WASHINGTON, D.C. 20549
PARADIGM HOLDINGS, INC.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The aggregate market value of the registrant’s common stock held by non-affiliates based on the closing price as of June 30, 2008 (the last business day of registrant’s most recently completed second fiscal quarter) was approximately $8.0 million.
Number of shares of common stock outstanding as of June 30, 2008 was 20,548,153 shares.
Number of shares of common stock outstanding as of March 26, 2009 was: 43,868,027 shares.
This Form 10-K 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 relate to future events or 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 sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and other sections of this Form 10-K.
Such forward-looking statements include, but are not limited to:
| · | 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:
| · | 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; |
| · | The ability to attract and retain qualified personnel; |
| · | Our ability to retain our contracts during any rebidding process; and |
| · | The other factors outlined under “Risk Factors.” |
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.
TABLE OF CONTENTS
| PART I | | |
| | | | | |
| ITEM 1. | | BUSINESS | | 1 |
| ITEM 1A. | | RISK FACTORS | | 12 |
| ITEM 1B. | | UNRESOLVED STAFF COMMENTS | | 20 |
| ITEM 2. | | PROPERTIES | | 20 |
| ITEM 3. | | LEGAL PROCEEDINGS | | 21 |
| ITEM 4. | | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | | 21 |
| PART II | | | | |
| ITEM 5. | | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | | 22 |
| ITEM 6. | | SELECTED FINANCIAL DATA | | 23 |
| ITEM 7. | | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | | 23 |
| ITEM 7A. | | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | | 34 |
| ITEM 8. | | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | | 34 |
| ITEM 9. | | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | | 34 |
| ITEM 9A. | | CONTROLS AND PROCEDURES | | 35 |
| ITEM 9A(T). | | CONTROLS AND PROCEDURES | | 35 |
| ITEM 9B. | | OTHER INFORMATION | | 35 |
| PART III | | | | |
| ITEM 10 | | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | | 36 |
| ITEM 11 | | EXECUTIVE COMPENSATION | | 39 |
| ITEM 12 | | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | | 42 |
| ITEM 13 | | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | | 44 |
| ITEM 14 | | PRINCIPAL ACCOUNTING FEES AND SERVICES | | 45 |
| PART IV | | | | |
| ITEM 15 | | EXHIBITS, FINANCIAL STATEMENT SCHEDULES | | 46 |
| | | | | |
| SIGNATURES | | | | 47 |
CERTIFICATIONS
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Paradigm Holdings, Inc. (“Paradigm” and/or the “Company”) (website: www.paradigmsolutions.com) 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 foundation of experienced executives, Paradigm has grown from six employees in 1996 to the current level of 189 personnel. Our annual revenue was $39.1 million in 2008.
As of December 31, 2008, Paradigm was comprised of three subsidiary companies: 1) Paradigm Solutions Corporation, which was incorporated in 1996 to deliver IT services to federal agencies, 2) Trinity IMS, Inc. (“Trinity”), which was acquired on April 9, 2007 to deliver IT security and cyber forensics solutions into the national security marketplace, and 3) 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. Paradigm is dedicated to providing premier IT solutions to Paradigm’s federal clients, focusing on expanding support for national security programs with current and new customer agencies. Paradigm’s targeted agencies include the U.S. Department of the Treasury, U.S. Department of Homeland Security (“DHS”), U.S. Department of State, U.S. Department of Justice, and the U.S. Department of Defense (“DoD”) (including Secretary of Defense, Army, Navy/Marine Corps, Air Force, and Joint Forces Command), as well as agencies and departments comprising the U.S. intelligence community, including the Office of the Director of National Intelligence (“ODNI”). In addition, Paradigm serves other agency clients such as the Department of Commerce in cases where they offer valuable contract opportunities that require our specialized expertise or significantly augment Paradigm’s revenue.
Paradigm Solutions International ("PSI")—PSI was established in 2004 to apply Paradigm’s technical expertise, developed in supporting federal government customers, to the commercial market in a growth-oriented, profitable manner. In October of 2005, PSI acquired Blair Technology Group (“Blair”), a provider of business continuity and IT security solutions primarily to commercial clients. The Company defines the commercial business as all of the outstanding capital stock of PSI, which included all of the capital stock of Blair, and certain assets associated with the OpsPlanner software tool (“OpsPlanner”). The Company classified the commercial business as discontinued operations at December 31, 2006 based on the Company meeting the necessary criteria listed in paragraph 30 of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The commercial business has been reported as a discontinued operation of the Company and, accordingly, its operating results, financial position and cash flows have been presented separately from the Company’s continuing operations in the consolidated financial statements for all current and prior periods presented. Refer to our 2006 Annual Report on Form 10-K for Paradigm Holdings, Inc. for a further discussion of the Blair acquisition. Refer to Note 3 of the Notes to Consolidated Financial Statements for a further discussion of the discontinued operations.
Paradigm supports our clients’ mission-critical initiatives in four core technical competency areas: Enterprise Optimization, Enterprise Solutions, Mission Support, and Mission Assurance. Refer to Product and Service Offerings in this section for additional discussion of these competency areas. Our primary focus for business growth will be to pursue IT solutions work with the DoD, DHS, intelligence community member agencies and other national security oriented agencies where we believe the opportunity for profitable business is greater.
Paradigm is steadfast in its commitment to be a leading provider of technology and mission services to the U.S. Federal Government, primarily supporting national security missions. As an emerging member of the federal IT community, we plan to build success and respect through the provision of specialized technical services and solutions. We are committed to our customers’ mission success through the delivery of high-quality IT services on-time and within budget through reduced-risk transitions, program stability, and effective contract implementation and administration. We are dedicated to employee development and the advancement of a culture of integrity, teamwork, and trust, objectives that will be key factors in making us a leading employer and solution provider of choice in our market.
CORPORATE HISTORY
Paradigm, formerly known as Cheyenne Resources, Inc. (“Cheyenne Resources”), was incorporated in Wyoming on November 17, 1970.
Paradigm acquired PSC, a Maryland corporation incorporated in 1996, through a reverse acquisition on November 3, 2004. Cheyenne Resources, prior to the reverse acquisition, operated principally in one industry segment, the exploration for and sale of oil and gas. Cheyenne Resources had no operations as of the date of the reverse acquisition, and the operations of PSC, which consisted primarily of providing IT services to the federal government, continued following the reverse acquisition.
On December 17, 2004, Paradigm formed the wholly-owned subsidiary, PSI, to focus on providing IT and software solutions to the commercial arena.
On October 14, 2005, PSI acquired Blair. PSI was the surviving corporation and continued its corporate existence under the laws of the State of Maryland as a wholly-owned subsidiary of Paradigm until February 28, 2007. The Company defined the commercial business as all of the outstanding capital stock of PSI, which included all of the capital stock of Blair, and certain assets associated with the OpsPlanner software tool. The Company classified the commercial business as discontinued operations at December 31, 2006 based on the Company meeting the necessary criteria listed in paragraph 30 of SFAS No. 144. The Company completed the sale of the commercial business on February 28, 2007.
On January 29, 2007, the Company entered into the Trinity Stock Purchase Agreement by and among the Company, Trinity and certain shareholders of Trinity. On April 9, 2007, the Company completed the acquisition of Trinity.
On June 6, 2007, the Company entered into the Purchase Agreement by and among the Company, CTS and its members. On July 2, 2007, the Company completed the acquisition of CTS.
OUR GROWTH STRATEGY
Our strategy to grow our business in the federal IT market and expand our business supporting national security customers and programs has several principal components:
| · | LEVERAGING CURRENT INCUMBENT WORK—We emphasize thoroughly analyzing our current customers and then systematically targeting and pursuing new business and expansion opportunities within our existing customer set. The incumbency analysis/leveraging process involves: |
| | · | Convening focused meetings involving Operations & Business Development staff for all of our key incumbent contracts and ensuring continued strong performance on projects and fostering positive relationships with our customers and prime contractors. |
| | · | Identifying related and non-related divisions within existing customer organizations, offices, and initiatives where Paradigm can add value. |
| | · | Identifying contracts (current and new) within these offices/initiatives where we can bid competitively as a prime or subcontractor. |
| | · | Analyzing the competition (especially the incumbent where there is a current contract) to determine relative strengths, weaknesses, and possible winning strategies. |
| | · | Meeting systematically and frequently with current/potential clients. |
| | · | Continually researching and deepening our knowledge of the goals and strategies of each client organization. |
| | · | Targeting and qualifying the highest-priority opportunities where we have the best chance to expand current or win new business. |
| | · | Commit sufficient resources necessary to execute plans to win identified business opportunities, focusing first on high-revenue, high-margin business in where are core competencies are most relevant. |
We believe that leveraging the benefits of our incumbency is an efficient and effective means of growing our Company based on where we are currently performing most successfully. In particular, we emphasize strategies to learn of viable opportunities long before the expected request for proposal date—at least a year ahead whenever possible.
| · | STRATEGIC MARKET PENETRATION—To augment our efforts in building a profitable business within new client agencies and arenas, management has implemented a focused process of “strategic market penetration”. This process involves the following: |
| | · | Conducting extensive research on the background, mission, and objectives of a new agency/division. |
| | · | Identifying key contracts (current and projected) where we could provide a viable alternative or more complete solution. |
| | · | Identifying key decision-makers who influence contract awards and retaining outside consultants who have deeper insight into key customer programs and strategic priorities. |
| | · | Researching incumbent and other competitors. |
| | · | Interviewing decision-makers in depth to understand their mission and requirements and introducing our success with other clients and our core competencies. |
| | · | Tracking and pursuing new and re-compete opportunities within the agency/division. |
| | · | In instances where it is not feasible or cost effective to penetrate a strategic market or customer through the aforementioned methods, we will selectively consider acquiring companies who have an established positive track record of growth, profitability and strong technical performance. Such acquisition candidates will be evaluated based on: |
| | · | Track record of revenue growth and profitability in targeted customer agencies where we have limited insight or ability to penetrate via traditional marketing methods. |
| | · | Percentage of prime contracts (vs. subcontracts) as well as access to larger agency or government wide acquisition contract vehicles. |
| | · | Key technical offerings or employee skill sets that support or expand our strategic core competencies. |
The process is carried out in a systematic, highly organized manner based on the agencies and opportunities that appear to offer the greatest strategic fit with our capabilities and strategic objectives.
| · | STRATEGIC ALLIANCES—We pursue strategic alliances with large systems integrators, niche small businesses and innovative software and hardware vendors. We are continually seeking relationships and innovative technologies that allow us to apply our Enterprise Optimization, Enterprise Solutions, Mission Assurance and Mission Support expertise to larger programs to enhance growth prospects in the federal civilian, homeland security, law enforcement or national security markets. |
Depending on the alliance, we may partner with a company to provide integration services to support our sales, or we will establish a relationship as a value-added reseller (“VAR”) so we can sell the product in conjunction with our consulting services as a complete solution. VAR relationships are advantageous as they provide us with the opportunity to generate additional income through product sales, as well as create additional customer loyalty since customers deal primarily with Paradigm as the solution provider. We also pursue strategic relationships with prime system integrator companies who have a significant presence in target markets. By aligning with these firms as a subcontractor, we accelerate our penetration of the space with a plan to move toward a niche prime contractor role over time.
Furthermore, our growth strategy emphasizes additional key elements, which include:
| | · | Recruit, train, and deploy a highly motivated, professional business development team. |
| | · | Selectively add sales and professional delivery resources, deployed in a broader geographic area. |
| | · | Achieve rapid expansion through organic growth and strategic acquisitions. |
| | · | Remain focused in the federal civilian agency specific service offerings where we have a track record of success and we support priority mission-related projects. |
| | · | Target vertical market prospects in the homeland security, law enforcement, and national security markets. |
KEY INFORMATION TECHNOLOGY TRENDS: GOVERNMENT
Key trends within the federal arena that affects our growth and day-to-day success include:
OFFICE OF MANAGEMENT AND BUDGET (“OMB”) ACTIVISM AND AGENCY OVERSIGHT - Government organizations rely heavily on outside contractors to provide skilled resources to accomplish technology programs. We expect this reliance will continue to intensify due to political and budgetary pressures in many government agencies and also due to the difficulties facing governments in recruiting and retaining highly skilled technology professionals in a competitive labor market. In concert with its transition to more commercial-like practices, government is increasingly outsourcing technology programs as a means of simplifying the implementation and management of technology, so that government workers can focus on their functional mission.
However, counterbalancing increased reliance on outsourcing is increased oversight of contractors and large IT projects. The OMB Management Watch List (“MWL”) was established under the authority of the 1996 Clinger-Cohen Act and helps OMB oversee the planning of IT investments at the start of the federal budget cycle each fall when OMB receives fiscal year agency budget submissions. The information under review within the business cases includes acquisition strategies, security and privacy plans, and its organizational design. If the agency’s investment plan contains one or more planning weaknesses, it is placed on OMB’s MWL. Early 2007 marked the beginning of a new phase of accountability and transparency. Since then, significant developments related to federal IT management include:
| | · | As of February 2007, with the release of the then President’s budget, agencies have been instructed to post their IT investment business cases (Exhibit 300) on the Internet. |
| | · | OMB agreed to release the MWL to Congress and the public on a quarterly basis. |
We believe that over the next five years, federal IT program management will be under watch and will continue to receive substantial attention over the forecast period. With contracting making up more than a third of the federal discretionary budget, increased federal contract oversight will be a main focus.
CONSOLIDATION AND MODERNIZATION PRESSURES COMBINED WITH UNITED STATES GOVERNMENT STAFF SHORTAGE - We believe that political pressures and budgetary constraints are forcing government agencies at all levels to improve their processes and services and operate more efficiently. Organizations throughout the federal, state and local governments—like their counterparts in the private sector—are investing heavily in IT to improve effectiveness, enhance productivity and extend new services in order to deliver increasingly responsive and cost-effective public services. In addition, OMB is seeking opportunities to leverage IT investments across the entire federal government through initiatives such as the OMB Lines of Business and the Federal Desktop Core Configuration. Also contributing to IT services demand are initiatives such as DoD Transformation, DHS Integration, DoD Base Relocation and Consolidation and ongoing information sharing initiatives.
We believe that these Information Sharing initiatives, in particular, will continue to drive consolidation and modernization efforts through a focus on Service Oriented Architecture and Web Services. Information sharing is a recommendation of the 9/11 Commission. For example, in an effort to share information more freely, the intelligence community has established the ODNI since the passage of the Intelligence Reform and Terrorism Prevention Act of 2004.
GLOBAL WAR ON TERRORISM DRIVES BROAD SET OF MISSION SUPPORT REQUIREMENTS – We believe that the United States faces a profound challenge in meeting the threats associated with fighting terrorism around the globe. Beyond the potential attacks on property and lives, protecting against potential losses resulting from network outages, information theft, internal sabotage, viruses, intellectual property infringement, and external hacking by terrorists and state sponsored cyber attacks has become a priority of increasing importance to the federal government. Criminals and terrorists generally seek to exploit vulnerabilities and weaknesses in U.S. cyber security. Proposing methods for identifying and preventing major attacks and developing plans and systems for alerting, containing, and denying an attack and reconstituting essential capabilities in the aftermath of an attack are all emerging as key components of the U.S. homeland defense and national security strategies. This focus is evidenced by increasing budgets and reliance on contractors for information assurance and information operations support and solutions.
HEIGHTENED SECURITY AND PRIVACY CONCERNS UNDERSCORE THE NEED FOR MISSION ASSURANCE - In recent years, several factors have combined to greatly increase awareness of the need for effective IT risk and business continuity management within the federal government market. The OMB has added new requirements for incorporating the cost of security in agency IT investments beginning with fiscal 2008 IT budget submissions. In addition, agencies are expected now to provide detailed plans regarding how they will successfully deploy their financial and human capital resources to correct existing security weaknesses, such as those found during privacy program reviews and implementation of security controls, and to integrate security solutions into the full over the lifecycle of each system undergoing development, modernization or enhancement.
There is also a renewed emphasis on contingency planning and continuity of operations plans, especially as agencies expand the use of Web-services. Precautions must be taken to ensure the survivability of agency networks. These factors include:
| | · | Increased regulatory requirements (corporate governance and the Federal Information Security Management Act). |
| | · | The continued threat of terrorism (including employee sabotage and cyber attacks) as evidenced by recent episodes of high profile data compromise. |
| | · | Increasing threat and awareness of state sponsored cyber attacks. |
| | · | Homeland Security Commission 9/11 Report standardization on how to measure preparedness, National Fire Protection Association 1600, and Federal Emergency Management Agency’s Federal Preparedness Circular 65 dated June 15, 2004 and updated March 1, 2006. |
| | · | HSPD-20 establishes a comprehensive national policy on the continuity of federal government structures and operations and a single National Continuity Coordinator responsible for coordinating the development and implementation of federal continuity policies. |
| | · | The increasing awareness of the negative mission impact of natural disasters such as hurricanes, floods and tornados increases receptivity of current and prospective clients to Mission Assurance offerings. |
PRODUCT & SERVICE OFFERINGS
We are an information technology and business solutions provider focused on supporting the operational efficiency and security of government enterprises. As a trusted federal government contracting partner, we help our clients plan, perform and assure (i.e. secure and protect) their essential mission functions, especially those involving IT systems.
With a proven track record of program management, contract transitions support, and project implementations, we have consistently delivered quality services and solutions as specified by our clients, within budget, and on time. Our practice areas include Enterprise Optimization, Enterprise Solutions, Mission Support, and Mission Assurance.
| · | ENTERPRISE OPTIMIZATION—We focus on results, and we demand, high performance standards in all aspects of delivering service to our customers to ensure mission success. To fully support the missions of our clients we focus on the planning aspects of projects, starting with the enterprise architecture and optimizing the performance of existing systems and infrastructure investments, focusing on federally mandated standards. We also extend our support services to system sustainment services, applying proactive and measurable results-oriented strategies for the management and delivery of IT projects and supporting services. This practice area encompasses: |
| | · | Program Management Office |
| | · | Strategic Consulting (including total cost of ownership analysis) |
| | · | Information Technology Infrastructure Library (“ITIL”) |
Government agencies, both civilian and defense, have come under increasing pressure due to budget constraints and Congressional oversight, to demonstrate value in their projects and alignment of their programs with strategic and tactical objectives. These performance and oversight requirements have resulted in the proliferation of program management offices within federal agencies to implement a common framework; describe and analyze IT investments; enhance inter-organizational collaboration; and to ensure that agencies are seeking transformation into results-oriented, market-based organizations.
Enterprise Optimization skills are a critical element of our offerings because the practice area: a) involves highly skilled technical expertise that can command higher margins, b) often requires security clearance levels that difficult to acquire, thus increasing demand, and c) enables us to connect with the senior decision makers and understand operational infrastructure of federal organizations.
| · | ENTERPRISE SOLUTIONS—This practice area involves the development and deployment of mission-critical, often enterprise-wide solutions that are central to the organization and management of information. The practice area involves the full life cycle of IT support and encompasses: |
| | · | Software & Database Engineering |
| | · | Enterprise Deployment & Distribution |
| | · | Infrastructure Operations |
| | · | Data Center & Facilities Management |
Enterprise Solutions are a critical element of our offerings because the practice area: a) involves enterprise-wide involvement with a client’s network, which can in itself yield additional areas of opportunity, b) allows for relatively long-term and full-time equivalent (“FTE”) intensive contracts, and c) enables us to connect with the operational infrastructure of commercial and federal organizations while building an “entrenched” role and position for our Company.
| · | MISSION SUPPORT—This practice moves beyond technical and engineering support to deliver solutions that directly support the missions of our customers. In these engagements, our employees often work as an integrated member of government team to provide the following services: |
· Specialized Engineering
· Technical Support
· Linguistics
· Intelligence Analysis
· Quick Reaction Capabilities
Mission support skills are a critical element of our offerings because the practice area: a) involves highly skilled technical expertise that can command higher margins, b) often requires security clearance levels that can yield greater profit, and c) expands our exposure to the national security community, a market area that has demonstrated strong demand for mission support services like those we provide.
| · | MISSION ASSURANCE—This practice area involves providing services that help to secure, protect and sustain the various missions of our federal clients. We are prepared to assist our federal partners with any phase of their information security, critical infrastructure protection or continuity programs, including: policy creation, business impact analysis, risk analysis, strategy selection, plan creation, test, training, exercise, plan maintenance, lab and systems operations, and supporting services. The practice area encompasses: |
· Computer and Network Forensics
· Critical Infrastructure Protection
· Continuity of Operations Consulting
· IT Contingency Planning/Disaster Recovery Consulting Services
· Pandemic Influenza Planning
· Certification & Accreditation Services
We work to protect the nation's critical infrastructure components and resources from natural disasters, acts of terrorism, and other emergencies by applying methodologies and tools to identify and analyze risks, and deploy systems to reduce those risks and the consequences of an event. With the current level of national security concerns and the increase in security related incidents such as fraud, network penetration, theft of proprietary information and corporate espionage, our computer forensics expertise has become an important part of information protection and incident response for certain federal agencies.
