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, 2006
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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 _________
Commission file number: 0-20824
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
(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
- -------------------------------- -----------------------------------------
- -------------------------------- -----------------------------------------
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
Page 1
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, 2006, the aggregate market value of the outstanding shares of
voting common stock held by non-affiliates of the registrant was approximately
$232,973,000 based on the closing price of $11.55 as reported on the National
Association of Securities Dealers Automated Quotation System on June 30, 2006.
The registrant has no non-voting stock.
On March 14, 2007, there were 22,006,842 shares of the registrant's Common
Stock, $0.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Performance Graph in Part II, Item 5, and 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 April 30, 2007.
Page 2
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 within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended, that involve risks and
uncertainties. These statements relate to future events or our future financial
performance, including statements relating to products, clients, 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
clients and renewing contracts with existing clients on favorable terms;
expanding services to existing clients; new products; technological changes; our
dependence on third party suppliers; intellectual property rights; difficulties
with the identification, completion, and integration of acquisitions; 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. You are
encouraged to review the financial statements and accompanying notes beginning
on page F-1 for details of our results of operations and financial condition.
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 clients' IT computing operations including, but not
limited to, mainframes, iSeries, Windows, Unix and Linux servers. Clients
utilize our data centers, 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, clients can redirect valuable IT resources to
other business priorities. Generally, our client 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.
In August 2006, (i)Structure was renamed Infocrossing, LLC, a wholly owned
subsidiary of Infocrossing, Inc. Infocrossing, LLC, 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 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 Infocrossing, LLC. 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 The increasing complexity of IT systems and the need to connect
electronically with clients, suppliers and other external 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 Client Service--We believe close attention to client service and
support is vital to our business success and is a key competitive
differentiator. Clients are served by a dedicated Account Management team who
ensure consistent and responsive client 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.
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Maximize Leveraged Business Model--By leveraging data centers in New Jersey,
Georgia, Nebraska, Arizona, and California and our highly skilled IT operations
staff, we are able to support multiple clients 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 clients' systems regardless
of location. Sharing technology and staff across our broad client base reduces
our operating costs, streamlines service delivery and presents us with
attractive margin opportunities. Once a client 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.
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
clients, 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 that leverage our data center infrastructure. Typical
candidates have a history of client 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 client 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 client's computing
operations.
We believe that when considering wholesale outsourcing or maintaining an
in-house infrastructure our potential clients consider the following factors:
Lower IT Costs--We believe that by using our services our clients realize
significant savings over their current internal IT costs. By leveraging our IT
infrastructure, personnel, processes, and proprietary tools across multiple
clients, we believe our economies of scale translate into reduced costs for our
clients.
Improved Service Delivery--We believe our experience and resources result in
more efficient services than if our clients perform the operations tasks
in-house. Our clients benefit from the operational leverage we enjoy by
allocating our resources over multiple clients. Because of economies of scale,
we believe that our clients may enjoy greater access to resources otherwise
uneconomical on a standalone basis.
Access to New Technologies--We believe outsourcing with us enables our clients
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 clients can concentrate on their core business.
Increased Flexibility--We believe that outsourcing enables our clients 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.
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IT OPERATIONS INFRASTRUCTURE
Data Center Infrastructure--Delivering high-availability IT outsourcing
solutions to enterprise clients requires a significant investment in a secure
data center infrastructure. Our facilities have been designed to meet the
stringent environmental and security requirements of enterprise and government
clients: 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.
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 clients' 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 client 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 client base, we believe our labor costs per client
typically are lower than the costs our clients 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 clients' systems and components from
our facilities, at a client'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 client site.
PRODUCTS AND SERVICES
Our services are generally organized by computing platform and value-added
business process management services.
o Mainframe Outsourcing--Our mainframe outsourcing solutions provide clients
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
clients. 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.
o Mid-Range Systems Management--We provide specialized support and
outsourcing resources for clients 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 client chooses to
have them managed.
o Open Systems Management--We provide on-site hosting and remote management
of clients' hardware and software running on Linux, Unix and Windows
servers for both Internet based and other applications. Clients 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 clients
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 client 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 clients. 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 $1,406,000; $947,000; and $367,000 for the years ended
December 31, 2006, 2005, and 2004, respectively.
o Email Security Services--Our email security service provides clients spam
blocking, virus scanning, identification, cleansing, content filtering,
email archiving and compliance monitoring services. The entire process is
transparent to end users and creates an effective boundary around a
clients' email infrastructure that blocks unwanted email and viruses from
entering or leaving their corporate network, thus ensuring compliance with
corporate email policies. Data is stored and accessible to clients through
a proprietary web portal so they can retrieve and review content.
o Business Continuity--Our business continuity solutions help assure clients
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 organization of senior sales
executives contacts prospective clients 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 Client Service Representatives--As a result of its frequent client contact,
the Account Management organization identifies potential new business
opportunities with current clients.
o Client Referrals--Current clients are an excellent source of referrals for
potential new business.
For the years ended December 31, 2006 and 2005, one client, the Missouri
Department of Social Services, accounted for in excess of 10% of our
consolidated revenue. For the year ended December 31, 2004, one client, ADT
Security Services, Inc., accounted for in excess of 10% of our consolidated
revenue.
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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 clients. Among the most significant of our competitors are IBM
Corporation; Electronic Data Systems Corporation; Affiliated Computer Services,
Inc.; Computer Sciences Corp.; SunGard, Inc.; and Savvis, 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 client'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 clients. In addition,
technological change increases the risk of obsolescence to potential clients
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 client 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. We are experienced in handling confidential and
sensitive information for our clients, and we maintain numerous security
procedures to help ensure that the confidentiality of our client'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, 2006, we had 870 full-time and 12 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 client's data.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Substantially all of our revenues are derived from U.S. sources. Income from
foreign sources is derived from one European client and amounts to approximately
1% in each of 2006, 2005 and 2004. 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 clients include commercial enterprises, institutions, and government
agencies. From time to time, some of our clients have accounted for more than
10% of our consolidated revenue. For the years ended December 31, 2006 and 2005,
one client, the Missouri Department of Social Services, accounted for in excess
of 10% of our consolidated revenue. For the year ended December 31, 2004, one
client, ADT Security Services, Inc., accounted for in excess of 10% of our
consolidated revenue.
Our success depends substantially upon the retention of our major 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
clients.
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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 CLIENTS OR PREVENT US FROM OBTAINING NEW
CLIENTS.
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 clients. Among the most significant of our competitors are IBM
Corporation; Electronic Data Systems Corporation; Affiliated Computer Services,
Inc.; Computer Sciences Corp.; SunGard, Inc., and Savvis, 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 client. Accordingly, our
clients 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 client 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 client 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, clients, 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
clients and harm our reputation within the IT outsourcing industry.
Page 11
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.
ACQUISITIONS WE MAKE MAY NOT PROVIDE EXPECTED BENEFITS AND COULD POSSIBLY RESULT
IN A LOSS OF MONEY AND RESOURCES.
We make acquisitions with the expectation that they will result in various
benefits, including, among others, a strengthened position in our markets,
additional capabilities in distributed systems and networking services, and
sales and market synergies. Achieving the anticipated benefits of an acquisition
is subject to a number of uncertainties, including whether we integrate the
acquired company 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 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, clients
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.
Page 12
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, 2006, we had an accumulated deficit
of approximately $45 million, although we had positive net worth of
approximately $125 million. For the year ended December 31, 2006, we had net
income of $8.5 million. There is no assurance that we will generate positive net
income in the future.
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, 2006, we had total
indebtedness of $132.0 million consisting of a $47.6 million balance on a senior
secured term loan, convertible notes with a book value of $65.5 million and a
face value of $72.0 million, and $18.9 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.
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.
During 2006, we made prepayments of $2.6 million related to exercises of
warrants.
Beginning on September 30, 2006, we have been required to make amortization
payments on the senior secured term loan at the end of each quarter. The
amortization schedule is adjusted for prepayments made, and $4.8 million in
amortization payments were made in 2006. Future amounts of the required
amortization payments are $2.38 million through June 30, 2007, $3.57 million
from September 30, 2007 through June 30, 2008 and $4.76 million on September 30,
2008 and December 31, 2008. Within five business days after financial statements
for a fiscal year are delivered, we must also make principal payments equal to
50% of excess cash flow, as defined in the loan agreement, for such fiscal year.
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.
Page 14
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 clients 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.
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 fourth quarter of 2006 was as high
as $16.47 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 stock 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, 2006, there were 22,006,842 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.
Page 15
As of December 31, 2006, Zach Lonstein, our Chairman and Chief Executive
Officer, beneficially owned 2,729,796 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.
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.
Page 16
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None
ITEM 2. PROPERTIES.
We lease a building of approximately 67,000 square feet in Leonia, NJ for our
corporate headquarters and a data center facility. The lease expires on December
31, 2019.
We lease five additional facilities for data center operations. We lease 30,600
square feet in a building located in Norcross, GA expiring on July 31, 2015;
10,700 square feet in a building in Atlanta, GA expiring December 31, 2007; a
building consisting of 68,800 square feet in Brea, California expiring December
31, 2014. With the acquisition of (i)Structure, LLC on November 30, 2005, we
acquired two properties: a 86,800 square foot data center in Omaha, Nebraska and
a 60,000 square foot data center in Tempe, Arizona. We sold the building in
Omaha at the closing of the acquisition, applying the proceeds to the closing
transaction, and entered into a lease with the buyer expiring November 30, 2025.
We sold the building in Tempe on December 29, 2005 and entered into a lease with
the buyer expiring December 31, 2025. The facility in Tempe is also subject to a
ground lease which expires December 31, 2025.
We maintain offices around the country for various client support and
administrative functions. These include a lease of 5,700 square feet in a New
York, NY building expiring December 31, 2009; a lease of 10,500 square feet
space in a building in Woodland Hills, CA expiring April 30, 2008; a lease of a
building consisting of 16,100 square feet in Jefferson City, MO expiring
November 15, 2007; a lease of 45,000 square feet in a building in Phoenix,
Arizona expiring April 30, 2008; a lease of 6,400 square feet in a building in
Tampa Florida expiring October 31, 2010; a lease of 35,500 square feet in a
building in Broomfield, CO expiring August 31, 2016; a lease of 2,000 square
feet in a building in Dayton, OH expiring December 31, 2007; a lease of 1,000
square feet in Charlotte, NC expiring June 30, 2007; and a lease of 10,500
square feet in a building in Westwood, MA expiring September 30, 2009. We have
sublet 4,000 square feet of the Woodland Hills office through April 29, 2008.
All space measurements listed above are approximate.
We believe our facilities to be in good condition and adequate to accommodate
our current volume of business as well as anticipated increases.
We generally lease our equipment under standard commercial leases; in many
instances the equipment leases are structured as capital leases and contain
bargain purchase options. Our equipment is generally covered by standard
commercial maintenance agreements.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in various claims and proceedings. While management currently
believes that the ultimate outcome of these proceedings, individually and in the
aggregate, will not have a material adverse effect on our financial position,
resolution of proceedings is subject to inherent uncertainties, and unfavorable
rulings could occur. We continually evaluate our exposure to loss contingencies
arising from pending or threatened legal proceedings. If circumstances arose
which would change management's view with respect to the ultimate outcome of any
of these matters, we would, as appropriate, recognize a loss contingency at such
time.
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 Global Select market ("NGS") 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 the NGS (in
dollars).
BID
High Low
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
For the year ended December 31, 2006:
1st Quarter ended March 31, 2006 12.850 8.411
2nd Quarter ended June 30, 2006 13.100 10.300
3rd Quarter ended September 30, 2006 13.500 10.500
4th Quarter ended December 31, 2006 16.470 11.410
The closing price of our common stock on the NGS on March 14, 2007 was $13.66
per share. At March 14, 2007, we had 84 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. All plans have been approved by our stockholders.
