SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
---------------------
DATE OF REPORT: AUGUST 18, 2004
(Date of earliest event reported)
INCENTRA SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)
NEVADA
(State or other jurisdiction of incorporation)
333-16031 86-0793960
(Commission File No.) (I.R.S. Employer
Identification No.)
1140 PEARL STREET
BOULDER, COLORADO 80302
(Address of principal executive offices; zip code)
(303) 440-7930
(Registrant's telephone number, including area code)
N/A
(Former Name or Former Address, if changed Since Last Report)
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions (SEE General Instruction A.2. below):
|_| Written communications pursuant to Rule 425 under the Securities Act (17
CFR 230.425)
|_| Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17
CFR 240.14a-12)
|_| Pre-commencement communications pursuant to Rule 14-2(b) under the
Exchange Act (17 CFR 240.14d-2(b))
|_| Pre-commencement communications pursuant to Rule 13-4(e) under the
Exchange Act (17 CFR 240.13e-4(c))
EXPLANATORY NOTE:
Incentra Solutions, Inc. (formerly known as Front Porch Digital, Inc.) filed a
Current Report on Form 8-K on August 18, 2004 announcing that it had completed
its acquisition of all of the outstanding capital stock of ManagedStorage
International, Inc., a Delaware corporation, ("MSI"). The purpose of this
amendment is to file various financial statements relating to the MSI business.
SECTION 9 - FINANCIAL STATEMENTS AND EXHIBITS
ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS.
Paragraphs (a) and (b) of Item 9, "Financial Statements and Exhibits" is
hereby amended to include the following:
(a) Financial Statements of Business Acquired (ManagedStorage
International, Inc.):
(1) Audited Financial Statements: PAGE
Report of Independent Registered Public Accounting
Firm...................................................
Consolidated Balance Sheet as of December 31, 2003.....
Consolidated Statement of Operations for the year
ended December 31, 2003................................
Consolidated Statement of Mandatorily Redeemable
Preferred Stock for the year ended December 31, 2003...
Consolidated Statement of Shareholders' Deficit for
the year ended December 31, 2003.......................
Consolidated Statement of Cash Flows for
the year ended December 31, 2003 ......................
Notes to Consolidated Financial Statements.............
(2) Audited Financial Statements of Business Acquired
(ManagedStorage International, Inc.):
PAGE
:
Independent Auditors Report............................
Consolidated Balance Sheets as of December 31,
2001 and 2002..........................................
Consolidated Statements of Operations for the
year ended December 31, 2001 and year ended
December 31, 2002......................................
Consolidated Statements of Cash Flows for the
year ended December 31, 2001 and year ended
December 31, 2002......................................
Consolidated Statement of Changes in Shareholders'
Deficit for the ... year ended December 31, 2001
and year ended December 31, 2002.......................
Notes to Financial Statements..........................
(3) Unaudited Financial Statements: PAGE
Condensed Consolidated Balance Sheet as of June 30,
2004 (Unaudited).......................................
Condensed Consolidated Statements of Operations for the
six months ended June 30, 2004 and 2003 (Unaudited)....
Condensed Consolidated Statements of Cash Flows for the
the six months ended June 30, 2004 and 2003
(Unaudited)............................................
Notes to Condensed Consolidated Financial
Statements (Unaudited).................................
(b) Pro Forma Financial Information (Unaudited) ..................
Pro Forma Condensed Consolidated Balance Sheet
as of June 30, 2004 (Unaudited)........................
Pro Forma Condensed Consolidated Statement of
Operations for the year ended December 31, 2003
(Unaudited)............................................
Pro Forma Condensed Consolidated Statement of
Operations for the six months ended June 30, 2004
(Unaudited)............................................
Notes to Pro Forma Condensed Consolidated
Financial Information (Unaudited)......................
(c) Exhibits .....................................................
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholder
ManagedStorage International, Inc.:
We have audited the accompanying consolidated balance sheet of ManagedStorage
International, Inc. and subsidiaries as of December 31, 2003 and the related
consolidated statements of operations, mandatorily redeemable preferred stock,
shareholders' deficit, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements 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 the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ManagedStorage
International, Inc. and subsidiaries as of December 31, 2003 and the results of
their operations and their cash flows for the year then ended, in conformity
with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Denver, Colorado
October 29, 2004
3
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheet
December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents $ 2,201,192
Short-term investments 3,793,099
Accounts receivable, net of allowance for doubtful
accounts of $199,493 1,343,177
Accounts receivable - related party 40,269
Note receivable - Front Porch Digital, Inc., including
interest receivable of $13,666 263,666
Prepaid expenses 160,817
Other current assets 518,389
------------
8,320,609
------------
Restricted cash 79,410
Property and equipment, net 2,784,434
Investment in Front Porch Digital, Inc. and related goodwill 592,381
Intangible assets, net 1,670,863
Other assets 115,864
------------
5,242,952
------------
$ 13,563,561
============
4
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheet
December 31, 2003
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK, AND
SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 657,945
Accrued and other current liabilities 1,074,770
Deferred revenue, current portion 950,017
Capital leases payable, net of discount of $15,285 534,891
---------------
3,217,623
Capital leases payable, less current portion, net of
discount of $6,368 128,739
Deferred revenue 292,045
Other long-term liabilities 47,201
Series C redeemable preferred stock, par value $0.01
(liquidation preference of $24,253,747):
Authorized shares - 24,500 shares. Issued and
outstanding - 22,104 shares 19,326,402
---------------
23,012,010
---------------
Mandatorily redeemable preferred stock:
Series A redeemable preferred stock, par value
$0.01 per share (liquidation preference of $5,000,000):
Authorized, issued, and outstanding - 50,000 shares 5,000,000
Series B convertible preferred stock, par value
$0.01 per share (liquidation preference of $8,681,918):
Authorized, issued, and outstanding - 650,000 shares 8,587,011
---------------
13,587,011
---------------
Shareholders' equity (deficit):
Class A common stock, par value $.0001 per share:
Authorized shares - 100,000,000 shares. Issued and
outstanding - 62,844,070 6,284
Warrants 181,223
Deferred compensation (362,140)
Additional paid-in capital 85,119,655
Accumulated deficit (107,980,482)
---------------
(23,035,460)
---------------
$ 13,563,561
===============
See accompanying notes to consolidated financial statements.
5
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statement of Operations
Year ended December 31, 2003
Revenues:
Storage revenues $ 9,810,741
--------------
Total revenues 9,810,741
--------------
Costs and expenses:
Cost of storage revenues 6,951,781
Sales and marketing expenses 3,105,638
General and administrative expenses 7,547,401
Impairment of goodwill related to equity method investment 692,098
--------------
Total costs and expenses 18,296,918
--------------
Loss from operations (8,486,177)
--------------
Other income (expense):
Interest income 39,167
Interest expense (2,225,443)
Share of losses of Front Porch Digital, Inc., an
equity-method investee (636,185)
Other investment income 48,529
Gain from early extinguishment of debt 20,826
Other income 247,912
--------------
Total other income (expense) (2,505,194)
--------------
Net loss before amounts attributable to
common shareholders (10,991,371)
--------------
Amounts allocable to common shareholders:
Dividends on mandatorily redeemable preferred stock (1,647,669)
Accretion of mandatorily redeemable preferred stock
to redemption amount (96,236)
--------------
Total amounts allocable to common shareholders (1,743,905)
--------------
Net loss allocable to common shareholders $ (12,735,276)
==============
Net loss allocable to common shareholders per weighted
average common share outstanding - basic and diluted $ (0.21)
==============
Weighted average common shares outstanding - basic and diluted 61,062,235
==============
See accompanying notes to consolidated financial statements.
6
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statement of Mandatorily Redeemable Preferred Stock
Year ended December 31, 2003
"NEW" SERIES PREFERRED
----------------------------------------------------------------------------
SERIES A REDEEMABLE SERIES B CONVERTIBLE SERIES C REDEEMABLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
----------------------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT TOTAL
-------------------------------------------------------------------------------------------
Balance at December 31, 2002 50,000 $5,000,000 650,000 $7,955,122 $12,955,122
Issuance of mandatorily redeemable
Series C preferred stock for cash of
$12,858,817 and the conversion of
$4,760,000 of principal amount and
$85,811 of related interest of
notes payable -- 22,104 $17,704,628 $17,704,628
Series C offering costs -- ($626,113) ($626,113)
Issuance of mandatorily redeemable
Series C preferred stock in
asset acquisition -- 333 $33,283 $33,283
Repurchase of mandatorily redeemable
Series C preferred stock -- (333) ($33,283) ($33,283)
Estimated fair value of warrants to
purchase Class A common stock and
Series C redeemable preferred stock
issued in exchange for services
rendered in the Series C Offering -- ($126,637) ($126,637)
Accretion of mandatorily redeemable
preferred stock to redemption amount -- $31,889 $64,347 $96,236
Accrual of dividends on redeemable
preferred stock -- $600,000 $1,047,669 $1,647,669
Reclassification of mandatorily
redeemable Series C preferred stock
to liabilities upon adoption of
SFAS No. 150 effective July 1, 2003 -- (22,104) ($18,063,894) ($18,063,894)
-------------------------------------------------------------------------------------------
Balance at December 31, 2003 50,000 $5,000,000 650,000 $8,587,011 -- $-- $13,587,011
===========================================================================================
See accompanying notes to consolidated financial statements.
7
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statement of Shareholders' Deficit
Year ended December 31, 2003
SERIES C
CLASS A REDEEM.
CLASS A COMMON COMMON PREF. ADDITIONAL
----------------------- STOCK STOCK DEFERRED PAID-IN ACCUM.
SHARES AMOUNT WARRANTS WARRANTS COMP. CAPITAL DEFICIT TOTAL
---------------------------------------------------------------------------------------------
Balance at December 31, 2002 204,513 $20 -- -- -- 81,082,587 (96,989,111) (15,906,504)
Accretion of mandatorily redeemable
preferred stock -- $0 -- -- -- (96,235) -- (96,235)
Dividends on redeemable preferred stock -- $0 -- -- -- (1,647,669) -- (1,647,669)
Issuance of Class A common stock for
cash of $3,214,704 and the
conversion of $1,190,000 of
principal amount and $21,453 of
related interest of notes payable 53,726,228 $5,373 -- -- -- 4,420,784 -- 4,426,157
Issuance of Class A common stock to
induce conversion of notes payable
in the Series C redeemable preferred
and Class A common stock financing 8,774,999 $878 -- -- -- 876,622 -- 877,500
Class A common stock offering costs -- $0 -- -- -- (156,528) -- (156,528)
Issuance of restricted Class A common
stock for cash 93,702 $9 -- -- -- 460 -- 469
Exercise of stock options 49,828 $5 -- -- -- 735 -- 740
Repurchase of nonvested restricted
Class A common stock (5,200) ($1) -- -- -- -- -- (1)
Estimated fair value of warrants
issued to purchase Series C
mandatorily redeemable preferred
stock in exchange for the equipment
lease facility -- $0 -- 22,927 -- -- -- 22,927
Estimated fair value of warrants
issued to purchase Class A common
stock and Series C mandatorily
redeemable preferred stock in
exchange for services in the
Series C financing -- $0 65,571 92,725 -- (31,659) -- 126,637
Deferred compensation related to
grants of options to employees to
purchase common stock -- $0 -- -- (670,558) 670,558 -- --
Amortization of deferred compensation -- $0 -- -- 308,418 -- -- 308,418
Net loss before amounts allocable to
common Shareholders -- $0 -- -- -- -- (10,991,371) (10,991,371)
---------------------------------------------------------------------------------------------
Balance at December 31, 2003 62,844,070 $6,284 65,571 115,652 (362,140) 85,119,655 (107,980,482) (23,035,460)
=============================================================================================
See accompanying notes to consolidated financial statements.
8
MANAGEDSTORAGE INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statement of Cash Flows
Year ended December 31, 2003
Cash flows from operating activities:
Net loss ($10,991,371)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 2,337,524
Amortization of intangible assets 928,851
Amortization of noncash loan discount 1,274
Stock-based compensation 308,418
Interest expense paid with common stock 877,500
Noncash interest expense on converted notes 14,191
Noncash interest expense on Series C mandatorily
redeemable preferred stock liability 1,262,508
Share of losses of Front Porch Digital, Inc. and
related impairment of goodwill 1,328,283
Gain on disposal of assets (15,868)
Noncash interest income on note receivable (13,666)
Bad debt expense 266,387
Gain from early extinguishments of debt (20,826)
Changes in operating assets and liabilities:
Accounts and other receivables (967,544)
Other current assets (93,226)
Prepaid expenses 16,211
Other assets 15,687
Accounts payable (286,417)
Accrued liabilities 34,523
Deferred revenue 831,790
Other liabilities (9,518)
------------
(4,175,289)
------------
Cash flows from investing activities:
Purchase of property and equipment (2,103,746)
Capitalized software development costs (320,414)
Proceeds from sale of property and equipment 267,902
Purchase of intangible assets (2,349,714)
Net change in restricted cash (648)
Issuance of note receivable from Front Porch Digital (250,000)
Purchases of short-term investments (5,300,000)
Maturity of short-term investments 1,506,901
------------
(8,549,719)
------------
Cash flows from financing activities:
Cash proceeds from issuance of redeemable preferred stock 12,858,817
Proceeds from issuance of common stock 3,214,704
Redeemable preferred stock and Class A common stock
offering costs (782,641)
Payments on capital leases (446,372)
Proceeds from exercise of stock options and purchase of
restricted stock 1,208
------------
14,845,716
------------
2,120,708
Cash and cash equivalents at beginning of year 80,484
------------
Cash and cash equivalents at end of year $ 2,201,192
============
9
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 72,789
Supplemental disclosures of noncash financing activities:
Deferred compensation for options granted at less
than fair value $ 670,558
Redeemable preferred stock issued for discount on
capital lease obligation $ 22,927
Redeemable preferred stock warrants and common stock warrants
issued for financing costs $ 158,296
Notes payable and accrued interest converted to preferred
and common stock $ 6,057,264
Capital lease obligations incurred in connection with the
purchase of property and equipment $ 654,852
Purchases of property and equipment included in accounts payable $ 215,715
See accompanying notes to consolidated financial statements.
10
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(1) ORGANIZATION
ManagedStorage International, Inc. (the Company or MSI) was incorporated
on March 7, 2000 as a data-storage service provider specializing in
storage design, implementation and operation services, and content
management services throughout the United States and Europe.
The Company had no business operations until March 29, 2000, when Storage
Technology Corporation (StorageTek) contributed various assets,
contracts, and employees in exchange for common stock and mandatorily
redeemable Old Series B preferred stock. At formation, Great Hill
Partners, L.P. funded $10,000,000 in exchange for common stock and
mandatorily redeemable Old Series A preferred stock.
The Company has entered into three recapitalization and stock purchase
agreements with the Company's investors on August 9, 2000, January 11,
2002, and January 10, 2003. See note 4 and note 13 for further discussion
on the equity structure of the Company.
On January 10, 2003, MSI acquired an existing customer base and
infrastructure assets from Sanrise Group, Inc. See note 18 for an
additional discussion of the asset acquisition.
On August 18, 2004, Front Porch Digital, Inc. (FPDI) acquired MSI in a
merger transaction. As a result of the merger, MSI will operate as a
wholly owned subsidiary of FPDI.
At December 31, 2003, the consolidated entity consists of ManagedStorage
International, Inc., and its wholly owned subsidiaries Seabrook
Technologies, Inc. and ManagedStorage International Canada, Inc.
RISKS AND UNCERTAINTIES
The Company is subject to various risks and uncertainties frequently
encountered by companies in the early stages of development, particularly
companies in the rapidly evolving market for technology-based products
and services. Such risks and uncertainties include, but are not limited
to, its limited operating history, need for additional capital, a
volatile business and technological environment, an evolving business
model, and the management of expected growth. To address these risks, the
Company must, among other things, gain access to capital in amounts and
on terms acceptable to it, maintain and increase its customer base,
implement and successfully execute its business strategy, continue to
enhance its technology, provide superior customer service, and attract,
retain, and motivate qualified personnel. There can be no guarantee that
the Company will be successful in addressing such risks.
The Company has incurred substantial operating losses and has a net
capital deficiency. Management of the Company intends to fund these
deficiencies by utilizing its existing cash and cash equivalents, and
increasing cash flows from its business operations. Realization of the
Company's investment in property and equipment and other long-lived
assets is dependent upon achieving positive operating cash flows. If the
Company does not achieve and maintain such positive operating cash flows,
its long-lived assets could be considered impaired resulting in a
significant charge against earnings.
The Company's 2004 operating plan and execution thereof is focused on
increasing revenue, controlling costs, and conserving cash, however,
there is no guarantee that the Company will be able to meet the
operational and financial requirements of its operating plan. The Company
11
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
cannot predict with certainty the expected revenue, gross profit margin,
net loss, and/or usage of cash and cash equivalents. However, the
Company's management believes that the Company's cash and cash
equivalents and working capital provide adequate capital resources to
fund its operations, 2004 debt repayments, and working capital needs at
least through December 31, 2004.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION
The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated in consolidation.
(b) USE OF ESTIMATES
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates. The Company has recorded transactions that
include the issuance of options and warrants to purchase shares of
the Company's preferred and common stock. The accounting for such
securities is based upon fair values of the Company's equity
securities and other valuation criteria that were determined by
management and the board of directors. The Company believes these
estimates of fair value are reasonable. Other significant
estimates made by management include those related to fair values
of acquired intellectual property, and the establishment of
reserves for estimates of uncollectible accounts receivable.
(c) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with
an original maturity of three months or less to be cash
equivalents.
(d) RESTRICTED CASH
The Company has restricted cash of $79,410 at December 31, 2003,
which secures a letter of credit securing a lease for the
corporate headquarter premises. See note 11 for further discussion
of the letter of credit.
(e) SHORT-TERM INVESTMENTS
At December 31, 2003, short-term investments consisted of
certificates of deposits with original maturities greater than
three months but less than one year. All such investments are
carried at amortized cost, which approximates fair value.