Mission Assurance is a critical element of our offerings because the quadrant: a) “opens up” program areas within a client organization that can be different from the Chief Information Office or technology-focused divisions, b) allows for relatively long-term and FTE intensive contracts, c) enables Paradigm to penetrate deep within the operational infrastructure of federal organization while building a key enterprise role and relationship for our Company, and d) expands our exposure to the law enforcement, homeland security and national security markets.
In addition to service-focused expertise, we are the exclusive reseller in the federal market for a licensed proprietary software tool, OpsPlanner ™ through our reseller agreement with PSI. OpsPlanner is one of the first tool sets to integrate continuity planning, emergency management, and automated notification in one easy-to-use platform. Although the intellectual property rights of this offering transferred with the sale of the commercial business on February 28, 2007, we plan to continue to utilize OpsPlanner as part of our business continuity consulting practice in the federal government market. From inception, this platform was developed as an integrated application—unlike those of competitors, which offer continuity planning, emergency management and automated notification as separate software modules. We believe that the OpsPlanner™ offering, when implemented with our consulting expertise, provides a superior solution for continuity of operations planning and risk management challenges.
EXISTING CUSTOMER SERVICE EXAMPLES
COMPUTER FORENSIC
Challenge: Develop and implement a full service computer forensic technical support and analysis capability.
Results: Going beyond indexing file types, our personnel provide full forensic and network services. These functions are broken down into several key components: pre-incident response training and preparation, evidence handling, forensic imaging, forensic analysis, reporting and documentation, and data management. Our personnel develop and implement the standard operating guidelines required to support these services. This support deals with a wide variety of cases, from standard criminal and administrative cases to national security investigations. Our personnel are highly trained and certified as computer analysts with many years of experience handling digital media.
Challenge: Develop and implement a computer forensic quality assurance program to support full service computer forensic laboratory.
Result: Our personnel have developed a multi-tiered approach to quality assurance within the computer forensics industry. Our procedures cover all aspects of the computer forensics operations and are subjected to peer review. During the peer review, checklists are used to ensure that quality and accurate work was performed. The culmination of the forensic analysis is the report. This report is also subject to a peer review whereby an analyst of equal or higher capability reviews the analytical processes applied by the primary forensic analyst. Once passed, the report is then subject to an independent administrative review to ensure that it is free from spelling and grammatical errors. The final phase of review for each report is a management review. This review ensures the report adequately meets the needs of the client. External to these quality assurance steps, our personnel are currently creating an extended quality assurance process. This quality assurance process will evaluate cases after they have been closed to determine adequacy and compliance with existing policies/procedures. This post-mortem approach will identify trends and allow our management to recommend policy/procedural changes for forensic management consideration.
DATA MANAGEMENT & ADMINISTRATION
Challenge: Develop and manage a solution to efficiently house data for enterprise applications
Results: Our team provides full life-cycle database administrative services for mainframe and client server operating environments. Our service offerings include database modeling and design, implementation and integration, replication, backup and recovery; and cover 3 major categories to include database design, database support, and expert consulting. Working closely with our customer’s business units our teams work to determine business and data requirements resulting in the development of logical models, business process diagrams, resulting in the development of the corresponding physical models inclusive of server model diagrams, database design documentation and user feedback documentation.
DISASTER RECOVERY & BUSINESS CONTINUITY SUPPORT
Challenge: Developing, testing, and implementing recovery objectives for the enterprise
Results: Our team assists customer in continuity of operations and disaster recovery planning and testing. Our support includes identifying critical hardware and software recovery objectives, calculating and formulating recovery metrics, defining the relationship between recovery and availability, and identifying and implementing technologies that support the established recovery objectives. Our team also provides consulting expertise in support of identifying special recovery requirements for enterprise applications within our customer’s business unit.
EXISTING CONTRACT PROFILES
As of December 31, 2008, we had a portfolio of 32 active contracts with the federal government. Contract mix for the year ended December 31, 2008 was 60% fixed price contracts and 40% time and materials contracts.
Under a fixed price contract, the contractor agrees to perform the specified work for a firm fixed price. To the extent that actual costs vary from the price negotiated we may generate more or less than the targeted amount of profit or even incur a loss. We generally do not pursue fixed price software development work that may create material financial risk; however, we had one contract of this type which ended in the first quarter of 2007. We do, however, execute some fixed price labor hour and fixed price level of effort contracts which represent similar levels of risk as time and materials contracts in that these fixed price contracts involve a defined number of hours for defined categories of personnel. We refer to such contracts as “level of effort” contracts.
Under a time and materials contract, the contractor is paid a fixed hourly rate for each direct labor hour expended and is reimbursed for direct costs. To the extent that actual labor hour costs vary significantly from the negotiated rates under a time and materials contract, we may generate more or less than the targeted amount of profit.
Cost-plus contracts provide for reimbursement of allowable costs and the payment of a fee which is the contractor’s profit. Cost-plus fixed fee contracts specify the contract fee in dollars or as a percentage of allowable costs. Cost-plus incentive fee and cost-plus award fee contracts provide for increases or decreases in the contract fee, within specified limits, based upon actual results as compared to contractual targets for factors such as cost, quality, schedule and performance.
Historical contract mix from the continuing operations is summarized in the table below.
| Contract Type | | 2008 | | | 2007 | |
| Fixed Price (FP) | | | 60 | % | | | 68 | % |
| Time and Materials (T&M) | | | 40 | % | | | 27 | % |
| Cost-Plus (CP) | | | 0 | % | | | 5 | % |
Listed below are the top programs by 2008 revenue, including single award and multiple award contracts.
TOP PROGRAMS/CONTRACTS BY 2008 REVENUE
($ in millions)
| Contract Programs | | Customer | | Period of Performance | | 2008 Revenue | | | Estimated Remaining Contract Value as of 12/31/08 | | Type |
| ACCESS-LTMCC | | Department of Treasury - IRS | | October 2007 - September 2012 | | $ | 7.2 | | | $ | 7.3 | | FP |
| OCC-GSO | | Department of Treasury – Office of the Comptroller of the Currency | | January 2005 – September 2012 | | $ | 5.8 | | | $ | 16.3 | | FP |
DESCRIPTION OF MAJOR PROGRAMS / CONTRACTS:
DEPARTMENT OF THE TREASURY - INTERNAL REVENUE SERVICE, LONG TERM MAINTENANCE OF COMPUTING CENTERS (“LTMCC”)
We provide computing center hardware maintenance and software administration support to the IRS main Tax Reporting Systems in Detroit, Michigan and Martinsburg, West Virginia. At the IRS Detroit Computing Center, we currently respond to hardware remedial and preventive maintenance and we administer the software that resides on the IBM z990, 2084-302 mainframe. Our staff of technicians supports the Enterprise Computing Center at Martinsburg’s more than 1425 IBM/IBM compatible peripherals and higher maintenance items in place at the IRS that include sophisticated tape drives, monitors, and printers. We have established a technical support center to resolve problems on a 24x7x365 basis. As of October 1, 2007, we migrated our prime contract role to being the primary subcontractor on the contract.
DEPARTMENT OF THE TREASURY – OFFICE OF THE COMPTROLLER OF THE CURRENCY GLOBAL SERVER OPERATIONS (“OCC-GSO”)
We provide facilities maintenance, mainframe operations, client server operations and network operations center support services to the OCC. With a team of over forty personnel that operate on site supporting the OCC mission, we are responsible for key functional areas in the network operations center, including support of mainframe legacy systems; security monitoring; and desktop engineering; and facility management.
BACKLOG
Backlog is the estimate of the amount of revenue expected to be realized over the remaining life of awarded contracts and task orders we have in hand as of the measurement date. Total backlog consists of funded and unfunded backlog. We define funded backlog as estimated future revenue under government contracts and task orders for which funding has been authorized and appropriated by Congress for expenditure by the applicable agency and the agency has modified our contract to reflect the funding level. Unfunded backlog is the difference between total backlog and funded backlog. Unfunded backlog reflects the estimate of future revenue under awarded government contracts and task orders for which either funding has not yet been appropriated or expenditure has not yet been authorized. Total backlog does not include estimates of revenue from government-wide acquisition contracts (“GWAC”) or General Services Administration (“GSA”) schedules beyond task orders and delivery orders that have already been awarded, but unfunded backlog does include estimates of revenue beyond awarded or funded task orders for other types of indefinite delivery, indefinite quantity (“ID/IQ”) contracts.
Total backlog as of December 31, 2008 was approximately $68.6 million, of which approximately $16.4 million was funded. Total backlog as of December 31, 2007 was approximately $87.8 million, of which approximately $16.1 million was funded. However, there can be no assurance that we will receive the amounts we have included in backlog or that we will ultimately recognize the full amount of our funded backlog as of December 31, 2008. We estimate our funded backlog will be recognized as revenue during fiscal 2009 or thereafter.
We believe that backlog is not necessarily indicative of the future revenue that we will actually receive from contract awards that are included in calculating our backlog. We assess the potential value of contracts for purposes of backlog based upon several subjective factors. These subjective factors include our judgments regarding historical trends (e.g., how much revenue we have received from similar contracts in the past), competition (e.g., how likely are we to successfully keep all parts of the work to be performed under the contract) and budget availability (e.g., how likely is it that the entire contract will receive the necessary funding). If we do not accurately assess each of these factors, or if we do not include all of the variables that affect the revenue that we recognize from our contracts, the potential value of our contracts, and accordingly, our backlog, will not reflect the actual revenue received from contracts and task orders. As a result, there can be no assurance that we will receive amounts included in our backlog or that monies will be appropriated by Congress or otherwise made available to finance contracts and task orders included in our backlog. Many factors that affect the scheduling of projects could alter the actual timing of revenue on projects included in backlog. There is always the possibility that the contracts could be adjusted or cancelled. We adjust our backlog on a quarterly basis to reflect modifications to or renewals of existing contracts.
COMPETITIVE ANALYSIS
Today we operate in an environment characterized by increased competition and additional barriers to entry. Some of these barriers include:
| · | Highly specialized areas (e.g. enterprise resource planning) where entrenched competitors have an advantage in terms of industry recognition or proprietary products/services. |
| · | “Economies of scale” offered by the very largest competitors, who at times can provide solutions cost-effectively due to their sheer size. |
| · | Contract bundling scenarios where agencies render only the largest contractors competitive because of the size and scope of the requirement. |
We compete with many companies, both large and small, for our contracts. We do not have a consistent number of competitors against whom we repeatedly compete. These and other companies in our market may compete more effectively than we can because they are larger, have greater financial and other resources, have better or more extensive relationships with governmental officials involved in the procurement process and have greater brand or name recognition.
We have developed—and will continually refine—a multi-element approach to attempt to compete effectively even in the presence of one or all of the above factors. We offer an array of services and solutions that support our client's ability to focus on their core functional responsibilities and leverage, protect, and maximize their IT investments. More importantly, we are committed to utilizing industry best practices to implement emerging technologies while providing innovative solutions to support and advance our customer's mission.
Our competitive strengths include the following:
| · | Focused Mission Assurance Practice with expertise in Information Assurance. |
| · | Increased emphasis on quality and performance measurement through ITIL & capability maturity model processes - this allows us to compete more effectively on procurements where quality processes signify a key evaluation criterion. |
| · | Proactive approach to identifying the latest technology and business trends - we work as a corporate-wide team to research, identify, and discuss technology and trends impacting our industry. |
| · | Large pool of resources to develop leading-edge technology and business solutions - in addition to our highly capable staff, we have access to a pool of expert consulting resources to help customize solutions to meet client needs. |
| · | Outstanding management solutions through best practices and processes - we interact routinely to share information on best business practices that can be applied to all business opportunities and contracts. |
| · | Ongoing Customer Relationship Management program that is a highly responsive approach to achieving high customer satisfaction - a key distinguishing factor for us is the excellent reputation attained with our customers over the years. |
We routinely apply these competitive strengths in bidding on new procurements - as well as in performing work on our current contracts.
BUSINESS DEVELOPMENT SUMMARY
Our business development function is based on a team approach wherein our executives, business development (“BD”), and operations managers and staff interact and coordinate closely on a day-to-day basis to build our business in mission-critical areas for our customers. New opportunities are identified and qualified by all three functional areas (executive, BD, and operations)—this helps to gain maximum leverage from all BD budgeted resources as well as to more quickly and effectively penetrate our targeted client organizations.
We employ a formal methodology for identifying, pursuing, and capturing new business. Day-to-day business development efforts are based on the following principles:
| · | Fully leverage current client relationships to: (a) grow current contracts, and (b) identify and win new opportunities within not only the current divisions/departments, but also across the client organization. |
| · | Manage and communicate critical client and opportunity information effectively across development and operations groups to help take advantage of all available knowledge and insight—working fully as a team. |
| · | Qualify opportunities according to a structured, systematic process that helps ensure that we devote our resources to the highest priority leads. |
| · | Measure and evaluate our achievements against a specific, quantifiable set of short and long-term objectives. |
Furthermore, we employ a systematic approach to opportunity identification, qualification, and capture. The overarching goal is to continually refine business development efforts, placing much greater emphasis on opportunities that provide sufficient lead time for us to win. The Company’s lead qualification and bid/no-bid processes support this structured approach, helping to ensure that we devote the vast majority of our resources to the most winnable bids.
CULTURE, PEOPLE AND RECRUITING
To ensure effective response to the key trends outlined in the previous section, we have developed and nurtured a corporate culture that promotes excellence in job performance, respect for the ideas and judgment of our colleagues, and recognition of the value of the unique skills and capabilities of our professional staff. We utilize a wide variety of methodologies and techniques to attract and retain highly qualified and ambitious staff, helping to ensure continuity of support and client satisfaction. Integrity and the highest standards of ethics are also emphasized as core principles for our Company culture.
Furthermore, we strive to establish an environment in which all employees can make their best personal contribution and have the satisfaction of being part of a unique, forward-looking team.
As of December 31, 2008, we had 189 personnel (full time, part time, and consultants). Of total personnel, 160 were IT service delivery professionals and consultants and 29 were management and administrative personnel performing corporate marketing, human resources, finance, accounting, legal, internal information systems and administrative functions. None of our personnel is represented by a collective bargaining unit. As of December 31, 2007, we had 229 personnel (full time, part time, and consultants). Of total personnel, 193 were IT service delivery professionals and consultants and 36 were management and administrative personnel performing corporate marketing, human resources, finance, accounting, legal, internal information systems and administrative functions.
WEBSITE ACCESS TO REPORTS
Our filings with the U.S. Securities and Exchange Commission (the “SEC”) and other information, including our Ethics Policy, can be found on our website (www.paradigmsolutions.com). Information on our website does not constitute part of this report. We make available free of charge, on or through our Internet website, as soon as reasonably practicable after they are electronically filed with or provided to the SEC, among other things, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports.
ITEM 1A. RISK FACTORS
WE MAY NEED TO RAISE ADDITIONAL CAPITAL TO FINANCE OPERATIONS
We have relied on significant external financing to fund our operations. As of December 31, 2008 and December 31, 2007, we had $52,257 and $7,771, respectively, in cash, $0 and $1,687,491, respectively, of bank overdraft, and our total current assets were $8,668,833 and $10,558,497, respectively. As of December 31, 2008, current liabilities exceeded current assets by $4,482,752 million. We may need to raise additional capital to fund our anticipated operating expenses and future expansion. Among other things, external financing may be required to cover our operating costs. If we do not maintain profitable operations, it is unlikely that we will be able to secure additional financing from external sources. The sale of our common stock to raise capital may cause dilution to our existing shareholders. Any of these events would be materially harmful to our business and may result in a lower stock price. Our inability to obtain adequate financing may result in the need to curtail business operations.
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 (“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”) to a group of investors, led by Hale Capital Partners, LP. Paradigm received gross proceeds of approximately $6.2 million from the private placement. Among the use of proceeds, $2.1 million was used to pay off the promissory note issued in connection with our acquisition of Trinity, we paid fees and transaction costs of approximately $0.7 million and we intend to use the remaining $3.4 million to pay down debt and for general working capital purposes. Despite the proceeds from the private placement, we may need to raise additional capital in the future. Our inability to obtain adequate financing may result in the need to curtail business operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
ALL OF OUR ASSETS ARE PLEDGED TO SECURE CERTAIN DEBT OBLIGATIONS, WHICH WE COULD FAIL TO REPAY
Our Loan and Security Agreement, dated March 13, 2007, with Silicon Valley Bank (“SVB”), secures our repayment obligations with a first priority perfected security interest in any and all assets of Paradigm as described in the Loan and Security Agreement and in related intellectual property security agreements. Under the Loan and Security Agreement, our line of credit is due on demand and interest is payable monthly based on a floating per annum rate based on the Prime Rate plus a premium as is more fully set forth in Loan and Security Agreement. In the event we are unable to timely repay any amounts owed under the Loan and Security Agreement, we could lose all of our assets and be forced to curtail our business operations. In addition, because our debt obligations with SVB are secured with a first priority lien, it may make it more difficult for us to obtain additional debt financing from another lender, or obtain new debt financing on terms favorable to us, because such new lender may have to be willing to be subordinate to SVB. The expiration date of the Loan and Security Agreement has been extended to May 12, 2009.
ALL OF OUR REVENUE WOULD BE SUBSTANTIALLY THREATENED IF OUR RELATIONSHIPS WITH AGENCIES OF THE FEDERAL GOVERNMENT WERE HARMED
Our largest clients are agencies of the federal government. If the federal government in general, or any significant government agency, uses less of our services or terminates its relationship with us, our revenue could decline substantially and we could be forced to curtail our business operations. During the year ended December 31, 2008, contracts with the federal government and contracts with prime contractors of the federal government accounted for 100% of our revenue from continuing operations. During that same period, our three largest clients, all agencies within the federal government, generated approximately 66% of our revenue. We believe that federal government contracts are likely to continue to account for a significant portion of our revenue for the foreseeable future.
WE MAY LOSE MONEY OR GENERATE LESS THAN ANTICIPATED PROFITS IF WE DO NOT ACCURATELY ESTIMATE THE COST OF AN ENGAGEMENT WHICH IS CONDUCTED ON A FIXED-PRICE BASIS
We perform a significant portion of our engagements on a fixed-price basis. We derived 60% of our total revenue in the fiscal year ended December 31, 2008 and 68% of our total revenue in the fiscal year ended December 31, 2007 from fixed-price contracts. Fixed price contracts require us to price our contracts by predicting our expenditures in advance. In addition, some of our engagements obligate us to provide ongoing maintenance and other supporting or ancillary services on a fixed-price basis or with limitations on our ability to increase prices.
When making proposals for engagements on a fixed-price basis, we rely on our estimates of costs and timing for completing the projects. These estimates reflect our best judgment regarding our capability to complete the task efficiently. Any increased or unexpected costs or unanticipated delays in connection with the performance of fixed-price contracts, including delays caused by factors outside our control, could make these contracts less profitable or unprofitable. From time to time, unexpected costs and unanticipated delays have caused us to incur losses on fixed-price contracts, primarily in connection with state government clients. On rare occasions, these losses have been significant. In the event that we encounter such problems in the future, our actual results could differ materially from those anticipated.
Many of our engagements are also on a time-and-material basis. While these types of contracts are generally subject to less uncertainty than fixed-price contracts, to the extent that our actual labor costs are higher than the contract rates, our actual results could differ materially from those anticipated.
THE CALCULATION OF OUR BACKLOG IS SUBJECT TO NUMEROUS UNCERTAINTIES AND WE MAY NOT RECEIVE THE FULL AMOUNTS OF REVENUE ESTIMATED UNDER THE CONTRACTS INCLUDED IN OUR BACKLOG, WHICH COULD REDUCE OUR REVENUE IN FUTURE PERIODS.