Number of Securities
Remaining Available for
Future Issuance
Number of Securities to Weighted Average (Excluding Securities
be Issued Upon Exercise Exercise Price of Reflected in the First
of Outstanding Options Outstanding Options Column)
------------------------- -------------------------- --------------------------
Three qualified Plans - previously
approved by stockholders 4,072,982 $14.174 1,009,212 (a)
(a) Of the options available for future grant, 75,000 are reserved pursuant to
an executive's employment agreement (See Note 6 of the Notes to Financial
Statements accompanying this report) and 50,000 are reserved for committed
issuances, subject to the continued employment of the persons involved. 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, 2006, we had reserved 1,591,903 common shares for issuance upon
exercise of the following warrants: (i) 65,000 shares exercisable at $18.00 per
share expiring September 16, 2010; (ii) 50,000 shares exercisable at $15.00 per
share expiring January 13, 2009; and (iii) 1,476,903 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 certain net assets and a business on
January 5, 2006, we issued 216,241 shares of common stock, $0.01 par value,
valued at $1,786,367, to Soft Link Solutions, 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 and other shares with the Securities and Exchange Commission.
This Registration Statement was declared effective April 21, 2006.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
No shares were repurchased during 2006. Certain provisions of our credit
agreement dated November 30, 2005 with our bank debt incurred 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.
PERFORMANCE GRAPH
This information is incorporated by reference to a Definitive Proxy Statement to
be filed on or before April 30, 2007.
Page 19
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
The selected balance sheet data as of December 31, 2006, and 2005 and the
selected statement of operations data for the years ended December 31, 2006,
2005, and 2004 have been derived from our audited financial statements included
elsewhere herein. The selected balance sheet data as of December 31, 2004, 2003
and 2002 and the statement of operations data for the years ended December 31,
2003 and 2002 have been derived from our previously-published 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,
-----------------------------------------------------------------------------
2006 2005 2004 (a) 2003 2002
------------- ------------ ------------ ------------ ------------
Revenues $ 229,207 $ 148,006 $ 104,949 $ 55,228 $ 50,774
--------- -------- -------- --------- ---------
Net income from
continuing operations $ 8,486 $ 2,573 $ 19,963 $ 1,356 $ 1,137
--------- -------- -------- --------- ---------
Accretion and dividends
on redeemable preferred
stock (b) $ - $ - $ - $ (6,877) $ (9,293)
--------- -------- -------- --------- ---------
Net income (loss) to
Common stockholders $ 8,486 $ 2,573 $ 19,963 $ (5,521) $ (8,156)
========= ======== ======== ========= =========
Net income (loss) to common
stockholders per
diluted common share $ 0.37 $ 0.12 $ 0.95 $ (0.76) $ (1.52)
========= ======== ======== ========= =========
SELECTED BALANCE SHEET DATA
============================================================================================================
AS OF DECEMBER 31,
----------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------- ----------- ------------ ------------ ------------
Goodwill (c) $ 157,454 $ 150,799 $ 103,177 $ 28,361 $ 28,451
========= ======== ======== ========= =========
Total assets $ 298,125 $ 286,435 $ 216,650 $ 67,138 $ 65,495
========= ======== ======== ========= =========
Notes payable, long term
debt, and capitalized lease
obligations, net of
current portion $ 113,202 $ 123,734 $ 100,432 $ 25,732 $ 10,878
========= ======== ======== ========= =========
Redeemable preferred stock (a) $ - $ - $ - $ - $ 53,188
========= ======== ======== ========= =========
Common stockholders'
equity (deficit) $ 125,242 $ 107,030 $ 91,237 $ 30,801 $ (12,205)
========= ======== ======== ========= =========
No cash dividends have been declared (See Item 5, above).
Page 20
(a) In 2004, we recorded a tax benefit of $12,539,000. This was due to a
decrease of $12,550,000 in a reserve against deferred tax assets,
recognizing them at amounts considered by management, more likely than
not, to be realized. The tax benefit from the change in deferred tax
assets amounted to $0.70 per basic share and $0.57 per diluted share.
(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 accompanying warrants 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.
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 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 history of more than twenty years, 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 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 (the "(i)Structure Acquisition"). In August 2006, we changed the
name of (i)Structure, LLC to Infocrossing, LLC.
The operations of Infocrossing, LLC are included in consolidated operations from
the date of the acquisition. The operations of this acquired company are being
integrated into our operations so that the entire enterprise will benefit from
operational leverage and consolidation. The (i)Structure Acquisition was
recorded as a purchase in accordance with the Financial Accounting Standards
Board, Statements of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141").
We operate in one reportable segment of providing information technology
outsourcing services.
Page 21
Reclassifications were made to the prior years' income statements to conform to
the current year presentation of certain employee benefit costs, as shown
below:.
Year Ended December 31, 2005 Year Ended December 31, 2004
----------------------------------------------- -------------------------------------------------
As Published Adjustment As Adjusted As Published Adjustment As Adjusted
------------ -------------- ------------- ------------- -------------- -------------
Cost of revenues,
exclusive of
depreciation and
amortization $ 106,354 $ 464 $ 106,818 $ 71,368 $ 10 $ 71,378
Selling and
promotion costs $ 4,726 $ 40 $ 4,766 $ 3,277 $ 6 $ 3,283
General and
administrative
expenses $ 14,841 $ (504) $ 14,337 $ 8,744 $ (16) $ 8,728
YEAR ENDED DECEMBER 31, 2006 AS
COMPARED TO THE YEAR ENDED DECEMBER 31, 2005
For 2006, revenues increased $81,201,000 (55.0%) to $229,207,000 from
$148,006,000 for 2005. This increase includes $71,058,000 attributable to
revenues from clients added as the result of the (i)Structure Acquisition.
Excluding revenues added through the (i)Structure Acquisition, revenues
increased by $10,143,000 (7%). This increase is net of attrition of less than 5%
of revenues from existing clients during 2006. The contract with our largest
client had a scheduled termination date of June 30, 2007 and contained two
one-year options to extend the Agreement through June 30, 2009. During 2006, the
client exercised its first option, extending the scheduled expiration date
through June 30, 2008. In addition, Infocrossing granted the client an
additional one-year renewal option that could extend the contract through June
30, 2010. Infocrossing Healthcare Services, Inc. and its predecessors have been
providing claims processing services for this client since 1988.
Costs of revenues, excluding depreciation and amortization, increased by
$53,602,000 (50%) to $160,420,000 during 2006 compared with $106,818,000 for
2005. $626,000 (1%) of the increase results from stock option expense according
to SFAS No. 123(R) as discussed below under general and administrative expenses.
The remainder of the increase results from the expansion of the capacity and
quality of our infrastructure to deliver the additional client services
activities added by the (i)Structure Acquisition. Costs of revenues, excluding
depreciation and amortization, were 70% in 2006 and 72% in 2005. Our
infrastructure provides a shared operating environment that enables us to
integrate new clients, including clients acquired through acquisitions. After
the close of the (i)Structure Acquisition, we began implementing cost reductions
forecasted to be between $13,000,000 and $15,000,000 in annual cost synergies,
with $9,000,000 to $11,000,000 of the savings expected to be realized in 2006.
Infocrossing successfully completed the integration and achieved $14,000,000 in
annual cost savings, with approximately $12,000,000 of the savings realized in
2006. The cost savings achieved in 2006 also reflect an estimated incentive of
approximately $1,372,000 attributable to the Company's participation in a state
incentive program for economic growth based on maintaining certain levels of
qualified property within the sponsoring state. We entered into the final
agreement with the state in September 2006. Approximately $100,000 of the
incentive is based on December 2005 activity. Costs of revenues, excluding
depreciation and amortization, as a percentage of revenues are 68% for the
fourth quarter of 2006 compared with 73% for the fourth quarter of 2005. This
percentage is expected to increase in the first quarter of 2007 due to higher
costs from the migration of new clients, higher payroll taxes incurred at the
beginning of each year and the initiation of data center transformation projects
that will provide greater standardization and automation of our data center
operations so that we can install and more cost effectively support additional
clients.
Selling and promotion costs increased by $3,963,000 (83%) to $8,729,000 for 2006
from $4,766,000 for 2005, and increased as a percentage of revenues 4% for 2006
from 3% for 2005. Additional compensation and related expenses for an expanded
sales force account for $3,029,0000 or 77% of the increase. The remainder of the
increase is attributable to expanded marketing activities. We expect to increase
our sales and marketing expenses by approximately $3,000,000 in 2007, to add
more people to our sales team and increase our spending on marketing to build
broader market awareness.
Page 22
General and administrative expenses increased by $3,730,000 (26%) to $18,067,000
for 2006 from $14,337,000 for 2005, but declined as a percentage of revenues
from 10% in 2005 to 8% in 2006. An increase of approximately $2,823,000 (76% of
the increase) was related to the (i)Structure Acquisition. Additionally, in
2006, there were increases in severance of $363,000 related to the integration
of the (i)Structure Acquisition; and of $957,000 in professional fees, including
legal, accounting, and other professional fees; $273,000 in directors fees;
$262,000 in occupancy costs; and $374,000 in insurance premiums. Increased
expenses were partially offset by lower compensation costs of $953,000 and a
reduction in bad debt expense of approximately $1,557,000 in 2006 compared with
2005. In 2005, we added approximately $1,527,000 to the allowance for doubtful
accounts, including a charge of $1,000,000 relating to incremental usage-based
charges billed to a client in 2004. Finally, non-cash expense relating to stock
options granted was $1,024,000 in 2006. The non-cash expense of stock options
included in general and administrative expenses was due to the granting of stock
options to directors and employees (excluding employees whose cash compensation
was included in costs of revenues or selling and promotion costs).
On January 1, 2006, we adopted Statement of Financial Accounting Standards
("SFAS") No. 123(R), Share-Based Payment ("SFAS No. 123(R)") using the modified
prospective approach, which establishes standards for transactions in which an
entity exchanges its equity instruments for goods or services. This standard
requires us to measure the cost of employee services received in exchange for an
award of equity instruments based on the fair value of the award on the grant
date. It eliminates the intrinsic method previously allowable under Accounting
Principles Board Opinion No. 25 Accounting for Stock Issued to Employees. The
total pre-tax expense recorded in 2006 was $1,651,000. As noted above, $626,000
related to grants to employees included in costs of revenues, $1,024,000 to
employees included in general and administrative expense, with the remainder
included in selling and promotion costs. At our current effective tax rate, the
after-tax effect of the expense of stock options in 2006 was approximately
$918,000 or $0.04 per both basic and diluted shares. Had we elected early
adoption of this standard, the total pre-tax expense we would have recorded in
2005 would have been $3,709,000. The total unrecorded pre-tax compensation cost
relating to unvested options at December 31, 2006 totals approximately
$3,051,000, amortizable over the period ending December 31, 2009. Additional
option grants will increase this amount, and forfeitures of out-of-the-money
options held by terminating employees will reduce it.
Depreciation and amortization of fixed assets and other intangible assets
increased $5,796,000 (52%) to $16,942,000 for 2006 from $11,146,000 for 2005.
This increase was related to increases in assets resulting from the (i)Structure
Acquisition, including $1,870,000 in amortization of client contracts.
Net interest expense increased by $3,536,000 to $9,750,000 for 2006 from
$6,214,000 for 2005. This increase consists of additional interest expense of
$3,376,000 and a reduction in interest income of $160,000. Interest expense on
the Convertible Notes, including amortization of deferred financing costs and
discount, was $3,260,000 for 2006 compared with $3,127,000 in the Prior Year's
Period. The increase related to the Notes was solely attributable to the
amortization of the discount realized on the Notes during 2005. 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 discount increases interest expense by approximately $19,000 per month over
the term of the Notes. Interest expense on bank debt in 2006 was $5,620,000
compared with interest expense (including amortization of deferred financing
costs) on bank debt in 2005 of $2,593,000. The average balance of such debt was
$55,778,000 for 2006 and $25,551,000 for 2005.
For 2006, we recorded tax expense of $6,813,000, compared with tax expense of
$2,152,000 for 2005. The effective tax rate in 2006 was 45%, compared with an
effective tax rate of 46% in 2005. Although income taxes were accrued at a rate
of 45% in the Current Period, they are payable at the rate of 10% after the
application of net operating loss carry-forwards.
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 payable. If there is sufficient uncertainty of
realizing deferred tax benefits, a valuation allowance must be established. We
had a deferred tax valuation allowance of $2,462,000 at December 31, 2006 and
2005. We have net operating loss carry-forwards of approximately $34,000,000 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 of 1986.
