger. The holder of each Company Option will be entitled only to the right to receive, without any interest thereon, an amount in cash payable at the time of cancellation of such Company Option equal to the product of (i) the excess, if any, of the Common Merger Consideration over the per share exercise price of such Company Option, and (ii) the number of shares of Company Common Stock covered by such Company Option (including both vested and unvested shares) as of immediately prior to the effective time of the Merger.
Each Company SAR which is outstanding immediately prior to the effective time of the Merger will be cancelled as of the effective time of the Merger. The holder of each Company SAR would be entitled only to the right to receive, without any interest thereon, an amount in cash payable at the time of cancellation of such Company SAR equal to the product of (i) the excess, if any, of the Common Merger Consideration over the per share exercise price of such Company SAR and (ii) the number of shares of Company Common Stock with respect to which such Company SAR is exercisable as of the effective time of the Merger.
At the effective time of the Merger, pursuant to the Termination Agreement (as defined below), each outstanding Class A Warrant will be cancelled in exchange for the payment to each holder of a Class A Warrant of an amount in cash equal to (x) the greater of (I) the Common Merger Consideration and (II) $0.2913 (the greater of (I) and (II) is referred to as the “Adjusted Common Merger Consideration”) multiplied by (y) the number of shares of Company Common Stock that would have been issuable upon a cashless exercise of such Class A Warrant immediately prior to the effective time of the Merger based on the Adjusted Common Merger Consideration (the “Series A Preferred Warrant Merger Consideration”).
At the effective time of the Merger, pursuant to the Termination Agreement, each outstanding Class B Warrant will be cancelled in exchange for the payment to each holder of a Class B Warrant of an amount in cash equal to (x) the Adjusted Common Merger Consideration multiplied by (y) the number of shares of Company Common Stock that would have been issuable upon a cashless exercise of such Class B Warrant immediately prior to the effective time of the Merger based on the Adjusted Common Merger Consideration (the “Series B Preferred Warrant Merger Consideration”). We refer to the Series A Preferred Warrant Merger Consideration and the Series B Preferred Warrant Merger Consideration together as the “Preferred Warrant Merger Consideration”.
The Merger Agreement provides that the Company will take the necessary actions to cause each outstanding warrant (excluding Company SARs, Class A Warrants and Class B Warrants) (the “Other Company Warrants”) which is issued and outstanding at the effective time of the Merger to be deemed exercised effective as of the effective time of the Merger, for cash, with such cash deemed paid via the Common Merger Consideration payable to such holders. Other Company Warrants that have an exercise price less than the Common Merger Consideration will be cancelled and terminated at the effective time of the Merger.
Each of the Company’s Senior Notes that are outstanding as of the effective time of the Merger will be cancelled and the Company will pay to each holder of a Senior Note cash in an amount equal to the sum of (x) the aggregate principal amount of the Senior Notes held by such holder then outstanding, together with any accrued and unpaid interest thereon through the effective time of the Merger (calculated at an interest rate of 6% per annum) and (y) the Present Value of Interest (as defined in the Senior Notes) with respect to such aggregate principal amount of the Senior Notes then outstanding (collectively, the “Senior Note Merger Consideration”).
At the effective time of the Merger, all outstanding restricted stock awards (“Company Restricted Shares”) will automatically become fully vested and will be paid in the same fashion as other shares of Company Common Stock.
The Merger Agreement defines “Aggregate Common Merger Consideration” as being equal to the amount determined by subtracting (i) the aggregate Preferred Share Merger Consideration, (ii) the aggregate Senior Note Merger Consideration, (iii) the aggregate amount to which the holders of Company Options, Company SARs, Other Company Warrants, the Class A Warrants, the Class B Warrants and Company Restricted Shares (collectively, the “Company Stock-Based Securities”) are entitled, (iv) the aggregate amount of Company Transaction Expenses that are unpaid at the effective time of the Merger, and (v) the aggregate amount of outstanding Company Debt (excluding the Senior Notes) at the effective time of the Merger, from the sum of (A) $61.5 million and (B) the aggregate amount of Closing Cash.
The completion of the Merger is subject to the satisfaction or waiver of certain conditions, including, among other things, the adoption of the Merger Agreement by the Company’s stockholders, which was effected on July 25, 2011 by the written consent of the holders of securities representing 104,829,858 votes, or approximately 92.43% of the votes entitled to be cast with respect to the adoption and approval of the Merger Agreement.
The Merger Agreement contains customary termination provisions, including, without limitation, that the Merger Agreement may be terminated by either the Company or Parent if the Merger has not been consummated by the close of business on November 10, 2011, other than due to the failure of the terminating party to fulfill its obligations under the Merger Agreement. The Merger Agreement requires the Company to pay a $1,537,500 termination fee to Parent under certain limited circumstances.
The Merger Agreement contains customary representations and warranties made by the Company, Parent and Merger Sub. In addition, the Company has agreed to various covenants in the Merger Agreement, including, among other things, covenants to continue to conduct its business in the ordinary course and in accordance with past practices and not to take certain actions prior to the closing of the Merger without the prior consent of Parent.
Termination Agreement
On July 25, 2011, in connection with the execution of the Merger Agreement, the Company, Parent and the Holders entered into the Preferred Stock, Warrant and Note Termination Agreement (the “Termination Agreement”). The Termination Agreement, among other things, (i) provides for the cancellation of the shares of Series A-1 Preferred Stock, Class A Warrants, Class B Warrants and Senior Notes held by the Holders in exchange for the right to receive the Preferred Share Merger Consideration, the Preferred Warrant Merger Consideration and the Senior Note Merger Consideration, respectively, and (ii) restricts the transfer of the Series A-1 Preferred Stock, Class A Warrants, Class B Warrants and Senior Notes except under certain limited circumstances. . Pursuant to the Termination Agreement, the Company remains obligated to make certain payments and redemptions pursuant to the terms of the Series A-1 Preferred Stock, the Class A Warrants, the Class B Warrants, the Senior Notes and Certificate of Designations until the effective time of the Merger.
The Preferred Share Merger Consideration, Preferred Warrant Merger Consideration and the Senior Note Merger Consideration are potentially less favorable to the Holders than what their rights would have been upon the Merger under the terms of the Series A-1 Preferred Stock, the Senior Notes, the Class A Warrants and the Class B Warrants. The Termination Agreement also provides that until the earlier of the effective time of the Merger or the termination of the Merger Agreement, that, and for so long as certain specified events do not occur, the Holders will refrain from exercising any of their rights or remedies that may exist as a result of any Event of Default (as such term is defined in the Senior Notes and the Certificate of Designations, as applicable). In consideration of these agreements by the Holders, the Termination Agreement provides that the Company will reimburse the Holders’ reasonable legal fees in connection with the contemplated transactions.
Martin Hale, a member of the Company’s Board of Directors, is the Chief Executive Officer of each of Hale Capital and Hale Fund Management, LLC, the managing member of EREF PARA.
Support Agreements
On July 25, 2011, the Company and Parent entered into Stockholder Support Agreements with each of the Holders, Raymond Huger, John Moore (together with his spouse), Peter LaMontagne, Richard Sawchak, Robert Boakai, Anthony Verna and Diane Moberg (the “Stockholder Support Agreements”). The Stockholder Support Agreements, among other things, (i) require the execution of the Merger Consent (as defined below) by the stockholder, (ii) require that in the event of a stockholder meeting such stockholder will vote in favor of the Merger, the Merger Agreement and the transactions contemplated by the Merger Agreement and against any adverse proposal, (iii) appoints Parent or its designee as such stockholder’s proxy and attorney-in-fact to vote such stockholder’s shares in favor of the Merger, the Merger Agreement and the transactions contemplated by the Merger Agreement and against any adverse proposal, (iv) restricts the transfer of such stockholder’s shares and (v) provides a general release, effective as of the Merger, of certain claims against the Company and certain other identified persons and entities.
Indemnification Agreements
On July 25, 2011, the Company entered into Indemnification Agreements (the “Indemnification Agreements”) with each of the current members of the Board of Directors of the Company and Richard Sawchak, the Company’s Senior Vice President and Chief Financial Officer. Among other things, the Indemnification Agreements require the Company to indemnify the directors and Mr. Sawchak in the event of certain proceedings and to advance expenses as provided in the Indemnification Agreements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the quarter ended June 30, 2011. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2011, the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and accumulated and communicated to the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
In connection with the evaluation required by paragraph (d) of Rule 13a-15 under the Exchange Act, there was no change identified in the Company's internal control over financial reporting that occurred during the three months ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None.
ITEM 1A: RISK FACTORS
Smaller reporting companies are not required to provide the information required by this item.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: (REMOVED AND RESERVED)
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS
| EXHIBIT NO. | DESCRIPTION | |||
| 2.1 | Agreement and Plan of Merger dated July 25, 2011 among Paradigm Holdings, Inc., CACI, Inc.—Federal and CACI Newco Corporation | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on July 27, 2011 | ||
| 10.1 | Assumption Agreement dated May 6, 2011 among Paradigm Holdings, Inc., Paradigm Solutions Corporation, Caldwell Technology Solutions LLC, Trinity Information Management Services and Silicon Valley Bank | Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.2 | Intellectual Property Security Agreement dated May 6, 2011 between Paradigm Holdings, Inc. and Silicon Valley Bank | Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.3 | Securities Account Control Agreement dated May 6, 2011 among Paradigm Holdings, Inc., Silicon Valley Bank, SVB Securities and Penson Financial Services, Inc. | Incorporated by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.4 | Ratification of Subordination Agreement dated May 6, 2011 among Paradigm Holdings, Inc., Paradigm Solutions Corporation, Caldwell Technology Solutions LLC, Trinity Information Management Services, Silicon Valley Bank, Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 10.4 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.5 | Assumption and Reaffirmation Agreement dated May 6, 2011 among Paradigm Holdings, Inc., Paradigm Solutions Corporation, Caldwell Technology Solutions LLC, Trinity Information Management Services Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 10.5 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.6 | Senior Secured Subordinated Promissory Notes issued to Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 10.6 of the Registrant’s Current Report on Form 8-K as filed with the Commission on May 12, 2011 | ||
| 10.7 | Sixth Loan Modification Agreement dated May 16, 2011 among Paradigm Holdings, Inc., Paradigm Solutions Corporation, Caldwell Technology Solutions LLC, Trinity Information Management Services and Silicon Valley Bank | Incorporated by reference to Exhibit 10.8 of the Registrant’s Quarterly Report on Form 10-Q as filed with the Commission on May 16, 2011 | ||
| 10.8 | Amendment to Senior Secured Subordinated Notes dated May 16, 2011 among Paradigm Holdings, Inc., Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 10.9 of the Registrant’s Quarterly Report on Form 10-Q as filed with the Commission on May 16, 2011 | ||
| 10.9 | Letter agreement dated May 16, 2011 among Paradigm Holdings, Inc., Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 10.10 of the Registrant’s Quarterly Report on Form 10-Q as filed with the Commission on May 16, 2011 |
| 10.10 | Preferred Stock, Warrant and Note Termination Agreement dated July 25, 2011 among Paradigm Holdings, Inc., CACI, Inc.—Federal, Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on July 27, 2011 | ||
| 10.11 | Form of Stockholder Support Agreement among Paradigm Holdings, Inc., CACI, Inc.—Federal and the applicable stockholder: Raymond Huger, John Moore (together with his spouse), Peter LaMontagne, Richard Sawchak, Robert Boakai, Anthony Verna or Diane Moberg | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on July 27, 2011 | ||
| 10.12 | Stockholder Support Agreement dated July 25, 2011 among Paradigm Holdings, Inc., CACI, Inc.—Federal, Hale Capital Partners, LP and EREF PARA, LLC | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on July 27, 2011 | ||
| 10.13 | Form of Indemnification Agreement for the Chief Financial Officer and members of the Board of Directors of Paradigm Holdings, Inc. | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K as filed with the Commission on July 27, 2011 | ||
| Certification of CEO pursuant to Rule 13a-14(a)/ 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Provided herewith | |||
| Certification of CFO pursuant to Rule 13a-14(a)/ 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Provided herewith | |||
| Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | Provided herewith | |||
| Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | Provided herewith | |||
| 101 | The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows and (iv) related notes. | Provided herewith |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| PARADIGM HOLDINGS, INC. (Registrant) | |
| Date: August 12, 2011 | By: /s/ Peter B. LaMontagne |
| Peter B. LaMontagne | |
| President and Chief Executive Officer | |
| Date: August 12, 2011 | By: /s/ Richard Sawchak |
| Richard Sawchak | |
| Senior Vice President and Chief Financial Officer |
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