(f) PROPERTY AND EQUIPMENT
Property and equipment, if acquired at the formation date or
through the 2003 Sanrise acquisition, have been recorded at the
estimated fair value at that time. Otherwise, all other property
and equipment has been recorded at cost. Property and equipment
are depreciated on a straight-line basis over their respective
estimated useful lives ranging
12
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
from two to five years. Equipment recorded under capital leases
and leasehold improvements is amortized using the straight-line
method over the shorter of the respective lease term or estimated
useful life of the asset.
(g) INTANGIBLE ASSETS
Intangible assets reflects the estimated fair value of the Sanrise
customer base acquired on January 10, 2003 and payments made to
Storage Networks International on December 31, 2002 for customer
relationships, and are being amortized over 36 months and 18
months, respectively.
(h) IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, ACCOUNTING FOR DISPOSAL OF LONG-LIVED ASSETS (SFAS
144), the Company reviews the carrying value of long-lived In
accordance with Statement of Financial Accounting Standards (SFAS)
No. 144, ACCOUNTING FOR THE IMPAIRMENT OR assets, including
property and equipment and amortizable intangible assets, to
determine whether there are any indications of impairment.
Impairment of long-lived assets is assessed by a comparison of the
carrying amount of an asset to future cash flows expected to be
generated by the asset. If the assets are considered to be
impaired, the impairment recognized is measured by the amount by
which the carrying amount of the assets exceeds the estimated fair
value of the assets.
(i) INVESTMENT IN FRONT PORCH DIGITAL, INC. AND RELATED GOODWILL
The Company's investment in the common stock and warrants of FPDI
is accounted for by the equity method. The excess of the estimated
fair value of Front Porch Digital, Inc. common stock and warrants
over the Company's share of FPDI's net assets at the acquisition
date was recognized as goodwill, and in accordance with SFAS No.
142, GOODWILL AND OTHER INTANGIBLE ASSETS, is not being amortized.
The Company reviews such goodwill for impairment, and recognizes a
loss when there is a loss in value in the equity method investment
which is other than a temporary decline. In 2003, due to a
substantial decrease in the indicated value of FPDI, and due to
FPDI's continuing losses, the Company recorded an impairment of
$692,098.
(j) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. 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 and operating loss and
tax credit carryforwards. 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
income in the period that includes the enactment date.
13
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(k) REVENUE RECOGNITION
Revenue is recognized when all of the following criteria are met:
persuasive evidence of an agreement exists, delivery has occurred
or services have been rendered, the sales price is fixed or
determinable, and collectibility is reasonably assured. Revenues
from storage services are recognized at the time the services are
provided and are billed on a monthly basis. Fees received for
up-front implementation services are deferred and recognized over
the term of the arrangement. Deferred revenue is recorded for
billings sent to or paid by customers for which the Company has
not yet performed the related services.
(l) ADVERTISING EXPENSES
All advertising and promotion costs are expensed as incurred.
Total advertising expenses incurred were $270,964 for the year
ended December 31, 2003.
(m) SOFTWARE DEVELOPMENT COSTS
The Company's Gridworks software product is used internally as the
basis for providing services to the Company's customers and is
also marketed separately as a stand-alone product. The Company
accounts for costs related to software developed for internal use
and marketed for external use in accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased,
or Otherwise Marketed. As required by SFAS No. 86, qualifying
software development cost incurred subsequent to the establishment
of technological feasibility are capitalized. Cost incurred prior
to the establishment of technological feasibility are expensed as
incurred. The Company capitalizes costs related to significant
enhancements. Capitalization ceases when the product or
enhancement is available for general release. For the year ended
December 31, 2003, capitalized software development costs totaled
$320,414. The capitalized portion of these costs is amortized
based on current and future revenue for the product with an annual
minimum equal to the straight-line amortization over the estimated
life of three years. Research and development costs are expensed
as incurred.
(n) COST OF STORAGE REVENUES
Cost of storage revenues consists primarily of direct labor,
depreciation, amortization, third-party royalties and licenses,
and facilities costs.
(o) PER SHARE DATA
The Company reports its earnings (loss) per share in accordance
with Statement of Financial Accounting Standards No. 128,
ACCOUNTING FOR EARNINGS PER SHARE (SFAS 128). Basic loss per share
is calculated using the net loss allocable to common shareholders
divided by the weighted average common shares outstanding during
the period. Due to the Company's net loss, shares from the assumed
conversion of outstanding warrants, options and convertible
preferred stock have been omitted from the computations of diluted
loss per share for the year ended December 31, 2003 because the
effect would be antidilutive.
14
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(p) STOCK-BASED COMPENSATION
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related
interpretations, including FASB Interpretation No. 44 (FIN 44),
ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION,
AN INTERPRETATION OF APB OPINION NO. 25, to account for its
fixed-plan stock options. Under this method, compensation expense
is generally recorded on the date of grant only if the current
market price of the underlying stock exceeds the exercise price.
FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
and FASB Statement No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION - TRANSITION AND DISCLOSURE, AN AMENDMENT OF FASB
STATEMENT NO. 123, established accounting and disclosure
requirements using a fair value-based method of accounting for
stock-based employee compensation plans. As permitted by existing
accounting standards, the Company has elected to continue to apply
the intrinsic value-based method of accounting described above,
and has adopted only the disclosure requirements of Statement 123,
as amended. The following table illustrates the effect on net loss
if the fair value-based method had been applied to all outstanding
and unvested awards in the period at December 31, 2003.
Net loss, before amounts attributable to
common shareholders as reported $ (10,991,371)
Add stock-based employee compensation expense
included in reported net loss, net of tax 308,418
Deduct total stock-based employee compensation
expense determined under fair value-based
method for all awards, net of tax (321,847)
--------------
Pro forma net loss $ (11,004,800)
==============
Net loss per weighted average common share
outstanding - basic and diluted - pro forma $ (0.21)
==============
Net loss per weighted average common share
outstanding - basic and diluted - as reported $ (0.21)
==============
Pro forma information related to fair value for options granted in
2003 was determined at the date of grant using the minimum value
method with the following weighted average assumptions:
Risk-free interest rate 3.91%
Expected dividend yield 0.00%
Expected lives 10 years
Volatility 0.001%
The weighted average fair value of options granted during 2003 was
$0.09. For purposes of pro forma disclosures, the estimated fair
value of the options was amortized to expense over the vesting
period of the related option. Previously recognized compensation
expense for forfeited options is included as a reduction of
compensation expense in the period of forfeiture.
15
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
Option valuation models such as the minimum value method described
above require the input of highly subjective assumptions. Because
the Company's employee stock options have characteristics
significantly different from those of traded options, and because
changes in the subjective input assumptions can materially affect
the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the
fair value of the Company's employee stock options.
(q) FINANCIAL INSTRUMENTS
Carrying amounts of financial instruments held by the Company,
which include cash equivalents, restricted cash, short-term
investments, accounts receivable, and accounts payable,
approximate fair value due to their short duration. The carrying
amount of the Series C preferred stock liability approximates its
estimated fair value based upon the specific attributes of the
security and expected market returns for similar securities.
(r) CONCENTRATIONS OF CREDIT RISK
Services provided to three customers who individually represent
greater than 10% of revenue totaled 66% of revenues for the year
ended December 31, 2003. Accounts receivable from these customers
were $699,704 (52%) as of December 31, 2003. The Company records a
provision for doubtful accounts for all receivables not expected
to be collected and generally does not require collateral. The
Company evaluates the collectibility of accounts receivable based
on a combination of factors. In circumstances when the Company is
aware of a specific customer's inability to meet its financial
obligations (e.g., bankruptcy filings), the Company records a
specific reserve for bad debts against amounts due. For all other
instances, the Company recognizes reserves based on historical
experience and review of the individual accounts outstanding.
(s) RECENTLY ISSUED OR PROPOSED ACCOUNTING PRONOUNCEMENTS
On March 31, 2004, the FASB issued a proposed Statement,
"Share-Based Payment", which addresses the accounting for
share-based payment transactions. The proposed Statement would
eliminate the ability to account for share-based compensation
transactions using APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and generally would require instead that such
transactions be accounted and recognized in the statement of
income based on their fair value. The FASB recently announced that
the final standard will be effective for public companies for
fiscal periods beginning after June 15, 2005. The proposed final
standard offers the Company alternative methods of adopting this
final rule. At the present time, the Company has not yet
determined which alternative method it will use and the impact on
operation results.
(3) DIVESTITURE OF MANAGEDSTORAGE INTERNATIONAL FRANCE
On July 31, 2002, the Company entered into a stock and asset purchase
agreement with FPDI to sell all of the outstanding shares of capital
stock of ManagedStorage International France. Initial consideration was
5,000,000 shares of FPDI common stock, 1,750,000 warrants to purchase
FPDI common stock at a price of $2.00 per share, and 1,750,000 warrants
to purchase FPDI common stock at a price of $4.00 per share. The warrants
are exercisable immediately and expire on July 31, 2012. The common stock
was subject to a lock-up agreement with FPDI whereby, subject to certain
exceptions, the Company was unable to sell or otherwise dispose of it
prior to July 31, 2003. The agreement has an earn-out provision payable
in common stock of FPDI. As of December 31, 2002,
16
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
the earn-out criteria had been fully met and the Company received an
additional 2,500,000 shares of FPDI common stock in complete fulfillment
of the earn-out arrangement. The Company accounts for its investment in
FPDI common stock using the equity method. In addition, the Company has
identified an element of goodwill in such investment. During 2003, the
Company recorded equity losses on the investment of $636,185, and
recorded an impairment loss of the related goodwill of $692,098.
(4) RECAPITALIZATION AND STOCK PURCHASE AGREEMENTS
In January 2003 and May 2003, the Company entered into a securities
purchase agreement with certain existing investors and new investors.
Pursuant to this agreement, the Company issued 22,104 shares of Series C
mandatorily redeemable preferred stock (New Series C) and 62,501,227
shares of Class A common stock. In connection with this securities sale,
the Company also issued warrants for the purchase of 270 shares of New
Series C and 656,267 shares of Class A common stock. The warrants for the
purchase of the New Series C and the Class A common stock are exercisable
for $1,000 and $.001, respectively, for a period of 5 years from the date
of the securities purchase agreement.
Proceeds and cost of the sale of the Class A common stock and the New
Series C were allocated to each class of stock based on relative fair
values on the date of the financing. The New Series C is nonvoting, has a
par value of $0.01 per share, accrues a dividend of $100 per share per
annum, has a $1,000 per share liquidation preference, and is redeemable
January 9, 2008. The purchase price of the New Series C was $800 per
share. The Series C proceeds were $17,704,628 and consisted of cash of
$12,858,817 and the conversion of a note payable with a $4,760,000
principal amount and $85,811 of related interest. Cash costs of the
financing were $626,113 and noncash cost of financing were warrants with
an estimated value of $126,637.
The purchase price of the Class A common stock was $0.10 per share. A
total of 53,726,228 shares of the Class A common stock was issued for
total proceeds consisting of $3,214,704 cash and the conversion of a note
payable with $1,190,000 principal amount and $21,453 of related interest.
The remaining 8,774,999 shares of Class A common stock were issued as an
inducement to convert the notes payable. Interest expense in the amount
of $877,500 was recorded in connection with the conversion based on an
estimated fair value of the common stock of $0.10.
The Company was granted an irrevocable right and option (the "Call
Right") to purchase all of the shares of Class A common stock issued to
each investor pursuant to the purchase agreement dated January 10, 2003
and any other shares of stock issued or issuable with respect thereto
(the "Call Shares") upon or in connection with a liquidation event or the
redemption of the New Series C shares. The call price to be paid by the
Company to each Investor to exercise the Call Right with respect to such
Investor's Call Shares shall be an amount equal to the product of (i)
$1,000, multiplied by (ii) the quotient of (X) the total number of Call
Shares then held by such Investor, divided by (Y) the total number of
Call Shares then outstanding.
17
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(5) CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company's cash equivalents and short-term investments consist of the
following as of December 31, 2003:
Cash equivalents:
Operating cash accounts $ 99,327
Shares of money market mutual funds 203,119
Certificates of deposit with banks 1,898,746
------------
Total cash equivalents 2,201,192
------------
Short-term investments:
Certificates of deposit with banks 3,793,099
------------
Total short-term investments 3,793,099
------------
Total cash equivalents and short-term investments $ 5,994,291
============
(6) PROPERTY AND EQUIPMENT
Property and equipment consists of the following items as of December 31,
2003:
Storage equipment $ 3,162,759
Storage software 2,916,737
Lab equipment and software 374,802
Furniture, fixtures, and office equipment 1,743,855
Leasehold improvements 17,149
------------
8,215,302
Less accumulated depreciation (5,430,868)
------------
Property and equipment, net $ 2,784,434
============
Depreciation expense for the year ended December 31, 2003 was $2,337,524.
Included in the balances above is property and equipment under capital
lease with a cost of $955,480 and accumulated depreciation of $330,041 at
December 31, 2003.
18
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(7) INTANGIBLE ASSETS
Intangible assets consists of the following items as of December 31,
2003:
Acquired customer contracts $ 2,349,714
Acquired customer list 250,000
-----------
2,599,714
Less accumulated amortization (928,851)
-----------
Intangible assets, net $ 1,670,863
===========
Amortization expense for the year ended December 31, 2003 was $928,851.
Future amortization expense is as follows:
Year ending December 31:
2004 $ 866,571
2005 783,238
2006 21,054
-----------
$ 1,670,863
===========
(8) INVESTMENTS IN FRONT PORCH DIGITAL, INC. AND RELATED GOODWILL
As discussed above, the Company received common stock and warrants to
purchase common stock of FPDI as consideration for the sale of MSI
France. This investment is accounted for under the equity method, as the
common stock ownership percentage represented by the Company's FPDI
holdings was approximately 18% at December 31, 2003. The Company's
investment in FPDI common stock and warrants has been reduced by the
Company's share of FPDI losses and impairments of the related goodwill.
The balance of $592,381 as of December 31, 2003 represents unimpaired
goodwill.
Based on closing prices, the market value of the common stock of FPDI
held by the Company was $900,000 at December 31, 2003. Unaudited summary
financial information for FPDI as of and for the year ended December 31,
2003, as derived from FPDI's Annual Report on Form 10-KSB, are as
follows:
19
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
Financial position:
Current assets $ 1,562,335
Other assets 1,252,439
-----------
Total assets 2,814,774
-----------
Current liabilities 3,885,483
Long-term debt 372,318
-----------
Total liabilities 4,257,801
-----------
Stockholders' (deficit) equity $(1,443,027)
===========
Operations:
Sales $ 2,921,755
===========
Operating loss $(2,819,805)
===========
Net loss $(7,386,251)
===========
(9) ASSET IMPAIRMENT
The Company evaluated the ongoing value of its equipment and intangible
assets and determined that no impairment exists as of December 31, 2003.
The Company recorded an impairment loss of $692,098 for the year ended
December 31, 2003 related to its investment in FPDI common stock and
warrants.
(10) ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consist of the following as of
December 31, 2003:
Wages, benefits, and payroll taxes $ 448,160
Contract labor --
Professional service fees 333,793
Equipment maintenance 36,504
Co-location fees --
Estimated property tax liability 189,017
Other accrued liabilities 67,296
-----------
$ 1,074,770
===========
(11) COMMITMENTS AND CONTINGENCIES
The Company has employment agreements with certain executives that
provide for up to one year of salary upon termination with the Company.
The Company leases facilities and equipment under noncancelable capital
and operating leases. Rental expense relating to operating leases was
$492,901 for the year ended December 31, 2003. Certain of the operating
lease agreements have renewal provisions, which range from month-to-month
to 24-month terms.
20
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
A letter of credit was entered into as additional security for an
operating lease due to the limited cash resources of the Company at the
time the lease was signed. The agreement requires a letter of credit in
decreasing amounts through the expiration of the lease on September 30,
2007. The letter of credit expires on April 1st of every year and is
automatically extended without written amendment every year and would be
used to pay rent on the corporate headquarters facility if the Company
were unable to make the monthly rent payments. At December 31, 2003, the
amount of the letter of credit is $79,410. The letter of credit is
secured by restricted cash in the same amount.
Future minimum lease payments as of December 31, 2003 follows:
CAPITAL OPERATING
LEASES LEASES
----------- -----------
Year ending December 31:
2004 $ 598,878 362,723
2005 139,274 161,070
2006 -- 158,065
2007 -- 105,376
----------- -----------
Total minimum lease payments 738,152 $ 787,234
===========
Less amounts representing interest (52,869)
-----------
Present value of minimum lease payments 685,283
Less current portion (550,176)
-----------
Capital lease obligations, long-term $ 135,107
===========
(12) DEBT FINANCING
On November 20, 2003, the Company entered into a capital lease line of
credit agreement for $1,500,000 with a third-party lender. The term of
the agreement is for term leases ranging from 12 to 18 months. The
Company drew $654,853 on the line in November 2003. The interest rate on
the line ranges from 10.514% to 10.731%. In 2004, an additional $815,654
was utilized and $29,493 of the line expired unused.
(13) MANDATORILY REDEEMABLE PREFERRED STOCK AND COMMON STOCK
The Company's authorized capital stock at December 31, 2003 consists of
the following:
(a) MANDATORILY REDEEMABLE PREFERRED STOCK
The Company has issued three classes of mandatorily redeemable
preferred stock: Series A mandatorily redeemable preferred stock
(New Series A), Series B mandatorily redeemable, convertible
preferred stock (New Series B), and New Series C as of December
31, 2003.
21
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
SERIES A MANDATORILY REDEEMABLE PREFERRED STOCK
The Company authorized and issued 50,000 shares of New Series A as
part of the Recapitalization discussed in note 4. New Series A
does not have voting rights and the holders are not entitled to
receive dividends on the shares. However, on January 11, 2007, the
fifth anniversary of the issuance of the stock, a cumulative
dividend of $10.00 (adjusted for subsequent stock dividends, stock
splits, combinations, recapitalizations or the like with respect
to such share) per share per year may be paid, if approved by the
board of directors. After January 11, 2007, dividends shall accrue
daily in arrears and be compounded annually, whether or not such
dividends are declared by the board of directors or paid. This
cumulative dividend is subordinate to dividends paid on the New
Series B and New Series C.