Page 23
We have net income of $8,486,000 for 2006 compared with $2,574,000 for 2005. In
2006, we had income per basic common share of $0.40 and $0.37 on a diluted
basis, compared with $0.13 per basic share and $0.12 per diluted share in 2005.
The number of weighted average shares increased to approximately 21,392,000
basic shares and 27,884,000 diluted shares in 2006 from approximately 20,217,000
basic shares and 21,726,000 diluted shares for 2005. The increase in weighted
average basic shares of 1,175,000 was the result of issuing 216,200 shares for
one of the minor acquisitions and exercises of options and warrants. For 2006
and 2005, the weighted average number of shares used in calculating diluted
earnings per share includes options and warrants to purchase common stock
aggregating 818,000 and 1,509,000 shares, respectively. The calculation for 2006
also includes the potential conversion of the Notes (which includes a pro forma
adjustment to reported net income to add back $1,808,000 of interest on the
Notes, net of tax). In 2005, no adjustment was required since such adjustment
would not have been dilutive.
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 clients.
Costs of revenues excluding depreciation increased by $35,440,000 (50.0%) to
$106,818,000 during 2005 compared with $71,378,000 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 72% in 2005 from 68% 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 $1,483,000 (45%) to $4,766,000 for 2005
from $3,283,000 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 $5,658,000 (65%) to $14,337,000
for 2005 from $8,679,000 for 2004. Approximately $1,222,000, or 22% of the total
increase, was related to acquisitions completed in 2004 and 2005. Compensation
costs increased approximately $1,538,000 (27% 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 23% of the total increase, was due to higher professional fees
due to our growth. Approximately $1,324,000 (23% 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 client in 2004.
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.
Page 24
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.
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 2006, our EBITDA was $41,990,000 compared with $22,086,000 for 2005, 18% and
15% as a percentage of revenue, respectively.
Page 25
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,
-------------------------------
2006 2005
------------ -----------
NET INCOME $ 8,486 $ 2,573
Add back (deduct):
Tax expense (benefit) 6,812 2,152
Net Interest expense 9,750 6,214
Depreciation and amortization 16,942 11,146
------------ -----------
EBITDA $ 41,990 $ 22,085
============ ===========
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.
Liquidity and Capital Resources
Net cash provided by operating activities was $30,402,000 (net of a $178,000
decrease in taxes payable related to the exercise of stock options that is
classified as a financing activity) for 2006 on $8,486,000 of net income, as
adjusted for non-cash depreciation, amortization, and the accretion of debt
discount of $16,942,000 and $5,673,000 from a decrease in deferred tax assets
and an increase in taxes payable other than the amount classified as a financing
activity), which includes the utilization of a portion of the Company's net
operating loss carry-forwards. SFAS 123(R) requires that the tax benefit
attributable to disqualifying dispositions be classified as a financing activity
in the statement of cash flows beginning with the year ended December 31, 2006,
rather than as a component of cash from operations. Significant sources of cash
during 2006 included: the accrual of $406,000 for a non-qualified unfunded
pension plan; a decrease of $969,000 in deferred client acquisition costs and
other assets; $1,651,000 from the non-cash-expense related to stock options now
required pursuant to SFAS 123(R); a $5,082,000 increase in client deposits and
deferred revenues, including approximately $3,000,000 from one client; and
$2,730,000 from a decrease in accounts receivable. In the third quarter of 2006,
cash flow from operations was reduced by delays in collecting approximately
$3,500,000 in certain accounts receivable, the majority of which were collected
in October. The delay was caused by changing the name of (i)Structure, LLC to
Infocrossing, LLC and billing (i)Structure, LLC clients in the name of
Infocrossing, LLC in September 2006. Significant uses of cash during 2006
include an increase in prepaid expenses and other current assets of $5,132,000,
which includes an annual payment made in February 2006 of $7,650,500 for
software license fees payable pursuant to an (i)Structure, LLC (now known as
Infocrossing, LLC.) contract that was effective prior to the acquisition; and a
decrease in accounts payable, accrued expenses and other liabilities of
$6,843,000 as a result of payments of liabilities assumed on the balance sheets
of companies acquired.
Page 26
During 2006, we paid $3,809,000 related to certain minor acquisitions and
$440,000 in costs related to the (i)Structure Acquisition. Other investing
activities during 2006 include $6,553,000 for the purchase of fixed assets. We
also entered into capital leases having an aggregate carrying value of
approximately $11,223,000 and invested $1,406,000 in internally-developed
software.
Free cash flow, defined as cash flow from operations less cash disbursed for
capital expenditures and deferred software additions, was $22,443,000 for 2006
compared with $16,682,000 for 2005. We present this measure because we consider
such information an important supplemental measure of performance and believe it
is frequently used by securities analysts, investors and other interested
parties in the evaluation of companies with market capitalization comparable to
our own, many of which present free cash flow when reporting their results. The
table below shows the reconciliation of free cash fro to cash flow from
operations for 2006 and 2005.
Twelve Months Ended December 31,
----------------------------
2006 2005
------------ -----------
(In thousands)
Cash flow provided by operations $ 30,402 $ 21,944
Less:
Purchases of property and equipment
including software costs deferred (7,959) (5,262)
------------ -----------
Free Cash Flow $ 22,443 $ 16,682
============ ===========
Free cash flow 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 GAAP. These limitations include that free cash flow excludes
other significant cash flows, such as principal payments on debt. Because of
these limitations, free cash flow should not be considered as a principal
indicator of our performance. We compensate for these limitations by relying
primarily on the Company s GAAP results and using free cash flow only on a
supplemental basis.
Financing activities during 2006 include the repayment of $5,000,000 on the
revolving credit facility; payments of $7,425,000 on the Term Loan; and
$6,591,000 of capital leases. We received $6,111,000 from the exercise of stock
options and warrants. As noted above, we entered into $11,223,000 of new capital
lease agreements during 2006.
On November 30, 2005, we entered into a $70,000,000 senior secured credit
facility (the "Credit Agreement"), with certain banks and other financial
institutions that were initially, or in the future might become, lenders (the
"Lenders"), including one bank that also acts as sole and exclusive
administrative and collateral agent (the "Agent") and as a lender, and an
affiliate of the Agent that acts as sole and exclusive lead arranger and sole
book manager. 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, subject to a
combination of scheduled quarterly repayment amounts which began September 30,
2006, potential annual payments due no more than 95 days after each year-end of
50% of our Excess Cash Flow, as that term is defined in the Credit Agreement,
with the first of such payments due no later than April 3, 2007 estimated to be
$177,000, and other payments as described below. The Credit Agreement also
provides for a $15 million revolving credit facility (including letter of credit
subfacilities). During 2006, we repaid $5,000,000 on the revolving credit
facility and currently have no balance due. The maturity date for both the term
loan 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. At December 31, 2006, the interest rate on the term loan was
8.5%.
Page 27
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,
2006 and 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 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 and the Guarantors entered into a
Security Agreement pursuant to which we and the Guarantors granted a security
interest in certain collateral to the 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 with certain of our subsidiaries, pursuant to which we granted a
security interest in certain equity securities held by them to the Agent for the
benefit of the Lenders.
If we receive certain types of cash proceeds, including but not limited to
insurance proceeds, proceeds from the sale of assets, or proceeds from the
exercise of stock warrants and certain stock options, we are required to make
prepayments of the term loan in the amount of one-half of the received proceeds.
During 2006, we made payments of $2,626,000 as a result of warrant exercises,
and made a payment on January 4, 2007 of $179,500 related to option exercises in
2006. Such prepayments, when made, reduce the amounts of future scheduled
quarterly amortization payments. Scheduled quarterly amortization payment made
in 2006 totaled $4,779,000. The currently scheduled quarterly amounts due on the
term loan are: $11,894,000 for 2007; and $16,651,000 for 2008. The balance of
the term loan and any amounts outstanding under the revolving credit facility
are due April 14, 2009.
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.
We have $72,000,000 of outstanding 4.0% Convertible Senior Notes due July 15,
2024 (the "Notes"). Interest on the Notes is payable semi-annually in the amount
of $1,440,000 in July and January.
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 our option, cash, shares of common
stock, or a combination thereof. At the initial conversion price of $15.36, the
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.
On August 5, 2005, because the market price of our common stock was less than
$10.48 (68.23% of the initial conversion price) for at least 20 trading days
during the 30 consecutive trading day period ending on August 5, 2005, a reset
adjustment was triggered, whereby the conversion price was immediately reduced
by 17.38% to $12.69. 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. No further reset adjustments will be made, but the adjusted conversion
price of $12.69 remains subject to adjustment as noted above for stock
dividends, splits, issuances of rights to purchase shares of common stock, and
other events .
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 is being accreted to
the carrying value of the Notes through a charge to interest expense over the
life of the Notes.
Page 28
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 period 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 (a)
distributions to our common stockholders of rights to acquire shares of our
common stock at a discount; (b) 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 (c) 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 (the "CIC Put"). 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. The CIC Put represents an embedded
derivative that would require bifurcation. Since we believe that any value
associated with the CIC Put would be de minimis, no value was assigned at the
time of issuance or in the subsequent periods, and this embedded derivative was
not bifurcated. If the value should become material in the future, we will
report it at such time.
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. We have no current
plans to call the Notes.
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.
Page 29
The following table summarizes information about our contractual obligations as
of December 31, 2006 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 47,396 11,894 35,502 - -
Interest on convertible Notes 51,840 2,880 5,760 5,760 37,440
Interest on the term loan
at the most recent rate 6,785 3,740 3,045 - -
Operating leases and
software licenses 128,068 21,576 38,316 12,693 55,483
Operating contracts for
disaster recovery and
communications
services 12,146 4,388 5,828 1,930 -
Capital lease obligations 21,934 8,284 10,224 2,756 670
Deferred compensation
liability (2) 1,740 - - 240 1,500
Other long-term
liabilities reflected on
the Company's balance
sheet under GAAP (3) - - - - -
--------------- -------------- --------------- -------------- ---------------
Total contractual cash
obligations $ 341,999 $ 52,762 $ 98,675 $ 23,379 $ 167,093
=============== ============== =============== ============== ===============
(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) Estimated future benefit amounts payable. The unfunded amount accrued
at December 31, 2006 is $795,000. (3) Excludes accrued loss on leased
facilities and deferred rent, since these payments are included under
operating leases.
As of December 31, 2006, we had cash and equivalents of $22,324,000. 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 may use the net proceeds we expect to receive from the sale of the securities
to reduce our outstanding debt or 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 30
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.
Revenue Recognition
Our services are provided under a combination of fixed monthly fees and time and
materials billings. Contracts with clients typically range from two to seven
years. Revenue is recognized (1) after we have obtained an executed service
contract from the client; (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 clients to make required payments. In determining these
allowances, we evaluate a number of factors, including the credit risk of
clients, historical trends, and other relevant information. If the financial
condition of our clients 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 client
lists, client 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 single
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 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. 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 client base, and
material negative change in relationship with significant clients. The "implied
fair value" of our single 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 client lists and client 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.
Page 31
We take into consideration the history of contract renewals in determining our
assessment of useful life and the corresponding amortization period. We analyze
our client 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 clients
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.
Client 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 client 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
carry-forwards. 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, we determined that it would be more likely than not that our
net operating loss carry-forwards and other temporary differences will be
realized. However, due to a lack of a history of generating taxable income on a
subsidiary, we recorded a valuation allowance equal to 100% of that subsidiary's
net deferred tax assets. In the event that the subsidiary is able to generate
taxable earnings in the future and it is determined that it is more likely than
not that we will realize those deferred tax assets, an adjustment to the
valuation allowance will be made which may increase goodwill in the period that
such determination is made.
Stock-Based Compensation
In December 2004, the FASB issued Statement of Financial Accounting Standards
("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 us 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.
The Company adopted SFAS 123(R) using the modified-prospective method on January
1, 2006.
Page 32
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 and earnings per share in previously filed
consolidated financial statements.
