Under the terms of the Pequot/Constellation Purchase Agreement, until shareholder approval was received for the transaction, the Investors had the right to acquire Series A-4 Convertible Secured Subordinated Promissory Notes (“Series A-4 Notes”) in lieu of Series A-4 Convertible Preferred Stock and Series A-5 Convertible Secured Subordinated Promissory Notes (“Series A-5 Notes”) in lieu of Series A-5 Convertible Preferred Stock. As a result, the initial $16.0 million invested under the Pequot/Constellation Purchase Agreement was in the form of Series A-4 Notes, together with warrants to purchase common stock. On June 23, 2005 the shareholders approved the transaction and the outstanding Series A-4 Notes converted into shares of Series A-4 Preferred Stock.
The Company originally assigned a value of $6.8 million to the beneficial conversion feature of the Series A-4 Notes and the common stock warrants issued in connection therewith (the “Series A-4 Warrants”), and the Investors’ option to acquire additional Series A-4 Notes and Series A-4 Warrants and to acquire Series A-5 Notes based on the relative fair values using Black-Scholes at the date of issuance and recorded this value as a discount to the Series A-4 Notes when issued. This discount was accreted to interest expense over the term of the applicable Series A-4 Notes. During the period ended June 30, 2005, the discount accreted to interest expense amounted to approximately $2.9 million.
Beginning May 21, 2006, the Series A Preferred Stock began to accrue dividends, payable semi-annually in arrears, in an amount equal to 6% of the applicable Series A purchase price. As of December 31, 2006, the Company has accrued $2.2 million in preferred dividends which was charged to equity. Until May 21, 2008 dividends may at the option of the Company, be paid in cash or shares of the applicable Series A Preferred Stock valued at the applicable Series A purchase price. The Series A purchase prices range from $2.15 to $3.25. During the third quarter of fiscal 2007 the Company paid $1.8 million in preferred dividends for the period May 21, 2006 to November 20, 2006 in the form of 600,732 shares of Series A Preferred Stock. Dividends are accrued as other long-term liabilities since the current intention of the Company is to pay dividends in the form of equity.
On November 23, 2005 the Company entered into a secured credit agreement with Columbia Partners, L.L.C. Investment Management, as Investment Manager, (“Columbia Partners”) and National Electric Benefit Fund, as Lender (the “Lender”), whereby the Company issued and sold to the Lender a promissory note in the principal amount of $25 million (the “Note”) and the Company issued and sold to the Lender a warrant entitling the Lender to purchase 700,000 shares of the Company’s Common Stock at an exercise price of $4.06 per share (the “Lender Warrant”).
The Note is a four year $25 million secured subordinated term loan with the Note coming due at the earlier of maturity or the occurrence of certain fund raisings or other liquidity events. The amount outstanding on the Note bears interest equal to 4.52%, of which 2% per annum is payable quarterly in cash and all remaining interest will accrue and only become due at maturity. Upon maturity or upon the occurrence of certain liquidity events, the Company will pay a payment premium in respect of the Note equal to an amount which, when combined with previous payments made, will yield an internal rate of return to the Lender of 11%. As of December 31, 2006, $2.8 million in interest has been accrued on the Note, of which $0.4 million has been paid in cash, $0.1 million is accrued and payable within the next quarter, and $2.3 million is accrued and is payable at maturity. The Note is secured by a subordinated lien on the assets of the Company. In connection with the issuance of the Note and the related Lender Warrant, the Company allocated and charged $2.2 million to debt discount, which will be amortized over the life of the Note to interest expense, and assigned and credited to additional paid in capital $2.2 million for the fair value of the Lender Warrant. The Company is permitted to settle the warrants with unregistered shares. The value attributed to the Lender Warrant was determined by independent valuation utilizing Black-Scholes.
The Note requires, among other things, that the Company maintain certain financial covenants including that the Company maintain Consolidated Senior Leverage of not greater than 4.40 to 1.00 as of the end of December 31,
2006, and for the trailing four quarters and consecutive four quarters ending thereafter and that the Company maintain a Consolidated Fixed Charge Coverage Ratio of not less than .90 to 1.00 for the trailing four quarters ended December 31, 2006 and consecutive four quarters ending thereafter. It also restricts the Company’s ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. The Company received a waiver letter in November 2006 from Columbia Partners, which included a waiver of the Consolidated Senior Leverage Ratio and the Consolidated Fixed Charge Coverage Ratio until the end of the four fiscal quarters ending on March 31, 2008.
NOTE 10. SEGMENT INFORMATION
The Company currently operates only within the United States. Substantially all of the Company’s revenue generating operations have similar economic characteristics, including the nature of the products and services sold; the type and class of clients for products and services; the methods used to deliver products and services and regulatory environments.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K/A for the year ended March 31, 2006 and the unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q.
Introductory Comment—Terminology
Throughout this Form 10-Q, the terms “we,” “us,” “our” and “our company” refers to MTM Technologies, Inc. (“MTM”) and, unless the context indicates otherwise, our subsidiaries on a consolidated basis.