Backlog is our estimate of the amount of revenue we expect to realize over the remaining life of the signed contracts and task orders we have in hand as of the measurement date. Our total backlog consists of funded and unfunded backlog. In the case of government contracts, we define funded backlog as estimated future revenue under government contracts and task orders for which funding has been appropriated by Congress and authorized for expenditure by the applicable agency under our contracts. Unfunded backlog is the difference between total backlog and funded backlog. Our total backlog does not include estimates of backlog from GWAC or GSA schedules beyond signed, funded task orders, but does include estimated backlog beyond signed, funded task orders for other types of ID/IQ contracts.
The calculation of backlog is highly subjective and is subject to numerous uncertainties and estimates, and there can be no assurance that we will in fact receive the amounts we have included in our backlog. Our assessment of a contract’s potential value is based upon factors such as historical trends, competition and budget availability. In the case of contracts which may be renewed at the option of the applicable agency, we generally calculate backlog by assuming that the agency will exercise all of its renewal options; however, the applicable agency may elect not to exercise its renewal options. In addition, federal contracts typically are only partially funded at any point during their term and all or some of the work to be performed under a contract may remain unfunded unless and until Congress makes subsequent appropriations and the procuring agency allocates funding to the contract. Our estimate of the portion of backlog from which we expect to recognize revenue in fiscal 2009 or any future period is likely to be inaccurate because the receipt and timing of any of these revenue is dependent upon subsequent appropriation and allocation of funding and is subject to various contingencies, such as timing of task orders, many of which are beyond our control. In addition, we may never receive revenue from some of the engagements that are included in our backlog and this risk is greater with respect to unfunded backlog. The actual receipt of revenue on engagements included in backlog may never occur or may change because a program schedule could change, the program could be canceled, the governmental agency could elect not to exercise renewal options under a contract or could select other contractors to perform services, or a contract could be reduced, modified or terminated. Additionally, the maximum contract value specified under a government contract or task order awarded to us is not necessarily indicative of the revenue that we will realize under that contract. We also derive revenue from ID/IQ contracts, which typically do not require the government to purchase a specific amount of goods or services under the contract other than a minimum quantity which is generally very small. If we fail to realize revenue included in our backlog, our revenue and operating results for the then current fiscal year as well as future reporting periods may be materially harmed.
OUR GOVERNMENT CONTRACTS MAY BE TERMINATED OR ADVERSELY MODIFIED PRIOR TO COMPLETION, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
We derive substantially all of our revenue from government contracts that typically are awarded through competitive processes and span a one year base period and one or more option years. The unexpected termination or non-renewal of one or more of our significant contracts could result in significant revenue shortfalls. Our clients generally have the right not to exercise the option periods. In addition, our contracts typically contain provisions permitting an agency to terminate the contract on short notice, with or without cause. Following termination, if the client requires further services of the type provided in the contract, there is frequently a competitive re-bidding process. We may not win any particular re-bid or be able to successfully bid on new contracts to replace those that have been terminated. Even if we do win the re-bid, we may experience revenue shortfalls in periods where we anticipated revenue from the contract rather than its termination and subsequent re-bidding. These revenue shortfalls could harm operating results for those periods and have a material adverse effect on our business, prospects, financial condition and results of operations.
OUR LOAN AND SECURITY AGREEMENT WITH SVB, OUR PREFERRED STOCK PURCHASE AGREEMENT WITH THE HOLDERS OF OUR SERIES A-1 SENIOR PREFERRED STOCK AND THE CERTIFICATE OF DESIGNATIONS OF THE SERIES A-1 SENIOR PREFERRED STOCK CONTAIN COVENANTS THAT MAY LIMIT OUR LIQUIDITY AND CORPORATE ACTIVITIES
Our Loan and Security Agreement with SVB, our Preferred Stock Purchase Agreement with the holders of our Series A-1 Senior Preferred Stock and the Certificate of Designations of the Series A-1 Senior Preferred Stock impose operating and financial restrictions on us. These restrictions may limit our ability to, among other things:
| · | incur additional indebtedness or modify the terms of existing indebtedness; |
| · | create liens on our assets; |
| · | engage in mergers or acquisitions; |
| · | pay dividends or redeem or repurchase capital stock |
| · | change the size of our Board of Directors; and |
| · | undertake certain fundamental transactions. |
In addition, we are subject to a number of financial covenants that require us to, among other things, maintain minimum amounts of cash, minimum gross revenues, minimum EBITDA and minimum amounts of working capital. Therefore, we may need to seek permission from our lenders and/or the holders of our Series A-1 Senior Preferred Stock in order to undertake certain corporate actions. The interests of the holders of our Series A-1 Senior Preferred Stock and/or our lenders may be different from those of our common stockholders.
CURRENT ECONOMIC CONDITIONS, INCLUDING THOSE RELATED TO THE CREDIT MARKETS, MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND RESULTS OF OPERATIONS
Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and recession in most major economies continuing into 2009. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, the availability and cost of credit, and the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for Western and emerging economies. In the second half of 2008, added concerns fueled by the U.S. government conservatorship of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, the declared bankruptcy of Lehman Brothers Holdings Inc., the U.S. government financial assistance to American International Group Inc., Citibank, Bank of America and other federal government interventions in the U.S. financial system lead to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels.
As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide credit to businesses and consumers. As a result of the tightening credit markets, we may not be able to obtain additional financing on favorable terms, or at all. If the financial institution that supports our existing credit facility fails, we may not be able to find a replacement, which would negatively impact our ability to borrow under our credit facility. In addition, if the current pressures on credit continue or worsen, we may not be able to refinance our outstanding debt when due, which could have a material adverse effect on our business, results of operations or financial condition.
If, as a result of the risks outlined above, our operating results falter and our cash flow or capital resources prove inadequate, we could face liquidity problems that could have a material adverse effect on our business, financial condition or results of operations.
THE HOLDERS OF OUR SERIES A-1 SENIOR PREFERRED STOCK HAVE SIGNIFICANT INFLUENCE ON OUR MAJOR CORPORATE DECISIONS AND COULD TAKE ACTIONS THAT COULD BE ADVERSE TO YOU
Holders of our Series A-1 Senior Preferred Stock have the right to appoint a majority of our Board of Directors. In addition, each share of Series A-1 Preferred Stock entitles the holder to such number of votes as shall equal the number of shares of common stock issuable upon exercise of the Class A Warrants held by such holder as of the applicable record date. Following the increase in the number of authorized shares of common stock, as anticipated by the Company’s agreement with the holders of Series A-1 Preferred Stock, we anticipate that the holders of our Series A-1 Preferred Stock will hold a majority of the outstanding voting equity of the Company. In addition, holders of our Series A-1 Preferred Stock have the right to approve certain corporate actions.
As a result, holders of our Series A-1 Preferred Stock have significant influence over us, our management, our policies and on all matters requiring shareholder approval. The ability of the holders of our Series A-1 Preferred Stock to influence certain of our major corporate decisions may harm the market price for our common stock by delaying, deferring or preventing transactions that are in the best interests of all shareholders or discouraging third-party investors.
THE ISSUANCE OF COMMON STOCK TO THE HOLDERS OF THE CLASS A WARRANTS AND CLASS B WARRANTS OR THE SALE OF OUR COMMON STOCK BY SUCH HOLDERS COULD LOWER THE MARKET PRICE OF OUR COMMON STOCK
The holders of our Class A Warrants and Class B Warrants have the right to acquire, immediately following the increase in the number of authorized shares of our common stock, as anticipated by the Company’s agreement with the holders of Series A-1 Preferred Stock, approximately 75.9% of the fully-diluted common stock of the Company. The issuance of these shares upon exercise of the Class A Warrants and Class B Warrants will decrease the ownership percentage of current outstanding shareholders and may result in a decrease in the market price of our common stock.
Additionally, the offer, sale, disposition or consummation of other such transactions involving substantial amounts of our common stock held by the holders of our Class A Warrants, Class B Warrants or other significant shareholders could result in a decrease of the market price of our common stock, particularly if such offers, sales, dispositions or transactions occur simultaneously or relatively close in time.
WE MAY HAVE DIFFICULTY IDENTIFYING AND EXECUTING FUTURE ACQUISITIONS ON FAVORABLE TERMS, WHICH MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND STOCK PRICE.
We cannot ensure that we will be able to identify and execute acquisitions in the future on terms that are favorable to us, or at all. One of our key growth strategies is to selectively pursue acquisitions. Through acquisitions, we plan to expand our base of federal government clients, increase the range of solutions we offer to our clients and deepen our penetration of existing clients. Without acquisitions, we may not grow as rapidly as the market expects, which could cause our actual results to differ materially from those anticipated. We may encounter other risks in executing our acquisition strategy, including:
| · | Increased competition for acquisitions which may increase the price of our acquisitions; |
| · | Our failure to discover material liabilities during the due diligence process, including the failure of prior owners of any acquired businesses or their employees to comply with applicable laws, such as the Federal Acquisition Regulation and health, safety, employment and environmental laws, or their failure to fulfill their contractual obligations to the federal government or other clients; and |
| · | Acquisition financing may not be available on reasonable terms, or at all. |
In connection with any future acquisitions, we may decide to consolidate the operations of any acquired business with our existing operations or to make other changes with respect to the acquired business, which could result in special charges or other expenses. Our results of operations also may be adversely affected by expenses we incur in making acquisitions and, in the event that any goodwill resulting from present or future acquisitions is found to be impaired, by goodwill impairment charges.
In addition, our ability to make future acquisitions may require us to obtain additional financing. To the extent that we seek to acquire other businesses in exchange for our common stock, fluctuations in our stock price could have a material adverse effect on our ability to complete acquisitions and the issuance of common stock to acquire other businesses could be dilutive to our stockholders. To the extent that we use borrowings to acquire other businesses, our debt service obligations could increase substantially and relevant debt instruments may, among other things, impose additional restrictions on our operations, require us to comply with additional financial covenants or require us to pledge additional assets to secure our borrowings.
Any future acquisitions we make could disrupt our business and seriously harm our financial condition. We intend to consider investments in complementary companies, products and technologies. We anticipate buying businesses, products and/or technologies in the future in order to fully implement our business strategy. In the event of any future acquisitions, we may:
| · | Issue stock that would dilute our current stockholders’ percentage ownership; |
| · | Incur amortization expenses related to intangible assets; or |
| · | Incur significant write-offs or restructuring charges to integrate and operate the acquired business. |
The use of debt or leverage to finance our future acquisitions may allow us to make acquisitions with an amount of cash in excess of what may be currently available to us. If we use debt to leverage up our assets, we may not be able to meet our debt obligations if our internal projections are incorrect or if there is a market downturn. This may result in a default and the loss in foreclosure proceedings of the acquired business and have a material adverse affect on our business.
Our operation of any acquired business will also involve numerous risks, including:
| · | Integration of the operations of the acquired business and its technologies or products; |
| · | Diversion of management’s attention from our core business; |
| · | Adverse effects on existing business relationships with suppliers and customers; |
| · | Risks associated with entering markets in which we have limited prior experience; and |
| · | Potential loss of key employees, particularly those of the purchased organizations. |
The success of our acquisition strategy will depend upon our ability to successfully integrate any businesses we may acquire in the future. The integration of these businesses into our operations may result in unforeseen events or operating difficulties, absorb significant management attention and require significant financial resources that would otherwise be available for the ongoing development of our business. These integration difficulties could include the integration of personnel with disparate business backgrounds, the transition to new information systems, coordination of geographically dispersed organizations, loss of key employees of acquired companies and reconciliation of different corporate cultures. For these or other reasons, we may be unable to retain key clients or to retain or renew contracts of acquired companies. Moreover, any acquired business may fail to generate the revenue or net income we expected or produce the efficiencies or cost-savings that we anticipated. Any of these outcomes could materially adversely affect our operating results.
FAILING TO MAINTAIN STRONG RELATIONSHIPS WITH PRIME CONTRACTORS COULD RESULT IN A DECLINE IN OUR REVENUE
We derived approximately 53% of our revenue during the year ended December 31, 2008 through our subcontractor relationships with prime contractors, which, in turn, hold the prime contract with end-clients. We project over the next few years the percentage of subcontractor revenue will increase significantly. If any of these prime contractors eliminate or reduce their engagements with us, or have their engagements eliminated or reduced by their end-clients, we will lose this source of revenue, which, if not replaced, could adversely affect our operating results.
OUR RELATIVELY FIXED OPERATING EXPENSES EXPOSE US TO GREATER RISK OF INCURRING LOSSES
We incur costs based on our expectations of future revenue. Our operating expenses are relatively fixed and cannot be reduced on short notice to compensate for unanticipated variations in the number or size of engagements in progress. These factors make it difficult for us to predict our operating results. If we fail to predict our revenue accurately, it may materially adversely harm our financial condition.
A REDUCTION IN OR THE TERMINATION OF OUR SERVICES COULD LEAD TO UNDERUTILIZATION OF OUR EMPLOYEES AND COULD HARM OUR OPERATING RESULTS
Our employee compensation expenses are relatively fixed. Therefore, if a client defers, modifies or cancels an engagement or chooses not to retain us for additional phases of a project, our operating results will be harmed unless we can rapidly redeploy our employees to other engagements in order to minimize underutilization. If we fail to redeploy our employees, we could be forced to incur significant costs which could adversely affect our operating results.
IF WE EXPERIENCE DIFFICULTIES COLLECTING RECEIVABLES IT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED
As of December 31, 2008, 48% of our total assets were in the form of accounts receivable, thus, we depend on the collection of our receivables to generate cash flow, provide working capital, pay debt and continue our business operations. As of December 31, 2008, we had unbilled receivable of $3,094,254 included in the total accounts receivable for which we are awaiting authorization to invoice. If the federal government, any of our other clients or any prime contractor for whom we are a subcontractor does not authorize us to invoice or fails to pay or delays the payment of their outstanding invoices for any reason, our 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.
SECURITY BREACHES IN SENSITIVE GOVERNMENT SYSTEMS COULD RESULT IN THE LOSS OF CLIENTS AND NEGATIVE PUBLICITY
Some of the systems we develop involve managing and protecting information involved in sensitive government functions. A security breach in one of these systems could result in negative publicity and could prevent us from having further access to such critically sensitive systems or other similarly sensitive areas for other government clients, which could force us to curtail our business operations. Losses that we could incur from such a security breach could exceed the policy limits under the “errors and omissions” liability insurance we currently have. Our current coverage under the “errors and omission” liability insurance is $5 million.
IF WE CANNOT OBTAIN THE NECESSARY SECURITY CLEARANCES, WE MAY NOT BE ABLE TO PERFORM CLASSIFIED WORK FOR THE GOVERNMENT AND WE COULD BE FORCED TO CURTAIL OR CEASE CLASSIFIED OPERATIONS
Government contracts require us, and some of our employees, to maintain security clearances. If we lose or are unable to obtain security clearances, the client can terminate the contract or decide not to renew it upon its expiration. As a result, if we cannot obtain the required security clearances for our employees working on a particular engagement, we may not derive the revenue anticipated from the engagement, which, if not replaced with revenue from other engagements, could force us to curtail our business operations.
WE MUST RECRUIT AND RETAIN QUALIFIED PROFESSIONALS TO SUCCEED IN OUR LABOR INTENSIVE BUSINESS
Our future success depends in large part on our ability to recruit and retain qualified professionals skilled in complex information technology services and solutions. Such personnel as Java developers and other hard-to-find information technology professionals are in great demand and are likely to remain a limited resource in the foreseeable future. Competition for qualified professionals is intense. Any inability to recruit and retain a sufficient number of these professionals could hinder the growth of our business. The future success of Paradigm will depend on our ability to attract, train, retain and motivate direct sales, customer support and highly skilled management and technical employees. We may not be able to successfully employ the appropriate level of direct sales personnel, which would limit our ability to expand our customer base. Further, we may not be able to hire highly trained consultants and support engineers which would make it difficult to meet our clients’ demands. If we cannot successfully identify and integrate new employees into our business, we will not be able to manage our growth effectively. Because a significant component of our growth strategy relates to increasing our revenue from sales of our services and software, our growth strategy will be adversely affected if we are unable to develop and maintain an effective sales force to market our services to our federal customers. Our effort to build and maintain an effective sales force may not be successful and, therefore, we could be forced to cut back on our growth strategy.
WE DEPEND ON OUR SENIOR MANAGEMENT TEAM, AND THE LOSS OF ANY MEMBER MAY ADVERSELY AFFECT OUR ABILITY TO OBTAIN AND MAINTAIN CLIENTS
We believe that our success depends on the continued employment of our senior management team of Peter LaMontagne, President and CEO and Richard Sawchak, Senior Vice President & CFO. We have key executive life insurance policies for Mr. LaMontagne and Mr. Sawchak for up to $1 million. Their employment is particularly important to our business because personal relationships are a critical element of obtaining and maintaining client engagements. If one or more members of our senior management team were unable or unwilling to continue in their present positions, such persons would be difficult to replace and our business could be seriously harmed. Furthermore, clients or other companies seeking to develop in-house capabilities may attempt to hire some of our key employees. Employee defections to clients or competitors would not only result in the loss of key employees but could also result in the loss of a client relationship or a new business opportunity.
AUDITS OF OUR GOVERNMENT CONTRACTS MAY RESULT IN A REDUCTION IN THE REVENUE WE RECEIVE FROM THOSE CONTRACTS OR MAY RESULT IN CIVIL OR CRIMINAL PENALTIES THAT COULD HARM OUR REPUTATION
Federal government agencies routinely audit government contracts. These agencies review a contractor’s performance on its contract, pricing practices, cost structure and compliance with applicable laws, regulations and standards. An audit could result in a substantial adjustment to our revenue because any costs found to be improperly allocated to a specific contract will not be reimbursed, while improper costs already reimbursed must be refunded. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with federal government agencies. If any or all of these allegations were made against us, we could be forced to curtail or cease our business operations.
WE MAY BE LIABLE FOR PENALTIES UNDER A VARIETY OF PROCUREMENT RULES AND REGULATIONS, AND CHANGES IN GOVERNMENT REGULATIONS COULD SLOW OUR GROWTH OR REDUCE OUR PROFITABILITY
We must comply with and are affected by federal government regulations relating to the formation, administration and performance of government contracts. These regulations affect how we do business with our clients and may impose added costs on our business. Any failure to comply with applicable laws and regulations could result in contract termination, price or fee reductions or suspension or debarment from contracting with the federal government, which could force us to curtail our business operations. Further, the federal government may reform its procurement practices or adopt new contracting methods relating to the GSA Schedule or other government-wide contract vehicles. If we are unable to successfully adapt to those changes, our business could be seriously harmed.
OUR FAILURE TO ADEQUATELY PROTECT OUR CONFIDENTIAL INFORMATION AND PROPRIETARY RIGHTS MAY HARM OUR COMPETITIVE POSITION
While our employees execute confidentiality agreements, we cannot guarantee that this will be adequate to deter misappropriation of our confidential information. In addition, we may not be able to detect unauthorized use of our intellectual property in order to take appropriate steps to enforce our rights. If third parties infringe or misappropriate our copyrights, trademarks or other proprietary information, our competitive position could be seriously harmed, which could force us to curtail our business operations. In addition, other parties may assert infringement claims against us or claim that we have violated their intellectual property rights. Such claims, even if not true, could result in significant legal and other costs and may be a distraction to management.
RISKS RELATED TO THE INFORMATION TECHNOLOGY SOLUTIONS AND SERVICES MARKET COMPETITION COULD RESULT IN PRICE REDUCTIONS, REDUCED PROFITABILITY AND LOSS OF MARKET SHARE
Competition in the federal marketplace for information technology solutions and services is intense. If we are unable to differentiate our offerings from those of our competitors, our revenue growth and operating margins may decline, which would harm our business operations. Many of our competitors are larger and have greater financial, technical, marketing and public relations resources, larger client bases and greater brand or name recognition than Paradigm. Our larger competitors may be able to provide clients with additional benefits, including reduced prices. We may be unable to offer prices at those reduced rates, which may cause us to lose business and market share. Alternatively, we could decide to offer the lower prices, which could harm our profitability. If we fail to compete successfully, our business could be seriously harmed and our profitability could be adversely affected.