The Company has not determined what impact SFAS 123(R) might have on the nature,
timing, and amounts of its share-based compensation to employees in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board ("FASB") released FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the
accounting and reporting for uncertainties in income taxes and prescribes a
comprehensive model for the financial statement recognition, measurement,
presentation and disclosure of uncertain tax positions taken or expected to be
taken in income tax returns. FIN 48 prescribes a two-step evaluation process for
tax positions. The first step is recognition based on a determination of whether
it is more likely than not that a tax position will be sustained upon
examination, including resolution of any related appeals or litigation
processes, based on the technical merits of the position. The second step is to
measure a tax position that meets the more-likely-than-not threshold. The tax
position is measured at the largest amount of benefit that is greater than 50%
likely of being realized upon ultimate settlement. If a tax position does not
meet the more-likely-than-not recognition threshold, the benefit of that
position is not recognized in the financial statements. FIN 48 is effective
beginning in the first quarter of fiscal 2007. The cumulative effects, if any,
of applying FIN 48 will be recorded as an adjustment to retained earnings as of
the beginning of the period of adoption which for calendar year companies is
January 1, 2007. We believe that the adoption of FIN 48 will not have a material
impact on the consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 applies under other accounting
pronouncements that require or permit fair value measurements. SFAS 157 will be
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. We are currently evaluating the effect that
the application of SFAS 157 will have on our results of operations and financial
condition.
In October 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans", an amendment of FASB
Statements No. 87, 88, 106 and 132(R) ("SFAS 158"). SFAS 158 requires us to
recognize in our statement of financial position an asset for a defined benefit
postretirement plan's over funded status or a liability for a plan's under
funded status, measure a defined benefit postretirement plan's assets and
obligations that determine its funded status as of the end of the employer's
fiscal year, and recognize changes in the funded status of a defined benefit
postretirement plan in comprehensive income in the year in which the changes
occur. We have a plan for certain executives that is unfunded, and have recorded
the accrued liability for this plan on our balance sheet. SFAS 158 did not have
a material effect on our results of operations or financial condition.
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 issued only by major
financial institutions of recognized strength and security. . We do not make
investments for trading purposes. We believe that the carrying amount of our
fixed rate debt and capitalized leases of $84,374,910 approximates fair value
based on interest rates that are currently available to us with similar terms
and remaining maturities. As of December 31, 2006, we had $47,575,200 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%). The rate on this portion of our debt was 8.5% at December 31, 2006. A
one percent change in the interest rate paid on this debt, at the balance at
December 31, 2006, would result in a $475,752 change in interest expense.
Page 33
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.
FOREIGN CURRENCY RISKS
We believe that our foreign currency risk is immaterial. Our income from foreign
sources is derived from a single client and amounts to approximately 1% of total
revenues in each of 2006, 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, 2006. 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, 2006.
During the quarter ending on December 31, 2006 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, 2006. 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.
Page 34
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.
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, 2006 using the
criteria set forth in Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management has determined that the Company's internal control over
financial reporting as of December 31, 2006 is effective.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2006 has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as stated in their
report which is appended hereto.
Page 35
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, 2006, 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.
In our opinion, management's assessment that Infocrossing maintained effective
internal control over financial reporting as of December 31, 2006, 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, 2006, 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, 2006 and 2005, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2006 of Infocrossing and our report
dated March 15, 2007 expressed an unqualified opinion thereon.
New York, New York /s/ ERNST & YOUNG LLP
March 15, 2007
Page 36
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 April 30, 2007.
ITEM 11. EXECUTIVE COMPENSATION.
The contents of this Item are incorporated by reference to a Definitive Proxy
Statement to be filed on or before April 30, 2007.
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 April 30, 2007.
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 April 30, 2007.
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 45.
(b) Exhibits:
Page 37
Exhibit No. Description
2.1 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.
2.2 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
2.3 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.
4.1A 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.
4.1B 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.
4.1C 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.
4.1D 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.
Page 38
Exhibit No. Description
4.2A 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.
4.2B 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.
4.3A 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.
4.3B 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.
4.4 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.
4.5 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.
4.6A 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.
4.6B 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.
4.7A 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.
4.7B 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.
4.7C 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.
Page 39
Exhibit No. Description
4.8A The Company's 2005 Stock Plan, incorporated by reference to the
Company's Definitive Proxy Statement for the Annual Meeting of
Stockholders held on June 13, 2005.
4.8B Amendment to the 2005 Stock Plan, incorporated by reference to
the Company's Definitive Proxy Statement for the Annual Meeting
of Stockholders held on June 15, 2006.
10.1A 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.
10.1B 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.
10.1C 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.
10.2A 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.
10.2B 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.
10.2C 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.
10.2D 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.
10.2E 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.
10.2F 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.
Page 40
Exhibit No. Description
10.3A 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.
10.3B 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.
10.3C 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.
10.3D (b) Amendment No. 1 to Credit Agreement and Waiver between the
Company and Bank of America, N.A
10.3E (b) Amendment No. 2 to Credit Agreement Waiver between the
Company and Bank of America, N.A
10.3F (b) Amendment No. 3 to Credit Agreement and Waiver between the
Company and Bank of America, N.A.
10.3G (b) Security Joinder Agreement by Infocrossing iConnection dated
as of June 23, 2006.
10.3H (b) Pledge Agreement Supplement between the Company and Bank of
America, N.A. dated as of June 23, 2006.
10.10A 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.
10.10B 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.
10.10C 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.
10.11A 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.
10.11B 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.
10.11C 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.
10.11D 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 41
Exhibit No. Description
10.11E 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.
10.12A 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.
10.12B 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.
10.20 (c) 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.
10.21 (c) 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.
10.22A (c) 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.
10.22B (c) Amendment One to Employment Agreement between the Company
and Mr. Wallach, dated as of December 22, 2006, incorporated by
reference to a Current Report on Form 8-K filed December 22,
2006.
10.23 (c) 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.
10.24 (c) Employment Agreement between the Company and Lee C. Fields,
dated as of August 8, 2005, incorporated by reference to a
Current Report on Form 8-K filed August 9, 2005
10.25 (c) 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.
Page 42
Exhibit No. Description
10.26A (c) Employment Agreement between the Company and Michael D.
Jones dated as of May 4, 2006, incorporated by reference to a
Current Report on Form 8-K filed May 8, 2006
10.26B (c) Special Sale Bonus Agreement between (i)Structure, LLC and
Mr. Jones, incorporated by reference to Exhibit 10.30 to the
Company's Annual Report on Form 10-K for December 31, 2005.
10.30 (a) 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.
10.31A Contract for Services between Verizon Information Technologies,
Inc. (now Infocrossing Healthcare Services, Inc.) and the State
of Missouri, including Amendments 1 through 6, (the "Missouri
Contract") incorporated by reference to the Company's Quarterly
Report on Form 10-Q for March 31, 2005.
10.31B Amendments no. 7 and 8 to the Missouri Contract, incorporated
by reference to Exhibit 10.32B to the Company's Quarterly Report
on Form 10-Q for September 30, 2006.
14 Code of Ethics, incorporated by reference to the Company's Annual
Report on Form 10-K for December 31, 2004.
21 (b) Subsidiaries of the Company.
23 (b) Consent of Ernst & Young, Independent Registered Public
Accounting Firm
31 (b) Certifications required by Rule 13a-14(a) to be filed.
32 (b) Certifications required by Rule 13a-14(b) to be furnished but
not filed.
(a) Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
(b) Filed herewith.
(c) Management compensatory plan or arrangement.
Page 43
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 16, 2007 /s/ ZACH LONSTEIN
--------------------------------------------------
Zach Lonstein - Chief Executive Officer
March 16, 2007 /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 16, 2007 /s/ ZACH LONSTEIN
--------------------------------------------------
Zach Lonstein - Chairman of the Board of Directors
March 16, 2007 /s/ PETER J. DaPUZZO
--------------------------------------------------
Peter J. DaPuzzo - Director
March 16, 2007 /s/ JEREMIAH M. HEALY
--------------------------------------------------
Jeremiah M. Healy - Director
March 16, 2007 /s/ KATHLEEN A. PERONE
--------------------------------------------------
Kathleen A. Perone - Director
March 16, 2007 /s/ ROBERT B. WALLACH
--------------------------------------------------
Robert B. Wallach - Director
March 16, 2007 /s/ HOWARD L. WALTMAN
--------------------------------------------------
Howard L. Waltman - Director
Page 44
EXHIBIT INDEX
Exhibit No. Description
10.3D Amendment No. 1 to Credit Agreement and Waiver between the
Company and Bank of America, N.A
10.3E Amendment No. 2 to Credit Agreement between the
Company and Bank of America, N.A
10.3F Amendment No. 3 to Credit Agreement and Waiver between the
Company and Bank of America, N.A.
10.3G Security Joinder Agreement by Infocrossing iConnection dated
as of June 23, 2006.
10.3H Pledge Agreement Supplement between the Company and Bank of
America, N.A. dated as of June 23, 2006.
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.
Page 45
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, 2006 and 2005 F-3
Consolidated Statements of Operations -
Years ended December 31, 2006, 2005, and 2004 F-4
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2006, 2005, and 2004 F-5
Consolidated Statements of Cash Flows -
Years ended December 31, 2006, 2005, and 2004 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, 2006 and 2005, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2006. 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, 2006 and 2005, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2006, 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.
As discussed in Notes 1 and 9 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standard No. 123 (revised
2004), "Share-Based Payments," effective January 1, 2006.
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, 2006, 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 15, 2007 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG, LLP
New York, New York
March 15, 2007
Page F-2
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands Except Share Data)
December 31,
----------------------------------
ASSETS 2006 2005
--------------- ---------------
CURRENT ASSETS:
Cash and equivalents $ 22,324 $ 16,892
Trade accounts receivable, net of allowances for doubtful accounts of $380 and
$637, respectively 23,000 25,631
Due from related parties 167 254
Prepaid software costs 8,399 5,604
Deferred income taxes 2,447 3,727
Current deferred client acquisition costs 1,039 1,084
Other current assets 7,584 4,064
------------ ------------
Total current assets 64,960 57,256
Property, equipment and purchased software, net 45,049 40,749
Deferred software, net 2,826 1,581
Goodwill 157,454 150,799
Other intangible assets, net 16,819 19,853
Deferred income taxes 4,184 8,468
Deferred client acquisition costs 2,658 2,770
Deferred financing costs 2,836 3,710
Other non-current assets 1,339 1,249
------------ ------------
TOTAL ASSETS $ 298,125 $ 286,435
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 11,065 $ 11,880
Current portion of long-term debt and capitalized lease obligations 18,749 15,551
Accrued expenses 13,596 20,719
Income taxes payable 1,544 560
Current deferred revenue 4,334 1,000
------------ ------------
Total current liabilities 49,288 49,710
Notes payable, long-term debt and capitalized lease obligations, net of current
portion 113,202 123,734
Deferred revenue, net of current portion 6,067 3,017
Other long-term liabilities 4,326 2,944
------------ ------------
TOTAL LIABILITIES 172,883 179,405
------------ ------------
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
22,675,811 and 21,216,032 at December 31, 2006 and 2005, respectively 227 212
Additional paid-in capital 173,684 163,973
Accumulated deficit (45,048) (53,534)
------------ ------------
128,863 110,651
Less 668,969 shares at December 31, 2006 and 2005,
respectively, of common stock held in treasury, at cost (3,621) (3,621)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 125,242 107,030
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 298,125 $ 286,435
============ ============
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,
-------------------------------------------------------
2006 2005 2004
--------------- ---------------- ----------------
REVENUES $ 229,207 $ 148,006 $ 104,949
----------- ------------ -------------
COSTS and EXPENSES:
Costs of revenues, excluding
depreciation and
amortization shown below 160,420 106,818 71,378
Selling and promotion costs 8,729 4,766 3,283
General and administrative
expenses 18,067 14,337 8,728
Depreciation and amortization 16,942 11,146 8,679
----------- ------------ -------------
204,158 137,067 92,068
----------- ------------ -------------
INCOME FROM OPERATIONS 25,049 10,939 12,881
----------- ------------ -------------
Interest income (527) (687) (313)
Interest expense 10,277 6,901 5,770
----------- ------------ -------------
9,750 6,214 5,457
----------- ------------ -------------
INCOME BEFORE INCOME TAXES 15,299 4,725 7,424
Income tax expense (benefit) 6,813 2,152 (12,539)
----------- ------------ -------------
NET INCOME $ 8,486 $ 2,573 $ 19,963
=========== ============ =============
BASIC EARNINGS PER SHARE:
Net income to common
stockholders per share $ 0.40 $ 0.13 $ 1.12
=========== ============ =============
Weighted average number of
common shares outstanding 21,392,122 20,216,863 17,827,006
=========== ============ =============
DILUTED EARNINGS PER SHARE:
Net income to common
stockholders per share $ 0.37 $ 0.12 $ 0.95
=========== ============ =============
Weighted average number of
common share equivalents
outstanding 27,884,253 21,726,496 21,931,982
=========== ============ =============
See Notes to Consolidated Financial Statements.
Page F-4
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In Thousands)
Additional Treasury
Common Paid in Accumulated Stock at
Shares Par Value Capital Deficit Cost Total
---------- ------------ ------------- --------------- ------------- -------------
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 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 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
Exercises of stock options 120 1 858 - - 859
Exercises of warrants 1,124 12 5,240 - - 5,252
Stock issued in connection
with acquisitions 216 2 1,784 - - 1,786
Stock option expense - - 1,651 - - 1,651
Tax credit for stock options - - 178 - - 178
Net income - - - 8,486 - 8,486
---------- -------- ----------- ------------ ---------- -----------
Balances,
December 31, 2006 22,676 $ 227 $ 173,684 $ (45,048) $ (3,621) $ 125,242
========== ======== =========== ============ ========== ===========
See Notes to Consolidated Financial Statements.
Page F-5
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
---------------------------------------------------------------
2006 2005 2004
------------------ ------------------ -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,486 $ 2,573 $ 19,963
Adjustments to reconcile net income to cash provided by
operating activities (operating activities include the
operations of companies acquired subsequent to their
respective acquisition dates):
Depreciation and amortization 16,942 11,146 8,679
Addition to allowance for doubtful accounts - 1,527 329
Accretion of discounted debt 351 218 62
Unamortized fees relating to loans repaid - - 1,097
Non-employee option issued for services - - 168
Deferred income taxes 5,285 1,592 (12,550)
Compensation expense related to stock options 1,651 - -
Deferred compensation expense related to executive
pension benefits 406 390 -
Payments received on related party balances, net of
interest charges 87 (16) (12)
Changes in operating assets and liabilities (net of
effect of acquisitions):
Decrease (increase) in:
Trade accounts receivable 2,730 5,952 (10,985)
Prepaid software costs (2,795) 1,604 (639)
Deferred client acquisition costs and other
current assets (2,337) (349) (1,499)
Other non-current assets 969 (2,230) (165)
Increase (decrease) in:
Accounts payable (1,056) 1,178 4,242
Income taxes payable 388 (890) 437
Accrued expenses (6,635) (2,504) (2,213)
Deferred revenue 5,082 1,471 (251)
Other liabilities 848 282 (347)
--------------- --------------- ----------------
Net cash provided by operating activities 30,402 21,944 6,316
--------------- --------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and purchased software (6,553) (4,315) (1,456)
Disposal of property - 24,962 -
Payments related to acquisitions (4,249) (84,394) (88,593)
Purchases of auction-rate securities - - (64,200)
Redemptions of auction-rate securities - - 64,200
Repurchase of Company shares - (483) -
Increase in deferred software costs (1,406) (947) (367)
--------------- --------------- ----------------
Net cash used in investing activities (12,208) (65,177) (90,416)
--------------- --------------- ----------------
Continued on next page.
Page F-6
INFOCROSSING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
---------------------------------------------------------------
2006 2005 2004
------------------ ------------------ -------------------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Net proceeds from a private equity
placement $ - $ - $ 28,240
Proceeds from sale of convertible notes - - 69,480
Proceeds from debt financing - 67,043 39,375
Repayments of debt and capitalized leases (19,016) (39,071) (43,764)
Payment of costs related to debt
financings - - (1,096)
Excess tax benefit from exercise of stock
options 178 - -
Exercises of stock options and warrants 6,111 5,894 8,159
--------------- --------------- ----------------
Net cash provided by (used in) financing activities (12,727) 33,866 100,394
--------------- --------------- ----------------
Net cash provided by (used in)
continuing operations 5,467 (9,367) 16,294
CASH FLOWS FROM DISCONTINUED OPERATION:
Payments on portion of accrued loss on
leased facilities relating to discontinued
operation (35) (52) (56)
--------------- --------------- ----------------
Net increase (decrease)
in cash and equivalents 5,432 (9,419) 16,238
Cash and equivalents, beginning of year 16,892 26,311 10,073
--------------- --------------- ----------------
Cash and equivalents, end of year $ 22,324 $ 16,892 $ 26,311
=============== =============== ================
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 8,644 $ 6,216 $ 2,802
=============== =============== ================
Income taxes $ 1,428 $ 1,767 $ 169
=============== =============== ================
SUPPLEMENTAL DISCLOSURE OF
NON-CASH INVESTING ACTIVITIES:
Common stock issued for a portion of
purchase price on acquisitions $ 1,786 $ 2,500 $ 2,939
=============== =============== ================
Equipment acquired subject to a capital lease $ 11,223 $ 8,301 $ 5,942
=============== =============== ================
SUPPLEMENTAL DISCLOSURE OF
NON-CASH FINANCING ACTIVITIES:
Treasury shares received in
payment of a stock option exercise $ - $ - $ 287
=============== =============== ================
See Notes to Consolidated Financial Statements.
Page F-7
INFOCROSSING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business - Infocrossing, Inc. and its wholly-owned subsidiaries (collectively,
the "Company") provide 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 client base. The Company performs ongoing credit
evaluations of clients' financial condition, and generally does not require
collateral. The Company maintains allowances 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
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 longer 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 clients, 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 client
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, consisting of acquired client 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, 2006, 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 client (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, other costs
of the data centers, and the cost of client 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.
Stock Option Expense - In December 2004, the FASB issued Statement of Financial
Accounting Standards ("SFAS") No. 123(R), Share-Based Payments, which
establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires the Company 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 Accounting for Stock Issued to Employees.
SFAS 123(R) also requires that the excess tax benefit from exercises of stock
options during the year be classified as a financing activity in the Company's
statement of cash flows, rather than as a component of cash from operations. The
Company adopted SFAS 123(R) using the modified-prospective method on January 1,
2006 (See Note 9).
Deferred Revenue - The Company records deferred revenue for amounts billed for
which the services have not yet been provided. Deferred revenue amounts are
recognized as revenue as the services are rendered.
Deferred Client Acquisition Costs - The Company may incur significant direct and
incremental costs in connection with services provided related to the migration
and transition of new clients to the Company's systems. These services are
performed so that the Company can provide on-going services in connection with
long-term client 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 carry-forwards
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, 2006, the weighted average
number of shares used in calculating diluted earnings per share includes options
and warrants to purchase common stock aggregating 818,372 shares and 5,673,759
shares issuable upon conversion of the convertible notes. The calculation of
earnings per share for the year ended December 31, 2006 excludes 2,700,712
shares related to stock options and warrants because to include them in the
calculation would be antidilutive. The calculation for 2006 also includes a pro
forma increase to net earnings equal to interest expense relating to the
convertible debt, adjusted for income taxes, of $1,808,000. 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 1,509,633 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 a pro forma
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.
Page F-9
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 is equal to its net income 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 client and amounts to approximately 1% in each of
2006, 2005 and 2004. All of the Company's assets are in the U.S.
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, 2006 and 2005, the
carrying amounts of cash and equivalents, trade accounts receivable, accounts
payable, accrued expenses, accrued loss on leased facilities, client 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 were made to the prior years' income statements to conform to
the current year presentation of certain employee benefit costs, as shown
below:
Year Ended December 31, 2005 Year Ended December 31, 2004
----------------------------------------------- -------------------------------------------------
As Published Adjustment As Adjusted As Published Adjustment As Adjusted
------------ -------------- ------------- ------------- -------------- -------------
Cost of revenues,
exclusive of
depreciation and
amortization $ 106,354 $ 464 $ 106,818 $ 71,368 $ 10 $ 71,378
Selling and
promotion costs $ 4,726 $ 40 $ 4,766 $ 3,277 $ 6 $ 3,283
General and
administrative
expenses $ 14,841 $ (504) $ 14,337 $ 8,744 $ (16) $ 8,728
Major Clients - For the years ended December 2006 and 2005, one client accounted
for 11% and 17%, respectively, of the Company's total revenues. For the year
ended December 31, 2004, a different client accounted for 13% of the Company's
total revenues.
Recently Issued Accounting Pronouncements - In July 2006, the Financial
Accounting Standards Board ("FASB") released FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109" ("FIN 48"). FIN 48 clarifies the accounting and reporting for
uncertainties in income taxes and prescribes a comprehensive model for the
financial statement recognition, measurement, presentation and disclosure of
uncertain tax positions taken or expected to be taken in income tax returns. FIN
48 prescribes a two-step evaluation process for tax positions. The first step is
recognition based on a determination of whether it is more likely than not that
a tax position will be sustained upon examination, including resolution of any
related appeals or litigation processes, based on the technical merits of the
position. The second step is to measure a tax position that meets the
more-likely-than-not threshold. The tax position is measured at the largest
amount of benefit that is greater than 50% likely of being realized upon
Page F-10
ultimate settlement. If a tax position does not meet the more-likely-than-not
recognition threshold, the benefit of that position is not recognized in the
financial statements. FIN 48 is effective beginning in the first quarter of
fiscal 2007. The cumulative effects, if any, of applying FIN 48 will be recorded
as an adjustment to retained earnings as of the beginning of the period of
adoption which for calendar year companies is January 1, 2007. The Company
believes that the adoption of FIN 48 will not have a material impact on the
consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 applies under other accounting
pronouncements that require or permit fair value measurements. SFAS 157 will be
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The Company is currently evaluating the
effect that the application of SFAS 157 will have on its results of operations
and financial condition.
In October 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans", an amendment of FASB
Statements No. 87, 88, 106 and 132(R) ("SFAS 158"). SFAS 158 requires the
Company to recognize in its statement of financial position an asset for a
defined benefit postretirement plan's over funded status or a liability for a
plan's under funded status, measure a defined benefit postretirement plan's
assets and obligations that determine its funded status as of the end of the
employer's fiscal year, and recognize changes in the funded status of a defined
benefit postretirement plan in comprehensive income in the year in which the
changes occur. The Company has a plan for certain executives that is unfunded,
and has recorded the accrued liability for this plan on the balance sheet. The
Company has adopted SFAS 158, which did not have a material effect on the
Company's results of operations or financial condition.
2. ACQUISITIONS
During the period ended December 31, 2006, the Company acquired two additional
businesses (the "Minor Acquisitions") for approximately $3,513,000 in cash,
$179,000 in acquisition expenses, and 216,241 shares of the Company's common
stock valued at approximately $1,786,000. The purchase price was allocated to
tangible and intangible assets acquired and liabilities assumed based on their
preliminary respective fair values. As part of the allocation, approximately
$7,145,000 was allocated to goodwill, $701,000 was allocated to amortizable
intangible assets (contract rights and client relationships) that are being
amortized over their estimated useful life of five years, and $500,000 to
purchased deferred software development cost being amortized over three years.
The goodwill related to the Minor Acquisitions is deductible for tax purposes.
The Company agreed to register for resale the shares issued for minor
acquisitions and, accordingly, included such shares in a Registration Statement
on Form S-3 filed February 16, 2006. This Registration Statement was declared
effective April 21, 2006.
(i)STRUCTURE LLC
On November 30, 2005, the Company acquired 100 percent of the membership
interests of (i)Structure, LLC from Level 3 Financing, Inc., a Delaware
corporation ("Level 3") for a cash payment of approximately $82,267,000 and
346,597 shares of Company stock valued at $2,500,000 (the "(i)Structure
Acquisition"). The Company funded the cash portion of the purchase price through
a combination of the net proceeds of $67,043,000 from a $70 million debt
facility which matures April 14, 2009, $11,512,000 in net proceeds from the
sale/leaseback of land and an 88,000 rentable square foot building in Omaha,
Nebraska (the "Omaha Property"), and the remainder with available cash. In
September 2006, the Company and the State of Nebraska entered into an agreement
approving the Company's participation in a state incentive program for economic
growth based on maintaining certain levels of "qualified property," as defined,
within Nebraska. The application to participate in this program had been
submitted by (i)Structure, LLC prior to the (i)Structure Acquisition. The
incentive under the program totals approximately $1.05 million, and was recorded
as a reduction in costs of revenues, excluding depreciation. Subsequent to the
acquisition, the Company also sold and leased back a 60,000 square foot building
and improvements in Tempe, Arizona (the "Tempe Property"). The Tempe Property is
subject to a ground lease. The purchase price for the (i)Structure Acquisition
is subject to an adjustment based on final values of certain components of
working capital, the values of which are being negotiated between the Company
and Level 3. This negotiation has been submitted to an arbitrator, and the
ultimate result of that arbitration will be booked to income once finalized. In
August 2006, (i)Structure, LLC's name was changed to Infocrossing, LLC.
Page F-11
The following table summarizes the fair values of the assets acquired and the
liabilities assumed at the date of the (i)Structure Acquisition. The intangible
asset subject to amortization relates to client 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 4,183
-----------
Total current assets 10,586
Property, equipment, and purchased software 37,565
(see discussion of sale-leasebacks above)
Intangible asset subject to amortization 9,400
Goodwill 45,907
-----------
Total assets acquired 103,458
-----------
Accounts payable and accrued expenses (15,019)
Deferred revenues (1,279)
Capitalized lease obligations (318)
-----------
Total liabilities assumed (16,616)
-----------
Purchase price $ 86,842
===========
INFOCROSSING HEALTHCARE SERVICES, INC.
On October 1, 2004, the Company acquired the common stock of the Medicaid,
Medicare and Managed Care claims processing business (the "Claims Processing
Business") of Verizon Information Technologies Inc. ("VITI") from Verizon
Communications Inc. for $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
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, relating to contract rights and client
relationships, was recorded in the amount of $10,320,000. 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.
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 SMS 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 $41,320,000 and an intangible asset subject
to amortization, relating to contract rights and client relationships, was
recorded in the amount of $1,650,000. 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, 2006, such contingent
consideration totaled $775,000, which was recorded as additional goodwill.
The results of each of the aforementioned acquisitions are included with that of
the Company for the period subsequent to the respective acquisition dates.
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
Page F-12
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. 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
============ ===========
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)
------------------------------------------ --------------
2006 2005
-------------------- ------------------ --------------
Computer equipment $ 24,050 $ 22,826 5-7
Computer equipment acquired under capital leases (Note 7) 38,114 27,523 5
Furniture and office equipment 3,372 3,171 7
Leasehold improvements 11,630 10,335 *
Purchased software 15,712 12,349 5
Vehicles 218 153 3
---------------- --------------
93,096 76,357
Less accumulated depreciation and amortization, including
$18,771 and $13,490 attributable to assets under
capital leases at December 31, 2006 and 2005, respectively (48,047) (35,608)
---------------- --------------
$ 45,049 $ 40,749
================ ==============
* Shorter of the useful life or the length of the lease.
Depreciation and amortization charged to operations was $12,545,000; $8,828,000;
and $7,194,000 for the years ended December 31, 2006, 2005, and 2004,
respectively.
Page F-13
Deferred Software Costs
Deferred software costs consist of the following (in thousands):
December 31,
-----------------------------------
2006 2005
--------------- ----------------
Cost of internally-developed software $ 9,314 $ 7,407
and enhancements, including software
under development, and also including
$500 obtained as part of an acquisition
(Note 2)
Accumulated amortization (6,488) (5,826)
----------- ------------
$ 2,826 $ 1,581
=========== ============
Amortization of deferred software costs charged to operations was $661,000;
$443,000; and $554,000 for the years ended December 31, 2006, 2005, and 2004,
respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Changes in goodwill for the years ended December 31, 2006 and 2005 are as
follows:
Year ended December 31,
-------------------------------------
2006 2005
---------------- -----------------
Goodwill, beginning of year $ 150,799 $ 103,177
(i)Structure Acquisition (a) (490) 46,396
SMS Acquisition - 1,166
Minor Acquisitions 7,145 60
------------ -------------
Goodwill, end of year $ 157,454 $ 150,799
============ =============
(a) The (i)Structure Acquisition occurred November 30, 2005, and certain
accruals made during the initial purchase price allocation were later determined
to be unnecessary.
Other Intangible Assets
Other intangible assets, consisting of acquired client lists, are as follows (in
thousands):
December 31,
-------------------------------------
2006 2005
---------------- -----------------
Beginning of year $ 24,250 $ 14,850
(i)Structure Acquisition - 9,400
Minor Acquisitions 701 -
------------ -------------
24,951 24,250
Accumulated amortization (8,132) (4,397)
------------ -------------
End of year $ 16,819 $ 19,853
============ =============
Page F-14
Amortization charged to operations was $3,735,000; $1,875,000; and $931,000 for
the years ended December 31, 2006, 2005, and 2004, respectively. The weighted
average life of all client lists is 6.7 years. Future amortization expense
related to client lists is estimated as follows (in thousands):
Years ending December 31:
2007 $ 3,281
2008 2,861
2009 2,424
2010 2,144
2011 1,970
Thereafter 4,139
-----------
$ 16,819
===========
5. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
December 31,
--------------------------------
2006 2005
-------------- --------------
$ 2,893 $ 8,211
Payroll related accruals excluding taxes
Software licenses and maintenance 2,767 2,044
Interest 2,031 1,754
Outside processing 1,908 2,108
Taxes other than corporate income 1,249 988
Professional fees 574 860
Building rents 561 865
Hardware leases and maintenance 386 2,211
Other 1,227 1,678
---------- ----------
$ 13,596 $ 20,719
========== ==========
6. RELATED PARTY TRANSACTIONS
Due from related parties consists of the following (in thousands):
December 31,
---------------------------
2006 2005
----------- ------------
Due from the Chairman, bearing interest
at the Prime Rate (8.25% at December 31,
2006) plus 1% per annum, repayable,
including accrued interest, on demand $ 56 $ 101
Due from other officers, bearing interest at
the Prime Rate, repayable, including
accrued interest, on demand 111 153
------- --------
Total due from related parties $ 167 $ 254
======= ========
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-15
The President IT Outsourcing (see Note 10) received a bonus of $1,150,000 in
connection with the (i)Structure Acquisition, which was paid by the Company and
applied as a credit against the amount otherwise payable to the Seller.
7. NOTES PAYABLE, CONVERTIBLE DEBT, AND CAPITALIZED LEASE OBLIGATIONS
Long-Term Debt consists of the following (in thousands):
December 31,
------------------------------------
2006 2005
--------------- ----------------
Senior secured term loan $ 47,575 $ 55,000
Senior secured revolving loan - 5,000
Convertible debt due 2024 (a) 65,515 65,164
Capitalized lease obligations 18,861 14,121
----------- -------------
131,951 139,285
Less current portion (18,749) (15,551)
----------- -------------
$ 113,202 $ 123,734
=========== =============
(a) Face value of $72 million.
Senior Secured Credit Agreement
On November 30, 2005, the Company entered into a $70,000,000 senior secured
credit facility (the "Credit Agreement"), with certain banks and other financial
institutions that were initially, or in the future might become, lenders (the
"Lenders"), including one bank that also acts as sole and exclusive
administrative and collateral agent (the "Agent") and as a lender, and an
affiliate of the Agent that acts as sole and exclusive lead arranger and sole
book manager. The Company'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,
subject to a combination of scheduled quarterly repayment amounts beginning
September 30, 2006, potential annual payments due no more than 95 days after
each year-end of 50% of our Excess Cash Flow, as that term is defined in the
Credit Agreement, with the first of such payments due no later than April 3,
2007 estimated to be $177,000, and other payments as described below. The Credit
Agreement also provides for a $15 million revolving credit facility (including
letter of credit subfacilities). During 2006, the Company repaid $5,000,000 on
the revolving credit facility and currently has no balance due. The maturity
date for both the term loan 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. At December 31, 2006, the interest rate on the term loan was
8.5%.
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, 2006 and 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 Agent, upon instruction from a
majority of the Lenders, may terminate the commitments and may declare all of
the Company's obligations under the Credit Agreement to be immediately due and
payable.
Page F-16
In connection with the Credit Agreement, the Company and the Guarantors entered
into a Security Agreement pursuant to which the Company and the Guarantors
granted a security interest in certain collateral to the 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. The Company also entered into a
securities pledge agreement with certain of its subsidiaries, pursuant to which
they granted a security interest in certain equity securities held by them to
the Agent for the benefit of the Lenders.
If the Company receives certain types of cash proceeds, including but not
limited to insurance proceeds, proceeds from the sale of assets, or proceeds
from the exercise of stock warrants and certain stock options, it is required to
make prepayments of the term loan in the amount of one-half of the received
proceeds. During 2006, the Company made payments of $2,626,000 as a result of
warrant exercises, and made a payment on January 4, 2007 of $179,500 related to
option exercises in 2006. Such prepayments, when made, reduce the amounts of
future scheduled quarterly amortization payments. Scheduled quarterly
amortization payment made in 2006 totaled $4,779,000. The currently scheduled
quarterly amounts due on the term loan are: $11,894,000 for 2007; and
$16,651,000 for 2008. The balance of the term loan and any amounts outstanding
under the revolving credit facility are due April 15, 2009.
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.
Convertible Debt
The Company has $72,000,000 of outstanding 4.0% Convertible Senior Notes due
July 15, 2024 (the "Notes"). Interest on the Notes is payable semi-annually in
the amount of $1,440,000 in July and January.
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, 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 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.
On August 5, 2005, because the market price of the Company's common stock was
less than $10.48 (68.23% of the initial conversion price) for at least 20
trading days during the 30 consecutive trading day period ending on August 5,
2005, a reset adjustment was triggered, whereby the conversion price was
immediately reduced by 17.38% to $12.69. 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. No further reset adjustments will be made, but
the adjusted conversion price of $12.69 remains subject to adjustment as noted
above for stock dividends, splits, issuances of rights to purchase shares of
common stock, and other events .
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 is being accreted to
the carrying value of the Notes through a charge to interest expense over the
life of the Notes.
Page F-17
The holders may convert their Notes into shares of 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 period 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 (a)
distributions to common stockholders of rights to acquire shares of common stock
at a discount; (b) distributions to common stockholders when the distribution
has a per share value in excess of 5% of the market price of common stock; and
(c) 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 the
Company to repurchase all or part of the Notes for cash equal to 100% of
principal plus accrued interest (the "CIC Put"). 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 CIC Put represents an embedded
derivative that would require bifurcation. Since the Company believes that any
value associated with the CIC Put would be de minimis, no value was assigned at
the time of issuance or in the subsequent periods, and this embedded derivative
was not bifurcated. If the value should become material in the future, the
Company will report if at such time.
The Company 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 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.
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.
Capital Lease Obligations
Assets subject to capital lease agreements are reflected in property and
equipment as capital leases. During the years ended December 31, 2006, 2005, and
2004, the Company entered into capital leases aggregating approximately
$11,223,000; $8,302,000; and $5,942,000, respectively, excluding those assumed
in business combinations.
Page F-18
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:
2007 $ 8,284
2008 6,250
2009 3,974
2010 1,901
2011 855
Thereafter 670
--------------
Total minimum lease payments 21,934
Less amount representing interest (3,073)
--------------
Present value of net minimum lease payments 18,861
Less current portion of obligations under capital leases (6,855)
--------------
Long-term portion $ 12,006
==============
8. INCOME TAXES
The significant components of provision (benefit) for income taxes consists of
(in thousands):
Years ended December 31,
--------------------------------------------------
2006 2005 2004
--------------- ------------- --------------
Current tax provision (benefit):
Federal $ 162 $ - $ 60
State and local 1,366 560 (49)
Deferred tax provision (benefit) 5,285 1,592 (12,550)
----------- ---------- ----------
Provision (benefit) for
income taxes $ 6,813 $ 2,152 $ (12,539)
=========== ========== ==========
Page F-19
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,
----------------------------------------------------
2006 2005 2004
---------- ----------- -----------
Tax provision computed at the statutory rate $ 5,202 $ 1,599 $ 2,612
Increase (decrease) in taxes resulting from:
State and local income taxes,
net of federal income taxes 1,094 489 361
Alternative minimum tax 162 - 60
Non-deductible expenses 42 43 28
Stock option compensation expense 337 - -
Change in valuation allowance - - (15,207)
Other, net (24) 21 (393)
---------- ----------- -----------
$ 6,813 $ 2,152 $ (12,539)
========== =========== ===========
Page F-20
Significant components of the Company's deferred tax assets and liabilities are
as follows (in thousands):
December 31,
---------------------------------------
2006 2005
----------------- ------------------
Deferred tax assets:
Accrued liabilities $ 513 $ 419
Allowance for doubtful accounts 139 194
Deferred rent 798 648
Deferred revenue 2,832 1,135
Net operating loss 15,053 18,179
Stock option exercise 1,882 1,680
Stock options issued 277 -
Other 160 217
------------- --------------
21,654 22,472
------------- --------------
Deferred tax liabilities:
Depreciation and amortization (3,006) (1,976)
Goodwill and intangible assets (7,376) (4,573)
Deferred software costs (972) (658)
Sales tax credits (576) -
Other deferred costs (631) (608)
------------- --------------
(12,561) (7,815)
------------- --------------
Net tax assets 9,093 14,657
Valuation allowance (2,462) (2,462)
------------- --------------
Net deferred taxes $ 6,631 $ 12,195
============= ==============
In 2006, 2005 and 2004, the Company recorded $178,000; $713,000; and $967,000 of
deferred taxes attributable to the disqualifying disposition of stock options,
directly increasing additional paid in capital. SFAS 123(R) requires that the
tax benefit attributable to disqualifying dispositions be classified as a
financing activity in the Company's statement of cash flows beginning with the
year ended December 31, 2006, rather than as a component of cash from
operations.
As of December 31, 2006 and 2005, 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 carry-forwards acquired in the
SMS Acquisition due to the uncertainty of realizing a tax benefit from that
deferred tax asset.
At December 31, 2006, the Company had net operating loss carry-forwards of
approximately $34 million for federal income tax purposes that begin to expire
in 2019. The use of these net operating loss carry-forwards 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, 2006, the Company has federal alternative minimum tax credit
carry-forwards of approximately $206,000 that do not expire.
Page F-21
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, 2006 and 2005, no preferred shares were outstanding.
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 liquid ation, 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.
Warrants
On October 21, 2003, in connection with a private placement of stock, the
Company issued five year warrants to purchase 3,408,689 shares of common stock
(the "PIPE Warrants"). The PIPE Warrants have an exercise price of $7.86 per
share and expire in October 2008. On February 12, 2004, a Registration Statement
on Form S-3, filed by the Company on behalf of the private placement investors
as selling shareholders, was declared effective. The Company does not receive
any proceeds from any sales of stock under this registration statement.
In 2006, holders of PIPE Warrants to purchase 311,633 shares exercised their
warrants for cash, resulting in proceeds to the Company of approximately
$2,449,000. In addition, one holder exercised a PIPE Warrant to purchase 89,059
shares by surrendering warrants for 63,660 shares in a cashless exercise. The
shares underlying the surrendered warrants had, at the exercise date, a market
value equal to the $199,636 exercise price of the warrants. The holders received
net shares totaling 25,399. No PIPE Warrants were exercised in 2005.
In connection with the issuance of debentures in February 2002, the Company
issued warrants (the "Debenture Warrants") to purchase up to 2,000,000 shares of
the common stock of the Company. 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 Debenture Warrants had
an exercise price of $5.86 per share and would have expired on January 31, 2007.
During 2006, holders of the Debenture Warrants to purchase 478,126 shares
exercised their warrants for cash, resulting in proceeds to the Company of
approximately $2,802,000. The holders exercised the remaining 584,374 Debenture
Warrants by surrendering warrants for 276,230 shares in a cashless exercise. The
holders received net shares totaling 308,144.
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-22
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"). On June 15, 2006,
the stockholders approved a proposal to increase the number of authorized shares
of Common Stock available for issuance under the 2005 Plan from 1,000,000 to
2,000,000. 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 the Options and Compensation Committee of the Board
of Directors (the "Committee") The Plans require that the Committee consists 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 the individuals to whom awards will be
granted from among those who may be eligible to receive such awards, 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-23
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-24
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, 2003 through December
31, 2006 is as follows:
Number of Exercise Price Range Weighted Average
Options Exercise Price
--------------- -------------------------- --------------------
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 $7.36 - $18.43 $10.18
Options granted in excess of market 750,000 $25.00 $25.00
Options exercised (473,962) $3.88 - $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
===============
Options granted 647,688 $10.29 - $14.46 $12.12
Options exercised (120,226) $3.63 - $12.90 $7.14
Options cancelled (140,122) $5.33 - $27.25 $15.26
---------------
Options outstanding, December 31, 2006 4,072,982 $4.38 - $37.78 $14.18
===============
The intrinsic value (calculated by subtracting the exercise price from the fair
value on the date of exercise) for options exercised during the year ended
December 31, 2006 was approximately $665,000; for all options outstanding at
December 31, 2006 was approximately $8,677,000; and for all options exercisable
at December 31, 2006 was $5,871,000.
Page F-25
Additional information regarding activity relating to unvested options during
the year ended December 31, 2006:
Number of
Unvested Weighted Average
Options Exercise Price Range Exercise Price
--------------- -------------------------- --------------------
Unvested Options, December 31, 2005 501,980 $6.32 - $18.43 $13.91
Options granted - unvested 553,731 $10.29 - $14.46 $12.23
Options vesting (249,026) $6.32 - $18.43 $11.72
Unvested options cancelled (56,759) $6.84 - 18.43 $15.83
---------------
Unvested Options, December 31, 2006 749,926 $9.05 - $18.43 $12.57
===============
Additional information regarding exercise price ranges of options outstanding:
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Weighted Contractual Exercise Contractual
Number of Average Life Number of Price of Life Remaining
Exercise Price Options Exercise Remaining Options Exercisable of Exercisable
Range Outstanding Prices (Years) Exercisable Options Options (Years)
- -------------------- --------------- ------------ --------------- --------------- -------------- -- -----------------
$4.38 - $6.56 99,714 $5.55 2.6 99,714 $5.55 2.6
$6.57 - $9.84 723,443 $8.36 5.0 640,111 $8.27 4.5
$9.85 - $14.77 2,029,128 $11.81 7.6 1,461,141 $11.64 6.6
$14.78 - $22.15 456,097 $17.52 6.9 357,490 $17.54 6.6
$22.16 - $33.22 760,850 $25.05 1.4 760,850 $25.05 1.4
$33.23 - $37.78 3,750 $37.78 3.3 3,750 $37.78 3.3
--------------- ---------------
4,072,982 5.7 3,323,056 4.9
=============== ===============
There were 3,323,056; 3,183,762; and 2,445,576 options exercisable at December
31, 2006, 2005, and 2004, respectively. At December 31, 2006, there are
1,009,212 options available for future grant, of which 250,000 are reserved
pursuant to executive employment agreements (See Note 6).
At December 31, 2006, the Company has reserved 1,591,903 common shares for
issuance upon exercise of the following warrants: (i) 65,000 shares exercisable
at $18.00 per share expiring September 16, 2010; (ii) 50,000 shares exercisable
at $15.00 per share expiring January 13, 2009; and (iii) 1,476,903 shares
exercisable at $7.86 per share expiring October 20, 2008.
At December 31, 2006, 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
12,347,965.
Page F-26
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 certain prior investors.
Stock-Based Compensation
The Company adopted SFAS 123(R) (see Note 1) using the modified prospective
method effective as of January 1, 2006.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation", the
Company previously accounted for share-based payments to employees using APB
Opinion 25's intrinsic value method and, as such, generally recognized 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. 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 and earnings per share below.
The fair value of each stock option is estimated on the date of the grant using
the Black-Scholes option pricing model with the following assumptions used for
grants in 2006: a risk-free interest rates of between 4.37% and 5.20%; expected
lives of between three and five years; and expected volatilities of between
42.4% and 48.4%. The following assumptions were used for grants in 2005: a
risk-free interest rate of between 3.38% and 4.38%; expected lives of three
years; and expected volatility of between 33.3% 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 41.1%.
The expense recorded, representing the fair value of options vesting during the
year ended December 31, 2006, was approximately $1,651,000. At the Company's
current effective tax rate, the after-tax effect of this charge for 2006 was
approximately $918,000 or $0.04 per both basic and diluted shares. The
unrecorded pre-tax compensation cost related to unvested options at December 31,
2006 totals approximately $3,051,000, amortizable over the period ending
December 31, 2009. Additional option grants will increase this amount, and
forfeitures of out-of-the-money options held by terminating employees will
reduce it. The weighted average amortization period is 2.2 years.
The Company has not determined what impact SFAS 123(R) might have on the nature,
timing, and amounts of its share-based compensation to employees in the future.
Page F-27
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 and 2004,
respectively, would have been as follows:
Year Ended December 31,
-------------------------------------
2005 2004
----------------- ----------------
Net income to common stockholders:
As reported $ 2,573 $ 19,963
Stock compensation expense determined
under fair value method (2,151) (2,739)
-------------- -------------
Pro forma $ 422 $ 17,224
============== =============
Basic net earnings to common stockholders per share:
As reported $ 0.13 $ 1.12
Stock compensation expense (0.11) (0.15)
-------------- -------------
Pro forma $ 0.02 $ 0.97
============== =============
Diluted net earnings
to common stockholders per
equivalent share:
As reported $ 0.12 $ 0.95
Stock compensation expense (0.10) (0.13)
-------------- -------------
Pro forma $ 0.02 $ 0.82
============== =============
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 per share underlying stock
options granted during the years ended December 31, 2006, 2005, and 2004 was
$5.29; $2.75; and $3.30, respectively.
10. COMMITMENTS AND CONTINGENCIES
Employment Agreements
Chairman and Vice Chairman
The Company's Chairman and Chief Executive Officer (the "Chairman); and the
Company's Vice Chairman, President and Chief Operating Officer (the "Vice
Chairman") each have employment agreements which 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 was amended December
22, 2006 and, as amended, provides for full-time employment for three 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 purpose of the amendment to the Vice Chairman's employment agreement
was to add an additional full-time year and extend the term of the agreement
accordingly. The first year of full-time employment for both executives began on
January 1, 2005. During part-time periods, if they elect to remain on the Board
of Directors, they will remain as Chairman and Vice-Chairman.
Page F-28
The employment agreements provide for lifetime pension benefits, of $180,000
annually for the Chairman beginning January 1, 2012, and $120,000 annually for
the Vice Chairman beginning January 1, 2010. The Company will also continue to
provide medical, life and disability benefits for life to the executives and
their spouses. The Company pays 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 2006, and does not expect to contribute to
this plan in 2007.
The following tables provide information regarding the executive plan's benefit
obligations for the years ended December 31, 2006 and 2005.
Benefit Obligations and Funded Status
The disclosure information shown below as of December 31, 2006 was estimated by
projecting employee data forward from January 1, 2006 to December 31, 2006.
Fiscal Year Ending Fiscal Year Ending
12/31/2006 12/31/2005
Accumulated Benefit Obligation at the End of the Year $ 795,226 $ 389,352
------------------- -------------------
Change In Projected Benefit Obligation
Projected Benefit Obligation at the Beginning of the Year 389,352 0
Service Cost 408,878 347,836
Interest Cost 21,414 20,870
Employee Contributions 0 0
Actuarial (Gain) or Loss (24,418) 20,646
Benefits Paid 0 0
------------------- -------------------
Projected Benefit Obligation at the End of the Year: $ 795,226 $ 389,352
------------------- -------------------
Change in Plan Assets
Fair Value of Plan Assets at the Beginning of the Year $ 0 $ 0
Contributions 0 0
Benefits Paid 0 0
Fair Value of Assets at the End of the Year: 0 0
------------------ ------------------
Funded Status at End of the Year: $ (795,226) $ (389,352)
------------------ ------------------
Amounts Recognized in the Statement of Financial Position
Non-current Liabilities $ (795,226) $ (389,352)
------------------ ------------------
Total $ (795,226) $ (389,352)
Amounts Recognized From Change to SFAS 158
Net Loss (Gain) $ (3,772) $ 0
------------------- -------------------
Total $ (3,772) $ 0
------------------- -------------------
(Accrued) Prepaid Pension Cost $ (798,998) $ (389,352)
------------------- -------------------
Weighted Average Assumptions at the End of the Year
Discount Rate 5.70% 5.50%
Rate of Compensation Increase N/A N/A
Page F-29
SFAS 158 requires a transition year disclosure of the effect of applying the new
standard. The following table shows the change in the amount recognized by
calculating the amount recognized on balance sheet before and after application
SFAS 158.