Upon liquidation of the Company, each holder of outstanding shares
of New Series A shall be entitled to be paid in cash, after the
prior payment in full of the New Series C and New Series B
Liquidation Preference Amounts and of any amount payable upon a
liquidation event to the holders of any other class or series of
capital stock ranking on liquidation senior to the New Series A
and before any amount shall be paid or distributed to holders of
Class A Common Stock or to holders of any other class or series of
capital stock ranking on liquidation junior to the New Series A,
an amount per share of New Series A equal to (i) $100, plus (ii)
an amount equal to all accumulated but unpaid dividends on such
share of New Series A. If the amounts available for distribution
by the Company to the holders of the New Series A upon a
liquidation event are not sufficient to pay the aggregate New
Series A Liquidation Preference Amount due to such holders, such
holders of the New Series A shall share ratably in any
distribution in proportion to the full respective preferential
amount to which they are entitled.
The New Series A is automatically redeemable upon the earlier of
(a) the date upon which the holders of the Series B convertible
preferred stock have received cash and/or equity securities that
can be immediately resold to the public or (b) the date following
the end of any period of 60 consecutive trading days, beginning
after the trading day which is 180 days following the closing of
an initial public offering. The Company may elect at its option to
redeem in cash all of the outstanding securities of New Series A
at any time, with 15-day written notice, at the New Series A
liquidation preference amount.
In the case of an Insider Down Round, as defined, each New Series
A Holder shall be entitled to receive, without payment of any
further consideration, an aggregate number of shares of Class A
Common Stock equal to the difference between (i) the product of
(A) the number of shares of Class A Common Stock held by such New
Series A Holder immediately prior to the Insider Down Round and
(B) a fraction, the numerator of which is the Conversion Price of
the New Series B prior to the Insider Down Round and the
denominator of which is the Conversion Price of the New Series B
after the Insider Down Round and (ii) the number of shares of
Class A Common Stock held by such New Series A Holder immediately
prior to the Insider Down Round.
22
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
SERIES B MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Company has authorized and issued 650,000 shares of New Series
B as part of the Recapitalization discussed in note 4. Each share
of New Series B has voting privileges equal to the number of
shares of Class A common stock into which such share of New Series
B is convertible pursuant to the conversion terms of the
agreement. The New Series B accrues a dividend of $0.923077 per
share per year (adjusted for subsequent stock cumulative
dividends, stock splits, combinations, recapitalizations or the
like with respect to such share).
In a liquidating event, each holder of the New Series B shall be
entitled to be paid in cash, after the prior payment in full to
the holders of outstanding shares of New Series C of the New
Series C Liquidation Preference Amount and before any amount shall
be paid or distributed to holders of any class or series of stock
ranking on liquidation junior to the New Series B an amount per
share equal to (a) $11.5384615 (New Series B original issue price)
plus (b) an amount equal to all accumulated but unpaid dividends
on shares of Series B convertible preferred stock.
On or at any time after January 11, 2007, the fifth anniversary of
the date of original issuance of the New Series B, the holder(s)
of a New Series B majority interest may elect to have all (but not
less than all) of the outstanding shares of New Series B redeemed.
In such event, the Company shall redeem all (but not less than
all) of the outstanding shares of New Series B in cash, for an
amount equal to the aggregate New Series B redemption price
($13.3568 per share at December 31, 2003). Any election by a New
Series B majority interest shall be made by written notice to the
Company and the other holders of New Series B at least 15 days
prior to the elected redemption date. Upon such election, all
holders of New Series B shall be deemed to have elected to have
their shares of New Series B redeemed and such election shall bind
all holders of New Series B. The price for each share of New
Series B redeemed shall be an amount equal to the New Series B
liquidation preference amount, $13.3568 at December 31, 2003,
(such amount to be adjusted for stock splits, stock dividends,
combinations, recapitalizations and the like). The aggregate New
Series B redemption price shall be payable in cash in immediately
available funds to the respective holders of the New Series B on
the New Series B redemption date.
The holders of New Series B may convert such shares into Class A
common stock at any time after the issuance of such shares.
The New Series B may be converted, at any time, upon written
election of the holder without the payment of any additional
consideration into such number of fully paid and nonassessable
shares of Class A common stock as is determined by dividing (i)
the New Series B Anti-dilution Price, by (ii) the Conversion Price
at the time in effect for such New Series B. As of the most recent
charter filing date, the New Series B Anti-dilution Price per
share for shares of the New Series B is $0.415 per share. Both the
conversion value and conversion price are subject to future
adjustment. In addition, all New Series B are automatically
convertible into the Company's Class A common stock upon a
qualified public offering raising at least $40 million in proceeds
for the Company at a price per share of at least $35.
23
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
SERIES C MANDATORILY REDEEMABLE PREFERRED STOCK
The Company has authorized 24,500 shares and issued 22,104 shares
of New Series C as discussed in note 4. The holders of New Series
C are not entitled to vote on any matters except as provided in
the covenants or to the extent otherwise required under the
Delaware General Corporation Law. The holders of outstanding
shares of New Series C shall be entitled to receive cumulative
dividends at the rate of $100 per share of New Series C per year
(as adjusted for subsequent stock dividends, stock splits,
combinations, recapitalizations or the like with respect to such
share) from the date of original issuance of such share.
Upon a liquidating event, each holder of outstanding shares of New
Series C shall be entitled to be paid in cash, before any amount
shall be paid or distributed to the holders of New Series B, New
Series A, Class A Common Stock or any other class or series of
capital stock ranking on liquidation junior to the New Series C,
an amount per share equal to (i) $1,000, plus (ii) an amount equal
to all accumulated but unpaid dividends on such share of New
Series C.
New Series C will be automatically redeemed on the earliest to
occur of (1) January 9, 2008, (2) one day prior to the redemption
of the Company's New Series B, and (3) closing of the Company's
initial public offering pursuant to a registration statement
covering the offer and sale to the public of its Class A Common
stock.
The New Series C redemption price per share is $1,000, plus
accrued and unpaid dividends, plus, in the case of redemption on
January 9, 2008, or one day prior to the redemption of the
Company's New Series B, but not in the case of redemption upon the
Company's initial public offering of its Class A Common stock, an
amount equal to the amount a New Series C holder would receive on
a liquidation of the Company at its fair market value for the
Company's Class A Common stock held by such New Series C holder
and purchased at the same time as such holder's New Series C
(Series C Deemed Shares) divided by the number of such Series C
Deemed Shares.
If the Company issues shares of Class A Common Stock for a
consideration per share less than $0.083, then the New Series C
holders shall be entitled to receive without payment of any
additional consideration, a number of shares of Common Stock equal
to the excess of (i) the number of shares of Common Stock
purchased by such Investor adjusted appropriately for stock
splits, stock dividends, combinations, recapitalizations and the
like with respect to the Common Stock and held by such Investor
immediately prior to such issuance or sale multiplied by a
fraction, (A) the numerator of which shall be the Anti-dilution
Price per Common Share, and (B) the denominator of which shall be
a number determined by dividing (1) the sum of (x) the Common
Stock Deed Outstanding immediately prior to such issuance or sale
multiplied by the Anti-dilution Price Per Common Share and (y) the
consideration, if any received by the Company upon such issuance
or sale by (2) the Common Stock Deemed Outstanding immediately
after such issuance or sale, over (ii) the number of shares of
Common Stock purchased by such
24
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
Investor (such amount to be adjusted appropriately for stock
splits, stock dividends, combinations, recapitalizations and the
like with respect to the Class A Common Stock).
SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, (SFAS 150) was
issued in May 2003. This Statement establishes standards for the
classification and measurement of certain financial instruments
with characteristics of both liabilities and equity. For the
Company, SFAS 150 is generally effective for financial instruments
entered into or modified after May 31, 2003, and otherwise at the
beginning of the first interim period beginning after June 15,
2003. The Company's New Series C preferred stock is mandatorily
redeemable on January 9, 2008, (the redemption amount is currently
estimated to be $33,156,000, representing $1,000 per share plus
five years of dividends at $100 per share per year), and therefore
is considered a liability under the provisions of SFAS 150.
Accordingly, on July 1, 2003, the carrying amount of the New
Series C, which approximates its fair value, was reclassified from
the "mezzanine" section of the balance sheet to the liability
section. There was no gain or loss recorded upon the adoption of
SFAS 150. From July 1, 2003, the Company has recorded noncash
interest expense of $1,262,508, reflecting an effective interest
rate on this security of 13.477%. The Company will record future
interest charges related to the New Series C through its
redemption. New Series A and New Series B are not within the scope
of SFAS 150, as they are not redeemable on a date certain.
The Company's outstanding New Preferred Stock provides for
cumulative dividends payable in cash, or in securities of
equivalent value if converted to common stock, at the following
rates compounded annually:
Series B Convertible
Preferred Stock $0.923077 per share per annum
Series C Redeemable
Preferred Stock $100 per share per annum
At December 31, 2003 there were cumulative New Series B dividends
of $1,181,918 and New Series C dividends of $1,047,669.
(b) COMMON STOCK AND CLASS A COMMON STOCK
In April 2003, the Company approved a 1-for-5 reverse stock split
of its Class A common stock and New Series B. All amounts in the
accompanying consolidated financial statements and related notes
reflect this stock split.
The Company authorized 100,000,000 shares of Class A common stock
of which 62,844,070 shares were outstanding at December 31, 2003.
(14) EMPLOYEE STOCK OPTION PLAN
On March 27, 2000, the Company established the ManagedStorage
International, Inc. 2000 Stock Option and Grant Plan (the Option Plan),
which was amended on August 2000, October 2000, January 2002, and July
2003. The maximum number of shares of Class A common stock available for
issuance to eligible employees, consultants, and directors of the Company
under the Option Plan is 10,669,553 at December 31, 2003. Options to
purchase the Company's Class A common stock are exercisable at a price as
determined by the board of directors at the time the
25
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
option is granted. Under the terms of the Option Plan, the exercise
prices for incentive stock options granted shall not be less than 100% of
the fair market value of the Class A common stock or common stock of the
Company at the date of grant, or if a participant owns more than 10% of
the Company, the option price may not be less than 110% of the fair
market value of the Class A common stock or common stock. No incentive
stock options may be exercised more than 10 years from the date of grant,
or when an employee owns more than 10% of the Company, the incentive
stock options may not be exercised more than five years from the date of
grant.
The Option Plan is administered by the board of directors, which has the
authority to select the individuals to whom awards will be granted and to
determine whether and to what extent stock options are to be granted, the
number of shares of Class A common stock and common stock to be covered
by each award, the vesting schedule of stock options, and all other terms
and conditions of each award. Options granted during 2003 vest over a
four-year period, 25% per year, commencing on the one-year anniversary of
the grant and/or the employee hire date. Unless terminated or otherwise
canceled under the Option Plan provisions, the contractual life of all
such options is no greater than ten years.
During 2003, a total of 7,056,793 stock options were granted (net of
cancellations) with exercise prices less than the estimated fair value of
the underlying common stock resulting in total deferred compensation
expense to be recognized ratably over the vesting period of $635,111 of
which $290,436 was recognized during 2003.
During 2002, a total of 69,350 shares of restricted stock were purchased
by employees for prices less than their estimated fair value, resulting
in $35,447 of compensation expense which will be recognized over the
vesting period, of which $17,982 has been recognized through December 31,
2003.
Options which were granted during 2000 and 2001 vest over a four-year
period, 25% commencing on the one-year anniversary date of the grant and
6.25% each three-month period thereafter. All 2000 and 2001 options were
cancelled in 2002. The cancelled options were replaced with 14,124
options and 11,770 shares of restricted stock. The replacement options
and restricted stock are subject to the variable accounting rules under
FIN 44. The option exercise price on the replacement options was $0.50
per share, which exceeded the fair value of the Company's common stock as
of December 31, 2003.
The purchase price on the replacement restricted stock was $0.005 and the
estimated fair value of the underlying Class A common stock on December
31, 2003 was $0.10. On December 31, 2003, 8,610 shares of the replacement
restricted stock were vested and $818 cumulative compensation expense had
been recognized.
26
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
A summary of all activity in the Option Plan is as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF OPTIONS PRICE
------------- ---------
Balance, December 31, 2002 6,514 $ 0.50
Granted 8,079,928 0.01
Exercised (49,828) 0.01
Forfeited (616,559) 0.02
---------
Balance, December 31, 2003 7,420,055 0.02
=========
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
--------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE SHARES AVERAGE
EXERCISE SHARES UNDER CONTRACTUAL EXERCISE CURRENTLY EXERCISE
PRICE OPTION LIFE PRICE EXERCISABLE PRICE
---------- -------------- ------------- ---------- ------------- ---------
$ 0.01 7,007,460 9.12 $ 0.01 1,737,691 $ 0.01
0.10 409,000 9.63 0.10 7,500 0.10
0.50 3,595 8.31 0.50 2,065 0.50
------------ -----------
7,420,055 8.31 0.02 1,747,256 0.01
============ ===========
In 2002, the Company issued restricted stock grants, which are restricted
in terms of their disposal and vesting. Vesting of restricted stock
awards is determined by the board of directors for each specific grant.
On April 24, 2002, the Company sold 5,385,783 (107,715 shares adjusted
for the 1-for-10 and the 1-for-5 reverse splits) restricted shares under
the Option Plan to members of management. The shares sold in 2002 vest
over a four-year period, 25% per year, commencing on the one-year
anniversary of the grantee's date of hire.
(15) EMPLOYEE CONTRIBUTION PLAN
The Company sponsors a 401(k) Savings Plan (the Plan). The Plan is a
defined contribution plan for all regular employees of the Company who
have attained at least 18 years of age. Employees who meet these
requirements may become a participant in the Plan on the first day of the
following month after meeting the eligibility requirements.
Participants may elect to make contributions ranging from 1% to 20% of
their eligible compensation, subject to limitations based on provisions
of the tax law. The Company may make a discretionary pretax matching
contribution. The amount would be equal to a percentage determined
annually by a board of directors' resolution. To date, no matching
contributions have been made.
27
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
Employee contributions are 100% vested. Company contributions, when made,
will be subject to the following vesting schedule: Up to one year of
service, 40% vested; two years of service, 80% vested; three or more
years of service, 100% vested.
(16) RELATED-PARTY TRANSACTIONS
The Company acquired equipment and equipment maintenance services with
two shareholders in the amount of $191,142 for the year ended December
31, 2003.
The Company incurred $153,320 for the use of a shareholder's private
aircraft for the year ended December 31, 2003.
The Company paid salaries, consulting fees, and other reimbursable
expenses to various shareholders in the amount of $1,304,541 for the year
ended December 31, 2003.
(17) INCOME TAXES
As of December 31, 2003, the Company had federal and state net operating
loss carryforwards totaling $59,000,000. The domestic net operating loss
carryforwards will expire at various dates through 2023 if not utilized.
The Tax Reform Act of 1986 contains provisions that limit the utilization
of net operating loss carryforwards if there has been a change in
ownership as described in Section 382 of the Internal Revenue Code. Such
a change in ownership may limit the Company's utilization of its net
operating loss carryforwards. As a result of a private placement in 2003,
the Company believes that there are substantial limitations on the
utilization of its net operating loss carryforwards.
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes consist of the following
as of December 31, 2003:
Deferred tax assets:
Net operating loss carryforwards $23,087,288
Basis in Front Porch Digital, Inc. shares 5,813,305
Other 1,339,708
-----------
Deferred tax assets 30,240,301
Valuation allowance (30,240,301)
-----------
Net deferred tax assets (liabilities) $ --
===========
The Company had no deferred tax liabilities as of December 31, 2003.
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the
realization of the deferred tax assets such that a full valuation
allowance has been recorded because the Company cannot conclude that the
deferred tax asset will
28
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
be realized on a more likely than not basis. The Company will continue to
assess the realization of the deferred tax assets based on actual and
forecasted operating results.
The following table reconciles the amount, which would be provided by
applying the 35% federal statutory rate to income (loss) before income
tax expense (benefit) to federal income taxes actually provided for the
year ended December 31, 2003:
Income taxes at federal statutory rate of 35% $ (3,847,979)
Effect of permanent differences 559,857
State income taxes, net of federal benefit (444,892)
Other 277,133
Tax loss benefit not recognized through increase
in valuation allowance 3,455,881
------------
$ --
============
(18) ASSET ACQUISITION
On October 16, 2002, the Company entered into an asset purchase
agreement, whereby the Company would purchase certain assets from Sanrise
for $1,000,000 in cash and $2,000,000 in escrowed funds to be released
over a 120-day period, provided certain conditions in the contract were
met. The asset purchase agreement contains an earn-out provision payable
in cash and stock, payable upon meeting certain conditions. The
transaction closed January 10, 2003.
In September 2003, the Company settled an outstanding lawsuit with
Sanrise for $156,667 in cash and 333 shares of New Series C. The payment
in cash and shares was made in full satisfaction of the earn-out
provision. In the settlement, Sanrise relinquished any and all right to
further payment in connection with the asset acquisition of its DataVault
business and the Company released all remaining escrow payments.
The 333 shares of Series C redeemable preferred stock were repurchased
from Sanrise on December 19, 2003 for $33,283 and such shares were
retired.
The total purchase price for the Sanrise assets (including direct costs
of the acquisition) of $3,216,992 was allocated to the acquired
intangible asset of acquired customer contracts and fixed assets based on
their estimated fair market values.
(19) SUBSEQUENT EVENTS
(a) INVESTMENT IN FRONT PORCH DIGITAL, INC.
On April 1, 2004, the note receivable in the amount of $250,000
from FPDI was converted to 5,952,381 shares of FPDI common stock.
This note bore interest at 8%, and was due on September 15, 2004.
Following such conversion, the Company owned 13,452,381 shares, or
23%, of FPDI.