Our current competitors include, and may in the future include, information technology services providers and large government contractors such as Pragmatics, Booz Allen & Hamilton, Computer Sciences Corporation, RSIS, SRA, ATS, Electronic Data Systems, Science Applications International Corporation, and Lockheed Martin.
Current and potential competitors have also established or may establish cooperative relationships among themselves or with third parties to increase their ability to address client needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, some of our competitors may develop services that are superior to, or have greater market acceptance than the services that we offer.
OUR COMMON STOCK MAY BE AFFECTED BY LIMITED TRADING VOLUME AND MAY FLUCTUATE SIGNIFICANTLY
Our common stock is traded on the Over-the-Counter Bulletin Board. There has been a limited public market for our common stock and there can be no assurance that an active trading market for our common stock will develop. As a result, this could adversely affect our shareholders’ ability to sell our common stock in short time periods, or possibly at all. Our common stock is thinly traded compared to larger, more widely known companies in the information technology services industry. Thinly traded common stock can be more volatile than common stock traded in an active public market. The average daily trading volume of our common stock for the year ended December 31, 2008 was 1,501 shares per day. Our common stock has experienced, and is likely to experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and changes in the overall economy or the condition of the financial markets could cause the price of our common stock to fluctuate substantially.
QUARTERLY REVENUE AND OPERATING RESULTS COULD BE VOLATILE AND MAY CAUSE OUR STOCK PRICE TO FLUCTUATE
The rate at which the federal government procures technology may be negatively affected by new presidential administrations and senior government officials. As a result, our operating results could be volatile and difficult to predict, and period-to-period comparisons of our operating results may not be a good indication of our future performance.
A significant portion of our operating expenses, such as personnel and facilities costs, are fixed in the short term. Therefore, any failure to generate revenue according to our expectations in a particular quarter could result in reduced income in the quarter. In addition, our quarterly operating results may not meet the expectations of investors, which in turn may have an adverse affect on the market price of our common stock.
OUR COMMON STOCK IS DEEMED TO BE "PENNY STOCK," WHICH MAY MAKE IT MORE DIFFICULT FOR INVESTORS TO SELL THEIR SHARES DUE TO SUITABILITY REQUIREMENTS
Our common stock is deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. Penny stocks are stock:
| · | With a price of less than $5.00 per share; |
| · | That are not traded on a “recognized” national exchange; or |
| · | In issuers with net tangible assets less than $2.0 million (if the issuer has been in continuous operation for at least three years) or $5.0 million (if in continuous operation for less than three years), or with average revenue of less than $6.0 million for the last three years. |
Broker/dealers dealing in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker/dealers are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor. These requirements may reduce the potential market for our common stock by reducing the number of potential investors. This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of them. This could cause our stock price to decline.
INVESTORS SHOULD NOT RELY ON AN INVESTMENT IN OUR STOCK FOR THE PAYMENT OF CASH DIVIDENDS
We have not paid any cash dividends on our capital stock and we do not anticipate paying cash dividends in the future. Investors should not make an investment in our common stock if they require dividend income. Any return on an investment in our common stock will be as a result of any appreciation, if any, in our stock price.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal offices are located at the following locations:
| Location | | Square Feet | | | Monthly Rent | | Expiration Date |
| 9715 Key West Avenue, Third Floor, Rockville, Maryland, 20850 (a) | | | 15,204 | | | $ | 31,924 | | May 31, 2012 |
| 2600 Tower Oaks Boulevard, Suite 500, Rockville, Maryland 20852 (a) | | | 14,318 | | | $ | 37,799 | | May 31, 2011 |
| 2424 West Vista Way, suite 204, Oceanside, CA 92054 (b, c) | | | 2,127 | | | $ | 3,948 | | November 30, 2010 |
| 1420 Spring Hill Road, suite 420, McLean, VA 22102 (b) | | | 6,139 | | | $ | 11,629 | | April 30, 2009 |
| 17001 Science Drive, suite 110-111, Bowie, MD 20715 (b) | | | 2,490 | | | $ | 3,585 | | November 30, 2008 |
| (a) | We moved our Headquarters from 2600 Tower Oaks Boulevard, Suite 500, Rockville, Maryland 20852 to 9715 Key West Avenue, Third Floor, Rockville, Maryland, 20850 in June 2006. We subleased the Tower Oaks facility in June 2006. The monthly rent is $36,980. |
| (b) | These facilities were assumed in connection with the Trinity and CTS acquisitions and are used for general business purposes. |
| (c) | As part of our acquisition and integration plan, we subleased the Oceanside facility in March 2008. |
Management believes our two principal offices located at Rockville, Maryland and McLean, Virginia are adequate for current needs.
ITEM 3. LEGAL PROCEEDINGS
The Company, from time to time, is a party to litigation and legal proceedings that it believes to be a part of the ordinary course of business. While it cannot predict the ultimate outcome of these matters, the Company currently believes that any ultimate liability arising out of these proceedings will not have a material adverse effect on its financial position.
During the year ended December 31, 2008, a former employee of the Company filed a claim with Maryland Department of Labor claiming that the Company owes him $0.1 million as a severance payment pursuant to an employment agreement with the Company. The Company filed an opposition; however, the Maryland Department of Labor and the Office of the Attorney General ruled on November 7, 2008 and February 26, 2009, respectively, that the claim is valid and should be paid. The Company has agreed to pay such employee an aggregate of approximately $92,000 in three equal installments.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
| ITEM 5. | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock has been listed on the Over-the-Counter Bulletin Board under the symbol “PDHO” since September 14, 2004, following our name change and a 1 for 85 reverse stock split.
The following table sets forth the high and low market prices for the common stock as reported on the Over-the-Counter Bulletin Board for each quarter since January 2006 for the periods indicated. Such information reflects inter dealer prices without retail mark-up, mark down or commissions and may not represent actual transactions.
The following table sets forth, for the periods indicated, the market price range of our common stock from the finance.yahoo.com.
| YEAR 2008 | | High Price | | | Low Price | |
| Quarter Ended March 31, 2008 | | $ | 1.00 | | | $ | 0.53 | |
| Quarter Ended June 30, 2008 | | $ | 0.63 | | | $ | 0.25 | |
| Quarter Ended September 30, 2008 | | $ | 0.39 | | | $ | 0.10 | |
| Quarter Ended December 31, 2008 | | $ | 0.20 | | | $ | 0.05 | |
| | | | | | | | | |
| YEAR 2007 | | High Price | | | Low Price | |
| Quarter Ended March 31, 2007 | | $ | 0.92 | | | $ | 0.75 | |
| Quarter Ended June 30, 2007 | | $ | 0.94 | | | $ | 0.60 | |
| Quarter Ended September 30, 2007 | | $ | 1.00 | | | $ | 0.80 | |
| Quarter Ended December 31, 2007 | | $ | 1.01 | | | $ | 0.70 | |
On March 26, 2009, the closing price of our common stock as reported on the Over-the-Counter Bulletin Board was $0.07 per share. As of March 26, 2009, we had approximately 2,700 holders of common stock and 43,868,027 shares of our common stock were issued and outstanding. Many of our shares are held in brokers’ accounts, so we are unable to give an accurate statement of the number of shareholders.
DIVIDENDS
We have not paid any dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We intend to retain any earnings to finance the growth of our business. In addition, our credit facility with Silicon Valley Bank (“SVB”) and the documents governing our Series A-1 Preferred Stock restrict our ability to pay dividends on our common stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” We cannot assure investors that we will ever pay cash dividends on our common stock. Whether we pay any cash dividends in the future will depend on the financial condition, results of operations and other factors that the Board of Directors will consider. During the years ended December 31, 2008 and 2007, $180,000 and $75,000, respectively, were paid to the holders of the Company’s Series A Preferred Stock as dividends. All of the aforementioned Series A Preferred Stock was exchanged for shares of common stock or repurchased for cash in connection with the completion of the private placement of our Series A-1 Preferred Stock on February 27, 2009. The Series A-1 Preferred Stock bears an annual dividend of 12.5%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
Equity Compensation Plan Information
The following table gives information about equity awards as of December 31, 2008:
| Plan category | | Number of securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted-average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |
| | | (a) | | | (b) | | | (c) | |
| Equity compensation plans approved by security holders (1) | | | 3,432,000 | | | $ | 0.46 | | | | 326,799 | |
| | | | | | | | | | | | | |
| Equity compensation plans not approved by security holders (2) | | | 1,154,333 | | | $ | 0.36 | | | | — | |
| | | | | | | | | | | | | |
| Total | | | 4,586,333 | | | $ | 0.43 | | | | 326,799 | |
| | (1) | Represents (i) a total of 2,925,000 shares of restricted common stock issued to key employees and directors and (ii) options granted to employees to acquire 507,000 shares of the Company’s common stock. |
| | (2) | Represents (i) 1,071,000 shares issuable upon exercise of options granted to employees and directors before adoption and approval of the 2006 Stock Incentive Plan on August 3, 2006 and (ii) a warrant issued to acquire 83,333 shares of the Company’s common stock to the placement agent in connection with the sale of the Company’s Series A Preferred Stock on July 25, 2007. The options include (i) an option, granted to Peter LaMontagne, the Company’s President and Chief Executive Officer on May 15, 2006, to purchase 500,000 shares of common stock, that expires on May 15, 2016, is subject to three year vesting and has an exercise price of $0.30 per share (following the repricing of such option as discussed elsewhere in this Annual Report on Form 10-K) and (ii) options granted on December 15, 2005 to 13 employees and directors to purchase an aggregate of 571,000 shares of common stock, which expire on December 15, 2015, are fully vested and have an exercise price of $0.30 per share (following the repricing of such option as discussed elsewhere in this Annual Report on Form 10-K). The warrant has an exercise price of $1.20 per share and expires on July 25, 2012. |
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
| ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The reader should read the following discussion in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements, the accuracy of which involves risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described in Part I, Item 1A “RISK FACTORS”.
GENERAL
Paradigm provides information technology (“IT”) and business continuity solutions primarily to government customers. Headquartered in Rockville, Maryland, Paradigm was founded based upon strong commitment to high standards of performance, integrity, customer satisfaction, and employee development.
With an established core foundation of experienced executives, we have grown from six employees in 1996 to the current level of 189 personnel (full time, part time, and consultants). Our annual revenue was approximately $39.1 million in 2008.
As of December 31, 2008, Paradigm was comprised of three subsidiary companies: 1) Paradigm Solutions Corporation, which was incorporated in 1996 to deliver IT services to federal agencies, 2) Trinity IMS, Inc. (“Trinity”), which was acquired on April 9, 2007 to deliver IT solutions into the national security marketplace, and 3) 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 year ended December 31, 2008, our business was comprised of approximately 60% fixed price and 40% time and material contracts.
At the end of December 31, 2008, 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 three largest clients, both agencies within the federal government, generated approximately 66% 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 our cash and cash equivalents and interest payable on our revolving credit facility.
DESCRIPTION OF CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these 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 consolidated financial statements and the reported amounts of revenue 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. Management believes that our critical accounting policies which require more significant judgments and estimates in the preparation of our consolidated financial statements are revenue recognition, costs of revenue, goodwill and intangible assets, impairment of long-live assets, and share-based compensation.
REVENUE RECOGNITION
Substantially all of the Company's revenue is derived from services and solutions provided to the federal government by the Company’s 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 Securities Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” For those contracts that are within the scope of the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 81-1, “Accounting for Performance of Construction-Type and Certain 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 and 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 Emerging Issues Task Force (“EITF”) No.00-21, “Revenue Arrangements with Multiple Deliverables”, and allocates revenue to each element based on relative fair value.
Software revenue recognition for sales of OpsPlanner is in accordance with AICPA SOP 97-2, “Software Revenue Recognition.” Since the Company has not yet established vendor specific objective evidence of fair value for the multiple arrangements typically contained within an OpsPlanner sale, revenue from the sale of OpsPlanner is recognized ratably over the term of the contract. The OpsPlanner software was sold as part of the sale of the commercial business on February 28, 2007. Effective March 1, 2007, the Company is the exclusive reseller of the OpsPlanner software to the federal government.
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 EITF No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent”, 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 determined 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.
Revenue recognized on contracts for which billings have not yet been presented to customers is included in unbilled receivables.
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
Our costs are categorized as cost of revenue or selling, general & administrative expenses. Cost of revenue are those that can be identified with and allocated to specific contracts and tasks. They include labor, subcontractor costs, consultant fees, travel expenses, materials and an allocation of indirect costs. Indirect costs consist primarily of fringe benefits (vacation time, medical/dental, 401K plan matching contribution, tuition assistance, employee welfare, worker’s compensation and other benefits), intermediate management and certain other non-direct costs which are necessary to provide direct labor. Indirect costs, to the extent that they are allowable, are allocated to contracts and tasks using appropriate government-approved methodologies. Costs determined to be unallowable under the Federal Acquisition Regulations cannot be allocated to projects. Our principal unallowable costs are interest expense and certain general and administrative expenses. Cost of revenue is considered to be a critical accounting policy because it inherently involves estimation on our FP contracts. Examples of such estimates include the level of effort needed to accomplish the tasks under the contract, the cost of those efforts, and a continual assessment of our progress toward the completion of the contract. From time to time, circumstances may arise which require us to revise our estimated total costs.
ASSUMPTIONS RELATED TO PURCHASE ACCOUNTING AND GOODWILL AND INTANGIBLE ASSETS
We account for our acquisitions using the purchase method of accounting. This method requires estimates to determine the fair value of assets and liabilities acquired, including judgments to determine any acquired intangible assets such as contract-related intangibles, as well as assessments of the fair value of existing assets such as property and equipment. Liabilities acquired can include balances for litigation and other contingency reserves established prior to or at the time of acquisition, and require judgment in ascertaining a reasonable value. Third party valuation firms may be used to assist in the appraisal of certain assets and liabilities, but even those determinations would be based on significant estimates provided by us, such as forecasted revenues or profits on contract-related intangibles. Numerous factors are typically considered in the purchase accounting assessments, which are conducted by Company professionals from legal, finance, human resources, information systems, program management and other disciplines. Changes in assumptions or estimates of the acquired assets and liabilities would result in changes to the fair value, resulting in an offsetting change to the goodwill balance associated with the business acquired.
We conduct a review for impairment of goodwill and intangible assets recorded in the continuing operations at least annually, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. 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 a 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.
For the annual goodwill impairment assessment, the Company used both the income approach (i.e., discounted cash flow method) and the market approach (i.e., the guideline public company method and the merger and acquisition method) to value its reporting unit. The discounted cash flow method consists of discounting long-term projected future cash flows, which are derived from internal forecasts and economic expectations for the respective reporting unit. The projected future cash flows are discounted using the weighted average cost of capital, which is calculated by weighting the required returns on interest-bearing debt and equity in proportion to their estimated percentages. The guideline public company method applies a market multiple, based on seven similar public companies, to the projected EBITDA (earnings before interest, income taxes, depreciation and amortization) of the Company for the fiscal years ending December 31, 2009 and 2010. The guideline merged and acquired company method applies a market multiple, based on nineteen (19) recently observed transactions within the Company’s peer group, to the Company’s projected 2009 and 2010 EBITDA results. The Company weighted the three valuation methods equally to determine the fair value of its reporting unit, which is approximately $1.7 million above the carrying value. The Company does not believe that by weighting the three methods differently, the conclusion would have yielded a different result as the values from all three methods were similar.
As an overall test of the reasonableness of the estimated fair value of the reporting unit, the Company reconciled the fair value estimates to its market capitalization as of December 31, 2008. The reconciliation confirmed that the fair value was reasonably representative of market views when applying a reasonable control premium of 10% to the average market capitalization during December 2008.
Even though the analysis as of December 31, 2008 indicated that no impairment exists, future impairment reviews may result in the recognition of such impairment if the Company experiences a further significant decline in the stock price (i.e., stock price below $0.03 as of March 26, 2009), a significant decline in expected future cash flows, or a significant adverse change in growth rates.
IMPAIRMENT OF LONG-LIVED ASSETS
Pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company periodically evaluates the recoverability of its long-lived assets. This evaluation consists of a comparison of the carrying value of the assets with the assets’ expected future cash flows, undiscounted and without interest costs. Estimates of expected future cash flows represent management’s best estimate based on reasonable and supportable assumptions and projections. If the expected future cash flow, undiscounted and without interest charges, exceeds the carrying value of the asset, no impairment is recognized. Impairment losses are measured as the difference between the carrying value of long-lived assets and their fair market value, based on discounted future cash flows of the related assets.
SHARE-BASED COMPENSATION
The Company has used stock options and restricted common stock to attract, retain, and reward employees for long-term service. The following assumptions were used for option grants during the years ended December 31, 2008 and 2007:
Dividend Yield - The Company has never declared or paid dividends on its common stock and has no plans to do so in the foreseeable future.
Risk-Free Interest Rate - Risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term approximating the expected life of the option term assumed at the date of grant.
Expected Volatility - Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The expected volatility is based on historical volatility of the Company's common stock for the periods that it has been publicly traded.
Expected Term of the Options - This is the period of time that the options granted are expected to remain unexercised. The Company estimates the expected life of the option term based on an estimated average life of the options granted. Due to the lack of historical information, the Company estimated the expected life of six years for options granted during 2007, using the safe harbor criteria of SEC SAB No. 107, “Share-Based Payments.” Effective January 1, 2008, the Company estimated the expected life based on the reported data for a peer group of publicly traded companies for which historical information was available.
Forfeiture Rate - The Company estimates the percentage of options granted that are expected to be forfeited or canceled on an annual basis before stock options become fully vested. The Company uses the forfeiture rate that is a blend of past turnover data and a projection of expected results over the following twelve month period based on projected levels of operations and headcount levels at various classification levels with the Company.
As of December 31, 2008, there was $1.2 million of total unrecognized compensation costs related to nonvested stock option arrangements granted during fiscal years 2006, 2007 and 2008 and nonvested restricted common stock issued during fiscal years 2007 and 2008. The cost is to be recognized over a weighted average period of 1.1 years for the stock options and 3.3 years for the restricted common stock.
Upon adoption of SFAS No. 123 (revised), the Company continues to use the Black-Scholes option pricing models for share-based awards, as was utilized previously and required under SFAS No. 123.
Refer to Notes 1 and 15 of the Notes to Consolidated Financial Statements for a further discussion of the Company’s share-based awards.
ESTIMATES USED TO DETERMINE INCOME TAX EXPENSE
We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which principally arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must analyze income tax reserves, as well as determine the likelihood of recoverability of deferred tax assets, and adjust any valuation allowances accordingly. Considerations with respect to the recoverability of deferred tax assets include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors. Uncertain tax benefits are evaluated and recorded based on the guidance provided in the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109”, upon adoption on January 1, 2007.
SEGMENT REPORTING
SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information”, 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. SFAS No. 131 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
New accounting pronouncements that have a current or future potential impact on our consolidated financial statements are as follows:
Recent Accounting Pronouncements – Adopted
On January 1, 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.” The statement modifies and expands the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation and requires quantitative disclosures about fair value amounts and gains and losses on derivative instruments. It also requires disclosures about credit-related contingent features in derivative agreements. The adoption of SFAS No. 161 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” The statement establishes the accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The adoption of SFAS No. 160 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), “Business Combinations.” The statement establishes principles and requirements for how the acquirer recognizes and measures the identifiable assets acquired, the goodwill acquired, the liabilities assumed and any noncontrolling interest in the acquiree and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption of SFAS No. 141 (revised 2007) did not have a material impact on the Company’s statements of operations, financial position or cash flows. The Company will apply SFAS No. 141 (revised 2007) on its future acquisitions, if any.
In November 2008, the Company adopted SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the source of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with GAAP. The adoption of SFAS No. 162 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement provides an option, on specified election dates, to report selected financial assets and liabilities, including insurance contracts, at fair value. Subsequent changes in fair value for designated items are reported in income in the current period. The adoption of SFAS No. 159 did not impact the Company’s consolidated financial statements, as no items were elected for measurement at fair value upon initial adoption. The Company will continue to evaluate eligible financial assets and liabilities on their election dates. Any future elections will be disclosed in accordance with the provisions outlined in the statement.