“Pequot Fund” refers to Pequot Private Equity Fund III, L.P., “Pequot Partners” refers to Pequot Offshore Private Equity Partners III, L.P., and collectively with Pequot Fund, “Pequot,” “Constellation Venture” refers to Constellation Venture Capital II, L.P., “Constellation Offshore” refers to Constellation Venture Capital Offshore II, L.P., “BSC” refers to the BSC Employee Fund VI, L.P., “CVC” refers to the CVC Partners II, LLC, and collectively with Constellation Venture, Constellation Offshore and BSC, “Constellation,” and together with Pequot, the “Investors.”
Introductory Comment—Forward-Looking Statements
Statements contained in this Form 10-Q include “forward-looking statements” within the meaning of such term in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual financial or operating results, performances or achievements expressed or implied by such forward-looking statements not to occur or be realized. Forward-looking statements made in this Form 10-Q generally are based on our best estimates of future results, performances or achievements, predicated upon current conditions and the most recent results of the companies involved and their respective industries. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “should,” “project,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” “potential,” “opportunity” or similar terms, variations of those terms or the negative of those terms or other variations of those terms or comparable words or expressions. Potential risks and uncertainties include, among other things, such factors as:
we have incurred losses in our last three fiscal years and our losses may continue;
our dependence on third party licenses and the failure to maintain our status as an authorizedreseller/service provider of IT products could have a material adverse effect on our business andoperations;
we require access to significant working capital and vendor credit to fund our day-to-dayoperations;
our ability to acquire additional companies and ability to successfully integrate such acquirees, if
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any, into our operations;
the competitive environments within the industries in which we operate;
our ability to raise additional capital, if and as needed; the cost-effectiveness of our product andservice development activities;
the extent that our sales network and marketing programs achieve satisfactory response rates;
general economic conditions in the United States and elsewhere, as well as the economicconditions affecting the industries in which we operate; and
the other risks detailed in this Form 10-Q and, from time to time, in our other filings with theSecurities and Exchange Commission.
Readers are urged to carefully review and consider the various disclosures made by us in this Form 10-Q and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this Form 10-Q speak only as of the date hereof and we disclaim any obligation to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements 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, as well as the reported amounts of revenues and expenses during the reporting period. The methods, estimates, and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. Actual results may differ from these estimates under different assumptions or conditions. The Securities and Exchange Commission has defined critical accounting policies as policies that involve critical accounting estimates that require (a) management to make assumptions that are highly uncertain at the time the estimate is made and (b) different estimates that could have been reasonably used for the current period, or changes in the estimates that are reasonably likely to occur from period to period, which would have a material impact on the presentation of our financial condition, changes in financial condition or in results of operations. Based on this definition, our most critical policies include, but are not limited to, revenue recognition, allowance for doubtful accounts, inventory valuation reserve, the assessment of recoverability of long-lived assets, the assessment of recoverability of goodwill and intangible assets, and valuation of deferred tax assets.
The Company’s critical accounting policies are disclosed in the Company’s Annual Report on Form 10-K/A. There have been no material changes to these policies during the first nine months of fiscal 2007.
Overview
We are a leading national provider of innovative information technology (“IT”) solutions, including Access, Convergence, Consolidation, Virtualization, and Managed Services. We enable our clients to achieve improved operational efficiency and to focus on growth, while mitigating the risk of implementing complex IT systems. We achieve these results by providing systems, networking, IP telephony, storage, security and data center infrastructure services that address the full life cycle of a client’s IT requirements from needs analysis, through planning, development, deployment, and testing, to on-going maintenance and support. We combine these services with technology from leading software and hardware manufacturers delivering strategic IT solutions that solve many of today’s business challenges.
Our clients consist of middle market corporations (generally those with $50 million to $1 billion in revenues), divisions of Global 2000 corporations, municipal, state and federal government agencies, and educational institutions. We serve clients in most major US metropolitan markets.
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As of December 31, 2006 the Pequot and Constellation investment has totaled $60 million. The Company has used these funds to execute a growth strategy, as well as for working capital needs. We believe that there is an opportunity to consolidate similar businesses throughout the United States. The Company expects to focus its acquisition strategy on businesses providing networking, messaging, storage and security solutions. The Company has executed its growth strategy since July 2004 by completing six strategic acquisitions through December 31, 2006 of providers of advanced technology solutions and products. We have spent the last few fiscal quarters integrating those businesses, building necessary infrastructure and centralizing operations in an effort to provide our customers with a national strategy to enhance customer service and to be able to provide customers with a wide offering of practices. We believe that the Company is poised to focus on enhancing our relationship with customers and to operate our business in a more efficient and effective manner.
The Company continues to seek acquisitions that will further the Company’s growth and operating strategies. As additional companies are acquired, the sales mix, market focus, cost structure and operating leverage may change significantly. As of the date of this Form 10-Q, we did not have any formal or informal agreements or understandings with respect to any material acquisitions.