29
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(b) LITIGATION SETTLEMENT
In September 2003, the Company was served with a lawsuit from a
bankruptcy estate asserting that it has a preference claim as to
all or a part of $730,000 paid by the bankrupt company to the
Company pursuant to a settlement agreement for services provided.
On June 30, 2004, the Company settled the lawsuit for $195,000 in
cash. In the settlement, each of the parties agreed to relinquish
any and all right to further payments or claims in connection
therewith. The $195,000 settlement was fully accrued at December
31, 2003.
(c) POTENTIAL LITIGATION
In August 2004, the Company was notified by a liquidating trust
formed in the Cable & Wireless bankruptcy proceedings stating that
preferential payments totaling $218,782 were made by Cable &
Wireless to the Company. The trust is requesting payment of
$196,904 in settlement of such alleged preferential payments. The
Company denies any liability exists for the alleged preferential
payments and will aggressively oppose the claim.
30
Item 9 (a) (2) Audited Financial Statements as of December 31, 2001 and 2002
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
ManagedStorage International, Inc.
We have audited the accompanying consolidated balance sheets of ManagedStorage
International, Inc. and subsidiaries (the "Company") as of December 31, 2002 and
2001, and the related consolidated statements of operations, cash flows, and
changes in mandatorily redeemable preferred stock and shareholders' deficit for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements 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 ManagedStorage
International, Inc. and subsidiaries at December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
September 6, 2003, except Note 17,
as to which the date is December 12, 2003
31
MANAGEDSTORAGE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
2002 2001
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 80,484 $ 1,315,013
Restricted cash 78,762 --
Short-term investments -- 69,166
Accounts receivable, net of allowance for doubtful
accounts of $185,000 and $51,650 at December 31,
2002 and 2001, respectively 682,289 2,298,505
Equipment held for sale -- 4,750,060
Other current assets 602,191 1,682,023
---------- -----------
1,443,726 10,114,767
Property and equipment, net 2,079,264 8,671,847
Intellectual property 250,000 --
Investment in Front Porch Digital, Inc. 1,920,664 --
Other assets 131,551 89,725
---------- -----------
4,381,479 8,761,572
---------- -----------
Total assets $5,825,205 $18,876,339
========== ===========
32
MANAGEDSTORAGE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIT DECEMBER 31,
Current liabilities: 2002 2001
----------- -----------
Accounts payable $ 728,647 $ 1,424,209
Accrued and other current liabilities 1,133,320 3,300,159
Billings in excess of costs and recognized revenue 270,346 213,090
Notes payable to investors 5,950,000 --
Capital leases payable 440,673 9,803,870
----------- -----------
8,522,986 14,741,328
Capital leases payable, less current portion 56,956 8,042,701
Dividend payable -- 8,961,457
Billings in excess of costs and recognized revenue, less current portion
196,645 --
Other long-term liabilities -- 223,936
----------- -----------
Total liabilities $ 8,776,587 $31,969,422
----------- -----------
MANDATORILY REDEEMABLE PREFERRED STOCK
Series A redeemable preferred stock, par value $0.01 per share
(liquidation preference of $5,000,000):
Authorized shares--50,000 shares
Issued and outstanding--50,000 shares at December 31, 2002 $ 5,000,000 $ --
Series B convertible preferred stock, par value $0.01 per share
(liquidation preference of $8,081,918):
Authorized shares--650,000 shares
Issued and outstanding--650,000 shares at December 31, 2002 7,955,122 --
Series B preferred stock, par value $0.01 per share
(liquidation preference of $14,550,223 at December 31, 2001):
Authorized shares--20,000 shares
Issued and outstanding--12,697 shares at December 31, 2001 -- 12,696,978
Series A convertible preferred stock, par value $0.0001
(liquidation preference of $11,463,112 at December 31, 2001):
Authorized shares--17,000,000 shares
Issued and outstanding--16,900,000 shares at December 31, 2001 -- 10,087,492
Series C convertible preferred stock, par value $0.0001
(liquidation preference of $58,553,781 at December 31, 2001):
Authorized shares--10,500,000 shares
Issued and outstanding--10,399,919 shares at December 31, 2001 -- 52,405,820
----------- -----------
12,955,122 75,190,290
----------- -----------
33
MANAGEDSTORAGE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
DECEMBER 31,
2002 2001
----------- -----------
SHAREHOLDERS' DEFICIT
Class A common stock, par value $0.0001 per share
Authorized shares--100,000,000 shares
Issued and outstanding--204,513 shares at December 31, 2002 20 --
Common stock, par value $0.0001 per share
Authorized shares--114,000,000 shares
Issued and outstanding--22,733,061 shares at December 31, 2001 -- 2,273
Additional paid-in capital 81,694,344 299,658
Accumulated other comprehensive income -- 393,908
Accumulated deficit (97,600,868) (88,979,212)
----------- -----------
Total shareholders' deficit (15,906,504) (88,283,373)
----------- -----------
Total liabilities, mandatorily redeemable preferred stock and shareholders' deficit
$ 5,825,205 $18,876,339
=========== ===========
SEE ACCOMPANYING NOTES.
34
MANAGEDSTORAGE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
2002 2001
----------- ------------
Revenues:
Storage revenues $ 8,569,368 $ 15,809,428
----------- ------------
Total revenues 8,569,368 15,809,428
Costs and expenses:
Cost of storage revenues 9,633,811 25,322,974
Sales and marketing expenses 5,073,102 8,180,109
General and administrative expenses 4,856,490 11,952,407
Product development costs 364,100 2,596,098
Restructuring expenses 2,192,550 2,114,160
Impairment loss -- 20,768,419
----------- ------------
Total costs and expenses 22,120,053 70,934,167
----------- ------------
Loss from operations (13,550,685) (55,124,739)
Other operating income (loss):
Interest income 42,531 56,214
Interest expense (320,895) (1,965,045)
Investment (loss) income (305,536) 718,165
Gain from early extinguishment of debt 6,372,861 --
Other (loss) income (248,175) 104,221
----------- ------------
Total other operating (loss) income 5,540,786 (1,086,445)
----------- ------------
Loss before amounts attributable to
common shareholders (8,009,899) (56,211,184)
Amounts attributable to common shareholders:
Mandatorily redeemable preferred stock dividends (581,918) (6,258,135)
Accretion of mandatorily redeemable preferred
stock to redemption amount (29,839) (116,820)
----------- ------------
Total amounts attributable to common shareholders (611,757) (6,374,955)
----------- ------------
Net loss attributable to common shareholders $(8,621,656) $(62,586,139)
=========== ============
SEE ACCOMPANYING NOTES.
35
MANAGEDSTORAGE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
2002 2001
------------ ------------
OPERATING ACTIVITIES
Net loss $ (8,009,899) $(56,211,184)
Adjustment to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,560,758 10,405,286
Noncash compensation (income) expense (9,280) 177,994
Noncash expense for issuance of mandatorily redeemable
preferred stock 125,000 --
Loss on investment in Front Porch Digital, Inc. 329,336 --
Loss on disposal of assets 1,537,516 616,395
Bad debt expense 225,436 1,373,919
Gain from early extinguishment of debt (6,372,861) --
Asset impairment -- 20,768,419
Accretion of interest on held-to-maturity investments -- (395,574)
Other (253,781) --
Changes in operating assets and liabilities:
Accounts and other receivables 498,524 (1,282,994)
Other current assets 353,256 1,847,504
Other assets (125,300) 459,128
Accounts payable (205,650) (1,256,915)
Accrued liabilities (1,218,831) (2,678,905)
Billings in excess of costs and recognized revenue 333,551 13,958
Other liabilities (180,151) 289,113
------------ ------------
Net cash used in operating activities (10,412,376) (25,873,856)
INVESTING ACTIVITIES
Purchase of property and equipment (849,453) (8,575,991)
Proceeds from sale of property and equipment 1,789,764 926,692
Purchase of intellectual property (250,000) --
Net change in restricted cash (78,762) --
Net change in short-term investments (7,612) 10,487,937
------------ ------------
Net cash provided by investing activities 603,937 2,838,638
FINANCING ACTIVITIES
Proceeds from issuance of redeemable preferred stock, net
of issuance costs of $156,635 and noncash transaction
of $125,000 7,218,365 --
Payment of capital lease obligations (3,638,219) (5,772,989)
Net proceeds from issuance of notes payable 5,943,908 --
Prepayment penalty settlement on early extinguishments of debt (950,500) --
Net proceeds from exercise of stock options 356 93,750
------------ ------------
Net cash provided by (used in) financing activities 8,573,910 (5,679,239)
Effect of exchange rates on cash and cash equivalents -- (324,253)
------------ ------------
Net decrease in cash and cash equivalents (1,234,529) (29,038,710)
Cash and cash equivalents at beginning of year 1,315,013 30,353,723
------------ ------------
Cash and cash equivalents at end of year $ 80,484 $ 1,315,013
============ ============
YEAR ENDED DECEMBER 31,
2002 2001
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for interest $ 484,301 $ 1,497,187
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES
Capital lease obligations incurred in connection with
the purchase of property and equipment $ 37,534 $ 14,177,620
============ ============
Purchases of property and equipment included in accounts payable $ 57,236 $ 22,925
============ ============
36
Table 1
ManagedStorage International, Inc.
Consolidated Statements of Changes in Mandatorily Redeemable Preferred Stock
Years ended December 31, 2002 and 2001
SERIES A REDEEMABLE SERIES B CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK SERIES B PREFERRED STOCK
------------------------- ------------------------- ------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
---------- ---------- ---------- ---------- ------------ ------------
Balance at December 31, 2000 -- $ -- -- -- $ 12,697 $ 12,696,978
Accretion of mandatorily redeemable
preferred stock to redemption amount -- -- -- -- -- --
---------- ---------- ---------- ---------- ------------ ------------
Balance at December 31, 2001 -- -- -- -- 12,697 12,696,978
Issuance of mandatorily redeemable
Series A redeemable preferred stock 50,000 5,000,000 -- -- -- --
Issuance of manditorily redeemable
Series B convertible preferred stock -- -- 650,000 7,343,365 -- --
Conversion of mandatorily redeemable
Series A convertible preferred
stock to Class A common stock -- -- -- -- -- --
Conversion of mandatorily redeemable
Series B preferred stock to Class A
common stock -- -- -- -- (12,697) (12,696,978)
Conversion of mandatorily redeemable
Series C convertible preferred stock
to newly issued mandatorily
redeemable Series A preferred stock
and Class A common stock -- -- -- -- -- --
Issuance of mandatorily redeemable
preferred stock -- -- -- 581,918 -- --
Accretion of mandatorily redeemable
preferred stock to redemption amount -- -- -- 29,839 -- --
---------- ---------- ---------- ---------- ------------ ------------
Balance at December 31, 2002 50,000 $5,000,000 650,000 $7,955,122 -- $ --
========== ========== ========== ========== ============ ============
SERIES A CONVERTIBLE SERIES C CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK
------------ ----------- ------------ ------------
SHARES AMOUNT SHARES AMOUNT TOTAL
------------ ----------- ------------ ------------ -----------
Balance at December 31, 2000 16,900,000 $10,024,625 10,399,919 $ 52,351,867 $75,073,470
Accretion of mandatorily redeemable
preferred stock to redemption amount -- 62,867 -- 53,953 116,820
------------ ----------- ------------ ------------ -----------
Balance at December 31, 2001 16,900,000 10,087,492 10,399,919 52,405,820 75,190,290
Issuance of mandatorily redeemable
Series A redeemable preferred stock -- -- -- -- 5,000,000
Issuance of manditorily redeemable
Series B convertible preferred stock -- -- -- -- 7,343,365
Conversion of mandatorily redeemable
Series A convertible preferred
stock to Class A common stock (16,900,000) (10,087,492) -- -- (10,087,492)
Conversion of mandatorily redeemable
Series B preferred stock to Class A
common stock ) -- -- -- -- (12,696,978)
Conversion of mandatorily redeemable
Series C convertible preferred stock
to newly issued mandatorily
redeemable Series A preferred stock
and Class A common stock -- -- (10,399,919) (52,405,820) (52,405,820)
Issuance of mandatorily redeemable
preferred stock -- -- -- -- 581,918
Accretion of mandatorily redeemable
preferred stock to redemption amount -- -- -- -- 29,839
------------ ----------- ------------ ------------ -----------
Balance at December 31, 2002 $ -- -- $ -- -- $12,955,122
============ =========== ============ ============ ===========
SEE ACCOMPANYING NOTES.
(Table continues on following page)
37
ManagedStorage International, Inc.
Consolidated Statements of Changes in Shareholders' Deficit
Years ended December 31, 2002 and 2001
CLASS A COMMON STOCK COMMON STOCK
-----------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ----------
Balance at December 31, 2000 -- $ -- 22,639,311 $ 2,264
Exercise of stock options -- -- 94,010 9
Noncash stock option compensation -- -- -- --
Accretion of mandatorily redeemable preferred stock to
redemption amount and mandatorily redeemable preferred
stock dividends -- -- -- --
Net loss before amounts attributable to common shareholders -- -- -- --
Foreign currency translation adjustment -- -- -- --
----------- ---------- ----------- ----------
Balance at December 31, 2001 -- -- 22,733,321 2,273
Conversion of common stock to Class A common stock -- -- (22,733,321) (2,273)
Conversion of mandatorily redeemable Series A convertible
preferred stock to Class A common stock -- -- -- --
Conversion of mandatorily redeemable Series B preferred
stock to Class A common stock -- -- -- --
Conversion of mandatorily redeemable Series C convertible
preferred stock to newly issued mandatorily redeemable
Series A redeemable preferred stock and Class A common stock 43,334 4 -- --
Issuance of Class A common stock in exchange for note payable 108,333 11 -- --
Issuance of Class A common stock in exchange for note
payable--antidilutive provisions 43,334 4 -- --
Dividend to shareholders who overpaid for stock shares -- -- -- --
Exercise of stock options 9,512 1 -- --
Noncash stock option compensation -- -- -- --
Divestiture of ManagedStorage International France -- -- -- --
Accretion of mandatorily redeemable preferred stock to
redemption amount and mandatorily redeemable preferred
stock dividends -- -- -- --
Net loss before amounts attributable to common shareholders -- -- -- --
----------- ---------- ----------- ----------
Balance at December 31, 2002 204,513 $ 20 -- $ --
=========== ========== =========== ==========
ACCUMULATED
ADDITIONAL OTHER
PAID-IN COMPREHENSIVE ACCUMULATED
CAPITAL INCOME DEFICIT TOTAL
------------ ------------- ------------ ------------
Balance at December 31, 2000 $ 80 $ 9,710 $(26,393,073) $(26,381,019)
Exercise of stock options 93,741 -- -- 93,750
Noncash stock option compensation 205,837 -- -- 205,837
Accretion of mandatorily redeemable preferred stock to
redemption amount and mandatorily redeemable preferred
stock dividends -- -- (6,374,955) (6,374,955)
Net loss before amounts attributable to common shareholders -- -- (56,211,184) (56,211,184)
Foreign currency translation adjustment -- 384,198 -- 384,198
------------
Comprehensive loss (55,826,986)
------------ ---------- ------------ ------------
Balance at December 31, 2001 299,658 393,908 (88,979,212) (88,283,373)
Conversion of common stock to Class A common stock 2,273 -- -- --
Conversion of mandatorily redeemable Series A convertible
preferred stock to Class A common stock 10,087,492 -- -- 10,087,492
Conversion of mandatorily redeemable Series B preferred
stock to Class A common stock 12,696,978 -- -- 12,696,978
Conversion of mandatorily redeemable Series C convertible
preferred stock to newly issued mandatorily redeemable
Series A redeemable preferred stock and Class A common stock 47,405,621 -- -- 47,405,625
Issuance of Class A common stock in exchange for note payable 2,249,989 -- -- 2,250,000
Issuance of Class A common stock in exchange for note
payable--antidilutive provisions (199) -- -- (195)
Dividend to shareholders who overpaid for stock shares (52) -- -- (52)
Exercise of stock options 407 -- -- 408
Noncash stock option compensation (9,280) -- -- (9,280)
Divestiture of ManagedStorage International France -- (393,908) -- (393,908)
Accretion of mandatorily redeemable preferred stock to
redemption amount and mandatorily redeemable preferred
stock dividends 8,961,457 -- (611,757) 8,349,700
Net loss before amounts attributable to common shareholders -- -- (8,009,899) (8,009,899)
------------ ---------- ------------ ------------
Balance at December 31, 2002 $ 81,694,344 $ -- $(97,600,868) $(15,906,504)
============ ========== ============ ============
SEE ACCOMPANYING NOTES.
38
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. ORGANIZATION
ManagedStorage International, Inc. (the "Company") was incorporated on
March 7, 2000 as a data-storage service provider specializing in storage
design, implementation and operation services, and content management
services throughout the United States and Europe.
The Company had no business operations until March 29, 2000, when Storage
Technology Corporation ("StorageTek") contributed various assets,
contracts, and employees in exchange for common stock and mandatorily
redeemable Series B preferred stock. At formation, Great Hill Partners,
L.P. funded $10,000,000 in exchange for common stock and mandatorily
redeemable Series A preferred stock.
The Company has entered into two recapitalization and stock purchase
agreements with the Company's investors on August 9, 2000 and January 11,
2002. See Note 4 and Note 11 for further discussion on the equity
structure of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LIQUIDITY AND MANAGEMENT PLANS
The Company has incurred substantial operating losses and has a net
capital deficiency. Management of the Company intends to fund these
deficiencies by utilizing its existing cash and cash equivalents,
increasing cash flows from its business operations, and closing a fourth
round of financing in January 2003 as discussed in Note 17.
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
39
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
RESTRICTED CASH
The Company has restricted cash of $78,762 at December 31, 2002, which
represents a letter of credit, plus accrued interest to date, and
securing the corporate headquarter premises. The letter of credit was
entered into as additional security for an operating lease due to the
limited cash resources of the Company at the time the lease was signed.
The agreement requires a letter of credit in decreasing amounts through
the expiration of the lease. The letter of credit would be used to pay
rent on the corporate headquarters facility if the Company were unable to
make the monthly rent payments.
SHORT-TERM INVESTMENTS
Management determines the appropriate classification of debt securities
at the time of purchase and reevaluates such designation as of each
balance sheet date. Debt securities are classified as held-to-maturity
when the Company has the positive intent and ability to hold the
securities to maturity. Held-to-maturity securities are stated at
amortized cost, and adjusted for amortization of premiums and accretion
of discounts to maturity. Such amortization is included in investment
income in the consolidated statements of operations. Interest on
securities classified as held-to-maturity is included in investment
income in the consolidated statements of operations. At December 31,
2001, short-term investments consisted of certificates of deposits with
original maturities greater than three months but less than one year. All
such investments were classified as held-to-maturity, which are carried
at amortized cost, which approximates fair market value.
PROPERTY AND EQUIPMENT
Property and equipment, if acquired at the formation date, have been
recorded at the estimated fair market value at that time. Otherwise, all
other property and equipment has been recorded at cost. Property and
equipment are depreciated on a straight-line basis over their respective
estimated useful lives ranging from three to five years. Equipment
recorded under capital leases and leasehold improvements is amortized
using the straight-line method over the shorter of the respective lease
term or estimated useful life of the asset.
INTELLECTUAL PROPERTY
Intellectual property includes proprietary software licenses and rights
and is recorded at the fair market value at the date of purchase.
Amortization of intellectual property is recorded on a straight-line
basis over three years. As of December 31, 2001, the Companies
intellectual property was fully impaired as discussed in Note 7.
Amortization expense for the year ended December 31, 2001 was $1,075,407.
Accumulated amortization for the year ended December 31, 2001 was
$1,209,832.
40
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
("SFAS 144"), the Company reviews the carrying value of long-lived
assets, including property and equipment and intellectual property, to
determine whether there are any indications of impairment losses. If the
assets are considered to be impaired, the impairment recognized is
measured by the amount in which the carrying amount of the assets exceeds
the fair value of the assets. Recoverability of long-lived assets is
measured by a comparison of the carrying amount of an asset to future net
cash flows expected to be generated by the asset. See further discussion
in Note 7.
INCOME TAXES
The Company accounts for income taxes using the liability method under
which deferred tax assets and liabilities are determined based on
differences between financial reporting and tax basis of assets and
liabilities measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse.
REVENUE RECOGNITION
Revenue is recognized when all of the following criteria are met:
Persuasive evidence of an agreement exists, delivery has occurred or
services have been rendered, the sales price is fixed or determinable,
and collectibility is reasonably assured. Revenues from storage services
are recognized at the time the services are provided and are billed on a
monthly basis. System integration revenues are recognized using the
percentage of completion method by comparing costs of progress completed
during the period to total expected costs of the project. A current
liability for billings in excess of costs and recognized revenue is
recorded for billings sent to customers in which the Company has not yet
performed certain services or delivered goods per the billings.
Provisions for estimated losses on contracts are recorded when
identified.
ADVERTISING EXPENSES
All advertising and promotion costs are expensed as incurred. The
advertising expenses incurred were $590,979 and $540,603, for the years
ended December 31, 2002 and 2001, respectively.
PRODUCT DEVELOPMENT COSTS
Product development costs are expensed as incurred and include costs to
develop, manage and enhance the Company's proprietary technology.
41
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
STOCK-BASED COMPENSATION
The Company has elected to account for its stock-based compensation plans
utilizing the provisions of Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"). Under APB 25, no
compensation expense is typically recognized when the exercise price of
the Company's employee stock options is equal to or less than the market
price of the underlying stock on the date of the grant. SFAS No. 123,
ACCOUNTING AND DISCLOSURE OF STOCK-BASED COMPENSATION ("SFAS 123"),
establishes an alternative method of expense recognition for stock-based
compensation awards based on fair values.
SFAS No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION AND DISCLOSURE
requires the disclosure of pro forma net income (loss) as if the Company
had adopted the fair value method of accounting for stock-based awards
accounted for under the intrinsic method based on the guidance outlined
in SFAS 123.
The fair value for the Company's options was estimated at the date of
grant using the minimum value method available to nonpublic companies
under SFAS 123. Under this method, option value is determined as the
excess of the fair value of the stock at the date of grant over the
present value of both the exercise price (lump sum) and the expected
dividend payment (annuity), each discounted at the risk-free rate, over
the expected exercise life of the option for 2002 and 2001.
Option valuation models such as the minimum value method described above
require the input of highly subjective assumptions. Because the Company's
employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
Pro forma information related to fair value for these options was
determined at the date of grant using the minimum value method with the
following weighted-average assumptions:
DECEMBER 31,
2002 2001
Risk-free interest rate 4.3% 4.0%
Expected dividend yield 0.0% 0.0%
Expected lives 4 years 5 years
The weighted-average fair value of options granted during 2002 and 2001
was $0.00 and $0.18, respectively. For purposes of pro forma disclosures,
the estimated fair value of the options was amortized to expense over the
options vesting period. Our pro forma net loss applicable to common
shareholders and pro forma net loss applicable to common shareholders per
share, as if we had used the fair value accounting provisions of SFAS 123
would have been as follows:
42
YEAR ENDED DECEMBER 31,
2002 2001
Net loss before amounts attributable to
common shareholders $(8,009,899) $(56,211,184)
Expense calculated under SFAS 123 (579,612) (696,059)
Pro forma net loss before amounts
attributable to common shareholders $(8,589,511) $(56,907,243)
COMPREHENSIVE LOSS
There is no difference between consolidated net loss and comprehensive
loss for the year ending December 31, 2002 as there are no longer any
foreign currency translation adjustments subsequent to the divestiture of
ManagedStorage International France discussed in Note 3. For the year
ended December 31, 2001 the difference relates to the foreign currency
translation adjustments totaling $393,908. The financial statements of
the Company's foreign subsidiaries have been translated into U.S. dollars
at the average exchange rate during the year for the statements of
operations and cash flows and year-end rates for the balance sheets.
FINANCIAL INSTRUMENTS
Carrying amounts of financial instruments held by the Company, which
include cash equivalents, restricted cash, short-term investments,
accounts receivable, accounts payable, and accrued and other current
liabilities, approximate fair value due to their short duration.
CONCENTRATIONS OF CREDIT RISK
Services provided to three customers represent 92% and 72% of revenues
generated for the years ended December 31, 2002 and 2001, respectively.
Accounts receivable from these customers were $543,474 and $1,383,730 as
of December 31, 2002 and 2001, respectively. The Company records a
provision for doubtful accounts for all receivables not expected to be
collected and generally does not require collateral. The Company
evaluates the collectibility of their accounts receivable based on a
combination of factors.
In circumstances when they are aware of a specific customer's inability
to meet its financial obligations (e.g., bankruptcy filings), the Company
records a specific reserve for bad debts against amounts due. For all
other instances, the Company recognizes reserves based on historical
experience and review of the individual accounts outstanding.
3. DIVESTITURE OF MANAGEDSTORAGE INTERNATIONAL FRANCE
On July 31, 2002 the Company entered into a stock and asset purchase
agreement with Front Porch Digital, Inc. ("FPDI") to sell all of the
outstanding shares of capital stock of ManagedStorage International
France. The operations of ManagedStorage International France are
included in the 2002 consolidated statement of operations for the Company
through the date of disposition. Initial consideration was 5,000,000
shares of FPDI common stock, 1,750,000
43
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
warrants to purchase FPDI common stock at a price of $2.00 per share and
1,750,000 warrants to purchase FPDI common stock at a price of $4.00 per
share. The warrants are exercisable immediately and expire on July 31,
2012. The common stock has certain restrictions and the agreement has an
earn out provision. The earn out is based on certain criteria being met
as of December 31, 2002 and is payable in common stock of FPDI. As of
December 31, 2002, the earn out criteria had been fully met and the
Company received 100% of the earn out proceeds resulting in an additional
2,500,000 shares of common stock. The Company accounts for the investment
using the equity method. During 2002, the Company recorded equity losses
on the investment of $329,337, which are included in other (loss) income
in the consolidated statements of operations.
The operations of ManagedStorage International France through the
disposition date as part of the continuing operations of the Company in
accordance with the provisions of SFAS 144 and SEC requirements. The gain
on the sale is included in other (loss) income in the consolidated
statements of operations.
4. RECAPITALIZATION AND STOCK PURCHASE AGREEMENT
On January 11, 2002, the Company entered into a recapitalization and
stock purchase agreement with the Company's first-, second- and
third-round investors. The recapitalization resulted in the exchange of
all of the outstanding shares of the Company's common stock, mandatorily
redeemable Series A convertible preferred stock, and mandatorily
redeemable Series C convertible preferred stock for shares of the
Company's Class A common stock and mandatorily redeemable Series A
redeemable preferred stock.
It also resulted in the exchange of all of the mandatorily redeemable
Series B preferred stock for net proceeds of $7,343,365. In addition,
certain previously assigned real estate leases were assigned to and
assumed by StorageTek in exchange for shares of Class A common stock and
a convertible Subordinated Promissory Note (the "Note") in the amount of
$2,250,000 with a compounded annual rate of 6%. The Note was converted
during 2002 in exchange for 514,583 shares of Class A common stock. In
addition, 27,084 shares of Class A common stock were issued to existing
common stock holders in conjunction with an antidilution clause, which
went into effect upon conversion of the Note.
5. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company's cash equivalents and short-term investments consist of the
following:
DECEMBER 31,
2002 2001
------- --------
Cash equivalents:
Shares of money market mutual funds $29,824 $913,870
------- --------
Total cash equivalents 29,824 913,870
Short-term investments:
Certificate of deposit with banks -- 69,166
------- --------
Total short-term investments -- 69,166
------- --------
Total cash equivalents and
short-term investments $29,824 $983,036
======= ========
44
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following items:
DECEMBER 31,
2002 2001
----------- -----------
Storage equipment $ 1,763,128 $ 7,587,349
Storage software 1,896,667 1,361,789
Lab equipment and software 399,473 623,899
Furniture, fixtures, and office equipment 1,747,457 2,504,780
Leasehold improvements 1,792 54,357
----------- -----------
5,808,517 12,132,174
Less accumulated depreciation (3,729,253) (3,460,327)
----------- -----------
Property and equipment, net $ 2,079,264 $ 8,671,847
=========== ===========
Depreciation expense for the year ended December 31, 2002 and 2001 was
$2,561,966 and $9,329,879, respectively.
Included in the balances above is property and equipment under capital
lease with a cost of $1,218,299 and $6,486,812 and accumulated
depreciation of $988,370 and $1,656,984 at December 31, 2002 and 2001,
respectively.
7. ASSET IMPAIRMENT
During 2001, several events occurred that caused significant adverse
conditions in the data storage market. Such conditions forced several
companies (customers) to downsize their operations in order to survive.
Those events, along with the oversupply of data storage equipment in the
secondary market, caused the Company to evaluate the ongoing value of the
equipment and intellectual property associated with its current revenue
stream. Based on this evaluation, equipment with a carrying value of
$33,108,317 and intellectual property with a carrying value of $2,554,091
were impaired in the amount of $18,214,328 and $2,554,091, respectively.
The impairment has adjusted these assets to their estimated fair value
and is recorded to impairment loss in the consolidated statements of
operations. Fair value was determined from bids from third parties to
purchase the equipment, actual equipment sale transactions, and general
market information obtained from original equipment manufacturer
representatives. Fair value of the intellectual property was determined
to be $0 at December 31, 2001, as the Company is not longer pursuing the
sale of this technology. The Company evaluated the ongoing value of its
equipment and intellectual property and determined that no impairment
exists as of December 31, 2002.
45
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
8. ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consist of the following items:
DECEMBER 31,
2002 2001
---------- ----------
Wages, benefits and payroll taxes $ 415,696 $1,047,782
Restructuring expenses -- 401,709
Contract labor 15,000 234,091
Professional service fees 208,423 212,104
Equipment maintenance 113,382 184,370
Colocation fees 41,670 6,424
Other liabilities 339,149 1,213,679
---------- ----------
$1,133,320 $3,300,159
========== ==========
9. COMMITMENTS AND CONTINGENCIES
The Company has employment agreements with certain executives that
provide for up to one year of salary upon termination with the Company.
The Company leases facilities and equipment under noncancelable capital
and operating leases. Rental expense relating to operating leases was
$691,387 and $2,141,996 for the years ended December 31, 2002 and 2001,
respectively. Certain of the operating lease agreements have renewal
provisions, which range from month-to-month to 24-month terms. Future
minimum lease payments as of December 31, 2002 follows:
CAPITAL OPERATING
LEASES LEASES
-------- ----------
Year ending December 31,
2003 $484,350 $ 427,225
2004 58,417 347,615
2005 -- 156,483
2006 -- 156,493
2007 -- 119,111
-------- ----------
Total minimum lease payments 542,767 $1,206,927
==========
Less amounts representing interest (45,138)
--------
Present value of minimum lease payments 497,629
Less current portion (440,673)
--------
Capital lease obligations long term $ 56,956
========
10. DEBT FINANCING
During the period from July 2002 through December 2002, the Company
borrowed $5,950,000 from existing shareholders, which is included as
notes payable to investors in the consolidated balance sheets. The
borrowed funds, plus accrued interest, were converted to equity in
conjunction with a financing round completed January 2003, discussed in
Note 17.
46
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
11. MANDATORILY REDEEMABLE PREFERRED STOCK AND COMMON STOCK
Stock at December 31, 2002 consists of the following:
MANDATORILY REDEEMABLE PREFERRED STOCK
The Company had issued two classes of mandatorily redeemable preferred
stock: Series A redeemable preferred stock and Series B convertible
preferred stock as of December 31, 2002.
SERIES A REDEEMABLE PREFERRED STOCK
The Company has authorized and issued 50,000 shares as part of the
Recapitalization discussed in Note 4. The stock does not have voting
rights and the holders are not entitled to receive dividends on the
shares. However, on the fifth anniversary of the issuance of the stock, a
cumulative dividend of $10.00 (adjusted for subsequent stock dividends,
stock splits, combinations, recapitalizations or the like with respect to
such share) per share per year may be paid, if approved by the Board of
Directors. This cumulative dividend is subordinate to dividends paid on
the mandatorily redeemable Series B convertible preferred stock.
The Series A redeemable preferred stock is automatically redeemable upon
the earlier of (a) the date upon which the holders of the Series B
convertible preferred stock have received cash and/or equity securities
that can be immediately resold to the public or (b) the date following
the end of any period of 60 consecutive trading days, beginning after the
trading day which is 180 days following the closing of an initial public
offering. The Company may elect at its option to redeem in cash all of
the outstanding securities of the Series A redeemable preferred stock at
any time, with 15-day written notice, at the Series A redeemable
liquidation preference amount.
SERIES B CONVERTIBLE PREFERRED STOCK
The Company has authorized and issued 3,250,000 shares as part of the
Recapitalization discussed in Note 4. Each share of Series B convertible
preferred stock has voting privileges equal to the number of shares of
Class A common stock into which such share of Series B convertible
preferred stock is convertible pursuant to the conversion terms of the
agreement. The Series B convertible preferred stock pays a dividend of
$0.01846154 per share per year (adjusted for subsequent stock cumulative
dividends, stock splits, combinations, recapitalizations or the like with
respect to such share).
In a liquidating event, each holder of the Series B convertible preferred
stock shall be entitled to be paid in cash before any amount shall be
paid or distributed to holders of any class of series of stock ranking on
liquidation junior to the Series B convertible preferred stock an amount
per share equal to (a) $0.23076923 (Series B convertible preferred stock
original issue price) plus (b) an amount equal to all accumulated but
unpaid dividends on shares of Series B convertible preferred stock.
The Series B convertible preferred stock is optionally redeemable on or
at any time after the fifth anniversary of the Series B convertible
preferred stock closing date at which time the holders of
47
Series B convertible preferred stock majority interest may elect to have
all (but not less than all) of the outstanding shares of Series B
convertible preferred stock redeemed in cash at an amount equal to the
Series B convertible liquidation preference amount.
The holders of Series B convertible preferred stock may convert such
shares into Class A common stock at any time after the issuance of such
shares.
On or at any time after the fifth anniversary of the date of original
issuance of the Series B convertible preferred stock, the holder(s) of a
Series B convertible majority interest may elect to have all (but not
less than all) of the outstanding shares of
Series B convertible preferred stock redeemed. In such event, the Company
shall redeem all (but not less than all) of the outstanding shares of
Series B convertible preferred stock in cash, for an amount equal to the
aggregate Series B convertible redemption price ($2.4867 at December 31,
2002). Any election by a Series B convertible majority interest shall be
made by written notice to the Company and the other holders of Series B
convertible preferred stock at least 15 days prior to the elected
redemption date. Upon such election, all holders of Series B convertible
preferred stock shall be deemed to have elected to have their shares of
Series B convertible preferred stock redeemed and such election shall
bind all holders of Series B convertible preferred stock. The price for
each share of Series B convertible preferred stock redeemed shall be an
amount equal to the Series B convertible liquidation preference amount,
$2.4867 at December 31, 2002, (such amount to be adjusted appropriately
for stock splits, stock dividends, combinations, recapitalizations and
the like). The aggregate Series B convertible redemption price shall be
payable in cash in immediately available funds to the respective holders
of the Series B convertible preferred stock on the Series B convertible
redemption date.
The Series B convertible preferred stock may be converted, at any time,
upon written election of the holder without the payment of any additional
consideration into the fully paid and nonassessable shares of Class A
common stock which result from dividing the applicable series' conversion
value per share, as the numerator, by the applicable series' conversion
price per share, as the denominator. The initial conversion value and
conversion price per share for Series B convertible preferred stock is
$0.23076923 per share. Both the conversion value and conversion price are
subject to future adjustment. In addition, all Series B convertible
preferred stock are automatically convertible into the Company's Class A
common stock upon a qualified public offering raising at least $40
million in proceeds for the Company at a price per share of at least
$3.50.
At December 31, 2001, the Company had issued four classes of preferred
stock: Series A and Series B Preferred Stock and Series A and Series C
Convertible Preferred Stock ("Preferred Stock"). All classes are
considered to be mandatorily redeemable and have equal terms and rights
except as identified below.
The Company's outstanding Preferred Stock provides for cumulative
dividends payable in cash, or in securities of equivalent value if
converted to common stock, at the following rates compounded annually:
48
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
Series B Mandatorily Redeemable
Preferred Stock 8% per annum
Convertible Series A Preferred Stock $0.047337 per share per annum
Convertible Series C Preferred Stock $0.404465 per share per annum
At December 31, 2001, cumulative preferred dividends were Series B
mandatorily redeemable preferred stock of $1,851,544, Series A
Convertible Preferred Stock of $1,136,128, and Series C Convertible
Preferred Stock of $5,973,785.
The Series B Preferred Stock is redeemable on the occurrence of: a) an
initial public offering executed by the Company; b) at any time on or
after March 28, 2005, upon the majority vote of the holders of each
series of Preferred Stock; or c) upon the majority vote of the holders of
each series of Preferred Stock, after the occurrence of an extraordinary
transaction as defined in the agreement. In addition, the Company may
elect at any time to redeem all or a portion of the outstanding shares
with 30 days' prior written notice to the holders. The redemption price
is fixed at the liquidation preference amount. The holders of Series B
Preferred Stock do not have voting privileges.
The Series B Preferred Stock was redeemed on January 11, 2002 for
$7,500,000 net of stock issuance costs of $156,635, as discussed in Note
4.
The Company's Series A and Series C Convertible Preferred Stock were both
entitled to the number of votes equal to the largest number of full
shares of common stock into which such shares could be converted,
pursuant to the conversion terms of each series. Both series may be
redeemed any time on or after March 28, 2005 upon the majority vote of
the holders of each series provided that the Series A Convertible
Preferred Stock cannot be redeemed until all shares of Series C
Convertible Preferred Stock for which redemption has been requested have
been redeemed. In addition, both series may be redeemed upon an
extraordinary transaction as defined in the agreement. The redemption
price is defined as the higher of the liquidation amount ($0.609094 per
share plus accrued dividends and interest for Series A and $5.055809 per
share plus accrued dividends and interest for Series C) or conversion
amount, with the conversion amount being based on the number of shares
each series is convertible into pursuant to the conversion terms of each
series. This conversion amount is then multiplied by the value per share
of the Company's common stock based on the 30-day period ending three
business days prior to the closing of the extraordinary transaction based
on the common stock's closing price, if the Company's common stock is
traded on either a nationally recognized securities exchange,
inter-dealer quotation system or traded over-the-counter; or, if there is
no active public market, based on the fair market value determined by the
Company and majority interests of the Series A and Series C Convertible
Preferred Stock. If a mutual market value cannot be established by these
parties, an independent appraisal will be used by a mutually agreed upon
investment banker.
The Series A and Series C Convertible Preferred Stock may be converted,
at any time, upon written election of the holder without the payment of
any additional consideration into the fully paid and nonassessable shares
of common stock (including any resulting fractional shares) which result
from dividing the applicable series' conversion value per share, as the
numerator, by the applicable series' conversion price per share, as the
denominator. The initial conversion value
49
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
and conversion price per share for Series A Convertible Preferred Stock
and Series C Convertible Preferred Stock is $0.591716 per share and
$5.055809 per share, respectively. Both the conversion value and
conversion price are subject to future adjustment. In addition, all
Series A and Series C Convertible Preferred Stock are automatically
convertible into the Company's common stock upon a qualified public
offering raising at least $40 million in proceeds for the Company at a
price per share of at least $12.64 on or before August 9, 2002 or $15.17
after August 9, 2002.
On January 11, 2002, the Series A Convertible Preferred Stock was
converted into shares of Class A common stock and the Series C
Convertible Preferred Stock were converted into shares of Class A common
stock and mandatorily redeemable Series A Preferred Stock as part of the
Recapitalization discussed in Note 4.
COMMON STOCK AND CLASS A COMMON STOCK
In August 2002, the Company approved a 1-for-10 reverse stock split of
its Class A common stock and Series B redeemable convertible preferred
stock. All amounts in the accompanying consolidated financial statements
and related footnotes reflect this stock split.
The Company authorized 500,000,000 shares of Class A common stock of
which 1,022,563 shares were outstanding at December 31, 2002.
The Company has reserved 650,000 shares of Class A common stock in
conjunction with the Employee Stock Option Plan, 3,250,000 shares of
Class A common stock for conversion of the Series B convertible preferred
stock and 24,306,140 shares of Class A common stock for issuance as an
earn out in the DataVault business acquisition.
12. EMPLOYEE STOCK OPTION PLAN
On March 27, 2000, the Company established the ManagedStorage
International, Inc. 2000 Stock Option and Grant Plan (the "Option Plan"),
which was amended on August 9, 2000, October 5, 2000, and January 11,
2002. The maximum number of shares of Class A common stock and common
stock, respectively, available for issuance to eligible employees,
consultants and directors of the Company under the Option Plan is 650,000
and 1,387,500, at December 31, 2002 and 2001, respectively. Options to
purchase the Company's Class A common stock are exercisable at a price as
determined by the Board of Directors at the time the option is granted.
Under the terms of the Option Plan, the exercise prices for incentive
stock options granted shall not be less than 100% of the fair market
value of the Class A common stock or common stock of the Company at the
date of grant, or if a participant owns more than 10% of the Company, the
option price may not be less than 110% of the fair market value of the
Class A common stock or common stock. No incentive stock options may be
exercised more than 10 years from the date of grant, or when an employee
owns more than 10% of the Company, and incentive stock options may not be
exercised more than five years from the date of grant.
The Option Plan is administered by the Board of Directors, which has the
authority to select the individuals to whom awards will be granted and to
determine whether and to what extent stock
50
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
options are to be granted, the number of shares of Class A common stock
and common stock to be covered by each award, the vesting schedule of
stock options, and all other terms and
Notes to Consolidated Financial Statements
conditions of each award. Options, which were granted during 2002, vest
over a four-year period, 25% per year, commencing on the one-year
anniversary of the grant. Unless terminated or otherwise canceled under
the Option Plan provisions, the contractual life of all options is no
greater than 10 years.
Options which were granted during 2001 and 2000 vest over a four-year
period, 25% commencing on the one-year anniversary date of the grant and
6.25% each three-month period thereafter. Unless terminated or otherwise
canceled under the Option Plan provisions, the contractual life of all
options is no greater than 10 years.
A summary of all activity in the Option Plan is as follows:
WEIGHTED-
AVERAGE
NUMBER EXERCISE
OF OPTIONS PRICE
-----------------------
Balance, December 31, 2000 5,699,750 1.39
Granted 2,401,400 1.00
Exercised (94,010) (1.00)
Forfeited (3,738,566) (1.34)
-----------------------
Balance, December 31, 2001 4,268,574 1.22
-----------------------
Granted 82,520 .01
Exercised (13,614) (.01)
Forfeited (1,592,540) 1.14
-----------------------
Balance, December 31, 2002 2,744,940 1.24
=======================
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
-------------------------------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE SHARES AVERAGE
EXERCISE SHARES UNDER REMAINING EXERCISE CURRENTLY EXERCISE
PRICE OPTION CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- --------------------------------------------------------------------------------
$0.01 32,568 9.31 $0.01 9,524 $ .01
$1.00 2,017,810 8.27 $1.00 755,595 $1.00
$2.00 694,562 7.79 $2.00 276,719 $2.00
------------------------------------------- -----------------------
2,744,940 8.16 $1.24 1,041,838 $1.26
=========================================== =======================
In 2002, the Company issued restricted stock grants, which are restricted
in terms of their disposal and vesting. Vesting of restricted stock
awards is determined by the Board for each specific grant. On April 24,
2002 and March 27, 2000, the Company sold 538,578 (53,857 shares
51
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
adjusted for the 1-for-10 reverse split) and 5,625,000, respectively,
restricted shares under the Option Plan to members of management. In
2002, the shares vest over a four-year period, 25% per year, commencing
on the one-year anniversary of the grant. In 2000, upon distribution of
the shares, 10% of the shares were immediately vested. The unvested
shares will vest at a rate of 20% per year on each anniversary date from
the grant date; or if there is an initial public offering of the Company,
the remaining shares will vest at a rate of 33.33% per year on each
anniversary date following the grant date.
13. EMPLOYEE CONTRIBUTION PLAN
The Company sponsors a 401(k) Savings Plan (the "Plan"). The Plan is a
defined contribution plan for all regular employees of the Company who
have attained at least 18 years of age. Employees who meet these
requirements may become a participant in the Plan on the first day of the
following month after meeting the eligibility requirements.
Participants may elect to make contributions ranging from 1%-20% of their
eligible compensation, subject to limitations based on provisions of the
tax law. The Company may make a discretionary pretax matching
contribution. The amount would be equal to a percentage determined
annually by a Board of Directors' resolution. To date, no matching
contributions have been made.
Employee contributions are 100% vested. Company contributions, when made,
will be subject to the following vesting schedule: Up to one year of
service, 40% vested; two years of service, 80% vested; three or more
years of service, 100% vested.
14. RELATED PARTY TRANSACTIONS
The Company acquired equipment and equipment maintenance services with
two shareholders in the amount of $3,566,460 and $18,200,989 for the
years ended December 31, 2002 and 2001, respectively. Of this amount,
$834,652 and $13,892,031 was acquired through leases with these related
parties for the years ended December 31, 2002 and 2001, respectively.
In 2001, a shareholder provided a $5,000,000 guarantee on one of the
Company's lease agreements for equipment and software. In 2002, that
guarantee was removed. The outstanding debt balance on the guaranteed
lease is $0 and $2,432,218 as of December 31, 2002 and 2001,
respectively.
The Company incurred $101,375 and $124,003 for the use of a shareholder's
private aircraft for the years ended December 31, 2002 and 2001,
respectively.
The Company paid salaries, consulting fees and other reimbursable
expenses to various shareholders in the amount of $1,336,213 and $751,604
for the years ended December 31, 2002 and 2001, respectively.
52
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
15. INCOME TAXES
As of December 31, 2002, the Company had federal and state net operating
loss carryforwards of $48,938,850. The net operating loss carryforwards
will expire at various dates through 2021 if not utilized.
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes consist of the following:
DECEMBER 31,
2002 2001
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 19,148,548 $ 21,170,362
Allowance for doubtful accounts 72,391 11,190
Start up costs 1,240,398 --
Accrued liabilities 88,249 184,459
Charitable contributions 978 978
Accumulated depreciation 469,445 8,709,753
Noncash compensation 7,264 --
Suspended capital loss 5,259,303 --
Accrued payroll 5,987 --
Notes receivable reserve 12,130 --
Basis in Front Porch Digital, Inc. shares 402,779 --
Billings in excess of costs and
recognized revenue 76,948 72,187
------------ ------------
Deferred tax assets 26,784,420 30,148,929
Valuation allowance (26,784,420) (30,148,929)
------------ ------------
Net deferred tax assets (liabilities) $ -- $ --
============ ============
The Company had no deferred tax liabilities as of December 31, 2002 and
2001.
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the
realization of the deferred tax assets such that a full valuation
allowance has been recorded. The Company will continue to assess the
realization of the deferred tax assets based on actual and forecasted
operating results.
The following table reconciles the amount, which would be provided by
applying the 35% federal statutory rate to income (loss) before income
tax expense (benefit) to federal income taxes actually provided for the
years ended December 31, 2002 and 2001:
53
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
DECEMBER 31,
2002 2001
------------ ------------
Income taxes at federal statutory rate
of 35% $ (2,803,465) $(21,912,283)
Effect of permanent differences (6,091,194) 2,558,870
State income taxes, net of federal benefit (992,449) (1,975,643)
Effect of foreign operations, other (9,206) 2,600,531
Benefit of tax losses not recognized 9,896,314 18,728,525
------------ ------------
$ -- $ --
============ ============
16. RESTRUCTURING CHARGES
During 2002, certain previously assigned real estate leases were assigned
to and assumed by StorageTek in exchange for shares of Class A common
stock and a Note in the amount of $2,250,000 with a compounded annual
rate of 6%. The Note was converted during 2002 in exchange for 514,583
shares of Class A common stock. In addition, 27,084 shares of Class A
common stock were issued to existing common stock holders in conjunction
with an antidilution clause, which went into effect upon conversion of
the Note. The Company recorded rent expense of $75,000 for the months it
would occupy the real estate that StorageTek had assumed the leases on.
In addition, the Company reversed $14,350 of reserves from a prior year
for a net restructuring expense of $2,160,650.
During 2001, as a result of significant adverse market conditions, along
with the rapid consumption of cash, the Company announced plans to
eliminate numerous positions. As a result, approximately 135 employees
jobs were terminated. The terminations were dispersed throughout the
Company and included positions in sales, operations, finance, human
resources, marketing, and technical areas. The termination benefits of
$2,114,160 were paid in cash and were charged to restructuring expenses
in the consolidated statements of operations.
In addition, during 2001 the Company incurred other related restructuring
expenses primarily for contract termination fees and related legal costs.
17. SUBSEQUENT EVENTS
ASSET ACQUISITION
On October 16, 2002 the Company entered into an asset purchase agreement.
The agreement was to purchase certain assets for $1,000,000 in cash and
$2,000,000 in escrowed funds to be released over a 120-day period,
provided certain conditions in the contract are met. The agreement has an
earn out provision payable in cash and stock, provided certain conditions
are met. The transaction closed January 10, 2003.
JANUARY 2003 FUNDING--SERIES C REDEEMABLE PREFERRED STOCK AND
CLASS A COMMON STOCK
In January 2003 and May 2003, the Company entered into a securities
purchase agreement with certain existing investors and new investors.
Pursuant to this agreement, the Company issued 22,103 shares of Series C
redeemable preferred stock and 53,726,228 shares of Class A common stock.
In connection with this securities sale, the Company also issued warrants
for the purchase
54
MANAGEDSTORAGE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
of 270 shares of Series C redeemable preferred stock and 656,267 shares
of Class A common stock. The Company has reserved 2,000 shares of Series
C redeemable preferred stock and 4,861,228 shares of Class A common stock
for issuance as an earn-out in the DataVault business acquisition.
The Series C redeemable preferred stock is nonvoting, has a par value of
$.01 per share, accrues a dividend of $100.00 per share per annum, has a
$1,000.00 per share liquidation preference, and is redeemable January 9,
2008. The purchase price of the Series C redeemable preferred stock was
$1,000.00 per share. The net proceeds from the transaction were
$21,239,962.
REVERSE STOCK SPLIT
In February 2003, the Company approved a 1-for-5 reverse stock split of
its Class A common stock and Series B convertible preferred stock. This
split has been reflected in the consolidated balance sheets and
consolidated statements of changes in shareholders' deficit on a
retroactive basis.
LITIGATION SETTLEMENT
In September 2003, the Company settled an outstanding lawsuit with
Sanrise for $156,667 in cash and 332,833 shares of Series C redeemable
preferred stock. In the settlement, Sanrise relinquished any and all
right to further payment in connection with the Sanrise asset acquisition
of the DataVault business. In conjunction with the settlement, the
Company released all remaining escrow payments.
POTENTIAL LITIGATION
In September 2003, the Company was served with a lawsuit from a
bankruptcy estate that believes it has a preference claim as to all or a
part of $730,000 paid by the bankrupt company to the Company pursuant to
a settlement agreement for services provided. The Company denies there
are any amounts subject to being reclaimed as a preferential payment and
will aggressively oppose this claim.
LEASE LINE OF CREDIT
On November 20, 2003 the Company entered into a lease line of credit
agreement for $1,500,000 with a third-party lender. The term of the
agreement is for term leases ranging from 12 to 24 months. The Company
drew $654,853 on the line in November 2003. The interest rate on the line
ranges from 10.514% to 10.731%.
55
ITEM 9 (a) 3 UNAUDITED FINANCIAL STATEMENTS AS OF JUNE 30, 2004
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
Assets JUNE 30, 2004
Current assets:
Cash and cash equivalents $ 3,053,230
Accounts receivable, net of allowance for doubtful accounts of $317,776 1,533,595
Other current assets 698,246
-------------
Total current assets 5,285,071
-------------
Property and equipment, net 3,491,444
Restricted cash 79,727
Intangible assets, net 1,195,911
Investment in Front Porch Digital, Inc. and related goodwill 644,101
Other assets 124,082
-------------
Total assets $ 10,820,336
=============
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 987,968
Accrued and other current liabilities 1,073,814
Capital leases payable, net of discount of $14,009 1,040,861
Deferred revenue, current portion 546,794
-------------
Total current liabilities 3,649,437
Capital leases, less current portion 36,011
Deferred revenue 232,175
Other long term liabilities 40,269
Series C redeemable preferred stock (liquidation preference of $25,356,150)
Authorized - 24,500 shares; Issued and outstanding - 22,104 shares 20,662,052
-------------
Total liabilities 24,619,944
-------------
Mandatorily redeemable preferred stock
Series A redeemable preferred stock (liquidation preference of $5,000,000)
Authorized, issued and outstanding - 50,000 shares 5,000,000
Series B convertible preferred stock (liquidation preference of $8,979,452)
Authorized, issued and outstanding - 650,000 shares 8,900,211
-------------
Commitments and contingencies 13,900,211
-------------
Shareholders' equity(deficit)
Class A common stock, par value $.0001 per share
Authorized - 100,000,000 shares; Issued and outstanding - 62,934,623 shares 6,293
Additional paid-in capital 84,796,613
Warrants 181,223
Deferred Compensation (262,271)
Accumulated deficit (112,421,677)
-------------
Total shareholders' equity(deficit) (27,699,819)
-------------
Total liabilities, mandatorily redeemable preferred stock, and shareholders' equity(deficit) $ 10,820,336
=============
See accompanying notes to unaudited consolidated financial statements.
56
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
2004 2003
----------- -----------
Revenues:
Storage revenues $ 4,261,827 $ 5,182,949
----------- -----------
Total revenues 4,261,827 5,182,949
----------- -----------
Costs and expenses:
Cost of storage revenues 2,549,699 4,230,645
Sales and marketing expenses 1,003,681 1,583,351
General and administrative expenses 3,655,081 3,911,071
Impairment of goodwill related to equity method investment 198,280 182,499
----------- -----------
Total costs and expenses 7,406,741 9,907,566
----------- -----------
Loss from operations (3,144,914) (4,724,617)
Other income (expense):
Interest income 5,818 16,459
Interest expense (1,391,219) (925,743)
Other investment income 77,647 81,735
Gain from early extinguishment of debt -- 20,826
Share of losses of Front Porch Digital, Inc., an equity-method investee -- (636,185)
Other income 11,474 26,940
----------- -----------
Total other income (expense) (1,296,281) (1,415,969)
----------- -----------
Net loss before amounts attributable to common shareholders (4,441,195) (6,140,586)
----------- -----------
Amounts allocable to common shareholders:
Dividends on mandatorily redeemable preferred stock (297,534) (1,345,203)
Accretion of mandatorily redeemable preferred stock to redemption amount (15,666) (80,013)
----------- -----------
Total amounts allocable to common shareholders (313,200) (1,425,216)
----------- -----------
Net loss allocable to common shareholders $(4,754,395) $(7,565,802)
=========== ===========
Net loss allocable to common shareholders per weighted average common
share outstanding - basic and diluted $ (0.08) $ (0.13)
Weighted average common shares outstanding - basic and diluted 62,847,216 59,301,212
See accompanying notes to unaudited consolidated financial statements.
57
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
2004 2003
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,441,195) $ (6,140,586)
Adjustments to reconcile net loss to net cash used in operating activities: --
Depreciation 1,068,824 1,202,093
Amortization of intangibles assets 474,952 453,898
Amortization of noncash loan discount 7,643 --
Stock-based compensation 88,618 217,265
Interest expense paid with common stock -- 877,500
Noncash interest expense on Series C mandatorily redeemable preferred stock 1,335,650 --
Noncash interest expense on converted notes -- 14,191
Loss on disposal of assets 9,541 26,897
Gain from early extinguishment of debt -- (20,826)
Share of losses of Front Porch Digital, Inc. and related impairment of goodwill 198,280 818,685
Bad debt expense 126,924 32,234
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts and other receivables (277,073) (1,884,039)
Other current assets (5,374) (1,012,960)
Other assets (8,218) (127,553)
Accounts payable 330,023 95,978
Accrued liabilities (956) 317,886
Deferred revenue (463,093) 734,836
Other liabilities (6,932) (7,563)
----------- ------------
Net cash used in operating activities (1,562,386) (4,402,064)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (750,750) (2,374,613)
Capitalized software development costs (353,729) (158,104)
Proceeds from sale of property and equipment 134,758 68,682
Purchase of intangible assets -- (2,349,714)
Net change in restricted cash (317) (45,272)
Issuance of note receivable from Front Porch Digital -- (250,000)
Maturity of short-term investments 3,793,099 --
----------- ------------
Net cash provided by (used in) investing activities 2,823,061 (5,109,021)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital leases (410,055) (248,311)
Cash proceeds from issuance of redeemable preferred stock -- 12,858,817
Proceeds from issuance of common stock -- 3,214,704
Redeemable preferred stock and Class A common stock offering costs -- (782,641)
Proceeds from exercise of stock options and purchase of restricted stock 1,418 637
----------- ------------
Net cash provided by financing activities (408,637) 15,043,205
Net increase in cash and cash equivalents 852,038 5,532,121
----------- ------------
Cash and cash equivalents at beginning of period 2,201,192 80,484
----------- ------------
Cash and cash equivalents at end of period $ 3,053,230 $ 5,612,605
=========== ============
Supplemental disclosures of cash flow information
Cash paid during the period for interest $ 40,051 $ 34,285
Supplemental disclosures of noncash financing activities
Capital lease obligations incurred in connection
with the purchase of property and equipment $ 815,654 $ --
Purchases of property and equipment included in accounts payable $ 329,566 $ 205,492
See accompanying notes to unaudited consolidated financial statements.
58
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
NOTES TO UNAUDITED FINANCIAL STATEMENTS AS OF JUNE 30, 2004
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the six-month period
ended June 30, 2004 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004.
At June 30, 2004, the consolidated entity consists of ManagedStorage
International, Inc., and its wholly owned subsidiaries, Seabrook Technologies,
Inc. and MSI United Kingdom, Inc.. At June 30, 2003, the consolidated entity
consists of ManagedStorage International, Inc. and its wholly-owned
subsidiaries, ManagedStorage International Canada, Inc. and Seabrook
Technologies, Inc.
On August 18, 2004 (the "Acquisition Date"), Front Porch Digital, Inc. acquired
all of the outstanding capital stock of MSI, a Delaware corporation. The
transaction was structured as a reorganization of MSI with and into Front Porch
Merger Corp., a Delaware corporation, a newly-formed, wholly-owned subsidiary of
Front Porch Digital. The Acquisition of MSI by Front Porch Digital, Inc. has
been accounted for as a reverse merger because on a post-merger basis, the
former MSI shareholders hold a majority of the outstanding common stock of Front
Porch Digital, Inc. on a voting and diluted basis. As a result, MSI is deemed to
be the acquirer for accounting purposes. The Acquisition has also been accounted
for as a step acquisition since it occurred in multiple steps over the period
from July 31, 2002, when MSI sold its French subsidiary to Front Porch Digital,
Inc.. After the Acquisition, the former MSI shareholders owned approximately 64%
of the common stock of Front Porch Digital, Inc..
The aggregate market price paid for the capital stock of MSI was approximately
$34.4 million. Such amount was paid through the issuance to the former MSI
stockholders of 47,454,985 restricted shares of common stock and 2,466,971
restricted shares of the newly-designated, voting and non-interest bearing
Series A Redeemable Preferred Stock, $.001 par value per share (the "Series A
Preferred"), of the Company. The Series A Preferred shares are convertible into
shares of common stock on a twenty-for-one basis. In connection with the
Acquisition, Front Porch Digital, Inc. canceled 13,452,381 shares of outstanding
common stock and warrants to purchase 3.5 million shares of common stock that
were held by MSI prior to the Acquisition Date. MSI canceled $0.2 million in
receivables owed to it from Front Porch Digital, Inc.. Front Porch Digital, Inc.
also assumed outstanding warrants of MSI to purchase 202,740 shares of
restricted common stock at a price per share of $.0003 and outstanding warrants
of MSI to purchase 33,029 shares of Series A Preferred at a price per share of
$10.35.
In connection with the Acquisition, each outstanding share of MSI's Series A
Redeemable Preferred Stock was converted into 200 shares of common stock of
Front Porch Digital, Inc., each outstanding share of MSI's Series B Convertible
Preferred Stock was converted into 27.789 shares of common stock of Front Porch
Digital, Inc., each outstanding share of MSI's Series C Redeemable Preferred
Stock was converted into 111.6042 shares of Series A Preferred and each
outstanding share of MSI common stock was converted into 0.3089 shares of common
stock of Front Porch Digital, Inc.. In addition, Front Porch
59
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
Digital, Inc. assumed all options outstanding under MSI's stock option plan and
each outstanding option to purchase MSI Common Stock was converted into an
option to purchase unregistered common stock of Front Porch Digital, Inc.,
subject to certain adjustments to the exercise price and the number of shares
issuable upon exercise of such options to reflect the exchange ratios in the
Acquisition.
The holders of Series A Preferred and certain other former MSI stockholders
executed a lock-up agreement pursuant to which such stockholders agreed not to
transfer their unregistered shares of Front Porch Digital, Inc.'s common stock
for a period of 18 months (with limited exceptions). Concurrent with the
consummation of the Acquisition, Front Porch Digital, Inc. entered into a
Registration Rights Agreement (the "Registration Rights Agreement") with the
holders of the Series A Preferred. Under the terms of such agreement, at any
time after February 16, 2006, the holders of at least 51% of the Series A
Preferred have the right to cause Front Porch Digital, Inc. to register, under
the Securities Act of 1933, the shares of common stock and Series A Preferred
(including the common stock underlying the Series A Preferred) issued to such
holders in the Acquisition. In addition, such holders have `piggy-back' and Form
S-3 registration rights.
NOTE B - USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The Company
has recorded transactions that include the issuance of options and warrants to
purchase shares of the Company's preferred and common stock. The accounting of
such securities is based upon fair values of the Company's equity securities and
other valuation criteria that were determined by management and the board of
directors. The Company believes these estimates of fair value are reasonable.
Other significant estimates made by management include those related to fair
values of acquired intellectual property, and establishment of reserves for
estimates of uncollectible accounts receivable.
NOTE C - RISKS AND UNCERTAINTIES
The Company is subject to various risks and uncertainties frequently encountered
by companies in the early stages of development, particularly companies in the
rapidly evolving market for technology-based products and services. Such risks
and uncertainties include, but are not limited to, its limited operating
history, need for additional capital, a volatile business and technological
environment, an evolving business model, and the management of expected growth.
To address these risks, the Company must, among other things, gain access to
capital in amounts and on terms acceptable to it, maintain and increase its
customer base, implement and successfully execute its business strategy,
continue to enhance its technology, provide superior customer service, and
attract, retain, and motivate qualified personnel. There can be no guarantee
that the Company will be successful in addressing such risks.
The Company has incurred substantial operating losses and has a net capital
deficiency. Management of the Company intends to fund these deficiencies by
utilizing its existing cash and cash equivalents, and increasing cash flows from
its business operations. Realization of the Company's investment in property and
equipment and other long-lived assets is dependent upon achieving positive
operating cash flows. If
60
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
the Company does not achieve and maintain such positive operating cash flows,
its long-lived assets could be considered impaired resulting in a significant
charge against earnings.
The Company's 2004 operating plan and execution thereof is focused on increasing
revenue, controlling costs, and conserving cash, however, there is no guarantee
that the Company will be able to meet the operational and financial requirements
of its operating plan. The Company cannot predict with certainty the expected
revenue, gross profit margin, net loss, and/or usage of cash and cash
equivalents. However, the Company's management believes that the Company's cash
and cash equivalents and working capital including those resulting from the
transaction with FPDI provide adequate capital resources to fund its operations,
2004 debt repayments, and working capital needs at least through June 2005.
NOTE D - STOCK-BASED COMPENSATION
The Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations including FASB Interpretation No. 44 (FIN
44), Accounting for Certain Transactions Involving Stock Compensation, an
Interpretation of APB Opinion No. 25, to account for its fixed-plan stock
options. Under this method, compensation expense is generally recorded on the
date of grant only if the current market price of the underlying stock exceeds
the exercise price. FASB Statement No. 123, Accounting for Stock-Based
Compensation and FASB Statement No. 148, Accounting for Stock-Based Compensation
- - Transition and Disclosure, an amendment of FASB Statement No. 123, established
accounting and disclosure requirements using a fair-value-based method of
accounting for stock-based employee compensation plans. As permitted by existing
accounting standards, the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of Statement 123, as amended. The following table
illustrates the effect on net loss if the fair-value-based method had been
applied to all outstanding and unvested awards in each period.
SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Net loss before amounts attributable to common
shareholders as reported ($4,441,195) ($6,140,586)
Add stock-based employee compensation expense
included in reported net loss, net of tax $ 88,618 $ 217,265
Deduct total stock-based employee compensation
expense determined under fair-value-based
method for all awards ($ 93,735) ($ 225,294)
----------- -----------
Pro forma net loss ($4,446,312) ($6,148,615)
=========== ===========
Net loss per weighted average common share
outstanding - basic and diluted - pro forma
and actual $ (0.08) $ (0.13)
61
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
Pro forma information related to fair value for options granted during the six
months ended June 30, 2004 and 2003 was determined at the date of grant using
the minimum volatility method and the following weighted average assumptions:
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Risk-free interest rate 4.76% 3.89%
Expected dividend yield 0.00% 0.00%
Expected lives 10 years 10 years
Volatility 0.001% 0.001%
The weighted average fair value of options granted $ 0.09 $ 0.09
======= =======
Option valuation models such as the minimum value method described above require
the input of highly subjective assumptions. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
NOTE E - LOSS PER COMMON SHARE
The Company's basic net loss per share is computed by dividing net loss by the
weighted average number of outstanding common shares as follows:
SIX MONTHS ENDED JUNE 30,
2004 2003
------------ ------------
Numerator
Net loss allocable to common shareholders $ (4,754,395) $ (7,565,802)
Denominator
Weighted average shares 62,847,216 59,301,212
Net loss per common share $ (0.08) $ (0.13)
62
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
NOTE F - INTANGIBLE ASSETS
Intangible assets consist of the following items:
JUNE 30,
------------------------------
2004 2003
----------- -----------
Acquired customer base $ 2,349,714 $ 2,349,714
Customer referral fees 250,000 250,000
----------- -----------
2,599,714 2,599,714
Less accumulated amortization (1,403,802) (453,897)
----------- -----------
$ 1,195,911 $ 2,145,816
=========== ===========
Amortization expense for the periods ended June 30, 2004 and 2003 was $474,952
and $453,898, respectively. Future amortization expense is as follows:
Remainder of 2004 $ 391,619
Year ending December 31, 2005 783,238
Year ending December 31, 2006 21,054
----------
$1,195,911
==========
NOTE G - INVESTMENT IN FRONT PORCH DIGITAL, INC. AND RELATED GOODWILL
During the six months ended June 30, 2004, the Company converted a $250,000 note
receivable from Front Porch Digital into additional equity holdings. Based
primarily on Front Porch Digital's continuing losses, the Company has recorded
its share of losses of $636,185 for the six months ended June 30, 2003, as well
as recorded impairment of the related goodwill of $198,280 and $182,499 for the
periods ended June 30, 2004 and 2003, respectively.
NOTE H - NOTE CONVERSION
On April 1, 2004, the note receivable in the amount of $250,000 from Front Porch
Digital was converted to 5,952,381 shares of Front Porch Digital common stock.
This note bore interest at 8%, and was due on September 15, 2004. Following such
conversion, the Company owned 13,452,381 shares, or 23% of Front Porch Digital.
NOTE I - SUBSEQUENT EVENT
In August 2004, the Company was notified by a liquidating trust formed in the
Cable & Wireless bankruptcy proceedings stating that preferential payments
totaling $218,782 were made by Cable & Wireless to the Company. The trust is
requesting payment of $196,904 in settlement of such alleged preferential
payments. The Company denies any liability exists for the alleged preferential
payments and will aggressively oppose the claim.
63
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
NOTE J - RECENTLY ISSUED OR PROPOSED ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the FASB issued a revised Statement Number 123,
"Share-Based Payment", which addresses the accounting for share-based payment
transactions. The revised Statement eliminates the ability to account for
share-based compensation transactions using APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and generally requires instead that such
transactions be accounted for and recognized in income based on their fair
value. The revised standard is effective for public companies for fiscal periods
beginning after June 15, 2005. The revised standard offers the Company
alternative methods of adopting this final rule. At the present time, the
Company has not yet determined which alternative method it will use and the
expected impact on operating results.
64
ITEM 9.01 (b) UNAUDITED PRO FORMA FINANCIAL INFORMATION
On August 18, 2004 (the "Acquisition Date"), Front Porch Digital, Inc. acquired
all of the outstanding capital stock of MSI, a Delaware corporation. The
transaction was structured as a reorganization of MSI with and into Front Porch
Merger Corp., a Delaware corporation, a newly-formed, wholly-owned subsidiary of
Front Porch Digital. The Acquisition of MSI by Front Porch Digital, Inc. has
been accounting for as a reverse merger because on a post-merger basis, the
former MSI shareholder hold a majority of the outstanding common stock of Front
Porch Digital, Inc. on a voting and diluted basis. As a result, MSI is deemed to
be the acquirer for accounting purposes. The Acquisition has also been accounted
for as a step acquisition since it occurred in multiple steps over the period
from July 31, 2002, when MSI sold its French subsidiary to Front Porch Digital,
Inc. After the Acquisition, the former MSI shareholders owned approximately 64%
of the common stock of Front Porch Digital, Inc.
The aggregate market price paid for the capital stock of MSI was approximately
$34.4 million. Such amount was paid through the issuance to the former MSI
stockholders of 47,454,985 restricted shares of common stock and 2,466,971
restricted shares of the newly-designated, voting and non-interest bearing
Series A Redeemable Preferred Stock, $.001 par value per share (the "Series A
Preferred"), of the Company. The Series A Preferred shares are convertible into
shares of common stock on a twenty-for-one basis. In connection with the
Acquisition, Front Porch Digital, Inc. canceled 13,452,381 shares of outstanding
common stock and warrants to purchase 3.5 million shares of common stock that
were held by MSI prior to the Acquisition Date. MSI canceled $0.2 million in
receivables owed to it from Front Porch Digital, Inc. Front Porch Digital, Inc.,
also assumed outstanding warrants of MSI to purchase 202,740 shares of
restricted common stock at a price per share of $.0003 and outstanding warrants
of MSI to purchase 33,029 shares of Series A Preferred at a price per share of
$10.35.
In connection with the Acquisition, each outstanding share of MSI's Series A
Redeemable Preferred Stock was converted into 200 shares of common stock of
front Porch Digital, Inc., each outstanding share of MSI's Series B Convertible
Preferred Stock was converted into 27.789 shares of common stock of Front Porch
Digital Inc., each outstanding share of MIS's Series C Redeemable Preferred
Stock was converted into 111.6042 shares of Series A Preferred and each
outstanding share of MSI common Stock converted into 0.3089 shares of common
stock of Front Porch Digital, Inc. In addition, front Porch Digital, Inc.
assumed all options outstanding under MSI's stock option plan and each
outstanding option to purchase MSI Common Stock was converted into an option to
purchase unregistered common stock of Front Porch Digital Inc., subject to
certain adjustments to the exercise price and the umber of shares issuable upon
exercise of such options to reflect the exchange ratios in the Acquisition.
65
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
The holders of Series A Preferred and certain other former MSI stockholders
executed a lock-up agreement pursuant to which such stockholders agreed not to
transfer their unregistered shares of Front Porch Digital, Inc.'s common stock
for a period of 18 months (with limited exceptions). Concurrent with the
consummation of the Acquisition, Front Porch Digital, Inc. entered into a
Registration Rights Agreement (the "Registration Rights Agreement") with the
holders of the Series A Preferred. Under the terms of such agreement at any time
after February 16, 2006, the holders of at least 51% of the Series A Preferred
have the right to cause Front Porch Digital, Inc. to register, under the
Securities Act of 1933, the shares of common stock and Series A Preferred
(including the common stock underlying the Series A Preferred ) issued to such
holders in the Acquisition. In addition, such holders have "piggy-back" and Form
S-3 registration rights.
The Pro Forma Consolidated Statements of Operations for the year ended December
31, 2003 and the six months ended June 30, 2004 are based on the historical
financial statements of Front Porch Digital, now Incentra Solutions, Inc., and
MSI. The acquisition of FPDI has been accounted for using the purchase method of
accounting. The Pro Forma Consolidated Statements of Operations for the year
ended December 31, 2003 and for the six months ended June 30, 2004 have been
prepared assuming the transaction was completed on January 1, 2003. The Pro
Forma Consolidated Balance Sheet as of June 30, 2004 assumes the transaction was
completed on June 30, 2004.
The Unaudited Pro Forma financial statement information is presented for
informational purposes only. The Pro Forma Balance Sheet and Statements of
Operations do not purport to represent what Incentra Solution's actual financial
position or results of operations would have been had the acquisition of FPDI
occurred as of such dates, or to project Incentra Solution's financial position
or results of operations for any period or date, nor does it give effect to any
matters other than those described in the notes thereto. The unaudited Pro Forma
information should be read in conjunction with Incentra Solution's consolidated
financial statements and notes thereto, and the historical financial statements
of MSI which are incorporated by reference in this Current Report on Form 8-K/A.
Certain assumptions, estimates and adjustments are preliminary and have been
made solely for purposes of developing such pro forma information. The pro forma
adjustments are based on preliminary estimates and certain assumptions that the
Company believes are reasonable under the circumstances. The purchase price
allocation is preliminary and subject to change once the Company receives
certain information it believes is necessary to finalize the purchase
accounting. Specifically, the Company has engaged an appraisal firm to complete
a valuation of FPDI's assets which will be used by the Company's management as
the basis for recording the assets acquired and liabilities assumed. The Company
expects to record a significant amount of intangible assets as a result of the
transaction. The Company has not finalized the valuation, therefore, the
following pro forma financial information reflects management's current estimate
of the nature, allocated amounts, and estimated useful lives of the acquired
identifiable intangible assets. As a result of the tentative nature of the
estimates used in the accompanying pro forma information, the nature, allocated
amounts, and useful lives of the acquired identifiable intangible assets
resulting from the transaction could be different and such differences could be
significant.
66
MANAGEDSTORAGE INTERNATIONAL, INC. AND SUBSIDIARIES
SELECTED NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
JUNE 30, 2004
Item 9.01 (b) Pro Forma Financial Information
Incentra Solutions, Inc.
Pro Forma Condensed Consolidated Balance Sheet
June 30, 2004
(unaudited)
FRONT PORCH MANAGEDSTORAGE
DIGITAL, INTERNATIONAL, PRO FORMA
Assets INC. INC. ADJUSTMENTS PRO FORMA
----------- -------------- ------------- -----------
Current assets:
Cash and cash equivalents $1,304,770 $ 3,053,230 $ -- $ 4,358,000
Accounts receivable - trade & other, net of allowance
for doubtful accounts of $30,200 and $317,776 1,538,453 1,533,595 (170,812) a 2,901,236
Other current assets 129,070 698,246 (19,167) b b 808,149
---------- ------------ ------------ -----------
Total current assets 2,972,293 5,285,071 (189,979) 8,067,385
Property and equipment, net 158,216 3,491,444 -- 3,649,660
Software and Intellectual property, net 842,469 1,195,911 16,279,246 c 18,317,626
Goodwill, net 415,718 -- (415,718) c --
Investment in Front Porch Digital, Inc. -- 644,101 (644,101) c --
Restricted cash 3,500,000 79,727 -- 3,579,727
Other assets -- -- -- --
951,937 124,082 (940,015) a,f 136,003
---------- ------------ ------------ -----------
Total assets $8,840,633 $ 10,820,336 $ 14,089,433 $33,750,402
========== ============ ============ ===========
67
Incentra Solutions, Inc.
Pro Forma Condensed Consolidated Balance Sheet (Continued)
June 30, 2004
(unaudited)
FRONT PORCH MANAGEDSTORAGE
DIGITAL, INTERNATIONAL, PRO FORMA
INC. INC. ADJUSTMENTS PRO FORMA
----------- -------------- ------------- -------------
Liabilities and stockholders' equity (deficit)
Current liabilities:
Current portion of notes payable, capital leases
and other long term obligations $ 737,437 $ 1,040,861 $ (333,323) f $ 1,444,975
Accounts payable 1,083,891 987,968 (96,089) a 1,975,770
Accrued expenses 1,676,746 1,073,814 179,833 b,c 2,930,393
Current portion of deferred revenue -- -- -- --
946,432 546,794 (74,923) a 1,418,303
------------ ------------ ------------ ------------
Current portion of deferred revenue -- -- -- --
Total current liabilities 4,444,506 3,649,437 (324,502) 7,769,441
Notes payable, capital leases and other long term
obligations, net of current portion 3,269,712 76,280 (606,492) f 2,739,500
Deferred revenue - net of current portion -- 232,175 -- 232,175
Series C convertible preferred stock, nonvoting,
$0.01 par value, 24,500 shares authorized,
22,104 shares issued and outstanding -- 20,662,052 (20,662,052) e --
------------ ------------ ------------ ------------
Total liabilities 7,714,218 24,619,944 (21,593,046) 10,741,116
------------ ------------ ------------ ------------
Commitments and contingencies
Series A redeemable preferred stock, $.01 par value,
50,000 shares authorized, issued and outstanding -- 5,000,000 (5,000,000) e --
Series B convertible preferred stock, $.01 par value,
650,000 shares authorized, issued and outstanding -- 8,900,211 (8,900,211) e --
Series A convertible preferred stock, nonvoting,
$.001 par value, 2,500,000 shares authorized,
2,466,971 shares issued and outstanding -- -- 20,662,052 e 20,662,052
Stockholders' equity (deficit):
Preferred stock, convertible, nonvoting, $.001 par value,
2,500,000 shares authorized, none issued or outstanding --
Common stock, $.001 par value 150,000,000 shares
authorized, 94,130,599 shares issued, 92,696,960
shares outstanding, 1,433,639 shares in treasury 58,694 -- 34,003 g 92,697
Common stock - Managed Storage International -- 6,293 (6,293) g --
Additional paid-in capital -- 84,796,613 29,960,649 c,e,g 114,757,262
Additional paid-in capital-Front Porch Digital, Inc. 29,241,937 -- (29,241,937) g --
Deferred compensation (262,271) (262,271)
Warrants 181,223 181,223
Accumulated other comprehensive income
78,254 -- (78,254) g --
Accumulated deficit - Front Porch Digital, Inc.
(28,252,470) -- 28,252,470 g --
Accumulated deficit -- (112,421,677) -- (112,421,677)
------------ ------------ ------------ ------------
Total stockholders' equity (deficit) 1,126,415 (27,699,819) 28,920,638 2,347,234
------------ ------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 8,840,633 $ 10,820,336 $ 14,089,433 $ 33,750,402
============ ============ ============ ============
The following adjustments made to prepare the pro forma condensed consolidated
balance sheet as of June 30, 2004 assume that the transaction whereby
ManagedStorage International, Inc. (MSI) became a wholly-owned subsidiary of
Front Porch Digital, Inc. (FPDI) (now known as Incentra Solutions, Inc.), in a
transaction accounted for under the purchase method of accounting as a reverse
acquisition with MSI being the accounting acquirer, occurred on June 30, 2004.
Adjustment Explanation
- ---------- -----------
a To eliminate receivables of $170,812 from FPDI to MSI for services
performed prior to the acquisition, $74,923 of related deferred
revenue on the books of MSI, and the related payables on the books
of FPDI totaling $95,889.
b To eliminate interest receivable of $19,167 on the books of MSI
resulting from a $250,000 note receivable from FPDI, and the
related payable.
The following entries reflect the allocation of the estimated fair value of the
assets acquired and the liabilities assumed. Because MSI shareholders control
the combined entity after the combination transaction, the transaction is
accounted for as a reverse acquisition such that MSI is considered to have
acquired FPDI. Accordingly, the estimated fair value of FPDI was determined by
reference to its publicly traded market value for a period of three days prior
to the transaction date, the transaction date (August 18, 2004) and three days
after the transaction date. The estimated fair value of FPDI, net of the common
stock of FPDI already owned by MSI prior to the acquisition, was approximately
$15.7 million. In addition, the estimated fair value of FPDI's outstanding
warrants and options for common stock was estimated to be approximately $1.7
million. Direct costs incurred by MSI for the acquisition are estimated to be
approximately $0.2 million. MSI has preliminarily concluded that the fair values
of the acquired FPDI accounts payable, accrued expenses, deferred revenue, cash,
restricted cash, accounts receivable, other assets, and property and equipment
approximate their historical carrying amounts. MSI has also identified two
amortizable intangible assets--developed technology with an estimated fair value
of $6.6 million and customer relationships of $10.5 million. As noted above,
such amounts are subject to final determination. Accordingly, based on the above
estimates of fair value, the Company recorded the following entries to adjust
the June 30, 2004 pro forma balance sheet of FPDI to its estimated fair value:
c To record the fair values of the intangible assets acquired of
$10.5 million for customer relationships and $6.6 million for
developed technology; to record an accrual for estimated costs of
the acquisition of $199,000; to eliminate the carrying amount of
MSI's investment ($644,101) in FPDI, as it is already considered
in the fair value determinations discussed above; to increase FPDI
additional paid in capital to reflect the fair value increase
resulting from the transaction.
e To record the exchange of MSI Series C preferred stock for FPDI
Series A preferred stock (the Company believes that the estimated
fair value of the Series A approximates the carrying amount of the
Series C); to record the conversion of the MSI Series A and B into
common stock.
f To eliminate the deferred financing costs ($939,815) on FPDI's
books, and to record the related reduction of the carrying amount
of the related debt on FPDI's books to record such debt at its
estimated fair value.
g To eliminate FPDI equity accounts and accumulated deficit; to
eliminate FPDI's accumulated other comprehensive income; to
conform MSI's equity accounts to FPDI's capital structure.
68
Incentra Solutions, Inc.
Pro Forma Condensed Consolidated Statements of Operations
Six months ended June 30, 2004
(unaudited)
FRONT PORCH MANAGEDSTORAGE
DIGITAL, INTERNATIONAL, PRO FORMA
INC. INC. ADJUSTMENTS PRO FORMA
----------- -------------- ------------- -------------
Revenue:
Products $ 3,047,611 $ 2,000 $ -- $ 3,049,611
Services 501,743 4,259,827 (6,373) a 4,755,197
------------ ----------- ----------- ------------
Total revenues 3,549,354 4,261,827 (6,373) 7,804,808
------------ ----------- ----------- ------------
Cost of revenue:
Products 494,672 -- -- 494,672
Services 462,754 2,549,699 -- 3,012,453
------------ ----------- ----------- ------------
Total cost of revenue 957,426 2,549,699 -- 3,507,125
------------ ----------- ----------- ------------
Gross profit 2,591,928 1,712,128 (6,373) 4,297,683
------------ ----------- ----------- ------------
Operating expenses:
Selling, general and administrative 2,674,985 4,101,731 (55,621) a 6,721,095
Amortization 144,572 474,952 1,041,514 d 1,661,038
Depreciation 34,841 82,079 -- 116,920
Impairment of goodwill related to equity method investee -- 198,280 (198,280) e --
------------ ----------- ----------- ------------
Total operating expenses 2,854,398 4,857,042 787,613 8,499,053
Loss from operations (262,470) (3,144,914) (793,986) (4,201,370)
Other income (expense):
Interest income 7,564 5,818 -- 13,382
Interest expense (618,892) (1,391,219) 1,335,649 f (674,462)
Other income (expense) 20,873 11,474 32,347 --
Other investment income 77,647 (49,248) -- a 28,399
Transaction (loss) gain (12,191) -- -- (12,191)
------------ ----------- ----------- ------------
(602,646) (1,296,280) 1,286,401 (612,525)
------------ ----------- ----------- ------------
Net loss (865,116) (4,441,194) 492,415 (4,813,895)
------------ ----------- ----------- ------------
Deemed dividends on redeemable preferred stock -- (297,534) 297,534 f --
Accretion of redeemable preferred stock to redemption amount 0 (15,666) (1,324,446) f (1,340,112)
------------ ----------- ----------- ------------
Net loss applicable to common stockholders $ (865,116) $(4,754,394) $ (534,497) $ (6,154,007)
============ =========== =========== ============
Weighted average shares outstanding - basic and diluted 48,641,473 62,847,216 96,096,408
============ =========== ============
Loss per share - basic and diluted:
Net loss per share applicable to common stockholders $ (0.02) $ (0.08) $ (0.06)
============ =========== ============
69
Incentra Solutions, Inc.
Pro Forma Condensed Consolidated Statements of Operations
Year ended December 31, 2003
(unaudited)
FRONT PORCH MANAGEDSTORAGE
DIGITAL, INTERNATIONAL, PRO FORMA
INC. INC. ADJUSTMENTS PRO FORMA
----------- -------------- ------------- -------------
Revenue:
Products $ 2,084,532 $ 11,273 $ (4,543) a $ 2,091,262
------------ ------------ ------------ ------------
Services 837,223 9,799,468 -- 10,636,691
------------ ------------ ------------ ------------
Total revenue 2,921,755 9,810,741 (4,543) 12,727,953
Cost of revenue:
Products 387,016 -- -- 387,016
Services 616,669 6,951,781 -- 7,568,450
------------ ------------ ------------ ------------
Total cost of revenue 1,003,685 6,951,781 -- 7,955,466
------------ ------------ ------------ ------------
Gross profit 1,918,070 2,858,960 (4,543) 4,772,487
------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 4,153,469 9,362,347 (25,550) a 13,490,266
Amortization 290,835 928,851 2,081,337 d 3,301,023
Depreciation 293,572 361,841 -- 655,413
Impairment of goodwill related to equity method investee -- 692,098 (692,098) e --
------------ ------------ ------------ ------------
Total operating expenses 4,737,875 11,345,137 1,363,689 17,446,701
------------ ------------ ------------ ------------
Loss from operations (2,819,805) (8,486,177) (1,368,232) (12,674,214)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 10,466 39,167 -- 49,633
Interest expense (782,689) (2,225,443) 1,262,509 f (1,745,623)
Other income (expense) 6,799 247,912 (45,940) a 208,771
Share of losses of Front Porch Digital, Inc. -- (636,185) 636,185 e -
Other investment income 48,529 48,529
Gain from early extinguishment of debt 20,826 20,826
Transaction (loss) gain (89,849) -- -- (89,849)
------------ ------------ ------------ ------------
(855,273) (2,505,194) 1,852,754 (1,507,713)
------------ ------------ ------------ ------------
Loss from continuing operations (3,675,078) (10,991,371) 484,522 (14,181,927)
------------ ------------ ------------ ------------
Loss from operations of discontinued operations (3,262,644) 0 $ 0 ($ 3,262,644)
Gain on sale of discontinued operations $ (448,529) $ -- $ -- $ (448,529)
Loss from discontinued operations $ (3,711,173) $ -- $ -- $ (3,711,173)
------------ ------------ ------------ ------------
Net loss $ (7,386,251) $(10,991,371) $ 484,522 $(17,893,100)
------------ ------------ ------------ ------------
Deemed dividends on redeemable preferred stock -- (1,647,669) 1,647,669 f --
Accretion of redeemable preferred stock to
to redemption amount -- (96,236) (2,521,324) f (2,617,560)
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $ (7,386,251) $(12,735,276) $ (389,133) $(20,510,660)
============ ============ ============ ============
Weighted average shares outstanding - basic and diluted 38,773,487 61,062,235 86,228,422
Loss per share - basic and diluted:
Loss from continuing operations ($0.09) ($0.16)
Loss from dividends and accretion $0.00 ($0.04)
Net loss per share applicable to common shareholders ($0.19) ($0.21) ($0.24)
The following adjustments made to prepare the proforma condensed consolidated
statements of operations for the year ended December 31, 2003 and the six months
ended June 30, 2004 assume that the transaction whereby ManagedStorage
International, Inc. (MSI) became a wholly-owned subsidiary of Front Porch
Digital, Inc. (FPDI) (now known as Incentra Solutions, Inc.), in a transaction
accounted for under the purchase method of accounting as a reverse acquisition
with MSI being the accounting acquiror, occurred on January 1, 2003.
a To eliminate transactions between FPDI and MSI which occurred
prior to the acquisitions date.
d To record additional amortization for the acquired intangible
assets using estimated lives of five years for the developed
technology and ten years for acquired customer relationships,
using the straight line method.
e To eliminate impairment and share of loss recorded related to
MSI's equity method investment of FPDI for periods subsequent to
the assumed acquisition.
f To eliminate interest expense recorded on MSI's Series C preferred
stock, as such stock was considered to be a liability under SFAS
150. It was replaced with FPDI Series A, which is not a liability,
and therefore the accretion, of approximately the same amount, is
reflected as additional accretion of preferred stock to redemption
value. Also, to eliminate the deemed dividends on the MSI Series A
and B, as those were converted to common stock on the assumed
acquisition date.
70
Item 9.01(c) Exhibits
Number Documents
------ --------
23.1 Consent of KPMG LLP
23.2 Consent of Ernst & Young LLP
71
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
INCENTRA SOLUTIONS, INC.
Date: January 6, 2005 By:/s/Thomas P. Sweeney III
-----------------------------
Thomas P. Sweeney III
Chief Executive Officer