On January 1, 2008, the Company adopted certain provisions of SFAS No. 157, which establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and expands on required disclosures about fair value measurement. The provisions of SFAS No. 157 adopted on January 1, 2008 relate only to financial assets and liabilities as well as other assets and liabilities carried at fair value on a recurring basis and did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2009, the Company adopted FASB Staff Positions (“FSP”) No. 157-2 (“FSP No. 157-2”), “Effective Date of FASB Statement No. 157.” FSP No. 157-2 applies to nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually) and defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for items within the scope of this FSP. The Company has not yet evaluated the impact, if any, of SFAS 157 on its non-financial assets and liabilities upon initial adoption.
On January 1, 2009, the Company adopted FSP No. 142-3 (“FSP No. 142-3”), “Determination of the useful life of intangible assets.” FSP No. 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP No. 142-3 also requires additional disclosures on information that can be used to assess the extent to which future cash flows associated with intangible assets are affected by an entity’s intent or ability to renew or extend such arrangements and on associated accounting policies. The adoption of FSP No. 142-3 may impact the Company in the future if the Company acquires intellectual property or other assets.
In October 2008, the FASB issued FSP No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active.” FSP No. 157-3 is consistent with the joint press release the FASB issued with the SEC on September 30, 2008, which provides general clarification guidance on determining fair value under SFAS No. 157 when markets are inactive. FSP No. 157-3 specifically addresses the use of judgment in determining whether a transaction in a dislocated market represents fair value, the inclusion of market participant risk adjustments when an entity significantly adjusts observable market data based on unobservable inputs, and the degree of reliance to be placed on broker quotes or pricing services. FSP No. 157-3 became effective October 10, 2008 and should be applied prospectively. The adoption of FSP No. 157-3 did not have a significant impact on the Company’s current fair value measurements.
On January 1, 2009, the Company adopted FSP APB 14-1 (“FSP APB 14-1), “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 requires issuers of convertible debt to account separately for the liability and equity components of these instruments if they have stated terms permitting cash settlement upon conversion. This practice marks a significant change from the current accounting practice for convertible debt instruments in the scope of the FSP. Current practice does not require separation of the liability and equity components of such instruments. Separately accounting for these instruments’ liability and equity components results in the recording of more interest cost over the life of the convertible debt instrument, because of an initial debt discount. The adoption of FSP APB 14-1 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2009, the Company adopted FSP EITF 03-6-1(“FSP EITF 03-6-1”), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities. An entity must include participating securities in its calculation of basic and diluted earnings per share (“EPS”) pursuant to the two-class method, as described in FASB Statement 128, “Earnings per Share.” The Company does not issue share-based payment awards that contain nonforfeitable rights to dividends and, as a result, the adoption of FSP EITF 03-6-1 did not have a significant effect on its consolidated financial statements.
On January 1, 2009, the Company adopted FSP EITF 99-20-1(“FSP EITF 99-20-1”), “Amendment to the Impairment Guidance of EITF Issue 99-20.” FSP EITF 99-20-1 amends the impairment guidance in EITF Issue 99-20 to achieves more consistent determination of whether an other-than temporary-impairment has occurred. The Company does not have any beneficial interest in securitized financial assets and, as a result, the adoption of FSP EITF 99-20-1 did not have a significant effect on its consolidated financial statements.
RESULTS OF OPERATIONS
The following table sets forth the relative percentages that certain items of expense and earnings bear to revenue.
Consolidated Statements of Operations Years Ended December 31, 2008 and 2007
| | | Years Ended December 31, | |
| (in thousands, except the percentages) | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | |
| Statements of operations data: | | | | | | | | | | | | |
| Contract revenue | | $ | 39,141 | | | $ | 46,678 | | | | 100.0 | % | | | 100.0 | % |
| Cost of revenue | | | 31,095 | | | | 39,525 | | | | 79.4 | | | | 84.7 | |
| Gross margin | | | 8,046 | | | | 7,153 | | | | 20.6 | | | | 15.3 | |
| Selling, General & Administrative | | | 8,126 | | | | 6,941 | | | | 20.8 | | | | 14.9 | |
| (Loss) Income from operations | | | (80 | ) | | | 212 | | | | (0.2 | ) | | | 0.4 | |
| Total other expense | | | (1,039 | ) | | | (1,182 | ) | | | (2.7 | ) | | | (2.5 | ) |
| Benefit for income taxes | | | (342 | ) | | | (245 | ) | | | (0.9 | ) | | | (0.5 | ) |
| Loss from continuing operations | | | (777 | ) | | | (725 | ) | | | (2.0 | ) | | | (1.6 | ) |
| Net loss | | $ | (777 | ) | | $ | (834 | ) | | | (2.0 | %) | | | (1.8 | %) |
The table below sets forth the service mix in revenue with related percentages of total revenue.
| | | Years Ended December 31, | |
| (in thousands, except the percentages) | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | |
| Federal service contracts | | $ | 27,686 | | | | 26,675 | | | | 70.7 | % | | | 57.2 | % |
| Federal repair & maintenance contracts | | | 11,455 | | | | 19,899 | | | | 29.3 | % | | | 42.6 | % |
| Commercial | | | — | | | | 104 | | | | — | % | | | 0.2 | % |
| Total revenue | | $ | 39,141 | | | $ | 46,678 | | | | 100.0 | % | | | 100.0 | % |
YEAR ENDED DECEMBER 31, 2008 COMPARED WITH YEAR ENDED DECEMBER 31, 2007
Revenue. For the year ended December 31, 2008, revenue decreased 16.1% to $39.1 million from $46.7 million for the same period in 2007. The decrease in revenue is attributable to a decrease in our federal repair and maintenance business of $8.4 million. The decrease in repair and maintenance business was partially off-set by an increase of $0.9 million in our federal service business. The decrease in repair and maintenance business is attributable to lower revenue on one federal contract as the Company transitioned from the prime contractor role to the subcontractor role in the fourth quarter of 2007. The increase in service business for the year ended December 31, 2008 compared to the same period in 2007 is attributable to a $5.4 million increase in revenue from contracts associated with the Trinity and CTS acquisitions in 2007 along with $2.4 million higher revenue on PSC service contracts which more than off-set the $6.9 million revenue lost from the completion of three of our federal contracts. We expect our current lower revenue run-rate to be reflective of near-term anticipated results.
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 year ended December 31, 2008, cost of revenue decreased by 21.3% to $31.1 million from $39.5 million for the same period in 2007. The decrease in cost of revenue was primarily attributable to the corresponding decrease in revenue. Cost of revenue for our service business decreased $1.9 million which was primarily attributable to higher gross margin on the time and material contracts associated with the Trinity and CTS acquisitions. Cost of revenue for our repair and maintenance business decreased $6.5 million which was primarily attributable to the corresponding decrease in repair and maintenance revenue. As a percentage of revenue, cost of revenue was 79.4% for the year ended December 31, 2008 as compared to 84.7% for the year ended December 31, 2007. The decrease in cost as a percentage of revenue was primarily due to better contract management and better profitability on our existing contract mix.
Gross Margin. For the year ended December 31, 2008, gross margin increased 12.5% to $8.0 million from $7.2 million for the same period in 2007. Gross margin as a percentage of revenue increased to 20.6% for the year ended December 31, 2008 from 15.3% for the year ended December 31, 2007. Gross margin as a percentage of revenue increased due to increased service business margin. Gross margin as it relates to our service business increased 74.7% to $6.5 million from $3.7 million for the same period in 2007. The increase in services gross margin is due to higher gross margin on the time and material contracts associated with the Trinity and CTS acquisitions. Gross margin, as it relates to our repair and maintenance business, decreased 55.9% to $1.5 million from $3.4 million for the same period in 2007. The decrease in maintenance gross margin is directly attributable to the decrease in revenue.
Selling, General & Administrative. For the year ended December 31, 2008, selling, general & administrative (SG&A) expenses increased 17.1% to $8.1 million from $6.9 million for the same period in 2007. As a percentage of revenue, SG&A expenses increased to 20.8% for the year ended December 31, 2008 from 14.9% for the same period in 2007. The increase in SG&A expense is attributable to amortization of intangible assets recorded from the Trinity and CTS acquisitions, increased share-based compensation from stock options granted since the second quarter of 2007 and increased corporate expenses resulting from the acquisitions, additional legal and professional services incurred in fiscal year 2008 for outside federal marketing consultants retained to work on proposals on potential business opportunities and other corporate matters. Management will continue monitoring SG&A expenses in 2009 to balance the impact resulting from decreased revenues.
Other Expense. For the year ended December 31, 2008, other expense decreased to $1.0 million from $1.2 million for the same period in 2007. The decrease in other expense was primarily attributable to lower interest expenses. The interest rates charged by SVB, our line of credit facility provider, ranged from 6.50% to 8.5% for the year ended December 31, 2008. The interest rates charged by SVB ranged from 9.75% to 13.25% for the year ended December 31, 2007. As a percentage of revenue, other expense increased to 2.7% for the year ended December 31, 2008 from 2.5% for the same period in 2007. The increase in percentage is directly attributable to the decrease in revenue. We expect to have a lower interest expense on our line of credit facility in 2009 as a result of the trend in the interest rate market and the level of debt outstanding. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for further discussion.
Income Taxes. For the year ended December 31, 2008, income tax benefit increased to $342 thousand from $245 thousand for the same period in 2007. The increase in income tax benefit was primarily attributable to higher pre-tax loss for the year ended December 31, 2008. The Company’s tax provision for the tax years ended December 31, 2008 and 2007, represents an estimated annual effective tax rate, excluding discrete items, of 33.1% and 34.0%, respectively. Management believes the entire $342 thousand of income tax benefit will be realizable as we have sufficient taxable income from prior years to utilize the tax benefit for the year ended December 31, 2008.
Net Loss. For the year ended December 31, 2008, net loss decreased to $777 thousand from $834 thousand for the same period in 2007 which included an after-tax loss of $186 thousand from discontinued operations and an after-tax gain of $78 thousand on the sale of the discontinued operations.
For the year ended December 31, 2008, net loss from continuing operations increased to $0.8 million from $0.7 million for the same period in 2007. The increased net loss from continuing operations was due to increase in SG&A expenses discussed above, which was partially off-set by increases in gross margin and decreases in interest.
LIQUIDITY AND CAPITAL RESOURCES
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 revolving credit facility and the cash realized from the preferred stock issuance in February 2009. We have historically financed our operations through our existing cash, cash generated from operations and cash available from borrowings under our revolving credit facility. Based upon the current level of operations, we believe that cash flow from operations, together with borrowings available from our credit facility with SVB and the combination of in-process cost reductions along with the completion of a private placement discussed below will be adequate to meet future liquidity needs for the next twelve months.
For the year ended December 31, 2008, we generated $44 thousand in cash and cash equivalents compared to $0.4 million of cash and cash equivalents used for the same period in 2007.
Cash flow from operating activities provided by continuing operations was $1.4 million for the year ended December 31, 2008 compared to $2.7 million for the same period in 2007. Cash flow from operating activities from continuing operations decreased due to decrease in accounts receivable and accounts payable and accrued expenses. As of December 31, 2008, we had cash on hand of $52 thousand.
Net loss was $777 thousand for the year ended December 31, 2008 compared to $834 thousand for the same period in 2007. The net loss was primarily due to pre-tax loss.
Accounts receivable decreased by $2.1 million for the year ended December 31, 2008 compared to $8.1 million for the same period in 2007. The decrease in accounts receivable for 2008 is attributable to lower revenue and more focused billings and collection efforts.
Accounts payable decreased by $0.5 million for the year ended December 31, 2008 compared to $2.1 million for the same period in 2007. The decrease in accounts payable for 2008 is primarily reflective of decreased cost of revenue.
Net cash used in investing activities from continuing operations was $0.1 million for the year ended December 31, 2008 compared to $0.8 million for the same period in 2007. Cash used in investing activities from continuing operations in 2008 was primarily due to the cash payment on the earn-out compensation earned by the members of CTS as of December 31, 2007 and the purchases of property and equipment.
Net cash used in financing activities from continuing operations was $1.2 million for the year ended December 31, 2008 compared to $2.3 million for the same period in 2007. Net cash used in financing activities from continuing operations in 2008 consisted primarily of payments on the Company’s line of credit and dividends paid on preferred stock issued in the third quarter of 2007.
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. Among the use of proceeds, $2.1 million was used to pay off the promissory note issued in connection with the Company’s acquisition of Trinity, the Company paid fees and transaction costs of approximately $0.7 million and the remaining $3.4 million will be used to pay down debt and for general working capital purposes.
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 required to make cash dividend payments of approximately $26,000 a month.
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 (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. If at anytime a Purchaser realizes cash proceeds with respect to the Securities or common stock received upon exercise of the Class A Warrants and Class B Warrants (together, 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 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 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 that 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.
Loan and Security Agreement
On March 13, 2007, the Company entered into a two year Loan and Security Agreement with SVB that provides for a revolving line of credit facility of up to $10 million and a line of credit agreement of up to $12 million under which agreements total funds are available up to a limit of $12.5 million based on the Company’s collateral. The Loan and Security Agreement became effective March 13, 2007. The Loan and Security Agreement is being used to borrow funds for working capital and general corporate purposes. 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. Under the Loan and Security Agreement, the Company may use up to $500,000 for letters of credit. The Loan and Security Agreement, requires the Company to maintain certain EBITDA covenants as specified in the Loan and Security Agreement. Because the Company was not in compliance with the EBITDA covenant at June 30, 2008, the Company and SVB amended the Loan and Security Agreement to waive the covenant compliance for the periods ended June 30 and July 31, 2008 and provide for modified EBITDA covenant amounts for the remainder of 2008. The EBITDA covenant amounts for 2009 remain unchanged from the original agreement. The Company was in compliance with the EBITDA covenant requirements as of December 31, 2008. As of December 31, 2008, the Company had outstanding revolving line of credit with SVB of $5.9 million and $0 additional availability on its revolving line of credit with SVB.
Even though the Company was in compliance with the EBITDA covenant requirement as of December 31, 2008, it is reasonably possible that the Company may not be in compliance in future periods if the Company can not maintain the same growth rates.
On March 18, 2009, the Company and SVB entered into a Second Loan Modification Agreement. This Second Loan and Modification Agreement amended the Loan and Security Agreement dated March 13, 2007 to extend the maturity date to May 12, 2009 and modify the funds available under the revolving 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 are consistent with the previous agreement for the remainder of the extension period. SVB and the Company are working on renewing the Loan and Security Agreement for an additional one-year period. Based on the term sheet provided to the Company by SVB, the Company believes that the interest rates and access to funding under the agreement will be similar to the extension agreement. The EBITDA covenant and other significant terms contained within the agreement are currently being negotiated by the Company and 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.
The Company has relied on significant external financing to fund its operations. If the Company does not maintain profitable operations, it is unlikely that it will be able to secure additional financing from external sources. As of December 31, 2008, the Company had stockholders' equity of $1.1 million due to the completion of the private placement of convertible preferred stock in the third quarter of 2007. As of December 31, 2008, the Company had $52 thousand in cash and its total current assets were $8.7 million. As of December 31, 2008, current liabilities exceeded current assets by $4.5 million. The Company financed the acquisition of Trinity IMS, Inc. on April 9, 2007 through the use of its existing credit facility with SVB and a note payable to the shareholders of Trinity IMS, Inc.
As of December 31, 2008, 48% of the total assets were in the form of accounts receivable, thus, 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 December 31, 2008, the Company had unbilled receivables of $3.1 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 will be successful.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements are provided in Part IV, Item 15 of this filing.
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. CONTROLS AND PROCEDURES
Not applicable.
ITEM 9A(T). 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 year ended December 31, 2008. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2008, 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.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.
Because of the inherent limitations of internal control over financial reporting, including the possibility of human error and the circumvention or overriding of controls, material misstatements may not be prevented or detected on a timely basis. Accordingly, even internal controls determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Furthermore, projections of any evaluation of the effectiveness to future periods are subject to the risk that such controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of Paradigm’s internal control over financial reporting as of December 31, 2008 based upon the criteria set forth in a report entitled “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, management has concluded that, as of December 31, 2008, Paradigm’s internal control over financial reporting was effective.
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this Annual Report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth information as of December 31, 2008 with respect to the directors and executive officers of the Company.
| Name | | Age | | Position with the Company |
| Raymond A. Huger(1) | | 62 | | Chairman of the Board of Directors |
| Peter B. LaMontagne(2) | | 42 | | President, Chief Executive Officer (“CEO”) and Director |
| Richard Sawchak | | 34 | | Senior Vice President and Chief Financial Officer |
| Anthony Verna | | 42 | | Senior Vice President, Strategy and Business Development |
| Robert Boakai | | 40 | | Vice President, Enterprise Solution |
| Francis X. Ryan | | 57 | | Director |
| John A. Moore | | 55 | | Director |
| Edwin Mac Avery | | 61 | | Director |
| (1) | Mr. Huger stepped down as CEO of the Company effective December 31, 2006. . |
| (2) | Mr. LaMontagne was appointed by the Board of Directors to succeed Mr. Huger to serve as CEO of the Company effective January 1, 2007. |
Raymond A. Huger, Chairman of the Board - Mr. Huger has served as Chairman of the Board of the Company since 2004 and was Chief Executive Officer of the Company from 2004 to May 2006. Since 2007, Mr. Huger has served as the Chairman and Chief Executive Officer of Paradigm Solutions International, which provides IT and software solutions to the commercial market. Mr. Huger has more than 30 years of experience in business management, information technology, and sales/marketing and technical support services. He established PSC in 1991 following a successful 25-year career with IBM, beginning as a Field Engineer and holding a variety of challenging technical support, sales/marketing and executive management positions. Prior to his early retirement from IBM, he was a Regional Manager, responsible for the operations of several IBM Branch offices that generated over $500 million dollars in annual revenue. Mr. Huger has a Bachelor’s Degree (BA) from Bernard Baruch College and a Master’s Degree (MBA) from Fordham University.
Mr. Huger's Prior Five Year History: | | 2007 – Present, Chairman, CEO of Paradigm Solutions International Inc. |
| | | 2004 - 2006, Chairman & CEO, Paradigm Holdings, Inc. |
Peter B. LaMontagne, President, CEO and Director - Mr. LaMontagne has served as President, Chief Executive Officer and as a director of the Company since May 2006. From April 1999 to May 2006, Mr. LaMontagne served as Senior Vice President of ManTech International Corporation, an information technology provider to the federal government with annual revenue of approximately $1 billion. While at ManTech, he played a lead role in strategic planning, acquisitions and execution of the company’s growth strategy, including supporting the IPO and follow-on offering in 2002. Most recently, he served as Senior Vice President of ManTech Information Systems and Technology where he had profit & loss responsibility for a government wide practice area focused on information assurance and information technology systems life cycle management. Prior to joining ManTech, Mr. LaMontagne served as a U.S. Foreign Service Officer, specializing in East Asian political and economic affairs. He graduated magna cum laude from Bowdoin College in Brunswick, Maine where he majored in Government/Legal Studies and Classics.