Fiscal Year Ending
12/31/2006
Amount Recognized Prior to Application of SFAS 158
Unfunded Accrued Benefit Obligation $ (795,226)
--------------
$ (798,998)
(Accrued) Prepaid Pension Cost
--------------
Amount Recognized $ (798,998)
Contributions between Measurement and Disclosure $ 0
--------------
Amount Recognized prior to SFAS 158 $ (798,998)
Funding Status (795,226)
--------------
Change in Amount Recognized due to SFAS 158 $ 3,772
--------------
Cash Flows
The following table shows plan contributions for the next year, the benefits
expected to be paid in each of the next five fiscal years, and in the aggregate
for the five fiscal years thereafter.
Cash Flow
Expected Return of Plan Assets to Employer $ 0
Contributions for the Period of 01/01/2007 - 12/31/2007
None 0
Estimated Future Benefit Payments
Reflecting Expected Future Service
01/01/2007 - 12/31/2007 0
01/01/2008 - 12/31/2008 0
01/01/2009 - 12/31/2009 0
01/01/2010 - 12/31/2010 120,000
01/01/2011 - 12/31/2011 120,000
01/01/2012 - 12/31/2016 $ 1,500,000
Page F-30
Other Accounting Items
Below is information required to be disclosed under SFAS 132.
Fiscal Year Ending
12/31/2006 12/31/2005
Market-Related Value of Assets as of beginning of fiscal year $0 $0
Amount of Future Annual Benefits of Plan Participants Covered by
Insurance Contracts Issued by the Employer or Related Parties None None
Alternative Amortization Methods Used
Prior Service Cost Straight Line Straight Line
Unrecognized Net (Gain)/Loss Straight Line Straight Line
Average Future Service 5.0 6.0
Employer Commitments to Make Future Plan Amendments (that Serve as
the Basis for the Employer's Accounting for the Plan) None None
Description of Special or Contractual Termination Benefits
Recognized During the Period None None
Cost of Benefits Described in 0 $0 N/A
Explanation of Any Significant Change in Benefit Obligation or Plan
Assets not Otherwise Apparent in the Above Disclosures None None
Measurement Date Used 12/31/2006 12/31/2005
Reconciliation of (Accrued)/Prepaid Pension Cost
The table below details how the (Accrued)/Prepaid Pension Cost at the end of the
prior fiscal year is adjusted forward one year by the pension expense and
contributions during 2006.
Fiscal Year
Ending
12/31/2006
(Accrued)/Prepaid Pension Cost as of 12/31/2005 $ (368,706)
Contributions During the Year ending 12/31/2006 0
Net Periodic Pension Cost During the Year ending 12/31/2006 430,292
-------------
(Accrued)/Prepaid Pension Cost as of 12/31/2006 $ (798,998)
-------------
Explanation of Significant Changes and Events
Below is an explanation of changes or events that occurred since last year and
had a significant effect on this year's disclosure information:
The following Significant changes in actuarial assumptions or methods have been
made:
12/31/2006 12/31/2005
Discount Rate 5.70% 5.50%
Rate of Return on Plan Assets N/A N/A
Future Salary Increase N/A N/A
The net effect of these changes was to decrease the Projected Benefit Obligation
by approximately $24,000. There were no significant changes were made to the
plan. There were no significant events that occurred last year.
Page F-31
Demographic Data
There are two active plan participants and no inactive plan participants.
The following summary describes principal plan provisions assumed in calculating
the cost of your pension plan.
Early Retirement Benefit
Participants who have attained age 55 and have completed 10 years of
service are eligible to retire early and receive their accrued
retirement benefit reduced by 1/4% for each of the first 60 months
retirement precedes age 65 and 5/12% for each of the next 60 months
retirement precedes age 65.
Disability Benefit
Upon total and permanent disability, participants will be eligible to
receive their accrued retirement benefit.
Death Benefit
Immediate eligibility. 100% of the pension which would be payable if
member retires immediately prior to death and without actuarial
reduction. The benefit is payable to the spouse or estate.
Normal Form of Payment
Life annuity. Optional forms of benefit are available with actuarial
reduction.
Amendment or Termination of Plan
The Employer reserves the right to amend or terminate the Plan at any
time. Generally, the Pension Benefit Guaranty Corporation reserves the
right to terminate the Plan if the Employer fails to meet the minimum
funding standards, or is unable to pay benefits when due. If the Plan
is terminated, the Plan assets will be distributed among the Plan
participants based upon a priority allocation procedure and the
Employer shall be liable for any unfunded vested benefits to the
extent required by law.
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 provided that no stock option awards would
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. Thereafter, the Board agreed to consider, in good faith, additional
annual grants of stock options.
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).
Page F-32
Other Officers
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, served as the President of IHS and reported
directly to the Board of Directors. The employment agreement provided for an
annual base salary of $250,000, reviewed no less than annually. Also provided
was 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 was 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 would have vested 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. On July 10, 2006, this
executive resigned.
On May 4, 2006, the Company entered into an employment agreement with an
executive having the title of President IT Outsourcing. The executive had
occupied this position since the (i)Structure Acquisition on November 30, 2006.
The initial term of the employment agreement expires November 30, 2008 and it
provides for renewals for successive one-year periods if no notice of
non-renewal is given by either party. The employment agreement provides for
compensation of no less than $303,000 per year, subject to review annually, and
the ability to earn a bonus of up to 100% of the base salary then in effect each
year based on achieving certain performance criteria as determined by the
Options and Compensation Committee. If the Agreement is terminated by the
Company without "Cause", or by the executive without "Good Reason" (as those
terms are defined in the Agreement), the executive will receive severance in an
amount of up to twelve months of the executive's base salary at that time. The
Agreement also provides that the executive will receive a non-qualified option
to purchase 75,000 shares of the Company's stock, vesting in equal monthly
amounts over the three years from the grant date, on November 30, 2006 and every
twelve months thereafter, for as long as he remains actively employed by the
Company or one of its subsidiaries. The executive also had received a
fully-vested option to acquire 75,000 shares of the Company's stock on December
1, 2005. All of these options are or will be issued subject to the Company's
2005 Stock Plan. The executive received a bonus, paid by the seller, of
$1,150,000 in connection with the (i)Structure Acquisition.
Effective, January 1, 2006, the Company entered into an employment agreement
with a President of Enterprise Application Services ("EAS President") who
reported directly to the President of the Company. The agreement had a term of
three years and provided for, among other things, an annual base salary of at
least $300,000, subject to review no less than annually. Also provided was 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. The EAS President was granted a fully-vested option to
acquire 75,000 shares of common stock of the Company, par value $.01 per share
("Common Stock"). The option was granted pursuant to the Company's 2005 Stock
Plan. On August 1, 2006, the EAS President became disabled and passed away on
February 8, 2007.
In August 2005, the Company entered into an employment agreement for a term of
three years with an executive having the title of Executive Vice President for
Marketing and Business Development (the "EVP") that provides, among other
things, an annual salary of $300,000, which may be adjusted upwards annually by
the Board of Directors or a compensation committee of the Board; the ability to
earn two bonuses, one of up to 100% of his annual salary and a second one of up
to 50% of his annual salary (each bonus shall be prorated during 2005) based
upon the achievement of goals to be determined by the Board or a compensation
committee of the Board; a sign-on bonus of $100,000, half of which was paid in
2005 and the second half of which was paid in 2006; and the grant of an option
to purchase 200,000 shares of the Company's common stock with an exercise price
equal to the fair market value on August 8, 2005, vesting 25% immediately, 25%
after one year, and the remainder vesting ratably over the next twenty-four
months. The employment agreement also provides for a severance payable under
certain circumstances equal to 100% of annual salary if the termination occurs
in the first year of the agreement, 83.33% if the termination occurs in the
second year, and 66.66% if the termination occurs in the third year, plus a
prorated amount of the total bonus the EVP would have been entitled to earn in
the year of termination.
Page F-33
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 $8,152,000; $7,046,000; and $3,989,000 for the years ended
December 31, 2006, 2005, and 2004.
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,
2007 $ 25,965
2008 24,031
2009 20,113
2010 7,734
2011 6,889
Thereafter 55,483
--------------------
$ 140,215
====================
Legal Proceedings
The Company is involved in various claims and proceedings. While management
currently believes that the ultimate outcome of these proceedings, individually
and in the aggregate, will not have a material adverse effect on the Company's
financial position, resolution of proceedings is subject to inherent
uncertainties, and unfavorable rulings could occur. The Company continually
evaluates its exposure to loss contingencies arising from pending or threatened
legal proceedings and believes it has made adequate provisions therefor.
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-34
12. Quarterly Financial Information (Unaudited)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2006 and 2005 (in thousands except per share data):
Three Months Ended:
------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2006 2006 2006 2006
------------------- ------------------ ------------------- -----------------
Revenues $ 55,921 $ 56,836 $ 57,517 $ 58,933
--------------- -------------- --------------- --------------
Costs of revenues, excluding 40,265 40,234 39,605 40,316
depreciation and amortization
shown below
Selling and promotion costs 1,958 2,121 2,286 2,364
General and
administrative expenses 5,233 4,581 4,537 3,716
Depreciation and amortization 4,131 4,129 4,248 4,434
Net interest expense 2,417 2,455 2,444 2,434
--------------- -------------- --------------- --------------
Pretax income 1,917 3,316 4,397 5,669
Provision for income tax 906 1,366 1,808 2,733
--------------- -------------- --------------- --------------
Net income $ 1,011 $ 1,950 $ 2,589 $ 2,936
=============== ============== =============== ==============
Net income per
basic common share $ 0.05 $ 0.09 $ 0.12 $ 0.13
=============== ============== =============== ==============
Net income per
diluted common share $ 0.05 $ 0.09 $ 0.11 $ 0.12
=============== ============== =============== ==============
Three Months Ended:
------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2005 2005 2005 2005
------------------- ------------------ ------------------- -----------------
Revenues $ 37,527 $ 35,194 $ 34,094 $ 41,191
--------------- -------------- --------------- --------------
Costs of revenues, excluding 25,847 25,506 25,335 29,946
depreciation and amortization
shown below
Selling and promotion costs 958 1,156 1,275 1,360
General and
administrative expenses 2,579 4,011 3,065 4,883
Depreciation and amortization 2,620 2,671 2,713 3,142
Net interest expense 1,465 1,490 1,434 1,825
--------------- -------------- --------------- --------------
Pretax income 4,058 360 272 35
Provision for income tax 1,621 236 159 136
--------------- -------------- --------------- --------------
Net income (loss) $ 2,437 $ 124 $ 113 $ (101)
=============== ============== =============== ==============
Net income (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)
=============== ============== =============== ==============
Page F-35
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, 2006 $ 637 $ (20) $ $ 237 (a) $ 380
============= ============ =========== ============ ============
Year ended
December 31, 2005 $ 249 $ 1,527 $ 100 (b) $ 1,238 (a) $ 637
============= ============ =========== ============ ============
Year ended
December 31, 2004 $ 570 $ 329 $ - $ 650 (a) $ 249
============= ============ =========== ============ ============
Valuation allowance
offsetting Net
Deferred Tax Assets
Year ended
December 31, 2006 $ 2,462 $ - $ - $ - $ 2,462
============= ============ =========== ============ ============
Year ended
December 31, 2005 $ 2,462 $ - $ - $ - $ 2,462
============= ============ =========== ============ ============
Year ended
December 31, 2004 $ 15,207 $ 15,207 $ 2,462 $ - $ 2,462
============= ============ =========== ============ ============
(a) Uncollectible accounts written off, net of recoveries. (b) Assumed in the
(i)Structure acquisition
Page S-1