UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended DECEMBER 31, 2005
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR the transition period from to
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Commission file number: 0-20824
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INFOCROSSING, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 13-3252333
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State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
2 CHRISTIE HEIGHTS STREET, LEONIA, NJ 07605
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(Address of principal executive offices)
Registrant's telephone number, including area code: (201) 840-4700
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
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(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
[ ] Yes [X] No
Indicate by checkmark if the registrant is not required to file reports pursuant
to Section 13 or Section 15(d) of the Act.
[ ] Yes [X] No
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in a definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. Check one.
Large Accelerated Filer [ ] Accelerated Filer [X] Non Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
As of June 30, 2005, the aggregate market value of the outstanding shares of
voting common stock held by non-affiliates of the registrant was approximately
$234,578,000 based on the closing price of $12.47 as reported on the National
Association of Securities Dealers Automated Quotation System on June 30, 2005.
The registrant has no non-voting stock.
On March 8, 2006, there were 20,763,413 shares of the registrant's Common Stock,
$0.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III, Items 10-14 of this document are incorporated by reference from a
Definitive Proxy Statement to be filed by the Company on or before May 1, 2006.
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FORWARD LOOKING STATEMENTS
Statements made in this Annual Report on Form 10-K (the "Annual Report"),
including the accompanying financial statements and notes, other than statements
of historical fact, are forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance, including statements relating to products, customers, suppliers,
business prospects and effects of acquisitions. In some cases, forward-looking
statements can be identified by terminology such as "may," "will," "should,"
"expect," "anticipate," "intend," "plan," "believe," "estimate," "potential," or
"continue," the negative of these terms or other comparable terminology. These
statements involve a number of risks and uncertainties and as such, final
results could differ from estimates or expectations due to a number of factors
including, without limitation: incomplete or preliminary information; changes in
government regulations and policies; continued acceptance of our products and
services in the marketplace; competitive factors; closing contracts with new
customers and renewing contracts with existing customers on favorable terms;
expanding services to existing customers; new products; technological changes;
our dependence on third party suppliers; intellectual property rights;
difficulties with the identification, completion, and integration of
acquisitions, including the integration of Verizon Information Technologies
Inc., now known as Infocrossing Healthcare Services, Inc. and the completion of
the integration of (i)Structure, LLC; and other risks and uncertainties
including those set forth in this Annual Report that could cause actual events
or results to differ materially from any forward-looking statement. For any of
these factors, we claim the protection of the safe harbor for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995, as
amended.
You are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Annual Report and are based
on information currently and reasonably known to us. We undertake no obligation
to release any revisions to or update these forward-looking statements to
reflect events or circumstances that occur after the date of this Annual Report
or to reflect the occurrence or effect of anticipated or unanticipated events.
PART I
ITEM 1. BUSINESS.
GENERAL
Unless stated otherwise, references in this report to "Infocrossing," the
"Company," "we," "our" or "us" refer to Infocrossing, Inc., a Delaware
corporation, and its subsidiaries. Each trademark, trade name or service mark of
any other company appearing in this Annual Report belongs to its holder.
We are a national provider of selective information technology ("IT")
outsourcing solutions to large and medium size commercial and government
enterprises. Leveraging our data center infrastructure, Infocrossing takes over
and manages all or part of customers' IT mainframe and non-mainframe operations.
Customers utilize our IT systems, personnel and processing expertise in order to
reduce their operational and capital expenses, improve service delivery, scale
their IT operations or implement new technologies. By selectively outsourcing
well-defined IT operations that are often too costly or inefficient to maintain
in-house, customers can redirect valuable IT resources to other business
priorities. Generally, our customer contracts are long-term - typically ranging
from two to seven years with an average between three and four years - and
require fixed monthly fees.
We were organized as a New York corporation in October 1984 and reincorporated
in Delaware as of August 31, 1999. On June 5, 2000, we changed our name from
Computer Outsourcing Services, Inc. to highlight our expanded business base. We
have grown through acquisitions as well as through internal growth.
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On November 30, 2005, we acquired (i)Structure, LLC ("(i)Structure"), pursuant
to the terms of a Purchase Agreement (the "Purchase Agreement"), dated as of
October 24, 2005, between us and Level 3 Financing, Inc., a Delaware corporation
("Level 3"). Pursuant to the Purchase Agreement, we acquired 100 percent of the
membership interests of (i)Structure from Level 3 (the "(i)Structure
Acquisition"). The purchase price of the (i)Structure Acquisition consisted of
cash in the amount of approximately $82,267,000 and 346,597 shares of our common
stock valued at $2,500,000. We funded the cash portion of the purchase price
through a combination of the net proceeds of $67,043,000 from a new $70 million
debt facility which matures April 14, 2009, $11,512,000 in net proceeds from the
sale/leaseback of a certain parcel of land containing a data center with
approximately 88,000 rentable square feet in Omaha, Nebraska (the "Omaha
Property"), and the remainder with available cash. Subsequent to the
acquisition, we also sold and leased back a building and improvements with
approximately 60,000 square feet in Tempe, Arizona (the "Tempe Property"). The
Tempe Property is also subject to a ground lease.
(i)Structure, headquartered in Broomfield, CO, provides computing operations and
managed infrastructure services to enterprise clients from data centers located
in the central and western United States, and is recognized for their deep
expertise across computing platforms and commitment to client satisfaction.
(i)Structure's business model is based on signing clients to long-term contracts
for managing mainframe, midrange and open system computing platforms, and
related network and security services. An affiliate of Level 3 Financing was and
continues to be a vendor of communications services to us and to (i)Structure.
This vendor relationship is independent of, and did not affect the decision to
enter into, the purchase of (i)Structure.
MARKET OVERVIEW
We believe that the move toward IT outsourcing is a trend, with companies
focusing on their strengths and choosing to outsource select IT operations to
service providers with specialized expertise. As a result, we believe the IT
outsourcing market will continue to grow for the following reasons:
o The need for companies to reduce costs and improve operating margins;
o A general slowdown in capital spending on existing IT infrastructure;
o The increasing complexity of IT systems and the need to connect
electronically with customers, suppliers and other internal systems;
o The increasing requirements for rapid processing of information and the
instantaneous communication of large amounts of data to multiple locations;
o The desire of business and government organizations to focus on their core
competencies;
o The desire by business and government organizations to take advantage of
the latest advances in technology without the cost and resource commitment
required to maintain an in-house system;
o The need to provide alternative or back-up locations for mission critical
information; and
o The proliferation of web-based and wireless technologies.
BUSINESS STRATEGY
Our long-term business strategy is focused on the following:
SUPERIOR CUSTOMER SERVICE--We believe close attention to customer service and
support is vital to our business success and is a key competitive
differentiator. Customers are served by a dedicated Account Management team who
ensure consistent and responsive customer service; a highly experienced
Technical Services staff who plan and execute migrations across multiple
platforms; and an Operations Production group who manage our secure,
state-of-the art facilities.
MAXIMIZE LEVERAGED BUSINESS MODEL--By leveraging data centers in New Jersey,
Georgia, Omaha, Tempe, and California and our highly skilled IT operations
staff, we are able to support multiple customers with different computing
platforms and operating systems with different processes and different
requirements. Additional operating efficiencies are achieved by establishing
consistent processes throughout the organization and by using proprietary
software tools that enable us to efficiently manage customers' systems
regardless of location. Sharing technology and staff across our broad customer
base reduces our operating costs, streamlines service delivery and presents us
with attractive margin opportunities. Once a customer migrates its IT operations
to us, we can maximize profitability by automating processes and tasks as well
as taking full advantage of underutilized hardware and processing capacity.
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DEPLOY NEW PRODUCTS AND SERVICES--We maintain an extensive infrastructure that
serves as the underlying foundation across various IT solutions and continuously
is refined to encompass new computing platforms. Development of new service
offerings is focused on applying our expertise in infrastructure and systems
management to evolving hardware and software environments. New products and
services are developed or acquired in order to be replicated across multiple
customers, and augment our portfolio of recurring revenue services.
PURSUE ACQUISITION OPPORTUNITIES--Strategic acquisitions are an integral
component of our long-term growth strategy as we seek to add complementary IT
outsourcing services that augment our current service offerings. We look for
accretive acquisitions to leverage our data center infrastructure. Typical
candidates have a history of customer or transaction volume growth and mirror
our business model of revenue predictability.
VALUE PROPOSITION
Selective IT outsourcing is an option considered by many business and government
organizations that want to reduce their IT operating costs without the risk and
loss of control associated with outsourcing their entire IT function.
We believe that we differentiate ourselves in the market by providing higher
levels of customer service and flexibility than our competitors. We have more
than two decades of experience managing mission-critical IT systems, assuring
the optimal performance, reliability, and scalability of our customer's
mainframe and non-mainframe environments.
We believe that when considering wholesale outsourcing or maintaining an
in-house infrastructure our potential customers consider the following factors:
LOWER IT COSTS--We believe our customers realize significant savings by using
our services over their current internal IT costs. By leveraging our IT
infrastructure, personnel, processes, and proprietary tools across multiple
customers, we believe our economies of scale translate into reduced costs for
our customers.
IMPROVED SERVICE DELIVERY--We believe our experience and resources result in
more efficient services than if our customers continued to perform the
operations tasks in-house. Our customers benefit from the operational leverage
we enjoy by allocating our resources over multiple customers. Because of
economies of scale, we believe that our customers may enjoy greater access to
resources otherwise uneconomical on a standalone basis.
ACCESS TO NEW TECHNOLOGIES--We believe outsourcing with us enables our customers
to take advantage of new technologies and best practices while minimizing the
capital investment and risks associated with implementing these solutions
in-house.
RE-DEPLOY RESOURCES--By turning over select IT operations to us, we believe that
our customers can concentrate on their core business.
INCREASED FLEXIBILITY--We believe that outsourcing enables our customers to
respond rapidly to changing markets, mergers and acquisitions, and major
organizational changes by providing a flexible, multi-platform infrastructure
that can scale or transition to accommodate change.
IT OPERATIONS INFRASTRUCTURE
DATA CENTER INFRASTRUCTURE--Delivering high-availability IT outsourcing
solutions to enterprise customers requires a significant investment in a secure
data center infrastructure. Our fully constructed facilities have been designed
to meet the stringent environmental and security requirements of enterprise and
government customers: raised-floor facilities feature state-of-the-art physical
components and redundant network offerings, including high standards for
security and reliability; fully redundant power supply systems; redundant
ingress and egress Internet access across multiple providers' multiple power
feeds; N+1 fire suppression systems and 24-hour security services.
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TECHNOLOGY INFRASTRUCTURE--We have fully deployed mainframe, mid-range, open
system processing; data storage systems; printing equipment; and networking
hardware across our facilities. Our skilled operations team manages the
scheduling and production of customers' processing via a centralized command
center. We utilize technologies such as IBM's Virtual Tape Subsystem ("VTS") to
reduce operational overhead by automating processes. The VTS is a system of
hardware and software licensed from IBM that eliminates the need for personnel
to manually load and unload tapes containing customer data.
IT PROFESSIONAL STAFF --Supporting a 24 x 7 computing environment requires
significant operational resources skilled across a number of technology areas
including operating systems, computing, networking, and applications. Few
companies have the financial and human resources to support a 24-hour,
multi-platform computing environment. Our operations team is a highly skilled,
process driven organization that brings technical expertise across multiple
computing platforms and operating systems. As a result of our technical
competency and broad customer base, we believe our labor costs per customer
typically are lower than the costs our customers would incur by having internal
IT departments deliver the same service levels. Most of our computer hardware is
manufactured by IBM. We also rely heavily on system software licensed from IBM
or Computer Associates.
MANAGEMENT TOOLS--With the growth of networking as a low-cost method for
transmitting information, we have developed a proprietary suite of management
tools that enables us to monitor and manage customers' systems and components
from our facilities, at a customer's site, or at a third-party facility. These
tools enable us to grow our data-center infrastructure without having to
replicate the network operations center at each customer site.
PRODUCTS AND SERVICES
Our services are organized into two primary solution areas: Mainframe
Outsourcing Services and Non-Mainframe Services.
MAINFRAME OUTSOURCING--Our mainframe outsourcing solutions provide customers
with a cost-effective, operationally superior alternative to running and
managing a mainframe infrastructure in-house. We combine the scalability and
reliability of mainframe systems with the world-class management of, and access
to, hardware, systems software, and communications. We offer the latest
technologies, including VTS, IBM's zSeries technology and Linux on the
mainframe, to provide greater uptime and more efficiency for our customers. We
have experience in operating multiple computer systems running on different
operating and complex enterprise environments and provide high capacity in
processing speed, connectivity, and storage management solutions.
NON-MAINFRAME SERVICES AND SOLUTIONS
o MID-RANGE SYSTEMS MANAGEMENT--We provide specialized support and
outsourcing resources for customers that rely on AS/400 and iSeries
computer systems. We operate, administer, and maintain midrange systems and
have the expertise and flexibility to manage systems the way the customer
chooses to have them managed.
o OPEN SYSTEMS MANAGEMENT--We provide on-site hosting and remote management
of customers' hardware and software running on Linux, Unix and Windows
servers for both Internet based and other applications. Customers can
choose from a wide range of options for their open systems - starting with
basic on-site hosting all the way up to fully customized, fully managed
services. This highly flexible approach makes it easy to support a variety
of systems from a simple website or database application, to a full-scale,
multinational Enterprise Resource Plan system.
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o BUSINESS PROCESS OUTSOURCING--Business process outsourcing involves
customers contracting with us to perform functions that support their
business, but are not their core competency. These functions, commonly
called "back-office" processes, include services such as healthcare claims
processing, payroll, accounts receivable management, payment processing,
logistics, data entry and customer care services. Back-office processes are
often supported by an extensive IT infrastructure and we leverage our IT
infrastructure and personnel to support our business process outsourcing
activities. Our business process outsourcing activities are dependent on
our IT infrastructure and personnel. In connection with certain business
process outsourcing activities, we provide a variety of customized IT
services, including the development of proprietary software to meet the IT
processing requirements of particular customers. We manage the software
application and retain ownership of the software we develop. Capitalized
expenditures for the development and enhancement of our proprietary
software totaled $947,000, $367,000, and $138,000 for the years ended
December 31, 2005, 2004, and 2003, respectively.
o EMAIL SECURITY SERVICES--Our email security service provides customers spam
blocking; virus scanning, identification, cleansing, and content filtering.
The entire process is transparent to end users and creates an effective
boundary around a customers' email infrastructure that blocks unwanted
email and viruses from entering or leaving their corporate network thus
ensuring compliance with corporate email policies.
o BUSINESS CONTINUITY--Our business continuity solutions help assure
customers that their operations can proceed in the face of disaster. We
offer 24 x 7, high-availability services, including disaster-planning
assistance. We provide a full alternate office site, including desktop
workstations, phone systems, and conventional office infrastructure such as
fax and copier machines, networked printers and conferencing facilities.
SALES AND MARKETING
Our direct sales, business development and marketing organizations target a
broad range of large and medium-size commercial and government enterprises.
Although we have developed specific expertise in several industries, including
financial services, publishing, manufacturing, consumer products, and
healthcare, we believe our reputation for technical expertise and service
quality extends across all industries.
o DIRECT SALES--A quota-carrying direct sales channel of senior sales
executives contacts prospective customers and uses its strong industry and
business relationships to identify new business opportunities.
o INDIRECT CHANNELS--We maintain marketing relationships with indirect sales
channels. Industry advisers and consultants play an important lead
generation role for qualified new business. Hardware and software vendors
also represent a highly qualified source of new business opportunities.
o CUSTOMER SERVICE REPRESENTATIVES--As a result of its frequent customer
contact, the Account Management organization identifies potential new
business opportunities with current customers.
o CUSTOMER REFERRALS--Current customers are an excellent source of referrals
for potential new business.
For the year ended December 31, 2005, one client, the Missouri Department of
Social Services, accounted for in excess of 10% of our consolidated revenue. For
the years ended December 31, 2004 and 2003, one client, ADT Security Services,
Inc., accounted for in excess of 10% of our consolidated revenues.
Page 7
COMPETITION
We operate in a highly competitive market. Our current and potential competitors
include other independent computer service companies and divisions of
diversified enterprises, as well as the internal IT departments of existing and
potential customers. Among the most significant of our competitors are IBM
Corporation; Electronic Data Systems Corporation; Affiliated Computer Services,
Inc.; Computer Sciences Corp.; and SunGard Data Systems, Inc.
In general, the outsourcing services industry is fragmented, with numerous
companies offering services in limited geographic areas, vertical markets, or
product categories. Many of our larger competitors have substantially greater
financial and other resources than we do. We compete on the basis of a number of
factors, including price, quality of service, technological innovation, breadth
of services offered and responsiveness.
While our larger competitors seek to outsource entire IT departments, generally
we selectively target core IT functions such as computer processing and storage
solutions. In doing so, we position ourselves as a partner of the customer's IT
organization, rather than as a competitive threat.
We believe that our services are particularly attractive to mid-tier companies
that need substantial infrastructure to support their business environment, but
are considered "small" compared to the multi-billion dollar engagements signed
by our largest competitors. Many mid-market companies perceive, we believe,
larger outsourcers as "inflexible" and "unresponsive" to their smaller-scale
requirements. We believe that selective outsourcing enables them to maintain
overall control over their IT environment, while benefiting from the scale and
efficiency of an outsourcing provider.
We cannot be sure that we will be able to compete successfully against our
competitors in the future. If we fail to compete successfully against our
current or future competitors with respect to these or other factors, our
business, financial condition, and results of operations will be materially and
adversely affected.
TECHNOLOGICAL CHANGES
Although we are not aware of any pending or prospective technological changes
that would adversely affect our business, new developments in technology could
have a material adverse effect on the development or sales of some or all of our
services or could render our services noncompetitive or obsolete. There can be
no assurance that we will be able to develop or acquire new and improved
services or systems that may be required in order for it to remain competitive.
We believe, however, that technological changes do not present a material risk
to our business because we expect to be able to adapt to and acquire any new
technology more easily than our existing and potential customers. In addition,
technological change increases the risk of obsolescence to potential customers
that might otherwise choose to maintain in-house systems rather than use our
services, thus potentially creating selling opportunities for us.
INTELLECTUAL PROPERTY MATTERS
Due to the rapid pace of technological change in the computer industry, we
believe that copyright and other forms of intellectual property protection are
of less significance than factors such as the knowledge and experience of
management and other personnel, and our ability to develop, enhance, market, and
acquire new systems and services. As a result, our systems and processes are not
protected by patents or by registered copyrights, trademarks, trade names, or
service marks. To protect our proprietary services and software from illegal
reproduction, we rely on certain mechanical techniques in addition to trade
secret laws, restrictions in certain of our customer agreements with respect to
use of our services and disclosure to third parties, and internal non-disclosure
safeguards, including confidentiality restrictions with certain employees.
Despite these efforts, it may be possible for our competitors or customers to
copy aspects of our trade secrets. We are experienced in handling confidential
and sensitive information for our customers, and we maintain numerous security
procedures to help ensure that the confidentiality of our customer's data is
maintained.
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COMPLIANCE WITH ENVIRONMENTAL LAWS
We have not incurred any significant expense in our compliance with Federal,
state, and local environmental laws.
EMPLOYEES
As of December 31, 2005, we had 828 full-time and 10 part-time employees. None
of our employees is represented by a labor organization and we are not aware of
any activities seeking such organization. We consider our relationship with our
employees to be satisfactory.
INSURANCE
We maintain insurance coverage that we believe is reasonable, including errors
and omissions coverage, business interruption, and directors and officers
insurance to fund our operations in the event of catastrophic damage to any of
our operations centers, and insurance for the loss and reconstruction of our
computer systems. We also maintain extensive data backup procedures to protect
our data and our customer's data.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Substantially all of our revenues are derived from U.S. sources. All of our
assets are in the U.S.
AVAILABLE INFORMATION
We maintain a website with the address www.infocrossing.com. We are not
including the information contained on our website as part of, or incorporating
it by reference into, this Annual Report on Form 10-K. We make available, free
of charge, through a link from our website to the EDGAR database at www.sec.gov
our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current
Reports on Form 8-K, and amendments to such reports, as soon as reasonably
practicable after we file such material with the Securities and Exchange
Commission.
ITEM 1A. RISK FACTORS
You should carefully consider the following risk factors and warnings before
making an investment in our common stock or convertible debt. If any of the
following risks actually occur, our business, financial condition, results of
operations and prospects could be materially and adversely affected. In such
case, you may lose all or part of your investment. You should also refer to the
other information set forth or incorporated by reference in this Annual Report,
including our consolidated financial statements and the related notes included
in Item 15 of this Annual Report.
RISKS RELATED TO OUR BUSINESS
LOSS OF MAJOR CLIENTS COULD REDUCE OUR REVENUES AND CAUSE LOSSES FOR OUR
BUSINESS.
Our customers include commercial enterprises, institutions, and government
agencies. From time to time, some of our customers have accounted for more than
10% of our consolidated revenue. For the year ended December 31, 2005, one
client, the Missouri Department of Social Services, accounted for more than 10%
of our consolidated revenue. For the years ended December 31, 2004 and 2003, one
client, ADT Security Services, Inc., accounted for more than 10% of our
consolidated revenues.
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Our success depends substantially upon the retention of our major customers as
clients. Generally, we may lose a client as a result of a contract expiration,
merger or acquisition, business failure, or the selection of another provider of
information technology services. We cannot be sure that we will be able to
retain long-term relationships or secure renewals on favorable terms with our
customers.
OUR CONTRACTS CONTAIN TERMINATION PROVISIONS AND PRICING RISKS THAT COULD CAUSE
US TO LOSE OUR IT OUTSOURCING CONTRACTS OR LOSE MONEY ON OUR REMAINING IT
OUTSOURCING CONTRACTS.
Many of our IT outsourcing contracts with clients permit termination upon ninety
days notice and payment of an early termination fee. The ability of our clients
to terminate contracts creates an uncertain revenue stream. If clients are not
satisfied with our level of performance, pricing or other attributes, our
reputation in the IT outsourcing industry may suffer, which may also materially
and adversely affect our business, financial condition and results of
operations.
Some of our contracts contain pricing provisions that require the payment of a
set fee by the client for our services regardless of the costs we incur in
performing these services and/or provide for penalties in the event we fail to
achieve certain contract standards. These pricing provisions, particularly in
the case of long-term outsourcing agreements, require us to make estimates and
assumptions at the time we enter into the contracts that could differ from
actual results. These estimates may not necessarily reflect the actual costs to
provide the contracted services. Any increased or unexpected costs or
unanticipated delays in the performance of these engagements, including delays
caused by factors out of our control, could cause us to lose money on these
fixed price contracts and the losses could be material.
WE OPERATE IN HIGHLY COMPETITIVE MARKETS IN THE IT OUTSOURCING INDUSTRY THAT
COULD CAUSE US TO LOSE EXISTING CUSTOMERS OR PREVENT US FROM OBTAINING NEW
CUSTOMERS.
We operate in a highly competitive market. Our current and potential competitors
include other independent computer service companies and divisions of
diversified enterprises, as well as the internal IT departments of existing and
potential customers. Among the most significant of our competitors are IBM
Corporation; Electronic Data Systems Corporation; Affiliated Computer Services,
Inc.; Computer Sciences Corp.; and SunGard Data Systems, Inc.
In general, the IT outsourcing services industry is fragmented, with numerous
companies offering services in limited geographic areas, vertical markets, or
product categories. Many of our larger competitors have substantially greater
financial and other resources than we do. We compete on the basis of a number of
factors, including price, quality of service, technological innovation, breadth
of services offered and responsiveness. Our contracts do not establish us as the
exclusive provider of IT outsourcing services to each customer. Accordingly, our
customers may select one of our competitors to provide services beyond the scope
of our existing agreement or decide not to outsource certain portions of their
IT operations with us.
We cannot be sure that we will be able to compete successfully against our
competitors in the future. If we fail to compete successfully against our
current or future competitors with respect to these or other factors, our
business, financial condition, and results of operations will be materially and
adversely affected.
CHANGES IN TECHNOLOGY IN THE IT OUTSOURCING INDUSTRY COULD CAUSE OUR BUSINESS TO
LOSE MONEY OR COULD REQUIRE US TO INVEST ADDITIONAL CAPITAL IN NEW TECHNOLOGY.
The markets for our services change rapidly because of technological innovation,
new product and service introductions, and changes in customer requirements,
among other factors. New products and services and new technology often render
existing information services or technology infrastructure obsolete, costly, or
otherwise unmarketable. For example, the introduction of new software
applications for a particular computer platform will make other computer
platforms less attractive to companies desiring to use the new applications. As
a result, our success depends on our ability to timely innovate and integrate
new technologies into our service offerings. We cannot be sure that we will be
successful at adopting and integrating new technologies into our service
offerings in a timely manner.
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Advances in technology also require us to expend substantial resources to
acquire and utilize new technologies in our business. We must continue to commit
resources to train our personnel in the use of these new technologies. We must
also continue to train personnel to maintain the compatibility of existing
hardware and software systems with these new technologies. We cannot be sure
that we will be able to continue to commit the resources necessary to update our
technology infrastructure at the rate demanded by our markets.
OUR SYSTEMS AND PROCESSES ARE NOT PROTECTED BY PATENTS OR BY REGISTERED
COPYRIGHTS, TRADEMARKS, TRADE NAMES OR SERVICE MARKS AND AS A RESULT, OUR
COMPETITORS MAY BE ABLE TO USE OUR SYSTEMS AND PROCESSES TO COMPETE AGAINST US
AND HURT OUR BUSINESS.
We believe that because of the rapid pace of technological change in the
computer industry, copyright and other forms of intellectual property protection
are of less significance than factors such as the knowledge and experience of
management and other personnel, and our ability to develop, enhance, market, and
acquire new systems and services. As a result, our systems and processes are not
protected by patents or by registered copyrights, trademarks, trade names, or
service marks. To protect our proprietary services and software from illegal
reproduction, we rely on certain mechanical techniques in addition to trade
secret laws, restrictions in certain of our customer agreements with respect to
use of our services and disclosure to third parties, and internal non-disclosure
safeguards, including confidentiality restrictions with certain employees.
Despite these efforts, it may be possible for our competitors or clients to copy
aspects of our trade secrets. This could have a material adverse effect on our
business, financial condition, and results of operations.
INTELLECTUAL PROPERTY LITIGATION COULD CAUSE US TO LOSE MONEY AND LOWER OUR
STANDING IN THE IT OUTSOURCING INDUSTRY.
In recent years, there has been significant litigation in the United States
involving patent and other intellectual property rights. We are not currently
involved in any material intellectual property litigation. We may, however, be a
party to intellectual property litigation in the future to protect our trade
secrets or know-how.
Our suppliers, customers, and competitors may have patents and other proprietary
rights that cover technology employed by us. Such persons may also seek patents
in the future. Due to the confidential nature of United States patent
applications, we are not aware of all patents or other intellectual property
rights of which our services may pose a risk of infringement. Others asserting
rights against us could force us to defend ourselves against alleged
infringement of intellectual property rights. We could incur substantial costs
to prosecute or defend any such litigation, and intellectual property litigation
could force us to do one or more of the following:
o cease selling or using services that incorporate the challenged technology;
o redesign those services that incorporate the challenged technology; and
o obtain from the holder of the infringed intellectual property right a
license to sell or use the relevant technology, which may require us to pay
royalties, which could be substantial.
In addition, we generally agree in our contracts to indemnify our clients for
any expenses or liabilities they may incur resulting from claimed infringements
of the intellectual property rights of third parties. In some instances, the
amount of these indemnities may be greater than the revenues we receive from the
client.
Furthermore, any ongoing intellectual property litigation could cause us to lose
customers and harm our reputation within the IT outsourcing industry.
FAILURE TO PROPERLY MANAGE GROWTH COULD CAUSE OUR BUSINESS TO LOSE MONEY.
We have expanded our operations rapidly in recent years. We intend to expand our
operations in the foreseeable future to pursue existing and potential market
opportunities. This growth places a significant demand on management and
operational resources. In order to manage growth effectively, we must implement
and improve our operational systems and controls on a timely basis. If we fail
to implement these systems and controls, our business, financial condition, and
results of operations will be materially and adversely affected.
Page 11
ACQUISITIONS WE MAKE MAY NOT PROVIDE EXPECTED BENEFITS AND COULD POSSIBLY RESULT
IN A LOSS OF MONEY AND RESOURCES.
We recently purchased (i)Structure, LLC ("(i)Structure") with the expectation
that the acquisition will result in various benefits, including, among others, a
strengthened position in the IT outsourcing market, additional capabilities in
distributed systems and networking services, and sales and market synergies.
Achieving the anticipated benefits of the acquisition is subject to a number of
uncertainties, including whether we integrate (i)Structure in an efficient and
effective manner, and general competitive factors in the marketplace. Failure to
achieve these anticipated benefits could result in increased costs, decreases in
the amount of expected revenues and diversion of management's time and energy
and could materially impact our business, financial condition and operating
results.
We intend to consider selective acquisition opportunities going forward such as
our recent acquisitions of (i)Structure, LLC, Verizon Information Technologies,
Inc. (now known as Infocrossing Healthcare Services, Inc.) and ITO Acquisition
Corporation d/b/a Systems Management Specialists (now known as Infocrossing
West, Inc.). Therefore, we may acquire businesses or technologies in the future
that we believe are a strategic fit with our business. These acquisitions may
result in unforeseen operating difficulties and expenditures and may absorb
significant management attention that would otherwise be available for ongoing
development of our business. In addition, the integration of businesses or
technologies may prove to be more difficult than expected, and we may be
unsuccessful in maintaining and developing relations with the employees,
customers and business partners of acquisition targets.
Since we will not be able to accurately predict these difficulties and
expenditures, it is possible that these costs may outweigh the value we realize
from the acquisitions. Future acquisitions could also result in issuances of
equity securities that would reduce our stockholders' ownership interest, the
incurrence of debt, contingent liabilities, deferred stock based compensation or
expenses related to the valuation of goodwill or other intangible assets and the
incurrence of large, immediate write-offs.
LOSS OF KEY PERSONNEL COULD CAUSE OUR BUSINESS TO LOSE MONEY OR CAUSE US TO
INVEST CAPITAL TO REPLACE SUCH PERSONNEL.
Our success depends largely on the skills, experience, and performance of some
key members of our management, including our Chairman and Chief Executive
Officer, Zach Lonstein. The loss of any key members of our management may
materially and adversely affect our business, financial condition, and results
of operations. In addition, loss of key members of management could require us
to invest capital to search for a suitable replacement. Such a search could
serve as a distraction to the remaining members of management preventing them
from focusing on the ongoing development of our business, which, in turn, could
cause us to lose money.
OUR BUSINESS DEPENDS ON OUR ABILITY TO RECRUIT, TRAIN, AND RETAIN SKILLED
PERSONNEL TO PERFORM IT OUTSOURCING SERVICES; OUR FAILURE TO DO SO COULD
INCREASE OUR COSTS AND LIMIT OUR GROWTH.
We must continue to grow by hiring and training technically-skilled people in
order to perform services under our existing contracts and new contracts that we
will enter into. The people capable of filling these positions are in great
demand and recruiting and training qualified personnel require substantial
resources. Our business also experiences significant turnover of
technically-skilled people. If we fail to attract, train, and retain sufficient
numbers of these technically-skilled people, our business, financial condition,
and results of operations will be materially and adversely affected.
WE MAY HAVE DIFFICULTY ACHIEVING AND SUSTAINING PROFITABILITY AND MAY EXPERIENCE
ADDITIONAL LOSSES IN THE FUTURE.
From the fourth quarter of 1999 through the third quarter of 2003, we incurred
significant net losses. As of December 31, 2005, we had an accumulated deficit
of approximately $53.5 million, although we had positive net worth of
approximately $107 million. For the year ended December 31, 2005, we had net
income of $2.6 million. There is no assurance that we will generate positive net
income in the future.
Page 12
WE MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL ON TERMS THAT ARE ACCEPTABLE TO
US, WHICH COULD LIMIT OUR GROWTH.
We may need to raise additional capital to develop or enhance our technologies,
to fund expansion, or to acquire complementary products, businesses or
technologies. Additional financing may not be available on terms that are
acceptable to us. If we raise additional funds through the issuance of equity
securities or securities convertible into or exercisable for equity securities,
the percentage ownership of our other stockholders would be reduced.
Additionally, these securities might have rights, preferences and privileges
senior to those of our current stockholders. If adequate funds are not available
on terms acceptable to us, our ability to develop and enhance our services, fund
expansion, and otherwise take advantage of unanticipated opportunities would be
significantly limited.
OUR INDEBTEDNESS COULD LIMIT OUR AVAILABLE CASH FLOW, HARM OUR CREDIT RATING AND
PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER OUR OUTSTANDING INDEBTEDNESS.
We have a significant amount of indebtedness. At December 31, 2005, we had total
indebtedness of $139.3 million consisting of a $55.0 million senior secured term
loan, $5 million outstanding of a $15 million senior secured revolving loan,
convertible notes with a book value of $65.2 million and a face value of $72.0
million, and $14.1 million of capital leases.
The convertible notes mature on July 15, 2024 and bear interest at a rate of 4%,
payable semi-annually in arrears each January 15th and July 15th. They are
convertible, subject to certain conditions, at the option of the holder prior to
maturity, into shares of our common stock at a specified conversion price,
subject to certain adjustments. The conversion price must be adjusted to reflect
stock dividends, stock splits, issuances of rights to purchase shares of common
stock and other events. Upon conversion, we will have the right to deliver to
the holders, at our option, cash, shares of our common stock, or a combination
thereof. At the current conversion price, the $72 million of convertible notes
are convertible into 5,673,759 common shares.
We have a call option, pursuant to which we may redeem the convertible notes, in
part or in whole, for cash at any time on or after July 15, 2007 at a price
equal to 100% of the principal amount of the convertible notes, plus accrued
interest, plus a "premium" if the redemption is prior to July 15, 2009,
provided, however, the convertible notes are only redeemable prior to July 15,
2009 if the market price of our common stock has been at least 150% of the
conversion price then in effect for at least 20 trading days during any 30
consecutive trading day period. The "premium" referred to in the preceding
sentence shall be in an amount equal to $173.83 per $1,000 principal amount of
convertible notes, less the amount of any interest actually paid on such
convertible notes prior to the redemption date.
The holders of the convertible notes may require that we purchase for cash all
or a portion of the convertible notes on July 15, 2009, 2014, and 2019 at a
repurchase price equal to 100% of the principal amount of the convertible notes
plus any accrued interest. There are no financial covenants, other than a
limitation on incurring additional indebtedness, as defined in the indenture. We
are not restricted from paying dividends, or issuing other securities, or
repurchasing other securities issued by us under the terms of the indenture.
The senior secured loans mature in April 2009 and all remaining balances must be
paid at that time. The senior secured loans bear interest based on either the
eurodollar rate or the base rate plus a margin that will vary depending on our
consolidated senior secured leverage ratio. Default interest may also be payable
in certain circumstances. All computations of interest based on the base rate
when the base rate is determined by Bank of America's prime rate will be made on
the basis of a year of 365 or 366 days. All other computations of interest will
be made on the basis of a 360-day year. The senior secured loans and guarantees
are our and our subsidiaries' senior secured obligations, secured by a
first-priority interest on substantially all of our assets and the assets of our
subsidiaries, including the capital stock of our subsidiaries.
Beginning on September 30, 2006, we are required to make amortization payments
on the senior secured term loan at the end of each quarter. The amounts of the
required amortization payments are $2,500,000 from September 30, 2006 to June
30, 2007, $3,750,000 from September 30, 2007 through June 30, 2008 and
$5,000,000 on September 30, 2008 and December 31, 2008. Within five business
days after financial statements for a fiscal year are delivered, we must make
principal payments equal to 50% of excess cash flow for such fiscal year.
Page 13
We are also required to prepay the senior secured loans with:
o 100% of net proceeds from dispositions of assets if such dispositions are
not permitted by our credit agreement;
o 50% of net proceeds from certain issuances of equity interests;
o 100% of net proceeds from issuances of debt if such issuances are not
permitted by our credit agreement; and
o 100% of certain net insurance proceeds.
The senior secured loan documents provide for customary negative covenants,
including limitations with respect to:
o incurring indebtedness;
o incurring liens;
o fundamental changes;
o sales of assets;
o amendments to organizational notes documents and convertible notes
documents;
o dividends and other restricted payments, except, among other things, a
$500,000 basket for repurchase of stock from present or former officers
and employees upon death, disability or termination of employment;
o cash capital expenditures each fiscal year in excess of $10 million per
fiscal year;
o investments, loans and advances;
o transactions with affiliates;
o sales and leasebacks;
o changes in fiscal year, and
o lines of business.
The senior secured credit agreement provides for customary financial covenants,
including:
o a maximum consolidated leverage ratio;
o a maximum consolidated senior secured leverage ratio;
o minimum consolidated EBITDA; and
o a minimum fixed charge coverage ratio.
Our failure to comply with those covenants could result in an event of default
which, if not cured or waived, could result in the acceleration of all of our
indebtedness. This could severely constrain our available cash flow and would
require us to consider all of our financial and other alternatives including
possible replacement financing, a negotiated workout or seeking protection from
our creditors under chapter 11 of the U.S. bankruptcy code.
Our substantial indebtedness could have important consequences to you. For
example, it could:
o make it more difficult for us to satisfy our obligations with respect to
our outstanding indebtedness;
o increase our vulnerability to general adverse economic and industry
conditions;
o require us to dedicate a substantial portion of our cash flow from
operations to payments on our indebtedness, thereby reducing the
availability of our cash flow to fund working capital, capital
expenditures, research and development efforts and other general corporate
purposes;
o limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate;
o place us at a competitive disadvantage compared to our competitors that
have less debt; and
o limit our ability to borrow additional funds.
VARIABILITY OF QUARTERLY OPERATING RESULTS.
We expect our revenues and operating results to vary from quarter to quarter.
These variations are likely to be caused by many factors that are, to some
extent, outside our control, including the addition or loss of customers and the
time in the quarter that an addition or loss occurs; variability of fees and
expenses with respect to contractual arrangements when our fees are not fixed;
and an increase in depreciation or amortization because of the acquisition of
new equipment or software licenses and unusual charges whether incurred in the
ordinary course of business or not. Accordingly, we believe that
quarter-to-quarter comparisons of operating results for preceding quarters are
not necessarily meaningful. You should not rely on the results of one quarter as
an indication of our future performance.
Page 14
RISKS RELATED TO INVESTMENT IN OUR COMMON STOCK
OUR STOCK PRICE IS VOLATILE AND COULD DECLINE.
The price of our common stock has been, and is likely to continue to be,
volatile. For example, our stock price in the first quarter of 2005 was as high
as $20.15 per share and as low as $6.35 per share in the fourth quarter of 2005.
The market price of our common stock may fluctuate significantly in response to
a number of factors, some of which are beyond our control, including:
o quarterly variations in our operating results;
o announcements we make regarding significant contracts, acquisitions,
strategic partnerships, or joint ventures;
o additions or departures of key personnel;
o changes in market valuations of information technology service companies;
o changes in financial estimates by securities analysts; and
o sales of our common stock.
In addition, the stock market in general, and companies whose stock is listed on
The Nasdaq National Market, have experienced extreme price and volume
fluctuations that have often been disproportionate to the operating performance
of these companies. Broad market and industry factors may negatively affect the
market price of our common stock, regardless of our actual operating
performance.
AVAILABILITY OF SIGNIFICANT AMOUNTS OF OUR COMMON STOCK FOR SALE COULD CAUSE ITS
MARKET PRICE TO DECLINE.
As of December 31, 2005, there were 20,547,063 shares of our common stock
outstanding. If our stockholders sell substantial amounts of our common stock in
the public market or the perception exists that such sales could occur,
including shares issued upon exercise of outstanding common stock purchase
warrants, the market price of our common stock could fall.
As of December 31, 2005, Zach Lonstein, our Chairman and Chief Executive
Officer, beneficially owned 2,727,296 shares of our common stock, including
shares from options vesting over the succeeding sixty days. Substantially all of
those shares are available for sale in the public market pursuant to Rule 144
under the Securities Act, subject to certain volume, manner of sale and other
restrictions. Zach Lonstein may require us to register his shares for resale,
under certain conditions, pursuant to a resale registration rights agreement
that we entered into with him.
CONVERSION OF OUR OUTSTANDING CONVERTIBLE NOTES WILL DILUTE THE OWNERSHIP
INTEREST OF EXISTING STOCKHOLDERS AND FUTURE ISSUANCES OF OUR SECURITIES COULD
DILUTE YOUR OWNERSHIP.
The Company has $72,000,000 outstanding of 4.0% Convertible Senior Notes due
July 15, 2024, which we refer to as the convertible notes. These notes are
convertible, subject to certain conditions, at the option of the holder prior to
maturity, into shares of our common stock at a specified conversion price,
subject to certain adjustments. At the current conversion price, the $72,000,000
of convertible notes are convertible into 5,673,759 common shares.
The conversion of some or all of the outstanding convertible notes will dilute
the ownership interest of existing stockholders. Any sales in the public market
of the common stock issuable upon such conversion could adversely affect
prevailing market prices of our common stock. In addition, the existence of the
convertible notes may encourage short selling by market participants because the
conversion of the notes could depress the price of our common stock.
Additionally, we may decide to raise additional funds through public or private
debt or equity financing to fund our operations. If we raise funds by issuing
equity securities, the percentage ownership of current stockholders will be
reduced, and the new equity securities may have rights prior to those of our
common stock. We cannot predict the effect, if any, that future sales of our
common stock or notes, or the availability of shares of our common stock for
future sale, will have on the market price of our common stock or notes. Sales
of substantial amounts of our common stock (including shares issued upon the
exercise of stock options or warrants or the conversion of the notes), or the
perception that such sales could occur, may adversely affect prevailing market
prices for our common stock.
Page 15
WE HAVE NOT PAID CASH DIVIDENDS ON OUR COMMON STOCK AND DO NOT EXPECT TO DO SO.
We have never declared or paid a cash dividend on our common stock. We do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. Certain provisions of the credit agreement for our senior secured debt
do not permit us to pay cash dividends on our common stock.
PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW COULD
DETER TAKEOVER ATTEMPTS AND PREVENT STOCKHOLDERS FROM OBTAINING A PREMIUM FOR
THEIR SHARES.
Some provisions of our certificate of incorporation and bylaws, and Delaware law
could delay, prevent, or make more difficult a merger, tender offer, or proxy
contest involving us. Among other things:
o under our certificate of incorporation, our Board of Directors may issue up
to 3,000,000 shares of our preferred stock and may determine the price,
rights, preferences, privileges and restrictions, including voting and
conversion rights, of these shares of preferred stock;
o under our certificate of incorporation, our Board of Directors has three
classes of directors, with each director serving for a term of three years;
o under our certificate of incorporation, our stockholders may remove our
directors at any time, but only for cause; and
o Delaware law limits transactions between us and persons that acquire
significant amounts of our stock without approval of our Board of
Directors.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None
ITEM 2. PROPERTIES.
We lease a facility of approximately 67,000 square feet in Leonia, NJ for our
headquarters and data center operations. The lease expires on December 31, 2019.
We lease 30,600 square feet in a building located in the Atlanta metropolitan
area for data center operations. The lease expires on July 31, 2015.
We lease 5,700 square feet of office space in New York, NY. The lease expires on
December 31, 2009.
We lease space in buildings (the "Buckhead Facility") owned by the former owner
of Infocrossing Southeast, Inc. ("IFOX SE"). We occupy approximately 10,712
square feet in the Buckhead Facility as of December 31, 2005. This lease
agreement expires December 31, 2007.
With the purchase of ITO Acquisition Corporation ("ITO"), now known as
Infocrossing West, Inc. on April 2, 2004, we acquired a lease on a building
consisting of approximately 68,800 square feet in Brea, California for data
center operations. The lease expires on December 31, 2014. We have sublet
approximately 12,000 square feet of this facility through February 28, 2006.
Also with the purchase of ITO, we acquired a lease on approximately 10,500
square feet of office space in a building in Woodland Hills, CA. This lease
expires April 30, 2008.
With the purchase of Infocrossing Healthcare Services, Inc., f/k/a/ Verizon
Information Technologies Inc. ("IHS"), on October 1, 2004, we acquired a lease
on a building consisting of approximately 16,080 square feet in Jefferson City,
MO for general office use. The lease expires on November 15, 2007. The staff at
this location primarily provides Medicaid claims processing services to the
State of Missouri Department of Social Services, Division of Medical Services.
Page 16
Also with the purchase of IHS, we acquired a lease on approximately 45,000
square feet in a portion of a building in Phoenix, Arizona, for general office
use. The lease expires on April 30, 2008.
IHS also leases 6,400 square feet of office space in a building in Tampa
Florida, under a lease that expires October 31, 2010.
With the acquisition of (i)Structure on November 30, 2005, we acquired an 86,800
square foot data center in Omaha, Nebraska. As part of the acquisition closing
process, we sold this building for $12,850,000, and leased it back from the
buyer for term of twenty years. The net proceeds from the sale were used to
partially fund the acquisition of (i)Structure.
With the acquisition of (i)Structure, we also acquired a 60,000 square foot data
center in Tempe, Arizona. We sold this building on December 29, 2005 for
$12,150,000 and leased it back from the buyer for a term of twenty years. We
used $10 million of the proceeds from this sale to repay a portion of the
revolving loan we had outstanding, and the balance was retained for general
corporate purposes.
Also with the acquisition of (i)Structure, and in connection with a Transition
Services Agreement with Level 3, (i)Structure is leasing approximately 20,300
square feet in a Level 3 facility in Broomfield, Colorado for a period of nine
months.
We generally lease our equipment under standard commercial leases; in many
instances the leases are structured as capital leases with bargain purchase
options. Our equipment is generally covered by standard commercial maintenance
agreements.
We believe our facilities are in good condition and are adequate to accommodate
our current volume of business as well as anticipated increases.
ITEM 3. LEGAL PROCEEDINGS.
Corcoran and Tallas v. Cortens, Dolan, ITO Acquisition Corporation d/b/a Systems
Management Specialists, and Does 1 through 50
- --------------------------------------------------------------------------------
On November 1, 2004, we were served with a summons and complaint in a lawsuit
commenced by two former employees of ITO Acquisition Corporation d/b/a Systems
Management Specialists, now known as Infocrossing West, Inc. ("West") filed in
the Superior Court of California, Orange County (Case No. 04CC10709). Plaintiffs
asserted that they had been induced to join West in 2002 based on promises of
receiving equity interests and options to acquire additional equity in West.
West was indemnified pursuant to the Stock Purchase Agreement between us and ITO
Holdings, LLC ("Holdings") dated as of March 3, 2004 (the "SPA") for breaches of
numerous representations and warranties contained in the SPA. Holdings
represented and warranted to us, among other things, that it owned all of West's
capital stock and there were no other equity interests or commitments relating
to West's capital stock.
All matters were settled as of July 22, 2005. The settlement did not have any
financial impact on the Company. The entire settlement was paid from an escrow
account with respect to which Holdings was the beneficiary. The escrow account
had been established at the closing of the acquisition in the event of an
indemnification claim against Holdings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Page 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is traded on the NASDAQ Stock Market under the symbol IFOX. For
the periods reported below, the following table sets forth the high and low bid
quotations for our common stock as reported by NASDAQ-NMS (in dollars).
BID
HIGH LOW
FOR THE YEAR ENDED DECEMBER 31, 2004:
1st Quarter ended March 31, 2004 13.750 10.020
2nd Quarter ended June 30, 2004 14.780 9.880
3rd Quarter ended September 30, 2004 15.830 10.800
4th Quarter ended December 31, 2004 18.200 12.570
FOR THE YEAR ENDED DECEMBER 31, 2005:
1st Quarter ended March 31, 2005 20.150 14.500
2nd Quarter ended June 30, 2005 17.040 10.120
3rd Quarter ended September 30, 2005 12.980 8.356
4th Quarter ended December 31, 2005 9.370 6.350
The closing price of our common stock on NASDAQ-NMS on February 24, 2006 was
$11.32 per share. At December 31, 2005, we had 91 stockholders of record. In
addition, we believe that there are approximately 500 beneficial owners holding
their shares in "street name."
DIVIDENDS
We have not paid dividends to holders of our common stock since inception.
Certain provisions of a credit agreement to which we are a party do not permit
us to pay cash dividends on our common stock.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table presents information regarding securities authorized for
issuance under equity compensation plans approved September 1992, June 2002, and
June 2005.
NUMBER OF SECURITIES TO WEIGHTED AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE FOR
OF OUTSTANDING OPTIONS OUTSTANDING OPTIONS FUTURE ISSUANCE
------------------------- -------------------------- --------------------------
Three qualified Plans - previously
approved by stockholders 3,685,642 $14.37 643,000 (a)
- -------------------------------------
(a) Of the options available for future grant, 125,000 are reserved pursuant to
an executive's employment agreement (See Note 6 of the Notes to Financial
Statements accompanying this report) and 11,750 are reserved for promised
issuances, subject to approval of the Options and Compensation Committee of the
Board of Directors. For a complete discussion of these plans, please see Note 9
of the Notes to Financial Statements accompanying this report.
Page 18
SECURITIES AUTHORIZED FOR ISSUANCE UNDER OUTSTANDING WARRANTS
At December 31, 2005, we had reserved 3,055,095 common shares for issuance upon
exercise of the following warrants: (i) 1,062,500 shares exercisable at $5.86
per share expiring January 31, 2007; (ii) 65,000 shares exercisable at $18.00
per share expiring September 16, 2010; (iii) 50,000 shares exercisable at $15.00
per share expiring January 13, 2009; and (iv) 1,877,595 shares exercisable at
$7.86 per share expiring October 20, 2008.
RECENT ISSUANCES OF UNREGISTERED SECURITIES
Common Stock Issued for a Portion of Acquisition Price
In connection with the acquisition of (i)Structure on November 30, 2005,
Infocrossing issued 346,597 shares of common stock, $0.01 par value, valued at
$2,500,000, to Level 3 Financing, Inc. The common stock was issued without
registration pursuant to an exemption provided by Section 4(2) of the Securities
Act of 1933, as this issuance of common stock does not involve a public
offering. The Company has filed a Registration Statement on Form S-3 for the
sale of these shares with the Securities and Exchange Commission. This
Registration Statement has not yet been declared effective.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
On May 23, 2005, it was announced that the Company's Board of Directors approved
the repurchase of up to $10 million of the Company's outstanding common stock.
The following table gives information with respect to this program.
Total Number of Maximum Dollar Value
Shares Purchased as of Shares that May
Part of Publicly Yet Be Purchased
Total Number of Average Price Paid Announced Plans or Under the Plans or
Shares Purchased Per Share Programs Programs
Through December 31, 2005 50,000 $9.67 50,000 $9,516,511 (a)
- -------------------------- -----------------------
(a) Certain provisions of our credit agreement with Bank of America entered into
in connection with the (i)Structure Acquisition effectively restrict us from
making any further repurchases under this program, so long as the credit
agreement is in existence.
Page 19
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
The selected balance sheet data as of December 31, 2005 and 2004 and the
selected statement of operations data for the years ended December 31, 2005,
2004, and 2003 have been derived from our audited financial statements included
elsewhere herein. The selected balance sheet data as of December 31, 2003, 2002
and 2001 and the statement of operations data for the years ended December 31,
2002 and 2001 have been derived from our audited financial statements not
included herein. You should read these selected financial data in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations", our financial statements and the notes to those statements included
elsewhere herein.
SELECTED STATEMENT OF OPERATIONS DATA
=====================================================================================================================
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------
2005 2004 2003 2002 2001 (A)
------------- ------------- ------------- ------------- -------------
Revenues $ 148,006 $ 104,949 $ 55,228 $ 50,774 $ 26,987
--------- --------- --------- ---------- ----------
Net income (loss) from
continuing operations $ 2,573 $ 19,963 $ 1,356 $ 1,137 $ (36,524)
--------- --------- --------- ---------- ----------
Accretion and dividends
on redeemable preferred
stock (b) $ - $ - $ (6,877) $ (9,293) $ (8,524)
--------- --------- --------- ---------- ----------
Net income (loss) to
common stockholders $ 2,573 $ 19,963 $ (5,521) $ (8,156) $ (45,048)
========= ========= ========= ========== ==========
Net income (loss) to common
stockholders per
diluted common share $ 0.12 $ 0.95 $ (0.76) $ (1.52) $ (7.77)
========= ========= ========= ========== ==========
SELECTED BALANCE SHEET DATA
=====================================================================================================================
AS OF DECEMBER 31,
---------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------- ------------- ------------- ------------- -------------
Goodwill (c) $ 150,799 $ 103,177 $ 28,361 $ 28,451 $ 7,737
========= ========= ========= ========== ==========
Total assets $ 286,435 $ 216,650 $ 67,138 $ 65,495 $ 58,774
========= ========= ========= ========== ==========
Notes payable, long term
debt, and capitalized
lease obligations, net of
current portion $ 123,734 $ 100,432 $ 25,732 $ 10,878 $ 3,632
========= ========= ========= ========== ==========
Redeemable preferred stock (b) $ - $ - $ - $ 53,188 $ 43,961
========= ========= ========= ========== ==========
Common stockholders'
equity (deficit) $ 107,030 $ 91,237 $ 30,801 $ (12,205) $ (6,036)
========= ========= ========= ========== ==========
No cash dividends have been declared (See Item 5, above).
Page 20
(a) Included in the net loss to common stockholders in 2001 was $9,823,000 in
amortization of a restricted stock award and a $5,650,000 loss on leased
facilities and office closings.
(b) In May 2000, we raised $60 million through a private placement of
redeemable preferred stock and warrants to purchase 2.7 million shares of
common stock. The redeemable preferred stock was initially recorded net of
a discount representing that portion of the proceeds assigned to the
warrants. The difference between the face value and the book value of the
redeemable preferred stock was being accreted over a seven-year period
through a charge to retained earnings. In addition, dividends accrued on
the redeemable preferred stock at an 8% annual rate, compounded quarterly.
On October 21, 2003, we exchanged all outstanding redeemable preferred
stock (including the rights to all unpaid dividends) and warrants issued in
the May 2000 private placement for $55 million in cash and notes payable
for $25 million. We obtained the cash for this transaction from a private
offering of 9.7 million shares of common stock and warrants to purchase 3.4
million shares of common stock that also closed on October 21, 2003. The
redemption of the redeemable preferred stock ended the accretion and
accrual of dividends as of the redemption date. Had the redemption not
taken place, accretion and the accrual of dividends would have been
approximately $10.1 million in 2003.
(c) All goodwill has arisen from acquisitions: (i) $20,624,000 from the
acquisition of AmQuest, Inc. (now Infocrossing Southeast, Inc.) in February
2002; (ii) $76,042,000 from the acquisition of ITO Acquisition Corporation
(now Infocrossing West, Inc.), Infocrossing Healthcare Services, Inc., and
minor acquisitions during 2004; and (iii) $46,396,000 from the acquisition
of (i)Structure, LLC in November 2005.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Our management believes that we are a leading provider of selective information
technology outsourcing, or ITO, services to enterprise clients. We deliver a
full suite of outsourced solutions that enable clients to leverage our
infrastructure and process expertise to improve their efficiency and reduce
their operating costs. During our nearly twenty year history, we have developed
expertise in managing complex computing environments, beginning with traditional
data center outsourcing services and evolving to a comprehensive set of managed
solutions. We support a variety of clients, and assure the optimal performance,
security, reliability, and scalability of our clients' mainframes, distributed
servers, and networks, irrespective of where the systems' components are
located. Strategic acquisitions have contributed significantly to our historical
growth and remain an integral component of our long-term growth strategy.
On November 30, 2005, we acquired 100% of the membership interests in
(i)Structure, LLC., a Delaware limited liability company ("IST") with operations
in Colorado and data centers in Omaha, NE and Tempe, AZ, from Level 3 Financing,
Inc. for a total purchase price of approximately $86,767,000, including related
acquisition costs of $2,000,000 and 346,597 shares of our common stock valued at
$2,500,000.
On April 2, 2004, we acquired all of the outstanding capital stock of ITO
Acquisition Corporation, a California corporation doing business as Systems
Management Specialists ("SMS"), from ITO Holdings, LLC ("Holdings") for a total
purchase price of approximately $37,572,000 including related acquisition costs
of $1,224,000 and 135,892 shares of our common stock valued at $1,439,000. In
June 2004, the name of this subsidiary was changed to Infocrossing West, Inc. In
connection with an acquisition by SMS prior to April 2004, we may have to pay
contingent consideration for a period of up to four years. Through December 31,
2005, such contingent consideration totaled $775,000 that was recorded as
additional goodwill.
On October 1, 2004, we acquired a segment of Verizon Information Technologies
Inc. ("VITI") for a total purchase price of approximately $45,386,000 including
related acquisition costs of $1,886,000 (the "IHS Acquisition"). Immediately
after the IHS Acquisition we changed VITI's name to Infocrossing Healthcare
Services, Inc. ("IHS").
During 2004 we used $7,090,000 in cash, incurred an estimated $116,000 of
acquisition-related costs, and issued 123,193 shares of common stock valued at
$1,500,000 for other acquisitions, including a business that offers e-mail
security services.
Page 21
The operations of IST, IHS, SMS and the other acquisitions completed in 2005 and
2004 are included in consolidated operations from the date of the respective
acquisitions. The acquired businesses are being integrated into the Company so
that the entire enterprise will benefit from operational leverage and
consolidation.
The foregoing acquisitions were recorded as purchases in accordance with the
Financial Accounting Standards Board, Statements of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" ("SFAS 141"), which requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. SFAS 141 also includes guidance on the initial
recognition and measurement of goodwill and other intangible assets arising from
business combinations completed after June 30, 2001. We tested goodwill and
other intangible assets for impairment using processes described in SFAS 142 and
SFAS 144, and had no impairment to record in 2005, 2004, or 2003.
We operate in one reportable segment of providing information technology
outsourcing services.
YEAR ENDED DECEMBER 31, 2005 AS
COMPARED TO THE YEAR ENDED DECEMBER 31, 2004
Net income decreased by $17,390,000 from $19,963,000 for the year ended December
31, 2004 ("2004") to $2,573,000 for the year ended December 31, 2005 ("2005") on
41.0% higher revenues. For 2004, net income included $12,550,000 for the
reversal of deferred tax assets that had been fully reserved in prior periods,
Excluding this one-time reversal, net income declined $4,840,000 from 2005 to
2004, or 65.3%. Although revenues were higher, a lower gross margin percentage
as well as higher selling and promotion costs and general and administrative
expenses were the reasons for the decline in income before income taxes for 2005
compared with 2004.
For 2005, revenues increased $43,057,000 (41.0%) to $148,006,000 from
$104,949,000 for 2004. Approximately $52,321,000 of this growth is attributable
to revenue from clients added as the result of acquisitions completed in 2005
and 2004. Excluding revenues added through acquisitions in 2004 and 2005,
revenues decreased by $9,264,000 (8.8%). The decrease is net of growth from both
new and existing customers.
Costs of revenues excluding depreciation increased by $34,986,000 (49.0%) to
$106,354,000 during 2005 compared with $71,368,000 for the 2004. The increase
includes costs associated with our expansion from acquisitions completed in 2004
and 2005. The increase results from the expansion of revenues from acquisitions
and costs to increase the capacity and quality of our infrastructure. Costs of
revenues as a percentage of revenues increased to 71.9% in 2005 from 68.0% in
2004, reflecting a lower gross margin percentage of 28.1% in 2005 compared with
32% in 2004. This is related to the reduction in revenues other than from
acquisitions without offsetting cost reductions. Cost reductions had been
deferred during 2005 in anticipation of new revenue opportunities that did not
materialize and also for the acquisition of (i)Structure. Our infrastructure
provides a shared operating environment that enables us to integrate new
clients, including clients acquired through acquisitions. We expect our gross
margin to improve as we consolidate the operations of recent (i)Structure and
improve our organic growth rate.
Selling and promotion costs increased by $1,449,000 (44.2%) to $4,726,000 for
2005 from $3,277,000 for 2004. As a percentage of revenues they increased to
3.2% for 2005 from 3.1% for 2004. This increase is attributable to additional
compensation and related expenses for an expanded sales force.
General and administrative expenses increased by $6,097,000 (69.7%) to
$14,841,000 for 2005 from $8,744,000 for 2004. Approximately $1,222,000, or
20.0% of the total increase, was related to acquisitions completed in 2004 and
2005. Compensation costs increased approximately $1,538,000 (25.2% of the total
increase). Of this amount, $1,250,000 represents the amount of bonuses
distributed in February 2006 to our officers and employees, and approximately
$390,000 was attributable to pension benefits payable to our Chairman and Vice
Chairman. Approximately $1,328,000, or 21.8% of the total increase, was due to
higher professional fees due to our growth. Approximately $1,324,000 (21.7% of
the total increase) relates to bad debt expense, including a charge of
$1,000,000 relating to incremental usage-based charges billed to a customer in
2004.
Page 22
Depreciation and amortization of fixed assets and other intangibles increased
$2,467,000 (28.4%) to $11,146,000 for 2005 from $8,679,000 for 2004. Of this
increase, $387,000 or 15.7% of the increase related to the acquisition of IST.
Approximately $1,390,000 or 56.3% of the increase related to depreciation and
amortization related to entities acquired in 2004. The remainder of the increase
of $690,000, or 28.0% of the increase, resulted from new fixed asset additions
during 2005 and 2004. Depreciation and amortization decreased as a percentage of
revenues to 7.5% in 2005 compared with 8.3% in 2004.
Net interest expense increased by $757,000, to $6,214,000 for 2005 from
$5,457,000 for 2004. The results for 2004 include $1,347,000 for expensing the
unamortized balance of costs relating to approximately $40 million in term loans
repaid in June 2004. Excluding this write-off in 2004, there was a net increase
of $2,104,000, consisting of $2,478,000 in additional interest expense partially
offset by an increase in interest income of $374,000. The increases in interest
income and expense are due to larger average outstanding balances of both cash
and outstanding debt, respectively, as well as increases in interest rates
earned and incurred during 2005. Interest expense on the $72,000,000 aggregate
principal amount of 4.0% Convertible Senior Notes due July 15, 2024 (the
"Notes"), including amortization of deferred financing costs and discount,
amounted to $3,127,000 in 2005 compared with $1,509,000 in 2004. As explained in
Liquidity and Capital Resources below, in August 2005, the conversion price of
the Notes was reduced, and a reduction of the carrying value of the Notes of
$4,596,000 was recorded as an increase in paid in capital. The amortization of
this additional discount increases interest expense by approximately $19,000 per
month over the term of the Notes. The impact of this amortization in 2005 was
$95,000 of interest expense.
A deferred tax benefit reflects future income tax savings realizable when tax
credits, net operating loss carry-forwards, or other deductions based on
temporary differences between taxable income and income before income taxes can
be used to reduce income taxes. If there is uncertainty of realizing deferred
tax benefits, a valuation allowance must be established. We had a deferred tax
valuation allowance of $2,462,000 at the end of 2005 and 2004.
In 2005, we recorded a tax provision of $2,152,000 compared with a tax benefit
of $12,539,000 for 2004. This change was due to a decrease of the deferred tax
asset valuation allowance of $12,550,000 during the fourth quarter ended
December 31, 2004 to recognize fully-reserved deferred tax assets from prior
periods with respect to which management has determined that it is more likely
than not that such deferred tax assets will be realized. During 2005 we
generated a net operating loss for federal income tax purposes due to the timing
of certain deductions. We have net operating loss carry-forwards of
approximately $42,000,000 for Federal income tax purposes that begin to expire
in 2019. The use of these net operating loss carry-forwards is limited in amount
in future years pursuant to Section 382 of the Internal Revenue Code.
We have net income of $2,573,000 for 2005 compared with $19,963,000 for 2004.
In 2005, we had income per basic common share of $0.13 and $0.12 on a diluted
basis, compared with $1.12 per basic share and $0.95 per diluted share in 2004.
The tax benefit from the change in deferred tax assets in 2004 amounted to $0.78
per basic share and $0.57 per diluted share. The number of weighted average
shares increased to approximately 20,217,000 basic shares and decreased to
approximately 21,726,000 diluted shares in 2005 from approximately 17,827,000
basic shares and 21,932,000 diluted shares for 2004. The increase in weighted
average basic shares of 2,390,000 was the result of issuing 346,600 shares for
the acquisition of IST and exercises of options and warrants, net of the
repurchase of 50,000 shares. For 2005 and 2004, the weighted average number of
shares used in calculating diluted earnings per share includes options and
warrants to purchase common stock aggregating 1,510,000 and 1,774,000 shares,
respectively. The calculation for 2005 excludes the potential conversion of the
Notes (which includes an adjustment to reported net income to add back the
interest on the Notes, net of tax), because the effect of this adjustment would
be anti-dilutive. In 2004, this adjustment was dilutive and added 2,331,000
weighted average shares, reducing diluted net income per share by approximately
$0.07.
YEAR ENDED DECEMBER 31, 2004 AS
COMPARED TO THE YEAR ENDED DECEMBER 31, 2003
Net income to common stockholders increased by $25,484,000 from a loss of
$5,521,000 for the year ended December 31, 2003 ("2003") to income of
$19,963,000 for the year ended December 31, 2004 ("2004") on 90.0% higher
revenues. For 2004, the results of operations include SMS, IHS, and other
acquisitions completed in 2004.
Page 23
For 2004, revenues increased $49,721,000 (90.0%) to $104,949,000 from
$55,228,000 for, 2003. Approximately $40,630,000 of this growth is attributable
to revenue from clients added as the result of acquisitions completed in 2004.
The remainder of approximately $9,091,000 represents organic growth, of which
$5,900,000 was the result of new customer contracts while the remaining increase
resulted from increased revenues from existing clients.
Costs of revenues increased by $34,705,000 (94.7%) to $71,368,000 during 2004
compared with $36,663,000 for 2003. The increase results from the expansion of
revenues from both acquisitions and organic growth. Costs of revenues as a
percentage of revenues increased to 68.0% in 2004 from 66.4% in 2003, reflecting
a lower gross margin. We had expected our gross margin to decline after the SMS
Acquisition until its operations could be consolidated into our existing
operating infrastructure. The integration of SMS was completed in early March
2005. Gross margin improved from 30.0% in the third quarter ended September 30,
2004 to 35.3% in the fourth quarter ended December 31, 2004. This improvement
reflects the inclusion of IHS, which contributed 43% of our fourth quarter gross
margin. Our infrastructure provides a shared operating environment that enables
us to effectively integrate new clients, including clients acquired through
acquisitions. We expect our gross margin to improve as the integration of IHS
progresses.
Due to higher compensation costs in 2004, selling and promotion costs increased
by $299,000 (10.0%) to $3,277,000 for 2004 from $2,978,000 for 2003, but
decreased as a percentage of revenues to 3.1% for 2004 from 5.4% for 2003.
Higher compensation costs reflect a larger sales staff in 2004 than in 2003. The
reduction as a percentage of revenue reflects the benefits of integration of the
acquired businesses.
General and administrative expenses increased by $3,157,000 (56.5%) to
$8,744,000 for 2004 from $5,587,000 for 2003. General and administrative
expenses declined as a percentage of revenue to 8.3% in 2004 from 10.1% in 2003,
reflecting the benefits of operational leverage and consolidation of the
acquired businesses. Approximately $1,938,000, or 61.4% of the total increase,
was related to acquisitions completed in 2004. Approximately $700,000 (22.2% of
the total increase) was due to professional fees relating to compliance costs
with respect to the Sarbanes-Oxley Act of 2002. Also, an additional $200,000 of
professional fees was incurred, and salary costs were approximately $100,000
higher than in 2003.
Depreciation and amortization of fixed assets and other intangibles increased
$2,575,000 (42.2%) to $8,679,000 for 2004 from $6,104,000 for 2003. Of this
increase, $1,457,000 of depreciation of fixed assets and amortization of other
intangibles was related to acquisitions in 2004. The remainder of the increase
of $1,118,000 resulted from new fixed asset additions totaling approximately
$7,400,000 during 2004. Despite these increases, depreciation and amortization
decreased as a percentage of revenues to 8.3% in 2004 compared with 11.0% in
2003.
Net interest expense increased by $2,959,000 to $5,457,000 for 2004 from
$2,498,000 for 2003. This net increase consists of $210,000 in additional
interest income; $1,822,000 in additional interest expense; and $1,347,000 of
deferred financing costs which were expensed upon the prepayment of term loans
of approximately $40 million in June 2004. The increases in interest income and
expense are due to larger average outstanding balances of both cash and
outstanding debt, respectively, in 2004. Interest expense on the convertible
debt in 2004, including amortization of deferred financing costs and discount,
amounted to $1,509,000.
A deferred tax benefit reflects future income tax savings realizable when tax
credits, net operating loss carry-forwards, or other deductions based on
temporary differences between taxable income and income before income taxes can
be used to reduce income taxes. If there is uncertainty of realizing deferred
tax benefits, a valuation allowance must be established. We had a deferred tax
valuation allowance of $15,207,000 at the end of 2003.
For 2004, we recorded a tax benefit of $12,539,000 compared with a tax provision
of $42,000, which represented estimated state income taxes, for 2003. This
change is due to a decrease in the deferred tax asset valuation allowance of
$12,550,000 during the fourth quarter ended December 31, 2004 to recognize
deferred tax assets at amounts considered by management, more likely than not,
to be realized. Based on our recent history of profitability and our forecasts
for future periods, management has determined that it is more likely than not
that the net operating loss carryforwards and other temporary differences will
be realized. We have net operating loss carry-forwards of approximately
$37,000,000 for Federal income tax purposes that begin to expire in 2019. The
use of these net operating loss carry-forwards may be limited in amount in
future years pursuant to Section 382 of the Internal Revenue Code.
Page 24
Due to a lack of SMS's history of generating taxable income, we recorded a
valuation allowance equal to 100% of their net deferred tax assets. In the event
that we are able to generate taxable earnings from SMS in the future and
determine it is more likely than not that we can realize our deferred tax
assets, an adjustment to the valuation allowance would be made which may
increase goodwill in the period that such determination is made.
We have net income of $19,963,000 for 2004 compared with $1,356,000 for 2003.
Net loss to common stockholders after accretion and accrued dividends on
preferred stock was $5,521,000 for 2003. We redeemed the preferred stock in
October 2003. The net loss to common stockholders included non-cash charges for
accretion and accrued dividends on preferred stock of $6,877,000 in 2003.
In 2004, we had income per common share of $1.12 on a basic basis and $0.95 on a
diluted basis, compared with a loss of $0.76 per share for 2003, on both a basic
and diluted basis. The number of weighted average shares increased to
approximately 17,827,000 shares on a basic basis and approximately 21,932,000
shares on a diluted basis in 2004 from approximately 7,280,000 shares on both a
basic and diluted basis for 2003. The increase in shares reflects (i) private
placements of (a) 9,739,111 shares of common stock and warrants to purchase
3,408,689 shares of common stock in October 2003 and (b) 2,917,000 shares of
common stock in March 2004; (ii) the potential conversion of $72,000,000 of 4%
convertible notes due July 15, 2024, which were issued during 2004, into
4,687,500 shares of common stock; and (iii) the issuance of 259,085 shares of
common stock for acquisitions during 2004. The shares and equivalents enumerated
in the immediately preceding sentence are in absolute amounts, not weighted
average amounts. Common stock equivalents are excluded in determining the net
income or loss per share when the inclusion of such equivalents would be
antidilutive.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $21,944,000 for the year ended
December 31, 2005. During 2005, we had $2,573,000 of net income, a non-cash
increase in deferred tax assets of $1,493,000, $11,146,000 of depreciation and
amortization, and $218,000 of accretion of the discount on the Notes. Accounts
receivable decreased by $5,952,000, which includes $5,659,000 related to IHS
receivables, the collection of which was delayed into 2005 due to the transition
of accounts payable processing by certain of the IHS customers. Other
revenue-related working capital adjustments include additions to the allowance
for doubtful accounts of $1,527,000, including a charge of $1,000,000 relating
to incremental usage-based charges billed to a customer in 2004, and additions
to deferred revenues of $2,143,000, offset by an addition to deferred client
acquisition costs in other assets of $2,001,000. We also had a decrease in
prepaid expenses of $1,255,000 offset by a decrease in accounts payable and
accrued expenses of $1,181,000.
On November 30, 2005, we acquired all of the outstanding member interests in
(i)Structure for $84,267,000 in cash, including costs, and 346,597 shares of our
stock valued at $2,500,000. We financed this transaction by means of a new
$70,000,000 credit facility, the proceeds of the sale and leaseback of certain
real estate acquired, and with cash on hand. Cash outlays including costs paid
to date total $5,285,000.
Other investing activities during 2005 include $4,315,000 for the purchase of
fixed assets. During 2005, we also entered into capital leases having an
aggregate carrying value of approximately $8,301,000, paid $483,000 to
repurchase 50,000 of our own shares, and invested $947,000 in
internally-developed software.
On November 30, 2005, we entered into a $70,000,000 senior secured credit
facility (the "Credit Agreement"), with each of the banks and other financial
institutions that either now or in the future are parties thereto as lenders
(the "Lenders"), Bank of America, N.A., as sole and exclusive administrative and
collateral agent and as a lender ("Bank of America"), and Banc of America
Securities LLC, as sole and exclusive lead arranger and sole book manager ("Banc
of America Securities"). Our obligations under the Credit Agreement are
unconditionally guaranteed by each of our domestic wholly-owned subsidiaries
(the "Guarantors"). The Credit Agreement provides for a $55 million term loan
facility, subject to amortization pursuant to the provisions of the Credit
Agreement, and a $15 million revolving credit facility (including letter of
credit subfacilities). The
Page 25
maturity date for both the term loan facility and the revolving credit facility
is April 14, 2009. Loans outstanding under the Credit Agreement bear interest at
LIBOR plus the Applicable Rate (as such term is defined in the Credit Agreement)
or, at our option, the alternate base rate (the greater of the Bank of America
prime rate or the federal funds rate plus one half of one percent (0.50%)) plus
the Applicable Rate (as such term is defined in the Credit Agreement). The terms
of the Credit Agreement include various covenants including, but not limited to:
a maximum leverage ratio; minimum consolidated earnings before interest, taxes,
depreciation, and amortization; a minimum debt coverage ratio; and limitations
on indebtedness, capital expenditures, investments, loans, mergers and
acquisitions, stock issuances and repurchases, and transactions with affiliates.
In addition, the terms of the Credit Agreement limit our ability to pay cash
dividends. We were in compliance with such covenants at December 31, 2005. The
Credit Agreement also includes customary events of default, including, without
limitation, payment defaults, cross-defaults to other indebtedness and
bankruptcy-related defaults. If any event of default occurs and is continuing,
the administrative agent upon instruction from a majority of the lenders may
terminate the commitments and may declare all of our obligations under the
Credit Agreement to be immediately due and payable.
In connection with the Credit Agreement, we entered into a Security Agreement,
dated November 30, 2005 (the "Security Agreement"), with the Guarantors, and
Bank of America pursuant to which we and the Guarantors granted a security
interest in certain collateral to the Administrative Agent, for the benefit of
the Lenders. The pledged collateral includes substantially all of the grantors'
accounts receivable, chattel paper, documents, general intangibles, instruments,
inventory, letter-of-credit rights and supporting obligations, deposit accounts
and proceeds of the foregoing. We also entered into a securities pledge
agreement, dated November 30, 2005 (the "Pledge Agreement"), with certain of our
subsidiaries (the "Pledgors") and Bank of America, pursuant to which we and the
Pledgors granted a security interest in certain equity securities held by them
to the Administrative Agent for the benefit of the Lenders.
The descriptions above of the Credit Agreement, the Security Agreement and the
Pledge Agreement are qualified in their entirety by the complete text of the
Credit Agreement, the Security Agreement, and the Pledge Agreement.
On July, 2004, we completed a private offering of $72,000,000 aggregate
principal amount of 4.0% Convertible Senior Notes due July 15, 2024 (the
"Notes"). Approximately $40,000,000 of the net proceeds from this offering was
used to repay outstanding debt. The remaining balance was used to fund
acquisitions and for general corporate purposes. Net proceeds after a discount
of $2,520,000 and approximately $591,000 of costs and fees were approximately
$68,889,000. The discount and loan costs are being amortized over the life of
the Notes using the interest method. Interest on the Notes is payable
semi-annually in arrears beginning on January 15, 2005.
The Notes are convertible, subject to certain conditions, at the option of the
holder prior to maturity, into shares of our common stock at a specified
conversion price, subject to certain adjustments. The conversion price must be
adjusted to reflect stock dividends, stock splits, issuances of rights to
purchase shares of common stock and other events. Upon conversion, we will have
the right to deliver to the holders, at its option, cash, shares of common
stock, or a combination thereof. At the initial conversion price of $15.36, the
$72,000,000 of Notes were convertible into 4,687,500 common shares. The Notes
and the shares of common stock into which they may be converted may be resold
pursuant to a registration statement on Form S-3 that became effective in August
2004. After the effective date of the registration statement and prior to the
end of the 18th month thereafter, if the market price of our common stock were
to be less than 68.23% ($10.48) of the conversion price then in effect for at
least 20 trading days during any 30 consecutive trading day period, the
conversion price would immediately be reduced by 17.38% (to $12.69 initially,
subject to adjustment as noted above for stock dividends, splits, etc.) (the
"Reset Adjustment"); provided that (i) the Reset Adjustment shall only be
applicable to Notes that have been sold or otherwise distributed pursuant to the
registration statement referred to above or pursuant to Rule 144(k) under the
Securities Act (and such adjustment shall apply to all such Notes, regardless of
whether they are so sold or distributed before or after adjustment), and (ii)
there shall be no more than one Reset Adjustment during the term of the Notes.
On August 5, 2005, the Reset Adjustment was triggered. As a result of the Reset
Adjustment, the number of common shares into which the Notes are convertible is
5,673,759, an increase of 986,259 shares. The Reset Adjustment was valued in
accordance with EITF 00-27, "APPLICATION OF ISSUE NO. 98-5 - CERTAIN CONVERTIBLE
INSTRUMENTS" at $4,596,000, and this amount was recorded as an increase to
Additional Paid in Capital and as a discount to the carrying value of the Notes.
This additional discount will be accreted to the carrying value of the Notes
through a charge to interest expense over the life of the Notes.
Page 26
At December 31, 2004, the unamortized discount was $6,836,000 and unamortized
loan costs were $547,000.
The holders may convert their Notes into shares of our common stock, at the
conversion price in effect at the time, prior to the close of business on their
stated maturity date under any of the following circumstances: (1) during any
fiscal quarter if the market price per share of our common stock for a period of
at least 20 consecutive trading days during the 30 consecutive trading day
period ending on the last day of the preceding fiscal quarter is more than 130%
of the applicable conversion price; (2) on or before July 15, 2019, during the
five business-day period following any 10 consecutive trading-day period in
which the trading price for the Notes during such ten-day period was less than
98% of the applicable conversion value for the Notes during that period, subject
to certain limitations; (3) if the Notes have been called for redemption; or (4)
upon the occurrence of specified corporate transactions, such as (1)
distributions to our common stockholders of rights to acquire shares of our
common stock at a discount; (2) distributions to our common stockholders when
the distribution has a per share value in excess of 5% of the market price of
our common stock; and (3) a consolidation, merger or binding share exchange
pursuant to which our common stock will be converted into cash, securities or
other property. Upon a "change of control," as defined in the indenture, the
holders can require us to repurchase all or part of the Notes for cash equal to
100% of principal plus accrued interest. A consolidation, merger, or binding
exchange also may constitute a "change of control" in certain instances. If the
"change of control" occurred prior to July 15, 2009, in certain instances, we
may be required to pay a "make whole premium" as defined in the indenture when
repurchasing the Notes.
We have a call option, pursuant to which the Notes may be redeemed, in part or
in whole, for cash at any time on or after July 15, 2007 at a price equal to
100% of the principal amount of the Notes, plus accrued interest plus a
"premium" if the redemption is prior to July 15, 2009, provided, however, the
Notes are only redeemable prior to July 15, 2009 if the market price of our
common stock has been at least 150% of the conversion price then in effect for
at least 20 trading days during any 30 consecutive trading day period. The
"premium" referred to in the preceding sentence shall be in an amount equal to
$173.83 per $1,000 principal amount of Notes, less the amount of any interest
actually paid on such Notes prior to the redemption date.
The holders of the Notes may require that we purchase for cash all or a portion
of the Notes on July 15, 2009, 2014, and 2019 at a repurchase price equal to
100% of the principal amount of the Notes plus any accrued interest. There are
no financial covenants, other than a limitation on incurring of additional
indebtedness, as defined in the indenture. We are not restricted from paying
dividends, or issuing other securities, or repurchasing other securities issued
by us under the terms of the indenture.
On October 1, 2004, we borrowed $24,375,000 from a non-revolving loan facility
to pay a portion of the cost of the IHS acquisition. Monthly principal payments
of approximately $609,000 were to begin on July 1, 2007, and a final payment of
$11,578,000 was scheduled to be made on March 15, 2009. On October 21, 2005, we
repaid the outstanding balance of $24,375,000, plus accrued interest and a
$12,500 prepayment penalty. We recorded interest expense of $256,000 in October
2005 to eliminate unamortized loan costs.
Aside from the repayment of $24,375,000 in notes payable noted above, financing
activities during 2005 also include the repayment of approximately $14,696,000
of capital leases and the receipt of $5,894,000 from the exercise of warrants
and employee stock options.
Page 27
The following table summarizes information about our contractual obligations as
of December 31, 2005 and the periods in which payments are due. Certain of these
amounts are not required to be included in our consolidated balance sheet:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL WITHIN 2-3 4 - 5 AFTER
1 YEAR YEARS YEARS 5 YEARS
--------------- -------------- --------------- -------------- ---------------
Convertible notes (1) $ 72,000 $ - $ - $ - $ 72,000
Term loan 55,000 5,000 30,000 20,000 -
Revolving loan (2) 5,000 5,000 - - -
Interest on convertible
notes 54,720 2,880 5,760 5,760 40,320
Interest on the term loan
at the most recent rate 10,569 4,235 5,896 438 -
Operating leases and
software licenses 145,261 27,291 36,670 22,127 59,173
Operating contracts for
disaster recovery and
communications
services 5,681 4,150 1,531 - -
Capital lease obligations 15,831 6,563 8,136 1,132 -
Deferred compensation
liability (3) 1,080 - - - 1,080
Other long-term
liabilities reflected on
the Company's balance
sheet under GAAP (4) - - - - -
--------------- -------------- --------------- -------------- ---------------
Total contractual cash
obligations $ 365,142 $ 55,119 $ 87,993 $ 49,457 $ 172,573
=============== ============== =============== ============== ===============
(1) Excludes the provision whereby the holders of the convertible notes may
require the Company to repurchase for cash all or a portion of the
Notes on July 15, 2009, 2014, and 2019 at a repurchase price equal to
100% of the principal amount of the Notes plus any accrued interest.
(2) All current.
(3) Estimated future benefit amounts payable. Amount accrued at December
31, 2005 is $390. (4) Excludes accrued loss on leased facilities and
deferred rent, since these payments are included under
operating leases.
As of December 31, 2005, we had cash and equivalents of $16,892,000. On February
22, 2005, we filed a preliminary, or "shelf" registration statement with the
Securities and Exchange Commission. This registration statement will permit us
to sell equity or debt securities, in any combination, for up to $125,000,000.
We intend to use the net proceeds we expect to receive from the sale of the
securities to reduce our outstanding debt and to fund possible acquisitions and
investments. The exact timing and terms of this financing will depend upon
market conditions and other factors. There can be no assurance that such
financing will occur.
We believe that our cash and equivalents, current assets, and cash generated
from future operating activities will provide adequate resources to fund our
ongoing operating requirements for at least the next twelve months. We may need
to obtain additional financing to fund significant acquisitions or other
substantial investments.
Page 28
EBITDA
EBITDA represents net income before interest, taxes, depreciation and
amortization. We present EBITDA because we consider such information an
important supplemental measure of our performance and believe it is frequently
used by securities analysts, investors and other interested parties in the
evaluation of companies with comparable market capitalization to us, many of
which present EBITDA when reporting their results. We also use EBITDA as one of
the factors used to determine the total amount of bonuses available to be
awarded to executive officers and other employees. Our credit agreement uses
EBITDA (with additional adjustments) to measure compliance with covenants such
as interest coverage and debt incurred. EBITDA is also used by prospective and
current lessors as well as potential lenders to evaluate potential transactions
with us. In addition, EBITDA is also widely used by us and other buyers to
evaluate and determine the price of potential acquisition candidates.
For 2005, our EBITDA was $22,085,000 compared with $21,560,000 for 2004, 14.9%
and 20.5% as a percentage of revenue, respectively. We expect that the
percentage of incremental EBITDA to incremental revenues projected to be added
in the year ending December 31, 2006 will be in the range of 30% and 35%.
EBITDA has limitations as an analytical tool, and you should not consider it in
isolation, or as a substitute for analysis of our results as reported under U.S.
Generally Accepted Accounting Principles ("GAAP"). Some of these limitations
are: (a) EBITDA does not reflect changes in, or cash requirements for, our
working capital needs; (b) EBITDA does not reflect the significant interest
expense, or the cash requirements necessary to service interest or principal
payments, on our debts; and (c) although depreciation and amortization are
non-cash charges, the assets being depreciated and amortized may have to be
replaced in the future, and EBITDA does not reflect any cash requirements for
such capital expenditures. Because of these limitations, EBITDA should not be
considered as a principal indicator of our performance. We compensate for these
limitations by relying primarily on our GAAP results and using EBITDA only on a
supplemental basis.
The following table reconciles EBITDA to net income for the Current and Prior
Year.
RECONCILIATION - IN THOUSANDS
- -------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
--------------------------------------------
2005 2004
-------------------- --------------------
NET INCOME $ 2,573 $ 19,963
Add back (deduct):
Tax expense (benefit) 2,152 (12,539)
Interest expense 6,214 5,457
Depreciation and amortization 11,146 8,679
---------------- ----------------
EBITDA $ 22,085 $ 21,560
================ ================
EBITDA is a measure of our performance that is not required by, or presented in
accordance with, GAAP. EBITDA is not a measurement of our financial performance
under GAAP and should not be considered as an alternative to net income, income
(loss) from operating activities or any other performance measures derived in
accordance with GAAP.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
GENERAL
Our Consolidated Financial Statements are prepared in accordance with GAAP,
which require the selection and application of significant accounting policies,
and which require management to make significant estimates and assumptions. We
believe that the following are some of the more critical judgment areas in the
application of our accounting policies.
Page 29
REVENUE RECOGNITION
Our services are provided under a combination of fixed monthly fees and time and
materials billings. Contracts with customers typically range from two to seven
years. Revenue is recognized (1) after we have obtained an executed service
contract from the customer; (2) as the services are rendered; (3) when the price
is fixed as per the service contract; and (4) when we believe that
collectibility is reasonably assured, based on our credit risk policies and
procedures that we employ.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. In determining these
allowances, we evaluate a number of factors, including the credit risk of
customers, historical trends, and other relevant information. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
BUSINESS COMBINATIONS
Our current acquisitions and future acquisitions of businesses that we will
control will be accounted for under the purchase method of accounting. The
amounts assigned to the identifiable assets acquired and liabilities assumed in
connection with acquisitions will be based on estimated fair values as of the
date of the acquisition, with the remainder, if any, to be recorded as goodwill.
The fair values will be determined by our management, taking into consideration
information supplied by the management of acquired entities and other relevant
information. Such information will include valuations supplied by independent
appraisal experts for significant business combinations. The valuations will
generally be based upon future cash flow projections for the acquired assets,
discounted to present value. The determination of fair values requires
significant judgment both by management and by outside experts engaged to assist
in this process.
GOODWILL, INTANGIBLE ASSETS AND PROPERTY AND EQUIPMENT
Significant assets acquired in connection with our acquisitions include customer
lists, customer relationships, property and equipment and goodwill.
Goodwill represents the excess of the purchase price over the fair value of the
assets acquired. Goodwill is not amortized. However, we are required to perform
impairment reviews at least annually and more frequently in certain
circumstances.
The goodwill impairment test is a two-step process, which requires management to
make judgments in determining what assumptions to use in the calculation. The
first step of the process consists of estimating the fair value of our reporting
unit based on a discounted cash flow model using revenue and profit forecasts
and comparing those estimated fair values with the carrying values, which
include the allocated goodwill. If the estimated fair value is less than the
carrying value, a second step is performed to compute the amount of the
impairment by determining an "implied fair value" of goodwill. The determination
of a reporting unit's "implied fair value" of goodwill requires the allocation
of the estimated fair value of the reporting unit to the assets and liabilities
of the reporting unit. Any unallocated fair value represents the "implied fair
value" of goodwill, which will then be compared to its corresponding carrying
value. We cannot predict the occurrence of certain future events that might
adversely affect the reported value of goodwill and/or intangible assets. Such
events include, but are not limited to, strategic decisions made in response to
economic and competitive conditions, the impact of the economic environment on
our customer base, and material negative change in relationship with significant
customers. The "implied fair value" of reporting unit will be determined by our
management and will generally be based upon future cash flow projections for the
reporting unit, discounted to present value. We will use outside valuation
experts when management considers that it would be appropriate to do so.
Intangibles subject to amortization, including customer lists and customer
relationships, are amortized over the estimated useful lives of the intangible
asset after consideration of historical results and anticipated results based on
our current plans. We take into consideration the history of contract renewals
in determining our assessment of useful life and the corresponding amortization
period. We analyze our customer lists on a case-by-case basis, with examination
of the history of contract renewals as well as other factors, such as material
changes to contract terms or significant new commitments where applicable. Such
estimates are based on management's judgment of its current relationship with
the relevant customers and its estimate of future economic. Changes to either of
these factors could result in an impairment charge, which could have a material
effect on our results of operation and financial condition.
Page 30
Customer relationships are essential to our business. In determining the value
of these relationships, we discounted the expected returns for each contract
using a discounted cash flow analysis over the remaining terms of the contract.
We further estimate that it would be unlikely that a customer would terminate
its contract, due to the quality of service currently provided as well as the
lack of viable alternatives.
Property and equipment are initially stated at cost. Depreciation on property
and equipment is computed using the straight-line method over the estimated
useful lives of the property and equipment after consideration of historical
results and anticipated results based on our current plans. Our estimated useful
lives represent the period the asset is expected to remain in service assuming
normal routine maintenance. We will review the estimated useful lives assigned
to property and equipment when our business experience suggests that they may
have changed from our initial assessment. Factors that lead to such a conclusion
may include physical observation of asset usage, examination of realized gains
and losses on asset disposals and consideration of market trends such as
technological obsolescence or change in market demand.
We will perform impairment reviews of property and equipment and intangibles
subject to amortization, when events or circumstances indicate that the value of
the assets may be impaired. Indicators include operating or cash flow losses,
significant decreases in market value or changes in the long-lived assets'
physical condition. When indicators of impairment are present, management
determines whether the sum of the undiscounted future cash flows estimated to be
generated by those assets is less than the carrying amount of those assets. In
this circumstance, the impairment charge is determined based upon the amount by
which the carrying value of the assets exceeds their fair value. The estimates
of both the undiscounted future cash flows and the fair values of assets require
the use of complex models that require numerous highly sensitive assumptions and
estimates.
DEFERRED TAXES
Our deferred tax assets are comprised primarily of net operating loss
carryforwards. A tax valuation allowance is established, as needed, to reduce
net deferred tax assets to the amount for which recovery is probable. Based on
our profitability in 2004 and our forecasts, we determined that it would be more
likely than not that our net operating loss carry-forwards and other temporary
differences will be realized. Accordingly, we released the full valuation
allowance in the fourth quarter of 2004. Due to a lack of a history of
generating taxable income on SMS, we recorded a valuation allowance equal to
100% of its net deferred tax assets at December 31, 2004. In the event that we
are able to generate taxable earnings from SMS in the future and determine it is
more likely than not that we can realize our deferred tax assets, an adjustment
to the valuation allowance would be made which may increase goodwill in the
period that such determination was made.
STOCK-BASED COMPENSATION
To date, we have accounted for stock-based compensation by using the intrinsic
value based method in accordance with the provisions of Accounting Principles
Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO Employees, and
related interpretations. Accordingly, we have only recorded compensation expense
for any stock options granted with an exercise price that is less than the fair
market value of the underlying stock at the date of grant. Refer to the section
entitled "Recent Accounting Pronouncements" below for a discussion of the impact
of the recently issued Statement of Financial Accounting Standards ("SFAS") No.
123(R), SHARE-BASED PAYMENT, on our recording of stock-based compensation fiscal
years beginning on or after December15, 2005.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS,
which eliminated the exception for nonmonetary exchanges of similar productive
assets and replaces it with a general exception for exchanges of nonmonetary
assets that do not have commercial substance. SFAS No. 153 will be effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. We do not believe the adoption of SFAS No. 153 will have a material impact
on our operating results or financial position.
Page 31
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENT, which
establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. This
eliminates the exception to account for such awards using the intrinsic method
previously allowable under APB Opinion No. 25. SFAS 123(R) will be effective for
fiscal years beginning on or after December 15, 2005.
SFAS 123(R) permits public companies to adopt its requirements using one of the
following two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
SFAS 123(R) for all shared based payments granted after the effective date and
(b) based on the requirements of SFAS 123 for all awards granted to employees
prior to the effective date of SFAS 123(R) that remain unvested on the effective
date.
2. A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.
We plan to adopt SFAS 123(R) using the modified-prospective method.
As permitted by SFAS 123, we currently account for shared-based payments to
employees using APB Opinion 25's intrinsic value method and, as such, generally
recognize no compensation cost for employee stock options. Accordingly, the
adoption of SFAS 123(R)'s fair value method will have a significant impact on
our results of operations, although it will have no impact on our overall
financial position. Had we adopted SFAS 123(R) in prior periods, the impact of
that standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net income and earnings per share in Note 1 to our
consolidated financial statements. For options issued through February 8, 2006,
the projected after-tax expense in 2006, 2007, and 2008 is $779,000, $508,000,
and $136,000, respectively.
We have not determined what impact SFAS 123(R) might have on the nature of our
shared-based compensation to employees in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INTEREST RATE RISK
With respect to our investments, we are not significantly exposed to the impact
of interest rate changes, foreign currency fluctuations, or changes in market
values. We primarily invest in money market mutual funds or certificates of
deposit and commercial paper issued only by major corporations and financial
institutions of recognized strength and security, and hold all such investments
to term. We generally invest in instruments of no more than 30 days maturity. As
of December 31, 2005, however, we had $60,000,000 of outstanding debt bearing
interest at LIBOR plus the Applicable Rate (as such term is defined in the
Credit Agreement). At our option, this debt can alternatively bear interest at
the Applicable rate plus either the Bank of America prime rate or the federal
funds rate plus one-half of one percent (0.50%). We believe that the carrying
amount of our fixed rate debt and capitalized leases of $79,285,000 approximates
fair value based on interest rates that are currently available to us with
similar terms and remaining maturities.
MARKET RISK
Our accounts receivable are subject, in the normal course of business, to
collection risks. We regularly assess these risks and have established policies
and business practices to protect against the adverse effects of collection
risks.
Page 32
FOREIGN CURRENCY RISKS
We believe that our foreign currency risk is immaterial. Our income from foreign
sources is derived from a single customer and amounts to approximately 1% of
total revenues in each of 2005 and 2004.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements and Notes thereto are set forth beginning
at page F-1 of this Annual Report. Also included is Schedule II, Valuation and
Qualifying Accounts, which schedule is set forth at page S-1 of this Annual
Report. All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
inapplicable and therefore have been omitted.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
MANAGEMENT'S EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The term disclosure controls and procedures is defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, or the Exchange Act. This term
refers to the controls and procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
filed under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified by the Securities and Exchange Commission. An
evaluation was performed under the supervision and with the participation of the
Company's management, including the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), of the effectiveness of the Company's disclosure
controls and procedures as of December 31, 2005. Based on that evaluation, the
Company's management, including the CEO and CFO, concluded that the Company's
disclosure controls and procedures were effective as of December 31, 2005.
During the quarter ending on December 31, 2005 there was no change in the
Company's internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining
effective internal control over financial reporting, and for performing an
assessment of the effectiveness of internal control over financial reporting as
of December 31, 2005. Internal control over financial reporting is defined in
Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of
1934 as a process designed by, or under the supervision of, the Company's
principal executive and principal financial officers and effected by the
Company's Board of Directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
U.S. generally accepted accounting principles.
Internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the Company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit the preparation of financial statements in accordance with
U.S. generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the financial statements.
Page 33
All internal control systems, no matter how well designed, have inherent
limitations. Because of the inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Accordingly, even
those systems determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation.
Management performed an assessment of the effectiveness of the Company's
internal controls over financial reporting as of December 31, 2005 using the
criteria set forth in Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. In conducting
such assessment, management of the Company has excluded from its assessment of
and conclusion on the effectiveness of internal control over financial
reporting, the internal controls of (i)Structure which is included in the 2005
consolidated financial statements of the Company and constituted approximately
$108 million, or 38% of total assets, including goodwill of approximately $46
million as of December 31, 2005, and approximately $7 million or 5% of revenues
for the year then ended. Management did not assess the effectiveness of internal
control over financial reporting at this entity because the Company acquired
this entity in 2005. Refer to Note 2 to the consolidated financial statements
for further discussion of this acquisition and its impact on Infocrossing's
consolidated financial statements. Based on this assessment, management has
determined that the Company's internal control over financial reporting as of
December 31, 2005 is effective.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2005 has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as stated in their
report.
Page 34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
THE BOARD OF DIRECTORS AND STOCKHOLDERS OF INFOCROSSING, INC. AND SUBSIDIARIES
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that
Infocrossing, Inc. and subsidiaries (Infocrossing) maintained effective internal
control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the COSO criteria).
Infocrossing's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of
Infocrossing's internal control over financial reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process 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. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
As indicated in the accompanying Management's Report on Internal Control Over
Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include the
internal controls of (i)Structure, LLC which is included in the 2005
consolidated financial statements of Infocrossing and constituted approximately
$108 million or 38% of total assets, including goodwill of approximately $46
million as of December 31, 2005, and approximately $7 million or 5% of revenues
for the year then ended. Our audit of internal control over financial reporting
of Infocrossing also did not include an evaluation of the internal control over
financial reporting of (i)Structure, LLC.
In our opinion, management's assessment that Infocrossing maintained effective
internal control over financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on the COSO criteria. Also, in our
opinion, Infocrossing maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005, based on the COSO
criteria.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Infocrossing as of December 31, 2005 and 2004, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2005 of Infocrossing and our report
dated March 8, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
New York, New York
March 8, 2006
Page 35
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The contents of this Item are incorporated by reference to a Definitive Proxy
Statement to be filed on or before May 1, 2006.
ITEM 11. EXECUTIVE COMPENSATION.
The contents of this Item are incorporated by reference to a Definitive Proxy
Statement to be filed on or before May 1, 2006.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required by Item 201(d) of Regulation S-K is included above in
Part II, Item 5 of this Annual Report on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The contents of this Item are incorporated by reference to a Definitive Proxy
Statement to be filed on or before May 1, 2006.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The contents of this Item are incorporated by reference to a Definitive Proxy
Statement to be filed on or before May 1, 2006.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) 1 and 2. The financial statements and schedule required to be filed in
satisfaction of Item 8 are listed in the Index to Consolidated Financial
Statements and Schedule that appears as page F-1 of this report. Schedules
not required have been omitted.
3. The exhibits required to be filed as a part of this Annual Report
are listed below. An index of exhibits accompanying this Annual Report
appears on page 44.
(b) Exhibits:
Page 36
EXHIBIT NO. DESCRIPTION
2.1 Purchase Agreement, dated October 24, 2005, by and between
Infocrossing, Inc. and Level 3 Financing, Inc., incorporated by
reference to Exhibit 10 to a Current Report on Form 8-K filed
October 25, 2005.
3.1A Company's Restated Certificate of Incorporation, incorporated by
reference to the Company's Annual Report on Form 10-K for the
period ended December 31, 2004.
3.1B Certificate of Amendment to the Company's Certificate of
Incorporation, filed May 8, 2000, to increase the authorized
shares and to remove Article 11, incorporated by reference to the
Company's report on Form 10-Q for the period ended April 30,
2000.
3.1C Certificate of Amendment to the Company's Certificate of
Incorporation, filed as of June 5, 2000, to change the name of
the Company to Infocrossing, Inc., incorporated by reference to
the Company's report on Form 10-Q for the period ended April 30,
2000.
3.2 Amended and Restated Bylaws of the Company, incorporated herein
by reference to Exhibit 3.2 to the Company's Form 10-Q/A filed
May 17, 2004.
4.1 Indenture, dated as of June 30, 2004, between the Company as
issuer and Wells Fargo Bank, National Association, as trustee;
and form of 4.00% Convertible Senior Notes due 2024, incorporated
by reference to Exhibit 4.2 to a Registration Statement No.
333-117340 on Form S-3 filed July 13, 2004.
4.2 Resale Rights Agreement, dated as of June 30, 2004, by and
between the Company and Lehman Brothers, Inc. regarding the
Company's 4.00% Convertible Senior Notes due 2024, incorporated
by reference to Exhibit 4.4 to a Registration Statement No.
333-117340 on Form S-3 filed July 13, 2004.
4.3 Securities Purchase Agreement, dated as of March 24, 2004, by and
among the Company and certain purchasers of the Company's common
stock, incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K filed April 1, 2004.
4.4 Registration Rights Agreement, dated as of March 24, 2004, by and
the Company and certain purchasers of the Company's common stock,
incorporated by reference to Exhibit 4.2 to the Company's Current
Report on Form 8-K filed April 1, 2004.
4.5 Securities Purchase Agreement, dated as of October 16, 2003, by
and among the Company and certain purchasers of common stock and
warrants, incorporated by reference to Exhibit 4.1 to the
Company's Current Report on Form 8-K filed October 22, 2003.
4.6 Registration Rights Agreement, dated as of October 16, 2003, by
and among the Company and certain purchasers of common stock and
warrants, incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K filed October 22, 2003.
4.7 Exchange Agreement, dated as of October 16, 2003, by and among
the Company and holders of series A preferred stock and series A
warrants, incorporated by reference to Exhibit 4.3 to the
Company's Current Report on Form 8-K filed October 22, 2003.
Page 37
EXHIBIT NO. DESCRIPTION
4.8 Second Amended and Restated Registration Rights Agreement, dated
as of October 21, 2003, by and among the Company and certain
stockholders of the Company, incorporated by reference to Exhibit
4.4 to the Company's Current Report on Form 8-K filed October 22,
2003.
4.9 Warrant Agreement dated as of February 1, 2002 by and between the
Company and the Warrantholders party thereto, incorporated by
reference to Exhibit 4.3 to the Company's Current Report on Form
8-K filed February 5, 2002.
4.10 Warrant Agreement between the Company and the Warrantholders
party thereto, incorporated by reference to the Company's Annual
Report on Form 10-K for the period ended December 31, 2004.
10.1 Purchase and Sale Agreement, dated as of September 1, 2004
between Verizon Data Services, Inc. and the Company, incorporated
by reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed October 14, 2004
10.2 Stock Purchase Agreement between the Company and ITO Holdings,
LLC, dated as of March 3, 2004, incorporated by reference to
Exhibit 2.1 to the Company's Current Report on Form 8-K filed
April 7, 2004.
10.3 Stock Purchase Agreement dated as of February 5, 2002 by and
between the Company and American Software, Inc., incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form
8-K filed February 5, 2002.
10.4A Acquisition Loan Agreement dated July 29, 2004 between the
Company, various Lenders and CapitalSource Finance LLC as Agent
for the Lenders ("Acquisition Loan Agreement"), incorporated by
reference to Exhibit 10.7 to the Company's Quarterly Report on
Form 10-Q for the period ended June 30, 2004.
10.4B Consent, Waiver and First Amendment to Acquisition Loan
Agreement dated as of October 1, 2004, incorporated by reference
to Exhibit 10.1 to the Company's Current Report on Form 8-K filed
October 4, 2004.
10.4C Amended and Restated Consent, Waiver, and First Amendment to
Acquisition Loan Agreement, dated as of October 6, 2004,
incorporated by reference to Exhibit 10.16 to the Company's
Quarterly Report on Form 10-Q for the period ended September 30,
2004.
10.4D Second Amendment to Acquisition Loan Agreement and Other
Documents, dated as of November 8, 2004, incorporated by
reference to Exhibit 10.17 to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 2004.
10.4E Third Amendment to Acquisition Loan Agreement and Other
Documents, dated as of December 29, 2004, incorporated by
reference to the Company's Annual Report on Form 10-K for
December 31, 2004.
10.5A Guaranty and Security Agreement dated as of July 29, 2004,
between the Company and certain of the Company's subsidiaries and
CapitalSource Finance LLC ("Security Agreement"), incorporated by
reference to Exhibit 10.8 to the Company's Quarterly Report on
Form 10-Q for the period ended June 30, 2004.
10.5B Joinder to Security Agreement dated October 1, 2004,
incorporated by reference to the Company's Annual Report on Form
10-K for the period ended December 31, 2004.
Page 38
EXHIBIT NO. DESCRIPTION
10.6A Stock Pledge Agreement dated as of July 29, 2004, between the
Company and certain of the Company's subsidiaries and
CapitalSource Finance LLC ("Stock Pledge Agreement"),
incorporated by reference to Exhibit 10.9 to the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.6B Addendum to Stock Pledge Agreement dated October 1, 2004,
incorporated by reference to the Company's Annual Report on Form
10-K for December 31, 2004.
10.7A Amended and Restated Term Loan Agreement, dated as of April 2,
2004 between the lenders named therein and the Company ("Amended
and Restated Term Loan Agreement"), incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed
April 7, 2004.
10.7B First Amendment to Amended and Restated Term Loan Agreement,
dated as of June 30, 2004, between the lenders named therein and
the Company, incorporated by reference to Exhibit 4.5 to a
Registration Statement No. 333-117340 on Form S-3 filed July 13,
2004.
10.7C Term Loan Agreement dated as of October 21, 2003 by and among
the Company, Infocrossing Agent, Inc., and the lenders named
therein, incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed October 22, 2003.
10.7D First Amendment to Loan Agreement and other Loan Documents,
dated as of February 13, 2004, by and among the Company, certain
subsidiaries of the Company, certain lenders named therein, and
CapitalSource Finance LLC., incorporated by reference to the
Company's Annual Report on Form 10-K for the period ended
December 31, 2004.
10.7E Master Assignment and Assumption Agreement, dated as of February
13, 2004, by and among by and among the Company, as borrower;
certain subsidiaries of the Company, as guarantors; Infocrossing
Agent, Inc., as agent for assigning lenders named therein;
assigning lenders named therein; and CapitalSource Finance LLC.,
incorporated by reference to the Company's Annual Report on Form
10-K for the period ended December 31, 2004.
10.8A Guaranty and Security Agreement, dated as of April 2, 2004,
between a subsidiary of the Company and CapitalSource,
incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K filed April 7, 2004.
10.8B Guaranty and Security Agreement dated as of October 21, 2003 by
and among the Company, Infocrossing Agent, Inc., and the
Company's subsidiaries, incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K filed October 22,
2003.
10.9 Amended and Restated Stock Pledge Agreement, dated as of April 2,
2004, among the Company, a subsidiary of the Company, and
CapitalSource, incorporated by reference to Exhibit 10.3 to the
Company's Current Report on Form 8-K filed April 7, 2004.
10.10 Employment Agreement between the Company and Zach Lonstein,
dated as of January 1, 2005, incorporated by reference to Exhibit
10.1 to the Company's Current Report on Form 8-K filed January 5,
2005, superseding an Employment Agreement, dated as of November
1, 1999, incorporated by reference to Exhibit 10.4 to the
Company's Form 10-Q for the period ended July 31, 2000.
10.11 Employment Agreement between the Company and Robert Wallach,
dated as of January 1, 2005, incorporated by reference to Exhibit
10.2 to the Company's Current Report on Form 8-K filed January 5,
2005, superseding an Employment Agreement, dated as of November
1, 1999, incorporated by reference to Exhibit 10.5 to
Infocrossing's Form 10-Q for the period ended July 31, 2000.
Page 39
EXHIBIT NO. DESCRIPTION
10-12A Employment Agreement, dated as of April 2, 2004, by and between
the Company and Patrick A. Dolan, incorporated by reference to
Exhibit 10.4 to the Company's Current Report on Form 8-K filed
April 7, 2004.
10.12B Settlement and Release Agreement dated as of October 15, 2004
by and among the Company and Patrick A. Dolan, incorporated by
reference to Exhibit 99.2 to the Company's Current Report on Form
8-K filed November 5, 2004.
10.13A Employment Agreement, dated as of April 2, 2004, by and between
the Company and Jim Cortens, incorporated by reference to Exhibit
10.5 to the Company's Current Report on Form 8-K filed April 7,
2004.
10.13B Settlement and Release Agreement dated as of October 15, 2004
by and among the Company and Jim Cortens, incorporated by
reference to the Company's Annual Report on Form 10-K for
December 31, 2004.
10.14 Employment Agreement, dated as of October 1, 2004, by and
between a subsidiary of the Company and Michael J. Luebke,
incorporated by reference to the Company's Annual Report on Form
10-K for December 31, 2004.
10.15A Company's 2002 Stock Option and Stock Appreciation Rights Plan
("2002 Plan"), incorporated by reference to Appendix B to the
Company's Definitive Proxy Statement for the Annual Meeting of
Stockholders held on June 25, 2002.
10.15B Amendment to 2002 Plan adopted by the Board of Directors on
January 21, 2005, incorporated by reference to the Company's
Annual Report on Form 10-K for December 31, 2004.
10.15C Amendment to 2002 Plan approved at the Company's Annual Meeting
of Stockholders held on June 15, 2004, incorporated by reference
to the Company's Annual Report on Form 10-K for December 31,
2004.
10.15D Amendment to 2002 Plan adopted by the Board of Directors on
April 1, 2004, incorporated by reference to the Company's Annual
Report on Form 10-K for December 31, 2004.
10.16A Amended and Restated 1992 Stock Option and Stock Appreciation
Rights Plan ("1992 Plan"), incorporated by reference to Appendix
A to Company's Definitive Proxy Statement for the Annual Meeting
of Stockholders held on May 8, 2000.
10.16B Amendment to 1992 Plan approved at the Company's Annual Meeting
of Stockholders held on June 22, 2001, incorporated by reference
to the Company's Annual Report on Form 10-K for December 31,
2004.
10.17 Stock Option Agreement under the Company's 2002 Stock Option and
Stock Appreciation Rights Plan, dated January 21, 2005, between
the Company and Zach Lonstein, incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed
November 5, 2004.
10.18A Lease dated June 2, 1997 between the Company and Leonia
Associates, LLC, incorporated by reference to the Company's
Annual Report on Form 10-K for December 31, 2004.
10.18B First Amendment of Lease between the Company and Leonia
Associates, LLC, dated January 16, 1998, incorporated by
reference to the Company's Annual Report on Form 10-K for
December 31, 2004.
10.18C Second Amendment of Lease between the Company and Leonia
Associates, LLC, dated as of September 9, 1999, incorporated by
reference to the Company's Annual Report on Form 10-K for
December 31, 2004.
10.18D Third Amendment of Lease between the Company and Leonia
Associates, LLC, dated as of August 28, 2000, incorporated by
reference to Exhibit 10.7D to the Company's 10-K for the fiscal
year ended October 31, 2000.
Page 40
EXHIBIT NO. DESCRIPTION
10.18E Fourth Amendment of Lease between the Company and Leonia
Associates, LLC, dated as of April 19, 2004, incorporated by
reference to the Company's Annual Report on Form 10-K for
December 31, 2004.
10.19A Office Lease Agreement dated May 22, 2000 between the Company
and Crocker Realty Trust, incorporated by reference to Exhibit
10.6 to the Company's Form 10-Q for the period ended July 31,
2000.
10.19B First Amendment to Lease dated as of April 1, 2002 by and
between Crocker Realty Trust, L.P. and the Company, incorporated
by reference to Exhibit 10.1 to the Company's Form 10-Q for
period ended March 31, 2002.
10.20 Tenth Floor Option Agreement between the Company, G-H-G Realty
Company ("GHG"), and RSL Com USA, Inc. ("RSL"), dated as of
November 30, 1999, with related notice of exercise dated February
14, 2000, incorporated by reference to Exhibit 10.6A to the
Company's Form 10-K for the fiscal year ended October 31, 2000.
10.21 Eleventh Floor Option Agreement between the Company, GHG, and
RSL, dated as of November 30, 1999, with related notice of
exercise dated December 2, 1999, incorporated by reference to
Exhibit 10.6B to the Company's 10-K for the fiscal year ended
October 31, 2000.
10.22A* Master Services Agreement dated as of May 24, 2001 among the
Company, Alicomp, a Division of Alicare, Inc. and ADT Security
Services, Inc., incorporated by reference to Exhibit 10.1A to a
Registration Statement No. 333-110173 on Form S-3 filed February
6, 2004.
10.22B* Amendment to Master Services Agreement among the Company,
Alicomp, a Division of Alicare, Inc. and ADT Security Services,
Inc. dated as of January 11, 2002, incorporated by reference to
Exhibit 10.1B to a Registration Statement No. 333-110173 on Form
S-3 filed February 6, 2004.
10.23* Computer Services Agreement dated as of March 21, 1997 by and
between the Company and Alicomp, a Division of Alicare, Inc.,
incorporated by reference to Exhibit 10.2A to a Registration
Statement No. 333-110173 on Form S-3 filed February 6, 2004.
10.24* Marketing Agreement dated as of March 21, 1997 by and between
the Company and Alicomp, a Division of Alicare, Inc.,
incorporated by reference to Exhibit 10.2B to a Registration
Statement No. 333-110173 on Form S-3 filed February 6, 2004.
10.25* Extension Agreement dated as of October 1, 2002 by and between
the Company and Alicomp, a Division of Alicare, Inc.,
incorporated by reference to Exhibit 10.2C to a Registration
Statement No. 333-110173 on Form S-3 filed February 6, 2004.
10.26* Extension Agreement dated as of December 30, 2003 by and
between the Company and Alicomp, a Division of Alicare, Inc.,
incorporated by reference to Exhibit 10.2D to a Registration
Statement No. 333-110173 on Form S-3 filed February 6, 2004.
10.27A Credit Agreement, dated November 30, 2005, between
Infocrossing, Inc., the lenders thereto, Bank of America, N.A.
and Banc of America Securities, LLC, incorporated by reference to
a Current Report on Form 8-K filed December 1, 2005.
10.27B Security Agreement, dated November 30, 2005, between
Infocrossing, Inc., certain subsidiaries of Infocrossing, Inc.,
and Bank of America, N.A., incorporated by reference to a Current
Report on Form 8-K filed December 1, 2005.
Page 41
EXHIBIT NO. DESCRIPTION
10.27C Securities Pledge Agreement, dated November 30, 2005, between
Infocrossing, Inc., certain subsidiaries of Infocrossing, Inc.,
and Bank of America, N.A., incorporated by reference to a Current
Report on Form 8-K filed December 1, 2005.
10.28A Agreement of Sale and Leaseback, dated November 30, 2005,
between Infocrossing, Inc. and LSAC Operating Partnership, L.P.,
incorporated by reference to a Current Report on Form 8-K filed
December 1, 2005.
10.28B Lease, dated November 30, 2005, between (i)Structure, LLC and
LSAC Omaha L.P., incorporated by reference to a Current Report on
Form 8-K filed December 1, 2005.
10.28C Lease, dated December 29, 2005, between (i)Structure, LLC and
LSAC Tempe L.P. is not filed as it is substantially the same as
that between the (i)Structure, LLC and LSAC Omaha, L.P. except as
to the description of the building and the amount of rent.
10.29 Employment Agreement, dated as of January 1, 2006 between the
Company and Richard Giordanella, incorporated by reference to a
Current Report on Form 8-K filed January 6, 2006.
10.30 Special Sale Bonus Agreement between (i)Structure, LLC and
Michael D. Jones.
14 Code of Ethics, incorporated by reference to the Company's Annual
Report on Form 10-K for December 31, 2004.
21 Subsidiaries of the Company.
23 Consent of Ernst & Young, Independent Registered Public
Accounting Firm
31 Certifications required by Rule 13a-14(a) to be filed.
32 Certifications required by Rule 13a-14(b) to be furnished but not
filed.
* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
Page 42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INFOCROSSING, INC.
March 15, 2006 /s/ ZACH LONSTEIN
--------------------------------------
Zach Lonstein - Chief Executive Officer
March 15, 2006 /s/ WILLIAM J. McHALE
---------------------------------------
William J. McHale - Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
March 15, 2006 /s/ ZACH LONSTEIN
---------------------------------------
Zach Lonstein - Chairman of the Board of
Directors
March 15, 2006 /s/ PETER J. DaPUZZO
---------------------------------------
Peter J. DaPuzzo - Director
March 15, 2006 /s/ JEREMIAH M. HEALY
---------------------------------------
Jeremiah M. Healy - Director
March 15, 2006 /s/ KATHLEEN A. PERONE
---------------------------------------
Kathleen A. Perone - Director
March 15, 2006 /s/ ROBERT B. WALLACH
---------------------------------------
Robert B. Wallach - Director
March 15, 2006 /s/ HOWARD L. WALTMAN
---------------------------------------
Howard L. Waltman - Director
Page 43
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
10.30 Special Sale Bonus Agreement between (i)Structure, LLC and
Michael D. Jones.
21 Subsidiaries of the Company.
23 Consent of Ernst & Young, Independent Registered Public
Accounting Firm
31 Certifications required by Rule 13a-14(a) to be filed.
33 Certifications required by Rule 13a-14(b) to be furnished but not
filed.
Page 44
INFOCROSSING, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULE
Page No.
-----------
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets -
December 31, 2005 and 2004 F-3
Consolidated Statements of Operations -
Years ended December 31, 2005, 2004, and 2003 F-4
Consolidated Statements of Stockholders' Equity (Deficit) -
Years ended December 31, 2005, 2004, and 2003 F-5
Consolidated Statements of Cash Flows -
Years ended December 31, 2005, 2004, and 2003 F-6
Notes to Consolidated Financial Statements F-8
Schedule II: Valuation and Qualifying Accounts S-1
Page F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
THE BOARD OF DIRECTORS AND STOCKHOLDERS OF INFOCROSSING, INC. AND SUBSIDIARIES
We have audited the accompanying consolidated balance sheets of Infocrossing,
Inc. and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2005. Our
audits also included the financial statement schedule listed in the Index at
Item 15 (a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and 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 are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Infocrossing, Inc.
and subsidiaries at December 31, 2005 and 2004, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the financial statements taken as a whole, presents
fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Infocrossing,
Inc. and subsidiaries internal control over financial reporting as of December
31, 2005, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 8, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG, LLP
New York, New York
March 8, 2006
Page F-2
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
DECEMBER 31,
----------------------------------
ASSETS 2005 2004
--------------- ---------------
CURRENT ASSETS:
Cash and equivalents $ 16,892 $ 26,311
Trade accounts receivable, net of allowances for doubtful
accounts of $637 and $249, respectively 25,631 26,707
Due from related parties 254 238
Prepaid software costs 5,604 4,000
Deferred income taxes 2,097 1,260
Current deferred customer acquisition costs 1,084 540
Other current assets 4,064 1,695
------------ ------------
Total current assets 55,626 60,751
Property, equipment and purchased software 40,749 25,113
Deferred software, net 1,581 1,077
Goodwill 150,799 103,177
Other intangible assets, net 19,853 12,328
Deferred income taxes 10,098 11,715
Deferred customer acquisition costs 2,770 769
Deferred financing costs 3,710 866
Other non-current assets 1,249 854
------------ ------------
TOTAL ASSETS $ 286,435 $ 216,650
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 11,880 $ 9,041
Current portion of long-term debt and capitalized lease obligations 15,551 3,683
Accrued expenses 20,719 8,273
Income taxes payable 560 305
Current deferred revenue 1,000 1,267
------------ ------------
Total current liabilities 49,710 22,569
Notes payable, long-term debt and capitalized lease
obligations, net of current portion 123,734 100,432
Accrued loss on leased facilities, net of current portion 365 505
Deferred revenue, net of current portion 3,017 -
Other long-term liabilities 2,579 1,907
------------ ------------
TOTAL LIABILITIES 179,405 125,413
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock; $0.01 par value; 3,000,000 shares authorized; none issued - -
Common stock; $0.01 par value; 50,000,000 shares authorized; shares issued
of 21,216,032 and 20,395,473 at December 31, 2005 and 2004, respectively 212 204
Additional paid-in capital 163,973 150,278
Accumulated deficit (53,534) (56,107)
------------ ------------
110,651 94,375
Less 668,969 and 618,969 shares at December 31, 2005 and 2004,
respectively, of common stock held in treasury, at cost (3,621) (3,138)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 107,030 91,237
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 286,435 $ 216,650
============ ============
See Notes to Consolidated Financial Statements.
Page F-3
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT NUMBER OF SHARES AND PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
2005 2004 2003
--------------- ---------------- ----------------
REVENUES $ 148,006 $ 104,949 $ 55,228
----------- ------------ -------------
COSTS and EXPENSES:
Costs of revenues, excluding
depreciation shown below 106,354 71,368 36,663
Selling and promotion costs 4,726 3,277 2,978
General and administrative
expenses 14,841 8,744 5,587
Depreciation and amortization 11,146 8,679 6,104
----------- ------------ -------------
137,067 92,068 51,332
----------- ------------ -------------
INCOME FROM OPERATIONS 10,939 12,881 3,896
----------- ------------ -------------
Interest income (687) (313) (103)
Interest expense 6,901 5,770 2,601
----------- ------------ -------------
6,214 5,457 2,498
----------- ------------ -------------
INCOME BEFORE INCOME TAXES 4,725 7,424 1,398
Income tax (benefit) expense 2,152 (12,539) 42
----------- ------------ -------------
NET INCOME 2,573 19,963 1,356
Accretion and dividends on
redeemable preferred stock - - (6,877)
----------- ------------ -------------
NET INCOME (LOSS) TO COMMON
STOCKHOLDERS $ 2,573 $ 19,963 $ (5,521)
=========== ============ =============
BASIC EARNINGS PER SHARE:
Net income (loss) to common
stockholders per share $ 0.13 $ 1.12 $ (0.76)
=========== ============ =============
Weighted average number of
common shares outstanding 20,216,863 17,827,006 7,279,786
=========== ============ =============
DILUTED EARNINGS PER SHARE:
Net income (loss) to common
stockholders per share $ 0.12 $ 0.95 $ (0.76)
=========== ============ =============
Weighted average number of
common share equivalents
outstanding 21,726,496 21,931,982 7,279,786
=========== ============ =============
See Notes to Consolidated Financial Statements.
Page F-4
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
ADDITIONAL TREASURY
COMMON PAID IN ACCUMULATED STOCK AT
SHARES PAR VALUE CAPITAL DEFICIT COST TOTAL
---------- ------------ ------------- --------------- ------------- -------------
Balances,
December 31, 2002 5,973 $ 60 $ 61,135 $ (70,549) $ (2,851) $ (12,205)
Exercises of stock options 20 - 106 - - 106
Accretion and dividends on
redeemable preferred
stock - - - (8,091) - (8,091)
Vesting of a non-qualified
stock option - - 40 - - 40
Private stock offering 9,739 97 69,845 - - 69,942
Recapitalization of
preferred
stock and warrants - - (20,755) 1,214 - (19,541)
Cancellation of warrants on
repayment of debentures - - (806) - - (806)
Net income - - - 1,356 - 1,356
---------- -------- ----------- ------------ ---------- -----------
Balances,
December 31, 2003 15,732 $ 157 $ 109,565 $ (76,070) $ (2,851) $ 30,801
Exercises of stock options 346 4 1,952 - (287) 1,669
Exercises of warrants 1,141 11 6,479 - - 6,490
Vesting of a non-qualified
stock option - - 31 - - 31
Warrants issued - - 137 - - 137
Private stock offering 2,917 29 28,211 - - 28,240
Stock issued in connection
with acquisitions 259 3 2,936 - - 2,939
Tax credit for disqualifying
disposition of stock
options - - 967 - - 967
Net income - - - 19,963 - 19,963
---------- -------- ----------- ------------ ---------- -----------
Balances,
December 31, 2004 20,395 $ 204 $ 150,278 $ (56,107) $ (3,138) $ 91,237
Exercises of stock options 474 5 5,889 - - 5,894
Stock issued in connection
with acquisitions 347 3 2,497 - - 2,500
Value related to a change
in the conversion price
of convertible debt - - 4,596 - - 4,596
Repurchase stock - - - - (483) (483)
Tax credit for disqualifying
disposition of stock
options - - 713 - - 713
Net income - - - 2,573 - 2,573
---------- -------- ----------- ------------ ---------- -----------
Balances,
December 31, 2005 21,216 $ 212 $ 163,973 $ (53,534) $ (3,621) $ 107,030
========== ======== =========== ============ ========== ===========
See Notes to Consolidated Financial Statements.
Page F-5
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
2005 2004 2003
------------------- ----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,573 $ 19,963 $ 1,356
Adjustments to reconcile net income
to cash provided by operating
activities:
Depreciation and amortization 11,146 8,679 6,104
Accretion of discounted debt 218 62 422
Unamortized fees relating to
loans repaid - 1,097 -
Non-employee option issued for
services - 168 40
Deferred income taxes 1,493 (12,550) -
Bad debt expense 1,527 329 144
Interest due on related party balances (16) (12) (10)
Changes in operating assets and
liabilities (net
of effect of acquisitions:
Decrease (increase) in:
Trade accounts receivable 5,952 (10,985) 633
Prepaid software costs, customer
acquisition costs, and other
current assets 1,255 (2,138) (590)
Deferred financing costs, customer
acquisition costs, and
other non-current assets (2,230) (165) 84
Increase (decrease) in:
Accounts payable 1,178 4,242 (1,325)
Income taxes payable (791) 437 (96)
Accrued expenses (2,359) (2,057) (510)
Payments on accrued loss on leased
facilities (145) (156) (148)
Deferred revenue and other
liabilities 2,143 (598) (168)
--------------- -------------- -------------
Net cash provided by operating activities 21,944 6,316 5,936
--------------- -------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and
purchased software (4,315) (1,456) (1,419)
Proceeds from fixed asset disposals 24,962 - -
Purchase of businesses, net of cash
acquired (84,394) (88,593) (350)
Purchases of auction-rate securities - (64,200) -
Redemptions of auction-rate securities - 64,200 -
Repurchase of Company's shares (483) - -
Increase in deferred software costs (947) (367) (138)
--------------- -------------- -------------
Net cash used in investing activities (65,177) (90,416) (1,907)
--------------- -------------- -------------
Continued on next page.
Page F-6
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
2005 2004 2003
------------------- ----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from a private equity
placement $ - $ 28,240 $ 69,942
Proceeds from issuance of Debentures - - -
Proceeds from sale of convertible notes - 69,480
Proceeds from debt financing 67,043 39,375 -
Redemption of preferred stock and
warrants - - (56,321)
Repayment of debentures and interest
accrued - - (12,227)
Repayments of debt and capitalized leases (39,071) (43,764) (2,431)
Payment of costs related to debt
financings - (1,096) -
Exercises of stock options and warrants 5,894 8,159 106
--------------- -------------- -------------
Net cash provided by (used in) financing 33,866 100,394 (931)
activities
--------------- -------------- -------------
Net cash provided by (used in) (9,367) 16,294 3,098
continuing operations
CASH FLOWS FROM DISCONTINUED OPERATION:
Payments on portion of accrued loss on
leased facilities relating to
discontinued operation (52) (56) (51)
--------------- -------------- -------------
Net increase (decrease) (9,419) 16,238 3,047
in cash and equivalents
Cash and equivalents, beginning of year 26,311 10,073 7,026
--------------- -------------- -------------
Cash and equivalents, end of year $ 16,892 $ 26,311 $ 10,073
=============== ============== =============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 6,216 $ 2,802 $ 981
=============== ============== =============
Income taxes $ 1,767 $ 169 $ 132
=============== ============== =============
SUPPLEMENTAL DISCLOSURE OF
NON-CASH INVESTING ACTIVITIES:
Notes payable issued for a portion of
the redemption of the preferred stock
and warrants $ - $ - $ 25,000
=============== ============== =============
Common stock issued for a portion of
purchase price on acquisitions $ 2,500 $ 2,939 $ -
=============== ============== =============
Equipment acquired subject to a capital
lease $ 8,301 $ 5,942 $ 2,475
=============== ============== =============
SUPPLEMENTAL DISCLOSURE OF
NON-CASH FINANCING ACTIVITIES:
Treasury shares received in
payment of a stock option exercise $ - $ 287 $ -
=============== ============== =============
Additional Debentures issued in lieu
of a cash payment of interest $ - $ - $ 1,310
=============== ============== =============
See Notes to Consolidated Financial Statements.
Page F-7
INFOCROSSING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005
1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business - Infocrossing, Inc. and its wholly-owned subsidiaries (collectively,
the "Company") provides information technology outsourcing services to
companies, institutions, and government agencies.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All intercompany
balances and significant intercompany transactions have been eliminated.
Cash and Equivalents - Cash and equivalents include all cash, demand deposits,
money market accounts, and debt instruments purchased with an original maturity
of three months or less.
Concentration of Credit Risk - Financial instruments that potentially subject
the Company to concentration of credit risk consist primarily of temporary cash
investments and trade receivables. The Company restricts investment of temporary
cash investments to financial institutions with high credit standing. Credit
risk on trade receivables is minimized as a result of the large and diverse
nature of the Company's customer base. The Company performs ongoing credit
evaluations of customers' financial condition, and generally does not require
collateral. The Company maintains reserves for potential credit losses.
Property, Equipment and Software- Property and equipment is stated at cost
except for assets acquired under capital leases, which are recorded at the net
present value of the minimum lease commitments. Depreciation is provided using
the straight-line method over the estimated useful lives. Leasehold improvements
and assets acquired under capital leases are amortized over the shorter of the
lease term or the estimated useful lives. Software that has been purchased is
included in Property and Equipment and is amortized using the straight-line
method over five years. The cost of internally developed software and product
enhancements, not reimbursed by customers, is capitalized as Deferred Software
Costs. Such assets are internal-use software, accounted for in accordance with
Statement of Position 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE
DEVELOPED OR OBTAINED FOR INTERNAL USE. The estimated useful lives of such
assets vary between three and five years, based upon the estimated useful life
of each particular software product. If the software has been developed for a
particular client, the useful life equals the term of the related customer
contract.
Goodwill, Other Intangible and Long-Lived Assets - Goodwill is the excess of
purchase price over the fair value of identified net assets of businesses
acquired. Goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but instead are subject to annual impairment tests in
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Long-Lived assets and
intangible assets subject to amortization are reviewed for impairment in
accordance with SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS. Other intangible assets, primarily acquired customer lists,
are amortized over their respective useful lives ranging from five to ten years
and reviewed for impairment whenever events or changes in circumstances such as
significant declines in revenues, earnings or cash flows or material adverse
changes in the business climate indicate that the carrying amount of an asset
may be impaired. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of the assets to future estimated undiscounted
net cash flows expected to be generated by the assets. If the assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. As of December 31, 2005, no impairment has occurred.
Revenue Recognition - The Company's services are provided under a combination of
fixed monthly fees and time and materials billings. Contracts with clients range
from two to seven years. Revenue is recognized (1) after the Company has
obtained an executed service contract from the customer (2) as the services are
rendered (3) when the price is fixed as per the service contract and (4) when
the Company believes that collectibility is reasonably assured based on the
credit risk policies and procedures that the Company employs.
Page F-8
Costs of Revenues - Costs of revenues include software licenses, operating
hardware leases, hardware maintenance, telecommunication services, and the cost
of customer service personnel, computer operators, programmers, and other
technical personnel.
Advertising costs are expensed as incurred and are included in the caption
Selling and Promotion Costs.
Deferred Revenue - The Company records deferred revenue for amounts billed for
which the services have not yet been provided. Deferred revenue amounts are
recorded as revenue as the services are rendered.
Deferred Customer Acquisition Costs - The Company may incur significant direct
and incremental costs in connection with services provided related to the
migration and transition of new customers to the Company's systems. These
services are performed so that the Company can provide on-going services in
connection with long-term customer contracts. In certain instances, the Company
may invoice and receive payment for these services as up-front non-refundable
fees. The Company's policy is to defer these costs and associated revenues, if
any, and to recognize them ratably over the period of the related long-term
contract.
Income Taxes - The Company accounts for income taxes pursuant to the liability
method whereby deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Any deferred tax assets recognized for net operating loss carryforwards
and other items are reduced by a valuation allowance when it is more likely than
not that the benefits may not be realized. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in operations in the period that includes the enactment
date.
Earnings per Share - The Company computes earnings per share in accordance with
SFAS No. 128, EARNINGS PER SHARE. Basic earnings per share is computed by
dividing net income by the weighted average number of common shares outstanding
during the period. Diluted earnings per share adjusts basic earnings per share
for the effects of convertible securities, stock options and warrants and other
potentially dilutive financial instruments, only in the periods in which such
effect is dilutive. For the year ended December 31, 2005, the weighted average
number of shares used in calculating diluted earnings per share includes options
and warrants to purchase common stock aggregating 5,195,313 shares. The
calculation of earnings per share for the year ended December 31, 2005 excludes
5,673,759 shares issuable upon conversion of the convertible notes and 1,545,424
shares related to stock options and warrants because to include them in the
calculation would be antidilutive. For the year ended December 31, 2004, the
weighted average number of shares used in calculating diluted earnings per share
includes options and warrants to purchase common stock and the effects of
convertible securities aggregating 4,104,976 shares. The calculation for 2004
also includes an increase to net earnings equal to interest expense relating to
the convertible debt, adjusted for income taxes, of $906,000. The calculation of
earnings per share for the year ended December 31, 2004 excludes 1,145,100
shares related to stock options and warrants because to include them in the
calculation would be antidilutive. Earnings per share for the year ended
December 31, 2003 excluded weighted average shares related to stock options and
warrants of 594,026 because to include them in the calculations for that year
would have been antidilutive.
Comprehensive Income - SFAS No. 130, REPORTING COMPREHENSIVE INCOME establishes
standards for reporting and displaying comprehensive income and its components
in a full set of general purpose financial statements. The Company's
comprehensive net income (loss) is equal to its net income (loss) for all
periods presented.
Segments - The Company and its subsidiaries operate in one reportable segment of
providing information technology outsourcing services. Substantially all of the
Company's revenues are derived from U.S. sources. Income from foreign sources is
derived from one European customer the Company acquired as a result of an
acquisition in April 2004 and amounts to approximately 1% in each of 2005 and
2004. All of the Company's assets are in the U.S.
Page F-9
Derivatives - The Company does not invest in derivatives for trading purposes
nor does it use derivative financial instruments to manage risks associated with
fluctuating interest rates.
Fair Value of Financial Instruments - At December 31, 2005 and 2004, the
carrying amounts of cash and equivalents, trade accounts receivable, accounts
payable, accrued expenses, accrued loss on leased facilities, customer deposits,
deferred revenue and other current liabilities approximate fair value due to the
short-term nature of these instruments. The carrying amounts of long-term debt
approximate fair value based on interest rates that are currently available to
the Company with similar terms and remaining maturities.
Use of Estimates - The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenues and expenses
during the periods. Examples of estimates used by management include, but are
not limited to, the amount of reserve to apply to accounts receivable and to
deferred income taxes, the valuation of intangibles, the forecasts used to
evaluate the impairment of intangibles and other long term assets, the discount
rate used in the valuation of capitalized leases, the method and term of
depreciation and amortization applied to depreciable assets, the factors used in
the calculation of stock option compensation expense, and the factors used in
the calculation of deferred pension expense. Actual results could differ from
those estimates. Interim results are not necessarily indicative of results for a
full year.
Reclassifications - Certain reclassifications were made to the prior years'
financial statements to conform to the current year presentation.
Major Customers - For the year ended December 2005, one client accounted for 17%
of the Company's total revenues. For the years ended December 31, 2004 and 2003,
a different client accounted for 13% and 23%, respectively, of the Company's
total revenues.
Recently Issued Accounting Pronouncements - In December 2004, the FASB issued
SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS, which eliminated the exception
for nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. SFAS No. 153 will be effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
has no such transactions and, accordingly, does not expect that the adoption of
SFAS No. 153 will have a material impact on its operating results or financial
position.
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENT, which
establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. This
eliminates the exception to account for such awards using the intrinsic method
previously allowable under APB Opinion No. 25. SFAS 123(R) will be effective for
fiscal years beginning on or after December 15, 2005.
SFAS 123(R) permits public companies to adopt its requirements using one of the
following two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of SFAS 123(R) for all share based payments granted after
the effective date and (b) based on the requirements of SFAS 123 for
all awards granted to employees prior to the effective date of SFAS
123(R) that remain unvested on the effective date.
2. A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits
entities to restate based on the amounts previously recognized under
SFAS 123 for purposes of pro forma disclosures either (a) all periods
presented or (b) prior interim periods of the year of adoption.
Page F-10
The Company plans to adopt SFAS 123(R) using the modified prospective method.
As permitted by SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the
Company currently accounts for share-based payments to employees using APB
Opinion 25's intrinsic value method and, as such, generally recognizes no
compensation cost for employee stock options. Accordingly, the adoption of SFAS
123(R)'s fair value method will have a significant impact on its results of
operations, although it will have no impact on its overall financial position.
Had the Company adopted SFAS 123(R) in prior periods, the impact of that
standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net income (loss) and earnings (loss) per share below.
For options issued through February 8, 2006, the projected after-tax expense in
2006, 2007, and 2008 is $779,000, $508,000, and $136,000, respectively.
The Company has not determined what impact SFAS 123(R) might have on the nature
of its share-based compensation to employees in the future.
Had compensation cost been determined in accordance with SFAS No. 123, the
Company's income (loss) in thousands of dollars and basic and diluted earnings
(loss) per common share for the years ended December 31, 2005, 2004, and 2003,
respectively, would have been as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
2005 2004 2003 *
----------------- ---------------- -----------------
Net income (loss) to common stockholders:
As reported $ 2,573 $ 19,963 $ (5,521)
Stock compensation expense determined
under fair value method (2,151) (2,739) (1,020)
-------------- ------------- --------------
Pro forma $ 422 $ 17,224 $ (6,541)
============== ============= ==============
Basic net earnings (loss) to common
stockholders per share:
As reported $ 0.13 $ 1.12 $ (0.76)
Stock compensation expense (0.11) (0.15) (0.14)
-------------- ------------- --------------
Pro forma $ 0.02 $ 0.97 $ (0.90)
============== ============= ==============
Diluted net earnings (loss) to common
stockholders per equivalent share:
As reported $ 0.12 $ 0.95 $ (0.76)
Stock compensation expense (0.10) (0.13) (0.14)
-------------- ------------- --------------
Pro forma $ 0.02 $ 0.82 $ (0.90)
============== ============= ==============
* The Pro forma income (loss) and pro forma basic and diluted earnings (loss)
per share for the year ended December 31, 2003 has been restated to properly
account for forfeitures.
All incentive stock options under the Plan, other than those granted to any
person holding more than 10% of the total combined voting power of all classes
of outstanding stock, are granted at the fair market value of the common stock
at the grant date. The weighted average fair value of the stock options granted
during the years ended December 31, 2005, 2004, and 2003 was $3,361,000,
$6,093,000, and $595,000, respectively. The fair value of each stock option
grant is estimated on the date of the grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
2005: a risk-free interest rate of between 3.375% and 4.375%; expected lives of
three years; and expected volatility of between 33.31% and 48.1%. The following
weighted average assumptions were used for grants in 2004: a risk-free interest
rate of between 2.63% and 3.13%; expected lives of between six months and three
years; and expected volatility of between 35.7% and 41.13%. The assumptions used
in 2003 included a risk-free interest rate of between 2.21% and 2.63%, expected
lives of three years, and expected volatility of between 41.13% and 53.0%.
Page F-11
2. ACQUISITIONS
(i)STRUCTURE, LLC
On November 30, 2005, Infocrossing acquired (i)Structure, LLC ("(i)Structure"),
pursuant to the terms of a Purchase Agreement (the "Purchase Agreement"), dated
as of October 24, 2005, by and between Infocrossing and Level 3 Financing, Inc.,
a Delaware corporation ("Level 3"). Pursuant to the Purchase Agreement,
Infocrossing acquired 100 percent of the membership interests of (i)Structure
from Level 3 (the "(i)Structure Acquisition"). The purchase price of the
(i)Structure Acquisition consisted of cash in the amount of approximately
$82,267,000 and 346,597 shares of common stock of Infocrossing, $0.01 par value.
Infocrossing funded the cash portion of the purchase price through a combination
of the net proceeds of $67,043,000 from its new $70 million debt facility which
matures April 14, 2009, $11,512,000 in net proceeds from the sale/leaseback of a
certain parcel of land containing a data center with approximately 88,000
rentable square feet in Omaha, Nebraska (the "Omaha Property"), and the
remainder with available cash. Subsequent to the acquisition, Infocrossing also
sold and leased back a building and improvements with approximately 60,000
square feet in Tempe, Arizona (the "Tempe Property"). The Tempe Property is also
subject to a ground lease.
(i)Structure, headquartered in Broomfield, CO, provides computing operations and
managed infrastructure services to enterprise clients from data centers located
in the central and western United States, and is recognized for their deep
expertise across computing platforms and commitment to client satisfaction. The
company's business model is based on signing clients to long-term contracts for
managing mainframe, midrange and open system computing platforms, and related
network and security services. An affiliate of Level 3 Financing was and
continues to be a vendor of communications services to the Company and to
(i)Structure. This vendor relationship is independent of, and did not affect the
decision to enter into, the purchase of (i)Structure.
The following table summarizes the preliminary fair values of the assets
acquired and the liabilities assumed at the date of the (i)Structure
Acquisition. Certain information has not been received from the seller, the
receipt of which may affect the preliminary fair values. The intangible asset
subject to amortization relates to customer contracts acquired and is being
amortized over seven years. All of the goodwill is deductible for tax purposes.
NOVEMBER 30, 2005
(IN THOUSANDS)
Trade accounts receivable $ 6,403
Other current assets 4,695
-----------
Total current assets 11,098
Property, equipment, and purchased software 36,894
(see discussion of sale-leasebacks above)
Intangible asset subject to amortization 9,400
Goodwill 46,396
-----------
Total assets acquired 103,788
-----------
Accounts payable and accrued expenses (15,424)
Deferred revenue (1,279)
Capitalized lease obligations (318)
-----------
Total liabilities assumed (17,021)
-----------
Purchase price $ 86,767
===========
Page F-12
INFOCROSSING HEALTHCARE SERVICES, INC.
On October 1, 2004, the Company acquired the Medicaid, Medicare and Managed Care
claims processing business (the "Claims Processing Business") of Verizon
Information Technologies Inc. ("VITI") from Verizon Communications Inc. The sale
was structured as an acquisition of the common stock of the Claims Processing
Business. The purchase price was $43,500,000 in cash and approximately
$1,886,000 in related acquisition costs (the "IHS Acquisition"). Immediately
following the closing of the IHS Acquisition, the Claims Processing Business'
name was changed to Infocrossing Healthcare Services, Inc. ("IHS"). The IHS
Acquisition was pursuant to a Purchase and Sale Agreement, dated as of September
1, 2004, between Verizon Data Services, Inc. (VITI's parent) and the Company.
The acquisition was accounted for using the purchase method of accounting and,
accordingly, the purchase price was allocated to the tangible and intangible
assets acquired and the liabilities assumed based on their respective fair
values. In connection with the allocation of the purchase price, goodwill of
$25,357,000 and an intangible asset subject to amortization in the amount of
$10,320,000, relating to contract rights and customer relationships, was
recorded. The intangible asset is being amortized over its estimated useful life
of ten years. The goodwill related to the IHS Acquisition is deductible for tax
purposes.
IHS is engaged in the business of providing customers in the healthcare industry
with information technology outsourcing services, healthcare transaction
processing services, Health Insurance Portability and Accountability Act
consulting and implementation services, payer application solutions and Medicaid
fiscal agent services. Such customers mainly are located in Missouri, Florida,
Arizona, Alabama, Arkansas, North Dakota, Utah, and Montana.
INFOCROSSING WEST, INC.
On April 2, 2004, the Company acquired all of the outstanding capital stock of
ITO Acquisition Corporation, a California corporation doing business as Systems
Management Specialists ("SMS"), from ITO Holdings, LLC ("Holdings") for
$34,909,000 in cash, $1,224,000 in related acquisition costs and 135,892 shares
of common stock of the Company valued at approximately $1,439,000 (the "SMS
Acquisition"). Subsequent to the acquisition, SMS changed its name to
Infocrossing West, Inc. ("IFOX West"). The value of the 135,892 shares was
determined using the average market price of the Company's common stock two days
before and after March 4, 2004, when the terms of the acquisition were
determined and announced. The acquisition was accounted for using the purchase
method of accounting and, accordingly, the purchase price was allocated to the
tangible and intangible assets acquired and the liabilities assumed based on
their respective fair values. In connection with the allocation of the purchase
price, goodwill of $40,648,000 and an intangible asset subject to amortization
in the amount of $1,650,000, relating to contract rights and customer
relationships, was recorded. In connection with an acquisition by SMS prior to
April 2004, the Company may have to pay contingent consideration for a period of
up to four years. Through December 31, 2005, such contingent consideration
totaled $775,000, which was recorded as additional goodwill.
IFOX West, headquartered in Orange County, California, provides information
technology outsourcing and managed application services to clients primarily
located in the western United States.
In 2004, the Company acquired two additional businesses (the "Minor
Acquisitions") for $7,090,000 in cash, $116,000 in related acquisition costs and
123,193 shares of common stock of the Company valued at approximately
$1,500,000. The purchase price was allocated to tangible and intangible assets
acquired and liabilities assumed based on their respective fair values. As part
of the allocation, approximately $8,530,000 was allocated to goodwill and
$501,000 was allocated to an amortizable intangible asset (contract rights and
customer relationships) that are being amortized over its estimated useful life
of five years. The goodwill related to the Minor Acquisitions is deductible for
tax purposes.
The results of each of the aforementioned acquisitions are included with that of
the Company for the period subsequent to the respective acquisition dates.
Page F-13
The following unaudited condensed combined pro forma information for the years
ended December 31, 2005 and 2004 give effect to the (i)Structure Acquisition,
the IHS Acquisition, and the SMS Acquisition as if they had occurred on January
1, 2004. For the purposes of the pro forma information, the Company has assumed
that, other than the related financings, it had sufficient cash to make the
acquisitions. The pro forma information may not be indicative of the results
that actually would have occurred had these transactions been in effect on the
dates indicated, nor does it purport to indicate the results that may be
obtained in the future. The pro forma information does not give effect to
planned synergies and cost savings. For example, the Company expects to achieve
annual pretax cost savings of between $9 and $11 million through the elimination
of redundant positions and other savings. The pro forma information also does
not give effect to the Minor Acquisitions because the impact these acquisitions
would have on the pro forma information is not material.
PRO FORMA INFORMATION
(IN THOUSANDS EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-----------------------------------
2005 2004
---------------- ---------------
Revenues $ 214,957 $ 223,752
============ ===========
Net income (loss) $ (2,360) $ 15,326
============ ===========
Net income (loss) to common stockholders $ (2,360) $ 15,326
============ ===========
Basic net earnings (loss) to common
stockholders per share $ (0.11) 0.84
============ ===========
Diluted net earnings (loss) to common
stockholders per equivalent share $ (0.11) $ 0.73
============ ===========
On January 5, 2006, a subsidiary of the Company purchased substantially all of
the assets and assumed certain liabilities of Soft Link Solutions, Inc., a
provider of enterprise application services, for approximately $1,786,000 in
cash and 216,241 shares of Company stock. Pursuant to the terms of the asset
purchase agreement, we agreed to register the shares issued to Soft Link
Solutions, Inc. for resale and, accordingly, included such shares in a
Registration Statement on Form S-3 filed February 16, 2006. This Registration
Statement has not yet been declared effective.
3. PROPERTY, EQUIPMENT AND SOFTWARE
PROPERTY, EQUIPMENT AND PURCHASED SOFTWARE
Property, equipment and purchased software consists of the following (in
thousands):
DEPRECIABLE
DECEMBER 31, LIVES (YEARS)
----------------------- -------------
2005 2004
----------- -----------
Computer equipment $ 22,826 $ 12,907 5-7
Computer equipment acquired under
capital leases (Note 7) 27,523 19,445 5
Furniture and office equipment 3,171 1,566 7
Leasehold improvements 10,335 9,225 *
Purchased software 12,349 8,603 5
Vehicles 153 153 3
--------- ---------
76,357 51,899
Less accumulated depreciation and
amortization, including $13,490
and $8,630 attributable to assets
under capital leases at December 31,
2005 and 2004, respectively (35,608) (26,786)
--------- ---------
$ 40,749 $ 25,113
========= =========
* Shorter of the useful life or the length of the lease.
Page F-14
Depreciation and amortization charged to operations was $8,828,000, $7,194,000,
and $5,137,000 for the years ended December 31, 2005, 2004, and 2003,
respectively.
DEFERRED SOFTWARE COSTS
Deferred software costs consist of the following (in thousands):
DECEMBER 31,
-----------------------------------
2005 2004
--------------- ----------------
Cost of internally-developed software $ 7,407 $ 6,461
and enhancements, including software
under development
Accumulated amortization (5,826) (5,384)
----------- ------------
$ 1,581 $ 1,077
=========== ============
Amortization of deferred software costs charged to operations was $443,000,
$554,000, and $616,000 for the years ended December 31, 2005, 2004, and 2003,
respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
GOODWILL
Changes in Goodwill for the years ended December 31, 2005 and 2004 is as
follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
2005 2004
---------------- -----------------
$ 103,177 $ 28,361
Goodwill, beginning of year
(i)Structure Acquisition 46,396 -
SMS Acquisition 1,166 40,929
IHS Acquisition - 25,357
Minor Acquisitions 60 8,530
------------ -------------
Goodwill, end of year $ 150,799 $ 103,177
============ =============
OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
DECEMBER 31,
-------------------------------------
2005 2004
---------------- -----------------
$ 24,250 $ 14,851
Acquired customer lists
Accumulated amortization (4,397) (2,523)
------------ -------------
$ 19,853 $ 12,328
============ =============
Page F-15
Amortization charged to operations was $1,875,000, $931,000, and $354,000 for
the years ended December 31, 2005, 2004, and 2003, respectively. The weighted
average life of all customer lists is approximately 7.4 years. Future
amortization expense related to customer lists is estimated as follows (in
thousands):
Years ending December 31:
2006 $ 3,499
2007 3,025
2008 2,739
2009 2,334
2010 2,075
Thereafter 6,181
-----------
$ 19,853
===========
5. ACCRUED EXPENSES
Accrued expenses consists of the following (in thousands):
DECEMBER 31,
--------------------------------
2005 2004
-------------- --------------
Payroll related accruals excluding taxes $ 8,211 $ 1,619
Hardware leases and maintenance 2,211 1,412
Outside processing 2,108 389
Software licenses and maintenance 2,044 1,016
Interest 1,754 1,690
Payroll and sales taxes 988 463
Professional fees 860 958
Building rents 705 247
Other 1,838 479
---------- ----------
$ 20,719 $ 8,273
========== ==========
The Company assumed $14,975,000 in liabilities as part of the (i)Structure
Acquisition, including $9,712,000 of payroll related accruals. These liabilities
assumed reduced the purchase price paid.
6. RELATED PARTY TRANSACTIONS
Due from related parties consists of the following (in thousands):
DECEMBER 31,
---------------------------
2005 2004
----------- ------------
Due from the Chairman, bearing interest
at the Prime Rate (7.25% at December 31, 2005)
plus 1% per annum, repayable,
including accrued interest, on demand $ 101 $ 94
Due from other officers, bearing interest at
the Prime Rate, repayable, including
accrued interest, on demand 153 144
------- --------
Total due from related parties $ 254 $ 238
======= ========
In accordance with the Sarbanes-Oxley Act of 2002, no further advances have been
made to the Company's officers since July 2002. The accounts have accrued
interest. In February 2006, the amounts due from each of the Chairman and Vice
Chairman were reduced by $50,000 by applying a portion of their respective
bonuses against the balance due to the Company.
Page F-16
Employment Agreements
CHAIRMAN AND VICE CHAIRMAN
Effective January 1, 2005, the Company entered into employment agreements with
the Company's Chairman and Chief Executive Officer (the "Chairman); and the
Company's Vice Chairman, President and Chief Operating Officer (the "Vice
Chairman"), replacing prior agreements originally signed as of November 1, 1999.
The employment agreements each provide for, among other items: an initial annual
base salary of $455,815; increases at the greater of the Cost of Living Index or
as determined by the Compensation Committee of the Board of Directors; bonuses
at the discretion of, and related to the satisfaction of goals to be determined
by, the Board of Directors or the Compensation Committee; Company-paid medical,
life and other group benefits; and the use of a current model auto and
membership in a health club of the executive's choosing.
The Chairman's employment agreement provides for full-time employment for five
years, three years part-time employment at 75% of the base salary then in
effect, and two years of reduced part-time employment at 50% of the base salary
then in effect. The Vice Chairman's employment agreement provides for full-time
employment for two years, three years part-time employment at 75% of the base
salary then in effect, and two years of reduced part-time employment at 50% of
the base salary then in effect. During part-time periods, if they elect to
remain on the Board of Directors, they will remain as Chairman and
Vice-Chairman.
The employment agreements provide for lifetime pension benefits of $180,000
annually for the Chairman and $120,000 annually for the Vice Chairman, which
will be paid beginning with the commencement of each executive's reduced
part-time employment period. The Company will also continue to provide medical,
life and disability benefits for life to the executives and their spouses. The
Company will pay for a $2 million life insurance policy for the Chairman, and a
$500,000 policy for the Vice Chairman. Each executive shall designate their
beneficiaries.
The pension benefits payable to each of the Chairman and the Vice Chairman are
not payable pursuant to a funded qualified pension plan. The Company did not
make any contributions for 2005, and does not expect to contribute to this plan
in 2006. The following tables provide a reconciliation of the changes in the
executive plan's benefit obligations for the year ended December 31, 2005:
2005
--------------
RECONCILIATION OF BENEFIT OBLIGATION
Obligation at January 1 $ -
Service cost including expenses 347,836
Interest cost 20,870
--------------
Obligation at December 31 $ 368,706
--------------
FUNDED STATUS
Funded status at December 31 $ (389,352)
Unrecognized (gain) / loss 20,646
--------------
Net amount recognized $ (368,706)
--------------
The following table provides the components of net periodic benefit cost for
fiscal years 2005 and 2004:
2005
---------------
Service cost $ 347,836
Interest cost 20,870
---------------
Net periodic benefit cost 368,706
Settlement (gain) / loss -
---------------
Net periodic benefit cost $ 368,706
---------------
Page F-17
The assumptions used in the measurement of the company's benefit obligation are
shown in the following table:
Used for Net
Benefit Cost in
Fiscal Year Used for Benefit
01/01/2005 to Obligations as of
12/31/2005 12/31/2005
------------------- ----------------------
Discount rate 6.00% 5.50%
Mortality: 1983 GAM (Male) 1994 GAR
Male and Female Male and Female
The Company expects to have no payment obligation for the years 2006 through
2009, and expects to pay $1,080,000 for the years 2010 through 2014.
The Company may elect to defer compensation in excess of amounts deductible for
Federal income tax purposes (currently $1,000,000), to the earlier of (1) a tax
year where the compensation will be deductible, (b) the first anniversary of the
termination of employment of the executive, or (c) the date on which the
executive must pay Federal income tax on the amount.
The Chairman's employment agreement provides that no stock option awards will be
granted through December 31, 2006, except at the sole discretion of the Board of
Directors, or a duly authorized committee of the Board. The Vice Chairman's
agreement provides that no stock option awards will be granted through December
31, 2006. In August 2004, the Chairman and Vice Chairman had been granted fully
vested, non-qualified options to acquire 500,000 and 350,000 shares,
respectively, of the Company's common stock at a price equal to the market price
as of the date of grant. The options were granted pursuant to the Company's 2002
Stock Option and Stock Appreciation Rights Plan, as amended.
On January 21, 2005, the Chairman was awarded a fully vested, nonqualified
option to acquire 750,000 shares of the Company's common stock at $25.00 per
share (Note 9).
PRESIDENT OF A SUBSIDIARY
Effective October 1, 2004, Infocrossing Healthcare Services, Inc ("IHS"), a
wholly-owned subsidiary of the Company, entered into an employee agreement with
an executive who, during his term, shall serve as the President of IHS and
report directly to the Board of Directors.
The employment agreement provides for an annual base salary of $250,000,
reviewed no less than annually. The salary level achieved at any point shall be
referred to as the "base salary." Also provided is the eligibility to earn a
performance bonus with a target amount of $100,000, but payable in accordance
with performance goals set forth by and at the discretion of the Compensation
Committee of the Board of Directors of the Company. This bonus is to be paid no
later than ninety (90) days following the end of the fiscal year.
The President of IHS was granted an option to acquire 50,000 shares of common
stock of the Company, par value $.01 per share. The options will vest in equal
amounts on October 1, 2004, 2005, and 2006. The options were granted pursuant to
the terms and conditions of the Company's 2002 Stock Option and Stock
Appreciation Rights Plan.
In the event that the President of IHS is terminated by the Company or resigns
with good reason, as that term is defined in the employment agreement, he will
be entitled under certain circumstances to severance equal to one year's base
salary, paid monthly, unless during that twelve month period, he becomes
employed or retained as a consultant by another company, in which event, he will
receive 50% of the severance until the end of the twelve month period.
The President of IHS's employment agreement also provides that the Company will
pay the difference between his former employer's retirement health plan and the
Company's health plan up to an amount equal to the Company's health plan.
Additionally, the Company shall purchase a disability insurance policy on his
behalf and for his benefit under which he shall be eligible to receive annual
payments in an amount equal to no less than 60% of the annual base salary in
effect at the time he is determined to have become disabled.
Page F-18
DIVISION PRESIDENTS
Michael D. Jones, who has been appointed by the Company as President -
Information Technology Outsourcing, received a bonus of $1,150,000 in connection
with the (i)Structure Acquisition. Mr. Jones also has a severance agreement with
(i)Structure whereby if he is terminated by (i)Structure or the Company without
cause, as that term is defined in the severance agreement, within six months of
the (i)Structure Acquisition, he is entitled to a severance payment equal to
$303,000, plus any accrued but unpaid vacation time, less any compensation
(excluding the bonus payment noted above) actually earned during the period from
the (i)Structure Acquisition to the date of termination.
Effective, January 1, 2006, the Company entered into an employment agreement
with a divisional President of Enterprise Application Services ("EAS Division
President") who shall report directly to the President of the Company.
The agreement has a term of three years and provides for, among other things, an
annual base salary of at least $300,000, subject to review no less than
annually. The salary level achieved at any point shall be referred to as the
"base salary." Also provided is the eligibility to earn a bonus no more than one
hundred percent (100%) of the base salary, in accordance with the parameters and
satisfaction of performance goals to be determined by the Options and
Compensation Committee of the Board of Directors of the Company. For calendar
year 2006, the EAS Division President will earn a minimum bonus of $120,000
("Guaranteed First Year Bonus"). Any bonus otherwise earned in 2006 shall be
reduced by $120,000.
The EAS Division President was granted an option to acquire 75,000 shares of
common stock of the Company, par value $.01 per share ("Common Stock"), vesting
ratably at the end of each month of 2007. If he is actively employed January 1,
2008, the EAS Division President shall be granted an option to acquire an
additional 50,000 shares vesting ratably at the end of each month of 2008. The
options were and shall be granted pursuant to the Company's 2005 Stock Plan.
In the event that the EAS Division President is terminated by the Company
without Cause or Good Reason, as those terms are defined in the agreement, he
shall be entitled to severance which shall equal his semimonthly base salary at
the time of termination plus any unpaid portion of the Guaranteed First Year
Bonus, paid semimonthly, in arrears, during the Applicable Severance Period as
defined in the agreement.
The EAS Division President will also receive a monthly automobile allowance in
the amount of five hundred dollars ($500) per month to compensate for the
business use of his personal automobile and the ability to share in benefits
normally available to Company employees.
7. NOTES PAYABLE, CONVERTIBLE DEBT, AND CAPITALIZED LEASE OBLIGATIONS
Long-Term Debt consists of the following (in thousands):
DECEMBER 31,
----------------------------------
2005 2004
--------------- --------------
Borrowing under a non-revolving
loan facility $ - $ 24,375
Senior secured term loan 55,000 -
Senior secured revolving loan 5,000 -
Convertible debt due 2024 (a) 65,164 69,542
Capitalized lease obligations 14,121 10,198
----------- -----------
139,285 104,115
Less current portion (15,551) (3,683)
----------- -----------
$ 123,734 $ 100,432
=========== ===========
(a) Face value of $72 million.
Page F-19
ACQUISITION LOAN FACILITY
On November 30, 2005, Infocrossing, Inc., a Delaware corporation
("Infocrossing") entered into a $70 million senior secured credit facility (the
"Credit Agreement"), with each of the banks and other financial institutions
that either now or in the future are parties thereto as lenders (the "Lenders"),
Bank of America, N.A., as sole and exclusive administrative and collateral agent
and as a lender ("Bank of America"), and Banc of America Securities LLC, as sole
and exclusive lead arranger and sole book manager ("Banc of America
Securities"). Infocrossing's obligations under the Credit Agreement are
unconditionally guaranteed by each of its domestic wholly-owned subsidiaries
(the "Guarantors"). The Credit Agreement provides for a $55 million term loan
facility, subject to amortization pursuant to the provisions of the Credit
Agreement, and a $15 million revolving credit facility (including letter of
credit subfacilities). The maturity date for both the term loan facility and the
revolving credit facility is April 14, 2009. Loans outstanding under the Credit
Agreement bear interest at LIBOR plus the Applicable Rate (as such term is
defined in the Credit Agreement) or, at the option of Infocrossing, the
alternate base rate (the greater of the Bank of America prime rate or the
federal funds rate plus one half of one percent (0.50%)) plus the Applicable
Rate (as such term is defined in the Credit Agreement). The terms of the Credit
Agreement include various covenants including, but not limited to: a maximum
leverage ratio; minimum consolidated earnings before interest, taxes,
depreciation, and amortization; a minimum debt coverage ratio; and limitations
on indebtedness, capital expenditures, investments, loans, mergers and
acquisitions, stock issuances and repurchases, and transactions with affiliates.
In addition, the terms of the Credit Agreement limit the Company's ability to
pay cash dividends. The Company was in compliance with such covenants at
December 31, 2005. The Credit Agreement also includes customary events of
default, including, without limitation, payment defaults, cross-defaults to
other indebtedness and bankruptcy-related defaults. If any Event of Default
occurs and is continuing, the administrative agent upon instruction from a
majority of the lenders may terminate the commitments and may declare all of
Infocrossing's obligations under the Credit Agreement to be immediately due and
payable.
In connection with the Credit Agreement, Infocrossing entered into a Security
Agreement, dated November 30, 2005 (the "Security Agreement"), with the
Guarantors, and Bank of America pursuant to which the Borrower and the
Guarantors granted a security interest in certain collateral to the
Administrative Agent, for the benefit of the Lenders. The pledged collateral
includes substantially all of the grantors' accounts receivable, chattel paper,
documents, general intangibles, instruments, inventory, letter-of-credit rights
and supporting obligations, deposit accounts and proceeds of the foregoing.
Infocrossing also entered into a securities pledge agreement, dated November 30,
2005 (the "Securities Pledge Agreement"), with certain of its subsidiaries (the
"Pledgors") and Bank of America, pursuant to which Infocrossing and the Pledgors
granted a security interest in certain equity securities held by them to the
Administrative Agent for the benefit of the Lenders.
Principal payments due on the $55 million term loan facility are: $5,000,000 in
2006; $12,500,000 in 2007; $17,500,000 in 2008; and the balance due in 2009.
At December 31, 2005, the balance due on the revolving credit facility was
$5,000,000, and the Company has $10,000,000 available. The Company pays 0.5% per
annum on any unused credit line.
The descriptions above of the Credit Agreement, the Security Agreement and the
Pledge Agreement are qualified in their entirety by the complete text of the
Credit Agreement, the Security Agreement and the Pledge Agreement.
BORROWING UNDER A NON-REVOLVING LOAN FACILITY
On October 1, 2004, the Company borrowed $24,375,000 from a non-revolving loan
facility to pay a portion of the cost of the IHS acquisition. Monthly principal
payments of approximately $609,000 were to begin on July 1, 2007, and a final
payment of $11,578,000 was scheduled to be made on March 15, 2009. On October
21, 2005, the Company repaid the outstanding balance of $24,375,000, plus
accrued interest and a $12,500 prepayment penalty. The Company recorded interest
expense of $256,000 in October 2005 to eliminate unamortized loan costs.
Page F-20
CONVERTIBLE DEBT
On July, 2004, the Company completed a private offering of $72,000,000 aggregate
principal amount of 4.0% Convertible Senior Notes due July 15, 2024 (the
"Notes"). Approximately $40,000,000 of the net proceeds from this offering was
used to repay outstanding debt. The remaining balance was used to fund
acquisitions and for general corporate purposes. Net proceeds after a discount
of $2,520,000 and approximately $591,000 of costs and fees were approximately
$68,889,000. The discount and loan costs are being amortized over the life of
the Notes using the interest method. Interest on the Notes is payable
semi-annually in arrears beginning on January 15, 2005.
The Notes are convertible, subject to certain conditions, at the option of the
holder prior to maturity, into shares of the Company's common stock at a
specified conversion price, subject to certain adjustments. The conversion price
must be adjusted to reflect stock dividends, stock splits, issuances of rights
to purchase shares of common stock and other events. Upon conversion, the
Company will have the right to deliver to the holders, at its option, cash,
shares of common stock, or a combination thereof. At the initial conversion
price of $15.36, the $72,000,000 of Notes were convertible into 4,687,500 common
shares. The Notes and the shares of common stock into which they may be
converted may be resold pursuant to a registration statement on Form S-3 that
became effective in August 2004. After the effective date of the registration
statement and prior to the end of the 18th month thereafter, if the market price
of the Company's common stock were to be less than 68.23% ($10.48) of the
conversion price then in effect for at least 20 trading days during any 30
consecutive trading day period, the conversion price would immediately be
reduced by 17.38% (to $12.69 initially, subject to adjustment as noted above for
stock dividends, splits, etc.) (the "Reset Adjustment"); provided that (i) the
Reset Adjustment shall only be applicable to Notes that have been sold or
otherwise distributed pursuant to the registration statement referred to above
or pursuant to Rule 144(k) under the Securities Act (and such adjustment shall
apply to all such Notes, regardless of whether they are so sold or distributed
before or after adjustment), and (ii) there shall be no more than one Reset
Adjustment during the term of the Notes. On August 5, 2005, the Reset Adjustment
was triggered. As a result of the Reset Adjustment, the number of common shares
into which the Notes are convertible is 5,673,759, an increase of 986,259
shares. The Reset Adjustment was valued in accordance with EITF 00-27,
"APPLICATION OF ISSUE NO. 98-5 - CERTAIN CONVERTIBLE INSTRUMENTS" at $4,596,000,
and this amount was recorded as an increase to Additional Paid in Capital and as
a discount to the carrying value of the Notes. This additional discount will be
accreted to the carrying value of the Notes through a charge to interest expense
over the life of the Notes.
At December 31, 2004, the unamortized discount was $6,836,000 and unamortized
loan costs were $547,000.
The holders may convert their Notes into shares of the Company's common stock,
at the conversion price in effect at the time, prior to the close of business on
their stated maturity date under any of the following circumstances: (1) during
any fiscal quarter if the market price per share of the Company's common stock
for a period of at least 20 consecutive trading days during the 30 consecutive
trading day period ending on the last day of the preceding fiscal quarter is
more than 130% of the applicable conversion price; (2) on or before July 15,
2019, during the five business-day period following any 10 consecutive
trading-day period in which the trading price for the Notes during such ten-day
period was less than 98% of the applicable conversion value for the Notes during
that period, subject to certain limitations; (3) if the Notes have been called
for redemption; or (4) upon the occurrence of specified corporate transactions,
such as (1) distributions to the Company's common stockholders of rights to
acquire shares of the Company's common stock at a discount; (2) distributions to
the Company's common stockholders when the distribution has a per share value in
excess of 5% of the market price of the Company's common stock; and (3) a
consolidation, merger or binding share exchange pursuant to which the Company's
common stock will be converted into cash, securities or other property. Upon a
"change of control," as defined in the indenture, the holders can require the
Company to repurchase all or part of the Notes for cash equal to 100% of
principal plus accrued interest. A consolidation, merger, or binding exchange
also may constitute a "change of control" in certain instances. If the "change
of control" occurred prior to July 15, 2009, in certain instances, the Company
may be required to pay a "make whole premium" as defined in the indenture when
repurchasing the Notes.
The Company has a call option, pursuant to which the Notes may be redeemed, in
part or in whole, for cash at any time on or after July 15, 2007 at a price
equal to 100% of the principal amount of the Notes, plus accrued interest plus a
"premium" if the redemption is prior to July 15, 2009, provided, however, the
Notes are only redeemable prior to July 15, 2009 if the market price of the
Company's common stock has been at least 150% of the conversion price then in
effect for at least 20 trading days during any 30 consecutive trading day
period. The "premium" referred to in the preceding sentence shall be in an
amount equal to $173.83 per $1,000 principal amount of Notes, less the amount of
any interest actually paid on such Notes prior to the redemption date.
Page F-21
The holders of the Notes may require that the Company purchase for cash all or a
portion of the Notes on July 15, 2009, 2014, and 2019 at a repurchase price
equal to 100% of the principal amount of the Notes plus any accrued interest.
There are no financial covenants, other than a limitation on incurring of
additional indebtedness, as defined in the indenture. We are not restricted from
paying dividends, or issuing other securities, or repurchasing other securities
issued by us under the terms of the indenture.
CAPITAL LEASE OBLIGATIONS
Assets subject to capital lease agreements are reflected in property and
equipment as capital leases. During the years ended December 31, 2005, 2004, and
2003, the Company entered into capital leases aggregating approximately
$8,302,000, $5,942,000, and $2,475,000, respectively, excluding those assumed in
business combinations.
The following is a schedule of future minimum lease payments under capital
leases, together with the present value of the net minimum lease payments
(amounts in thousands):
Years ending December 31:
2006 $ 6,563
2007 4,982
2008 3,153
2009 1,132
--------------
Total minimum lease payments 15,830
Less amount representing interest (1,709)
--------------
Present value of net minimum lease payments 14,121
Less current portion of obligations under capital leases (5,551)
--------------
Long-term portion $ 8,570
==============
8. INCOME TAXES
The significant components of provision (benefit) for income taxes consists of
(in thousands):
YEARS ENDED DECEMBER 31,
--------------------------------------------------
2005 2004 2003
--------------- ------------- --------------
Current tax provision (benefit):
Federal $ - $ 60 $ -
State and local 560 (49) 42
Deferred tax provision (benefit) 1,592 (12,550) -
----------- ---------- ----------
Provision (benefit) for
income taxes $ 2,152 $ (12,539) $ 42
=========== ========== ==========
Page F-22
A reconciliation of income taxes computed at the federal statutory rate to
(benefit) provision for income tax is as follows (in thousands):
YEARS ENDED DECEMBER 31,
---------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Tax provision computed at the statutory rate $ 1,599 $ 2,612 $ 468
Increase (decrease) in taxes resulting from:
State and local income taxes,
net of federal income taxes 489 361 28
Non-deductible expenses 43 28 17
Benefit of tax credits - - (471)
Change in valuation allowance - (15,207) -
Other, net 21 (333) -
---------- ----------- -----------
$ 2,152 $ (12,539) $ 42
========== =========== ===========
Significant components of the Company's deferred tax assets and liabilities are
as follows (in thousands):
DECEMBER 31,
---------------------------------------
2005 2004
----------------- ------------------
Deferred tax assets:
Accrued liabilities $ 419 $ 1,211
Allowance for doubtful accounts 194 132
Deferred rent 648 519
Deferred revenue 1,135 61
Net operating loss 18,179 15,342
Stock option exercise 1,680 967
Other 217 303
------------- --------------
22,472 18,535
------------- --------------
Deferred tax liabilities:
Depreciation and amortization (1,976) (1,942)
Goodwill and intangible assets (4,573) (709)
Deferred software costs (658) (447)
Other deferred costs (608) -
------------- --------------
(7,815) (3,098)
------------- --------------
Net tax assets 14,657 15,437
Valuation allowance (2,462) (2,462)
------------- --------------
Net deferred taxes $ 12,195 $ 12,975
============= ==============
Page F-23
In 2005 and 2004, the Company recorded $713,000 and $967,000 of deferred taxes
attributable to the disqualifying disposition of stock options, directly
increasing additional paid in capital.
As of December 31, 2003, the Company had established a valuation allowance of
approximately $15.2 million against its deferred tax assets. As of December 31,
2004, the Company released the entire valuation allowance that was established
as of December 31, 2003. The Company believes that it is more likely than not
that it will be able to realize its deferred tax assets through expected future
profits.
As of December 31, 2005 and 2004, the Company has recorded a valuation allowance
of approximately $2.5 million against deferred tax assets related to
approximately $5.9 million of net operating loss carryforwards acquired in the
SMS Acquisition due to the uncertainty of realizing a tax benefit from that
deferred tax asset.
During 2005 the Company generated a net operating loss for federal income tax
purposes due to the timing of certain deductions. At December 31, 2005, the
Company had net operating loss carryforwards of approximately $42 million for
federal income tax purposes that begin to expire in 2019. The use of these net
operating loss carryforwards is limited under Section 382 of the Internal
Revenue Code.
The Company reviews its deferred tax asset on a quarterly basis to determine if
a valuation allowance is required, primarily based on its estimate of future
taxable income. Changes in the Company's assessment of the need for a valuation
allowance could give rise to adjustments in the valuation allowance and tax
expense in the period of change.
At December 31, 2005, the Company has federal alternative minimum tax credit
carryforwards of approximately $44,000 that do not expire.
9. STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue up to 3,000,000 shares of preferred stock,
$0.01 par value. The preferred stock may be issued in one or more series, the
terms of which may be determined by the Board of Directors without further
action by the stockholders, and may include voting rights (including the right
to vote as a series on certain matters), preferences as to dividends and
liquidation conversion, redemption rights, and sinking fund provisions. At
December 31, 2005, no preferred shares are outstanding.
SERIES A PREFERRED STOCK
In a private placement in May 2000, the Company issued 157,377 shares of
redeemable 8% Series A Cumulative Convertible Participating Preferred Stock (the
"Series A Preferred Stock") and warrants to purchase 2,531,926 shares of the
Company's common stock at an exercise price of $0.01 per share (the "Investor
Warrants"). The net proceeds were divided between the initial carrying values of
the Investor Warrants and the Series A Preferred Stock (approximately $28
million and $30 million, respectively). The difference between the carrying
value and the $60 million face value of the Series A Preferred Stock was then
accreted as a monthly charge against retained earnings using the interest
method. Accumulated and accrued unpaid dividends also increased the carrying
value of the Series A Preferred Stock through a charge to retained earnings.
On October 21, 2003, the Company purchased and retired all the outstanding
Series A Preferred Stock, including any dividends payable thereon, and all the
Investor Warrants for $80,000,000, using $55,000,000 in cash from the proceeds
of the first of two private stock offerings discussed below and issuing
$25,000,000 in notes, which have subsequently been repaid.
Page F-24
COMMON STOCK
The Company is authorized to issue up to 50,000,000 shares of common stock,
$0.01 par value. The holders of common stock are entitled to one vote per share.
There is no cumulative voting for the election of directors. Subject to the
prior rights of any series of preferred stock which may be outstanding in the
future, holders of common stock are entitled to receive ratably any dividends as
may be declared by the Board of Directors of the Company out of legally
available funds, and upon the liquidation, dissolution, or winding up of the
Company, are entitled to share ratably in all assets remaining after the payment
of liabilities, and payment of accrued dividends and liquidation preferences on
the preferred stock outstanding, if any. Certain provisions of a credit
agreement to which the Company is a party do not permit the payment of cash
dividends on common stock.
Holders of common stock have no preemptive rights, and have no rights to convert
their common stock into any other security.
PRIVATE STOCK OFFERINGS
On October 21, 2003, the Company sold 9,739,111 shares of common stock and five
year warrants to purchase 3,408,689 shares of common stock (the "PIPE Warrants")
for a net aggregate amount of approximately $69,942,000. The PIPE Warrants have
an exercise price of $7.86 per share and expire in October 2008. The private
stock offering was made only to accredited investors in a transaction exempt
from the registration requirements of the Securities Act of 1933. The net
proceeds of the private stock offering were principally used to fund the
redemption of Series A Preferred Stock and Investor Warrants discussed above,
the repayment of outstanding debentures as noted below, and to pay related fees
and expenses. The remainder of the proceeds was used for working capital
purposes. On February 12, 2004, a Registration Statement on Form S-3, filed by
the Company on behalf of the private stock offering investors as selling
shareholders, was declared effective. The Company does not receive any proceeds
from any sales of stock under this registration statement.
In 2004, holders of PIPE Warrants to purchase 825,706 shares exercised their
warrants for cash, resulting in proceeds to the Company of approximately
$6,490,000. In addition, four holders exercised warrants to purchase 705,388
shares by surrendering warrants for 389,412 shares in cashless exercises. The
shares underlying the surrendered warrants had, at the respective exercise
dates, market values equal to the exercise price of the total of the warrants,
$5,544,350 in the aggregate. The holders received net shares totaling 315,976.
No PIPE Warrants were exercised in 2005.
On March 31, 2004, the Company sold 2,917,000 shares of common stock for a net
aggregate amount of approximately $28,240,000. The private stock offering was
made only to accredited investors in a transaction exempt from the registration
requirements of the Securities Act of 1933. The net proceeds of the private
stock offering were principally used to fund a portion of the purchase price of
IFOX West as described in Note 2. On June 10, 2004, a Registration Statement on
Form S-3, filed by the Company on behalf of the private stock offering investors
as selling shareholders, was declared effective. The Company does not receive
any proceeds from any sales of stock under this registration statement.
PRIVATE SALE OF DEBENTURES WITH WARRANTS
In connection with the issuance in February 2002 of debentures, the Company
issued warrants (the "Debenture Warrants") to purchase up to 2,000,000 shares of
the common stock of the Company. The Debenture Warrants have an exercise price
of $5.86 per share and expire on January 31, 2007. On October 21, 2003, the
Company repaid the debentures and, in accordance with the debenture agreement,
cancelled Debenture Warrants to purchase 937,500 shares of common stock. The
remaining 1,062,500 Debenture Warrants have not been exercised.
OTHER WARRANTS
In February 2001, the Company issued a warrant to purchase 65,000 shares of the
Company's common stock at $18.00 per share in settlement of any future
contingent consideration payable under an agreement to purchase the assets of a
business. This warrant has a ten year life. The fair value of the warrant of
$146,900, calculated using the Black-Scholes pricing model, was recorded as
additional goodwill relating to the related acquisition.
Page F-25
On June 5, 2000, the Company issued warrants to former debt holders to purchase
30,000 shares of the Company's common stock at $19.25 per share as consideration
for the settlement of all other potential equity interests in the Company held
by them. The warrants were immediately exercisable and expired unexercised on
June 5, 2004.
On January 13, 2004, the Company issued warrants to a new client to purchase
50,000 shares of the Company's common stock at $15.00 per share in connection
with the signing of a five-year contract. The warrants are immediately
exercisable and expire January 13, 2009. The fair value of the warrants of
$137,300, calculated using the Black-Scholes pricing model, is being amortized
over the term of the contract with the client.
STOCK PLAN AND STOCK OPTION PLANS
2005 Stock Plan
On June 13, 2005, the stockholders approved a Board of Directors resolution
establishing the Company's 2005 Stock Plan (the "2005 Plan"). The Company has
reserved 1,000,000 of the authorized shares of Common Stock for issuance under
the 2005 Plan. Unless terminated earlier, the 2005 Plan will terminate on the
tenth anniversary of the day immediately preceding the date on which the 2005
Plan was approved by the stockholders.
The 2005 Plan and the 2002 and 1992 Plans described below (collectively, the
"Plans") are administered by a committee (the "Committee") consisting of at
least three Directors provided, however, that the composition of such committee
shall comply with applicable rules of the Securities and Exchange Commission, as
may be amended from time to time, and applicable listing requirements, as may be
amended from time to time.
The Committee has full power to select from among the persons eligible for
awards, the individuals to whom awards will be granted, to make any combination
of awards to participants and to determine the specific terms of each award,
subject to the provisions of the Plan. Persons eligible to participate in the
Plan generally will be those officers, employees and Directors of the Company
and consultants to the Company who are responsible for or contribute to the
management, growth or profitability of the Company, as selected from time to
time by the Committee.
STOCK OPTIONS GRANTED TO EMPLOYEES. The 2005 Plan permits the granting of both
incentive stock options ("Incentive Options") and non-qualified stock options
("Non-Qualified Options") to Company employees. The exercise price of each
option shall be determined by the Committee but shall not be less than 100% of
the fair market value for the shares on the date of grant.
The term of each option shall be fixed by the Committee and may not exceed 10
years from the date of grant. The Committee shall determine at what time or
times each option may be exercised and, subject to the provisions of the 2005
Plan, the period of time, if any, after death, disability or termination of
employment during which options may be exercised. Options may also be made
exercisable in installments.
To qualify as Incentive Options, options must meet additional federal tax
requirements, as may be amended from time to time, including limits on the value
of shares subject to Incentive Options which first become exercisable in any one
year, and a shorter term and higher minimum exercise price in the case of
certain large stockholders.
STOCK OPTIONS GRANTED TO NON-EMPLOYEE DIRECTORS AND CONSULTANTS. The 2005 Plan
permits the granting of Non-Qualified Options to non-employee officers and
Directors of the Company and to consultants to the Company. The exercise price
of such Non-Qualified Options shall be determined by the Committee and shall not
be less than 100% of the fair market value of the Common Stock on the date of
grant.
The term of each option shall be fixed by the Committee and may not exceed 10
years from the date of grant. The Committee shall determine at what time or
times each option may be exercised and, subject to the provisions of the 2005
Plan, the period of time, if any, after death, disability or termination of
employment during which options may be exercised. Options may also be made
exercisable in installments.
Page F-26
Upon exercise of options, the option exercise price must be paid in full either
(i) in cash (ii) with the approval of the Committee (which may be withheld in
its sole discretion), by the surrender of shares of the Company's common stock
then owned by the grantee, (iii) from the proceeds of a loan from an independent
broker-dealer whereby the loan is secured by the option or the stock to be
received upon exercise, or (iv) by any combination of the FOREGOING and with the
approval of the Committee (which may be withheld in its sole discretion) may be
affected wholly or in part by monies borrowed from the Company pursuant to
repayment terms and conditions as shall be determined from time to time by the
Committee, in its discretion, separately with respect to each exercise of an
Incentive Option and each grantee; PROVIDED, that each such method and time for
payment and each such borrowing and terms and conditions of repayment shall then
be permitted by and be in compliance with applicable law.
STOCK APPRECIATION RIGHTS. At the discretion of the Committee, options granted
under the 2005 Plan to officers, employees, Directors or consultants may include
stock appreciation rights. The exercise price of each stock appreciation right
shall be determined by the Committee but shall not be less than 100% of the fair
market value for the underlying shares on the date of grant. Such stock
appreciation rights are only exercisable with their related stock options. Upon
exercise of a stock appreciation right a grantee shall be entitled to receive in
stock the difference between the current fair market value of common stock and
the original exercise price of the underlying stock option. Stock appreciation
rights not exercised with the exercise of the underlying option will
automatically terminate.
RESTRICTED STOCK AND UNRESTRICTED STOCK. The Committee may also award shares of
Common Stock subject to such conditions and restrictions as the Committee may
determine ("Restricted Stock"). The purchase price, if any, of shares of
Restricted Stock shall be determined by the Committee.
Recipients of Restricted Stock must enter into a Restricted Stock award
agreement with the Company, in such form as the Committee determines, setting
forth the restrictions to which the shares are subject and the date on which the
restrictions will lapse and the shares become vested. The Committee may at any
time waive such restrictions or accelerate such dates. If a participant who
holds shares of Restricted Stock terminates the relationship with the Company
for any reason (including death) prior to the vesting of such Restricted Stock,
the Company shall have the right to require the forfeiture of such Restricted
Stock in exchange for the amount, if any, which the participant paid for them.
Prior to the vesting of Restricted Stock, the participant will have all rights
of a stockholder with respect to the shares, including voting and dividend
rights, subject only to the conditions and restrictions set forth in the 2005
Plan or in the Restricted Stock award agreement.
The Committee may also grant shares (at no cost or for a purchase price
determined by the Committee) which are free from any restrictions under the 2005
Plan ("Unrestricted Stock"). Unrestricted Stock may be issued in recognition of
past services or other valid consideration.
ADJUSTMENTS FOR STOCK DIVIDENDS, MERGERS, ETC. The Committee shall make
appropriate adjustments in connection with outstanding awards to reflect stock
dividends, stock splits and similar events. In the event of a merger,
liquidation or similar event, the Committee in its discretion may provide for
substitution or adjustments.
AMENDMENTS AND TERMINATION. The Board of Directors may at any time amend or
discontinue the 2005 Plan. Moreover, no such amendment, unless approved by the
stockholders of the Company, as may be required under (i) applicable rules of
the Securities and Exchange Commission, as may be amended from time to time, or
(ii) if the Stock is listed on a national securities exchange or the Nasdaq
system, with applicable listing requirements, as may be amended from time to
time, or (iii) with respect to Incentive Stock Options, as required under
applicable federal tax law or regulations, as may be amended from time to time.
Page F-27
2002 and 1992 Stock Option Plans
On June 25, 2002, the stockholders approved the Company's 2002 Stock Option and
Stock Appreciation Rights Plan (the "2002 Plan"). In September 1992, the Company
had adopted the 1992 Stock Option and Stock Appreciation Rights Plan (as
subsequently amended and restated, "the 1992 Plan") that provided for the
granting of options to employees, officers, directors, and consultants for the
purchase of common stock. The material features of the 1992 Plan and the 2002
Plan are substantially the same. Incentive stock options could be granted only
to employees and officers of the Company, while non-qualified options could be
issued to directors and consultants, as well as to officers and employees of the
Company. Both the 1992 Plan and the 2002 Plan provided a maximum exercise period
of ten years. Qualified options granted to a 10% or greater stockholder had to
have a maximum term of five years under Federal tax rules. As a matter of
practice, except with respect to a 10% or greater stockholder, the typical
exercise period for options granted under the 2002 and 1992 Plans was ten years
from the date of grant.
Upon adoption of the 2005 Plan, the resolution of the Board of Directors
stipulated that no further grants be made pursuant to the 2002 Plan. The grants
previously made under the 2002 Plan will not be affected. The number of
authorized shares available in the 2002 Plan is equal to the total unexercised
options remaining at any time. At December 31, 2005, the number of unexercised
options in the 2002 Plan was 2,473,160.
Upon adoption of the 2002 Plan, the resolution of the Board of Directors
stipulated that no further grants be made pursuant to the 1992 Plan. The grants
previously made under the 1992 Plan will not be affected. The number of
authorized shares available in the 1992 Plan is equal to the total unexercised
options remaining at any time. At December 31, 2005, the number of unexercised
options in the 1992 Plan was 855,482.
Activity in the Plans during the periods from December 31, 2002 through December
31, 2005 is as follows:
NUMBER OF EXERCISE PRICE RANGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
--------------- -------------------------- --------------------
Options outstanding, December 31, 2002 1,406,935 $3.25 - $37.78 $8.93
Options granted 228,750 $6.27 - $9.91 $8.34
Options exercised (19,034) $4.50 - $7.71 $5.57
Options cancelled (85,897) $4.63 - $27.25 $11.64
---------------
Options outstanding, December 31, 2003 1,530,754 $3.25 - 37.78 $8.73
Options granted 1,844,750 $6.98 - $17.38 $13.66
Options exercised (345,668) $3.25 - $12.59 $5.66
Options cancelled (17,231) $4.86 - $29.98 $10.06
---------------
Options outstanding, December 31, 2004 3,012,605 $3.63 - $37.78 $12.10
Options granted 470,250 $7.365 - $18.43 $10.18
Options granted in excess of market 750,000 $25.00 $25.00
Options exercised (473,962) $3.875 - $13.68 $12.44
Options cancelled (73,251) $4.00 - $27.25 $15.21
---------------
Options outstanding, December 31, 2005 3,685,642 $3.63 - $37.78 $14.37
===============
Page F-28
ADDITIONAL INFORMATION REGARDING EXERCISE PRICE RANGES OF OPTIONS OUTSTANDING:
- ------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
WEIGHTED CONTRACTUAL EXERCISE
NUMBER OF AVERAGE LIFE NUMBER OF PRICE OF
EXERCISE PRICE OPTIONS EXERCISE REMAINING OPTIONS EXERCISABLE
RANGE OUTSTANDING PRICES (YEARS) EXERCISABLE OPTIONS
- -------------------- ---------------- ------------- --------------- -------------- ---------------
$3.63 - $5.44 97,780 $5.06 3.4 97,780 $5.06
$5.45 - $8.16 296,196 $7.09 6.8 293,196 $7.09
$8.17 - $12.23 1,861,242 $10.73 7.2 1,654,414 $10.87
$12.24 - $18.35 599,774 $16.60 8.3 337,672 $16.37
$18.36 - $27.53 823,150 $24.51 2.8 793,200 $24.74
$27.54 - $37.78 7,500 $34.80 4.1 7,500 $34.80
---------------- --------------
3,685,642 3,183,762
================ ==============
There were 3,183,762, 2,445,576, and 1,262,972 options exercisable at December
31, 2005, 2004, and 2003, respectively. At December 31, 2005, there are 643,000
options available for future grant, of which 125,000 are reserved pursuant to an
executive's employment agreement (See Note 6) and 11,750 are reserved for
promised issuances, subject to Committee approval.
At December 31, 2005, the Company has reserved 3,055,095 common shares for
issuance upon exercise of the following warrants: (i) 1,062,500 shares
exercisable at $5.86 per share expiring January 31, 2007; (ii) 65,000 shares
exercisable at $18.00 per share expiring September 16, 2010; (iii) 50,000 shares
exercisable at $15.00 per share expiring January 13, 2009; and (iv) 1,877,595
shares exercisable at $7.86 per share expiring October 20, 2008.
At December 31, 2005, the Company had reserved 5,673,760 shares for issuance
upon the potential exchange of the $72,000,000 outstanding convertible notes
(see Note 7). Total shares reserved for exchange of convertible debt and the
exercise of warrants and options (including options available for grant) is
13,057,497.
Option Granted in Excess of Market
On January 21, 2005, the Chairman was awarded a fully vested, nonqualified
option to acquire 750,000 shares of the Company's common stock at $25.00 per
share. The average of the high and low prices for one share of the Company's
common stock on the date of the grant was $16.995. The award was made pursuant
to the 2002 Plan. The purpose of the grant is to mitigate the financial impact
on the Chairman for having provided options at $25.00 per share on 750,000
shares of the Company's common stock owned by him to the purchasers (including
their successors and assigns) of the Series A Preferred Stock.
10. COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
Operating leases for facilities extend through December 31, 2025. Several of
these leases contain escalation clauses, which cause the amounts paid each year
to increase by a stated amount or percentage. The Company records as expense,
however, a fixed amount representing the average of these varying payments. The
difference between the cash payments and the expense recorded is deferred rent.
The Company's obligation under certain of these leases are secured by either a
cash deposit or a standby letter of credit, and aggregated $544,000 at December
31, 2005 and $618,000 at December 31, 2004. The standby letter of credit is
collateralized by a cash investment that has been classified, along with the
cash deposits, as a long-term asset. Total expense for occupancy costs was
approximately $7,046,000, $3,989,000, and $2,492,000 for the years ended
December 31, 2005, 2004, and 2003.
Page F-29
The Company leases certain of its data center equipment, various items of office
equipment, and vehicles under standard commercial operating leases. The Company
also has fixed-term obligations for software licenses and for disaster recovery
services.
Approximate minimum future lease payments for real estate and other operating
leases, software licenses, communications and disaster recovery services are as
follows (in thousands):
Years ending December 31,
2006 $ 31,441
2007 20,337
2008 17,864
2009 16,167
2010 5,960
Thereafter 59,173
--------------------
$ 150,942
====================
The Company sublet approximately 12,000 square feet in its California facility
through February 28, 2006. Income from this sublease is approximately $202,000
in 2005 and will be approximately $32,000 in 2006.
LEGAL PROCEEDINGS
On November 1, 2004, the Company was served with a summons and complaint in a
lawsuit commenced by two former employees of ITO Acquisition Corporation d/b/a
Systems Management Specialists, now known as Infocrossing West, Inc. ("West")
filed in the Superior Court of California, Orange County (Case No. 04CC10709).
Plaintiffs asserted that they had been induced to join West in 2002 based on
promises of receiving equity interests and options to acquire additional equity
in West.
West is indemnified pursuant to the Stock Purchase Agreement between us and ITO
Holdings, LLC ("Holdings") dated as of March 3, 2004 (the "SPA") for breaches of
numerous representations and warranties contained in the SPA. Holdings
represented and warranted to the Company, among other things, that it owned all
of West's capital stock and there were no other equity interests or commitments
relating to West's capital stock.
All matters were settled as of July 22, 2005. The settlement did not have any
financial impact on the Company. The entire settlement was paid from an escrow
account with respect to which Holdings was the beneficiary. The escrow account
had been established at the closing of the acquisition in the event of an
indemnification claim against Holdings.
11. RETIREMENT PLANS
The Company maintains a 401(k) Savings Plan covering all eligible employees who
have attained the age of 21 years and worked at least 1,000 hours in a one-year
period. Plan participants may elect to contribute up to 100% of covered
compensation each year, to the IRS maximum. Eligible participants may elect
deferral contributions in excess of legal or plan limits under Code section
414(v), EGTRRA "Catch-up" contributions. The Company may make matching
contributions at the discretion of the Board of Directors. The Company has not
made any matching contributions. The administrative costs of the Plans are borne
by the Company.
Page F-30
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2005 and 2004 (in thousands except per share data):
THREE MONTHS ENDED:
------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2005 2005 2005 2005
------------------- ------------------ ------------------- -----------------
Revenues $ 37,527 $ 35,194 $ 34,094 $ 41,191
=============== ============== =============== ==============
Net income (loss) $ 2,437 $ 124 $ 113 $ (101)
=============== ============== =============== ==============
Net incoem (loss) per
basic common share $ 0.12 $ 0.01 $ 0.01 $ (0.01)
=============== ============== =============== ==============
Net income (loss) per
diluted common share $ 0.11 $ 0.01 $ 0.01 $ (0.01)
=============== ============== =============== ==============
THREE MONTHS ENDED:
------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30 DECEMBER 31,
2004 2004 2004 2004
------------------- ------------------ ------------------- -----------------
Revenues $ 15,176 $ 24,611 $ 26,445 $ 38,717
=============== ============== =============== ==============
Net income (loss) $ 775 $ (262) $ 2,041 $ 17,409
=============== ============== =============== ==============
Net income (loss) per
basic common share $ 0.05 $ (0.01) $ 0.11 $ 0.91
=============== ============== =============== ==============
Net income (loss) per
diluted common share $ 0.05 $ (0.01) $ 0.10 $ 0.68
=============== ============== =============== ==============
Page F-31
INFOCROSSING, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND CHARGED TO BALANCE AT END
PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS OF PERIOD
----------------- ---------------- --------------- --------------- ----------------
ALLOWANCE FOR
DOUBTFUL ACCOUNTS:
Year ended
December 31, 2005 $ 249 $ 1,527 $ 100 (b) $ 1,238 (a) $ 637
============= ============ =========== ============ ============
Year ended
December 31, 2004 $ 570 $ 329 $ - $ 650 (a) $ 249
============= ============ =========== ============ ============
Year ended
December 31, 2003 $ 1,051 $ 144 $ - $ 625 (a) $ 570
============= ============ =========== ============ ============
VALUATION ALLOWANCE
OFFSETTING NET
DEFERRED TAX ASSETS
Year ended
December 31, 2005 $ 2,462 $ - $ - $ - $ 2,462
============= ============ =========== ============ ============
Year ended
December 31, 2004 $ 15,207 $ 15,207 $ 2,462 $ - $ 2,462
============= ============ =========== ============ ============
Year ended
December 31, 2003 $ 15,799 $ - $ - $ 592 $ 15,207
============= ============ =========== ============ ============
(a) Uncollectible accounts written off, net of recoveries. (b) Assumed in the
(i)Structure acquisition.
Page S-1