Mr. LaMontagne's Prior Five Year History: | | 2006 - Present, President, CEO & Director, Paradigm Holdings, Inc. |
| | | 1999 - 2006, Senior Vice President, ManTech International Corporation |
Richard P. Sawchak, Senior Vice President and Chief Financial Officer - Mr. Sawchak has served as Senior Vice President and Chief Financial Officer of the Company since September 2005. From September 2003 to September 2005, he served as Director of Global Financial Planning & Analysis at GXS, Inc., a managed services company. At GXS, he was responsible for managing a global finance organization focused on improving business performance. From August 2000 to August 2003, he was the Director of Finance and Investor Relations at Multilink Technology Corporation, a manufacturer of advanced-mixed-signal integrated circuits and VLSI products. Mr. Sawchak has also held senior management positions at Lucent Technologies, Inc. and graduated in the top of his class from Lucent’s financial leadership program. He holds a Master’s Degree from Babson College and a Bachelor’s Degree in Finance from Boston College, where he graduated summa cum laude.
| Mr. Sawchak's Prior Five Year History: | | 2005 - Present, Senior Vice President & Chief Financial Officer, Paradigm Holdings, Inc. |
| | | 2003 - 2005, Director of Global Financial Planning & Analysis, GXS, Inc. |
Anthony Verna, Senior Vice President of Strategy and Business Development – Mr. Verna has served as a Senior Vice President of the Company since 2006. Mr. Verna served as a Senior Vice President at US. ProTech Corporation from April 2005 to November 2006 and as a Vice President at ManTech International Corporation from December 2000 to April 2005. Mr. Verna has over 16 years of federal government IT industry experience in both solutions sales and operations. A U.S. Navy veteran, Mr. Verna has extensive experience with information technology programs and enterprise systems, including comprehensive security solutions.
| Mr. Verna's Prior Five Year History: | | 2006 – Present, Senior Vice President, Paradigm Holdings, Inc. |
| | | 2005 – 2006, Senior Vice President, US. ProTech Corporation |
| | | 2000 – 2005, Vice President, ManTech International Corporation |
Robert Boakai, Vice President of Enterprise Solutions – Mr. Boakai has served as Vice President of Enterprise Solutions of the Company since 2007. From August 2006 to March 2007, Mr. Boakai served as a Director of Information Technology at Datatrac Information Services Inc., a logistics solutions company, where he developed and implemented the strategic direction of Datatrac’s corporate IT department. From March 2004 to July 2006, Mr. Boakai served as a Senior Systems Engineer at Apptis, a federal systems integrator, where he implemented and managed complex infrastructure solutions in support of ongoing technical initiatives. From December 1999 to March 2004, Mr. Boakai served as a Vice President at JenXSystems Inc. While at JenXsystems, he played a key role in implementing and managing infrastructure and multimedia solutions in federal space. Mr. Boakai holds a Bachelor's in Computer Science from the University of Maryland and a Master's in Systems Engineering from Johns Hopkins University.
| Mr. Boakai’s Prior Five Year History: | | 2007 – Present, Vice President, Paradigm Holdings, Inc. |
| | | 2006 – 2007, Director, Computer Sciences Corporation |
| | | 2004 – 2006, Senior Systems Engineer, Apptis Inc. |
Francis X. Ryan, Board Member - Mr. Ryan has served as a member of the Company's Board of Directors since November 2004. Mr. Ryan has over twenty years experience in managing private and public companies at the executive level. Since 1991, Mr. Ryan has served as President of F. X. Ryan & Assoc. Management Consulting firm specializing in turnarounds, workouts, crisis management, strategic planning, and working capital management. He has extensive experience in business process redesign. Prior to joining the Company’s board, Mr. Ryan was the Central Command Special Operations Officer for Operation Enduring Freedom, has served in Iraq and is currently retired from the U.S. Marine Corps at the rank of Colonel. Mr. Ryan is a highly regarded speaker in the fields of Corporate Governance and Sarbanes-Oxley regulations. Mr. Ryan has held positions as Chief Operating Officer and Executive Vice President, and Chief Financial Officer for manufacturers and high technology companies. Mr. Ryan currently serves or has served as a board member for the following organizations: Horne International, Inc. (also Chairman, Audit Committee) until 2008; St. Agnes Hospital (also Chairman, Audit Committee), Baltimore, MD; Good Shepherd Center, Baltimore, MD, Fawn Industries, and Carrollton Bank Corp. Mr. Ryan received his MBA. Finance, from the University of Maryland, and holds a B.S. in Economics from Mt. St. Mary’s College, where he graduated summa cum laude. Mr. Ryan also holds a CPA from the State of Pennsylvania.
| Mr. Ryan's Prior Five Year History: | | 1991 - Present, President, F.X. Ryan & Associates |
John A. Moore, Board Member - Mr. Moore has served as a director of the Company since April 2005. Mr. Moore has more than 30 years experience in private and public company management for information technology firms. He is the former Executive Vice President and CFO of ManTech International and was directly involved in taking ManTech public in 2002 as well as facilitating a secondary offering. Mr. Moore has extensive experience in strategic planning, corporate compliance, proposal preparation and pricing and SEC reporting. He has a deep knowledge of federal government contracting and financial management. Mr. Moore currently serves or has served as a board member for Horne International, Inc., MOJO Financial Services Inc. and Global Secured Corporation. Mr. Moore is a current member of the Board of Visitors for the University of Maryland’s Smith School of Business. Mr. Moore has an MBA from the University of Maryland and a B.S. in accounting from LaSalle University.
| Mr. Moore's Prior Five Year History: | | 2006 – Present, Chairman of the Board, MOJO Financial Services, Inc. |
| | | 2005 – 2007, Board Member, Global Secure Corporation |
| | | 2003 - 2004, Executive Vice President, ManTech International Corporation |
Edwin Mac Avery, Board Member - Mr. Avery has served as a member of the Company's Board of Directors since April 2005. Mr. Avery has 30 years of diverse experience in leading organizations through every lifecycle phase: form start-up to change and revitalization, to turnaround and accelerated growth. His background includes expertise in business development, finance and capital management, as well as regulatory issues. As Managing Partner of Avery & Company, a client services firm specializing in project design, management, funding, and mergers and acquisitions, in both the energy and technology sectors he has an extensive background in government and commercial arenas within the US and Internationally. Mr. Avery has served as US Manager of JED Oil, Inc., and as a corporate member on the Boards of Directors of the following corporations: TangibleData Inc., Duplication Technology Inc., Horizon Petroleum Corporation, Pioneer Energy Resources, Inc. and Lincoln Investment Corporation.
| Mr. Avery's Prior Five Year History: | | 2007 – Present, President, Avery & Company, Inc. |
| | | 2004 – 2006, Manager – US Activities, JED Oil, Inc. |
FAMILY RELATIONSHIPS
There is no family relationship between any of our officers or directors.
CODE OF ETHICS
We adopted a Code of Ethics applicable to our entire executive team, including our principal executive officer, principal financial officer and principal accounting officer, which is a “code of ethics” as defined by applicable rules of the SEC. Our Code of Ethics was filed as an exhibit to a registration statement on Form SB-2 dated February 11, 2005. Our Code of Ethics can be found on our website (www.paradigmsolutions.com).
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT
Section 16(a) of the Exchange Act of 1934 requires our executive officers and directors, and persons who beneficially own more than ten percent of our equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. Based on information provided to the Company, we believe that all of the Company’s directors, executive officers and persons who own more than ten percent of our common stock were in compliance with Section 16(a) of the Exchange act of 1934 during the last fiscal year except (1) Peter B. LaMontagne, John A. Moore, Richard Sawchak, Francis X. Ryan, Edwin M. Avery each filed a late Form 4 with respect to the repricing of certain options and the grant of certain shares of restricted stock on October 21, 2008, (2) Harry Kaneshiro filed a late Form 4 with respect to the repricing of certain options on October 21, 2008, and (3) Anthony Verna and Robert Boakai have not yet filed Form 3's with respect to their status as executive officers of the Company.
AUDIT COMMITTEE
The Audit Committee of our Board of Directors (the “Audit Committee”) recommends selection of independent public accountants to our Board, reviews the scope and results of the year-end audit with management and the independent auditors, reviews our accounting principles and our system of internal accounting controls and reviews our annual and quarterly reports before filing with the SEC. The current members of the Audit Committee are Francis X. Ryan (Chair), John A. Moore and Edwin Avery. Mr. Ryan and Mr. Avery meet the criteria for audit committee independence specified in the Marketplace Rules of the Nasdaq Stock Market. Mr. Moore does not meet the criteria for audit committee independence specified in the Marketplace Rules of the Nasdaq Stock Market. Our Board has determined that Mr. Ryan is an “audit committee financial expert” as defined by Item 407 of Regulation S-K of the Securities Act of 1933, as amended. The Audit Committee operates under a written charter adopted by the Board of Directors. The Audit Committee regularly reviews and assesses the adequacy of its charter.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows all the cash and non-cash compensation earned by the Company’s named executive officers during the fiscal years ended December 31, 2008 and 2007. No restricted stock awards, long-term incentive plan payouts or other types of compensation, other than the compensation identified in the table below, were paid to these named executive officers during fiscal year 2008.
SUMMARY COMPENSATION TABLE
| Name and Principal Position | | Year | | Salary ($) | | | Bonus ($) | | | Stock Awards (6) ($) | | | Option Awards (6) ($) | | | All Other Compensation (7) ($) | | | Total ($) | |
| Peter LaMontagne (1) | | 2008 | | $ | 324,000 | | | | — | | | $ | 108,884 | | | $ | 256,061 | | | $ | 14,535 | | | $ | 703,480 | |
| President and Chief Executive Officer | | 2007 | | $ | 315,000 | | | | — | | | $ | 68,571 | | | $ | 235,329 | | | $ | 21,036 | | | $ | 639,936 | |
| Richard Sawchak (2) | | 2008 | | $ | 250,016 | | | | — | | | $ | 70,194 | | | $ | 7,486 | | | $ | 10,275 | | | $ | 337,971 | |
| Senior Vice President and Chief Financial Officer | | 2007 | | $ | 231,015 | | | | — | | | $ | 45,714 | | | | — | | | $ | 9,833 | | | $ | 286,562 | |
| Anthony Verna (3) | | 2008 | | $ | 250,016 | | | $ | 7,500 | | | $ | 18,997 | | | $ | 32,747 | | | $ | 11,695 | | | $ | 320,955 | |
| Senior Vice President, Strategy and Business Development | | 2007 | | $ | 250,016 | | | | — | | | $ | 11,429 | | | $ | 31,388 | | | $ | 9,442 | | | $ | 302,275 | |
| Robert Boakai (4) | | 2008 | | $ | 179,669 | | | | — | | | $ | 1,391 | | | $ | 23,798 | | | $ | 9,666 | | | $ | 214,524 | |
| Vice President, Enterprise Solution | | 2007 | | $ | 120,504 | | | $ | 30,000 | | | | — | | | $ | 12,238 | | | $ | 6,313 | | | $ | 169,055 | |
| Diane Moberg (5) | | 2008 | | $ | 135,343 | | | | — | | | $ | 1,854 | | | $ | 12,268 | | | $ | 7,169 | | | $ | 156,634 | |
| Vice President, Human Resource and Compliance | | 2007 | | $ | 57,613 | | | $ | 20,000 | | | | — | | | $ | 4,910 | | | $ | 2,773 | | | $ | 85,296 | |
| (1) | Mr. LaMontagne was hired on May 15, 2006. His annual salary approved by the Compensation Committee of the Board of Directors (“Compensation Committee”) was $315,000 with an opportunity to earn an annual achievement bonus of $120,000 a year to be evaluated and paid annually. In addition, the Compensation Committee granted options to acquire 500,000 shares of common stock to Mr. LaMontagne with an exercise price of $2.50 per share subject to a three-year vesting period during fiscal year 2006. On October 21, 2008, the Compensation Committee approved a modification to reduce the exercise price of aforementioned options to $0.30 per share. On May 3, 2007 and October 21, 2008, the Compensation Committee granted 600,000 shares and 650,000 shares of restricted common stock, respectively, to Mr. LaMontagne. The restricted shares will vest on January 2, 2012 and January 2, 2013, respectively, and have no interim vesting. |
| (2) | Mr. Sawchak was hired on September 19, 2005. His annual salary was $200,000 with an opportunity to earn an annual bonus of $50,000. The Compensation Committee granted options to acquire 200,000 shares of common stock to Mr. Sawchak with an exercise price of $1.70 per share which vested immediately during fiscal year 2005. On October 21, 2008, the Compensation Committee approved a modification to reduce the exercise price of aforementioned options to $0.30 per share. On May 3, 2007 and October 21, 2008, the Compensation Committee granted 400,000 shares and 175,000 shares of restricted common stock, respectively, to Mr. Sawchak. The restricted shares will vest on January 2, 2012 and January 2, 2013, respectively, and have no interim vesting. |
| (3) | Mr. Verna was hired on December 18, 2006. His annual salary is $250,000 with an opportunity to earn incentive/bonus pay based on negotiated metrics. In addition, the Compensation Committee granted options to acquire 150,000 shares of common stock to Mr. Verna with an exercise price of $0.75 per share subject to a three-year vesting period during fiscal year 2006 in accordance with the Offer Letter for Employment. On October 21, 2008, the Compensation Committee approved a modification to reduce the exercise price of aforementioned options to $0.30 per share. On May 3, 2007 and October 21, 2008, the Compensation Committee granted 100,000 shares and 200,000 shares of restricted common stock, respectively, to Mr. Verna. The restricted shares will vest on January 2, 2012 and January 2, 2013, respectively, and have no interim vesting. |
| (4) | Mr. Boakai was hired on March 28, 2007. His annual salary was $150,000 and is eligible for executive bonuses in the form of cash or stock options based on performance under the Management Incentive Plan. In addition, the Compensation Committee granted options in two equal installments to acquire 100,000 shares of common stock to Mr. Boakai with exercise prices of $0.80 and $0.84 per share, respectively, subject to a three-year vesting period during fiscal year 2007 in accordance with the Offer Letter for Employment. On October 21, 2008, the Compensation Committee approved a modification to reduce the exercise price of aforementioned options to $0.30 per share. On October 21, 2008, the Compensation Committee granted 150,000 shares of restricted common stock to Mr. Boakai. The restricted shares will vest on January 2, 2013 and have no interim vesting. |
| (5) | Ms. Moberg was hired on July 9, 2007. Her annual salary was $120,640 and is eligible for executive bonuses in the form of cash or stock options based on performance under the Management Incentive Plan. In addition, the Compensation Committee granted options to acquire 50,000 shares of common stock to Ms. Moberg with an exercise price of $0.84 per share subject to a three-year vesting period during fiscal year 2007 in accordance with the Offer Letter for Employment. On October 21, 2008, the Compensation Committee approved a modification to reduce the exercise price of aforementioned options to $0.30 per share. On October 21, 2008, the Compensation Committee granted 200,000 shares of restricted common stock to Ms. Moberg. The restricted shares will vest on January 2, 2013 and have no interim vesting. The Company does not consider Ms. Moberg to be an executive officer. |
| (6) | Refer to Notes 1 and 15 of the Notes to Consolidated Financial Statements for a further discussion of the Company’s share-based awards. |
| (7) | See All Other Compensation chart below for amounts, which include perquisites and the Company matches on employee contributions to the Company’s 401(k) plan. |
| Name | Year | | Automobile Allowance | | | Life Insurance Premiums | | | Company 401(k) Match | | | Total | |
| Peter LaMontagne | 2008 | | $ | 3,000 | | | $ | 2,315 | | | $ | 9,220 | | | $ | 14,535 | |
| | 2007 | | $ | 12,000 | | | $ | 2,155 | | | $ | 6,881 | | | $ | 21,036 | |
| Richard Sawchak | 2008 | | | — | | | $ | 1,075 | | | $ | 9,200 | | | $ | 10,275 | |
| | 2007 | | $ | 3,000 | | | $ | 1,055 | | | $ | 5,778 | | | $ | 9,833 | |
| Anthony Verna | 2008 | | | — | | | $ | 2,495 | | | $ | 9,200 | | | $ | 11,695 | |
| | 2007 | | | — | | | $ | 2,275 | | | $ | 7,167 | | | $ | 9,442 | |
| Robert Boakai | 2008 | | | — | | | $ | 3,185 | | | $ | 6,481 | | | $ | 9,666 | |
| | 2007 | | | — | | | $ | 2,500 | | | $ | 3,813 | | | $ | 6,313 | |
| Diane Moberg | 2008 | | | — | | | $ | 955 | | | $ | 6,214 | | | $ | 7,169 | |
| | 2007 | | | — | | | $ | 813 | | | $ | 1,960 | | | $ | 2,773 | |
| (8) | The amount in the “Salary”, “Bonus” and “All Other Compensation” columns of the Summary Compensation Table above is reported on an accrual basis. |
The following table contains information regarding unexercised options for each named executive officer outstanding as of December 31, 2008. There were options to purchase an aggregate of 316,669 shares of common stock that have not vested related to equity incentive plan awards for named executive officers outstanding as of December 31, 2008.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
| | Option Awards | | Stock Awards | |
| Name | Year | | Number of Securities Underlying Unexercised Options (#) Exercisable | | | Number of Securities Underlying Unexercised Options (#) Unexercisable | | | Option Exercise Price ($) (2) | | Option Expiration Date | | Number of Shares or Units of Stock That Have Not Vested (#) | | | Market Value of Shares of Units of Stock That Have Not Vested ($) (3) | |
| Peter LaMontagne | 2008 | | | 333,333 | | | | 166,667 | | | $ | 0.30 | | 5/15/2016 | | | 650,000 | | | $ | 32,500 | |
| Richard Sawchak (1) | 2008 | | | 200,000 | | | | — | | | $ | 0.30 | | 12/14/2015 | | | 175,000 | | | $ | 8,750 | |
| Anthony Verna | 2008 | | | 100,000 | | | | 50,000 | | | $ | 0.30 | | 12/18/2016 | | | 200,000 | | | $ | 10,000 | |
| Robert Boakai | 2008 | | | 16,666 | | | | 33,334 | | | $ | 0.30 | | 5/2/2017 | | | 150,000 | | | $ | 7,500 | |
| | | | | 16,666 | | | | 33,334 | | | $ | 0.30 | | 8/1/2017 | | | | | | | | |
| Diane Moberg | 2008 | | | 16,666 | | | | 33,334 | | | $ | 0.30 | | 8/1/2017 | | | 200,000 | | | $ | 10,000 | |
| (1) | These options were granted on December 15, 2005 and vested immediately. |
| (2) | The Company modified the exercise price of the options granted prior to December 31, 2007 to $0.30 from the original exercise prices with other terms and condition remained unchanged on October 21, 2008. |
| (3) | Based on the closing market price of $0.05 at December 31, 2008. |
EMPLOYMENT ARRANGMENTS
Peter LaMontagne’s offer letter dated April 28, 2006 provides that if he is terminated from the Company for any reason other than “cause,” including a change in ownership control, he will be entitled to six months of severance pay at his then current salary.
Richard Sawchak’s offer letter dated June 28, 2007 provides that if he is terminated from the Company for any reason other than “cause,” including a change in ownership control, he will be entitled to six months of severance pay at his current salary along with full benefits.
Anthony Verna’s offer letter dated October 27, 2006 provides that if he is terminated from the Company for any reason other than “cause,” including a change in ownership control, he will be entitled to six months of severance pay at his then current salary.
Robert Bokai’s offer letter dated March 12, 2007 provides that if he is terminated from the Company for any reason other than “cause,” including a change in ownership control, he will be entitled to three months of severance pay at his then current salary.
Diane Moberg’s offer letter dated May 31, 2007 provides that if she is terminated from the Company for any reason other than “cause,” including a change in ownership control, she will be entitled to three months of severance pay at her then current salary.
COMPENSATION OF DIRECTORS
The following table shows all the fees earned or cash paid by the Company during the fiscal year ended December 31, 2008 to the Company’s non-employee directors. No option and restricted stock awards, long-term incentive plan payouts or other types of payments, other than the amount identified in the chart below, were paid to these directors during the fiscal year ended December 31, 2008.