Consolidated Results of Operations
The following table sets forth for the periods presented information derived from our unaudited consolidated statement of operations expressed as a percentage of net revenues, unless otherwise noted:
| | | Three Months Ended | | | Nine Months Ended | |
| | | December 31, | | | December 31, | |
| | | 2006 | | | 2005 | | | 2006 | | | 2005 | |
| | | | | | (Restated- | | | | | | (Restated- | |
| | | | | | See Note 1) | | | | | | See Note 1) | |
| Net revenues: | | | | | | | | | | | | |
| Products | | 75.2% | | | 78.8% | | | 75.6% | | | 73.2% | |
| Services | | 24.8% | | | 21.2% | | | 24.4% | | | 26.8% | |
| Total net revenues | | 100.0% | | | 100.0% | | | 100.0% | | | 100.0% | |
| |
| Gross Profit – products (a) | | 16.0% | | | 13.5% | | | 14.9% | | | 13.9% | |
| Gross Profit – services (a) | | 36.7% | | | 40.2% | | | 37.0% | | | 41.1% | |
| Gross Profit – total | | 21.1% | | | 19.2% | | | 20.3% | | | 21.2% | |
| Selling, general and administrative | | | | | | | | | | | | |
| expenses (b) | | 25.0% | | | 18.8% | | | 25.9% | | | 22.3% | |
| Restructuring | | 0.0% | | | 0.0% | | | 2.1% | | | 0.0% | |
| Operating (loss) income | | (3.9%) | | | 0.4% | | | (7.8%) | | | (1.1%) | |
| Interest expense (c) | | 1.8% | | | 0.9% | | | 1.8% | | | 2.6% | |
| Net loss | | (6.5%) | | | (0.8%) | | | (10.2%) | | | (3.9%) | |
| | (a) | Expressed as a percentage of the applicable product or service revenue. |
| |
| | (b) | Included in the nine months ended December 31, 2005 is $1.2 million of expense incurred in the first quarter of fiscal 2006 for the settlement of certain executive arrangements and deferred payments relating to the May 2004 Pequot investment. |
| |
| | (c) | Included in the nine months ended December 31, 2005 is $3.2 million of non cash interest expense and amortization of debt discount incurred during the first fiscal quarter of 2006 related to the convertible subordinated notes which converted to equity in June 2005. |
Three and Nine Months Ended December 31, 2006, as Compared to the Three and Nine Months Ended December 31, 2005
Net Revenue
Net revenues for the three months ended December 31, 2006 increased $0.8 million, or 1.1%, to $69.8 million. The three months ended December 31, 2006 included a full period of the revenue of Nexl, Inc. (“Nexl”), which was
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acquired in December 2005. The increase in net revenues for the three month ended December 31, 2006 was due to an increase in service revenue of $2.7 million, partially offset by a decrease in product revenue of $2.0 million. The increase in service revenue was attributable to the inclusion in the current period of a full quarter of Nexl’s service revenue, as well as success in the leveraging of the rollout of new practices into existing customer accounts. The decrease in product revenue was due to the Company’s strategy of not pursuing lower margin product business, as well as a change to a referral fee program by one of the Company’s software vendor partners. Under the old program, MTM recognized the gross revenue and cost related to certain products sales. Under the new program, MTM is paid a referral fee for these product sales. The referral fee is typically equal to the net gross margin that would have been recognized under the prior program.
Net revenues for the nine months ended December 31, 2006 increased $47.1 million, or 28.4%, to $212.7 million. The increase in revenue is primarily due to the acquisition of Nexl in December 2005.
Gross Profit
Gross profit for the three months ended December 31, 2006 increased $1.5 million, or 11.3%, to $14.7 million. Product gross margin was 16.0% for the quarter ended December 31, 2006 and 13.5% for the quarter ended December 31, 2005. Service gross margin was 36.7% for the quarter ended December 31, 2006 and 40.2% for the quarter ended December 31, 2005.
For the nine months ended December 31, 2006 gross profits increased $8.1 million, or 23.2% to $43.1 million. Product gross margin for the nine months ended December 31, 2006 was 14.9% in the period as compared with 13.9% for the nine months ended December 31, 2005. Included in product costs for the nine months ended December 31, 2006 were one time charges of $0.5 million related to a write-off of obsolete inventory purchased as part of prior business acquisitions. Service gross margin was 37.0% for the nine months ended December 31, 2006 as compared with 41.1% for the comparable prior year period.
Overall the increase in gross profit for the periods was primarily attributable to the inclusion of the results of Nexl, a business acquired in December 2005. The decrease in service gross margin was the result of early stage investments in our professional services business in anticipation of future acquisitions and the dilutive impact of the acquisition of Nexl, which had lower service gross margins than our historical businesses.
Selling, General and Administrative
Selling, general and administrative expenses (S,G&A) for the three months ended December 31, 2006 increased by $4.5 million, or 34.8%, to $17.4 million. For the nine months ended December 31, 2006 S,G&A increased by $18.3 million, or 49.5%, to $55.2 million. These increases were due primarily to the inclusion of a full period of operating expenses for Nexl, increased operating expenses attributable to the expansion of corporate administration necessary to support the Company’s expected future growth and acquisitions, and transition costs related to the integration of our national infrastructure. Additionally results for the current periods include the impact of adopting SFAS No. 123(R). Stock-based compensation cost recognized in the condensed consolidated statement of earnings for the three and nine months ended December 31, 2006 was approximately $0.4 million and $1.1 million respectively. Reflective of both periods were higher depreciation expenses related to recent investments in capital assets.
Restructuring
Results for the nine months ended December 31, 2006 include a restructuring charge of $4.5 million incurred during the first half of this fiscal year primarily related to a reduction in workforce of $3.0 million in accordance with our integration and cost reduction plans, a charge for unused or underutilized facility costs of $0.8 million, and other related restructuring charges of $0.7 million. There were no comparable charges in the quarter ended December 31, 2006 or in the prior year periods. See Note 3 to the Condensed Consolidated Financial Statements for a discussion of these cost savings initiatives.
EBITDA
Earnings before interest, taxes, depreciation, amortization, stock-based compensation cost and other expense (“EBITDA”) amounted to $0.1 million for the quarter ended December 31, 2006, as compared to $1.8 million in the comparable fiscal 2006 quarter. Third quarter EBITDA for fiscal 2007 includes $0.6 million of integration costs, which are not expenses in the corresponding prior period and an increase in S,G& A expenses primarily related to a
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full period of expenses for Nexl as well as increased corporate expenses as noted above. EBITDA for the nine months ended December 31, 2006 amounted to negative $8.4 million as compared to a positive $2.1 million for the nine months ended December 31, 2005. The reduction in EBITDA for nine months ended December 31, 2006 was primarily the result the increase in S,G&A expenses described above, as well as the impact of the $4.5 million of restructuring charges which was not an expense in the corresponding prior period. The following table sets forth a reconciliation of EBITDA to net loss for the periods presented.
| | | Three Months Ended | | | Nine Months Ended | |
| | | December 31, | | | December 31, | |
| (in thousands) | | | 2006 | | | | 2005 | | | | 2006 | | | | 2005 | |
| | | | | | | (Restated- | | | | | | | (Restated- | |
| | | | | | | See Note 1) | | | | | | | See Note 1) | |
| EBITDA | | $ | 51 | | | $ | 1,833 | | | $ | (8,371 | ) | | $ | 2,114 | |
| Depreciation and amortization | | | 2,312 | | | | 1,531 | | | | 6,846 | | | | 3,948 | |
| Interest expense (a) | | | 1,259 | | | | 631 | | | | 3,833 | | | | 4,344 | |
| Stock-based compensation cost | | | 463 | | | | 12 | | | | 1,380 | | | | 61 | |
| Other expense | | | 335 | | | | - | | | | 400 | | | | - | |
| Income taxes | | | 236 | | | | 179 | | | | 774 | | | | 179 | |
| Net loss | | $ | (4,554 | ) | | $ | (520 | ) | | $ | (21,604 | ) | | $ | (6,418 | ) |
(a) Included in the nine months ended December 31, 2005 is $3.2 million of non-cash interest expense and amortization of debt discount incurred during the first fiscal quarter of 2006 related to the convertible subordinated notes which converted to equity in June 2005.
We believe that EBITDA, which is not a recognized measure for financial presentation under GAAP, provides investors and management with a useful supplemental measure of our operating performance because it more closely approximates the cash generating ability of the Company as compared to operating income (loss). Operating income (loss) includes charges for depreciation and amortization of intangible assets as well as stock-based compensation cost. These non-GAAP results should be evaluated in light of our financial results prepared in accordance with GAAP. EBITDA is not a recognized measure for financial statement presentation under GAAP. Non-GAAP earnings measures do not have any standardized definition and are therefore unlikely to be comparable to similar measures presented by other reporting companies. This non-GAAP measure is provided to assist readers in evaluating our operating performance. Readers are encouraged to consider this non-GAAP measure in conjunction with our GAAP results.
Interest Expense
Interest expense was $1.3 million for the quarter ended December 31, 2006 compared to $0.6 million for the quarter ended December 31, 2005. The increase in interest for the quarter is primarily due to a full period of interest on the secured promissory note entered into in late November of the third quarter of fiscal 2006 coupled with the impact of higher average borrowings and related interest costs on our credit facilities. Interest for the nine months ended December 31, 2006 decreased $0.5 million, to $3.8 million compared to $4.3 million for the comparable prior year period. Included in the nine months ended December 31, 2005 is $3.2 million of non-cash interest expense and amortization of debt discount incurred during the first fiscal quarter of 2006 related to the convertible subordinated notes which converted to equity in June 2005. This decrease was partially offset by the impact of a full nine months of interest on the Columbia debt combined with higher average borrowings and related interest costs on our working capital lines.
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Liquidity and Capital Resources
The Company measures its liquidity in a number of ways, including the following:
| | | December 31, | | | March 31, |
| (in thousands) | | 2006 | | | 2006 |
| |
| Cash | | $ | 5,650 | | | $ | 18,154 |
| Working capital | | $ | (7,734 | ) | | $ | 10,704 |
| Current ratio | | | .89 to 1 | | | | 1.16:1 |
| Secured financing facilities | | $ | 21,732 | | | $ | 20,557 |
| Secured promissory note | | $ | 23,367 | | | $ | 22,947 |
For the nine months ended December 31, 2006 cash decreased $12.5 million to $5.6 million compared with $18.1 million at March 31, 2006, due primarily to the loss incurred during the period, increased working capital needs and the cost of capitalization of internal costs relating to software development and infrastructure investment. Working capital at December 31, 2006 was a deficit of $7.7 million as compared to working capital of $10.7 million at March 31, 2006. Included in current liabilities at December 31, 2006 are obligations of $21.7 million relating to the Company’s secured financing facilities, described below.
The Company has a secured revolving credit facility (the “CIT Facility”) with CIT Group/Business Credit Inc. (“CIT”) and an Amended and Restated Loan and Security Agreement (the “New Textron Facility”) which provide a combined availability of $40 million.
The CIT Facility is a three year revolving credit facility for up to $25 million, subject to a borrowing base consisting of eligible accounts receivable, eligible in-transit inventory (up to $0.5 million) and eligible finished goods inventory (up to $0.5 million). The amounts available to the Company from CIT are also reduced by amounts borrowed under the New Textron Facility. Effective the second quarter of fiscal 2007, CIT reduced the amount the Company can borrow under the CIT Facility by requiring an availability reserve of $3 million. The CIT Facility requires, among other things, that the Company maintain certain financial covenants including that the Company maintain Consolidated Liquidity of not less than $3 million measured on a weekly basis, Consolidated Senior Leverage of not greater than 4.00 to 1.00 for the trailing four quarters and that the Company maintain a Consolidated Fixed Charge Coverage Ratio of not less than 1.00 to 1.00 for the trailing four quarters. It also restricts the Company’s ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. Amounts borrowed under the CIT Facility bear interest at either the prime rate or at LIBOR plus 3%, in each case at the Company’s option.
The New Textron Facility allows the Company to finance inventory purchases up to $15 million from approved vendors on a 45-day interest-free basis in most cases. Interest accrues after expiration of the applicable interest free period at the rate equal to a specified prime rate plus 4%. The financial and other covenants in the New Textron Facility are substantially the same as those in the CIT Facility.
As of December 31, 2006, the Company was not in compliance with all covenants prescribed under the CIT Facility and the New Textron Facility; however, the Company received waiver letters from both CIT and Textron.
The Company’s outstanding debt and available funds under both the CIT Facility and the New Textron Facility amounted to $21.7 million and $4.9 million, respectively at December 31, 2006.
On November 23, 2005 the Company entered into a secured credit agreement with Columbia Partners, L.L.C. Investment Management, as Investment Manager, (“Columbia Partners”) and National Electric Benefit Fund, as Lender (the “Lender”), whereby the Company issued and sold to the Lender a promissory note in the principal amount of $25.0 million (the “Note”) and the Company issued and sold to the Lender a warrant entitling the Lender to purchase 700,000 shares of the Company’s Common Stock at an exercise price of $4.06 per share (the “Lender Warrant”). The Company used a portion of the funds to finance the acquisition of Nexl, Inc. on December 1, 2005.
The Note is a four year $25 million secured subordinated term loan with the Note coming due at the earlier of maturity or the occurrence of certain fund raisings or other liquidity events. The amount outstanding on the Note bears interest equal to 4.52%, of which 2% per annum is payable quarterly in cash and all remaining interest will accrue and only become due at maturity. Upon maturity or upon the occurrence of certain liquidity events, the
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Company will pay a payment premium in respect of the Note equal to an amount which, when combined with previous payments made, will yield an internal rate of return to the Lender of 11%. As of December 31, 2006, $2.8 million in interest has been accrued on the Note, of which $0.4 million has been paid in cash, $0.1 million is accrued and payable within the next quarter, and $2.3 million is accrued and is payable at maturity. The Note is secured by a subordinated lien on the assets of the Company. In connection with the issuance of the Note and the related Lender Warrant, the Company allocated and charged $2.2 million to debt discount, which will be amortized over the life of the Note to interest expense, and assigned and credited $2.2 million to additional paid-in capital for the fair value of the Lender Warrant. The Company is permitted to settle the warrants with unregistered shares. The value attributed to the Lender Warrant was determined by an independent valuation utilizing Black-Scholes.
The Note requires, among other things, that the Company maintain certain financial covenants including that the Company maintain Consolidated Senior Leverage of not greater than 4.40 to 1.00 as of the end of December 31, 2006, and for the trailing four quarters and consecutive four quarters ending thereafter and that the Company maintain a Consolidated Fixed Charge Coverage Ratio of not less than .90 to 1.00 for the trailing four quarters ended December 31, 2006 and consecutive four quarters ending thereafter. It also restricts the Company’s ability to incur certain additional indebtedness, and contains various customary provisions, including affirmative and negative covenants, representations and warranties and events of default. The Company received a waiver letter in November 2006 from Columbia Partners which included a waiver of the Consolidated Senior Leverage Ratio and the Consolidated Fixed Charge Coverage Ratio until the end of the four fiscal quarters ending on March 31, 2008.
As of December 31, 2006 the Pequot and Constellation investment totaled $60 million. The Company has used these funds to execute a growth strategy, as well as for working capital needs. The Company currently does not have any other agreements, arrangements or understandings with respect to any prospective material acquisitions.
Cash used in operating activities was $7.4 million for the nine months ended December 31, 2006, derived from a net loss of $21.6 million plus an increase in net operating liabilities of $2.8 million and non-cash charges of $11.4 million during the period. The increase in net operating liabilities relates primarily to an increase in accounts payable due to the timing of vendor payments and the increase in accrued expenses as a result of the restructuring and integration plans as well as $1.4 million accrued in the current period related to an earned payout for Nexl. These increases were partially offset by an increase in receivables as a result of strong product revenues in December.
Cash used in investing activities was $6.1 million for the nine months ended December 31, 2006 as a result of the acquisition of Axcent for $0.5 million and the additions to capital expenditures which approximated $5.6 million including capitalized costs related to the internal development of purchased and developed software and infrastructure investment of $2.7 million. The Company has no plans for any material purchases of property and equipment including capital software projects for the balance of the fiscal year.
Cash provided by financing activities was $0.9 million for the nine months ended December 31, 2006, primarily the result of higher net borrowings on our working capital lines of $1.2 million plus cash proceeds received from the exercise of stock options of $0.4 million offset by principal payments made on our long-term debt obligations of $0.8 million.
The Company sustained net losses during the years ended March 31, 2005, and 2006 and for the three and nine month periods ended December 31, 2006. At December 31, 2006 the Company had a net working capital deficit of $7.7 million. Net of the Company’s secured credit facility, working capital was $14.0 million. The Company has made a concerted effort in the current fiscal year to improve its working capital position. These have included a $4.5 million restructuring, other cost control initiatives, and the discontinuation of certain sales of low margin products. The Company anticipates that its available cash together with its credit facilities, will provide the Company with the capital necessary to meet its obligations as they come due in the foreseeable future. The Company currently has no commitments for material capital expenditures. The Company may seek additional capital or financing arrangements to consummate future acquisitions or meet working capital needs, however, no assurance can be given that such financing may be obtained.
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Lease Commitments
The Company leases locations for its administrative and operational functions under operating leases expiring at various dates through 2016. Certain leases are subject to escalation based on the Company’s share of increases in operating expenses for the locations. In addition, the Company leases equipment, software and vehicles used in operations under both operating and capital leases.
Future annual minimum lease payments including estimated escalation amounts under non-cancelable operating and capital leases as of December 31, 2006 are approximately $17 million.
Recently Issued Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We do not expect FIN 48 will have a material effect on our consolidated financial condition or results of operations.
In September 2006, the FASB issued Statement No. 157,Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands fair value measurement disclosures. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating whether adoption of SFAS 157 will have an impact on our financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 addresses the diversity in practice in quantifying financial statement misstatements and establishes an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the Company’s financial statements and the related disclosures. SAB 108 is effective for fiscal years ending after November 15, 2006. We currently do not expect that the adoption of SAB 108 will have a material impact on our financial position, results of operations and cash flows.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Interest on our financing arrangements are based on the prime rate, consequently, any changes in that rate will impact our interest expense. Based on the average current level of borrowings of approximately $21.5 million, a 0.25% increase in the prime rate would translate to an approximate $53,750 increase in our annual interest expense. The Company does not currently hedge interest rate exposures.
There has been no material change in credit risk or accounts receivable risk discussed in Item 7 of the Company’s Fiscal 2006 Annual Report on Form 10-K/A.
Item 4.Controls and Procedures
An evaluation was performed, as of December 31, 2006, under the supervision and with the participation of our management, including our Chief Executive Officer (‘CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on such evaluation, our management, including the CEO and CFO have concluded that our disclosure controls and procedures were effective as of December 31, 2006.
Changes in Internal Control
There have been no changes made in our internal controls over financial reporting identified in connection with our evaluation as of the end of our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
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Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all controls issues and instances of fraud, if any, within a company have been detected. Our disclosure controls and procedures are designed to provide a reasonable assurance of achieving their objectives and our CEO and CFO have concluded that the controls and procedures evaluated are effective at the “reasonable assurance” level.
PART II - OTHER INFORMATION
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Reference is made to the disclosures contained in Item 3.02 of our Current Report on Form 8-K (Date of Report: November 21, 2006), filed with the Securities and Exchange Commission on November 27, 2006 for information concerning certain unregistered sales of equity securities and the use of proceeds thereof.
Item 4.Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders was held on December 14, 2006. At the Annual Meeting the following proposals were adopted by the vote specified below:
Proposal No. 1: The election of seven directors to serve until the next Annual Meeting of Shareholders of the Company or until such person shall resign, be removed or otherwise leave office:
| | | Total Votes Cast |
| | | For | | Withheld |
| Gerald A. Poch | | 29,063,834 | | 438,069 |
| Francis J. Alfano | | 28,767,978 | | 753,925 |
| William Lerner | | 29,158,258 | | 363,645 |
| Alvin E. Nashman | | 29,158,258 | | 363,645 |
| Arnold J. Wasserman | | 29,158,258 | | 363,645 |
| Richard R. Heitzmann | | 29,150,266 | | 371,637 |
| Thomas Wasserman | | 29,160,716 | | 361,187 |
Proposal No. 2: The proposal to approve the exercise of the Series A-5 Warrants to purchase 450,000 shares of our common stock at $4.06 per share:
| Vote | | Number of Votes Cast |
| For | | 24,447,490 | |
| Against | | 411,995 | |
| Abstain | | 13,353 | |
| Broker Non-Votes | | 3,487,098 | |
| | | | |
Item 6.Exhibits
(a) Exhibits
Set forth below is a list of the exhibits to this Quarterly Report on Form 10-Q.
| Exhibit | | |
| No. | | Description |
| |
| 3.1 | | Restated Certificate of Incorporation.* |
| 3.2 | | Amended and Restated By-Laws.* |
| 4.1 | | Purchase Agreement, dated January 29, 2004, among Micros-to-Mainframes, Inc., Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P.* |
24
| 4.2 | Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P. Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.* |
| |
| 4.3 | Amendment No. 1 to the Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.* |
| |
| 4.4 | Amendment No. 2 to the Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.* |
| |
| 4.5 | Amended and Restated Shareholders’ Agreement, dated August 1, 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC.* |
| |
| 4.6 | Amended and Restated Registration Rights Agreement, dated August 1, 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. * |
| |
| 4.7 | Amendment No. 1 to the Amended and Restated Registration Rights Agreement, dated December 10 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. * |
| |
| 4.8 | Warrant Certificate, evidencing 438,225 warrants registered in the name of Pequot Private Equity Fund III, LLP. * |
| |
| 4.9 | Warrant Certificate, evidencing 61,775 warrants registered in the name of Pequot Offshore Private Equity Partners III, L.P. * |
| |
| 4.10 | Warrant Certificate, evidencing 350,580 warrants registered in the name of Pequot Private Equity Fund III, L.P. * |
| |
| 4.11 | Warrant Certificate, evidencing 49,420 warrants registered in the name of Pequot Offshore Private Equity Partners III, L.P. * |
| |
| 4.12 | Form of Series A-3 Warrant Certificate.* |
| |
| 4.13 | Form of the A-4 Warrant Certificate.* |
| |
| 4.14 | Form of the Series A-5 Warrant Certificate.* |
| |
| 4.15 | Warrant Certificate issued to the National Electric Benefit Fund.* |
| |
| 4.16 | Columbia Voting Agreement.* |
| |
| 4.17 | Series A-5 Voting Agreement.* |
| |
| 31.1 | Certification pursuant to Exchange Act Rule 13a-14(a) of Francis J. Alfano. |
| |
| 31.2 | Certification pursuant to Exchange Act Rule 13a-14(a) of J.W. Braukman III. |
| |
| 32.1 | Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Francis J. Alfano. |
| |
| 32.2 | Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of J.W. Braukman III. |
_________
* Incorporated by reference. See Exhibit Index.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | MTM TECHNOLOGIES, INC. |
| |
| February 14, 2007 | | By: | /s/ Francis J. Alfano |
| | | | Francis J. Alfano, Chief Executive Officer |
| | | | (Principal Executive Officer) |
| |
| |
| |
| February 14, 2007 | | By: | /s/ J.W. Braukman III |
| | | | J.W. Braukman III, Chief Financial Officer |
| | | | (Principal Financial and Accounting Officer) |
MTM Technologies, Inc.
QUARTERLY REPORT ON FORM 10-Q
Fiscal Quarter Ended December 31, 2006
EXHIBIT INDEX
Exhibit
Number | | Description |
| 3.1 | | Restated Certificate of Incorporation [Incorporated by reference to Exhibit 3 to the registrant’s Current Report on Form 8-K (Date of Report: June 29, 2005) filed with the Securities and Exchange Commission on July 5, 2005.] |
| |
| 3.2 | | Amended and Restated By-Laws. [Incorporated by reference to Exhibit 3.1 to the registrant’s Current Report on Form 8-K (Date of Report: August 5, 2004), filed with the Securities and Exchange Commission on August 13, 2004.] |
| |
| 4.1 | | Purchase Agreement, dated January 29, 2004, among Micros-to-Mainframes, Inc., Pequot Private Equity Fund III, L.P. and Pequot Offshore Private Equity Partners III, L.P. [Incorporated by reference to Appendix A to the proxy statement contained as part of the registrant’s definitive Schedule 14A, filed with the Securities and Exchange Commission on April 15, 2004.] |
| |
| 4.2 | | Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K, (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.] |
| |
| 4.3 | | Amendment No. 1 to the Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 4.3 to the registrant’s Quarterly Report on Form 8-K, (Date of Report: December 31, 2005), filed with the Securities and Exchange Commission on February 14, 2006.] |
| |
| 4.4 | | Amendment No. 2 to the Purchase Agreement, dated December 7, 2004, among MTM Technologies, Inc., Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K, (Date of Report: November 22, 2005), filed with the Securities and Exchange Commission on November 29, 2005.] |
| |
| 4.5 | | Amended and Restated Shareholders’ Agreement, dated August 1, 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K, (Date of Report: August 1, 2005), filed with the Securities and Exchange Commission on August 4, 2005.] |
| |
| 4.6 | | Amended and Restated Registration Rights Agreement, dated August 1, 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K, (Date of Report: August 1, 2005), filed with the Securities and Exchange Commission on August 4, 2005.] |
| |
| 4.7 | | Amendment No. 1 to the Amended and Restated Registration Rights Agreement, dated December 10, 2005, among MTM Technologies, Inc., Steven Rothman, Howard Pavony, Pequot Private Equity Fund III, L.P., Pequot Offshore Private Equity Partners III, L.P., Constellation Venture Capital II, L.P., Constellation Venture Capital Offshore II, L.P., The BSC Employee Fund VI, L.P. and CVC Partners II, LLC. [Incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K, (Date of Report: November 22, 2005), filed with the Securities and Exchange Commission on November 29, 2005.] |
| |
| 4.8 | | Warrant Certificate, evidencing 438,225 warrants registered in the name of Pequot Private Equity Fund III, LLP. [Incorporated by reference to Exhibit 10.6 to the registrant’s Current Report on Form 8-K (Date of Report: May 21, 2004), filed with the Securities and Exchange Commission on June 7, 2004.] |
| |
| 4.9 | Warrant Certificate, evidencing 61,775 warrants registered in the name of Pequot Offshore Private Equity Partners III, L.P. [Incorporated by reference to Exhibit 10.6 to the registrant’s Current Report on Form 8-K (Date of Report: May 21, 2004), filed with the Securities and Exchange Commission on June 7, 2004.] |
| |
| 4.10 | Warrant Certificate, evidencing 350,580 warrants registered in the name of Pequot Private Equity Fund III, L.P. [Incorporated by reference to Exhibit 4.5 to the registrant’s Registration Statement on Form S-3 (Commission File No. 333-117549) filed with the Securities and Exchange Commission on December 5, 2004.] |
| |
| 4.11 | Warrant Certificate, evidencing 49,420 warrants registered in the name of Pequot Offshore Private Equity Partners III, L.P. [Incorporated by reference to Exhibit 4.5 to the registrant’s Registration Statement on Form S-3 (Commission File No. 333-117549) filed with the Securities and Exchange Commission on October 5, 2004.] |
| |
| 4.12 | Form of Series A-3 Warrant Certificate [Incorporated by reference to Exhibit 10.7 of the registrant’s Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.] |
| |
| 4.13 | Form of the A-4 Warrant Certificate [Incorporated by reference to Exhibit 10.3 to the registrant’s Current Report on Form 8-K (Date of Report: December 7, 2004), filed with the Securities and Exchange Commission on December 13, 2004.] |
| |
| 4.14 | Form of Series A-5 Warrant Certificate [Incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K (Date of Report: November 22, 2005), filed with the Securities and Exchange Commission on November 29, 2005.] |
| |
| 4.15 | Warrant Certificate issued to the National Electrical Benefit Fund. [Incorporated by reference to Exhibit 10.5 to the registrant’s Current Report on Form 8-K (Date of Report: November 22, 2005), filed with the Securities and Exchange Commission on November 29, 2005.] |
| |
| 4.16 | Columbia Voting Agreement [Incorporated by reference to Exhibit 99.1 to the registrant’s Current Report on Form 8-K (Date of Report: November 4, 2005), filed with the Securities and Exchange Commission on November 4, 2005.] |
| |
| 4.17 | Series A-5 Voting Agreement [Incorporated by reference to Exhibit 99.2 to the registrant’s Current Report on Form 8-K (Date of Report: November 22, 2005), filed with the Securities and Exchange Commission on November 29, 2005.] |
| |
| 31.1 | Certification pursuant to Exchange Act Rule 13a-14(a) of Francis J. Alfano. |
| |
| 31.2 | Certification pursuant to Exchange Act Rule 13a-14(a) of J.W. Braukman III. |
| |
| 32.1 | Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of Francis J. Alfano. |
| |
| 32.2 | Certification pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 of J.W. Braukman III. |
| |