DIRECTOR COMPENSATION
| Name | Year | | Fees Earned or Paid in Cash ($) | | | Option Awards ($) | | | Stock Awards ($) | | | Total ($) | |
| Raymond Huger | 2008 | | $ | 60,500 | | | | — | | | | — | | | $ | 60,500 | |
| Francis X. Ryan (1) | 2008 | | $ | 45,288 | | | $ | 1,497 | | | $ | 17,606 | | | $ | 64,391 | |
| John A. Moore (1) | 2008 | | $ | 40,996 | | | $ | 1,497 | | | $ | 17,606 | | | $ | 60,099 | |
| Edwin Mac Avery (1) | 2008 | | $ | 39,491 | | | $ | 1,497 | | | $ | 17,606 | | | $ | 58,594 | |
| (1) | On October 21, 2008, the Compensation Committee granted 50,000 shares of restricted common stock to each of these directors. The restricted shares will vest on January 2, 2013 and have no interim vesting. On October 21, 2008, the exercise price of the options to acquire 40,000 shares of common stock held by each of the indicated directors was reduced to $0.30 per share from $1.70 per share. |
For the fiscal year ended December 31, 2008, non-employee directors received an annual fee that is paid quarterly, a fee of $1,500 per meeting and received reimbursement for out-of-pocket expenses incurred for attendance at meetings of the Board of Directors. Board members who are members of the audit and compensation committee received $1,000 and $1,500, respectively, and receive reimbursement for out-of-pocket expenses incurred for attendance at meetings of the Committees of the Board of Directors. Chairpersons of the audit and compensation committee received an additional annual fee of $10,000 that is paid quarterly.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information about the beneficial ownership of our common stock as of March 26, 2009 by (i) each person who we know is the beneficial owner of more than 5% of the outstanding shares of our common stock (ii) each of our directors, (iii) each of the officers named in the Summary Compensation Table and (iv) all of our directors and executive officers as a group.
| Title of Class | | Name and Address of Beneficial Owner (1) | | Amount and Nature of Beneficial Ownership | | | Percentage of Common Stock (2) | |
| Common Stock | | Peter LaMontagne | | | 3,040,352 | (3) | | | 6.85 | % |
| Common Stock | | Richard Sawchak | | | 2,065,352 | (4) | | | 4.69 | % |
| Common Stock | | Anthony Verna | | | 400,000 | (5) | | | * | |
| Common Stock | | Robert Boakai | | | 200,000 | (6) | | | * | |
| Common Stock | | Raymond Huger | | | 9,894,719 | | | | 22.56 | % |
| Common Stock | | John A. Moore | | | 7,341,757 | (7) | | | 16.72 | % |
| Common Stock | | Francis X. Ryan | | | 198,300 | (8) | | | * | |
| Common Stock | | Edwin Mac Avery | | | 190,000 | (9) | | | * | |
| | | | | | | | | | | |
| All Directors and Executive Officers as a Group (8 persons) | | 23,330,480 | | | | | | | 53.07 | % |
* Less than one percent of the outstanding common stock
| (1) | Unless otherwise indicated, the address of each person listed above is the address of the Company, 9715 Key West Avenue, Third Floor, Rockville, Maryland, 20850. |
| (2) | Applicable percentage of ownership is based on 43,868,027 shares of common stock outstanding as of March 26, 2009 together with securities exercisable or convertible into shares of common stock within 60 days of March 26, 2009 for each stockholder. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to securities exercisable or convertible into shares of common stock that are currently exercisable or exercisable within 60 days of March 26, 2009 are deemed to be beneficially owned by the person holding such securities for the purpose of computing the percentage of ownership of such person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. |
| (3) | Includes (i) 1,250,000 shares of restricted common stock subject to vesting, (ii) a warrant exercisable to purchase 8,300 shares of common stock within 60 days of March 24, 2009, and (iii) an option exercisable to purchase 500,000 shares of common stock within 60 days of March 24, 2009. |
| (4) | Includes (i) 575,000 shares of restricted common stock subject to vesting, (ii) a warrant exercisable to purchase 8,300 shares of common stock within 60 days of March 24, 2009, and (iii) an option exercisable to purchase 200,000 shares of common stock within 60 days of March 24, 2009. |
| (5) | Includes (i) 300,000 shares of restricted common stock subject to vesting and (ii) an option exercisable to purchase 100,000 shares of common stock within 60 days of March 24, 2009. |
| (6) | Includes (i) 150,000 shares of restricted common stock subject to vesting and (ii) an option exercisable to purchase 50,000 shares of common stock within 60 days of March 24, 2009. |
| (7) | Includes (i) 150,000 shares of restricted common stock subject to vesting, (ii) a warrant exercisable to purchase 41,500 shares of common stock within 60 days of March 24, 2009, (iii) an option exercisable to purchase 40,000 shares of common stock within 60 days of March 24, 2009 and (iv) 6,410,257 shares that Mr. Moore holds as a joint tenant with his spouse. |
| (8) | Includes (i) 150,000 shares of restricted common stock subject to vesting, (ii) warrants exercisable to purchase 8,300 shares of common stock within 60 days of March 24, 2009 held by Semper Finance and USA Asset Acquisition Corp entities of which Francis X. Ryan is President and (iii) an option exercisable to purchase 40,000 shares of common stock within 60 days of March 24, 2009. |
| (9) | Includes (i) 150,000 shares of restricted common stock subject to vesting and (ii) an option exercisable to purchase 40,000 shares of common stock within 60 days of March 24, 2009. |
CHANGES IN CONTROL
The Certificate of Designations provides that the Board of Directors shall consist of no more than seven directors and after the receipt of the shareholder approval specified in the Purchase Agreement (the “Amendment Date”), the Board of Directors shall consist of five directors (except upon the occurrence of an event of default as described below). For so long as the Ownership Threshold is met, a majority of the then outstanding shares of Series A-1 Preferred Stock (the “Majority Holders”) will have the right (subject to the terms of a side letter) to elect two directors to the Board of Directors and, until the Amendment Date, two observers to the Board of Directors, provided that after the Amendment Date, such shareholders may only elect one observer to the Board of Directors. Subject to certain limitations, the Majority Holders may elect to convert the board observers into directors. If the Ownership Threshold is not met, then the Majority Holders would have the right (subject to the side letter) to elect one director to the Board of Directors and one observer to the Board of Directors. On February 27, 2009, the Purchasers entered into a side letter, which was accepted and agreed to by the Company, that grants Hale Capital the authority to designate the directors and Board observers to be elected by the Majority Holders of the Series A-1 Preferred Stock pursuant to the Certificate of Designations.
In addition, upon the occurrence of an event of default under the Certificate of Designations, 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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
Each share of Series A-1 Preferred Stock entitles the holder to such number of votes as shall equal the number of shares of common stock issuable upon exercise of the Class A Warrants held by such holder as of the applicable record date. As of March 24, 2009, the Purchasers beneficially owned an aggregate of 5.8% of the voting securities of the Company (based on a determination of beneficial ownership pursuant to Rule 13d-3 of the Exchange Act). Following the increase in the number of authorized shares of common stock, as required by the Company’s agreement with the holders of Series A-1 Senior Preferred Stock, we anticipate that the holders of our Series A-1 Senior Preferred Stock will hold a majority of the outstanding voting equity of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
PREFERRED STOCK EXCHANGE AGREEMENT
On February 27, 2009, pursuant to a Preferred Stock Exchange Agreement dated as of the same date (the “Exchange Agreement”) among the Company and Peter LaMontagne, Richard Sawchak, John A. Moore and Annedenise Moore and FTC Emerging Markets (the “Former Series A Holders”), each of the Former Series A Holders exchanged all shares of Series A Preferred Stock held by such holders for an aggregate of 21,794,874 shares of the Company’s common stock. The Exchange Agreement provides that the Company is to offer each Former Series A Holder an opportunity to purchase its pro rata share of certain securities that may be sold by the Company in the future. In addition, the Exchange Agreement provides for the issuance of additional shares of Common Stock to the Former Series A Holders under certain circumstances. The Exchange Agreement also provides the Former Series A Holders with piggy back registration rights with respect to the shares of common stock issued pursuant to the Preferred Stock Exchange Agreement. Peter LaMontagne is the President and CEO of the Company and a member of the Company’s Board of Directors, Richard Sawchak is the Company’s Senior Vice President and Chief Financial Officer, and John A. Moore is a member of the Company’s Board of Directors. As of March 24, 2009, each of Peter B. LaMontagne, John A. Moore and FTC Emerging Markets beneficially owned 6.85%, 16.72% and 33.22%, respectively, of the Company’s outstanding common stock.
PREFERRED STOCK REDEMPTION AGREEMENT
On February 27, 2009, pursuant to a Preferred Stock Redemption Agreement dated as of the same date (the “Redemption Agreement”) among the Company, USA Asset Acquisition Corp. and Semper Finance, Inc. (the “Additional Former Series A Holders”), the Company redeemed all shares of Series A Preferred Stock held by such Additional Former Series A Holders for an aggregate of approximately $111,000. Francis X. Ryan, a member of the Company’s Board of Directors, is the President of each of the Additional Former Series A Holders.
DIRECTOR INDEPENDENCE
Francis X. Ryan, John A. Moore and Edwin Mac Avery are considered to be “ independent” as that term is defined by Rule 4200(a)(15) of the Marketplace Rules of The Nasdaq Stock Market. John A. Moore is a member of the Company’s Audit Committee and does not meet the criteria for audit committee independence specified in the Marketplace Rules of the Nasdaq Stock Market.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
AUDIT AND NON-AUDIT FEES
The following table presents fees for professional services rendered by Grant Thornton LLP (“GT”), BDO Seidman, LLP (“BDO”) and Aronson & Company (“Aronson”) for fiscal years ended December 31, 2008 and 2007.
| | | YEARS ENDED DECEMBER 31, | |
| | | 2008 (1) | | | 2007 (2) | |
| Audit fees | | $ | 323,700 | | | $ | 412,262 | |
| Audit related fees | | $ | 12,781 | | | $ | 23,227 | |
| Tax fees | | $ | — | | | $ | — | |
| All other fees | | $ | — | | | $ | 1,300 | |
| Total | | $ | 336,481 | | | $ | 436,789 | |
| (1) | 2008 amount included fees paid GT of $282,000 and $12,100, respectively, BDO of $24,000 and $0, respectively, and Aronson of $17,700 and $681, respectively. |
| (2) | 2007 amount included fees paid GT of $110,000, $5,500, $0 and $0, respectively, BDO of $266,912, $17,317, $0 and $0, respectively, and Aronson of $35,350, $410, $0 and $1,300, respectively. |
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES OF INDEPENDENT AUDITOR
Prior to engagement of the independent auditor for the next year’s audit, management will submit an aggregate of services expected to be rendered during that year for each of four categories of services to the Audit Committee for approval. Consistent with SEC policies regarding auditor independence, the Audit Committee has responsibility for appointing, setting compensation and overseeing the work of the independent auditor. In recognition of this responsibility, the Audit Committee established a policy in 2005 to pre-approve all audit and permissible non-audit services provided by the independent auditor. The Audit Committee will approve of all permissible non-audit services consistent with SEC requirements.
| 1. | Audit services include audit work performed in the preparation of the Consolidated Financial Statements, as well as work that generally only the independent auditor can reasonably be expected to provide, including comfort letters, statutory audits, and attest services and consultation regarding financial accounting and/or reporting standards. |
| 2. | Audit related services are for assurance and related services that are traditionally performed by the independent auditor, including due diligence related to mergers and acquisitions, employee benefit plan audits, and special procedures required to meet certain regulatory requirements. |
| 3. | Tax services include all services performed by the independent auditor’s tax personnel except those services specifically related to the audit of the Consolidated Financial Statements, and includes fees in the areas of tax compliance, tax planning, and tax advice. |
| 4. | Other fees are those associated with services not captured in the other categories. |
Prior to future engagements, the Audit Committee will pre-approve these services by category of service. During the year, circumstances may arise when it may become necessary to engage the independent auditor for additional services not contemplated in the original pre-approval. In those instances, the Audit Committee requires specific pre-approval before engaging the independent auditor. The Audit Committee may delegate pre-approval authority to one or more of its members. The member to whom such authority is delegated must report, for informational purposes only, any pre-approval decisions to the Audit Committee at its next scheduled meeting.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Exhibits. We have filed, or incorporated into this Annual Report on Form 10-K by reference, the exhibits listed on the accompanying Exhibits Index immediately following the signature page of this Annual Report on Form 10-K.
Financial Statements.
FINANCIAL STATEMENTS
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
TABLE OF CONTENTS
| | | Page |
| REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS | | F-1 |
| | | |
| AUDITED FINANCIAL STATEMENTS | | |
| | | |
| Consolidated Balance Sheets | | F-2 |
| Consolidated Statements of Operations | | F-3 |
| Consolidated Statements of Stockholders’ Equity | | F-4 |
| Consolidated Statements of Cash Flows | | F-5 — F-6 |
| | F-7 — F-33 |
| | | |
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Paradigm Holdings, Inc.
Rockville, MD
We have audited the accompanying consolidated balance sheets of Paradigm Holdings, Inc. (a Wyoming corporation) and Subsidiaries (the Company) as of December 31, 2008 and 2007 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. Our audit of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15. The financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Paradigm Holdings, Inc. and Subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ Grant Thornton LLP
Baltimore, Maryland
March 30, 2009
PARADIGM HOLDINGS, INC.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these consolidated financial statements.
PARADIGM HOLDINGS, INC.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these consolidated financial statements.
PARADIGM HOLDINGS, INC.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these consolidated financial statements.
PARADIGM HOLDINGS, INC.
The accompanying Notes to the Consolidated Financial Statements are an integral part of these consolidated financial statements.
PARADIGM HOLDINGS, INC.
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Paradigm Holdings, Inc. (“Paradigm Holdings”), formerly known as Cheyenne Resources, Inc., was incorporated in Wyoming on November 17, 1970. As further described in Note 2, Paradigm Holdings acquired Trinity IMS, Inc. (“Trinity”), on April 9, 2007 to deliver IT solutions into the national security marketplace and Caldwell Technology Solutions, LLC (“CTS”) on July 2, 2007 to provide advanced information technology solutions in support of National Security programs within the Intelligence Community (collectively, “PDHO” or “the Company”).
Headquartered in Rockville, Maryland, the Company provides information technology, information assurance, and business continuity solutions, primarily to U.S. federal government customers.
On November 3, 2004, Paradigm Holdings acquired Paradigm Solutions Corporation (“PSC”) through a reverse acquisition (the “Reverse Acquisition”). On December 17, 2004, Paradigm Holdings formed a wholly-owned subsidiary, Paradigm Solutions International, Inc. (“PSI”) for purposes of transferring the acquired net assets from Paradigm Holdings.
On October 14, 2005, PDHO acquired Blair Management Services, Inc. doing business as Blair Technology Group (“Blair”) to expand its presence in the commercial marketplace. Blair provided business continuity and information technology security solutions to commercial customers in a variety of industries including finance, healthcare and energy. The acquisition of Blair enhanced PDHO’s ability to offer customers a comprehensive business continuity solution.
As further discussed in Note 3, on September 22, 2006, the Company announced the plan to divest its commercial business and completed the divestiture on February 28, 2007. The decision to divest was made during the fourth quarter of 2006 following the completion of an independent committee’s evaluation of strategic alternatives. The Company defines the commercial business as all of the outstanding capital stock of PSI, which includes all of the capital stock of Blair, and certain assets associated with the OpsPlanner software tool (“OpsPlanner”). The commercial business has been reported as a discontinued operation of the Company and, accordingly, its operating results, financial position and cash flows have been presented separately from the Company’s continuing operations in the consolidated financial statements for all periods presented.
The Company’s operations are subject to certain risks and uncertainties including, among others, dependence on contracts with federal government agencies, dependence on significant clients, existence of contracts with fixed pricing, dependence on subcontractors to fulfill contractual obligations, current and potential competitors with greater resources, a dependence on key management personnel, our ability to recruit and retain qualified employees, and uncertainty of future profitability and possible fluctuations in financial results.
The accompanying Consolidated Financial Statements include the accounts of Paradigm and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
As of December 31, 2008, the Company had an accumulated deficit of approximately $2.3 million and working capital deficiency of $4.5 million. The Company has a note payable to the former shareholders of Trinity (Note 10) for $2.0 million. Effective as of October 31, 2008, the Company negotiated an amendment to the note that extended the payment date of the $2.0 million outstanding balance of the note from October 31, 2008 to December 15, 2008 in exchange for a cash fee of $40,000 plus accrued and unpaid interest based on the original terms. The Company and Christian Kleszewski (the Company’s Vice President (Trinity, IMS)) separately agreed that the $1.0 million portion of the note payable to Mr. Kleszewski was to be due in January 2009. Additionally, the Company is dependent on a line-of-credit financing arrangement. Although there can be no assurances, the Company believes that cash flow from operations, together with borrowings available from our credit facility with Silicon Valley Bank (“SVB”) and the combination of in-process cost reductions along with the completion of fundraising activities on February 27, 2009 will be adequate to meet future liquidity needs for the next twelve months. On February 27, 2009, the Company paid in full the note held by the former shareholders of Trinity.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
For purposes of financial statement presentation, the Company considers all highly liquid instruments with initial maturities of ninety days or less to be cash equivalents.
The Company’s assets that are exposed to credit risk consist primarily of cash and cash equivalents and accounts receivable. Accounts receivable consist primarily of billed and unbilled amounts, including indirect cost rate variances, due from various agencies of the federal government or prime contractors doing business with the federal government, and other commercial customers. The Company historically has not experienced significant losses related to accounts receivable and therefore, believes that credit risk related to accounts receivables is minimal. The Company maintains cash balances that may at times exceed federally insured limits. The Company maintains this cash at high-credit quality institutions and, as a result, believes credit risk related to its cash is minimal.
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”).
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 and 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 Emerging Issues Task Force Issue (“EITF”) No.00-21, “Revenue Arrangements with Multiple Deliverables”, and allocates revenue to each element based on relative fair value.
Software revenue recognition for sales of OpsPlanner is in accordance with AICPA SOP 97-2, “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. The OpsPlanner software was sold as part of the sale of the commercial business on February 28, 2007. Effective March 1, 2007, the Company is the exclusive reseller of the OpsPlanner software to the federal government.
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 EITF No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”, 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 determined 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.
Revenue recognized on contracts for which billings have not yet been presented to customers is included in unbilled receivables.
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 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.
All of the Company’s revenue is from federal agencies and 66% and 60% of total revenue was generated from three and two major customers during the years ended December 31, 2008 and 2007, respectively. The Company’s accounts receivable related to these major customers was 63% and 49% of total accounts receivable as of December 31, 2008 and 2007, 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 USA.
Goodwill represents the excess of cost over the fair value of net assets acquired in business combinations. Pursuant to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” , goodwill and intangibles with indefinite lives are not amortized, but instead are tested for impairment at least annually. SFAS No. 142 also requires that identifiable intangible assets with estimable useful lives be amortized over their estimated useful lives, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets ..” The Company recorded $4.0 million of goodwill and $1.8 million of identifiable intangible assets related to contract backlog associated with the Trinity and CTS acquisitions. The contract backlog will be amortized over their estimated useful lives of five years and is included under the caption “Intangible Assets” on the Company’s consolidated balance sheets.
The Company conducts a review for impairment of goodwill and intangible assets 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.
The Company completed its annual testing for impairment of goodwill and intangible assets as of December 31, 2008. The analysis indicated that no impairment exists as of December 31, 2008.
Pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company periodically evaluates the recoverability of its long-lived assets. This evaluation consists of a comparison of the carrying value of the assets with the assets’ expected future cash flows, undiscounted and without interest costs. Estimates of expected future cash flows represent management’s best estimate based on reasonable and supportable assumptions and projections. If the expected future cash flow, undiscounted and without interest charges, exceeds the carrying value of the asset, no impairment is recognized. Impairment losses are measured as the difference between the carrying value of long-lived assets and their fair market value, based on discounted future cash flows of the related assets. The Company believes that the carrying value of its long-lived assets are fully realizable as of December 31, 2008.
Accounts receivable are customer obligations due under normal trade terms. The Company provides an allowance for uncollectible accounts receivable based on historical experience, troubled account information and other available information. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Although it is reasonably possible that management’s estimate for uncollectible accounts could change in the near future, management is not aware of any events that would result in a change to its estimate which would be material to the Company’s financial position or results of operations.
Property and equipment are recorded at the original cost to the Company and are depreciated using straight-line methods over established useful lives of three to seven years. Purchased software is recorded at original cost and depreciated on the straight-line basis over three years. Leasehold improvements are recorded at original cost and are depreciated on the straight-line basis over the shorter of the useful life of the asset or the life of the lease.
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, 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.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN No. 48”), on January 1, 2007. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”, 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. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Based on the evaluation, the Company has concluded that there are no significant uncertain tax positions requiring recognition in the financial statements. If the Company is required to recognize any interest and penalties accrued related to unrecognized tax benefits, such amounts will be recognized as tax expense. To date, the Company has not recognized such interest or penalties.
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.
Basic and diluted net loss per common share are presented in accordance with SFAS No. 128, “Earning Per Share.” Basic net loss per common share is calculated by dividing the net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is calculated using the weighted average number of common shares giving effect to all dilutive potential common shares outstanding during the period, including stock options, restricted common stock, convertible preferred stock, warrants and promissory note. The effect of any potentially dilutive shares is not included in the calculation of diluted loss per share if the impact would be anti-dilutive. Calculations of the weighted average number of basic and diluted common shares are presented in Note 13.
The Company currently has one equity incentive plan, the 2006 Stock Incentive Plan (“the Plan”), which provides the Company the opportunity to compensate selected employees with stock options. A stock option entitles the recipient to purchase shares of common stock from the Company at the specified exercise price. All grants made under the Plan are governed by written agreements between the Company and the participants.
The Company uses the Black-Scholes option-pricing model to value all options and the straight-line method to amortize this fair value as compensation cost over the requisite service period, which is the vesting period. Total share-based compensation expense included in general and administrative expenses in the accompanying consolidated statements of operations for the years ended December 31, 2008 and 2007 was $622 thousand and $452 thousand, respectively.
Prior to the adoption of SFAS No. 123 (revised), the Company would report the benefit of tax deductions in excess of recognized stock compensation expense, or excess tax benefits, resulting from the exercise of stock options as operating cash inflows in its consolidated statements of cash flows. Since adoption and in accordance with SFAS No. 123 (revised), the Company will include these excess tax benefits from the exercise of stock options as financing cash inflows rather than operating cash inflows when participants exercise their stock options. There were no exercises of stock options during 2008 and 2007.
Under SFAS No. 123 (revised), we have elected to continue using the Black-Scholes option pricing model to determine the fair value of our awards on the date of grant. The Company will reconsider the use of the Black-Scholes model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated under this model.
The Company accounts for equity instruments issued to non-employees in accordance with SFAS No. 123 and EITF No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”
The following assumptions were used for option grants during the years ended December 31, 2008 and 2007:
Dividend Yield — The Company has never declared or paid dividends on its common stock and has no plans to do so in the foreseeable future.
Risk-Free Interest Rate — Risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term approximating the expected life of the option term assumed at the date of grant.
Expected Volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The expected volatility is based on the historical volatility of the Company’s common stock for the periods that it has been publicly.
Expected Term of the Options — This is the period of time that the options granted are expected to remain unexercised. The Company estimates the expected life of the option term based on an estimated average life of the options granted. Due to the lack of historical information, the Company estimated the expected life of six years for options granted during 2007, using the safe harbor criteria of SEC SAB No. 107, “Share-Based Payments.” Effective January 1, 2008, the Company estimated the expected life based on the reported data for a peer group of publicly traded companies for which historical information was available.
Forfeiture Rate — The Company estimates the percentage of options granted that are expected to be forfeited or canceled on an annual basis before stock options become fully vested. The Company uses the forfeiture rate that is a blend of past turnover data and a projection of expected results over the following twelve month period based on projected levels of operations and headcount levels at various classification levels with the Company.
The fair value of the common stock issued is based on the fair market value of the stock on the date of the award. The fair value of options granted in 2008 and 2007 was estimated on the date of the grant with the following assumptions:
The Company estimates the percentage of options granted that are expected to be forfeited or canceled on an annual basis before stock options become fully vested. The Company uses the forfeiture rate that is a blend of past turnover data and a projection of expected results over the following twelve month period based on projected levels of operations and headcount levels at various classification levels with the Company. A forfeiture rate of zero was used for the options granted during 2007 to 2008 as there have been no forfeitures for the options granted as of December 31, 2008. A forfeiture rate of zero was used for the restricted common stock issued to certain individuals in October 2008 and May 2007. As further described in Note 15, the restricted common stock was issued with the intent of providing a longer-term employment retention mechanism to key management and board members.
SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information”, 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. SFAS No. 131 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.
On January 1, 2009, the Company adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.” The statement modifies and expands the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation and requires quantitative disclosures about fair value amounts and gains and losses on derivative instruments. It also requires disclosures about credit-related contingent features in derivative agreements. The adoption of SFAS No. 161 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” The statement establishes the accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The adoption of SFAS No. 160 did not have a material impact on the Company’s statements of operations, financial position or cash flows as the Company does not have any noncontrolling interests in other active companies.
On January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), “Business Combinations.” The statement establishes principles and requirements for how the acquirer recognizes and measures the identifiable assets acquired, the goodwill acquired, the liabilities assumed and any noncontrolling interest in the acquiree and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This standard did not have immediate impact upon adoption by the Company, but will result in items such as transaction and acquisition related-restructuring costs with respect to business combinations closing after December 31, 2008 being charged to expense when incurred. The Company will consider this standard when evaluating potential future transactions to which it would apply.
In November 2008, the Company adopted SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the source of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with GAAP. The adoption of SFAS No. 162 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement provides an option, on specified election dates, to report selected financial assets and liabilities, including insurance contracts, at fair value. Subsequent changes in fair value for designated items are reported in income in the current period. The adoption of SFAS No. 159 did not impact the Company’s consolidated financial statements, as no items were elected for measurement at fair value upon initial adoption. The Company continues to evaluate eligible financial assets and liabilities on their election dates. Any future elections will be disclosed in accordance with the provisions outlined in the statement.
On January 1, 2008, the Company adopted certain provisions of SFAS No. 157, which establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and expands on required disclosures about fair value measurement. The provisions of SFAS No. 157 adopted on January 1, 2008 relate only to financial assets and liabilities as well as other assets and liabilities carried at fair value on a recurring basis and did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2009, the Company adopted FASB Staff Positions (“FSP”) No. 157-2 (“FSP No. 157-2”), “Effective Date of FASB Statement No. 157.” FSP No. 157-2 applies to nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually) and defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for items within the scope of this FSP. The Company has not yet evaluated the impact, if any, of SFAS 157 on its non-financial assets and liabilities upon initial adoption.
On January 1, 2009, the Company adopted FASB Staff Positions No. 142-3 (“FSP No. 142-3”), “Determination of the useful life of intangible assets.” FSP No. 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP No. 142-3 also requires additional disclosures on information that can be used to assess the extent to which future cash flows associated with intangible assets are affected by an entity’s intent or ability to renew or extend such arrangements and on associated accounting policies. The adoption of FSP No. 142-3 may impact the Company in the future if the Company acquires intellectual property or other assets.
In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active.” FSP FAS No. 157-3 is consistent with the joint press release the FASB issued with the SEC on September 30, 2008, which provides general clarification guidance on determining fair value under SFAS No. 157 when markets are inactive. FSP FAS No. 157-3 specifically addresses the use of judgment in determining whether a transaction in a dislocated market represents fair value, the inclusion of market participant risk adjustments when an entity significantly adjusts observable market data based on unobservable inputs, and the degree of reliance to be placed on broker quotes or pricing services. FSP FAS No. 157-3 became effective October 10, 2008 and should be applied prospectively. The adoption of FSP FAS No. 157-3 did not have a significant impact on the Company’s current fair value measurements.
On January 1, 2009, the Company adopted FASB Staff Position APB 14-1 (“FSP APB 14-1), “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 requires issuers of convertible debt to account separately for the liability and equity components of these instruments if they have stated terms permitting cash settlement upon conversion. This practice marks a significant change from the current accounting practice for convertible debt instruments in the scope of the FSP. Current practice does not require separation of the liability and equity components of such instruments. Separately accounting for these instruments’ liability and equity components results in the recording of more interest cost over the life of the convertible debt instrument, because of an initial debt discount. The adoption of FSP APB 14-1 did not have a material impact on the Company’s statements of operations, financial position or cash flows.
On January 1, 2009, the Company adopted FASB Staff Position EITF 03-6-1(“FSP EITF 03-6-1”), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities. An entity must include participating securities in its calculation of basic and diluted earnings per share (“EPS”) pursuant to the two-class method, as described in FASB Statement 128, “Earnings per Share.” The Company does not issue share-based payment awards that contain nonforfeitable rights to dividends and, as a result, the adoption of FSP EITF 03-6-1 did not have a significant effect on its consolidated financial statements.
On January 1, 2009, the Company adopted FSP EITF 99-20-1(“FSP EITF 99-20-1”), “Amendment to the Impairment Guidance of EITF Issue 99-20.” FSP EITF 99-20-1 amends the impairment guidance in EITF Issue 99-20 to achieves more consistent determination of whether an other-than temporary-impairment has occurred. The Company does not have any beneficial interest in securitized financial assets and, as a result, the adoption of FSP EITF 99-20-1 did not have a significant effect on its consolidated financial statements.
2. ACQUISITIONS
On January 29, 2007, the Company entered into a Stock Purchase Agreement (the “Trinity Stock Purchase Agreement”) between the Company, Trinity, a Nevada corporation and the shareholders of Trinity (the “Trinity Shareholders”). On April 9, 2007, the Company completed the acquisition of Trinity for $4 million. The Company purchased from the Trinity Shareholders, all of the issued and outstanding capital stock of Trinity and Trinity became a wholly-owned subsidiary of the Company in exchange for a $4 million promissory note, which was paid off by February 27, 2009, issued to the Trinity Shareholders as further described in Note 10. In addition, under certain conditions as set forth in the Trinity Stock Purchase Agreement, the sellers were eligible for incentive bonuses, if any, for winning new contracts for Trinity.
The results of Trinity’s operations have been included in the consolidated financial statements since the date of acquisition. Trinity provides specialized information assurance and cyber forensics support services to the federal government, primarily the U.S. Department of State. Trinity’s focus on cyber forensics and information assurance services in support of the U.S. Department of State complements the Company’s strategic plan to expand its information technology solutions into the national security marketplace. Trinity provides the Company with access to key customers, security clearances and technical expertise.
The acquisition was accounted for using the purchase method of accounting prescribed by SFAS No. 141, “Business Combinations.” The excess of the purchase price over assets acquired and liabilities assumed of $3.2 million was allocated to goodwill which is not deductible for income tax purposes. Identifiable intangible assets associated with contract backlog totaling $1.0 million, which is not deductible for income tax purposes, are being amortized over their estimated useful lives of five years using the straight-line method.
The total purchase price paid, including $90,976 of direct costs, has been allocated as follows:
On June 6, 2007, the Company entered into a Purchase Agreement (the “Purchase Agreement”) between the Company, CTS, a Maryland limited liability company and the members of CTS (the “Members”). The Company purchased from the Members, all of the issued and outstanding membership units of CTS and CTS became a wholly-owned subsidiary of the Company in exchange for the following consideration:
In addition, under certain conditions as set forth in the Purchase Agreement, the Members will be eligible for earn-out compensation of up to $2,540,000 for achieving certain revenue and pre-tax income goals during the twelve months following the closing of the transaction. The Members earned $0.3 million of the earn-out compensation as of December 31, 2007 based on the calculation performed.
On July 2, 2007, the Company, CTS and the Members completed the transactions contemplated in the CTS Stock Purchase Agreement.
The results of CTS’ operations have been included in the consolidated financial statements since the date of acquisition. CTS specializes in advanced information technology solutions in support of National Security programs within the Intelligence Community. CTS provides the Company with access to key customers, security clearances and technical expertise.
The acquisition was accounted for using the purchase method of accounting prescribed by SFAS No. 141, “Business Combinations.” The excess of the purchase price over assets acquired and liabilities assumed of $0.7 million was allocated to goodwill which is deductible for income tax purposes. Identifiable intangible assets associated with contract backlog totaling $0.8 million, which is also deductible for income tax purposes, are being amortized over their estimated useful lives of five years using the straight-line method.
The total purchase price paid, including $40,225 of direct costs, has been allocated as follows:
The unaudited pro forma information provided below has been prepared to reflect the acquisition of Trinity and CTS by the Company as if the acquisition occurred on January 1, 2007. The unaudited pro forma financial information does not necessarily represent what would have occurred if the transaction had taken place on the dates presented and should not be taken as representative of future consolidated results of operations or financial position:
For the year ended December 31, 2007 the Company determined the pro forma information in the table provided above by aggregating the financial information for the Company and for Trinity and CTS for the respective periods, along with adjustments for amortization of intangible assets, incremental compensation expense related to an employment contract issued in connection with the acquisition and additional interest expense to reflect the funding source used to acquire Trinity.
3. DISCONTINUED OPERATIONS
On September 22, 2006, the Company established an independent committee of its Board of Directors to evaluate strategic alternatives with regard to the Company’s commercial business activities, including the potential divestiture of the commercial business. The Company defines the commercial business as all of the outstanding capital stock of PSI, which included all of the capital stock of Blair Technology Group, a wholly-owned subsidiary of PSI, and certain assets associated with the OpsPlanner software tool. The decision to divest was made during the fourth quarter of 2006 following the completion of the independent committee’s evaluation of strategic alternatives. The Company classified the commercial business as discontinued operations at December 31, 2006 based on the Company meeting the necessary criteria listed in paragraph 30 of SFAS No. 144 in the fourth quarter. The divestiture supports the Company’s efforts to refocus Paradigm on its core information technology services business supporting the federal government. Refer to our 2006 Annual Report on Form 10-K for Paradigm Holdings, Inc. for a further discussion of the Blair acquisition.
On February 23, 2007, the Company entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with Mr. Raymond Huger, the Company’s Chairman of the Board of Directors, co-founder and former Chief Executive Officer. On February 28, 2007, the Company completed the sale of the Company’s commercial business, in the form of a sale of all of the capital stock of PSI. The sale price was $1,580,000 payable in 1,775,281 shares of common stock of the Company based on the closing price per share of the Company’s common stock as of February 28, 2007. This divestiture transaction resulted in a gain of $78 thousand, net of $84 thousand of selling costs and $405 thousand of income taxes, recorded in the first quarter of 2007.
The commercial business has been reported as a discontinued operation of the Company and, accordingly, its operating results, financial position and cash flows have been presented separately from the Company’s continuing operations in the consolidated financial statements for all current and prior periods presented.
The following tables summarize selected financial information related to the operating results and financial position of the commercial business. There were no assets and liabilities held for sale as of December 31, 2008 since the commercial business was sold on February 28, 2007.
After the sale of the commercial business, the Company does not have any financial relationship with PSI except for a Reseller Agreement.
According to the Reseller Agreement with PSI, the Company is the exclusive reseller in the federal market for the proprietary software tool, OpsPlanner (TM) and is committed to pay PSI a minimum of $60,000 annually for software usage after the sale of the commercial business. The Company expects to pay approximately the minimum amount committed during the term of the Reseller Agreement, which is two years.
4. FAIR VALUE MEASUREMENTS
In accordance with SFAS No. 157, a fair value measurement is determined based on the assumptions that a market participant would use in pricing an asset or liability. SFAS No. 157 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 Company does not have any assets and liabilities required to be carried at fair value on a recurring basis as of December 31, 2008. The Company also does not make any disclosures of amounts at fair value on a recurring basis due to the short term nature of these instruments.
5. 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 for 2008. In addition to the aforementioned governmental units, accounts receivable for 2007 included the U.S. Secret Service. The components of accounts receivable are as follows:
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 December 31, 2008 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 and $33,462 as an allowance for doubtful accounts related to certain customers at December 31, 2008 and 2007, respectively.
6. PREPAID EXPENSES
7. PROPERTY AND EQUIPMENT
Depreciation and amortization expense included in selling, general and administrative expenses in the accompanying consolidated statements of operations for the years ended December 31, 2008 and 2007 was $241,182 and $311,523, respectively.
8. INTANGIBLE ASSETS
The Company recorded $1.8 million of contract backlog associated with the Trinity and CTS acquisitions. 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 consolidated statements of operations for the years ended December 31, 2008 and 2007 was $347,273 and $218,136. The Company estimates that it will incur the following amortization expense for the future periods indicated below.
9. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
10. DEBTS
The Company entered into a two year Loan and Security Agreement with Chevy Chase Bank that provided for a revolving line of credit facility of up to $9 million. The agreement became effective August 4, 2005. The revolving line of credit was used to borrow funds for working capital and general corporate purposes. The Company terminated its revolving line of credit facility with Chevy Chase Bank when the new Loan and Security Agreement (the “Loan and Security Agreement”) with SVB, as described below, was activated and paid off the outstanding balance on March 23, 2007.
On March 13, 2007, the Company entered into a two year Loan and Security Agreement with SVB that provides for a revolving line of credit facility of up to $10 million and a line of credit agreement of up to $12 million under which agreements, total funds are available up to a limit of $12.5 million based on the Company's collateral. The agreements became effective on March 13, 2007. The Loan and Security Agreement is being used to borrow funds for working capital and general corporate purposes. The Loan and Security Agreement is collateralized 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. Under the Loan and Security Agreement, the Company may use up to $500,000 for letters of credit. The Loan and Security Agreement, requires the Company to maintain certain EBITDA covenants as specified in the Loan and Security Agreement. Because the Company was not in compliance with the EBITDA covenant at June 30, 2008, the Company and SVB amended the Loan and Security Agreement with SVB to waive the covenant compliance for the periods ended June 30 and July 31, 2008 and provide for modified EBITDA covenant amounts for the remainder of 2008. The EBITDA covenant amounts for 2009 remain unchanged from the original agreement. The Company was in compliance with the amended EBITDA covenant requirements as of December 31, 2008. As of December 31, 2008, the Company had outstanding revolving line of credit with SVB of $5.9 million and $0 additional availability on its revolving line of credit with SVB. The interest rates charged by SVB ranged from 6.50% to 8.50% for the year ended December 31, 2008.
On March 18, 2009, the Company and SVB entered into a Second Loan Modification Agreement. This Second Loan and Modification Agreement amended the Loan and Security Agreement dated March 13, 2007 to extend the maturity date to May 12, 2009 and modify the funds available under the revolving line of credit facility to not to 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 are consistent with the previous agreement for the remainder of the extension period.
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 December 31, 2008, no events of default had occurred.
As further described in Note 2, on April 9, 2007, the Company issued a $4.0 million promissory note to the former shareholders of Trinity to finance the acquisition of Trinity.
Under the terms of the promissory note, the Company will repay the principal plus interest at the annual rate of 7.75% of the unpaid balance pursuant to the following terms:
Effective as of October 31, 2008, the Company negotiated an amendment to the promissory note that extended the payment date of the Remainder Amount from October 31, 2008 to December 15, 2008 in exchange for a cash fee of $40,000 plus accrued and unpaid interest based on the original terms. If the Company failed to pay the Remainder Amount by December 15, 2008, the Company was required to pay an amount equal to $60,000 plus all accrued and unpaid interest through December 15, 2008. If the Company failed to pay the amounts owed under the promissory note by December 15, 2008, interest shall accrue, at a rate equal to 12% per annum, on such amounts. The Company did not pay the Reminder Amount prior to December 15, 2008. A failure by the Company to pay the Remainder Amount on or before December 15, 2008 would not constitute a default under the promissory note. The Company and Christian Kleszewski (the Company’s Vice President (Trinity, IMS)) separately agreed that the $1.0 million portion of the promissory note payable to Mr. Kleszewski was to be due in January 2009. In connection with the private placement, the Company used the proceeds to pay the note in full on February 27, 2009. Refer to Note 21 of the Notes to Consolidated Financial Statements for a further discussion of the private placement.
The Company paid $500 thousand on April 9, 2007 and paid the Second Amount in cash on July 31, 2007. The promissory note provided for a thirty day grace period from the due date of the Second Amount due on June 30, 2007 in exchange for a fee of 5% of the amount due.
The Company considered whether the provisions contained within the promissory note may be considered embedded derivatives as prescribed by SFAS No. 133 “Accounting for Derivatives and Hedging Activities” and concluded that the promissory note provisions did not constitute embedded derivatives.
11. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No.109, 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.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN No. 48”), on January 1, 2007. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes", 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. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company has 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, 2005, 2006 and 2007, the tax years which remain subject to examination by major tax jurisdictions as of December 31, 2008.
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 December 31, 2008, the Company had recorded immaterial state interest and penalties associated with the filing of the 2006 and 2007 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.
For the years ended December 31, 2008and 2007, the components of the provision for income taxes from continuing operations consisted of:
The net tax provision included in the loss from discontinued operations was $0.3 million for the year ended December 31, 2007; calculated using an effective rate of 38.62%.
In addition, as the Blair acquisition in October 2005 was structured as a tax-free purchase, the difference between GAAP reporting and tax reporting of goodwill resulting from the acquisition is considered to be a permanent difference. The goodwill impairment loss recorded during 2006 is also considered to be a permanent difference and is recorded as a component of the discontinued operations. Refer to our 2006 Annual Report on Form 10-K for Paradigm Holdings, Inc. for a further discussion of the Blair acquisition and goodwill impairment.
The provision for income taxes from continuing operations for the years ended December 31, 2008 and 2007 reflected in the accompanying financial statements varies from the amount which would have been computed using statutory rates as follows:
