AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 1, 2005
REGISTRATION NO. 333-128052
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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INCENTRA SOLUTIONS, INC.
(Name of Small Business Issuer in Its Charter)
NEVADA 7371 86-0793960
(State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification No.)
Organization)
1140 PEARL STREET
BOULDER, COLORADO 80302
(303) 440-7930
(Address and Telephone Number of Principal Executive Offices)
1140 PEARL STREET
BOULDER, COLORADO 80302
(Address of Principal Place of Business or Intended Principal Place of Business)
THOMAS P. SWEENEY III, CHIEF EXECUTIVE OFFICER
INCENTRA SOLUTIONS, INC.
1140 PEARL STREET
BOULDER, COLORADO 80302
(303) 440-7930
(Name, address and telephone number of agent for service)
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COPIES TO:
Eric M. Hellige, Esq.
Pryor Cashman Sherman & Flynn LLP
410 Park Avenue
New York, New York 10022-4441
Telephone: (212) 421-4100
Facsimile: (212) 326-0806
Approximate Date of Commencement of Proposed Sale to the Public: FROM TIME
TO TIME AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. |X|
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. |_| ____________________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ____________________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ____________________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. |_|
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
SUBJECT TO COMPLETION, DATED NOVEMBER __, 2005
PROSPECTUS
2,428,477 SHARES
INCENTRA SOLUTIONS, INC.
COMMON STOCK
This prospectus relates to the resale of up to 2,428,477 shares of our
common stock by Laurus Master Fund, Ltd ("Laurus"), of which 1,781,707 shares
are issuable upon the conversion of our secured convertible promissory note and
interest thereon, 400,000 shares are issuable upon the exercise of an
outstanding warrant and 246,770 shares are issuable upon the conversion of an
amended secured convertible promissory note. All of the shares, when sold, will
be sold by Laurus. Laurus may sell its common stock from time to time at
prevailing market prices. We will not receive any proceeds from the sale of the
shares of common stock by Laurus.
Our common stock is traded in the over-the-counter market and prices are
reported on the OTC Bulletin Board under the symbol "ICNS."
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR RISKS OF AN INVESTMENT IN THE
SECURITIES OFFERED BY THIS PROSPECTUS, WHICH YOU SHOULD CONSIDER BEFORE YOU
PURCHASE ANY SHARES.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is November ___, 2005
We have not registered the sale of the shares under the securities laws of
any state. Brokers or dealers effecting transactions in the shares of common
stock offered hereby should confirm that the shares have been registered under
the securities laws of the state or states in which sales of the shares occur as
of the time of such sales, or that there is an available exemption from the
registration requirements of the securities laws of such states.
This prospectus is not an offer to sell any securities other than the
shares of common stock offered hereby. This prospectus is not an offer to sell
securities in any circumstances in which such an offer is unlawful.
We have not authorized anyone, including any salesperson or broker, to give
oral or written information about this offering, Incentra Solutions, Inc., or
the shares of common stock offered hereby that is different from the information
included in this prospectus. You should not assume that the information in this
prospectus, or any supplement to this prospectus, is accurate at any date other
than the date indicated on the cover page of this prospectus or any supplement
to it.
TABLE OF CONTENTS
Page
Prospectus Summary.......................................................... 1
Risk Factors................................................................ 4
Special Note Regarding Forward-Looking Statements........................... 17
Use of Proceeds............................................................. 17
Market for Common Equity and Related Stockholder Matters.................... 18
Management's Discussion and Analysis or Plan of Operation................... 20
Business.................................................................... 35
Management.................................................................. 50
Principal Stockholders...................................................... 59
Certain Relationships and Related Transactions.............................. 62
Description of Securities................................................... 63
Selling Stockholder......................................................... 66
Plan of Distribution........................................................ 69
Legal Matters............................................................... 71
Experts..................................................................... 71
Where You Can Find Additional Information................................... 72
Index to Financial Statements............................................... 73
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DIVArchive(R) and BitScream(R) are registered trademarks of Incentra Solutions,
Inc. Gridworks(R) is a registered trademark of ManagedStorage International,
Inc.
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS
AND MAY NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD CONSIDER BEFORE
INVESTING IN THE SHARES. YOU ARE URGED TO READ THIS PROSPECTUS IN ITS ENTIRETY,
INCLUDING THE INFORMATION UNDER "RISK FACTORS" AND OUR CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS. UNLESS
OTHERWISE INDICATED, THE INFORMATION CONTAINED IN THIS PROSPECTUS, INCLUDING PER
SHARE DATA AND INFORMATION RELATING TO THE NUMBER OF SHARES OUTSTANDING, GIVES
RETROACTIVE EFFECT TO THE ONE-FOR-TEN REVERSE SPLIT OF OUR COMMON STOCK EFFECTED
ON JUNE 9, 2005.
OUR COMPANY
We are a leading provider of complete solutions for an enterprise's data
protection needs. We supply a broad range of storage products and storage
management services to broadcasters, enterprises and information technology
service providers worldwide. We market our products and services to broadcasters
under the trade name Front Porch Digital ("Front Porch") and to service
providers and enterprise clients under the trade names ManagedStorage
International ("MSI"), Incentra Solutions ("Incentra of CA") and PWI
Technologies ("PWI"). Front Porch provides unique software and professional
services solutions for digital archive management to broadcasters and media
companies. MSI provides outsourced storage solutions, including engineering,
hardware and software procurement and remote storage operations services.
Incentra of CA and PWI are leading systems integrators that provide Information
Technology ("IT") products, professional services and outsourcing solutions to
enterprise customers located primarily in the western United States.
We believe our ability to deliver a complete storage infrastructure and
management solution to our customers differentiates us from most of our
competitors. A complete storage solution for the customers in our target markets
includes the following components:
o Hardware and software products and services
o Outsourcing solutions - Automated/remote monitoring, management and
maintenance services
o Professional services - engineering/operations/IT help desk
o Capital/financing solutions
Through Front Porch, we provide a software and management solution that
enables searching, browsing, editing, storage and on-demand delivery of
media-rich content in nearly any digital format. Our complete digital archive
solution includes our proprietary software bundled with professional services,
hardware/software procurement and resale, remote monitoring/management services,
complete support for our proprietary software solutions and first call support
for third-party hardware and software maintenance. Our software converts audio,
video, images, text and data into digital formats for ease of use and archiving.
With more than 100 installations worldwide, our DIVArchive software solution has
become one of the leading digital archive management applications among European
and Asian broadcast and media companies, and is gaining an increasing share of
the North American market. Front Porch's DIVArchive and transcoding applications
provide the essential integration layer within the digital content creation and
broadcast environments. All of Front Porch's products were built on intelligent,
distributed architecture. As a result, Front Porch's archive management and
transcoding solutions are flexible, scalable, easily upgradeable, failure
resilient and integratable with leading automation and asset management
applications.
Through MSI, we deliver comprehensive storage services, including
professional services, third-party hardware/software procurement and resale,
financing solutions, remote monitoring/management
services and first call support for third-party hardware and software
maintenance. MSI focuses on providing data protection solutions and services
that ensure that its customers' data is backed-up and recoverable and meets
internal data retention compliance policies. MSI's remote monitoring and
management services are delivered from its Storage Network Operations Center
("NOC") in Broomfield, Colorado, which monitors and manages a wide spectrum of
diverse storage infrastructures on a 24x7 basis throughout the United States,
the United Kingdom, the Netherlands, Bermuda and Japan. MSI delivers this
service worldwide using its proprietary GridWorks Operations Support System,
which enables automated remote monitoring and management of complete storage
infrastructures and back-up applications. MSI provides outsourcing solutions for
customer data protection needs under long-term contracts. Customers pay on a
monthly basis for storage services based on the number of assets managed and/or
the volume of storage assets utilized. We believe customers benefit from
improved operating effectiveness with reduced operating costs and reductions in
capital expenditures.
Through Incentra of CA and PWI (which were acquired in the first quarter of
2005), we deliver complete IT solutions, including professional services,
third-party hardware/software procurement and resale, financing solutions and
the sale and delivery of first call support for third-party hardware and
software maintenance (including help desk operations). Solutions are sold
primarily to enterprise customers in the financial services, government,
hospitality, retail, security, healthcare and manufacturing sectors. With
offices and sales personnel located primarily throughout the western United
States, these recently-acquired entities are a cornerstone to our North American
expansion plans.
Our principal executive offices are located at 1140 Pearl Street, Boulder,
Colorado, 80302, and our telephone number at that address is (303) 440-7930. We
also maintain regional offices in Broomfield, Colorado, Mount Laurel, New
Jersey, San Ramon, California, San Diego, California, Seattle, Washington and
Toulouse, France. We maintain an Internet website at www.incentrasolutions.com.
Information on our website is not part of this prospectus.
ABOUT THIS OFFERING
This prospectus relates to the resale of up to 2,428,477 shares of common
stock, all of which are issuable upon the exercise of warrants or the conversion
of secured convertible promissory notes and interest thereupon held by Laurus
Master Fund, Ltd. ("Laurus"). All of the shares, when sold, will be sold by
Laurus. Laurus may sell its shares of our common stock from time to time at
prevailing market prices. We will not receive any proceeds from the sale of the
shares of common stock by Laurus. However, we would receive proceeds upon the
exercise of the warrants held by Laurus. See the "Use of Proceeds" section in
this prospectus for a discussion of the amount of proceeds we would realize from
the exercise of such warrants and our intended use of such proceeds. Unless
otherwise indicated, the information contained in this Prospectus, including per
share data and information relating to the number of shares outstanding, gives
retroactive effect to the one-for-ten reverse split of our common stock effected
on June 9, 2005.
Common Stock Offered............................... 2,428,477 shares
Common Stock Outstanding at October 10, 2005(1) ... 18,260,295 shares
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(1) Includes 4,933,942 shares issuable upon the conversion of outstanding
shares of Series A preferred stock. Does not include (i) 4,274,646 shares
that are issuable upon the conversion of outstanding convertible notes (of
which 3,681,111 shares are issuable upon the conversion of convertible
notes held by Laurus), (ii) 1,888,544 shares issuable upon the exercise of
outstanding warrants, (iii) 1,968,495 shares issuable upon the exercise of
outstanding options granted under our 2000 Equity Incentive Plan, or (iv)
217,032 shares issuable upon the exercise of outstanding options granted
under MSI's 2000 Option and Grant Plan.
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Use of Proceeds.................................... We will not receive any of
the proceeds from the sale
of the shares by Laurus,
but would receive proceeds
if certain common stock
purchase warrants are
exercised.
OTC Bulletin Board Ticker Symbol................... ICNS.OB
SELECTED FINANCIAL INFORMATION
The selected financial information presented below is derived from and
should be read in conjunction with our consolidated financial statements,
including notes thereto, appearing elsewhere in this prospectus. See "Financial
Statements."
SUMMARY OPERATING INFORMATION
FISCAL YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
2004 2003 2005 2004
------------ ------------ ------------ ------------
Net revenues ................................. $ 13,284,670 $ 9,810,741 $ 23,606,395 $ 4,261,827
Loss from operations ......................... (7,711,394) (8,486,177) (3,134,222) (3,144,914)
Net loss applicable to common shareholders ... (11,777,613) (12,735,276) (6,013,477) (4,754,395)
Basic and diluted net loss per share
applicable to common shareholders .......... (2.30) (6.70) (0.51) (2.44)
Weighted average number of common shares
outstanding - basic and diluted ............ 5,102,733 1,894,552 11,901,066 1,950,114
SUMMARY BALANCE SHEET INFORMATION
DECEMBER 31, 2004 JUNE 30, 2005
----------------- -------------
Working capital (deficit) ......................... $ 96,638 $ (3,802,607)
Total assets ...................................... 28,677,045 49,719,406
Total liabilities ................................. 11,699,719 25,634,062
Series A convertible redeemable preferred stock ... 22,000,767 23,309,550
Shareholders' equity (deficit) .................... (5,023,441) 775,794
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RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE BUYING
SHARES IN THIS OFFERING. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE
ONLY RISKS WE FACE. THESE RISKS ARE THE RISKS WE CONSIDER TO BE SIGNIFICANT TO
YOUR DECISION WHETHER TO INVEST IN OUR COMMON STOCK AT THIS TIME. WE MIGHT BE
WRONG. THERE MAY BE RISKS THAT YOU IN PARTICULAR VIEW DIFFERENTLY THAN WE DO,
AND THERE ARE OTHER RISKS AND UNCERTAINTIES THAT ARE NOT PRESENTLY KNOWN TO US
OR THAT WE CURRENTLY DEEM IMMATERIAL, BUT THAT MAY IN FACT IMPAIR OUR BUSINESS
OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, RESULTS
OF OPERATIONS AND FINANCIAL CONDITION COULD BE SERIOUSLY HARMED, THE TRADING
PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR
INVESTMENT.
OUR OPERATING HISTORY IS LIMITED, SO IT WILL BE DIFFICULT FOR YOU TO EVALUATE
OUR BUSINESS IN MAKING AN INVESTMENT DECISION.
Although we were incorporated in 1995, we have a limited operating history.
We commenced operations in our Front Porch line of business in May 2000 (at
which time we acquired Front Porch Digital, Inc., a Delaware corporation that
commenced operations in February 2000), in our MSI line of business in August
2004 (at which time we acquired MSI, a Delaware corporation that commenced
operations in March 2000) and in our Incentra of CA and PWI lines of business in
February 2005 and March 2005, respectively. We are still in the early stages of
our development, which makes the evaluation of our business operations and our
prospects difficult. Before buying our common stock, you should consider the
risks and difficulties frequently encountered by early stage companies. These
risks and difficulties, as they apply to us in particular, include:
o our need to expand the number of products we distribute and services
we offer;
o our need to expand and increase the resale of storage and storage
management hardware and software;
o potential fluctuations in operating results and uncertain growth
rates;
o limited market acceptance of the products we distribute and services
we offer;
o concentration of our revenues in a limited number of market segments;
o distribution of our operations and revenues in the North American,
European and Asian markets;
o our dependence on our existing service customer base for recurring
revenue and our ability to sustain it;
o our dependence on the broadcast, media and entertainment industries
for a significant portion of our revenue and cash flow;
o our need to continue to develop the United States and North American
markets, as well as continue to expand the European and Asian
markets;
o our need to expand our direct sales force;
o our need to expand our channel partner network;
o our need to continue to establish, secure and maintain key supplier
relationships;
o our need to manage rapidly expanding operations;
o our need to attract and train qualified personnel;
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o our ability to successfully integrate our recent acquisitions, and to
retain key personnel, customers and vendor relationships;
o our ability to successfully implement our acquisition strategy; and
o our international operations and foreign currency exchange rate
fluctuations.
WE HAVE INCURRED LOSSES SINCE INCEPTION AND WE MAY BE UNABLE TO ACHIEVE
PROFITABILITY OR GENERATE POSITIVE CASH FLOW.
We incurred net losses applicable to common stockholders of $12.7 million
in 2003, $11.8 million in 2004 and $6.0 million in the first six months of 2005
and we may be unable to achieve profitability in the future. In addition, we
used cash flow in operating activities of $4.2 million in 2003, $3.5 million in
2004 and $1.1 million in the first six months of 2005. If we continue to incur
net losses or continue to require cash to support our operations in future
periods, we may be unable to achieve one or more key elements of our business
strategy, which include the following:
o increasing the number of storage and storage management products we
distribute and services we offer;
o successfully implementing our acquisition strategy, including the
integration of our recent acquisitions;
o increasing our sales and marketing activities, including the number
of our sales personnel;
o increasing the number of markets into which we offer and sell
products;
o expanding our reach to customers for resale of hardware and software
and sale of managed storage services; or
o acquiring or developing additional product lines.
As of June 30, 2005, we had an accumulated deficit of $123.1 million. We
may not achieve profitability if our revenues increase more slowly than we
expect, or if operating expenses exceed our expectations or cannot be adjusted
to compensate for lower than expected revenues. If we do achieve profitability,
we may be unable to sustain or increase profitability on a quarterly or annual
basis. Any of the factors discussed above could cause our stock price to
decline.
WE HAVE A LIMITED AMOUNT OF CASH AND ARE LIKELY TO REQUIRE ADDITIONAL CAPITAL TO
CONTINUE OUR OPERATIONS.
We have a limited amount of available cash and will likely require
additional capital to successfully implement our business plan. On June 30,
2005, we obtained from Laurus a $9 million revolving, convertible credit
facility that matures on June 30, 2008 (the "2005 Facility"). On July 5, 2005,
we received an initial draw under the 2005 Facility of $6.0 million, of which
approximately $4.4 million was used to extinguish, in full, our indebtedness to
Wells Fargo Bank, N.A. and the balance of the initial draw, less expenses
incurred in connection with the 2005 Facility, are being used for general
corporate and working capital purposes. All of such proceeds are required to be
repaid to Laurus unless the principal amount of the convertible note is
converted into shares of our common stock in accordance with the applicable loan
documents. If the principal amount is not converted, we will have less funds
available to us under the Facility for our general corporate and working capital
purposes. Our management believes that our cash and cash equivalents will
provide us with sufficient capital resources
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to fund our operations, debt service requirements, and working capital needs for
the next twelve months. There can be no assurances that we will be able to
obtain additional funding when needed, or that such funding, if available, will
be obtainable on terms acceptable to us. In the event that our operations do not
generate sufficient cash flow, or we cannot obtain additional funds if and when
needed, we may be forced to curtail or cease our activities, which would likely
result in the loss to investors of all or a substantial portion of their
investment.
A DECREASE IN OUR ELIGIBLE ACCOUNTS RECEIVABLE WILL RESULT IN LESS FUNDS BEING
AVAILABLE TO US UNDER THE 2005 FACILITY IN THE FUTURE AND MAY REQUIRE US TO MAKE
ADDITIONAL INTEREST PAYMENTS IN THE EVENT OF A BORROWING BASE DEFICIENCY, EITHER
OF WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR LIQUIDITY AND FINANCIAL
CONDITION.
The maximum principal amount of all borrowings under the 2005 Facility
cannot exceed 90% of our borrowing base, which includes the combined eligible
accounts receivable of our wholly-owned subsidiaries, PWI and Incentra of CA. As
a result, the amounts available to us from time to time are limited by the
amount of eligible accounts receivable we generate from our sales. In the event
of a material decrease in our accounts receivable, we may be unable to borrow a
sufficient amount from Laurus to meet our working capital needs. In addition, in
connection with the original funding under the 2005 Facility, Laurus waived
until December 31, 2005 the borrowing base limitation under the 2005 Facility,
and permitted us to borrow $6.0 million under the 2005 Facility at a time that
we did not have sufficient eligible accounts receivable to support such funding.
If we are unable to generate sufficient accounts receivable as of such date, we
will be required to make interest payments to Laurus in the amount of 1.5% per
month on any such borrowing base deficiency. Depending on the amount of such
deficiency, the required interest payments to Laurus could adversely affect our
liquidity and financial condition by requiring us to divert cash that we intend
to use for other working capital purposes.
WE MAY NOT HAVE SUFFICIENT CASH TO MEET OUR REDEMPTION OBLIGATIONS UNDER OUR
SERIES A PREFERRED STOCK, WHICH WOULD HAVE A MATERIAL ADVERSE AFFECT ON OUR
FINANCIAL CONDITION.
We may not have sufficient cash to meet our redemption obligations under
our outstanding shares of Series A preferred stock, the holders of which may
elect to redeem such shares on or after August 18, 2008 at a price equal to the
greater of (i) $12.60 (subject to certain adjustments) per each share of Series
A preferred stock plus an amount equal to all accumulated but unpaid dividends
on each such share of Series A preferred stock or (ii) the fair market value of
the common stock into which the shares of Series A preferred stock is then
convertible. If we do not have the cash available to redeem the shares of Series
A preferred stock at such time, we are obligated to take any necessary or
appropriate action to obtain the cash necessary to make such redemption
payments. There can be no assurance that we will have the sufficient cash or
will be able to obtain financing on acceptable terms to us to allow us to comply
with our redemption obligations.
OUR LIMITED OPERATING HISTORY MAY MAKE IT DIFFICULT FOR US TO FORECAST
ACCURATELY OUR OPERATING RESULTS.
Our planned expense levels are and will continue to be based in part on our
expectations concerning future revenue, which is difficult to forecast
accurately based on our stage of development. We may be unable to adjust
spending in a timely manner to compensate for any unexpected shortfall in
revenue. Further, business development and marketing expenses may increase
significantly as we expand operations. If these expenses precede or are not
rapidly followed by a corresponding increase in revenue, our business, operating
results and financial condition may be materially and adversely affected.
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OUR RECENT ACQUISITIONS COULD MAKE IT DIFFICULT FOR US TO FORECAST ACCURATELY
OUR OPERATING RESULTS.
Our planned expense levels are and will continue to be based in part on our
expectations concerning future revenue, which is difficult to forecast
accurately as a result of our recent acquisitions. Our operating results may be
impacted significantly if we are unable to forecast accurately the revenues,
gross margins and operating results of our lines of business, including those
businesses we recently acquired. We may be unable to adjust spending in a timely
manner to compensate for any unexpected shortfall in revenue or gross margin.
Further, business development and marketing expenses may increase significantly
as we expand operations. In addition, we will incur costs to integrate and to
develop and extract the synergies of the acquired businesses. If these expenses
precede or are not rapidly followed by a corresponding increase in revenue, our
business, operating results and financial condition may be materially and
adversely affected.
CERTAIN OF THE MARKETS WE SERVE ARE IN THE EARLY STAGES OF DEVELOPMENT AND ARE
RAPIDLY EVOLVING OR CHANGING.
We offer products and services to the emerging market of digital
information management. This market for our products and services has only
recently begun to develop and is rapidly evolving. In addition, our products and
services are new and based on emerging technologies. We also offer managed
storage solutions to the enterprise and service provider markets, which also are
rapidly evolving. As is typical in the case of new and rapidly evolving
industries, demand and market acceptance for recently-introduced technology and
products are subject to a high level of uncertainty. Broad acceptance of our
products and services is critical to our success and ability to generate
revenues from these markets. Acceptance of our products and services will be
highly dependent on the functionality and performance of the products and
services and our success with the initial implementation of our products and
services. There can be no assurance that we will be successful in obtaining
market acceptance of our technology, products and services.
IF OUR DATA STORAGE PRODUCTS OR THE SOFTWARE OR SYSTEMS UNDERLYING OUR DATA
MANAGEMENT SERVICES CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS, WE COULD
INCUR SIGNIFICANT UNEXPECTED EXPENSES AND LOSE SALES.
The software-based products and services we offer may contain undetected
errors or defects when first introduced or as new versions are released.
Introduction by us of software-based products and software-based services with
reliability, quality or compatibility problems could result in reduced revenues,
uncollectible accounts receivable, delays in collecting accounts receivable and
additional costs. There can be no assurance that, despite testing by us or by
our customers, errors will not be found in our software-based products or
services after commencement of commercial deployment, resulting in product
redevelopment costs, the loss of, or delay in, market acceptance and/or the
inability to timely and effectively deliver our software-based services, such as
our remote monitoring/management services. In addition, there can be no
assurance that we will not experience significant product returns in the future.
Any such event could have a material adverse effect on our business, financial
condition or results of operations.
RAPID TECHNOLOGICAL CHANGES IN THE MARKETPLACE MAY ADVERSELY AFFECT OUR
BUSINESS.
The digital media industry is subject to rapid technological change and new
product introductions and enhancements. Our ability to remain competitive in
this market may depend in part upon our ability to develop new and enhanced
products or services and to introduce these products or services at competitive
prices on a timely and cost-effective basis. In addition, new product or service
introductions
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or enhancements by our competitors or the use of other technologies could cause
a decline in sales or loss of market acceptance of our existing products and
services. Our success in developing, introducing, selling and supporting new and
enhanced products or services depends upon a variety of factors, including the
timely and efficient completion of product design and development, and the
timely and efficient implementation of production and conversion processes.
Because new product development commitments may be made well in advance of
sales, new product or service decisions must anticipate changes in the
industries served. There can be no assurance that we will be successful in
selecting, developing, manufacturing and marketing new products or services or
in enhancing our existing products or services. Failure to do so successfully
may adversely affect our business, financial condition and results of
operations.
IF THE DATA STORAGE INDUSTRY FAILS TO DEVELOP COMPELLING NEW STORAGE
TECHNOLOGIES, OUR SOFTWARE SOLUTIONS BUSINESS MAY BE MATERIALLY ADVERSELY
AFFECTED.
Rapid and complex technological change, frequent new product introductions
and evolving industry standards increase demand for our services. As a result,
our future success depends in part on the data storage industry's ability to
continue to develop leading-edge storage technology solutions. Our customers
utilize our services in part because they know that newer technologies offer
them significant benefits over the older technologies they are using. If the
data storage industry ceases to develop compelling new storage solutions, or if
a single data storage standard becomes widely accepted and implemented, it will
be more difficult to sell new data storage systems to our customers.
WE HAVE ONLY LIMITED MARKETING CAPABILITY AND RELY ON OUR STRATEGIC PARTNERS,
OVER WHICH WE HAVE NO CONTROL, FOR A SUBSTANTIAL PART OF OUR MARKETING EFFORTS.
To date, our marketing efforts have been limited primarily to establishing
strategic alliances and commencement of in-house marketing efforts to potential
customers. We believe we will be dependent in the near term upon our strategic
alliances, in particular those with Thomason Broadcast and Media Solutions, Avid
Technology, Inc., Ascent Media Group and Cable and Wireless UK, to generate
revenues from the sales of products and delivery of services. There can be no
assurance that any strategic partner will actively market our products and
services or that, if they do so, their efforts will be successful or generate
significant revenues for our company. Although we have an existing sales force
that we are continuing to develop, there can be no assurance that we will have
the necessary resources to do so, or that any such efforts undertaken will be
successful.
THE MARKETS FOR STORAGE AND STORAGE MANAGEMENT PRODUCTS AND SERVICES ARE HIGHLY
COMPETITIVE.
The markets in which we sell our products and services are highly
competitive. Our primary competitors are information technology service
providers, large accounting, consulting and other professional service firms,
application service providers, packaged software vendors and resellers and
service groups of computer equipment companies. We also experience competition
from numerous smaller, niche-oriented and regionalized service providers. We
expect our competitors to continue to improve the design and performance of
their products. In addition, as the markets for our products and services grow,
we expect new competitors to enter the market. There can be no assurance that
our competitors will not develop enhancements to or future generations of
competitive products or services that will offer superior price or performance
features, or that new processes or technologies will not emerge that render our
products or services less competitive or obsolete. Increased competitive
pressure could lead to lower prices for our products or services, thereby
adversely affecting our business and results of operations.
8
COMPETITION IN THE MANAGED STORAGE SOLUTIONS MARKET COULD PREVENT US FROM
INCREASING OR SUSTAINING OUR REVENUES OR ACHIEVING PROFITABILITY.
A significant portion of our revenues are derived from storage solution
services that we provide to the enterprise and service provider markets. This
market is rapidly evolving and highly competitive. As technologies change
rapidly, we expect that competition will increase in the future. Current
economic conditions have also increased competition for available business. We
compete with independent storage system suppliers to the high-end market and
numerous resellers, distributors and consultants. We also compete in the storage
systems market with general purpose computer suppliers. Many of our current and
potential competitors in these markets have significantly greater financial,
technical, marketing, purchasing and other resources than we do. As a result,
they may respond more quickly to new or emerging technologies and changes in
customer requirements, devote greater resources to the development, promotion
and sale of products and deliver competitive products at lower end-user prices.
Some of our current and potential competitors in the enterprise-class
information storage market include our suppliers. We are not the exclusive
supplier of any data storage product we offer. Instead, our suppliers market
their products through other independent data storage solution providers,
original equipment manufacturers and, often, through their own internal sales
forces. We believe direct competition from our suppliers is likely to increase
if, as expected, the data storage industry continues to consolidate. This
consolidation would probably result in fewer suppliers with greater resources to
devote to internal sales and marketing efforts. In addition, our suppliers have
established and will probably continue to establish cooperative relationships
with other suppliers and other data storage solution providers. These
cooperative relationships are often intended to enable our suppliers to offer
comprehensive storage solutions, which compete with those we offer. If our
relationships with our suppliers become adversarial, it will be more difficult
for us to stay ahead of industry developments and provide our customers with the
type of service they expect from us.
FUTURE CHARGES DUE TO POSSIBLE IMPAIRMENTS OF ACQUIRED ASSETS MAY HAVE A
MATERIAL AFFECT ON OUR FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS.
A substantial portion of our assets is comprised of goodwill and other
intangible assets, which may be subject to future impairment that would result
in financial statement write-offs. Our recent acquisitions have resulted in
significant increases in goodwill and other intangible assets. Goodwill and
unamortized intangible assets, which include acquired customer lists and the
DIVArchive intellectual property, were approximately $29.4 million at June 30,
2005, representing approximately 59% of our total assets. If there is a material
change in our business operations, the value of the intangible assets we have
acquired could decrease significantly. On an ongoing basis, we will evaluate,
partially based on discounted expected future cash flows, whether the carrying
value of such intangible assets may no longer be recoverable, in which case a
charge to earnings may be necessary. Any future determination requiring the
write-off of a significant portion of unamortized intangible assets, although
not requiring any additional cash outlay, could have a material adverse affect
on our financial condition and results of operations.
FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS MAY CAUSE OUR STOCK PRICE TO
DECLINE AND A DECLINE IN THE VALUE OF YOUR INVESTMENT.
Our quarterly operating results have varied significantly in the past and
will likely fluctuate significantly in the future. Significant annual and
quarterly fluctuations in our results of operations may be caused by, among
other factors:
o the volume of revenues we have generated;
9
o the timing of our announcements for the distribution of new products
or services, and any such announcements by our competitors;
o the acceptance of the products we distribute and the services we
offer in the marketplace; and
o general economic conditions.
There can be no assurance that the level of revenues and profits, if any,
achieved by us in any particular fiscal period will not be significantly lower
than in other, including comparable, fiscal periods. We believe
quarter-to-quarter comparisons of our revenues and operating results are not
necessarily meaningful and should not be relied on as indicators of future
performance. Operating expenses are based on management's expectations of future
revenues and are relatively fixed in the short term. We plan to increase
operating expenses to:
o expand our product and service lines;
o expand our sales and marketing operations;
o increase our services and support capabilities; and
o improve our operational and financial systems.
If our revenues in a given quarter do not increase along with these expenses,
our operating margins in such quarter will decline and our net income would be
smaller or our losses would be larger than expected. It is possible that in some
future quarter our operating results may be below the expectations of public
market analysts or investors, which could cause a reduction in the market price
of our common stock.
OUR PROPOSED GROWTH AND EXPANSION COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS.
We expect to expand our operations through the increase of our sales and
marketing efforts, the building of strategic relationships with third parties,
the expansion of our research and development activities, and the acquisition of
complementary businesses or products. The anticipated growth could place a
significant strain on our management and our operational and financial
resources. Effective management of the anticipated growth will require expansion
of our management and financial controls, hiring additional appropriate
personnel as required, and development of additional expertise by existing
management personnel. There can be no assurance that these or other measures we
implement will effectively increase our capabilities to manage such anticipated
growth or to do so in a timely and cost-effective manner. Management of growth
is especially challenging for a company with a short operating history and
limited financial resources, and the failure to effectively manage growth could
have a material adverse effect on our results of operations.
OUR GROWTH PLANS DEPEND ON OUR ABILITY TO HIRE AND RETAIN SCARCE TECHNICAL
PERSONNEL.
Our future growth plans depend upon our ability to attract, retain and
motivate qualified engineers with information storage solutions experience. If
we fail to recruit and retain additional engineering personnel, we will
experience greater difficulty realizing our growth strategy, which could
negatively affect our business, financial condition and stock price. Current
economic conditions have required us to consider potential staff reductions. If
a downturn in our revenues or profits ultimately leads us to reduce our
engineering staff levels, we will incur delays in re-staffing and training upon
an economic upswing.
10
WE ARE EXPOSED TO POTENTIAL RISKS FROM RECENT LEGISLATION REQUIRING COMPANIES TO
EVALUATE INTERNAL CONTROLS UNDER SECTION 404 OF THE SARBANES OXLEY ACT OF 2002.
We are evaluating and documenting our internal controls systems so that
when we are required to do so, our management will be able to report on, and our
independent auditors to attest to, our internal controls, as required by this
legislation. We will be performing the system and process evaluation and testing
(and any necessary remediation) required in an effort to comply with the
management certification and auditor attestation requirements of Section 404 of
the Sarbanes Oxley Act. As a result, we expect to incur additional expenses and
diversion of management's time. If we are not able to implement the requirements
of Section 404 in a timely manner or with adequate compliance, we might be
subject to sanctions or investigation by regulatory authorities, such as the
Securities and Exchange Commission. Any such action could adversely affect our
financial results and could cause our stock price to decline.
ACQUISITIONS COULD DIVERT MANAGEMENT'S TIME AND ATTENTION, DILUTE THE VOTING
POWER OF EXISTING STOCKHOLDERS, AND HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS.
As part of our growth strategy, we expect to continue to acquire
complementary businesses and assets. Acquisitions that we may make in the future
could result in the diversion of time and personnel from our business. We also
may issue shares of common stock or other securities in connection with
acquisitions, which could result in the dilution of the voting power of existing
stockholders and could dilute earnings per share. Any acquisitions would be
accompanied by other risks commonly encountered in such transactions, including
the following:
o difficulties integrating the operations and personnel of acquired
companies;
o the additional financial resources required to fund the operations of
acquired companies;
o the potential disruption of our business;
o our ability to maximize our financial and strategic position by the
incorporation of acquired technology or businesses with our product
and service offerings;
o the difficulty of maintaining uniform standards, controls, procedures
and policies;
o the potential loss of key employees of acquired companies; o the
impairment of employee and customer relationships as a result of
changes in management;
o significant expenditures to consummate acquisitions; and
o internal control issues and related compliance with Section 404 of
the Sarbanes-Oxley Act of 2002.
As a part of our acquisition strategy, we expect to engage in discussions
with various businesses respecting their potential acquisition. In connection
with these discussions, we and each potential acquired business may exchange
confidential operational and financial information, conduct due diligence
inquiries, and consider the structure, terms and conditions of the potential
acquisition. In certain cases, the prospective acquired business may agree not
to discuss a potential acquisition with any other party for a specific period of
time, may grant us certain rights in the event the acquisition is not completed,
and may agree to take other actions designed to enhance the possibility of the
acquisition. Potential acquisition
11
discussions may take place over a long period of time, may involve difficult
business integration and other issues, and may require solutions for numerous
family relationships, management succession, and related matters. As a result of
these and other factors, potential acquisitions that from time to time appear
likely to occur may not result in binding legal agreements and may not be
consummated. Our acquisition agreements may contain purchase price adjustments,
rights of set-off, and other remedies in the event that certain unforeseen
liabilities or issues arise in connection with an acquisition. These remedies,
however, may not be sufficient to compensate us in the event that any unforeseen
liabilities or other issues arise.
OPTION EXPENSING WILL MAKE IT MORE DIFFICULT FOR US TO BE PROFITABLE.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123(R) SHARE-BASED PAYMENTS, which requires the expensing of stock
options. This new accounting pronouncements will create additional charges
against our income for periods after adoption of this standard for existing
unvested options and new options.
WE MAY NOT BE ABLE TO PROTECT AND ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS.
Our ability to compete effectively with other companies will depend, in
part, on our ability to maintain the proprietary nature of our intellectual
property. We rely on a combination of copyright, trademark and trade secret
laws, confidentiality procedures and licensing arrangements to establish and
protect our proprietary rights. Presently, we have one issued patent relating to
our DIVArchive software product and have initiated the process of determining if
we can file additional patent applications to protect our intellectual property
rights. As part of our confidentiality procedures, we generally enter into
non-disclosure agreements with our employees, distributors and corporate
partners, and license agreements with respect to our software, documentation and
other proprietary information. Despite these precautions, it may be possible for
a third party to copy or otherwise obtain and use our products or technology
without authorization, or to develop similar technology independently. Policing
unauthorized use of our products is difficult and, although we are unable to
determine the extent to which piracy of our software products exists, software
piracy can be expected to be a persistent problem.
The defense and prosecution of copyright, trademark and patent suits may be
both costly and time consuming, even if the outcome is favorable to our company.
An adverse outcome could subject us to significant liabilities to third parties,
require disputed rights to be licensed from third parties, or require us to
cease selling certain of our products. We also will rely on unpatented
proprietary technology and there can be no assurances that others may not
independently develop the same or similar technology or otherwise obtain access
to our proprietary technology. There can be no assurance that confidentiality
agreements entered into by our employees and consultants, advisors and
collaborators will provide meaningful protection for our trade secrets, know-how
or other proprietary information in the event of any unauthorized use or
disclosure of such trade secrets, know-how or other proprietary information.
THE LOSS OF THE SERVICES OF THOMAS P. SWEENEY III, OUR CHIEF EXECUTIVE OFFICER
AND CHAIRMAN OF THE BOARD, COULD IMPAIR OUR ABILITY TO SUPPORT CURRENT
OPERATIONS AND DEVELOP NEW BUSINESS AND TO RUN OUR BUSINESS EFFECTIVELY.
We are highly dependent on the services of Thomas P. Sweeney III, our Chief
Executive Officer and Chairman of the Board. The loss of the services of Mr.
Sweeney could have an adverse affect on our future operations. We do not
currently maintain a key man life insurance policy insuring the life of Mr.
Sweeney. In August 2004, we entered into a two-year employment agreement with
Mr. Sweeney. There can be no assurance that Mr. Sweeney will agree to renew the
agreement upon expiration of the two-year term.
12
OUR REVENUE RECOGNITION POLICIES FOR SALES TO OUR ENTERPRISE AND SERVICE
PROVIDER CUSTOMERS MAY RESULT IN THE DEFERRAL OF REVENUES.
In the course of providing software solutions to our enterprise and service
provider customers, we do not recognize revenues from our sale of hardware and
software products to such customers until we complete our required installation
or configuration of these products. Installation and configuration of these
solutions requires significant coordination with our customers and vendors.
Therefore, even if we have shipped all products to our customers, we may be
unable to control the timing of product installation and configuration. These
delays may prevent us from recognizing revenue on products we ship and may
adversely affect our quarterly reported revenues. As a result, our stock price
may decline.
OUR LONG SALES CYCLE MAY CAUSE FLUCTUATING OPERATING RESULTS, WHICH MAY
ADVERSELY AFFECT OUR STOCK PRICE.
Our sales cycle is typically long and unpredictable, making it difficult to
plan our business. Current economic conditions have increased this uncertainty.
Our long sales cycle requires us to invest resources in potential projects that
may not occur. Further, new product introductions, or the announcement of
proposed new products, may delay our customers' decisions to invest in storage
solutions we propose. Our long and unpredictable sales cycle may cause us to
experience significant fluctuations in our future annual and quarterly operating
results. It can also result in delayed revenues, difficulty in matching revenues
with expenses and increased expenditures. Our business, operating results or
financial condition and stock price may suffer as a result of any of these
factors.
WE DO NOT CARRY PRODUCT LIABILITY INSURANCE AND ANY SIGNIFICANT PRODUCT
LIABILITY CLAIMS MAY IMPAIR OUR ABILITY TO FUND CURRENT OPERATIONS OR PREVENT US
FROM CARRYING OUT OUR STRATEGIC PLANS.
While we maintain errors and omissions and general liability insurance, we
do not currently maintain product liability insurance. We attempt to limit our
potential liability by including in our client contracts provisions that limit
the maximum liability that may be incurred by us in connection with such
contract to an amount equal to the amount paid by the customer under such
contract. We believe that, as our business grows, our exposure to potential
product liability claims and litigation may increase. There can be no assurance
that our contractual limitations of liability will be enforceable or will be
sufficient to protect our business and assets from all claims. In addition,
should we ever seek to obtain product liability insurance, no assurance can be
given that we will be able to obtain adequate coverage at commercially
reasonable rates. Product liability losses could have a material adverse effect
on our business, financial condition and results of operations.
WE ARE RESTRICTED FROM PAYING DIVIDENDS ON OUR COMMON STOCK AND DO NOT INTEND TO
DO SO IN THE FORESEEABLE FUTURE, WHICH COULD CAUSE THE MARKET PRICE OF OUR
COMMON STOCK AND THE VALUE OF YOUR INVESTMENT TO DECLINE.
Provisions in several loan documents to which we are a party prevent the
holders of our common stock from receiving dividends out of funds legally
available therefore. To date, we have not paid any cash dividends. Our board of
directors does not intend to declare any cash dividends in the foreseeable
future, but instead intends to retain all earnings, if any, for use in our
business operations.
ANTI-TAKEOVER PROVISIONS AND OUR RIGHT TO ISSUE PREFERRED STOCK COULD MAKE A
THIRD-PARTY ACQUISITION OF US DIFFICULT.
We are a Nevada corporation. Anti-takeover provisions of Nevada law could
make it more difficult for a third party to acquire control of our company, even
if such change in control would be
13
beneficial to stockholders. Our articles of incorporation provide that our board
of directors may issue preferred stock without stockholder approval. The
issuance of preferred stock could make it more difficult for a third party to
acquire us. All of the foregoing could adversely affect prevailing market prices
for our common stock.
OUR COMMON STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.
The market price of our common stock is likely to be highly volatile as the
stock market in general, and the market for small cap and micro cap technology
companies in particular, has been highly volatile. For example, during the past
twelve months, our common stock has traded at prices ranging from $1.20 to $3.65
per share. Investors may not be able to resell their shares of our common stock
following periods of volatility because of the market's adverse reaction to
volatility. We cannot assure you that our common stock will trade at the same
levels of other stocks in our industry or that our industry stocks in general
will sustain their current market prices. Factors that could cause such
volatility may include, among other things:
o actual or anticipated fluctuations in our quarterly operating
results;
o large purchases or sales of our common stock;
o announcements of technological innovations;
o changes in financial estimates by securities analysts;
o investor perception of our business prospects;
o conditions or trends in the digital information asset management
industry;
o changes in the market valuations of other such industry related
companies;
o the acceptance of market makers and institutional investors of our
common stock; and
o worldwide economic or financial conditions.
SHARES OF COMMON STOCK ELIGIBLE FOR SALE IN THE PUBLIC MARKET MAY ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
Sales of substantial amounts of common stock by stockholders in the public
market, or even the potential for such sales, may adversely affect the market
price of our common stock and could impair our ability to raise capital by
selling equity securities. As of the date of this prospectus, approximately
6,735,858 of the 13,326,353 shares of common stock currently outstanding were
freely transferable without restriction or further registration under the
securities laws, unless held by "affiliates" of our company, as that term is
defined under the securities laws. In addition, 5,080,743 shares of common stock
have been registered for resale, including the 2,428,477 shares offered under
this prospectus and the 2,652,266 shares offered under our prospectus dated
April 14, 2005. We also have outstanding approximately 6,590,495 shares
(excluding 4,933,942 shares of common stock issuable upon conversion of our
outstanding shares of Series A preferred stock) of restricted stock, as that
term is defined in Rule 144 under the securities laws, that are eligible for
sale in the public market, subject to compliance with the holding period, volume
limitation and other requirements of Rule 144. Moreover, the exercise of
outstanding options and warrants and the conversion of outstanding convertible
promissory notes will result in additional outstanding shares of common stock
and will create additional potential for sales of additional shares of common
stock in the public market.
14
CONVERSION OR EXERCISE OF OUR OUTSTANDING CONVERTIBLE SECURITIES HELD BY LAURUS
COULD SUBSTANTIALLY DILUTE OUR EARNINGS PER SHARE AND THE VOTING POWER OF
EXISTING STOCKHOLDERS.
In connection with the execution of our two credit facilities with Laurus
in May 2004 and June 2005, we issued secured convertible promissory notes to
Laurus, the outstanding aggregate principal amount of which, at October 10,
2005, was convertible at a fixed conversion price into approximately 3,681,111
shares of our common stock. We also issued stock purchase warrants to Laurus
that, at October 10, 2005, were exercisable to purchase an aggregate of
1,256,000 shares of our common stock. In addition, we have available under our
June 2005 credit facility with Laurus, the ability to borrow an additional $3
million that would be convertible into approximately 1,033,344 shares of our
common stock. All interest payable from time to time on our credit facilities
with Laurus also is convertible by Laurus into shares of our common stock at the
applicable fixed conversion price. The large number of shares that we may
potentially issue to Laurus under our two credit facilities with Laurus,
including as a result of additional borrowings, could result in the dilution of
our earnings, if any, per share and the voting power of our existing
stockholders.
WE MAY BE UNSUCCESSFUL IN OUR EFFORTS TO CONTINUE MAKING PAYMENTS TO LAURUS
USING SHARES OF OUR COMMON STOCK IN LIEU OF CASH, WHICH COULD HAVE A MATERIAL
ADVERSE AFFECT ON OUR LIQUIDITY
The terms of the note we issued to Laurus in connection with the 2004
Facility provide that Laurus may direct us to pay scheduled monthly payments of
principal and interest either in cash, in shares of our common stock or a
combination of both. In the past, we have agreed to reduce the fixed conversion
price of such note in order to induce Laurus to allow us to pay the scheduled
monthly payment in shares of our common stock. In the short term, we intend to
continue to request that Laurus accept payment in the form of shares of our
common stock so that we may preserve cash for use in our business. However, if
the market price of our common stock is less than the fixed conversion price of
the note, or if the trading volume of our common stock is insufficient to allow
Laurus to sell its shares of our common stock, Laurus may be unwilling to permit
us to pay future scheduled monthly payments of principal and interest in shares
of our common stock. As a result, we would have to make such payments in cash
which could have a material adverse affect on our liquidity.
THE LARGE NUMBER OF FREELY-TRADEABLE SHARES OF OUR COMMON STOCK BENEFICIALLY
OWNED BY LAURUS COULD NEGATIVELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
At October 10, 2005, Laurus had the right to acquire upon conversion of a
convertible note issued under our May 2004 credit facility with Laurus (the
"2004 Note") and the exercise of stock purchase warrants issued in respect of
such credit facility an aggregate of 1,901,821 shares of our common stock that
are freely tradeable without restriction or further registration under the
Securities Act. In addition, upon payment in full of the 2004 Note, whether by
payment in cash or upon conversion of the 2004 Note into shares of our common
stock or the then-current market price is less than the conversion price of the
2004 Note, Laurus will have the right to acquire an additional 3,035,290 shares
of our common stock, including (i) 1,463,415 shares of common stock issuable
upon conversion of the minimum borrowing note currently outstanding in the
principal amount of $3.0 million under the 2005 Facility, which shares will be
freely tradeable without restriction and are offered in this prospectus, (ii)
400,000 shares of common stock issuable upon exercise of stock purchase warrants
issued in connection with the 2005 Facility, which shares will be freely
tradeable without restriction and are offered in this prospectus and (iii)
1,171,875 shares of common stock issuable upon conversion of the $3.0 million
currently drawn under the $6.0 million revolving note outstanding under the 2005
Facility, which shares will be `restricted securities', as that term is defined
in Rule 144 under the Securities Act, and will be eligible for sale in the
public market only in compliance with the holding period, volume limitation and
other requirements of Rule 144 under the Securities Act. Although the terms of
our credit facilities with Laurus provide that,
15
subject to certain limitations, Laurus may not exercise or convert any of our
securities if, as a result of such exercise or conversion, Laurus would
beneficially own more than 4.99% of our outstanding common stock, the potential
issuance of these securities could depress the market price of our common stock.
Moreover, the additional shares and convertible securities that we may be
required to issue to Laurus under our credit facilities with Laurus, including
as a result of additional borrowings or in lieu of the cash payments of interest
or penalties, could further adversely affect the market price of our common
stock.
ADDITIONAL DELAYS BY US IN FILING OR HAVING DECLARED EFFECTIVE A REGISTRATION
STATEMENT COVERING THE SHARES OF OUR COMMON STOCK BENEFICIALLY OWNED BY LAURUS
COULD REQUIRE US TO ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK TO LAURUS, WHICH
WOULD RESULT IN ADDITIONAL DILUTION TO OUR EXISTING STOCKHOLDERS AND MAY
ADVERSELY IMPACT OUR LIQUIDITY POSITION.
On two occasions over the past 12 months, we failed to maintain the
effectiveness of our registration statement covering the resale of shares of
common stock issuable to Laurus under the 2004 Note. As a result, we incurred
cash penalties totaling $464,000. In lieu of paying these penalties in cash, we
issued to Laurus warrants to purchase an aggregate of 412,500 shares of our
common stock. In addition, we have, in the past, required the consent of Laurus
and/or a modification of our credit facilities with Laurus in order for us to
consummate certain transactions. In connection with one of such consents and
modifications, we agreed to lower the fixed conversion price of the 2004 Note,
which will result in a greater number of shares being issued upon conversion of
the 2004 Note. Although we do not anticipate additional defaults by us under the
terms of the Laurus credit facilities, there can be no assurance that additional
defaults will not occur. The issuance of additional warrants upon any future
default could further depress the market price of our common stock and cause
further dilution to our existing stockholders. There also can be no assurance
that, upon any such event of default, Laurus will agree to accept warrants to
purchase shares of our common stock in lieu of a cash payment if we so request.
If Laurus refuses such a request, depending on our liquidity position at the
time of such default, the payment of such cash penalties could adversely affect
our financial condition.
CERTAIN RESTRICTIVE COVENANTS CONTAINED IN THE LAURUS CREDIT FACILITIES COULD
NEGATIVELY IMPACT OUR ABILITY TO OBTAIN FINANCING FROM OTHER SOURCES.
Our credit facilities with Laurus restrict us from obtaining additional
secured or unsecured debt financing in excess of $100,000 without the prior
approval of Laurus. We also are restricted from issuing any shares of preferred
stock without the prior approval of Laurus. To the extent that Laurus declines
to approve a proposed secured or unsecured debt financing or issuance of
preferred stock, we would be unable to obtain such financing without defaulting
under our credit facilities with Laurus. In addition, subject to certain
exceptions, we have granted to Laurus a right of first refusal to purchase any
additional debt or equity securities we may seek to issue to raise additional
capital. The securities held by Laurus contain anti-dilution protections against
the issuance of equity securities at a price per share that is less than the
fixed conversion price or exercise price of our convertible notes or stock
purchase warrants held by Laurus. The right of first refusal and anti-dilution
protections granted to Laurus could act as deterrents to third parties that may
be interested in providing us debt financing or purchasing our equity
securities. To the extent that such a financing is required for us to continue
to conduct or expand our operations, these restrictions could have a material
adverse affect on our operations or financial condition.
AN UNFAVORABLE OUTCOME IN OUR PENDING LEGAL PROCEEDING WITH ONE OF OUR CREDITORS
COULD RESULT IN THE ACCELERATION OF A $2.5 MILLION PROMISSORY NOTE, WHICH WOULD
HAVE A MATERIAL ADVERSE AFFECT ON OUR FINANCIAL CONDITION.
We are engaged in the early stages of an arbitration proceeding to resolve
a dispute with one of our creditors that, if resolved unfavorably, would have a
material adverse affect on our liquidity and
16
financial condition. In connection with our acquisition of STAR (now known as
Incentra of CA) in February 2005, we issued to Alfred Curmi, the principal
stockholder of STAR, a promissory note (the "STAR Note") in the principal amount
of $2.5 million that is payable in ten installments and matures on August 1,
2007. On August 1, 2005, we elected not to make a payment to Mr. Curmi due under
the STAR Note after we identified significant required post-closing adjustments
to the purchase price for the assets of STAR and, consequently, the principal
amount of the STAR Note. On August 16, 2005, we received a demand for
arbitration from legal counsel to Mr. Curmi. The parties have an arbitration
hearing scheduled in April 2006, but are currently seeking to schedule a
mediation prior to such hearing in order to resolve the dispute. In the event
the dispute is not resolved in a mediation and the parties proceed to submit to
arbitration, the full outstanding balance of the STAR Note could be accelerated
if the arbitrator were to rule in favor of Mr. Curmi in such proceeding. We do
not have the cash available to pay such amount and, in such event, we would
require additional financing to meet our obligation. There can be no assurance
that we would be able to obtain additional funding when needed, or that such
funding, if available, will be obtainable on terms acceptable to us. In the
event our operations do not generate sufficient cash flow, or we cannot obtain
additional funds if and when needed, we may be forced to curtail or cease our
activities, which would likely result in the loss to investors of all or a
substantial portion of their investment.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business," and elsewhere in this prospectus constitute
forward-looking statements. These statements involve risks known to us,
significant uncertainties, and other factors which may cause our actual results,
levels of activity, performance, or achievements to be materially different from
any future results, levels of activity, performance, or achievements expressed
or implied by those forward-looking statements.
You can identify forward-looking statements by the use of the words "may,"
"will," "should," "could," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "intends," "potential," "proposed," or "continue" or
the negative of those terms. These statements are only predictions. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined above. These factors may cause our actual results
to differ materially from any forward-looking statement.
Although we believe that the exceptions reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
USE OF PROCEEDS
We will not receive any proceeds from the sale of the shares of our common
stock by Laurus.
We would receive proceeds of up to $1,052,000 upon the exercise, if any, of
the seven-year warrants granted by us to Laurus, which warrants are exercisable
for an aggregate 400,000 shares of common stock. We intend to use any such
proceeds for working capital and general corporate purposes.
Further, to the extent that any of our obligations under our credit
facilities with Laurus are converted into, or paid in the form of, shares of our
common stock, we will be relieved of such obligations to the extent of such
conversion or payment.
17
The amount of proceeds to us described above assumes Laurus will not elect
to exercise its warrant through a "cashless exercise". Under the terms of such
warrant, payment of the exercise price may be made, at the option of the warrant
holder, either in cash or by a "cashless exercise". Upon a cashless exercise, in
lieu of paying the exercise price in cash, the warrant holder would receive
shares of our common stock with a value equal to the difference between the
market price of our common stock at the time of exercise and the exercise price
set forth in the warrant, multiplied by the number of shares so exercised. There
would be no proceeds to us upon a "cashless exercise" of the warrant.
We cannot assure you that Laurus will exercise the warrant described above,
or that it will elect to pay the exercise price in cash in lieu of a "cashless
exercise."
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
MARKET FOR COMMON STOCK
Our common stock is traded on the OTC Bulletin Board under the symbol
"ICNS."
The following table contains information about the range of high and low
bid prices for our common stock for each full quarterly period in our last two
fiscal years and for the four fiscal quarters of 2005 (through October 10),
based upon reports of transactions on the OTC Bulletin Board.
High Bid Low Bid
-------- -------
2003
First Quarter................................ $3.75 $1.55
Second Quarter............................... 2.60 1.00
Third Quarter................................ 3.40 1.50
Fourth Quarter............................... 2.05 1.10
2004
First Quarter................................ $11.50 $1.50
Second Quarter .............................. 8.20 3.25
Third Quarter................................ 3.70 2.10
Fourth Quarter............................... 3.45 2.30
2005
First Quarter................................ $3.00 $1.90
Second Quarter ............................. 2.30 1.40
Third Quarter............................... 1.95 1.20
Fourth Quarter (through October 10, 2005)... 1.78 1.55
The source of these high and low prices was the OTC Bulletin Board. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commissions and may not represent actual transactions. In addition, where
applicable, such quotations have been adjusted to give effect to the one-for-ten
reverse stock split effected on June 9, 2005.
The market price of our common stock is subject to significant fluctuations
in response to variations in our quarterly operating results, general trends in
the market for the products we distribute, and other factors, over many of which
we have little or no control. In addition, board market fluctuations, as well as
general economic, business and political conditions, may adversely affect the
market for our
18
common stock, regardless of our actual or projected performance. On October 10,
2005, the closing bid price of our common stock as reported by the OTC Bulletin
Board was $1.30 per share.
HOLDERS
As of October 10, 2005, there were approximately 357 stockholders of record
of our common stock.
DIVIDEND POLICY
We have not paid cash dividends on any class of common equity since
formation and we do not anticipate paying any dividends on our outstanding
common stock in the foreseeable future. The purchase agreement relating to our
outstanding secured convertible promissory notes prohibits the declaration or
payment of dividends on our common stock without the approval of Laurus.
Furthermore, the terms of our Series A preferred stock provide that, so long as
at least 250,000 shares of our originally issued shares of Series A preferred
stock are outstanding, we cannot declare or pay any dividend without having
first obtained the affirmative vote or consent of at least 80% of the voting
power of our outstanding shares of Series A preferred stock.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
When used in this discussion, the words "believes", "anticipates",
"expects" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected.
Our business and results of operations are affected by a wide variety of
factors that could materially and adversely affect us and our actual results,
including, but not limited to: (1) the availability of sufficient funds to
enable us to successfully pursue our business plan; (2) the uncertainties
related to the effectiveness of our technologies and the development of our
products and services; (3) our ability to maintain, attract and integrate
management personnel; (4) our ability to complete the development and continued
enhancement of our products in a timely manner; (5) our ability to effectively
market and sell our products and services to current and new customers; (6) our
ability to negotiate and maintain suitable strategic partnerships and corporate
relationships; (7) the intensity of competition; and (8) general economic
conditions. As a result of these and other factors, we may experience material
fluctuations in future operating results on a quarterly or annual basis, which
could materially and adversely affect our business, financial condition,
operating results and stock price.
Any forward-looking statements herein speak only as of the date hereof. We
undertake no obligation to publicly release the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
BUSINESS OUTLOOK
The following summarized discussion of financial results for the year ended
December 31, 2004 and the six months ended June 30, 2005 and 2004 is of our
results on a pro forma basis, giving effect to the acquisitions of Front Porch,
Incentra of CA and PWI as if they had occurred on January 1, 2004. We believe
the pro forma results of operations provide additional and more relevant
information about the operating performance of our business and give a better
indication of our results of operations, and the size and scalability of our
business on a forward looking basis. However, the pro forma statements are not
intended as a substitute for financial statements prepared in accordance with
generally accepted accounting principles. Please see our discussion of actual
results of operations which follow.
For the year ended December 31, 2004 and the six months ended June 30, 2004
and 2005, pro forma revenues totaled $56.5 million, $28.1 million and $34.1
million, respectively. The rate of year-over-year growth in revenues for the six
months ended June 30, 2005 was approximately 21%. The significant growth in
revenue was a result of increased sales and deliveries of our proprietary
DIVArchive solution, third-party hardware and software and our professional
services. In addition, we have a recurring revenue base created by our
proprietary Gridworks Operations System Support solution that provides added
stability and predictability in revenue, as well as a significant growth
opportunity through the expansion of services to existing customers, the
continued increase in the amount of data under protection, as well as new
enterprise and service provider customer opportunities.
We continue to invest in hardware and the development of our software and
digital archiving products in the data storage and infrastructure areas. During
the six months ended June 30, 2005, we
20
invested $0.7 million in software development and $0.5 million for data storage
infrastructure development.
During the six months ended June 30, 2005, we realized adjusted EBITDA(1)
of approximately $0.7 million on a pro forma basis. EBITDA adjustments remove
the impacts of the former owner's costs as well as non-cash stock compensation
expense and referral fee amortization. Also included in EBITDA for the six
months ended June 30, 2005 was a non-cash gain of approximately $390,000 due to
the revaluation of the derivative warrant liability.
We intend to further leverage our unique intellectual property by
continuing to leverage our position as a leading provider of archive software
solutions. In addition, we intend to expand our product and service offerings to
position ourselves as a provider of a wide range of services and products to the
broadcast and media markets. We believe we can increase revenues from existing
and new customers by
- ----------
(1) EBITDA is defined as earnings before interest, taxes, depreciation and
amortization and cumulative effect of changes in accounting principles.
Adjusted EBITDA is defined as EBITDA adjusted for former owner costs,
non-cash stock based compensation expense and referral fees. Although
EBITDA and adjusted EBITDA are not a measure of performance or liquidity
calculated in accordance with generally accepted accounting principles
(GAAP), we believe the use of the non-GAAP financial measure EBITDA and
adjusted EBITDA enhances an overall understanding of our past financial
performance and is a widely-used measure of operating performance in
practice. In addition, we believe the use of EBITDA and adjusted EBITDA
provides useful information to the investor because EBITDA excludes
significant non-cash interest and amortization charges related to our past
financings and amortization of intellectual property acquired in the
acquisitions, that, when excluded, we believe produces operating
information that we believe is meaningful to users of our financial
information. EBITDA also excludes depreciation and amortization expenses.
However, investors should not consider this measure in isolation or as a
substitute for net income, operating income, cash flows from operating
activities or any other measure for determining our operating performance
or liquidity that are calculated in accordance with GAAP, and this measure
may not necessarily be comparable to similarly titled measures employed by
other companies. A reconciliation of EBITDA and adjusted EBITDA to the most
comparable GAAP financial measure on a pro forma basis, net loss before
deemed dividends and accretion on preferred stock is set forth below.
* EBITDA and Adjusted EBITDA Reconciliation
June 30, 2005
All amounts in (000's)
Six Months Ended
June 30, 2005
Pro forma net loss before deemed dividends
and accretion on preferred stock $ (4,741)
Depreciation and amortization 2,694
Taxes 879
Interest (cash portion) 326
Interest (non-cash portion) 897
---------
EBITDA 55
---------
Former owner costs 314
Non-cash stock based compensation 264
Referral fees 72
---------
EBITDA, as adjusted $ 705
=========
21
offering complete archive solutions, including storage hardware and software,
servers and peripheral devices, as well as first call support services. To
facilitate this strategy, we intend to increase our volume of products available
for resale to customers both directly and through existing channel partners. We
also plan to increase our expenditures for sales and marketing initiatives to
meet what appears to be an increasing volume of digital archive implementations
in the North American market and throughout the rest of the world.
We also believe we can increase our sales of managed services by
introducing these services to the customers of our recently-acquired businesses.
We believe our professional services business will also be enhanced as we
leverage our engineering resources across our entire customer base. In the six
months ended June 30, 2005, we increased engineering and sales resources and
will continue to increase these resources, which are focused on the enterprise
market and will resell a variety of storage products directly to businesses.
As we continue to grow, we will need to sustain and possibly increase the
investment of capital into our software technologies, Gridworks and DIVArchive,
to ensure they maintain their competitive advantage and to further enhance their
inter-operability and feature sets.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 3 to the
Consolidated Financial Statements. Some of these significant accounting policies
require management to make difficult, subjective or complex judgments or
estimates. Management believes our most important accounting policies include
revenue recognition, software development costs, stock-based compensation,
impairment of long-lived assets and concentrations of risk related to customers.
REVENUE RECOGNITION
Given the growth in orders during 2004 and the continuation of such growth
into 2005, as well as the complexities and estimates involved in measuring and
determining revenue in accordance with generally accepted accounting principles,
our accounting for revenue is crucial to the proper periodic reporting of
revenue and deferred revenue.
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.
We license software under license agreements and provide professional
services, including training, installation, consulting and maintenance. License
fee revenues are recognized when a license agreement has been signed, the
software product has been shipped, the fees are fixed or determinable,
collection is reasonably assured, and no significant vendor obligations remain.
We allocate revenue to each component of a contract based on
vendor-specific objective evidence of its fair value. Because licensing of
software is generally not dependent on the professional services portion of the
contract, software revenue is generally recognized upon delivery, unless a
contract exists with the customer requiring customer acceptance.
Fees for first call maintenance agreements are recognized ratably over the
terms of the agreements. Maintenance is generally billed in advance, resulting
in deferred revenue.
22
We also provide software-related professional services. Services are
generally provided on a time-and-materials basis and revenue is recognized as
the services are provided.
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 we have not yet performed the related services.
Revenues from product sales, including the resale of third-party
maintenance contracts, are recognized when shipped. Consulting revenues are
recognized when the services are performed.
SOFTWARE DEVELOPMENT COSTS
As expenditures for software development are expected to increase, the
capture and measurement, as well as proper capitalization, of these costs is a
key focus of management. The proper matching of these costs with the related
revenue impacts the proper periodic reporting of revenues and related costs. We
capitalize costs in developing software products upon making a determination
that technological feasibility has been established for the product, if that
product is to be sold, leased or otherwise marketed. The establishment of
technological feasibility is highly subjective. Costs incurred prior to the
establishment of technological feasibility are charged to research and
development expense. When the product is available for general release to
customers, capitalization is ceased, and all previously capitalized costs are
amortized over the remaining estimated economic useful life of the product, not
to exceed to three years.
STOCK-BASED COMPENSATION
SFAS No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION, defines a
fair-value-based method of accounting for stock-based employee compensation
plans and transactions in which an entity issues its equity instruments to
acquire goods or services from non-employees, and encourages but does not
require companies to record compensation cost for stock-based employee
compensation plans at fair value.
We have elected to account for employee stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25
(APB No. 25), ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related
interpretations. Accordingly, employee compensation cost for stock options is
measured as the excess, if any, of the estimated fair value of our stock at the
date of the grant over the amount an employee must pay to acquire the stock.
Transactions in which we issue stock-based compensation for goods or
services received from non-employees are accounted for based on the fair value
of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measurable. We often utilize pricing models
in determining the fair values of options and warrants issued as stock-based
compensation to non-employees. These models require us to make certain estimates
and assumptions, and utilize the market price of our common stock and the
exercise price of the option or warrant, as well as time value and volatility
factors underlying the positions.
In December 2004, the FASB issued SFAS No. 123(R) SHARE-BASED PAYMENT,
which addresses the accounting for share-based payment transactions. SFAS No.
123(R) 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 and
recognized in the statement of income based on their fair value. SFAS No. 123(R)
will be effective for public companies that file as small business issuers as of
the first interim or annual reporting period that begins after
23
December 15, 2005. We are evaluating the provisions of this standard. Depending
upon the number and terms of options that may be granted in future periods, the
implementation of this standard could have a material impact on our financial
position and results of operations, and will require us to make estimates and
assumptions that have a significant impact in the estimated fair value.
ACCOUNTING FOR OBLIGATIONS AND INSTRUMENTS POTENTIALLY SETTLED IN THE COMPANY'S
COMMON STOCK
We account for obligations and instruments potentially to be settled in our
stock in accordance with EITF 00-19, ACCOUNTING FOR DERIVATIVE FINANCIAL
INSTRUMENTS INDEXED TO, AND POTENTIALLY SETTLED IN A COMPANY'S OWN STOCK. This
issue addresses the initial balance sheet classification and measurement of
contracts that are indexed to, and potentially settled in, our own stock.
Under EITF 00-19 contracts are initially classified as equity or as either
assets or liabilities, depending on the situation. All contracts are initially
measured at fair value and subsequently accounted for based on the then current
classification. The determination of fair value requires us to use valuation
models that incorporate estimates and assumptions, and their value is highly
dependent upon those estimates and assumptions. Contracts initially classified
as equity do not recognize subsequent changes in fair value as long as the
contracts continue to be classified as equity. For contracts classified as
assets or liabilities, we report changes in fair value in earnings and disclose
these changes in the financial statements as long as the contracts remain
classified as assets or liabilities. If contracts classified as assets or
liabilities are ultimately settled in shares, any previously reported gains or
losses on those contracts continue to be included in earnings. The
classification of a contract is reassessed at each balance sheet date.
At December 31, 2004, our authorized and unissued common shares were
insufficient to settle these contracts. As a result, we classified the value of
these contracts as a liability. As a result of the one-for-ten reverse stock
split on June 9, 2005, there are now sufficient authorized and unissued common
shares to settle these contracts. Accordingly, the fair value of the warrants at
the effective date of the stock split was reclassified to additional paid-in
capital.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived, tangible and intangible assets that do not have indefinite
lives, such as fixed assets and intellectual property, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. As a result of our recent
acquisitions, at June 30, 2005, we had approximately $29.4 million in intangible
assets, of which $14.5 million was goodwill. Determination of the recoverability
of finite-live assets, including intangibles, is based on an estimate of
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. Measurement of an impairment loss for such long-lived
assets is based on the fair value of the asset. Determining whether an asset has
been impaired requires projections of our future performance, and determination
of fair value requires the use of significant estimates. As such, these
assessments are highly subjective, and dependent upon the estimates and
assumptions used.
Goodwill and other intangible assets with indefinite lives are not
amortized and are subject to write downs charged to results of operations only
when their carrying amounts are determined to be more than their estimated fair
values based upon impairment tests that are required to be made annually or more
frequently under certain circumstances. Fair values are determined based on
models that incorporate estimates of future probability and cash flows.
Determining whether an asset has been impaired requires projections of our
future performance, and determination of fair value requires the use of
significant
24
estimates. As such, these assessments are highly subjective, and dependent upon
the estimates and assumptions used.
CONCENTRATION OF RISK - CUSTOMERS AND GEOGRAPHIC
We sell our products and services throughout North America, Europe and the
Asia/ Pacific Rim. We perform periodic credit evaluations of our customers'
financial condition and generally do not require collateral. Credit losses have
been within our expectations. For the years ended December 31, 2003 and 2004 and
the six months ended June 30, 2005, aggregate revenues from customers located in
Europe or Asia amounted to $1.1 million, $4.7 million and $7.4 million,
respectively, or 11%, 35% and 31%, respectively, of total revenue, while
revenues from customers located in North America totaled $8.7 million, $8.6
million and $16.2 million, respectively, or 89%, 65% and 69%, respectively, of
total revenue. For the six months ended June 30, 2004, our revenues from
customers located in Europe or Asia amounted to $0.9 million, or 20% of total
revenue, while revenues from customers located in North America totaled $3.4
million, or 80% of total revenue.
On a pro forma basis, giving effect to the acquisitions as if they had
occurred on January 1, 2004, for the year ended December 31, 2004 and the six
months ended June 30, 2005, aggregate revenues from customers located in Europe
or Asia amounted to $9.0 million and $7.4 million, or approximately 16% and 22%,
respectively, of total revenue, while revenues from customers located in North
America totaled $47.5 million and $26.6 million, respectively, or approximately
84% and 78%, respectively of total revenue.
For the six months ended June 30, 2005, no one customer represented 10% or
more of total revenues, and as of June 30, 2005 no one customer represented more
than 10% of accounts receivable. For the six months ended June 30, 2004,
revenues from three customers, each exceeding 10% of total revenues, represented
18% , 17% and 17%, respectively, of accounts receivable. During 2004, revenues
from two customers, each exceeding 10% of total revenue, aggregated 13% and 11%,
respectively. Accounts receivable from these customers represented approximately
20% of total trade receivables at December 31, 2004. During 2003, revenues from
three customers each exceeding 10% of revenue represented 36%, 19%, and 11%,
respectively, of total revenues.
The following discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. These estimates are based on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THE THREE MONTHS ENDED
JUNE 30, 2004
REVENUE. Total revenue for the three months ended June 30, 2005 increased
$15.7 million, or 827%, to $17.6 million compared to total revenue of $1.9
million for the three months ended June 30, 2004. Revenue from the sale of our
products increased to $13.8 million compared to revenue of approximately $30,000
for the comparable prior year period. This increase was attributable to the
additional revenues of $13.7 resulting from the acquisitions of Front Porch,
Incentra of CA and PWI.
25
Revenue from delivery of our services increased $1.9 million, or 100%, to $3.8
million compared to $1.9 million for the comparable prior year period. Service
revenue increased $1.9 million due to the acquisitions as described above.
For the quarter ended June 30, 2005, a significant portion of our revenues
were derived from the European and Asian geographic markets. During that period,
aggregate revenues from customers located in Europe or Asia amounted to $4.4
million, or 25% of total revenue, while revenues from customers located in North
America totaled $13.2 million, or 75% of total revenue. For the quarter ended
June 30, 2004, revenues from customers located in Europe and Asia amounted to
$1.0 million, or 55% of total revenue, while revenues from customers located in
North America totaled $0.9 million, or 45% of total revenue.
GROSS MARGIN. Total gross margin for the three months ended June 30, 2005
increased $4.5 million to $5.1 million, or 29% of total revenue, as compared to
gross margin of $0.6 million, or 30% of total revenue, for the comparable prior
year period. Product gross margin for the three months ended June 30, 2005
totaled $3.8 million, or 27% of product revenue. Service gross margin for the
three months ended June 30, 2005 totaled $1.3 million, or 35% of service
revenue. Gross margins were consistent with management expectations for the
quarter.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("SG&A") expenses for the three months ended June 30, 2005
increased by approximately $3.3 million to $5.4 million from $2.1 million for
the comparable prior year period. SG&A expenses included $3.6 million in
salaries and related benefits for employees not directly related to the
production of revenue, $0.7 million in general office expenses, $0.4 million in
professional fees, $0.3 million for travel-related costs, and $0.3 million in
facilities costs. SG&A expenses of $2.1 million for the comparable prior year
period included $1.3 million in salaries and related benefits for employees not
directly related to the production of revenue, $0.3 million in general office
expenses, $0.1 million in travel related costs, $0.2 million in professional
fees, $0.1 million of facilities costs and $0.1 million of bad debt expense. The
increase in SG&A expenses during the three months ended June 30, 2005 was due to
the inclusion of $3.9 million of SG&A expenses for the acquisitions described
above, offset by a reduction in MSI's SG&A expenses.
DEPRECIATION AND AMORTIZATION. Amortization expense consists of
amortization of intellectual property, capitalized software development costs
and other intangible assets. Depreciation expense consists of depreciation of
furniture, equipment, software and improvements. Depreciation and amortization
expense was approximately $1.3 million and $0.8 million for the three months
ended June 30, 2005 and 2004, respectively, of which $0.3 million and $0.4
million was included in cost of revenue for the periods ending June 30, 2005 and
2004. The increase was primarily due to the increase in amortization associated
with the intangible assets purchased in the acquisition of Front Porch.
OPERATING LOSS. During the three months ended June 30, 2005, we incurred a
loss from operations of $1.2 million as compared to a loss from operations of
$1.9 million for the three months ended June 30, 2004. This decrease in
operating loss was primarily the result of an increase in gross margin of
approximately $4.5 million for the three months ended June 30, 2005 offset by an
increase in selling, general and administrative expenses of approximately $3.3
million and depreciation expense of $0.6 million due to the acquisitions of
Front Porch, Incentra of CA and PWI.
INTEREST EXPENSE. Interest expense was $0.6 million for the three months
ended June 30, 2005 compared to $0.7 million for the three months ended June 30,
2004. The decrease in interest expense was attributable to a decrease of $0.7
million of non-cash interest expense on MSI's previously outstanding Series C
preferred stock, offset in part, by an increase in non-cash interest of $0.1
million related to
26
warrants, non-cash interest of $0.4 million for amortization of debt discounts
and deferred financing costs and $0.2 million of cash interest on senior secured
convertible notes and capital leases.
OTHER INCOME AND EXPENSE. Other income was approximately $11,000 for the
three months ended June 30, 2005 compared to approximately $34,000 for the three
months ended June 30, 2004. Other income for the three months ended June 30,
2005 and 2004 included investment income from leased equipment to customers and
gains from sales of fixed assets and the revaluation of our derivative warrant
liability.
FOREIGN CURRENCY TRANSACTION GAIN (LOSS). As discussed above, we conduct
business in various countries outside the United States in which the functional
currency of the country is not the U. S. dollar. We are subject to foreign
exchange transaction exposure because we provide for intercompany funding
between the U.S. and international operations, when we and/or our French
subsidiary transact business in a currency other than our own functional
currency. The effects of exchange rate fluctuations in remeasuring foreign
currency transactions for the three months ended June 30, 2005 resulted in a
loss of approximately $8,000.
INCOME TAX EXPENSE We incurred income tax expense for the three months
ended June 30, 2005 of $0.6 million. This expense represented non-cash income
tax expense related to our French subsidiary, Front Porch Digital International,
S.A.S. These income taxes have no cash impact due to the utilization of the
subsidiary's deferred tax assets during the period.
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the three months ended
June 30, 2005, we incurred a net loss applicable to common shareholders of $3.0
million as compared to a net loss applicable to common shareholders of $2.7
million for the three months ended June 30, 2004. The increase in net loss for
the three months ended June 30, 2005 was primarily due to an increase in
accretion on the outstanding Series A preferred stock of $0.7 million.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2004
REVENUE. Total revenue for the six months ended June 30, 2005 increased
$19.3 million, or 449%, to $23.6 million compared to total revenue of $4.3
million for the six months ended June 30, 2004. Revenue from the sale of our
products increased to $17.0 million compared to revenue of $0.4 million for the
comparable prior year period. Revenue from product sales increased $16.6 million
from $0.4 million to $17.0 million for the comparable prior year period. Front
Porch, Incentra of CA and PWI contributed $16.9 million of the increase, offset
slightly by a decline in MSI product revenue of $0.3 million. Revenue from
delivery of our services increased $2.7 million, or 71%, to $6.6 million
compared to $3.9 million for the comparable prior year period. Service revenue
increased $2.7 million due to the acquisitions of Front Porch, Incentra of CA,
and PWI.
For the six months ended June 30, 2005, a significant portion of our
revenues were derived from the European and Asian geographic markets. During
that period, aggregate revenues from customers located in Europe or Asia
amounted to $7.4 million, or 31% of total revenue, while revenues from customers
located in North America totaled $16.2 million, or 69% of total revenue. For the
six months ended June 30, 2004, revenues from customers located in Europe and
Asia amounted to $0.9 million, or 20% of total revenue, while revenues from
customers located in North America totaled $3.4 million, or 80% of total
revenue.
GROSS MARGIN. Total gross margin for the six months ended June 30, 2005
increased $6.3 million to $8.0 million, or 34% of total revenue, as compared to
gross margin of $1.7 million, or 40% of total revenue, for the comparable prior
year period. Product gross margin for the six months ended June 30,
27
2005 totaled $5.7 million, or 34% of product revenue. Service gross margin for
the six months ended June 30, 2005 totaled $2.3 million, or 35% of service
revenue. The decrease in gross margin was the result of lower gross margins on
third party products, offset by increased gross margins realized by Front Porch
on sales of its DIVArchive.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses for the six months ended June 30, 2005 increased by
approximately $5.3 million to $9.4 million from $4.1 million for the comparable
prior year period. SG&A expenses for the six months ended June 30, 2005 included
$6.2 million in salaries and related benefits for employees not directly related
to the production of revenue, $1.1 million in general office expenses, $0.9
million in professional fees, $0.6 million for travel-related costs, $0.5
million in facilities costs and $0.1 million in research and development costs.
SG&A expenses of $4.1 million for the comparable prior year period included $2.5
million in salaries and related benefits for employees not directly related to
the production of revenue, $0.7 million in general office expenses, $0.3 million
in travel related costs, $0.3 million in professional fees, $0.2 million of
facilities costs and $0.1 million of bad debt expense. The increase in SG&A
expenses during the six months ended June 30, 2005 was due to the inclusion of
$6.3 million of SG&A expenses for Front Porch, Incentra of CA and PWI for the
two full quarters. This increase was offset by $1.0 million of reduced SG&A
expenses at MSI, primarily as a result of decreased staffing levels, and in
general office expenses.
DEPRECIATION AND AMORTIZATION. Amortization expense consists of
amortization of intellectual property, capitalized software development costs
and other intangible assets. Depreciation expense consists of depreciation of
furniture, equipment, software and improvements. Depreciation and amortization
expense was approximately $2.6 million and $1.5 million for the six months ended
June 30, 2005 and 2004, respectively, of which $0.6 million and $0.8 million was
included in cost of revenue for the periods ended June 30, 2005 and 2004. The
increase was primarily due to the increase in amortization associated with the
intangible assets purchased in the acquisition of Front Porch.
OPERATING LOSS. During each of the six months ended June 30, 2005 and June
30, 2004, we incurred a loss from operations of $3.1 million. An increase in
gross margin of approximately $6.3 million for the six months ended June 30,
2005 offset by an increase in selling, general and administrative expenses of
approximately $6.3 million during the period related to the acquisitions.
INTEREST EXPENSE Interest expense was $1.2 million for the six months ended
June 30, 2005 compared to $1.4 million for the six months ended June 30, 2004.
The decrease in interest expense was attributable to a decrease of $1.3 million
of non-cash interest expense on MSI's previously outstanding Series C preferred
stock, offset in part, by an increase in non-cash interest of $0.3 million
related to warrants, non-cash interest of $0.5 million for amortization of debt
discounts and deferred financing costs, $0.1 million related to the conversion
of debt to equity and $0.3 million of cash interest on senior secured
convertible notes and capital leases.
OTHER INCOME AND EXPENSE. Other income was $0.4 million for the six months
ended June 30, 2005 compared to $0.1 million for the six months ended June 30,
2004. Other income of $0.4 million for 2005 included $0.3 million of income
resulting from the revaluation of our derivative warrant liability and $0.1
million of investment income from leased equipment to customers and gains from
sales of fixed assets.
FOREIGN CURRENCY TRANSACTION GAIN. As discussed above, we conduct business
in various countries outside the United States in which the functional currency
of the country is not the U. S. dollar. We are subject to foreign exchange
transaction exposure because we provide for intercompany funding between the
U.S. and international operations, when we and/or our French subsidiary transact
business in
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a currency other than our own functional currency. The effects of exchange rate
fluctuations in remeasuring foreign currency transactions for the six months
ended June 30, 2005 resulted in a loss of approximately $1,000. In addition, we
entered into a forward contract, which expired on April 1, 2005, for which we
recorded a realized gain of approximately $74,600 for the six months ended June
30, 2005, which represented the change in the fair value for the foreign
currency forward contract related to the difference between changes in the spot
and forward rates excluded from the assessment of hedge effectiveness.
INCOME TAX EXPENSE. We incurred income tax expense for the six months ended
June 30, 2005 of $0.9 million. This income tax expense represents non-cash
income tax expense related to our French subsidiary, Front Porch Digital
International, S.A.S. These income taxes have no cash impact due to the
utilization of the subsidiary's deferred tax assets (net operating losses)
during that period.
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the six months ended
June 30, 2005, we incurred a net loss applicable to common shareholders of $6.0
million as compared to a net loss applicable to common shareholders of $4.8
million for the six months ended June 30, 2004. The increase in net loss for the
six months ended June 30, 2005 was primarily due to an increase in accretion on
the outstanding Series A preferred stock of $1.3 million.
YEAR ENDED DECEMBER 31, 2004 COMPARED TO THE YEAR ENDED DECEMBER 31, 2003
REVENUE. Total revenue for the year ended December 31, 2004 increased $3.5
million, or 35%, to $13.3 million compared to total revenue of $9.8 million for
the year ended December 31, 2003. Revenue from the sale of our products
increased to $5.2 million compared to revenue of $0 for the comparable prior
year period. This increase was attributable to:(1) the additional revenues
resulting from the merger with Front Porch in August 2004, (2) increased orders
for our software and related products, consisting primarily of sales of our
DIVArchive solutions and the licensing of the Gridworks OSS solution and (3)
sales of hardware as part of complete archive solutions and as part of SAN
infrastructures. Revenue from delivery of our services decreased $1.7 million,
or 17%, to $8.1 million compared to $9.8 million for the comparable prior year
period. The decrease in service revenue was the result of a reduction in revenue
of $2.8 million from a large customer that filed for bankruptcy in December 2003
and did not renew the service upon contract expiration in 2004, which was
offset, in part, by additional revenues of $1.1 million related to our existing
and new customer base in 2004.
For the year ended December 31, 2004, a significant portion of our revenues
were derived from the European and Asian geographic markets. During that period,
aggregate revenues from customers located in Europe or Asia amounted to $4.7
million, or 35% of total revenue, while revenues from customers located in North
America totaled $8.6 million, or 65% of total revenue. For the year ended
December 31, 2003, our revenues from customers located in Europe and Asia
amounted to $1.1 million, or 11% of total revenue, while revenues from customers
located in North America totaled $8.7 million, or 89% of total revenue.
GROSS MARGIN. Total gross margin for the year ended December 31, 2004
increased $3.1 million to $6.0 million, or 45% of total revenue, as compared to
gross margin of $2.9 million, or 29% of total revenue, for the comparable prior
year period. Product gross margin for the year ended December 31, 2004 totaled
$3.7 million, or 71% of product revenue. Service gross margin for the year ended
December 31, 2004 totaled $2.3 million, or 28% of service revenue. The increased
gross margin was primarily the result of the acquisition of Front Porch and the
sale of higher margin software (DIVArchive). The gross margin as a percentage of
total revenue reported for the year ended December 31, 2004 met our anticipated
gross margin and was significantly higher than the gross margin of 29% reported
for the prior year-end due to the growth in revenues of our DIVArchive
solutions.
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("SG&A") expenses for the year ended December 31, 2004 increased
slightly by approximately $0.9 million to $10.3 million from $9.4 million for
the comparable prior year period. Actual SG&A expenses for the year ended
December 31, 2004 included $5.9 million in salaries and related benefits for
employees not directly related to the production of revenue, $1.6 million in
general office expenses, $1.0 million in professional fees, $0.8 million for
travel-related costs, $0.6 million in facilities costs, $0.3 million in bad debt
expense and $0.1 million in research and development costs. SG&A expenses of
$9.4 million for the prior year ending December 31, 2003 included $5.4 million
in salaries and related benefits for employees not directly related to the
production of revenue, $1.5 million in general office expenses, $0.9 million in
professional fees, $0.8 million in travel related costs, $0.5 million of
facilities costs and $0.3 million of bad debt expense. The increase in SG&A
expenses during the year ended December 31, 2004 was a direct result of the
inclusion of SG&A expenses for Front Porch from the date of the acquisition
forward, which was offset, in part, by a reduction in payroll and related costs
as a result of reductions in staffing levels.
MERGER COSTS. Merger cost of $1.3 million in 2004 consists of costs
incurred in the acquisition of Front Porch. The costs consist of $0.8 million in
accelerated compensation expense related to the accelerated vesting of stock
options, $0.4 million in professional fees or legal, banking and accounting,
$0.1 million of severance related costs due to reduction in staffing as result
of the acquisition. There were no merger related costs in 2003.
DEPRECIATION AND AMORTIZATION. Amortization expense consists of
amortization of intellectual property, and other intangible assets. Depreciation
expense consists of depreciation of furniture, equipment, software and
improvements and capitalized research and development costs. Depreciation and
amortization expense was approximately $4.0 million and $3.3 million for the
years ended December 31, 2004 and 2003, respectively. The increase is driven by
the increase in amortization associated with the intangible assets created in
the acquisition of Front Porch.
OPERATING LOSS. During the year ended December 31, 2004, we incurred a loss
from operations of $7.7 million as compared to a loss from operations of $8.5
million for the year ended December 31, 2003. Included in the operating loss for
the year ended December 31, 2004 was $1.3 million of costs related to the merger
with MSI. Excluding the costs of the acquisition, the decrease in loss from
operations for the year ended December 31, 2004 was primarily due to the
increased revenues and gross margin described above.
INTEREST EXPENSE. Interest expense was $2.4 million for the year ended
December 31, 2004 compared to $2.2 million for the year ended December 31, 2003.
The increase in interest expense was attributable to increased amortization of
debt discounts. Interest expense during 2004 included cash interest costs of
$0.2 million on notes payable and capital leases and non-cash interest charges
of $2.2 million consisting of $1.7 million of interest on MSI's previously
outstanding Series C preferred stock, $0.2 million related to amortization of
debt discounts, $0.2 million related to warrants, and $0.1 million related to
amortization of financing costs. Interest expense of $2.2 million in 2003
included cash interest of $0.1 million on capital leases and non-cash interest
charges of $2.1 million consisting of $1.3 million on MSI's previously
outstanding Series C preferred stock and $0.8 million of interest in connection
with an issuance of MSI's previously outstanding common stock.
OTHER INCOME AND EXPENSE. Other income of $0.4 million for 2004 included
$0.3 million of income for the sale of New Jersey state net operating losses
from prior years and $0.1 million for investment income and gains from the sale
of fixed assets. Other expense of $0.3 million for 2003 included a loss on the
investment in Front Porch of $0.6 million (prior to the merger), reduced by $0.1
30
million of income from the sale of fixed assets and $0.2 million of income from
leased equipment to customers.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS. As discussed above, we
conduct business in various countries outside the United States in which the
functional currency of the country is not the U. S. dollar. As a result, we have
foreign currency exchange translation exposure as the results of these foreign
operations are translated into U.S. dollars in our consolidated financial
statements. For the year ended December 31, 2004, we reported an accumulated
translation gain of approximately $19,000 as a component of accumulated other
comprehensive income. We are also subject to foreign exchange transaction
exposure because we provide for intercompany funding between the U.S. and
international operations, when we and/or our French subsidiary transacts
business in a currency other than our own functional currency. The effects of
exchange rate fluctuations in remeasuring foreign currency transactions for the
year ended December 31, 2004 was a $25,000 loss. In addition, we entered into
two new forward contracts, one of which expired on December 7, 2004 and the
other of which expired on April 1, 2005. We recorded a realized loss of $0.1
million and an unrealized loss of $0.1 million on the contracts as of December
31, 2004, which represented the change in the fair value for the foreign
currency forward contract related to the difference between changes in the spot
and forward rates excluded from the assessment of hedge effectiveness.
INCOME TAX EXPENSE. We incurred income tax expense for the year ended
December 31, 2004 of $0.4 million. This income tax expense represents non-cash
deferred income tax expense related to our French subsidiary, Front Porch
Digital International, S.A.S. These income taxes were incurred during the period
from the Acquisition through December 31, 2004 and represent the utilization of
the subsidiary's deferred tax assets (net operating losses) during that period,
which was recorded as a deferred tax asset in purchase accounting.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS. During the year ended December
31, 2004, we incurred a net loss applicable to common stockholders of $11.8
million as compared to a net loss applicable to common stockholders of $12.7
million for the year ended December 31, 2003. Included in the net loss for the
year ended December 31, 2004 was $1.3 million of costs related to the
acquisition. Excluding the acquisition costs, the decrease in net loss for the
year ended December 31, 2004 was primarily due to the increased revenues and
gross margin described above and the net decrease of the dividends and accretion
on preferred stock of $0.4 million.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2005, we had $2.1 million of cash and cash equivalents.
Issuance of convertible debt and equity securities have been a principal source
of liquidity for us.
On May 13, 2004, we consummated a private placement with Laurus pursuant to
which we issued a secured convertible term note due May 13, 2007 in the
principal amount of $5.0 million, and a common stock purchase warrant entitling
Laurus to purchase 4,435,500 shares of our common stock (See Note 7 of the Notes
to the Unaudited Condensed Consolidated Financial Statements as of and for the
periods ended June 30, 2005). In the past, we have agreed to reduce the fixed
conversion price of such note in order to induce Laurus to allow us to pay the
scheduled monthly payment in shares of our common stock. In the short term, we
intend to continue to request that Laurus accept payment in the form of shares
of our common stock so that we may preserve cash for use in our business. There
can be no assurances that Laurus will comply with our request.
On June 30, 2005, we entered into a Security Agreement with Laurus pursuant
to which Laurus agreed to provide us with a $9 million revolving, convertible
credit facility (the "2005 Facility"). The term of the 2005 Facility is three
years. In connection with the 2005 Facility, we issued to Laurus (i) a minimum
borrowing promissory note in the principal amount of $3.0 million that is
convertible into shares of our common stock at a fixed conversion price per
share of $2.05, subject to adjustment for dilutive issuances, stock splits,
stock dividends and the like, and (ii) a revolving convertible note in the
principal amount of $6.0 million, of which the first $3.0 million of borrowings
is convertible into shares of our common stock at a fixed conversion price per
share of $2.56, subject to adjustment, and the second $3.0 million of borrowings
is convertible into shares of our common stock at a fixed conversion price per
share of $2.99, subject to adjustment. On July 5, 2005, we borrowed $6 million
under the 2005 Facility, of which approximately $4.4 million was used to
extinguish, in full, our indebtedness to Wells Fargo Bank, N.A. and the balance
of the initial draw, less expenses of the 2005 Facility, has been used for
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general corporate and working capital purposes. At October 10, 2005, the
outstanding principal amount was $6.0 million. The terms of the 2005 Facility
significantly limit our ability to obtain future financing. For example, so long
as any principal amount borrowed under the 2005 Facility is outstanding, we may
not obtain any secured or unsecured debt financing in excess of $100,000 without
the prior approval of Laurus. We are also restricted from issuing any shares of
preferred stock without the prior approval of Laurus. To the extent that Laurus
declines to approve a proposed secured or unsecured debt financing or issuance
of preferred stock, we would be unable to obtain such financing without
defaulting under the 2005 Facility. To the extent that such a financing is
required for us to continue to conduct or expand our operations, these
restrictions could materially adversely impact our ability to achieve our
operational objectives. The securities held by Laurus contain anti-dilution
protections against the issuance of equity securities at a price per share that
is less than the conversion price or exercise price of our convertible notes or
stock purchase warrants held by Laurus.
In connection with the original funding under the 2005 Facility, Laurus
waived until December 31, 2005 the borrowing base limitation under the 2005
Facility, and permitted us to borrow $6.0 million under the 2005 Facility at a
time that we did not have sufficient eligible accounts receivable to support
such funding. If we are unable to generate sufficient accounts receivable as of
such date, we will be required to make interest payments to Laurus in the amount
of 1.5% per month on any such borrowing base deficiency.
As of August 11, 2005, the default on the STAR Note created an event of
default under the 2005 Facility. On August 12, 2005, we obtained a waiver from
Laurus waiving the event of default.
As of June 30, 2005, we had current assets of $15.4 million. These assets
were primarily derived from our operations in 2005 and from our acquisitions of
Incentra of CA and PWI. Long-term assets of $34.3 million consisted of $14.9
million of intangible assets acquired during the transactions with MSI, Incentra
of CA and PWI, $14.5 million of goodwill acquired during the Incentra of CA and
PWI transactions, $2.4 million of property and equipment, $1.7 million of
software development costs and $0.9 million of other assets, which consist of
$0.6 million of deferred financing costs, $0.1 million of restricted cash and
$0.2 million of deposits, prepaid expenses and other receivables.
Current liabilities of $19.2 million at June 30, 2005 consisted of $9.6
million of accounts payable; $1.4 million of deferred revenue, which consisted
of billings in excess of revenue recognized, deposits and progress payments
received on engagements currently in progress; $3.7 million of accrued expenses;
and $4.5 of current portion of notes payable, other long term obligations, and
capital leases.
Our working capital deficit was $3.8 million as of June 30, 2005, of which
$1.3 million of the deficit was attributable to the reclassification of the
promissory note issued to a former owner of Incentra of CA to current
liabilities due to a default on such note, as described in Note 8 (B) in the
notes to unaudited condensed consolidated financial statements as of June 30,
2005.
We used net cash of $4.2 million, $3.5 million and $1.1 million in
operating activities during the years ended December 31, 2003 and 2004 and the
six months ended June 30, 2005, respectively, primarily as a result of the net
loss incurred during such periods. We used net cash of $1.6 million from
operating activities during six months ended June 30, 2004 primarily as a result
of the net loss incurred during the period.
During the year ended December 31, 2003, we used $8.5 million of cash in
investing activities, of which $3.8 million was to purchase short term
investments, net of maturities of short term investments, $2.3 million was to
purchase intangible assets and $2.1 million was used to purchase property and
equipment and $0.3 million was invested in capitalized software development
costs. We generated net cash of $4.7 million in investing activities during the
year ended December 31, 2004, of which $4.0 million represented cash and
restricted cash acquired from Front Porch in the acquisition transaction, $3.8
million of proceeds from the maturity of short term investments and $0.1 million
of proceeds from the sale of fixed assets. These amounts were offset by capital
expenditures of $1.9 million, the investment in development for our video
software and Gridworks solutions of $1.2 million and capitalized acquisition
costs of $0.2 million. We generated net cash of $0.4 million in investing
activities during the six months ended June 30,2005, of which $1.7 million
represented cash acquired from the Incentra of CA
32
and PWI acquisition transactions, which was offset by $1.2 million used
primarily to purchase or develop computer software and equipment. We generated
net cash of $2.8 million in investing activities during the six months ended
June 30, 2004, of which $3.8 million represented proceeds from the maturity of
short-term investments, which was offset by $1.0 million used primarily to
purchase or develop computer software and equipment.
Financing activities provided net cash of $14.8 million during the year
ended December 31, 2003 primarily from proceeds from the issuance of preferred
stock of $12.9 million and common stock of $3.2 million, offset by offering
costs for the preferred and common stock of $0.8 million and principal
repayments on capital leases of $0.4 million. Financing activities used net cash
of $0.3 million during the year ended December 31, 2004 primarily from the
repayment of capital leases, long term obligations and notes payable of $1.2
million, which was partially offset by proceeds of $0.8 million from a lease
line of credit. Financing activities used net cash of $0.2 million during the
six months ended June 30, 2005 primarily from the repayment of capital leases,
long-term obligations and notes payable of $1.6 million, which was partially
offset by proceeds of $1.4 million from lease and bank lines of credit.
Financing activities used net cash of $0.4 million during the six months ended
June 30, 2004 primarily from the repayment of capital leases.
We are still in the early stages of executing our business strategy, have
recently completed two significant acquisitions and expect to begin numerous new
acquisition engagements during the next 12 months. Although we are experiencing
success in the deployment of our marketing strategy for the sale and delivery of
our DIVArchive and other software solutions, continuation of this success is
contingent upon several factors, including the availability of cash resources,
the prices of our products and services relative to those of our competitors,
and general economic and business conditions, among others.
On July 5, 2005, we borrowed $6.0 million of the $9.0 million loan facility
made available under the 2005 Facility, of which approximately $4.4 million was
used to extinguish, in full, our indebtedness to Wells Fargo Bank, N.A., which
was used to finance the acquisitions of STAR and PWI, and the balance of the
initial draw, less expenses incurred in connection with the establishment of the
2005 Facility, will be used for general corporate and working capital purposes.
Our management believes that our cash and cash equivalents and borrowings
available from the 2005 Facility, will provide us with sufficient capital
resources to fund our operations, debt service requirements, and working capital
needs for the next 12 months. There can be no assurances that we will be able to
obtain additional funding when needed, or that such funding, if available, will
be obtainable on terms acceptable to us. In the event that our operations do not
generate sufficient cash flow, or we cannot obtain additional funds if and when
needed, we may be forced to curtail or cease our activities, which would likely
result in the loss to investors of all or a substantial portion of their
investment.
During 2004 and the first half of 2005, we continued to have success in
deploying our marketing strategy for the sale and delivery of our DIVArchive
software solutions. We continue to build a backlog into the fourth quarter of
2005. In addition, we have experienced sales of complete archive solutions to
major broadcasters in the first half of 2005 and plan on continuing this sales
approach in 2005. In addition, our two acquisitions in the first quarter of 2005
have expanded our complete solutions offerings and are expected to help us
further penetrate the enterprise marketplace. Both acquisitions are expected to
be accretive on an operating cash flow basis and we anticipate further
improvements to operating cash flows as synergies are realized. Additional
synergies are expected to result from improved margins on maintenance contracts
due to the handling of first call support and improved service revenue growth
from the introduction of managed services to the new and existing enterprise
customers of these two acquisitions.
33
Our actual financial results may differ materially from our stated plan of
operations. Factors which may cause a change from our plan of operations to
vary, but include, without limitation, decisions of our management and board of
directors not to pursue our stated plan of operations based on its reassessment
of the plan and general economic conditions. Additionally, there can be no
assurance that our business will generate cash flows at or above current levels.
Accordingly, we may choose to defer capital expenditures and extend vendor
payments for additional cash flow flexibility.
We expect capital expenditures to be approximately $1.0 million and
capitalized software development costs to be approximately $1.6 million during
the 12-month period ended July 31, 2006. It is expected that our principal uses
of cash will be for working capital, to finance capital expenditures and for
other general corporate purposes, including financing the expansion of the
business and implementation of our sales and marketing strategy. The amount of
spending in each respective area is dependent upon the total capital available
to us.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR
CORRECTIONS, which changes the requirements for the accounting and reporting of
a change in accounting principle and applies to all voluntary changes in
accounting principle. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. APB No. 20 required
that most voluntary changes in accounting principle be recognized by including
in net income of the period of the change the cumulative effect of changing to
the new accounting principle. This statement requires retrospective application
to prior period financial statements of changes in accounting principle, unless
it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. The provisions of SFAS No. 154 are effective
for fiscal years beginning after December 15, 2005. We do not expect this
statement to have a material impact on our financial position or results of
operations.
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED, which
addresses the accounting for share-based compensation transactions. SFAS No.
123(R) eliminates the ability to account for share-based compensation
transactions using APB 25, and generally requires instead that such transactions
be accounted and recognized in the statement of operations based on their fair
value. SFAS No. 123(R) will be effective for public companies that file as small
business issuers as of the first interim or annual reporting period that begins
after December 15, 2005. We are currently evaluating the provisions of this
standard. However, we expect that the implementation of this standard will have
a material impact on our financial position and results of operations.
34
BUSINESS
We are a provider of complete solutions for enterprise's data protection
needs. We supply a broad range of storage products and storage management
services to broadcasters, enterprises and information technology service
providers worldwide. We market our products and services to broadcasters under
the trade name Front Porch Digital ("Front Porch") and to service providers and
enterprise clients under the trade names ManagedStorage International ("MSI"),
Incentra of CA Solutions (" Incentra of CA") and PWI Technologies ("PWI"). Front
Porch provides unique software and professional services solutions for digital
archive management to broadcasters and media companies. MSI provides outsourced
storage solutions, including engineering, hardware and software procurement and
remote storage operations services. Incentra of CA and PWI are leading systems
integrators which provide Information Technology ("IT") products, professional
services and outsourcing solutions to enterprise customers located primarily in
the western United States.
We believe our ability to deliver a complete storage infrastructure and
management solution to our customers differentiates us from most of our
competitors. A complete storage solution for the customers in our target markets
includes the following components:
o Hardware and software products and services
o Outsourcing solutions - Automated/remote monitoring, management and
maintenance services
o Professional services - engineering/operations/IT help desk
o Capital/financing solutions
Through Front Porch, we provide a software and management solution that
enables searching, browsing, editing, storage and on-demand delivery of
media-rich content in nearly any digital format. Our complete digital archive
solution includes our proprietary software bundled with professional services,
hardware/software procurement and resale, remote monitoring/management services,
complete support for our proprietary software solutions and first call support
for third-party hardware and software maintenance. Our software converts audio,
video, images, text and data into digital formats for ease of use and archiving.
With more than 100 installations worldwide, our DIVArchive software solution has
become one of the leading digital archive management applications among European
and Asian broadcast and media companies, and is gaining an increasing share of
the North American market. Front Porch's DIVArchive and transcoding applications
provide the essential integration layer within the digital content creation and
broadcast environments. All of Front Porch's products were built on intelligent,
distributed architecture. As a result, Front Porch's archive management and
transcoding solutions are flexible, scalable, easily upgradeable, failure
resilient and integratable with leading automation and asset management
applications.
Through MSI, we deliver comprehensive storage services, including
professional services, third-party hardware/software procurement and resale,
financing solutions, remote monitoring/management services and first call
support for third-party hardware and software maintenance. MSI focuses on
providing data protection solutions and services that ensure that its customers'
data is backed-up and recoverable and meets internal data retention compliance
policies. MSI's remote monitoring and management services are delivered from its
Storage Network Operations Center ("NOC") in Broomfield, Colorado, which
monitors and manages a wide spectrum of diverse storage infrastructures on a
24x7 basis throughout the United States, United Kingdom, the Netherlands,
Bermuda and Japan. MSI delivers this service worldwide using its proprietary
GridWorks Operations Support System, which enables automated remote monitoring
and management of complete storage infrastructures and back-up applications. MSI
35
provides outsourcing solutions for customer data protection needs under
long-term contracts. Customers pay on a monthly basis for storage services based
on the number of assets managed and/or the volume of storage assets utilized. We
believe customers benefit from improved operating effectiveness with reduced
operating costs and reductions in capital expenditures.
Through Incentra of CA and PWI, we deliver complete IT solutions, including
professional services, third-party hardware/software procurement and resale,
financing solutions and the sale and delivery of first call support for
third-party hardware and software maintenance (including help desk operations).
Solutions are sold primarily to enterprise customers in the financial services,
government, hospitality, retail, security, healthcare and manufacturing sectors.
With offices and sales personnel located primarily throughout the western United
States, these recently acquired entities are a cornerstone to our North American
expansion plans.
INDUSTRY TRENDS
International Data Corporation ("IDC") estimates data growth at a compound
rate of approximately 50% annually through 2007. We believe that because of the
ongoing growth in the creation and storage of data and the increasing strategic
importance of having data available, secure and recoverable, the data storage
markets in which we compete will continue to expand. We also believe this growth
will include an accelerating growth rate in the demand for services, including
data management and monitoring solutions. Total spending for data storage
products and services in 2003 was estimated by IDC at $31 billion and is
expected by IDC to exceed $34 billion by 2005. IT departments are faced with the
challenges of rapidly expanding amounts of data to manage, increasing demands
for availability for day-to-day business and to meet regulatory requirements,
and increasing and more stringent compliance and governmental regulations
regarding data storage, integrity and recoverability. Conversely, IT headcount
is projected by IDC to increase by only 10% annually, which should increase the
need for organizations to improve storage management productivity and to
evaluate outsourced management solutions to accommodate the increasing demands
being placed on the organization. We believe companies will consolidate their
storage infrastructures and implement enhanced software and service
capabilities, such as storage area network management, virtualization, storage
resource management and outsourcing automated storage monitoring and management
services.
Excluding hardware infrastructure, IDC estimates that worldwide revenue for
backup and archive software solutions in 2003 totaled $2.4 billion and is
expected to grow to an estimated $3.0 billion in 2008, or at a 4.1% compound
annual growth rate. Datamonitor reports that in Europe, our largest market for
archive software, sales of archive software are expected to grow at a compound
annual growth rate of 42% through 2008. The total market in Europe for complete
archive and digital workflow solutions, including hardware infrastructure (the
broadcast value chain), is estimated at $2.6 billion currently and is expected
to grow to $3.6 billion by 2008, or a compound annual growth rate of 8.4%.
Datamonitor estimates that today only 15% of broadcasters in Europe have
converted to a fully-digital environment. Based upon our experience in the
industry, we believe the rate of adoption in North America is no greater than
that in Europe, and likely significantly lower. Accordingly, we believe that
opportunities for the sale of complete archive solutions to broadcasters making
the conversion to a fully-digital environment will continue to accelerate in
2005 and beyond. We also believe our business strategy to grow archive software
sales as part of our complete solution offering, incorporating our proprietary
storage management and monitoring services, professional services and
third-party hardware and software solutions, will accelerate revenue growth and
increase profitability.
We believe companies will continue to make additional investments in data
storage products and services and that spending in this area will become a
larger percentage of the customer's total IT budget.
36
We believe the following customer needs will be primary drivers of data storage
and management spending:
ACCEPTANCE AND GROWING NEED FOR STORAGE SERVICES. We expect a few key
factors to drive organizations to increasingly outsource storage-related IT
services (consulting, implementation and support). These factors include IT
staffing limitations, the growing strategic importance of data retention
and recovery, increasing volume of types of data to be stored, the growing
complexity of networked storage environments and the increasing scope of
spending on storage.
DATA PROTECTION REQUIREMENTS. An increased need for high throughput
performance, greater frequency of backups, quicker restoration of data and
stringent data availability requirements are key factors that we expect to
drive the migration to disk-based data protection solutions. We believe
disk will not only be used as a target device for replication and
mirroring, but will also be incorporated into traditional backup systems.
EMPHASIS ON SECURITY. Organizations worldwide require data protection
solutions that assure financial compliance and transparent audits. Our
software solutions and 24X7 NOC provide solutions worldwide for the
delivery of accurate and timely information compliance.
ADOPTION OF ROBUST STORAGE MANAGEMENT SOFTWARE SOLUTIONS. A number of
storage management software innovations have recently entered the market.
Storage management software enhancements can be divided into four segments:
storage area network management, virtualization, storage resource
management and automated resource management. We anticipate advances in
each of these areas will enable improved storage availability,
manageability and performance.
CONTINUED MIGRATION TO NETWORKED STORAGE INFRASTRUCTURES. We expect that,
through a variety of storage networking technologies, organizations will
attain shared (consolidated) storage capabilities. Consolidated storage
benefits include increased flexibility in implementing and managing
storage, increased storage device utilization levels, improved quality of
service, reduced administration costs and increased operational efficiency.
EVOLUTION AWAY FROM LARGE, MONOLITHIC STORAGE SYSTEMS TO MODULAR STORAGE
SYSTEMS. We expect that many organizations will implement modular storage
systems as compared to large, monolithic storage systems. Smaller versions
of their high-end, full-featured counterparts, modular disk systems enable
organizations to cost-effectively implement storage, while enjoying the
performance and functionality of large, enterprise systems.
BUSINESS STRATEGY
Our objective is to further our position as a leading provider of storage
management and IT infrastructure solutions and services and to further expand
our worldwide presence. To achieve these objectives, we have adopted the
following strategies:
o GROWTH THROUGH ACQUISITION. Our acquisitions (two since January 2005, one
in 2004) have expanded our customer base, provided a large suite of
products and services, expedited the development of a strong 38-person
sales force, added management talent, created a platform from which to
extract revenue synergies among our various product and service offerings,
and provided excellent opportunities for consolidation/cost reduction. We
believe the storage management and services industry is highly fragmented
and that there are many smaller storage
37
product and software/services providers with successful product offerings
that are seeking merger or acquisition partners. We intend initially to
seek acquisition candidates that have the following characteristics: a
large portion of product sales are generated from storage solutions and
that represent most major manufacturers, strong professional services
organizations, recurring service revenues and strong sales, engineering and
management personnel. Our initial focus is on candidates with facilities
and targeted customers located in the United States.
o STRATEGIC ALLIANCES. We intend to supplement our marketing efforts by
aligning ourselves with complementary solutions providers and technology
partners. Strategic alliances also will assist us in keeping pace with
technological developments of the major software and hardware vendors and,
in certain instances, provide us with product development services. We have
entered into strategic alliances with a number of leading providers of
storage products and storage management solutions that often include
co-marketing and technology-sharing arrangements and provide us access to a
large existing customer base. Through similar alliances, we expect to gain
greater exposure and acceptance of our products and services.
o OFFER COMPLETE DIGITAL ARCHIVE SOLUTIONS TO BROADCASTERS. Through the sale
of our complete digital archive solutions, we intend to capture an
increasing portion of the total IT spending of our broadcast customers and
position ourselves for follow-on sales and services. A complete digital
archivesolution includes: Archive Software, Archive Servers, Transcoders,
Professional Services, and Storage Hardware and Maintenance. Historically,
Front Porch has focused on offering only the archive software component of
the complete digital archive solution with limited participation in the
other areas. We estimate that archive software comprises only 10-15% of the
total spending of a broadcast customer for a complete digital archive
solution. By increasing its penetration into these other areas, Front Porch
believes it will generate significant increases in revenue and gross margin
as these untapped components comprise the vast majority of a customer's
total spending. We believe by leveraging Front Porch's longstanding
customer relationships, the dominant market position of Front Porch's
DIVArchive solutions, Front Porch's world-class customer list of broadcast
entities and its reputation for superior service and support, Front Porch
will be able to successfully capture an increasingly larger portion of our
customers' total IT budget.
o OFFER COMPLETE DATA PROTECTION SOLUTIONS. A complete data protection
solution includes storage resource management, back-up applications,
storage hardware, professional services, operations and financing
solutions. Historically, MSI has been focused on the operations component
of the complete data protection solution with limited participation in the
other areas. We estimate that the operations component comprises only
10-15% of the total spending of an enterprise or service-provider customer
for a complete data protection solution. We believe our GridWorks
proprietary monitoring and management solutions position us to offer a
superior and more complete storage and data protection solution to our
customers than that which is currently offered by our competitors.
o NEW PRODUCT DEVELOPMENT. We intend to continue to produce a quality
software product and service solution that meets client expectations in
terms of functionality, flexibility, procurement cost, implementation cost
and ongoing maintenance cost. We believe our storage and digital archive
management product lines meet these expectations and will continue to do so
as these products evolve. We are committed to continuous product
improvement through a software development program that is driven by
industry focus groups and customer input. We intend to continue to utilize
our industry, customer and supplier relationships to keep abreast of
emerging standards, protocols and application programming interfaces as
such trends are introduced and gain market acceptance.
38
o INCREASE MARKETING AND DIRECT SALES EFFORTS. Our direct sales organization
is organized into sales teams that are assigned to our operating units. We
intend to leverage our successes by devoting significant marketing and
direct sales resources to cross-market products and services offered by our
operating units. Our sales teams intend to add established distributors
with the skills necessary to sell our comprehensive storage solutions.
o FOSTER A CULTURE OF EXCELLENCE AND CUSTOMER SERVICE. We intend to continue
to employ rigorous recruiting, training and evaluation practices to help us
attract and retain employees who dedicate themselves to delivering
outstanding products and consulting services to our customers. We have
emphasized the creation of an environment of excellence and customer
services and believe our commitment to excellence will continue to provide
new customer referrals from satisfied customers that have used our products
and services.
CUSTOMERS
Many organizations continue to face data growth, technology obsolescence,
shrinking IT budgets and new compliance objectives. Our focus on storage and IT
management from a complete solution approach allows customers to economically
deal with these challenges. Our complete solutions include professional
services, products, proprietary software platforms, IT outsourcing services and
financing services. By focusing on data protection services, organizations may
achieve numerous benefits, including improved infrastructure performance,
business risk mitigation and cost management/reduction for overall operations.
We believe organizations currently are facing the following issues:
o Total storage needs are increasing 50% annually
o New technologies require integration across platforms
o Increasing levels of external and internal compliance requirements
o Staffing is projected to grow only 10%
o Limited capital or operating expenses
Our customers are located in North America, Europe, Asia and the Pacific
Rim and are primarily in the following markets: Broadcast, Media and
Entertainment; Fortune 2000 Enterprises and mid-tier Enterprises; and Data
Center Operators and IT Service Providers.
Broadcast, Media and Entertainment
- ----------------------------------
Our customer base in the broadcast industry includes some of the largest
and best-known entities worldwide, including Comcast, Discovery Networks, A&E
Television Networks, Rainbow Networks Communications, Inc., Public Broadcasting
System (PBS), Microsoft Corporation, Canal +, Playboy Television, Walt Disney
Company, Chum Television, Oxygen, BBC Broadcast, Bayerischer Rundfunk, Turner
Entertainment Networks Asia, Sony Pictures, Telecinco, France 3, SKY Perfect TV,
Eastern Television/Taiwan, TV Azteca, Central China Television, Seven Networks
and MTV Networks-Europe. Many of the customers are served in multiple locations
worldwide.
Datacenter Operators and It Service Providers
- ---------------------------------------------
Customers in this segment consist primarily of managed service providers
offering hosting and collocation solutions. These are both regional and national
providers that require a competitive backup
39
offering and deep professional engineering support for their core data center
services. Representative customers include Cable & Wireless UK, Viawest,
Quovadis, Data 393, Data Return, Japan Telecom IDC (Softbank Group), and
Telepacific Communications.
Fortune 2000 Enterprises and Mid Market
- ---------------------------------------
Customers in this segment consist primarily of mid-tier enterprise
businesses that require IT expertise to manage their complex IT and storage
infrastructures. Complete solutions have been provided to customers such as
Network Appliance, Inc., Accenture, AON, American Airlines, Hilton Hotels, Good
Technology and Transora.
During the six months ended June 30, 2005, a significant portion of our
revenues were derived from the European and Asian geographic markets. For the
six months ended June 30, 2005, aggregate revenues from customers located in
Europe or Asia amounted to $7.4 million, or 22% of total revenue, while revenues
from customers located in North America totaled $26.6 million, or 78% of total
revenue, in each case on a pro forma basis assuming the acquisitions of Incentra
of CA and PWI occurred on January 1, 2005. For the six months ended June 30,
2005, actual aggregate revenues from customers located in Europe or Asia
amounted to $7.4 million, or 31% of total revenue, while revenues from customers
located in North America totaled $16.2 million, or 69% of total revenues. As a
result of our recent acquisitions of Incentra of CA and PWI we do not expect
this concentration of revenues to continue through the remainder of 2005.
PRODUCTS AND SERVICES
We are a complete solutions provider of storage management and IT
infrastructure products and services. We classify our revenues as either product
or service revenue. Product revenue includes the sale of all hardware and
software products. Service revenue includes recurring managed service revenue,
professional services revenue and recurring maintenance service revenue.
PRODUCTS
Our products include a broad range of software and hardware solutions that
are offered to our customers as part of our complete solution offerings. Under
our various product brands, we offer these product solutions worldwide to
customers in all of the market segments in which we compete.
DIGITAL VIDEO ARCHIVE MANAGEMENT SOFTWARE AND SOLUTIONS
Under our Front Porch Digital brand, we offer a comprehensive integrated
suite of digital video archive management solutions. Our proprietary DIVArchive
(Distributed Intelligent Versatile Archive) software products enable customers
to manage large-scale digital video archives in the broadcast, media and
entertainment industry. With over 100 installations worldwide, we believe
DIVArchive maintains a dominant position in Europe and Asia and is gaining
market share in North America. We believe participants in the entertainment
industry are increasingly seeking to convert non-digitized data to digital
formats that may easily be accessed, browsed, indexed, managed and distributed.
DIVArchive is a "middleware" software product that manages large-scale
digital archives for the entertainment industry. DIVArchive simplifies the
process of preserving, managing and accessing content, as part of a
high-capacity, expandable and scalable solution that satisfies the highest
performance standards. The principal benefits derived from DIVArchive include
storage optimization, protection and control, full-life cycle management,
near-line editing and partial retrieval, content repurposing and
40
sharing, and archives networking. Architectures can scale from small disk-only
systems to large capacity systems using different forms of physical storage to
balance response time, performance and cost.
Recent upgrades and modifications to the standard DIVArchive product
offering include the following:
DIVARCHIVE 5.8: The most recent version of DIVArchive features the
following enhanced functionality:
o Integration with the full range of TeleStream FlipFactory transcoding
solutions
o Enhanced integration with leading non-linear editing platforms
o Greater control through the Storage Plan Manager Configuration Engine
o Expanded support for Tape Import/Export and Meta Source
o New capabilities for MXF devices including partial restore
functionality
DIVADIRECTOR: This distributed, web-based content management application
addresses the most fundamental asset management requirements for global
broadcasters. It enables active tracking of all assets in the DIVARCHIVE
5.8 system, low bit rate proxy browse, frame accurate EDL generation and
export, and robust metadata search and management capabilities, among
others.
DIVAMONITOR: The ever-increasing complexity of mission-critical broadcast
systems often presents an operational challenge for broadcast customers,
particularly in the support and maintenance of multiple applications and
devices. DIVAMONITOR enables real time remote monitoring of DIVARCHIVE and
all connected broadcast/storage devices. Accessed through the DIVAMONITOR
portal, hardware and software in the archive layer are monitored by a team
of support professionals working at our NOC in Broomfield, Colorado.
DIVACOMPLETE: DIVACOMPLETE is a complete digital archive solution that
includes a set of products and services that deliver integration and
on-going support for complex storage and archive solutions. DIVACOMPLETE
solutions include archive layer workflow analysis, infrastructure
assessments, specification, designs, hardware procurement, installation and
commissioning. DIVACOMPLETE solutions may also include DIVACOMPLETE and
24x7 support for all associated storage hardware and software to complete a
total end-to-end archive management solution.
DIVAWORKS: DIVAWORKS is a robust, plug and play archive management
appliance that includes a server, near-line storage with a 10-cassette data
tape library that operates under the control of DIVARCHIVE 5.8. This
turnkey, single chasse unit is offered at prices tailored to the needs of
broadcasters making a first-time investment in a basic archive system. This
product was designed specifically to meet the needs of the independent
broadcaster for a high-performance system at an economical price point.
GRIDWORKS OPERATIONS SUPPORT SYSTEM (OSS)
Our GridWorks Operations Support System is a proprietary software
application that provides proactive management of the health, capacity and
utilization of a storage infrastructure. Our platform serves as the application
that enables our NOC to manage customer infrastructures globally through
automation. Our GridWorks Portal is the user interface into the GridWorks suite
of applications that monitor and manage the status, health, performance and
capacity of an enterprise storage infrastructure.
41
GridWorks provides the functionality of many costly Storage Resource Management
(SRM) software products, but is included as part of a service contract. From
this one consolidated application, enterprise customers can access all of the
information required to review our operation and management of their complex
heterogeneous, geographically-distributed storage environments.
RESALE OF THIRD-PARTY HARDWARE AND SOFTWARE
Our DIVArchive and GridWorks products and services use an open architecture
that enables customers to use various operating systems, operate on multiple
hardware platforms and interoperate with many third-party software applications
and legacy systems. This open system capability enables customers to continue
using their existing computer resources and to choose among a wide variety of
existing and emerging computer hardware and peripheral technologies.
In connection with the sale of DIVArchive and Gridworks, we resell various
products developed by third parties, including computer hardware and software
and other peripheral devices. We resell all third-party products pursuant to
agreements with the manufacturers or through distributor authorized reseller
agreements pursuant to which we are entitled to purchase products at discounted
prices and to receive technical support in connection with product installations
and subsequent product malfunctions. Accordingly, we believe we are able to
obtain pricing at competitive and often superior terms than other resellers. We
represent most major OEMs and all major storage OEMs, including the following:
PRODUCTS SUPPLIERS (OEMS)
- -------- ----------------
PRIMARY STORAGE: o Sun Microsystems
o Hitachi Data Systems Corporation
o Network Appliance, Inc.
o Storage Technology Corporation
o Xiotech
SERVERS AND SYSTEMS: o Sun Microsystems
o HP Compaq
o Dell Computer
TAPE AUTOMATION: o Quantum Corporation
o Spectra Logic Corporation
o Storage Technology Corporation
o Xiotech
SOFTWARE SOLUTIONS: o VERITAS Software Corporation
o Commvault Software
o Symantec Software
NETWORKING: o Brocade Communications Systems, Inc.
o Cisco Systems
o McData Corporation
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PROFESSIONAL SERVICES
Our professional services include a broad range of assessment, project
management, design and implementation services that are applied across all
products sold in all markets. Our engineering staff has a broad expertise and
has received appropriate certifications from our OEM partners. The services we
provide include:
o STORAGE & INFRASTRUCTURE ASSESSMENTS - providing critical feedback on
the health, performance and utilization of storage and systems
infrastructure, as well as a report card of business performance and
compliance relative to established objectives and peer organizations.
o STORAGE SYSTEM DESIGN SERVICES - defining the appropriate technical
architecture and unbiased product selection to meet key business
criteria and assure optimal results.
o IMPLEMENTATION AND INTEGRATION SERVICES - assuring technology
purchases are installed and optimized to achieve the best possible
performance and utilization of resources minimizing ongoing
operations costs while assuring the best possible availability.
o COST OF OWNERSHIP ASSESSMENTS - helping organizations identify key
cost areas, most effectively align resources and leverage technology
to reduce ongoing expenses and streamline operations
o PROJECT MANAGEMENT SERVICES - supplying professional assistance to
oversee deployment of assets, implementations of new applications
while assisting in the alignment of scarce technical resources for
timely solutions.
o LEVEL 1, 2 & 3 ENGINEERING SUPPORT - assisting in rapid problem
diagnosis, vendor response and problem resolution across a very broad
range of systems and storage applications.
24X7 FIRST CALL OPERATIONS AND MAINTENANCE SUPPORT
We operate a 24x7 NOC in Broomfield, Colorado at which all first call and
maintenance in-coming calls are received, diagnosed and routed to the
appropriate engineering personnel or vendor. We also have a secondary support
desk in San Diego, California. Support services are provided on all proprietary
and third-party products and services. In many cases, the support personnel in
our NOC have the ability, if enabled by the customer, to remotely access the
customer's infrastructure using our GridWorks platform to respond to alert
notifications from the customer and to remotely correct the problem. In other
cases, the NOC notifies our customer of a problem and corrects the problem (or
instructs corrective action) or dispatches vendor support prior to the customer
calling the NOC. Our engineering staff also provides level 2 and 3 support
worldwide. These services are sold under long-term recurring service contracts
ranging from one to three years.
OUTSOURCING SERVICES
Our service offerings revolve around the complimentary nature of our
products. Our managed services and first-call maintenance services are an
integral part of the continued operations, security and protection around the
products we sell and are key to the customers IT and storage infrastructure.
Services are sold under long-term recurring service contracts usually one to
three years in term.
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MANAGED STORAGE AND MONITORING SERVICES
We offer a proprietary managed storage and monitoring service through our
proprietary GridWorks Operations Support Systems platform. The GridWorks
platform enables automated remote monitoring, alert and notification and the
remote management of back-up applications. The service enables a proactive
heterogeneous look into a customer's infrastructure, which provides real-time
insight to the performance of the customer's technology investment. The service
is offered to customers in three options ranging from a basic monitoring service
to a complete service including all underlying IT equipment and software.
o Our GridWatch solution is a remote monitoring, alert and notification
service. The service is performed on the customer's existing storage
infrastructure and includes monthly reporting on performance,
efficiency, reliability and the integrity of the data storage
networks.
o Our GridManage solution provides remote management of storage
applications and hardware infrastructure. The service is performed
using the customer's existing storage infrastructure and includes the
actual day-to-day operation of the customer's data storage
applications, including specifically the back up and recoverability
of data. This service solution includes all of the services provided
by our GridWatch solution.
o Our GridComplete offering is a complete storage solution by which we
provide the storage infrastructure, integration/implementation
services and complete management of storage applications and
infrastructure. This solution encompasses all of the services offered
by our GridWatch and GridManage products.
OUTSOURCING AND SERVICE DESK OPERATIONS
Our outsourcing solutions assist our customers in the management of their
IT environment, by augmenting their staff and operations with personnel as well
as methodologies, and technologies that are based on industry best practices. We
assist in the design, implementation and management of new IT environments, or
leverage an existing environment to unlock value and enhance business
performance. Our flexible outsourcing solutions are provided as full or partial
service desk outsourcing as well as overflow support for existing service
operations. We provide full service desk solutions housed within our facilities
or design and implement custom solutions at the customer site. In each case we
coordinate all transitioning needs of the customer.
FINANCING SOLUTIONS
We offer various financing alternatives to our customers for the financing
of both equipment purchases and complete service solutions (GridComplete). Our
financing alternatives offer the customer a more flexible approach to purchasing
equipment. When a customer purchases a managed solution (long-term service
contract), it is common to incorporate the hardware cost into the monthly
recurring payment from the customer and finance a complete solution with one
monthly payment/operating expense for the customer. The financing alternatives
offered to a customer typically include alternatives for direct financing by our
company and by third-party financing sources. The decision of internal or
external financing is largely dependent on the size of the transaction, as well
as the creditworthiness and size of the customer.
44
SALES AND DISTRIBUTION
We distribute our products and services through both direct and indirect
sales channels depending on the products or services being sold. In many cases,
our sales personnel work closely with the sales personnel of third-party systems
integrators, data center operators, hardware and software distributors or
original equipment manufacturers to coordinate the sales efforts relating to a
particular customer or project.
At October 10, 2005, our direct sales force consisted of 43 sales people.
Sales and marketing personnel are located at our offices in Broomfield,
Colorado; Phoenix, Arizona; San Ramon, Los Angeles and San Diego, California;
Chicago, Illinois; Mount Laurel, New Jersey and Dallas, Texas. Sales and
marketing personnel are also located at our international sales and support
offices in the United Kingdom, France and Hong Kong. We conduct comprehensive
marketing programs that include telemarketing, public relations, direct mail,
advertising, seminars, trade shows and ongoing customer communications programs.
We obtain sales leads through advertising, seminars, trade shows and
relationships with industry consultants. A typical sales cycle begins with the
generation of a sales lead or the receipt of a request for proposal ("RFP") from
a prospective customer or his representative. After qualification of the sales
lead and analysis of the prospective customer's requirements, a formal proposal
in response to the RFP is prepared. The proposal generally describes how our
products and services are expected to meet the RFP requirements and associated
costs. Product demonstrations are often conducted at the prospective customer's
facilities. Site visits to existing installations of our products are also
encouraged by our sales staff. While the sales cycle varies substantially from
customer to customer, it typically ranges from 3 to 8 months.
We supplement our marketing efforts by entering into formal and informal
partnerships with entities focused on other areas of the complete solution value
chain. Since our products often are part of a larger-scale integration and
implementation project, we believe partnering with industry leaders is an
effective means of penetrating markets and positioning our products and
services. Strategic alliances also assist us in keeping pace with technological
developments of the major software and hardware vendors and system integrators.
Our indirect channel partners are located in the United States, Canada,
Europe, Australia, Asia and the Pacific Rim. Indirect sales channels lend
themselves more to the sale of our products and services to the broadcast, media
and entertainment industry than in our other markets. The supply chain for
digital media workflow conversion includes a wide range of providers of
hardware, software and services. Storage hardware, video server and other
component manufacturers, automation and asset management vendors and broadcast
systems integrators all exercise influence in the final selection of components
chosen in the final integrated solution.
We have co-marketing relationships with national and regional
distribution partners to help drive regional and local market penetration, and
market-specific regional marketing partners to help drive vertical market
penetration. Manufacturers and distributors make available to us certain funds
for marketing through various programs. These programs include direct mail, lead
generation, advertising, event marketing, brand awareness and sales solutions.
Manufacturing rebates are also applied to fund a significant portion of our
marketing expenses. Our businesses earn marketing co-op funds based on a
percentage of product sales and associated volumes. In addition to a percentage
of total sales volume, manufacturers also provide special rebate programs. These
co-op funds are managed to support our marketing activities, including, but not
limited to, marketing communications, training, certification, advertising,
events, branding and lead generation programs.
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RESEARCH AND DEVELOPMENT
We maintain a research and software development staff that designs and
develops new products and services. We believe that by performing most of our
own software development, we can more quickly and cost-effectively introduce new
and innovative technologies and services. In addition, we believe we are better
equipped to incorporate customer preferences into our development plans.
Through Front Porch, we seek to offer an extensive, integrated product line
that provides digital archive management solutions to broadcasters and media
companies worldwide. Through MSI, we seek to offer comprehensive storage
services using our proprietary Gridworks Operations Support System, which
enables automated remote monitoring and management of complete storage
infrastructures and back-up applications. To effect this strategy, we intend to
continue to introduce upgraded functionality and enhancements to existing
products.
We are continuing our software development efforts for our DIVArchive and
GridWorks software solutions by designing enhancements that address application
programming interfaces (APIs) for tape media, optical disk, tape and optical
libraries and autoloaders, tape images on disk, tape and disk operational
classes, components and test utilities. We are also directing our efforts toward
the development of digital audiovisual software and storage and streaming
applications covering DVD, Internet/Intranet, digital cable, broadcast digital
television, datacasting and wireless transmission.
Developing new technology, products and services is complex and involves
uncertainties. There can be no assurance that our development efforts will be
successful. For the years ended December 31, 2003 and 2004 and the six months
ended June 30, 2004 and June 30, 2005, we incurred total costs, of which a
portion was capitalized and the remainder was expensed, related to research and
development activities totaling $593,145, $1,420,299, $353,729 and $922,247,
respectively. On a pro forma basis, giving effect to the acquisitions of
Incentra of CA and PWI as if they occurred on January 1, 2004, for the year
ended December 31, 2004 and the six months ended June 30, 2004 and June 30,
2005, we incurred total costs, of which a portion was capitalized and the
remainder was expensed, related to research and development activities totaling
$1,429,299, $770,902 and $922,247, respectively.
PATENTS, TRADEMARKS AND LICENSES
We regard our technology as proprietary and will attempt to protect our
technology through patents, copyrights, trade secret laws, restrictions on
disclosure and other methods. We currently hold one issued patent relating to
our DIVArchive software and we are pursuing patents on key enabling
architectures, algorithms and processes that encompass fundamental technologies
associated with the compression, storage and transcoding of digital data
formats. We believe that, because of the rapid pace of technological change in
the computer software industry, trade secret and copyright protection are less
significant in affecting our business, results of operation or financial
condition than factors such as the knowledge, ability and experience of our
employees, frequent product enhancements and timeliness and quality of support
services.
We generally sell our products to our customers under a non-transferable
perpetual license. We generally license our products solely for the customer's
internal operations and only at a designated site. We also make available
multi-site licenses and enterprise licenses. Domestic multi-site licenses are
discounted from the first license fee for the second site and beyond. Enterprise
licenses are structured as a one-time fee with unlimited usage, plus an
additional fee as additional sites are installed with the software. Discounts
are generally applied for multi-site licenses. International license fees tend
to be slightly higher and are structured by region.
46
We do not provide source code to the customer under our licenses. We
believe that providing source code increases the likelihood of misappropriation
or other misuse of our intellectual property. We have, however, entered into
source code escrow agreements with certain customers whereby source code is made
available to a customer. This is a common practice in the software industry.
Under the terms of our license agreement, we generally own all modifications to
our software that are implemented for a customer.
We are not aware of any case in which our products, trademarks or other
proprietary rights infringe the property right of third parties, but have not
performed any independent investigations to determine whether such infringement
exists. Accordingly, there can be no assurance that third parties will not
assert infringement claims against us in the future with respect to current or
future product or that any such assertion may not require us to enter into
royalty arrangement or result in litigation. As the number of software products
in the industry increases and the functionality of these products further
overlap, we believe that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be time
consuming and expensive to defend.
COMPETITION
The markets for our products and services are becoming increasingly
competitive. We believe our ability to compete depends on a number of factors,
both within and outside of our control. These factors include, among others, the
functionality, price and performance our products and services relative to our
competitors' offerings, customer satisfaction and customer support capabilities,
the breadth of product lines and support services, the strength of our sales
force and channel partnership relationships and general economic and business
conditions. We expect additional companies to begin offering products and
services similar to those we offer. Many of these companies have significantly
greater financial resources than we do.
We expect our competitors to continue to improve the design and performance
of their products. Competitors may develop future generations of competitive
products that will offer superior price or performance features or technologies
that may render our products or services less competitive or obsolete. Increased
competitive pressures could also lead to lower prices for our products or
services, thereby adversely affecting our business and results of operations.
We believe the primary competitors for our digital archive solutions
include Avalon, a division of EMC Corporation, Software Generation Limited, a
privately-held company based in Southampton, England, and Masstech Group, a
privately-held corporation headquartered in Toronto, Canada.
We believe the primary competitors for our data protection solutions and
complete solutions to enterprises include Arsenal Digital, Electronic Data
Systems ("EDS") and IBM Global Services ("IBM"). However, EDS and IBM only
deliver solutions from a total IT outsourcing and management solution
perspective and do not focus on the storage layer as a core competency. In
addition, these competitors often do not meet mid-tier enterprise budget
constraints.
EMPLOYEES
As of October 10, 2005, we employed 149 persons on a full-time basis, of
which 19 were executive management, 20 were in finance and administration, 43
were in sales and marketing, 11 were in research and development, 25 were in
operations support and 31 were in engineering and delivery.
47
None of our employees is subject to a collective bargaining agreement and
we are not aware of any efforts to unionize any employees. We believe our labor
relations are good.
LEGAL PROCEEDINGS
We are engaged in the early stages of an arbitration proceeding to resolve
a dispute with one of our creditors. In connection with our acquisition of the
assets of STAR (now known as Incentra of CA) in February 2005, we issued Alfred
Curmi, the principal stockholder of STAR, a promissory note in the principal
amount of $2.5 million (the "STAR Note") that is payable in ten installments and
matures on August 1, 2007. On August 1, 2005, we elected not to make a payment
to Mr. Curmi due under the STAR Note after we identified significant required
post-closing adjustments to the purchase price for the assets of STAR and,
consequently, the principal amount of the STAR Note. Our decision not to make
the scheduled payment created an event of default under the terms of the STAR
Note as of August 11, 2005. On August 16, 2005, we received a demand for
arbitration from legal counsel to Mr. Curmi. The parties have an arbitration
hearing scheduled in April 2006, but are currently seeking to schedule a
mediation prior to such hearing in order to resolve the dispute. In the event
that the dispute is not resolved in a mediation, the parties could proceed to
submit to arbitration. There can be no assurance that we will be able to achieve
a favorable outcome in any such arbitration proceeding. An unfavorable outcome
in the proceeding could result in the acceleration of approximately $2.5 million
payable under the STAR Note.
DEVELOPMENT OF BUSINESS
We were incorporated in the State of Nevada on April 27, 1995 under the
name "Landmark Leasing, Corp." During the period from our formation to May 2,
2000, we generated no significant revenues, and accumulated no significant
assets, as we attempted to develop various business opportunities. On May 2,
2000, we acquired 100% of the outstanding equity securities of Front Porch
Digital, Inc., a Delaware corporation formed in February 2000. This transaction
is commonly referred to as a "reverse acquisition" in which all of the capital
stock of Front Porch was effectively exchanged for a controlling interest in our
company, which was a publicly-held "shell" corporation. In connection with that
transaction, we changed our name to Front Porch Digital, Inc.
In August 2002, we acquired from MSI, the DIVArchive operations of MSI
located in Toulouse, France. In connection with this acquisition, we acquired
intellectual property, fixed assets and substantially all of the personnel of
this business.
In April 2003, we sold to Eastman Kodak Company ("Kodak") our intellectual
property rights relating to the DIVArchive product applications for the medical
imaging and information management market. In connection with such sale, Kodak
offered employment to substantially all of our personnel associated with the
transferred assets and assumed certain software support obligations to our
existing DIVArchive customers in the medical industry.
On August 18, 2004, we acquired all of the outstanding capital stock of
MSI. This acquisition was accounted for as a reverse and MSI was deemed to be
the acquirer for accounting purposes. We changed our name on October 25, 2004 to
Incentra Solutions, Inc.
As a result of our acquisition of MSI, the consolidated financial
statements presented herein include the financial statements of MSI for all
periods presented and the financial statements of the consolidated companies
from the date of such acquisition forward. In addition, we are disclosing pro
forma financial information, which reflects the consolidated financial
statements to such acquisitions as if such acquisition occurred on January 1,
2004.
48
On February 18, 2005, we acquired all of the outstanding capital stock of
Star Solutions of Delaware, Inc., which subsequently changed its name to
Incentra Solutions of California, Inc. In connection with this acquisition, we
acquired all assets and liabilities of the business, consisting primarily of
cash and accounts receivable and payables, and substantially all of the
personnel of this business.
On March 30, 2005, we acquired all of the outstanding capital stock of PWI
Technologies, Inc., a privately-held company. In connection with this
acquisition, we acquired all assets and liabilities of the business, primarily
accounts receivable and payables, and substantially all of the personnel of this
business.
49
MANAGEMENT
MANAGEMENT AND BOARD OF DIRECTORS
The following sets forth the name, age and position of each of our
directors and executive officers as of October 10, 2005:
NAME AGE POSITION(S)
---- --- -----------
Thomas P. Sweeney III 44 Chairman of the Board and Chief
Executive Officer
Shawn O'Grady 42 President and Chief Operating Officer
Michael Knaisch 48 President of Front Porch Digital Division
Paul McKnight 48 Chief Financial Officer and Director
Matthew Richman 35 Senior Vice President - Corporate
Development
Walter Hinton 42 Chief Technology Officer
Patrick Whittingham 56 Director
James Wolfinger 49 Director
Carmen J. Scarpa 41 Director
All directors serve for one year and until their successors are elected and
qualified. All officers serve at the pleasure of the board of directors. There
are no family relationships among any of our officers and directors.
So long as at least 500,000 of the originally-issued shares of our Series A
preferred stock are outstanding, the holders of Series A preferred stock have
the right to elect three directors to our board of directors. In August 2004,
Carmen J. Scarpa was elected to our board of directors by the holders of our
outstanding shares of Series A preferred stock.
Information concerning our executive officers and directors is set forth
below.
THOMAS P. SWEENEY III. Mr. Sweeney has been our Chief Executive Officer
since August 18, 2004, the date of our acquisition of MSI, and Chairman of our
board of directors since August 2002. Mr. Sweeney previously served on our board
of directors for the period November 30, 2000 through February 12, 2002. From
February 2001 until August 19, 2004, Mr. Sweeney was Chief Executive Officer and
Chairman of the Board of MSI. Since such date, Mr. Sweeney has also served as
President and a director of MSI. Mr. Sweeney is the founder of Equity Pier LLC,
a business advisory and venture capital firm, and has served as its Managing
Partner since May 2000. From August 1997 through February 2000, Mr. Sweeney was
Senior Vice President of Marketing at Level 3 Communications, Inc., where he was
responsible for the development of global products and services.
SHAWN O'GRADY. Mr. O'Grady has been our President and Chief Operating
Officer since October 17, 2005. Prior to his employment with our company, Mr.
O'Grady was employed by Siemens Business Services ("SBS"), the information
technology (IT) services division of Siemens AG. From June 2004 until October
2005, Mr. O'Grady was the Senior Vice President and Business Unit General
Manager, Consulting and Integration of SBS. From October 2002 until June 2004,
he served as SBS' Senior Vice President, Business Development. From October 2000
until October 2002, Mr. O'Grady was the Senior Vice President, Regional Business
Unit of SBS. Prior to his employment with SBS, Mr. O'Grady held executive
positions with Intelogic Trace, Inc. and NBI, Inc.
50
MICHAEL KNAISCH. Mr. Knaisch has been President of our Front Porch Digital
Division since August 18, 2004. From June 2003 to August 18, 2004, Mr. Knaisch
was our Chief Executive Officer. From January 2003 to June 2003, Mr. Knaisch was
our Chief Operating Officer. From October 2002 to January 2003, Mr. Knaisch
provided consulting services to us. From August 1998 through September 2002, Mr.
Knaisch was Senior Vice President of Global Strategic Alliances at Level 3
Communications, Inc.
PAUL MCKNIGHT. Since October 12, 2004, Mr. McKnight has been our Chief
Financial Officer. Mr. McKnight has also served on our board of directors since
August 2002. From August 2002 to January 2003, Mr. McKnight also served as our
interim Chief Financial Officer. Since August 2001, Mr. McKnight has been the
Chief Financial Officer of MSI. From May 2000 to August 2001, Mr. McKnight
served as Chief Financial Officer of Equity Pier LLC, a business advisory and
venture capital firm. From January 1997 through May 2000, Mr. McKnight was the
Chief Operating Officer and Chief Financial Officer of MCI WorldCom Wireless.
MATTHEW RICHMAN. Mr. Richman has been our Senior Vice President - Corporate
Development since October 12, 2004. From January 2003 to October 12, 2004, Mr.
Richman was our Chief Financial Officer and from June 2003 to September 30,
2004, our Chief Operating Officer. From October 2002 to January 2003, Mr.
Richman provided consulting services to us. From February 2001 to September
2002, Mr. Richman served as Chief Financial Officer of Advanced Data Center,
Inc., a data center and managed technology services provider. From October 2000
through January 2001, Mr. Richman was Vice President of Finance for TelePlace,
Inc., a datacenter/co-location company. From September 1994 through September
2000, Mr. Richman was employed by Deloitte & Touche LLP, where he served in
various auditing and consulting roles, most recently as a Manager.
WALTER HINTON. Mr. Hinton has been our Chief Technology Officer since
October 12, 2004. Mr. Hinton was the Chief Technology Officer for MSI from March
2000 through October 12, 2004. From 1999 to March 2000, Mr. Hinton was the Vice
President and General Manager of Storage Networking for Storage Technology
Corporation.
PATRICK WHITTINGHAM. Mr. Whittingham has served on the board of directors
since April 2004. Since April 2004, Mr. Whittingham has been a consultant in the
area of broadcast and production technology, systems integration and digital
cinema. Prior to February 2004, Mr. Whittingham had been for more than 28 years
an employee of various affiliates of Sony Corporation, including President of
the Sony Broadcast and Production Systems Division of Sony Electronics (USA),
Inc. from June 2003 to January 2004; President of Sony Business Solution and
System Company (USA) from June 2002 to June 2003; Senior Vice President of
System Solutions Division (USA) from February 2001 to June 2002; and Executive
Vice President of Sony of Canada Ltd. from May 1997 to February 2001.
JAMES WOLFINGER. Mr. Wolfinger has served on our board of directors since
May 2004. Mr. Wolfinger is the founder of Outdoor Site Group, LLC, a wireless
site location company, and has served as its Managing Partner since February
2003. From October 2002 to September 2003, Mr. Wolfinger served as a business
and operational consultant for MSI. From 1996 through September 2002, Mr.
Wolfinger was the President of MCI WorldCom Wireless.
CARMEN J. SCARPA. Mr. Scarpa has served on our board of directors since
August 2004. Mr. Scarpa joined Tudor Ventures Group LLC, a private equity firm
specializing in mid- and late-stage technology and growth companies, in June
1996 and has been a partner and managing director of Tudor Ventures since
January 2001.
51
EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth compensation we paid
for services rendered to each person who served as our Chief Executive Officer
during the years ended December 31, 2004 and 2003, and to our most highly
compensated executive officers at December 31, 2004, other than our Chief
Executive Officer (collectively, the "Named Executive Officers").
Long Term
Compensation
Annual Compensation Awards
--------------------------------------------------
Awards Payouts
-----------------------------------------------------------------------------------------
Other Restricted Securities
Annual Stock Underlying LTIP All Other
Fiscal Salary Bonus Compensation Award(s) Options/ Payouts Compensation
Year ($) ($) ($) ($) SARs (#) ($) ($)
------ -------- -------- ------------ ---------- ---------- ------- ------------
Thomas P. Sweeney III(1) 2004 $220,192 $220,000 $-0- $-0- 1,106,200 $-0- $12,010
Chief Executive Officer 2003 $125,000 $150,000 $-0- $-0- 151,009 $-0- $3,200
2002 $162,500 $200,000 $-0- $22,927 2,008 $-0- $-0-
Michael Knaisch(2) 2004 $200,000 $142,667 $-0- $-0- 60,000 $-0- $-0-
Chief Executive Officer 2003 $217,000 $129,000 $-0- $-0- 75,000 $-0- $-0-
until August 18, 2004 2002 $50,000 $-0- $-0- $-0- -0- $-0- $-0-
President of Front Porch
Digital Division since
August 18, 2004
Matthew Richman(3) 2004 $160,000 $119,133 $-0- $-0- 42,500 $-0- $15,000
Chief Financial Officer & 2003 $168,000 $105,000 $-0- $-0- 50,000 $-0- $-0-
Chief Operating Officer 2002 $30,500 $-0- $-0- $-0- -0- $-0- $-0-
until October 12, 2004
Sr. Vice President -
Corporate Development
since October 12, 2004
Donald Maggi (7) 2004 $13,300 $-0- $-0- $-0- -0- $-0- $-0-
Sr. Vice President-Business 2003 $207,500 $-0- $-0- $-0- 84,000 $-0- $-0-
Development until January 2002 $180,000 $-0- $-0- $-0- -0- $-0- $-0-
2004, Chief Executive
Officer until June 1, 2003
Jay Yogeshwar(4) 2004 $12,381 $7,500 $-0- $-0- -0- $-0- $-0-
President and Chief 2003 $129,000 $10,500 $-0- $-0- -0- $-0- $-0-
Technology Officer 2002 $150,000 $-0- $-0- $-0- -0- $-0- $-0-
until January 2004
Paul McKnight(5) 2004 $195,000 $25,000 $-0- $-0- 50,000 $-0- $-0-
Chief Financial Officer 2003 $195,000 $9,000 $-0- $-0- 27,588 $-0- $-0-
since October 12, 2004 2002 $196,231 $1,500 $-0- $1,534 134 $-0- $-0-
Walter Hinton(6) 2004 $210,000 $50,000 $-0- $-0- 70,000 $-0- $3,920
Chief Technical Officer 2003 $210,000 $45,000 $-0- $-0- 33,642 $-0- $3,720
since October 12, 2004 2002 $210,000 $1,500 $-0- $3,845 337 $-0- $-0-
- ----------
(1) Mr. Sweeney was appointed as our Chief Executive Officer effective August
18, 2004 and has also served as our Chairman of the Board since August
2002. Prior to August 18, 2004, Mr. Sweeney served as the President and
Chief Executive Officer of MSI, which we acquired on August 18, 2004.
Compensation paid to Mr. Sweeney in 2004 includes salary of $93,077 paid by
our company after the Acquisition and salary of $127,115
52
paid by MSI prior to the Acquisition. Included in the 2004 bonus earned by
Mr. Sweeney is $220,000 of accrued but unpaid compensation. Compensation in
2003 and 2002 represents compensation paid to Mr. Sweeney by MSI.
(2) Mr. Knaisch served as our Chief Executive Officer from June 2, 2003 to
August 18, 2004 (the date of the Acquisition), on which date he was
appointed President of our Front Porch Digital division. Included in the
2004 bonus earned by Mr. Knaisch are $117,667 of paid compensation and
$25,000 of accrued but unpaid compensation. From June 1, 2003 to December
31, 2003, Mr. Knaisch was an employee of ours and received $117,000 in
salary for serving as our Chief Executive Officer. From January 1, 2003 to
June 2, 2003, Mr. Knaisch provided consulting services to us and received
$100,000 in consulting fees and $12,000 in bonus as compensation for
services provided as our Chief Operating Officer. Included in the $129,000
bonus earned by Mr. Knaisch in 2003 was $107,000 of accrued but unpaid
compensation. From October 2002 to December 2002, Mr. Knaisch provided
consulting services to us and was paid $50,000 in consulting fees and
reimbursed $6,700 in business expenses.
(3) Mr. Richman served as our Chief Financial Officer and Treasurer from
January 2003 and our Chief Operating Officer from June 2003 until October
12, 2004, on which date he was appointed Senior Vice President - Corporate
Development. Included in the 2004 bonus earned by Mr. Richman are $99,133
of paid compensation and $20,000 of accrued but unpaid compensation. From
June 1, 2003 to December 31, 2003, Mr. Richman was an employee of ours and
received $93,000 in salary for serving in the capacities described above.
From January 1, 2003 to May 31, 2003, Mr. Richman provided consulting
services to us and received $75,000 in consulting fees and $12,000 in bonus
as compensation for services provided as our Chief Financial Officer.
Included in the $105,000 bonus earned by Mr. Richman in 2003 was $85,000 of
accrued but unpaid compensation. From October 2002 to December 2002, Mr.
Richman provided consulting services to us and was paid $30,500 in
consulting fees and reimbursed $10,300 in business expenses.
(4) Dr. Yogeshwar resigned as an officer and employee of our company in January
2004. Dr. Yogeshwar was appointed to our board of directors in March 2004
and resigned from such position on August 16, 2004.
(5) Mr. McKnight was appointed to our board of directors in August 2002 and was
appointed our Chief Financial Officer on October 12, 2004. Prior to August
18, 2004 (the date of the Acquisition), Mr. McKnight served as the Chief
Financial Officer of MSI. Compensation paid to Mr. McKnight in 2004
includes salary and bonus of $66,000 and $25,000, respectively, paid by our
Company after the Acquisition and salary of $129,000 paid by MSI prior to
the Acquisition. Compensation in 2003 represents compensation paid to Mr.
McKnight by MSI. Compensation in 2002 represents compensation paid to Mr.
McKnight by MSI of $183,731 and compensation of $12,500 paid to Mr.
McKnight by us for his role as interim Chief Financial Officer.
(6) Mr. Hinton has served as our Chief Technical Officer since October 12,
2004. Prior to such date, Mr. Hinton served as the Chief Technical Officer
of MSI, which was acquired by us in August 2004. Compensation paid to Mr.
Hinton in 2004 includes salary and bonus of $71,077 and $45,000,
respectively, paid by us after the Acquisition and salary and bonus of
$138,923 and $50,000 respectively, paid by MSI prior to the Acquisition.
The $50,000 bonus paid in 2004 is included in 2003 compensation as it was
accrued but unpaid at December 31, 2003. Compensation in 2003 and 2002
represents compensation paid to Mr. Hinton by MSI.
(7) Mr. Maggi was appointed acting Chief Executive Officer of our company
effective December 1, 2001, in which capacity he served until June 1, 2003,
at which time he resigned from that office and took the position of Senior
Vice President of Business Development. Mr. Maggi resigned as an officer
and director of our company in January 2004. Mr. Maggi served as an officer
of our company in his capacity as controlling stockholder of Intertainment,
Inc., which provided consulting services to our company. Mr. Maggi was not
compensated directly by our company. For the year ended December 31, 2004,
our company paid Intertainment, Inc. $13,300 for Mr. Maggi's services as
Sr. Vice President of Business Development. Included in such payment was
$11,500 in consulting fees and $1,800 as reimbursement for a portion of the
rent on a New York office he occupied. For the year ended December 31,
2003, our company paid Intertainment, Inc. $358,647 for Mr. Maggi's
services as acting Chief Executive Officer and other capacities. Included
in such payment was $207,500 in consulting fees, $119,647 in business
expense reimbursements, and $31,500 as reimbursement for a portion of the
rent on a New York office he occupied. For the year ended December 31,
2002, our company
53
paid Intertainment, Inc. $314,830 for Mr. Maggi's services as acting Chief
Executive Officer. Included in such payment was $180,000 in consulting
fees, $100,483 in expense reimbursements, and $34,347 as reimbursement for
a portion of the rent on a New York office he occupied.
EMPLOYEE BONUS PLAN
In March 2001, our board of directors adopted the Front Porch Digital Inc.
Employee Bonus Plan (the "Bonus Plan") to promote the interests of our company
and our stockholders by permitting us to award bonuses in cash or in shares of
our common stock to key employees in order to reward such employees for their
successful efforts in attaining objectives beneficial to the growth and
profitability of our company and to retain their services. We have reserved
200,000 shares, subject to adjustment, of common stock for issuance under the
Bonus Plan. As of June 30, 2005, no shares have been issued under this plan. The
Bonus Plan will terminate on March 31, 2006, except that our board of directors
may terminate the Bonus Plan (except with respect to any outstanding bonus
awards) at an earlier date.
The Bonus Plan is administered by either our board of directors or the
Compensation Committee of the board. Members of the Compensation Committee are
eligible to receive bonuses only if such bonuses are granted by our board of
directors.
Our board of Directors or the Compensation Committee has the authority to
determine which key employees shall be awarded bonuses; the amounts of bonuses
and the number of shares of common stock, if any, to be awarded; and all other
terms and combinations of performance measurement criteria, which may differ as
to various key employees or attainment of certain performance levels. Our board
of directors or the Compensation Committee decides whether performance criteria
have been met, whether and when to award bonuses, time payment of bonuses, and
whether to pay bonuses in cash or in common stock or any combination thereof.
The determinations of our board of directors or the Compensation Committee, as
the case may be, on these matters shall be conclusive. The number of shares of
common stock to be awarded as a bonus is to be equal in value to a fixed cash
amount, with the value of such common stock computed at the higher of (a) the
fair market value of the common stock to be awarded on date of award, or (b) the
par value of the common stock to be awarded.
Any eligible employee whose employment has terminated for any reason other
than death prior to the end of the bonus measurement period may remain eligible
for a full or prorated bonus, or may forfeit his bonus in its entirety, in
accordance with such terms as may be set for such bonus from time to time by our
board of directors or the Compensation Committee. Bonuses payable will be paid
to the estate of designee of any eligible employee who has died after
termination of employment but before payment of the bonus award. In the event
that any eligible employee's employment is terminated either (i) for cause, or
(ii) without the consent of our company, his eligibility for a bonus under the
Bonus Plan shall terminate in whole immediately upon termination of employment.
If an eligible employee dies while he is employed by us or any of our
subsidiaries, his estate or designee shall be eligible to receive a prorated
bonus. Bonus rights are not transferable otherwise than by will or the laws of
descent and distribution.
No bonus award of common stock may be made under the Plan unless and until
the shares subject to such award have been listed, registered and qualified upon
any applicable securities exchange or under any applicable state or federal law,
including without limitation, the Securities and Exchange Act of 1933, as
amended, and the consent or approval of any governmental regulatory body,
necessary or desirable as a condition of, or in connection with, the award or
issuance of shares hereunder has been obtained.
54
EQUITY INCENTIVE PLAN
In May 2000, we adopted our 2000 Equity Incentive Plan (the "Incentra
Option Plan") for the purpose of attracting, retaining and maximizing the
performance of executive officers and key employees and consultants. We
currently have reserved 600,000 shares of common stock for issuance under the
Incentra Option Plan. On May 17, 2005, we increased the number of shares
reserved, post reverse split, from 600,000 to 2,262,500. The Incentra Option
Plan has a term of ten years. The Incentra Option Plan provides for the grant of
"incentive stock options" within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, non-statutory stock options, stock
appreciation rights and restricted stock awards. The Incentra Option Plan is
administered by a Compensation Committee of our board of directors (the
"Compensation Committee"). The exercise price for non-statutory stock options
may be equal to or more or less than 100 percent of the fair market value of
shares of common stock on the date of grant. The exercise price for incentive
stock options may not be less than 100 percent of the fair market value of
shares of common stock on the date of grant (110 percent of fair market value in
the case of incentive stock options granted to employees who hold more than ten
percent of the voting power of our issued and outstanding shares of common
stock).
Options granted under the Incentra Option Plan may not have a term of more
than a ten-year period (five years in the case of incentive stock options
granted to employees who hold more than ten percent of the voting power of our
common stock) and generally vest over a three-year period. Options generally
terminate three months after the optionee's termination of employment by us for
any reason other than death, disability or retirement, and are not transferable
by the optionee other than by will or the laws of descent and distribution.
The Incentra Option Plan also provides for grants of stock appreciation
rights ("SARs"), which entitle a participant to receive a cash payment, equal to
the difference between the fair market value of a share of common stock on the
exercise date and the exercise price of SAR. The exercise price of any SAR
granted under the Incentra Option Plan will be determined by our board of
directors at its discretion at the time of the grant. SARs granted under the
Incentra Option Plan may not be exercisable for more than a ten-year period.
SARs generally terminate one month after the grantee's termination of employment
by us for any reason other than death, disability or retirement. Although our
board of directors has the authority to grant SARs, it does not have any present
plans to do so.
Restricted stock awards, which are grants of shares of common stock that
are subject to a restricted period during which such shares may not be sold,
assigned, transferred, made subject to a gift, or otherwise disposed of, or
mortgaged, pledged or otherwise encumbered, may also be made under the Option
Plan. At this time, our board of directors has not granted, and does not have
any plans to grant, restricted shares of common stock.
MANAGEDSTORAGE INTERNATIONAL, INC. - 2000 STOCK OPTION AND GRANT PLAN
Prior to our acquisition of MSI, which is accounted for as a reverse
merger, MSI adopted and administered its 2000 Stock Option and Grant Plan (the
"MSI Plan") for its employees, directors, consultants and other key persons. As
a result of such acquisition, no additional grants will be made under the MSI
Plan; however, outstanding stock options previously issued pursuant to the MSI
Plan may be exercised for unregistered shares of common stock. As provided in
the MSI acquisition agreements, upon the exercise of any outstanding options
issued under the MSI Plan, we will issue 0.03089 shares of our unregistered
shares of common stock for each share of MSI common stock that would have been
issuable upon the exercise of such options. At October 10, 2005, there were
outstanding under the MSI Plan options to purchase 217,032 shares of our common
stock.
55
The following table sets forth information with respect to the stock
options granted to the Named Executive Officers during the year ended December
31, 2004.
OPTION/SAR GRANTS IN THE YEAR ENDED DECEMBER 31, 2004
(INDIVIDUAL GRANTS)
Number of % of Total
Securities Options/SARs
Underlying Granted to Exercise or
Options/SARs Employees in Base Price
Name Granted (#) Fiscal Year ($/Sh) Expiration Date
---- ----------- ------------ ----------- ---------------
Thomas P. Sweeney III 82,500 5.6% $2.20 March 16, 2014
1,023,700 69.5% $2.80 August 18, 2014
Michael Knaisch 60,000 4.1% $2.20 March 16, 2014
Matthew Richman 42,500 2.9% $2.20 March 16, 2014
Donald Maggi -0- 0% N/A N/A
Jay Yogeshwar -0- 0% N/A N/A
Paul McKnight 50,000 3.4% $3.20 November 17, 2014
Walter Hinton 70,000 4.7% $3.20 November 17, 2014
The following table sets forth information with respect to each exercise of
stock options during the year ended December 31, 2004 by each of the Named
Executive Officers and the value at December 31, 2004 of all unexercised stock
options held by such persons.
56
AGGREGATED OPTION EXERCISES IN THE YEAR ENDED DECEMBER 31, 2004
AND DECEMBER 31, 2004 OPTION VALUES
Number of Securities Value of Unexercised
Underlying Unexercised In-the-money options at
Shares Options at December 31, 2004
Acquired on Value December 31, 2004 Exercisable/
Exercise (#) Realized ($) Exercisable/ Unexercisable Unexercisable(1)
------------ ------------ -------------------------- -----------------------
NAME
Thomas P. Sweeney III -0- $-0- 75,505/1,182,709(2) $194,726/$354,847
Michael Knaisch -0- $-0- 135,000/-0- $49,500/$-0-
Matthew Richman -0- $-0- 92,500/-0- $34,750/$-0-
Jay Yogeshwar -0- $-0- 1,595/-0- $-0-/$-0-
Donald Maggi 10,000 $61,178 46,000/-0- $4,600/$-0-
Paul McKnight -0- $-0- 23,794/53,827(3) $11,785/$9,785
Walter Hinton -0- $-0- 16,821/86,821(4) $43,382/$43,382
- ----------
(1) Potential unrealized value is calculated as the fair market value of our
common stock at December 31, 2004 ($2.90) per share on the OTC Bulletin
Board), less the option exercise price, times the number of shares.
(2) Includes options to purchase 76,509 shares of unregistered common stock
issued under the MSI Plan.
(3) Includes options to purchase 3,895 shares of unregistered common stock
issued under the MSI Plan.
(4) Includes options to purchase 16,821 shares of unregistered common stock
issued under the MSI Plan.
COMPENSATION OF DIRECTORS
Non-employee independent directors receive $30,000 per annum for their
services and are reimbursed out-of-pocket expenses incurred in attending
meetings of our board of directors. In April 2004, James Wolfinger and Patrick
Whittingham, non-employee directors, were each granted options to purchase up to
25,000 shares of our common stock at a price of $2.20 per share. The options
vest pursuant to a three-year vesting schedule.
EMPLOYMENT AGREEMENTS
On August 18, 2004, we entered into a two-year employment agreement with
Thomas P. Sweeney III, our Chairman of the Board of Directors and Chief
Executive Officer. Mr. Sweeney's employment agreement contains the following
provisions: annual base salary of $275,000 and $300,000 for the first and second
years, respectively; annual bonus of up to 100% of the base salary; the payment
of insurance premiums under Mr. Sweeney's existing life insurance policy; the
issuance of options to purchase up to 1,023,700 shares of our common stock at
$2.80 per share, which options are subject to a three-year vesting schedule;
severance provisions for the payment of one-year of base salary; a pro-rated
bonus and certain benefits in the event of a change of control or the
termination of Mr. Sweeney's employment for any reason other than for cause (as
defined).
On December 6, 2004, we entered into a two-year employment agreement with
Michael Knaisch, the President of our Front Porch Digital division (and our
former Chief Executive Officer). The employment agreement with Mr. Knaisch
contains the following provisions: annual base salary of
57
$200,000, subject to increase at the discretion of the compensation committee of
our board of directors and quarterly performance-based bonuses of up to $37,500,
as determined by our board, during the fiscal year ending December 31, 2005. The
agreement provides that Mr. Knaisch may terminate the agreement upon thirty 30)
days prior written notice to us and we may terminate the agreement with or
without cause, upon written notice to Mr. Knaisch. If Mr. Knaisch is terminated
without cause he will be entitled to receive his full salary and group health
plan benefits for twelve months following such termination.
On June 1, 2003, we entered into a one-year employment agreement, which on
June 1, 2004 was automatically renewed for an additional one-year term, with
Matthew Richman, our Senior Vice President - Corporate Development (and former
Chief Financial Officer and Chief Operating Officer). The employment agreement
with Mr. Richman contains the following provisions: annual base salary of
$160,000; annual bonus of up to fifty percent (50%) of the base salary, subject
to increase at the discretion of the board of directors; a term of one year with
automatic renewal; additional life insurance for Mr. Richman paid by us with a
benefit equal to three times the annual base salary; and severance provisions
for the payment of one-year of annual salary and benefits in the event of a
change in control or the termination of the employee's employment for any reason
other than for cause (as defined).
On December 21, 2004, we entered into an at-will employment agreement with
Paul McKnight, our Chief Financial Officer. Mr. McKnight's employment agreement
contains the following provisions: annual base salary of $210,000, subject to
increase at the discretion of the compensation committee of our board of
directors, and an annual performance-based bonus of up to $75,000, as determined
by our Chief Executive Officer; termination of the agreement by Mr. McKnight
upon 30 days prior written notice and by us, with or without cause, upon written
notice to Mr. McKnight. Mr. McKnight will be entitled to receive his full salary
and group health plan benefits for 12 months following termination if he is
terminated by us without cause (as defined).
On December 21, 2004, we entered into an at-will employment agreement with
Walter Hinton, our Chief Technology Officer. Mr. Hinton's employment agreement
contains the following provisions: annual base salary of $225,000, subject to
increase at the discretion of the compensation committee of our board of
directors, and an annual performance-based bonus of up to $75,000, as determined
by our Chief Executive Officer, termination of the agreement by Mr. Hinton upon
30 days prior written notice and by us, with or without cause, upon written
notice to Mr. Hinton. Mr. Hinton will be entitled to receive his full salary and
group health plan benefits for 12 months following termination if he is
terminated by us without cause (as defined).
On October 10, 2005, we entered into a two-year employment agreement,
effective October 17, 2005, with Shawn O'Grady, our President and Chief
Operating Officer. Mr. O'Grady's employment agreement contains the following
provisions: an annual base salary of $240,000, which is subject to increase at
the discretion of the compensation committee of our board of directors; a
guaranteed performance bonus of $40,000 for the fiscal year ending December 31,
2005; a performance bonus of up to $160,000, but in no event less than $40,000,
for the fiscal year ending December 31, 2006; and participation in our Equity
Incentive Plan. The employment agreement provides that Mr. O'Grady may terminate
the employment agreement upon thirty (30) days prior written notice to us and we
may terminate Mr. O'Grady's employment, with or without cause, upon written
notice to Mr. O'Grady. If Mr. O'Grady is terminated without cause, he will be
entitled to receive his full salary and group health plan benefits for 12 months
following such termination.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information as of October 10, 2005 regarding
beneficial stock ownership of (i) all persons known to us to be beneficial
owners of more than five percent (5%) of our outstanding common stock and Series
A preferred stock, (ii) each of our directors, (iii) the Named Executive
Officers and (iv) all of our officers and directors as a group. Each of the
persons in the table below has sole voting power and sole dispositive power as
to all of the shares shown as beneficially owned by them, except as otherwise
indicated:
Number of
Shares Percent of
Beneficially Outstanding
Name Title of Class Owned(1) Shares(2)(3)
---- -------------- ------------ ------------
5% BENEFICIAL OWNERS
- --------------------
Great Hill Equity Partners LP Common Stock 3,732,612 24.9%(4)
One Liberty Square Series A Preferred Stock 843,170 34.2%
Boston, MA 02109
Tudor Investment Corporation Common Stock 2,684,612 17.5%(5)
1275 King Street Series A Preferred Stock 1,004,405 40.7 %
Greenwich, CT 06831
J.P. Morgan Direct Venture Capital Common Stock 2,330,797 16.0%(6)
Institutional Investors, LLC Series A Preferred Stock 602,775 24.4%
522 Fifth Avenue
New York, NY 10036
Alfred N. Curmi Common Stock 1,135,580 8.5%(7)
910 Seasage Drive
Delray Beach, Florida 33483
DIRECTORS AND NAMED EXECUTIVE OFFICERS
- --------------------------------------
Christopher S. Gaffney Common Stock 3,732,612 24.9%(4)
One Liberty Square Series A Preferred Stock 843,170 34.2%
Boston, MA 02109
Thomas P. Sweeney III Common Stock 1,047,659 7.4%(8)
1140 Pearl Street Series A Preferred Stock 16,588 *
Boulder, CO 80302
Michael Knaisch Common Stock 199,814 1.5%(9)
1140 Pearl Street
Boulder, CO 80302
Matthew Richman Common Stock 152,514 1.1%(10)
1140 Pearl Street
Boulder, CO 80302
59
Number of
Shares Percent of
Beneficially Outstanding
Name Title of Class Owned(1) Shares(2)(3)
---- -------------- ------------ ------------
James Wolfinger Common Stock 67,857 *(11)
1140 Pearl Street
Boulder, CO 80302
Walter Hinton Common Stock 28,726 *(12)
1140 Pearl Street
Boulder, CO 80302
Paul McKnight Common Stock 25,372 *(13)
1140 Pearl Street
Boulder, CO 80302
Patrick Whittingham Common Stock 8,333 *(14)
12 Heron Drive
Old Tappan, NJ 07675
Shawn O'Grady -- -- --
1140 Pearl Street
Boulder, CO 80302
Carmen J. Scarpa -- -- --
50 Rowes Wharf, 6th Floor
Boston, MA 02110
All directors and executive Common Stock 5,262,887 32.7%
officers as a group (10 persons) Series A Preferred Stock 859,758 34.9%
- ----------
* Constitutes less than 1%
(1) For the purposes of this table, a person is deemed to have "beneficial
ownership" of any shares of capital stock that such person has the right to
acquire within 60 days of October 10, 2005.
(2) All percentages for common stock are calculated based upon a total of
shares outstanding as of, October 10, 2005, plus, in the case of the person
for whom the calculation is made, that number of shares of common stock
that such person has the right to acquire within 60 days after October 10,
2005.
(3) All percentages for Series A preferred stock are calculated based upon a
total of 2,466,971 shares outstanding as of October 10, 2005.
(4) Represents 3,611,082 shares of common stock owned of record by Great Hill
Equity Partners LP ("GHEP") (assuming conversion of 815,715 shares of
Series A preferred stock into 1,631,430 shares of common stock) and 121,530
shares of common stock owned of record by Great Hill Investors, LLC ("GHI")
(assuming conversion of 27,455 shares of Series A preferred stock into
54,909 shares of common stock). The foregoing numbers represent shares for
which GHEP GHI each has shared dispositive and voting power. Such shares
may be deemed to be beneficially owned by Great Hill Partners GP, LLC
("GP"), the general partner of GHEP, Great Hill Partners, LLC ("GHP"), a
manager of GP and Messrs. Christopher S. Gaffney, John G. Hayes and Stephen
F. Gormley, the managers of GHI, GHP and GP. Share information is furnished
in
60
reliance on the Schedule 13D dated August 18, 2004 filed by the persons
named herein with the Securities and Exchange Commission. The persons named
herein have each specifically disclaimed that they are a member of a group
for purposes of Section 13(d) or 13(g) of the Securities Exchange Act of
1934, as amended (the "Exchange Act").
(5) Represents 2,416,209 shares of common stock owned of record by Tudor
Ventures II LP ("Tudor") (assuming conversion of 903,994 shares of Series A
preferred stock into 1,807,988 shares of common stock), 266,589 shares of
common stock owned of record by The Raptor Global Portfolio Ltd. ("Raptor")
(assuming conversion of 99,741 shares of Series A preferred stock into
199,482 shares of common stock), and 1,814 shares of common stock held by
The Altar Rock Fund LP ("Altar") (assuming conversion of 670 shares of
Series A preferred stock into 1,340 shares of common stock). The foregoing
numbers represent shares for which Tudor, Raptor and Altar each has shared
dispositive and voting power. Such shares may be deemed to be beneficially
owned by Tudor Investment Corporation ("TIC"), the sole general partner of
Altar and an investment advisor for Tudor and Raptor, and Paul Tudor Jones,
II, the controlling stockholder of TIC. Tudor Ventures Group LP ("TV GP"),
the general partner of Tudor, and Tudor Ventures Group LLC, the general
partner of TV GP, may also be deemed to be beneficial owners of the shares
held by Tudor. Share information is furnished in reliance on the Schedule
13D dated August 18, 2004 filed by the persons named herein with the
Securities and Exchange Commission. The persons named herein have each
specifically disclaimed that they are a member of a group for purposes of
Section 13(d) or 13(g) of the Exchange Act.
(6) Represents 1,924,580 shares of common stock owned of record by JP Morgan
Direct Venture Capital Institutional Investors LLC ("JPM Institutional")
(assuming conversion of 497,532 shares of Series A preferred stock into
995,063 shares of common stock), 311,514 shares of common stock owned of
record by JP Morgan Direct Venture Private Investors LLC ("JPM Private")
(assuming conversion of 81,136 shares of Series A preferred stock into
162,273 shares of common stock), and 94,703 shares of common stock owned of
record by 522 Fifth Avenue Fund, LP ("522 Fund") (assuming conversion of
24,107 shares of Series A preferred stock into 48,214 shares of common
stock). The foregoing numbers represent shares for which JPM Institutional,
JPM Private and 522 Fund each has shared dispositive and voting power. The
shares held by JPM Institutional may be deemed to be beneficially owned by
JPMorgan Chase Bank ("JPMCB"), its investment advisor, and JPMorgan Chase &
Co., the parent of JPMCB. The shares held by JPM Private may be deemed to
be beneficially owned by J.P. Morgan Investment Management Inc. ("JPMIM"),
its investment advisor. The shares held by 522 Fund may be deemed to be
beneficially owned by 522 Fifth Avenue Corp. ("522 Corp."), its general
partner, JPMIM, its investment advisor and the sole stockholder of 522
Corp., J.P. Morgan Fleming Asset Management Holdings Inc. ("Fleming"), the
sole stockholder of JPMIM, and JPMCB, the sole stockholder of Fleming and
the indirect parent of JPMIM. Share information is furnished in reliance on
the Schedule 13D dated August 18, 2004 filed by the persons named herein
with the Securities and Exchange Commission. The persons named herein have
each specifically disclaimed that they are a member of a group for purposes
of Section 13(d) or 13(g) of the Exchange Act.
(7) Share information is furnished in reliance on the Schedule 13G dated March
2, 2005 filed by Mr. Curmi with the Securities and Exchange Commission.
(8) Represents 122,443 shares of common stock owned of record by Equity Pier
LLC, of which Mr. Sweeney is the founder and managing member, 332,470
shares issuable upon the exercise of presently exercisable warrants held by
Equity Pier LLC, 141,827 shares of common stock owned of record by Mr.
Sweeney, and 417,742 shares issuable upon the exercise of presently
exercisable options held by Mr. Sweeney and assumes conversion of 16,588
shares of Series A preferred stock owned of record by Mr. Sweeney into
33,177 shares of common stock.
(9) Represents 64,814 shares of common stock owned of record by Mr. Knaisch and
135,000 shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Knaisch.
(10) Represents 60,014 shares of common stock owned of record by Mr. Richman and
92,500 shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Richman.
61
(11) Represents 59,524 hares owned of record by Mr. Wolfinger and 8,333 shares
of common stock issuable upon the exercise of presently exercisable options
held by Mr. Wolfinger.
(12) Represents 11,905 shares of common stock owned of record by Mr. Hinton and
16,821 shares issuable upon the exercise of presently exercisable options
held by Mr. Hinton.
(13) Represents 134 shares of common stock owned of record by Mr. McKnight, 100
shares of common stock owned by Mr. McKnight's spouse and 25,138 shares
issuable upon the exercise of presently exercisable options held by Mr.
McKnight. Mr. McKnight is a member of Equity Pier LLC and disclaims
beneficial ownership of the shares of common stock beneficially owned by
such entity.
(14) Represents shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Whittingham.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During 2003, MSI purchased one of our 8% convertible notes having a
principal amount of $250,000 in our private placement of convertible notes. Upon
our acquisition of MSI in August 2004, that note was converted into shares of
common stock and outstanding interest of $19,167 was cancelled. At the time of
the sale of the note, Thomas P. Sweeney III, our Chairman of the Board and Chief
Executive Officer, was the President and a director of MSI.
During 2003 and 2004, MSI provided services to us in human resources,
finance and technology support in exchange for service fees. Service fees
outstanding at the time of our acquisition of MSI in the amount of $180,516 were
cancelled upon consummation of our acquisition of MSI.
At the time of our acquisition of MSI, Thomas P. Sweeney III, our Chairman
of the Board and Chief Executive Officer, was the President and Chief Executive
Officer of MSI, and Paul McKnight, our Chief Financial Officer and a director,
was the Chief Financial Officer of MSI. In addition, immediately prior to the
acquisition, MSI was the beneficial owner of approximately 19% of the
outstanding shares of our common stock.
Thomas P. Sweeney III, our Chairman and Chief Executive Officer, is the
founder and Managing Partner of Equity Pier LLC ("Equity Pier"), a beneficial
owner of 5.8% of our outstanding common stock. During 2004 and 2003, we incurred
liabilities to Equity Pier totaling approximately $6,866 and $16,000,
respectively, primarily related the reimbursement of airplane usage, travel and
business expenses incurred by Mr. Sweeney and those incurred by our executives.
We also leased office space from Equity Pier in 2004 and 2003 and incurred total
costs incurred under the leasing arrangement and associated expenses (utilities,
supplies and insurances) amounted to approximately $130,252 and $18,000,
respectively. We paid consulting fees and other reimbursable expenses to the
members of Equity Pier during 2004 in the amount of $32,183. At December 31,
2004, we owed Equity Pier approximately $470, which amount has since been paid.
On a pro forma basis, as though we had owned MSI during the period January 1,
2004 through December 31, 2004, liabilities incurred to Equity Pier were
$100,571 for reimbursement of airplane usage, $250,347 for leasing arrangements
and associated expenses (utilities, supplies and insurances) and $32,183 for
consulting fees and other reimbursable expenses to the members of Equity Pier.
During 2004, Patrick Whittingham, a member of our board of directors, had a
consulting agreement with us. During 2004, we paid Mr. Whittingham $18,711 in
consulting fees and expenses.
62
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 200,000,000 shares of common
stock, par value $.001 per share, and 5,000,000 shares of preferred stock, par
value $.001 per share, of which 2,500,000 shares are designated as Series A
preferred stock, par value $.001 per share. As of October 10, 2005, 13,326,353
shares of common stock were issued and outstanding and 2,466,971 shares of
Series A preferred stock (which are convertible into 4,933,942 shares of common
stock) were issued and outstanding. In addition, at such date, 4,074,071 shares
of common stock were reserved for issuance upon the exercise of outstanding
options and warrants and 4,274,646 shares were reserved for issuance upon the
conversion of the outstanding principal under convertible debt securities.
COMMON STOCK
VOTING, DIVIDEND AND OTHER RIGHTS. Each outstanding share of common stock
will entitle the holder to one vote on all matters presented to the stockholders
for a vote. Holders of shares of common stock have no preemptive, subscription
or conversion rights. All shares of common stock to be outstanding following
this offering will be duly authorized, fully paid and non-assessable. Our board
of directors will determine if and when distributions may be paid out of legally
available funds to the holders. We have not declared any cash dividends during
the past fiscal year with respect to the common stock. Our declaration of any
cash dividends in the future will depend on a determination by our board of
directors as to whether, in light of our earnings, financial position, cash
requirements and other relevant factors existing at the time, it appears
advisable to do so. In addition, we are a party to a credit facility that
prohibits the payment of dividends without the lender's prior consent.
RIGHTS UPON LIQUIDATION. Upon liquidation, subject to the right of any
holders of the preferred stock to receive preferential distributions, each
outstanding share of common stock may participate pro rata in the assets
remaining after payment of, or adequate provision for, all our known debts and
liabilities.
MAJORITY VOTING. The holders of a majority of our outstanding shares of
common stock constitute a quorum at any meeting of the stockholders. A plurality
of the votes cast at a meeting of stockholders elects our directors. The common
stock does not have cumulative voting rights. Therefore, the holders of a
majority of the outstanding shares of common stock can elect all of our
directors. In general, a majority of the votes cast at a meeting of stockholders
must authorize stockholder actions other than the election of directors. Most
amendments to our certificate of incorporation require the vote of the holders
of a majority of all outstanding voting shares.
PREFERRED STOCK
Our board of directors has the authority to divide the authorized preferred
stock into series, the shares of each series to have such relative rights and
preferences as shall be fixed and determined by our board of directors. The
provisions of a particular series of authorized preferred stock, as designated
by the board of directors, may include restrictions on the payment of dividends
on common stock. Such provisions may also include restrictions on our ability to
purchase shares of common stock or to purchase or redeem shares of a particular
series of authorized preferred stock. Depending upon the voting rights granted
to any series of authorized preferred stock, issuance of such shares could
result in a reduction in the voting power of the holders of common stock. In the
event of any dissolution, liquidation or winding up of our company, whether
voluntary or involuntary, the holders of the preferred stock may receive, in
priority over the holders of common stock, a liquidation preference established
by our board of directors, together with accumulated and unpaid dividends.
Depending upon the consideration paid for authorized preferred stock, the
liquidation preference of authorized preferred stock and other matters, the
issuance of
63
authorized preferred stock could result in a reduction in the assets available
for distribution to the holders of common stock in the event of the liquidation
of our company.
SERIES A PREFERRED STOCK
On August 17, 2004, we filed a Certificate of Designations (the
"Certificate of Designations") with the Nevada Secretary of State designating
2,500,000 shares of our preferred stock as Series A convertible preferred stock.
CONVERSION. Holders of Series A preferred stock shall have the right to
convert each of their shares of Series A preferred stock into such number of
fully paid and nonassessable shares of common stock as is determined by dividing
the number of shares of Series A preferred stock held by such holder by the
conversion price at the time of such conversion. The initial conversion price
per share for shares of Series A preferred stock is $6.30 (subject to certain
adjustments as set forth in the Certificate of Designations). All outstanding
shares of Series A preferred stock may also be automatically converted upon the
election of the holders of 80% of the outstanding shares of Series A preferred
stock.
VOTING, DIVIDEND AND OTHER RIGHTS. Each outstanding share of Series A
preferred stock will entitle the holder to two votes of common stock on all
matters presented to the common stockholders for a vote. So long as at least
500,000 shares of the originally-issued shares of Series A preferred stock are
outstanding, the holders of Series A preferred stock have the right to elect
three directors to our board of directors. Our board of directors will determine
if and when distributions may be paid out of legally available funds to the
holders of Series A preferred stock. If and when our board of directors
determines to make distributions to the holders of our common stock, the holders
of Series A preferred stock shall be entitled to participate on a pro rata basis
(determined on an as-if-converted basis).
REDEMPTION. At any time after August 18, 2004, holders of at least 80% of
the outstanding shares of Series A preferred stock may elect at any time to have
all of the outstanding shares of Series A preferred stock redeemed by us. The
price for each share of Series A preferred stock redeemed shall be equal to the
greater of (i) $12.60 (subject to certain adjustments) per each share of Series
A preferred stock plus an amount equal to all accumulated but unpaid dividends
on such share of Series A preferred stock (collectively, the "Series A
Preference Amount") and (ii) the fair market value of the common stock into
which the Series A preferred stock is then convertible.
RIGHTS UPON LIQUIDATION. Upon liquidation, the holders of the Series A
preferred stock shall be entitled to receive distributions before any amount
shall be paid to the holders of common stock or any other junior capital stock.
The liquidation distribution shall be equal to the Series A Preference Amount.
Alternatively, the holders of Series A preferred stock may receive the amount
they would have received had they converted their shares into common stock
immediately prior to the liquidation. In addition, holders of at least 80% of
the outstanding shares of Series A preferred stock may elect to have certain
transactions treated as a liquidation event which would give rise to the
liquidating distributions discussed herein.
REGISTRATION RIGHTS
In connection with our acquisition of MSI, we granted registration rights
to certain former MSI stockholders pursuant to the terms of two registration
rights agreements. One agreement provides that at any time after February 18,
2006, the holders of at least 51% of the Series A preferred stock have the right
to cause us to register under the Securities Act the shares of common stock
underlying the Series A preferred stock issued to such holders in our
acquisition of MSI. In addition, such agreement provides for the grant of
"piggy-back" and S-3 registration rights to such holders. The other agreement
provides for
64
the grant of "piggy-back" registration rights certain former MSI stockholders.
None of the registration rights of the former holders of MSI stockholders have
been exercised or are presently exercisable.
In connection with our acquisition of Incentra of CA, we granted
registration rights to the former Incentra of CA principal stockholder, pursuant
to the terms of a registration rights agreement. The agreement provides that at
any time after March 1, 2006, the former stockholder shall have the right to
cause us to register under the Securities Act the shares of common stock and the
shares of common stock issuable upon conversion of a convertible promissory note
issued to him in the acquisition. In addition, such agreement provides for the
grant of "piggy-back" registration rights to the former stockholder.
In connection with our acquisition of PWI, we granted registration rights
to two former stockholders of PWI and one former noteholder of PWI, pursuant to
the terms of a registration rights agreement. The agreement provides that at any
time after March 31, 2006, the former stockholders and noteholder shall have the
right to cause us to register under the Securities Act the shares of common
stock issued to them on the closing date of the transaction and the shares
issuable pursuant to an earn-out provision more fully described in the governing
documents. In addition, such agreement provides for the grant of "piggy-back"
registration rights to the former stockholders and noteholder.
In connection with obtaining our two loan facilities from Laurus, we agreed
to register under the Securities Act the shares of our common stock into which
the promissory notes we issued to Laurus are convertible and for which the stock
purchase warrants we issued to Laurus are exercisable, and to maintain the
effectiveness of any such registration statements until the earliest of the date
on which (i) all shares registered thereunder have been sold, (ii) all shares
registered thereunder may be sold immediately without registration under the
Securities Act and without volume registrations pursuant to Rule 144(k) under
the Securities Act and (iii) all amounts payable to the Laurus under the
promissory notes for which registered shares are issuable upon conversion have
been paid in full.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Interwest Transfer
Company Inc., 1981 Murray Holladay Road, Salt Lake City, Utah 84117.
65
SELLING STOCKHOLDER
THE JUNE 2005 FACILITY
On June 30, 2005, we entered into a three-year, $9.0 million revolving,
convertible credit facility (the "2005 Facility") with Laurus. Pursuant to the
terms of the 2005 Facility, the maximum principal amount of all borrowings
cannot exceed 90% of the combined eligible accounts receivable of our company,
STAR and Incentra of CA. Borrowings under the 2005 Facility accrue interest at
the `prime rate' (as published in The Wall Street Journal) plus 1%, which is
subject to reduction if the market price of our common stock exceeds certain
designated thresholds. We also issued to Laurus a seven-year warrant that
entitles the holder thereof to purchase up to 400,000 shares of our common stock
at a price of $2.63 per share (subject to adjustment for dilutive issuances,
stock splits, stock dividends and the like) at any time prior to June 30, 2012.
On July 5, 2005, we borrowed $6.0 million under the 2005 Facility, which amount
remained outstanding at October 10, 2005. Under the 2005 Facility, we issued two
separate promissory notes:
o We issued a minimum borrowing note (the "Laurus MBN") in the principal
amount of $3.0 million that matures on June 30, 2008 and is convertible
into shares of our common stock at $2.05 per share, subject to adjustment.
The common shares issuable upon the conversion of the Laurus MBN may be
offered and sold under this prospectus. The Laurus MBN may be prepaid or
redeemed prior to maturity only upon payment of 125% of the outstanding
principal balance, together with accrued but unpaid interest thereon. In
the event the full balance of the Laurus MBN is converted into shares of
common stock, Laurus has the right to require us to issue an additional
minimum borrowing note in the principal amount of $3.0 million that is
convertible into shares of our common stock at the then-current market
price of our common stock, which would maintain the size of the total
facility at $9.0 million. If we are required to issue the additional
minimum borrowing note, we would be obligated to register under the
Securities Act the additional shares of our common stock that would be
reserved for issuance upon conversion of such note. At October 10, 2005,
the outstanding principal amount of the Laurus MBN was $3.0 million.
o We issued a revolving convertible note (the "Revolving Note") in the
principal amount of $6.0 million that matures on June 30, 2008 and is
convertible into shares of our common stock that will not be registered for
resale under the Securities Act. Of the $6.0 million principal amount
outstanding under the Revolving Note, the first $3.0 million is convertible
into restricted shares of our common stock at a conversion price of $2.56
per share, subject to adjustment, and the second $3.0 million is
convertible into restricted shares of our common stock at a conversion
price of $2.99 per share, subject to adjustment. The outstanding principal
amount of the Revolving Note may be prepaid from time to time without
penalty. At October 10, 2005, the outstanding principal amount of the
Revolving Note was $3.0 million. We are not registering for resale the
shares of our common stock issuable upon conversion of the Revolving Note.
The 2005 Facility contains certain negative covenants that require us to
obtain the prior written consent of Laurus or to otherwise comply with certain
specific requirements in order for us to take certain actions at any time when
borrowings remain outstanding under the 2005 Facility. These negative covenants
include, without limitation, restrictions on our ability to
o incur or assume indebtedness (other than trade debt);
o issue shares of preferred stock;
66
o pay or make any dividend or distribution on any class of our capital
stock;
o create or permit the existence of any subsidiary, other than
subsidiaries in existence on the date of the 2005 Facility;
o enter into any merger, consolidation or reorganization, with limited
exceptions; or
o sell, lease or transfer our assets, except in the ordinary course of
business.
As security for our obligations to Laurus under the 2005 Facility, we
granted to Laurus a blanket security interest in all of the assets of PWI and
Incentra of CA, two of our wholly-owned subsidiaries, and we entered into a
stock pledge with Laurus for the capital stock of PWI and Incentra of CA. If an
event of default occurs under the Laurus financing documents, 125% of the unpaid
principal balance, plus accrued interest and fees, will become immediately due
and Laurus will be entitled to payment of a default interest rate of 1.5% per
month on all amounts due. Such events of default include, without limitation,
the following:
o a failure to pay interest and principal payments under our promissory
notes issued to Laurus within three days of when due;
o a breach by us of any material covenant or term or condition of our
promissory notes issued to Laurus, or in any of the Laurus financing
documents, if not cured within 15 days of such breach;
o a breach by us of any material representation or warranty made in our
promissory notes issued to Laurus, or in any of the Laurus financing
documents;
o if we make an assignment for the benefit of our creditors, or a
receiver or trustee is appointed for us, or any form of bankruptcy or
insolvency proceeding is instituted by us, or any involuntary
proceeding is instituted against us if not vacated within 30 days;
o the filing of any money judgment or similar final process against us
for more than $100,000, which remains unvacated, unbonded or unstayed
for a period of 30 days;
o if our common stock is suspended for five consecutive days or for
five days during any ten consecutive days from a principal market or
pursuant to a SEC stop order; and
o a failure by us to timely deliver shares of common stock when due
upon conversions of the Laurus notes.
Upon an event of default, Laurus will be entitled to specified remedies,
including remedies under the Uniform Commercial Code.
Pursuant to a registration rights agreement between our company and Laurus,
we were obligated to (a) file within 55 days of the date of the funding of the
Laurus MBN the registration statement of which this prospectus forms a part (the
"Registration Statement") to register under the Securities Act the resale of the
shares of our common stock issuable upon the conversion of the Laurus MBN or the
exercise of certain stock purchase warrants and (b) use our best efforts to have
the Registration Statement declared effective under the Securities Act as
promptly as possible, but in any event prior to the 115th day following the date
of funding of the Laurus MBN. We are also obligated to maintain the
effectiveness of the Registration Statement until the earliest of the date on
which (i) all shares registered thereunder have been sold, (ii) all shares
registered thereunder may be sold immediately without registration under the
Securities Act and without volume restrictions pursuant to Rule 144(k) or (iii)
all amounts payable under
67
the Laurus MBN have been paid in full. Laurus is entitled to certain monetary
remedies if we do not timely comply with our registration obligations.
Under the terms of the 2005 Facility and the warrants issued in connection
with the 2005 Facility, Laurus may not exercise such warrants or convert the
principal or interest payable under the Laurus MBN or the Revolving Note if such
exercise or conversion would result in Laurus beneficially owning more than
4.99% of our outstanding common stock without first providing us 75 days' prior
notice.
This summary of the material terms of the 2005 Facility is not a complete
description of the material terms thereof and is qualified in its entirety by
reference to the agreements entered into in connection with the 2005 Facility,
which agreements are attached as exhibits to the registration statement of which
this prospectus forms a part.
AMENDMENTS TO MAY 2004 FACILITY
The 1,480,362 shares of our common stock underlying the convertible term
note (the "2004 Term Note") issued to Laurus in connection with the May 2004
Facility in the original principal amount of $5.0 million, as well as the
443,500 shares underlying stock purchase warrants issued in connection with the
May 2004 Facility and the 412,500 shares underlying stock purchase warrants
issued in lieu of cash penalties thereunder, have been registered for resale
under the Securities Act under our registration statement on Form SB-2 (Reg. No.
333-116942). At October 10, 2005, the outstanding principal amount of the 2004
Term Note was approximately $3,317,000. On each of May 4, 2005, May 31, 2005,
August 1, 2005 and August 31, 2005, we amended the 2004 Term Note issued to
Laurus in connection with the May 2004 Facility (collectively, the "Laurus
Amendments") to provide that Laurus may convert the principal and interest
payments due on those dates at a price below the then-applicable fixed
conversion price of the 2004 Term Note. As a result of the Laurus Amendments, an
additional 246,770 shares of our common stock were issued to Laurus under the
2004 Term Note, which shares have been registered for resale under the
registration statement of which this prospectus forms a part. The terms of the
2004 Term Note also provide that Laurus may not exercise or convert its
convertible securities if such exercise or conversion would result in Laurus
beneficially owning more than 4.99% of our outstanding common stock without
first providing us 75 days' prior notice. Furthermore, the monthly amount of
principal and interest to be converted by Laurus under the 2004 Term Note may
not exceed twenty percent (20%) of the aggregate dollar trading volume of our
common stock for the twenty (20) trading day period immediately preceding the
date Laurus directs us to pay any portion of the monthly amount due in shares of
our common stock.
The following table sets forth information with respect to the number of
shares of common stock beneficially owned by Laurus, and the number of such
shares as adjusted to give effect to the sale of the maximum number of shares
offered hereby. The shares beneficially owned have been determined in accordance
with rules promulgated by the SEC, and the information is not necessarily
indicative of beneficial ownership for any other purpose. The calculation of the
shares beneficially owned does not take into account the limitation on more than
4.99% beneficial ownership by Laurus or the dollar trading volume limitation
contained in the terms of our credit facilities with Laurus (as discussed
above). The information in the table below is current as of October 10, 2005.
All information contained in the table below is based upon information provided
to us by Laurus and we have not independently verified this information. Laurus
is not making any representation that any shares covered by this prospectus will
be
68
offered for sale. Laurus may from time to time offer and sell pursuant to this
prospectus any or all of the common stock being registered.
For purposes of this table, except as described above, beneficial ownership
is determined in accordance with SEC rules, and includes voting power and
investment power with respect to shares and shares owned pursuant to options or
warrants exercisable within 60 days. The "Number of Shares Beneficially Owned
After Offering" column assumes the sale of all shares offered.
NUMBER OF
SHARES NUMBER OF
BENEFICIALLY SHARES
OWNED NUMBER BENEFICIALLY
PRIOR TO OF SHARES OWNED AFTER
SELLING STOCKHOLDER OFFERING(1) % OFFERED((3)) OFFERING(1) %
------------------- ----------- ----- ---------------- ---------------- -----
Laurus Master Fund, Ltd(2) 5,198,324 28.5% 2,428,477(4) 2,769,847 15.2%
- ----------
(1) For purposes of this table beneficial ownership is determined in accordance
with SEC rules, and includes voting power and investment power with respect
to shares and shares owned pursuant to options or warrants exercisable
within 60 days. All percentages for common stock are calculated based upon
a total of shares outstanding as of October 10, 2005, plus that number of
shares of common stock that Laurus has the right to acquire within 60 days
of October 10, 2005.
(2) Laurus Capital Management, L.L.C. exercises voting and investment power on
behalf of Laurus Master Fund, Ltd., and may be deemed a control person of
the shares owned by such entity. David Grin and Eugene Grin are the
principals of and the natural persons exercising the voting power of Laurus
Capital Management, L.L.C. Neither Laurus Capital Management, L.L.C. nor
Laurus Master Fund, Ltd is a registered broker-dealer or an affiliate of a
broker dealer. The inclusion of any shares in this table does not
constitute an admission of beneficial ownership.
(3) The actual number of shares of our common stock offered hereby, and
included in the registration statement of which this prospectus is a part,
includes such additional number of shares of common stock as may be issued
or issuable upon exercise of any warrant or conversion of any note by
reason of adjustment mechanisms described therein, by reason of penalty
provisions described therein, or by reason of any future stock splits,
stock dividends or similar transactions involving our common stock, in
order to prevent dilution, in accordance with Rule 416 under the Securities
Act.
(4) Includes (i) 1,781,707 shares of our common stock issuable upon conversion
of outstanding principal (1,463,415 shares) and interest (318,292 shares)
under the Laurus MBN issued to Laurus under the 2005 Facility; (ii) 400,000
shares of our common stock issuable upon the exercise of stock purchase
warrants issued to Laurus in connection with the 2005 Facility; and (iii)
an aggregate of 246,770 shares of our common stock issued to Laurus in
connection with the payment of principal (215,941 shares) and interest
(28,829 shares) as a result of amendments to the 2004 Term Note. In each
case, the number of shares presented in the table represents the maximum
number of shares issuable under that convertible security.
No affiliate of Laurus has held any position or office with us or any of
our affiliates and Laurus has not had any other material relationship with us or
any of our affiliates within the past three years other than as a result of its
ownership of shares of our equity securities.
As explained below under "Plan of Distribution," we have agreed with Laurus
to bear certain expenses (other than broker discounts and commissions, if any)
in connection with the registration statement of which this prospectus is a
part.
69
PLAN OF DISTRIBUTION
Laurus may, from time to time, sell any or all of its shares of our common stock
on any stock exchange, market or trading facility on which the shares are traded
or in private transactions. These sales may be at fixed or negotiated prices.
Laurus may use any one or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o broker-dealers may agree with Laurus to sell a specified number of
such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
Laurus may also sell shares under Rule 144 under the Securities Act, if
available, rather than under this prospectus.
The terms of our credit facilities with Laurus prohibit Laurus from
engaging in short sales of our securities.
Broker-dealers engaged by Laurus may arrange for other broker-dealers to
participate in sales. Broker-dealers may receive commissions or discounts from
Laurus (or, if any broker-dealer acts as agent for the purchaser of shares, from
the purchaser) in amounts to be negotiated. Laurus does not expect these
commissions and discounts to exceed what is customary in the types of
transactions involved. Any profits on the resale of shares of common stock by a
broker-dealer acting as principal might be deemed to be underwriting discounts
or commissions under the Securities Act. Discounts, concessions, commissions and
similar selling expenses, if any, attributable to the sale of shares will be
borne by Laurus. Laurus may agree to indemnify any agent, dealer or
broker-dealer that participates in transactions involving sales of the shares if
liabilities are imposed on that person under the Securities Act.
Laurus may from time to time pledge or grant a security interest in some or
all of the shares of common stock owned by it and, if it defaults in the
performance of its secured obligations, the pledgees or secured parties may
offer and sell the shares of common stock from time to time under this
prospectus after we have filed an amendment to this prospectus under Rule
424(b)(3) or other applicable provision of the Securities Act amending the list
of selling stockholders to include the pledgees, transferees or other successors
in interest as selling stockholders under this prospectus.
Laurus may also transfer the shares of common stock in other circumstances,
in which case the transferees, pledgees or other successors in interest will be
the selling beneficial owners for purposes of this prospectus and may sell the
shares of common stock from time to time under this prospectus after we
70
have filed an amendment to this prospectus under Rule 424(b)(3) or other
applicable provision of the Securities Act amending the list of selling
stockholders to include the pledgees, transferees or other successors in
interest as selling stockholders under this prospectus.
We are required to pay all fees and expenses incident to the registration
of the shares of common stock. We have agreed to indemnify Laurus against
certain losses, claims, damages and liabilities, including liabilities under the
Securities Act.
Laurus acquired the securities offered hereby in the ordinary course of
business and has advised us that it has not entered into any agreements,
understandings or arrangements with any underwriters or broker-dealers regarding
the sale of its shares of common stock, nor is there an underwriter or
coordinating broker acting in connection with a proposed sale of shares of
common stock by Laurus. If we are notified by Laurus that any material
arrangement has been entered into with a broker-dealer for the sale of shares of
common stock, if required, we will file a supplement to this prospectus. If
Laurus uses this prospectus for any sale of the shares of common stock, it will
be subject to the prospectus delivery requirements of the Securities Act.
The anti-manipulation rules of Regulation M under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), may apply to sales of our common
stock and the activities of Laurus. If Laurus is deemed to be a "statutory
underwriter" within the meaning of Section 2(11) of the Securities Act, the
anti-manipulation provisions of Regulation M under the Exchange Act will apply
to purchases and sales of shares of our common stock by Laurus. In such case,
under Regulation M, neither Laurus nor its agents may bid for, purchase or
attempt to induce any person to bid for or purchase, shares of our common stock
while Laurus is distributing any shares covered by this prospectus. In addition,
Laurus is not permitted to cover short sales by purchasing shares while the
distribution is taking place. Laurus should be advised that if a particular
offer of common stock is to be made on terms constituting a material change from
the information set forth above with respect to the plan of distribution, then,
to the extent required, a post-effective amendment to the registration statement
of which this prospectus forms a part must be filed with the SEC.
LEGAL MATTERS
The legality of the issuance of the shares offered in this prospectus will
be passed upon for us by Pryor Cashman Sherman & Flynn LLP, New York, New York
10022. Pryor Cashman Sherman & Flynn LLP holds a warrant to purchase 50,000
shares of our common stock at an exercise price of $1.00 per share. In addition,
a member of Pryor Cashman Sherman & Flynn LLP holds warrants to purchase an
aggregate of 22,500 shares of our common stock at an exercise price of $1.00 per
share.
EXPERTS
The consolidated financial statements as of and for the year ended December
31, 2004 included herein have been audited by GHP Horwath, P.C., independent
registered public accounting firm, for the period and the extent set forth in
their report (which includes an explanatory paragraph describing that on August
18, 2004, we acquired MSI in a transaction recorded as a reverse merger)
appearing herein. Such consolidated financial statements have been so included
in reliance upon the report of such firm given upon their authority as experts
in auditing and accounting.
71
The consolidated financial statements of MSI, the acquirer of our company
for accounting purposes, for the year ended December 31, 2003 have been included
herein in reliance upon the report of KPMG LLP, independent registered public
accounting firm, appearing elsewhere herein, and upon the authority of said firm
as experts in accounting and auditing.
The audit report covering the December 31, 2003 financial statements notes
that on August 18, 2004, MSI was acquired by us in a transaction accounted for
as a reverse merger whereby MSI was the acquirer for accounting purposes.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form SB-2 (including
exhibits and schedules) under the Securities Act, with respect to the shares to
be sold in this offering. This prospectus does not contain all the information
set forth in the registration statement. For further information with respect to
our company and the common stock offered in this prospectus, reference is made
to the registration statement, including the exhibits filed thereto, and the
financial statements and notes filed as a part thereof. With respect to each
such document filed with the SEC as an exhibit to the registration statement,
reference is made to the exhibit for a more complete description of the matter
involved.
We file quarterly and annual reports, proxy statements and other
information with the SEC. You may read and copy any document that we file at the
public reference facilities of the SEC in Washington, D.C. You may call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. Our SEC
filings are also available to the public from the SEC's website at
http//www.sec.gov.
72
INCENTRA SOLUTIONS, INC.
INDEX TO FINANCIAL STATEMENTS
Page
(a) Interim Unaudited Financial Information of Incentra Solutions, Inc.
Unaudited Condensed Consolidated Balance Sheet as of June 30, 2005......F-1
Unaudited Condensed Consolidated Statements of Operations and
Comprehensive Loss for the three and six months ended
June 30, 2005 and 2004..................................................F-2
Unaudited Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 2005 and 2004.........................F-3
Notes to Unaudited Condensed Consolidated Financial.....................F-4
(b) Financial Statement of Incentra Solutions, Inc.
Report of Independent Registered Public Accounting Firm - GHP
Horwath, P.C............................................................F-21
Report of Independent Registered Public Accounting Firm - KPMG LLP......F-22
Consolidated Balance Sheet as of December 31, 2004......................F-23
Consolidated Statements of Operations for the years ended
December 31, 2004 and 2003..............................................F-24
Consolidated Statements of Mandatorily Redeemable Preferred Stock
for the years ended December 31, 2004 and 2003..........................F-25
Consolidated Statements of Shareholders' Deficit and Comprehensive
Loss for the years ended December 31, 2004 and 2003.....................F-27
Consolidated Statements of Cash Flows for the years ended
December 31, 2004 and 2003..............................................F-29
Notes to Consolidated Financial Statements..............................F-31
73
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 2005
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 2,058,585
Accounts receivable, net of allowance for doubtful accounts of $260,000 12,309,757
Other current assets 1,036,076
-------------
Total current assets 15,404,418
-------------
Property and equipment, net 2,366,712
Capitalized software development costs, net 1,655,837
Intangible assets, net 14,916,003
Goodwill 14,482,287
Other assets 894,149
-------------
34,314,988
-------------
TOTAL ASSETS $ 49,719,406
=============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of note payable, capital leases and other long-term obligations $ 4,495,929
Accounts payable 9,612,801
Accrued expenses 3,720,186
Current portion of deferred revenue 1,378,109
-------------
Total current liabilities 19,207,025
-------------
Note payable, capital leases and other long-term obligations, net of current portion 6,317,932
Deferred revenue, net of current portion 109,105
-------------
6,427,037
-------------
TOTAL LIABILITIES 25,634,062
-------------
Commitments and contingencies
Series A convertible redeemable preferred stock, $.001 par value, $31,500,000 liquidation preference,
2,500,000 shares authorized, 2,466,971 shares issued and outstanding 23,309,550
-------------
Shareholders' equity:
Preferred stock, nonvoting, $.001 par value, 2,500,000 shares --
authorized, none issued or outstanding
Common stock, $.001 par value, 200,000,000 shares authorized, 13,030,446 shares issued, --
12,887,082 shares outstanding, 143,364 shares in treasury 12,887
Additional paid-in capital 124,021,141
Accumulated other comprehensive loss (134,766)
Accumulated deficit (123,123,468)
-------------
TOTAL SHAREHOLDERS' EQUITY 775,794
-------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 49,719,406
=============
See accompanying notes to unaudited condensed consolidated financial statements.
F-1
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2005 2004 2005 2004
---- ---- ---- ----
Revenues:
Products $ 13,788,519 $ 30,500 $ 17,020,031 $ 402,000
Services 3,810,713 1,867,531 6,586,364 3,859,827
------------ ------------ ------------ ------------
TOTAL REVENUES 17,599,232 1,898,031 23,606,395 4,261,827
------------ ------------ ------------ ------------
Cost of revenue:
Products 10,010,843 -- 11,287,217 --
Services 2,494,582 1,337,362 4,282,191 2,549,699
------------ ------------ ------------ ------------
Total cost of revenue 12,505,425 1,337,362 15,569,408 2,549,699
------------ ------------ ------------ ------------
GROSS MARGIN 5,093,807 560,669 8,036,987 1,712,128
------------ ------------ ------------ ------------
Selling, general and administrative 5,361,134 2,046,528 9,388,507 4,101,731
Amortization 806,028 237,476 1,591,309 474,952
Depreciation 120,249 37,162 191,393 82,079
Impairment of goodwill -- 136,852 -- 198,280
------------ ------------ ------------ ------------
6,287,411 2,458,018 11,171,209 4,857,042
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (1,193,604) (1,897,349) (3,134,222) (3,144,914)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 3,516 659 25,947 5,818
Interest expense (610,000) (697,705) (1,171,310) (1,391,219)
Other income 11,425 34,173 378,167 87,188
Foreign currency transaction (loss) gain (8,464) 2,244 73,725 1,932
------------ ------------ ------------ ------------
(603,523) (660,629) (693,471) (1,296,281)
------------ ------------ ------------ ------------
LOSS BEFORE INCOME TAX EXPENSE (1,797,127) (2,557,978) (3,827,693) (4,441,195)
Income tax expense (559,000) -- (877,000) --
------------ ------------ ------------ ------------
NET LOSS (2,356,127) (2,557,978) (4,704,693) (4,441,195)
------------ ------------ ------------ ------------
Deemed dividends on redeemable preferred stock -- (149,589) -- (297,534)
Accretion of redeemable preferred stock to redemption amount (654,392) (7,833) (1,308,784) (15,666)
------------ ------------ ------------ ------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (3,010,519) $ (2,715,400) $ (6,013,477) $ (4,754,395)
============ ============ ============ ============
COMPREHENSIVE NET LOSS
Net Loss $ (2,356,127) $ (2,557,978) $ (4,704,693) $ (4,441,195)
Foreign currency translation adjustments (76,717) -- (153,950) --
------------ ------------ ------------ ------------
$ (2,432,844) $ (2,557,978) $ (4,858,643) $ (4,441,195)
============ ============ ============ ============
Weighted average number of common shares 12,703,068 1,953,308 11,901,066 1,950,114
outstanding - basic and diluted =========== ========== =========== ============
Basic and diluted net loss per share applicable to common shareholders $ (0.24) $ (1.39) $ (0.51) $ (2.44)
============ ============ ============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
F-2
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
2005 2004
---- ----
Cash flows from operating activities:
Net loss $(4,704,693) $(4,441,195)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 792,959 890,213
Amortization of intangible assets and software development costs 1,839,492 653,563
Amortization of non-cash loan discount 12,735 7,643
Stock-based compensation expense 263,753 88,618
Non-cash interest expense 959,402 --
Non-cash interest expense on Series C mandatorily redeemable preferred stock liability -- 1,335,650
Non-cash income tax expense 877,000 --
Share of losses of Front Porch Digital, Inc. and related impairment of goodwill -- 198,280
Loss on disposal of assets and other (25,205) 9,541
Bad debt expense 20,787 126,924
Gain on revaluation of derivative warrant liability (390,280) --
Changes in operating assets and liabilities, net of business acquisitions:
Accounts and other receivables (971,197) (277,073)
Other current assets (241,418) (5,374)
Other assets 29,524 (8,218)
Accounts payable 711,812 330,023
Accrued liabilities (49,099) (956)
Deferred revenue 83,955 (463,093)
Other liabilities (328,128) (6,932)
----------- -----------
Net cash used in operating activities (1,118,601) (1,562,386)
----------- -----------
Cash flows from investing activities:
Purchases of property and equipment (516,745) (750,750)
Capitalized software development costs (729,002) (353,729)
Proceeds from sale of property and equipment 750 134,758
Cash acquired in Incentra of CA acquisition (Note 2) 1,597,498 --
Cash acquired in PWI acquisition (Note 2) 74,297 --
Net change in restricted cash (366) (317)
Maturies of short-term investments -- 3,793,099
----------- -----------
Net cash provided by investing activities 426,432 2,823,061
----------- -----------
Cash flows from financing activities:
Proceeds from bank line of credit 862,000 --
Proceeds from lease line of credit 497,667
Payments on capital leases, notes payable and other long term liabilities (1,594,954) (410,055)
Proceeds from exercise of stock options and purchase of restricted stock -- 1,418
----------- -----------
Net cash used in financing activities (235,287) (408,637)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents (82,417) --
----------- -----------
Net (decrease) increase in cash and cash equivalents (1,009,873) 852,038
Cash and cash equivalents at beginning of period 3,068,458 2,201,192
----------- -----------
Cash and cash equivalents at end of period $ 2,058,585 $ 3,053,230
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 199,174 $ 34,285
Supplemental disclosures of non-cash investing and financing activities:
Net assets acquired in Incentra of CA acquisition, excluding cash (Note 2) 6,097,510 --
Net assets acquired in PWI acquisition, excluding cash (Note 2) 4,310,840 --
Conversion of notes payable and accrued interest in exchange for common stock 400,000
Reclassification of derivative warrant liability to equity 1,910,254
Purchases of property and equipment included in accounts payable 118,608 205,492
See accompanying notes to unaudited condensed consolidated financial statements.
F-3
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
Incentra Solutions, Inc. (which is referred to herein together with its
subsidiaries as ("we", "us" or "our"), formerly Front Porch Digital, Inc.
("FPDI" or "Front Porch"), was organized and incorporated in the state of
Nevada. On October 25, 2004, we changed our name from Front Porch Digital, Inc.
to Incentra Solutions, Inc.
We recently completed three acquisitions: On August 18, 2004, we acquired
ManagedStorage International, Inc., a Delaware corporation incorporated in March
2000 ("MSI"); on February 18, 2005, we acquired Incentra of CA, formally known
as STAR Solutions of Delaware, Inc., a privately-held Delaware corporation
("Incentra of CA "); and on March 30, 2005, we acquired PWI Technologies, Inc.,
a privately-held Washington corporation ("PWI"). The MSI acquisition was
accounted for as a reverse merger, and therefore, MSI was deemed to be the
acquirer for accounting purposes. Accordingly, the condensed consolidated
financial statements presented herein include the results of operations of MSI
for all periods presented, and include the results of operations of the acquired
companies from the dates of the acquisitions forward.
We are a provider of complete solutions for an enterprise's data protection
needs. We supply a broad range of storage products and storage management
services to broadcasters, enterprises and information technology service
providers worldwide. We market our products and services to broadcasters under
the trade name Front Porch Digital ("Front Porch") and to service providers and
enterprise clients under the trade names ManagedStorage International, Incentra
Solutions of CA and PWI Technologies. Front Porch provides unique software and
professional services solutions for digital archive management to broadcasters
and media companies. MSI provides outsourced storage solutions, including
engineering, hardware and software procurement and remote storage operations
services. Incentra of CA and PWI are systems integrators that provide
Information Technology ("IT") products, professional services and outsourcing
solutions to enterprise customers located primarily in the western United
States. Our customers are located in North America, Europe, Asia and the Pacific
Rim.
On April 12, 2005, our Board of Directors (the "Board") and the holders of the
required number of shares of our capital stock approved an amendment to our
Articles of Incorporation to effect a one-for-ten reverse stock split effective
June 9, 2005. All references to shares, options, and warrants in the three and
six months ended June 30, 2005 and in prior periods, have been adjusted to
reflect the post-reverse split amounts. Our common stock now trades on the
Over-the-Counter Bulletin Board under the trading symbol "ICNS".
The accompanying unaudited condensed consolidated financial statements have been
prepared by us in accordance with accounting principles generally accepted in
the United States of America for interim financial information and pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
regulations. The unaudited condensed
F-4
consolidated financial statements reflect all adjustments and disclosures that
are, in the opinion of management, necessary for a fair presentation. All such
adjustments are of a normal recurring nature. These interim condensed
consolidated financial statements should be read in conjunction with a reading
of the consolidated financial statements and notes thereto included in our
Annual Report on Form 10-KSB filed with the SEC on April 6, 2005, for the year
ended December 31, 2004.
Certain amounts in the 2004 financial statements have been reclassified to
conform to the 2005 presentation. We do not believe the effects of such
reclassifications are material. Operating results for the three or six months
ended June 30, 2005 are not necessarily indicative of the operating results to
be expected for the year ending December 31, 2005.
MANAGEMENT'S PLANS
Our 2005 operating plan and the execution thereof is focused on increasing
revenue, controlling costs, and conserving cash; however, there can be no
assurance that we will be able to meet the operational and financial
requirements of our operating plan. Our 2005 plan also includes growth through
our recent business acquisitions (Note 2). We cannot predict with certainty the
expected revenue, gross profit margin, net loss, and/or usage of cash and cash
equivalents as a result of these acquisitions. However, we believe that our cash
and cash equivalents and working capital will provide sufficient capital
resources to fund our operations, debt service requirements and working capital
needs at least through June 30, 2006.
STOCK-BASED COMPENSATION
We apply the intrinsic value-based method of accounting prescribed by Accounting
Principles Board Opinion No. 25 (APB 25), ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES, and related interpretations, including Financial Accounting Standards
Board ("FASB") Interpretation No. 44 (FIN 44), ACCOUNTING FOR CERTAIN
TRANSACTIONS INVOLVING STOCK COMPENSATION, AN INTERPRETATION OF APB OPINION NO.
25, to account for our 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. Statement of Financial
Accounting Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
and SFAS 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, we have elected to continue to apply the intrinsic value-based method
of accounting described above, and have 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 three and six months ended June 30, 2005 and 2004. All
amounts except per share amounts in (000's):
F-5
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
------- ------- ------- -------
Net loss before deemed dividends and accretion on preferred stock, as reported $(2,356) $(2,558) $(4,705) $(4,441)
Add stock-based employee compensation expense included in reported
net loss 108 44 264 89
Deduct total stock-based employee compensation expense determined under
fair value-based method for all awards (688) (47) (1,198) (94)
------- ------- ------- -------
Pro forma net loss before deemed dividends and accretion on preferred stock $(2,936) $(2,561) $(5,639) $(4,446)
======= ======= ======= =======
Net loss per weighted average common share outstanding - basic and
diluted - pro forma $ (0.28) $ (1.39) $ (0.58) $ (2.44)
======= ======= ======= =======
Net loss per weighted average common share outstanding - basic and
diluted - as reported $ (0.24) $ (1.39) $ (0.51) $ (2.44)
======== ======= ======= =======
In determining the fair value of stock options granted by us during the three
and six months ended June 30, 2005, and thus determining pro forma compensation
expense under the fair value method, we utilized the Black-Scholes valuation
model with the following weighted average assumptions: dividend yield of 0%,
risk free interest rate of 3.64%, expected volatility of 111%, and expected
lives of three years. The weighted average fair value of options granted during
2005 is $2.10 per option.
In determining the fair value of stock options granted by MSI for the three and
six months ended June 30, 2004, we utilized the Black-Scholes valuation model to
determine pro forma compensation expense under the fair value method with the
following weighted average assumptions: dividend yield of 0%, risk free interest
rate of 4.76%, expected volatility of 0.001%, and expected lives of ten years.
The weighted average fair value of options granted during 2004 was $3.20.
For purposes of pro forma disclosures, the estimated fair value of the options
is 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.
On August 16, 2004, our Board of Directors approved, and on April 1, 2005, our
stockholders approved by majority written consent, an amendment to our 2000
Equity Incentive Plan (the "Plan") to increase the maximum number of shares of
our common stock available for issuance there under from 600,000 shares to
2,265,000 shares.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The accounts of our international subsidiary, Front Porch Digital International,
SAS ("FPD International"), are translated using the exchange rate in effect at
the balance sheet date, and the results of operations are translated at the
average exchange rates during the period. For the six months ended June 30,
2005, we reported a cumulative translation loss of $153,950 as a component of
accumulated other comprehensive loss. We are also subject to foreign exchange
transaction exposure when our subsidiary transacts business in a currency other
than its own functional currency. The effects of exchange rate fluctuations in
remeasuring foreign currency transactions for the three months ended June 30,
2005 and 2004 was a loss of $8,500 and a gain of $2,200, respectively. The
effect of exchange rate fluctuations in remeasuring foreign currency
transactions for the six months ended June 30, 2005 and 2004 was a loss of
$1,000 and a gain of $2,000, respectively.
During 2004, we began managing our foreign currency cash flow exposure through
the use of $/Euro forward contracts, which are considered derivative instruments
and which are recorded as either an asset or liability, measured at fair value.
We recognize changes in fair value of the contracts currently
F-6
in the statements of operations. We recorded a realized gain of approximately $0
and $74,600 for the three and six months ended June 30, 2005, respectively,
which represented the change in the fair value of one foreign currency forward
contract related to the difference between changes in the spot and forward rates
excluded from the assessment of hedge effectiveness. This contract was settled
on April 1, 2005. Currently, there are no forward contracts outstanding.
ACCOUNTING FOR OBLIGATIONS AND INSTRUMENTS POTENTIALLY SETTLED IN THE
COMPANY'S COMMON STOCK
We account for obligations and instruments potentially settled in our stock in
accordance with Emerging Issues Task Force ("EITF") No. 00-19, ACCOUNTING FOR
DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO, AND POTENTIALLY SETTLED IN A
COMPANY'S OWN STOCK ("EITF 00-19"). This issue addresses the initial balance
sheet classification and measurement of contracts that are indexed to, and
potentially settled in, our stock.
Under EITF 00-19, contracts are initially classified as equity or as either
assets or liabilities, depending on the situation. All contracts are initially
measured at fair value and subsequently accounted for based on the then-current
classification. Contracts initially classified as equity do not recognize
subsequent changes in fair value as long as the contracts continue to be
classified as equity. For contracts classified as assets or liabilities, we
report changes in fair value in earnings and disclose these changes in the
financial statements as long as the contracts remain classified as assets or
liabilities. If contracts classified as assets or liabilities are ultimately
settled in shares, any previously reported gains or losses on those contracts
continue to be included in earnings.
At December 31, 2004, our authorized and unissued common shares were
insufficient to settle these contracts. As a result, we classified the value of
these contracts as a liability. As a result of the one-for-ten reverse stock
split on June 9, 2005, there are now sufficient authorized and unissued common
shares to settle these contracts. Accordingly, the fair value of the warrants at
the effective date of the stock split was reclassified to additional paid-in
capital. During the three and six months ended June 30, 2005 we recorded a gain
of $48,785 and $390,280, respectively, on these contracts. The appropriateness
of the classification of these contracts is reassessed at each balance sheet
date.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived tangible and intangible assets that do not have indefinite lives,
such as fixed assets and intellectual property, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. Determination of recoverability is based on
an estimate of undiscounted future cash flows resulting from the use of the
asset and its eventual disposition. Measurement of an impairment loss for such
long-lived assets is based on the fair value of the asset.
Goodwill and other intangible assets with indefinite lives are not amortized and
are subject to write downs charged to results of operations only when their
carrying amounts are determined to be more than their estimated fair values
based upon impairment tests that are required to be made annually or more
frequently under certain circumstances. Fair values are determined based on
models that incorporate estimates of future probability and cash flows.
As of June 30, 2005, we believe there were no indicators of a possible
impairment, and accordingly, no impairment tests were performed and no
impairment losses were recorded. For the three and six months ended June 30,
F-7
2004, MSI recorded impairment losses of $136,852 and $198,280, respectively.
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.
We license software under license agreements and provide professional services,
including training, installation, consulting and maintenance. License fee
revenues are recognized when a license agreement has been signed, the software
product has been shipped, the fees are fixed and determinable, collection is
reasonably assured, and no significant vendor obligations remain.
We allocate revenue to each component of a contract based on objective evidence
of its fair value, as established by management. Because licensing of software
is generally not dependent on the professional services portion of the contract,
software revenue is generally recognized upon delivery, unless a contract exists
with the customer requiring customer acceptance.
Fees for first call maintenance agreements are recognized ratably over the terms
of the agreements. Maintenance is generally billed in advance, resulting in
deferred revenue.
We also provide software-related professional services. Services are generally
provided on a time-and-materials basis and revenue is recognized as the services
are provided.
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 we have not yet performed the related services.
Revenues from product sales, including the resale of third-party maintenance
contracts, are recognized when shipped. Consulting revenues are recognized when
the services are performed.
SOFTWARE DEVELOPMENT COSTS
We account 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. MSI's Gridworks
software product is used internally for providing services to our customers and
is also marketed separately as a stand-alone product. FPDI's DIVArchive software
product is marketed solely as a stand-alone product. As required by SFAS No. 86,
we capitalize costs in developing software products upon determination that
technological feasibility has been established for the product, if that product
is to be sold, leased or otherwise marketed. Costs incurred prior to the
establishment of technological feasibility are charged to research and
development expense. When the product or enhancement is available for general
release to customers, capitalization is ceased, and previously capitalized costs
are amortized based on current and future revenue for the product, but with an
annual amortization amount at least equal to the straight-line, typically three
years. For the three and six months ended June 30, 2005 capitalized software
development costs, which related primarily to enhancements to our Gridworks and
DIVArchive software solutions, totaled $329,691 and $729,002, respectively. For
the three months ended June 30, 2005 and 2004, $130,449 and $91,505,
respectively, of software
F-8
development costs were charged to expense. For the six months ended June 30,
2005 and 2004, $248,182 and $178,611, respectively, of software development
costs were charged to expense. As of June 30, 2005, the unamortized portion of
software development costs was $1,655,837.
INCOME TAX
Income tax expense recognized for the three and six months ended June 30, 2005,
represented income tax expense on FPD International, our wholly-owned French
subsidiary. We are currently in the process of creating an agreement with FPD
International for the allocation of costs related to its sale of our proprietary
software solutions. Any such agreement is subject to acceptance by the French
taxing authorities. We expect that we will be able to implement this agreement
in the fourth quarter of 2005, and therefore allocate the appropriate costs to
FPD International, which we anticipate would serve to significantly reduce our
income tax exposure for the remainder of the year. However, there can be no
assurance that the French taxing authorities will accept this agreement with FPD
International and that we will be able to reduce this income tax expense. Our
income tax expense is a non-cash item due to the utilization of our net
operating loss carryforwards in France.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123(R), SHARE-BASED PAYMENT, which addresses the accounting for share-based
compensation transactions. SFAS No. 123(R) eliminates the ability to account for
share-based compensation transactions using APB 25, and generally requires
instead that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123(R) will be effective for
public companies that file as small business issuers as of the first interim or
annual reporting period that begins after December 15, 2005. We are currently
evaluating the provisions of this standard. However, we expect that the
implementation of this standard will have a material impact on our financial
position and results of operations.
In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR
CORRECTIONS, which changes the requirements for the accounting and reporting of
a change in accounting principle and applies to all voluntary changes in
accounting principles. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. APB No. 20 required
that most voluntary changes in accounting principle be recognized by including
in net income of the period of the change the cumulative effect of changing to
the new accounting principle. This statement requires retrospective application
to prior period financial statements of changes in accounting principles, unless
it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. The provisions of SFAS No. 154 are effective
for fiscal years beginning after December 15, 2005. We do not expect this
statement to have a material impact on our financial position or results of
operations.
(2) ACQUISITIONS
(A) ACQUISITION OF INCENTRA OF CA, FORMALLY KNOWN AS STAR SOLUTIONS OF
DELAWARE, INC.
On February 18, 2005 (the "STAR Closing Date"), we acquired all of the
outstanding capital stock of Incentra of CA. The acquisition was effected
pursuant to an Agreement and Plan of Merger (the "STAR Merger Agreement"). The
results of operations of Incentra of CA are included in our consolidated
F-9
financial statements beginning on February 18, 2005.
Pursuant to the STAR Merger Agreement, the purchase price consisted of (i) a
cash payment of $1,422,000, (ii) the issuance of 1,261,756 unregistered shares
of our common stock valued at $3,136,364 (based upon the market price three days
before and after the acquisition date) and (iii) the issuance of an unsecured
convertible promissory note for $2,500,000 (the "STAR Note"). In addition, we
paid $78,000 to the sole remaining stockholder of Incentra OF CA in exchange for
all shares of capital stock of Incentra OF CA held by such stockholder. We paid
approximately $400,000 in investment banking fees associated with the
transaction.
Interest on the STAR Note accrues at an annual rate of 0.5%. Accordingly, the
note has been discounted to reflect a fair value rate of interest. The remaining
principal of $2,374,139 is payable in eight consecutive quarterly payments of
$251,722, commencing on August 1, 2005, and a single payment of $377,583 on
August 1, 2007 (each of the foregoing dates, a "STAR Payment Due Date"). We
elected not to make the August 1, 2005 payment within the grace period allowed
under the STAR Note, which created an event of default on the STAR Note as of
August 11, 2005. We have not received notice of default or acceleration from the
STAR note holder. We elected not to make the scheduled payment as we are in the
process of negotiating post-closing adjustments to the purchase, which could
have a significant impact on the amount and terms of the STAR Note. As of the
balance sheet date, we have reclassified approximately $1.3 million of the debt
to current liabilities based on the default, as it was not cured within the
10-day grace period. Management does not believe the debt will be paid in one
year from the balance sheet date, however, the reclassification on the balance
sheet was made as the debt is now callable.
All or a portion of the outstanding principal and interest due under the STAR
Note may be converted by the holder into shares of our common stock at any time
from the end of each calendar quarter immediately preceding a STAR Payment Due
Date until and including one day prior to such STAR Payment Due Date. The STAR
Note is initially convertible at a conversion price equal to the greater of (i)
$4.00 or (ii) seventy percent (70%) of the average closing price of our common
stock, as reported on the Over-The-Counter Bulletin Board, for the ten (10)
consecutive trading days ending on and including the last day of the calendar
quarter immediately preceding the applicable STAR Payment Due Date. As of June
30, 2005, the STAR Note was convertible into a maximum of 593,535 shares of our
common stock. Our obligations under the STAR Note are not secured by any of our
assets.
The STAR Note provides that all unpaid principal and accrued interest shall, at
the option of the holder and without notice, become immediately due and payable
upon the occurrence of an event of default (as defined in the STAR Note). Such
events of default include the occurrence of any of the following events: (i)
failure to pay within ten (10) days after the applicable due date any amounts
payable under the STAR Note, (ii) an assignment for the benefit of creditors, or
(iii) failure to perform any material covenant under the STAR Merger Agreement,
the registration rights agreement or the consulting agreement described below or
any other material agreement between us and the seller. Principal amounts not
paid when due (subject to applicable cure periods) bear interest at the rate of
twelve percent (12%) per annum.
Concurrent with the consummation of the acquisition, we entered into a
registration rights agreement with the seller, pursuant to which, at any time
after March 1, 2006, the seller shall have the right to cause us to register
under the Securities Act of 1933, as amended, the shares of common stock issued
to the seller in the acquisition and the shares of common stock issuable upon
conversion of the STAR Note. The agreement also provides that, after March 1,
2006, the seller shall have `piggy-back' registration rights.
The following represents the preliminary purchase price allocation at the date
of the Incentra of CA acquisition:
F-10
Cash and cash equivalents $ 1,598,000
Other current assets 825,000
Property and equipment 20,000
Other assets 7,000
Goodwill 8,122,000
Other intangible assets (3-5 year lives) 540,000
Current liabilities (1,517,000)
Other liabilities (1,900,000)
-----------
Total purchase price $ 7,695,000
===========
The purchase price allocation is not considered final as of the date of this
report. However, we believe the final purchase price allocation will not be
materially different than that presented herein. In connection with the
acquisition, on February 18, 2005, Incentra of CA obtained a revolving line of
credit from a bank that provides for borrowings until March 1, 2007, of up to
$5,000,000 (Note 7(c)). This line of credit and all the related accrued interest
was paid in full on July 5, 2005, in connection with the New Laurus Financing
Agreement as discussed in Note 8.
(B) ACQUISITION OF PWI TECHNOLOGIES, INC.
On March 30, 2005 (the "PWI Closing Date"), we acquired all of the outstanding
capital stock of PWI. The acquisition was effected pursuant to a Stock Purchase
Agreement, dated as of the PWI Closing Date (the "PWI Stock Purchase
Agreement").
The purchase price of PWI consisted of $2,300,000 in cash and 841,934 shares of
our common stock valued at $1,683,868 (based upon the market price three days
before and after the acquisition date). In addition, the former PWI shareholders
have the opportunity to earn an additional $200,000 in cash and $1,000,000 in
our common stock based upon achieving certain earn out requirements. Should PWI
exceed the earn-out requirements, its former shareholders can earn additional
common stock having a value equal to PWI's EBITDA contribution over the earn out
requirement. We paid approximately $300,000 in investment banking fees in
connection with the transaction.
Concurrently with the consummation of the acquisition, we granted registration
rights with respect to the shares of our common stock issued in the acquisition.
Pursuant to the registration rights agreement, at any time after March 31, 2006,
the holders of such rights shall have the right to cause us to register under
the Securities Act of 1933, as amended, the shares of our common stock issued on
the PWI Closing Date and the shares of common stock issuable pursuant to the
earn-out described above. The agreement also provides that, after March 31,
2006, the holders shall have "piggy-back" registration rights with respect to
such shares.
In connection with the consummation of the acquisition, the Chief Executive
Officer of PWI prior to the acquisition was appointed President of PWI. PWI
entered into an "at-will" employment agreement dated as of the PWI Closing Date
that provides that the President will receive an initial annual base salary of
$211,500. The employment agreement also provides that the President may
terminate the agreement upon thirty (30) days prior written notice and that PWI
may terminate employment, with or without cause, at any time upon written
notice. In addition, the President's right to receive his pro rata share of the
earn-out described above is subject to his continued employment
F-11
with PWI for a period of at least one year from the date of the agreement,
except in cases of his death or disability.
The following represents the preliminary purchase price allocation at the date
of the PWI acquisition:
Cash and cash equivalents $ 74,000
Other current assets 7,010,000
Property and equipment 174,000
Other assets 28,000
Goodwill 6,361,000
Other intangible assets (3-5 year lives) 310,000
Current liabilities (7,157,000)
Other liabilities (2,415,000)
-----------
Total purchase price $ 4,385,000
===========
The purchase price allocation is not considered final as of the date of this
report. However, we believe the final purchase price allocation will not be
materially different than that presented herein.
Financing for the cash component of the acquisition was provided by a bank
through an existing line of credit ("LOC") that was established as part of the
acquisition of Incentra of CA. In connection with the financing, the LOC was
amended to make PWI a co-borrower under the agreements and to modify certain
financial covenants to accommodate the addition of PWI to the LOC. The LOC and
all related accrued interest was paid in full on July 5, 2005, in connection
with the New Laurus Financing Agreement, as discussed in Note 8 to these
condensed consolidated financial statements.
(C) ACQUISITION OF MANAGEDSTORAGE INTERNATIONAL, INC.
On August 18, 2004 (the "MSI Acquisition Date"), we acquired all of the
outstanding capital stock of MSI. The acquisition of MSI by us was accounted for
as a reverse merger because on a post-merger basis, the former MSI shareholders
held, immediately following the acquisition on the MSI Acquisition Date, a
majority of our outstanding common stock on a voting and diluted basis. As a
result, MSI was deemed to be the acquirer for accounting purposes. Accordingly,
the condensed consolidated financial statements presented herein include the
financial statements of MSI for all periods prior to the MSI Acquisition Date
and the financial statements of the consolidated companies from the MSI
Acquisition Date forward. Historical share and per share amounts for periods
prior to the MSI Acquisition Date have been retroactively restated to reflect
the exchange ratio established in the transaction, in a manner similar to a
reverse stock split, with the difference in par values being recorded as an
offset to additional paid-in capital. The restated consolidated accumulated
deficit of the accounting acquirer (MSI) has been carried forward after the MSI
Acquisition. The MSI Acquisition was also accounted for as a step acquisition as
it occurred in multiple steps over the period from July 31, 2002, when MSI sold
to us its French subsidiary. After the acquisition of MSI, the former MSI
shareholders beneficially owned approximately 64% of our outstanding common
stock, after giving effect to the conversion of the Series A Preferred Stock.
F-12
(D) PROFORMA RESULTS
The following unaudited pro forma financial information presents our combined
results of operations as if the acquisitions described in (A), (B) and (C) above
had occurred as of the beginning of each of the periods reported below. The
unaudited pro forma financial information is not intended to represent or be
indicative of the consolidated results of operations that would have been
reported by us had the acquisitions been completed as of the beginning of the
periods presented, and should not be taken as representative of our future
consolidated results of operations or financial condition. Pro forma results
were as follows for the three and six months ended June 30, 2005 and 2004:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
------------- ------------- ------------- -------------
Revenue $ 17,599,232 $ 13,860,231 $ 34,050,155 $ 28,136,898
Cost of revenue 12,505,425 9,510,887 24,475,325 19,638,441
------------ ------------ ------------ ------------
Gross margin 5,093,807 4,349,344 9,574,830 8,498,457
Operating expenses 6,287,411 6,883,428 12,667,511 12,704,662
------------ ------------ ------------ ------------
Loss from operations (1,193,604) (2,534,084) (3,092,681) (4,206,205)
------------ ------------ ------------ ------------
Other income (expense), net (603,523) (1,098,722) (771,301) (1,944,484)
Income tax expense (559,000) -- (877,000) --
------------ ------------ ------------ ------------
Net loss (2,356,127) (3,632,806) (4,740,982) (6,150,689)
Dividends on redeemable preferred stock -- (149,589) -- (297,534)
Accretion of redeemable preferred stock
to redemption amount (654,392) (7,835) (1,308,784) (15,666)
------------ ------------ ------------ ------------
Net loss applicable to common shareholders $ (3,010,519) $ (3,790,230) $ (6,049,766) $ (6,463,889)
============ ============ ============ ============
Net loss per share--basic and diluted $ (0.24) $ (0.30) $ (0.48) $ (0.51)
============ ============ ============ ============
(3) PROPERTY AND EQUIPMENT
As of June 30, 2005, property and equipment consisted of:
Computer equipment $4,439,951
Software 1,543,533
Office furniture and equipment 63,246
Leasehold improvements 615,793
----------
6,662,523
Less accumulated depreciation (4,295,811)
----------
$2,366,712
==========
For the three months ended June 30, 2005 and 2004, total depreciation expense
was $398,258 and $486,503, respectively, of which $278,008 and $449,341,
respectively, was included in cost of revenue. For the six months ended June 30,
2005 and 2004, total depreciation expense was $792,959 and $890,213,
respectively, of which $601,563 and $808,134, respectively, was included in cost
of revenue.
Included in the balance above is property and equipment under a capital lease
with a cost of $1,883,090 and accumulated depreciation and amortization of
$798,257.
F-13
(4) CONCENTRATION OF CREDIT RISK
We sell our products and services throughout North America, Europe, and Asia/
Pacific Rim. We perform periodic credit evaluations of our customers' financial
condition and generally do not require collateral. Credit losses have been
within our expectations. For the three months ended June 30, 2005, aggregate
revenues from customers located in Europe or Asia amounted to $4.4 million, or
25% of total revenue, while revenues from customers located in North America
totaled $13.2 million, or 75% of total revenue. For the three months ended June
30, 2004, our revenues from customers located in Europe or Asia amounted to $0.5
million, or 25% of total revenue, while revenues from customers located in North
America totaled $1.4 million, or 75% of total revenue. For the six months ended
June 30, 2005, aggregate revenues from customers located in Europe or Asia
amounted to $7.4 million, or 31% of total revenue, while revenues from customers
located in North America totaled $16.2 million, or 69% of total revenue. For the
six months ended June 30, 2004, our revenues from customers located in Europe or
Asia amounted to $0.9 million, or 20% of total revenue, while revenues from
customers located in North America totaled $3.4 million, or 80% of total
revenue. On a pro forma basis, giving effect to the acquisitions as if they had
occurred at the beginning of the periods presented for the six months ended June
30, 2005 aggregate revenues from customers located in Europe or Asia amounted to
$7.4 million, or approximately 22% of total revenue, while revenues from
customers located in North America totaled $26.6 million, or approximately 78%
of total revenue.
For the three months ended June 30, 2005, one customer represented 12% of total
revenues. For the six months ended June 30, 2005 no one customer represented 10%
or more of total revenues or accounts receivable as of June 30, 2005.
For the three and six months ended June 30, 2004, revenues from three customers,
each exceeding 10% of total revenues, represented 23%, 18% and 15%, and 18%, 17%
and 17%, respectively.
(5) PER SHARE DATA
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. In accordance with accounting requirements for reverse mergers, the
historical loss per share of MSI prior to the MSI Acquisition has been
retroactively restated to reflect our capital structure. Due to our net loss,
shares from the assumed conversion of outstanding warrants, options, convertible
preferred stock and convertible debt have been omitted from the computations of
diluted loss per share for the three and six months ended June 30, 2005 and 2004
because the effect would be antidilutive. Shares issuable from common stock
equivalents that could potentially dilute earnings per share in the future that
were not included in the computation of loss per share because their effect was
anti-dilutive totaled approximately 10.3 million and 0.3 million at June 30,
2005 and 2004, respectively.
(6) SERIES A CONVERTIBLE PREFERRED STOCK
In connection with the MSI Acquisition, we designated 2.5 million authorized
shares of preferred stock as Series A Preferred shares and issued 2,466,971 of
such shares. Warrants are outstanding for the purchase of the remaining 33,029
Series A Preferred shares at a purchase price of $10.35 per share.
The Series A Preferred shares are convertible at any time upon written notice to
us into shares of common stock on a two-for-one basis. So long as at least
500,000 originally issued shares of Series A Preferred are outstanding, the
holders of Series A Preferred shares have the right to appoint three directors
to our Board of Directors. As a result, our Board of Directors has
F-14
been expanded to seven members to accommodate these three directors. On or after
August 16, 2008, the holders of at least 80% of the Series A Preferred shares
may elect to have us redeem the Series A Preferred for a price equal to the
greater of (i) the original issue price of $12.60 per share ($31.5 million in
the aggregate) plus accrued dividends, to the extent dividends are declared by
us, or (ii) the fair market value of the number of shares of common stock into
which such shares of Series A Preferred are convertible. Other material terms of
the Series A Preferred shares include a preference upon liquidation or
dissolution of our company, weighted-average anti-dilution protection and
pre-emptive rights with respect to subsequent issuances of securities by us
(subject to certain exceptions).
(7) DEBT
(A) SENIOR SECURED CONVERTIBLE NOTE
On the MSI Acquisition Date, liabilities assumed in the MSI Acquisition included
the fair value of a convertible note. This convertible note originated on May
13, 2004, when we consummated a private placement pursuant to which we issued a
secured convertible term note due May 13, 2007 in the principal amount of
$5,000,000 (the "Laurus Note"), and we issued a common stock purchase warrant
entitling the holder to purchase 443,500 shares of common stock (the "Laurus
Warrant") at $4.80 per share. The Laurus Note and the Laurus Warrant were sold
to Laurus Master Fund, Ltd. ("Laurus"), for a purchase price of $5,000,000. The
principal and unpaid interest on the Laurus Note is convertible into shares of
our common stock at a price of $3.00 per share, subject to antidilution
adjustments.
In connection with the issuance of the Laurus Note, we recorded the fair value
of the Laurus Warrant as a debt discount in the amount of approximately $1.8
million based upon the Black-Scholes option-pricing model, resulting in an
imputed interest rate of 37%. This discount is being amortized to earnings as
additional interest expense over the term of the Laurus Note. Accordingly, we
have recorded $133,460 and $273,005 of additional non-cash interest expense
relating to the amortization of the discount for the three and six months ended
June 30, 2005, respectively.
In accordance with EITF 00-19, we initially accounted for the fair value of the
Laurus Warrant as equity. As discussed below, in the fourth quarter of 2004, due
to an October 2004 change in the Laurus Note conversion terms, our authorized
and unissued shares available to settle the Laurus Warrant (after considering
all other commitments that may require the issuance of stock during the maximum
period the Laurus Warrant could remain outstanding) were determined to be
insufficient. As a result, we reassessed and reclassified the value of the
Laurus Warrant to a liability at the reassessment date. As a result of the
one-for-ten reverse stock split effected on June 9, 2005, there are now
sufficient authorized and unissued common shares to settle the Laurus Warrant.
During the three and six months ended June 30, 2005, we recorded a gain of
$48,785 and $390,280, respectively, on these contracts. The appropriateness of
the classification of the Laurus Warrant is reassessed at each balance sheet
date.
The Laurus Note provides for monthly payments of interest at a rate per annum
equal to the prime rate plus 1%, which is subject to reduction if the market
price of our common stock exceeds certain designated thresholds. However, the
rate cannot be less than 5% per annum. The Laurus Note also provides for monthly
amortization of principal, which commenced on September 1, 2004, of $45,455
(increased to approximately $159,000 per month beginning in March 2005) with the
balance payable on the maturity date. Laurus has the option to receive shares of
our common stock in lieu of debt service payments at the market price of our
common stock at the date of conversion. The Laurus Note
F-15
is collateralized by a security interest in all of our assets. The Laurus
Warrant entitles the holder to purchase, at any time through May 13, 2011, up to
443,500 shares of our common stock at a price of $4.80 per share, subject to
antidilution adjustments.
Pursuant to a Securities Purchase Agreement (the "Securities Purchase
Agreement") with Laurus, for so long as 25% of the original principal amount of
the Laurus Note is outstanding, we may not directly or indirectly declare or pay
any dividends without the prior written consent of Laurus. The Securities
Purchase Agreement also requires the written consent of Laurus in connection
with any liquidation, material reorganization or issuance of certain additional
indebtedness of the Company.
On October 26, 2004, we entered into an Amendment and Waiver, (the "Amendment
and Waiver") with Laurus that amended the Securities Purchase Agreement and
certain other documents (the "Loan Documents") and waived certain events of
default under certain of the Loan Documents. Pursuant to the Amendment and
Waiver, the parties agreed to reduce the "Fixed Conversion Price" set forth in
the Laurus Note from $5.00 to $3.00 per share and to amend the Master Security
Agreement to provide for a "Lockbox Deposit Account" to be maintained by us and
our subsidiaries under the Master Security Agreement. Lockbox remittances do not
automatically reduce the debt outstanding unless an event of default has
occurred. Laurus further agreed to (i) release to us approximately $3 million,
which represented all funds then remaining in a restricted account (less
outstanding accrued interest and fees); (ii) postpone until the maturity date of
the Laurus Note the monthly principal payable by us under the Laurus Note from
November 1, 2004 through February 1, 2005; (iii) waive certain events of
default, and all fees and default interest rates applicable to such events of
default; (iv) extend the time for our subsidiaries to be joined as a party to
the Master Security Agreement; (v) waive all fees and default interest arising
from our failure to pay the liquidated damages set forth in the Registration
Rights Agreement and further waive any liquidated damages due and payable to
Laurus by us.
In consideration of the waivers, we issued a seven-year warrant to Laurus to
purchase 50,000 shares of our common stock with an exercise price of $5.00 per
share. We further agreed to register under the Securities Act the resale of the
shares of common stock issuable upon exercise of the new warrant and the
additional shares of our common stock issuable to Laurus upon conversion of the
Laurus Note due to the adjustment of the Fixed Conversion Price. We valued the
additional warrant at $89,000, which represents the total liquidated damages
waived by Laurus as a result of the Amendment and Waiver. We recorded this
amount as a liability and additional interest expense during the quarter ended
December 31, 2004. In connection with the reverse stock split discussed above,
the fair value of the additional warrant was reclassified to additional paid-in
capital on June 9, 2005. On February 17, 2005, we entered into an Amendment and
Waiver (the "Second Amendment and Waiver") with Laurus. The Second Amendment and
Waiver waived certain events of default under the Registration Rights Agreement
(as amended on October 25, 2004) and the Laurus Note. Pursuant to the Second
Amendment and Waiver, Laurus agreed to waive all fees and default interest
arising from our failure to pay the liquidated damages set forth in the
Registration Rights Agreement and to waive any liquidated damages due and
payable to Laurus in connection with our failure to maintain the effectiveness
of the Registration Statement.
On February 18, 2005, we entered into a Waiver and Subordination Agreement with
Laurus (the "Laurus Subordination"). The Laurus Subordination waived our
obligation under the Securities Purchase Agreement to cause Incentra of CA to
become a party to the Master Security Agreement. Pursuant to the Laurus
Subordination, Laurus also agreed to subordinate to a lender its security
interest in the accounts receivable and other rights to payments, general
F-16
intangibles, equipment and inventory of Incentra of CA.
On February 18, 2005, in satisfaction of $375,000 of liquidated damages incurred
due to our failure to maintain the effectiveness of the registration statement,
we issued to Laurus an immediately exercisable seven-year warrant to purchase
362,500 shares of common stock at an exercise price of $2.60 per share (the
"Additional Warrant") and further agreed to register under the Securities Act
the resale of the shares of common stock issuable upon exercise of the
Additional Warrant. The Additional Warrant was valued at $375,000 and was
recorded as a liability on the issuance date. We amended our registration
statement on April 14, 2005 to include the shares issuable upon exercise of the
additional warrant and such registration statement was declared effective by the
Securities and Exchange Commission on April 25, 2005. For the six months ended
June 30, 2005, we expensed $375,000 for the liquidated damages, of which $75,000
was incurred in the quarter ended June 30, 2005. In connection with the reverse
stock split discussed above, the fair value of this additional warrant was
reclassified to additional paid-in capital on June 9, 2005.
During the three months ended June 30, 2005, we entered into two amendments with
Laurus to the Laurus Note pursuant to which the conversion price for $400,000 of
principal converted on or after April 28, 2005 was reduced to eighty seven
percent (87%) of the five (5) lowest closing prices of the common stock during
the twenty-two (22) trading days immediately prior to the date of such
conversion; provided, however, that such conversion price shall not be less than
$1.40. During the three months ended June 30, 2005, Laurus converted this
$400,000 under the Laurus Note into 277,339 shares of our common stock. The
conversion was deemed beneficial, and, as a result, additional interest expense
of approximately $110,000 was recorded during the three months ended June 30,
2005.
(B) CAPITAL LEASES
On November 20, 2003, we entered into a capital lease line of credit agreement
(the "Lease Line") 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 interest rate on
the Lease Line ranges from 10.514% per annum to 10.731% per annum. As of June
30, 2005, we have drawn $1,470,507 on the Lease Line and $29,493 of the Lease
Line had expired unused. The Lease Line is to be repaid in monthly principal and
interest installments, with the final payment due in October 2005. The unpaid
balance at June 30, 2005 was $71,073.
On March 2, 2005, we entered into an amendment to the Lease Line. Under this
amendment, we may draw an additional $500,000 (the "New Credit Facility") for
equipment purchases through June 30, 2005. The amendment also grants us a call
option to purchase equipment from the lessor. With respect to $2,333 of the New
Credit Facility amount that was unfunded on June 30, 2005, we were required to
pay the lessor 5% of such unfunded amount upon demand by the lessor. The term of
the agreement is for 15 months with an interest rate of 14.96% per annum, which
amount has since been paid. During the three and six months ended June 30, 2005,
we drew $333,490 and $497,667 on the New Credit Facility. The New Credit
Facility is to be repaid in monthly principal and interest installments through
September 2006. The unpaid balance at June 30, 2005 was $443,649.
(C) REVOLVING LINE OF CREDIT
On February 18, 2005, Incentra of CA obtained a revolving line of credit from
F-17
a bank, that provides for borrowings, from time to time until March 1, 2007, of
up to $5,000,000. In connection with the line of credit, on February 18, 2005,
Incentra of CA entered into a credit agreement (the "Credit Agreement") with the
bank and executed in favor of the bank a revolving line of credit note (the "LOC
Note"), a continuing security agreement (rights to payment and inventory)
("Security Agreement #1") and a security agreement (equipment) ("Security
Agreement #2, and collectively with Security Agreement #1, the "Security
Agreements"). The Credit Agreement, the LOC Note and the Security Agreements are
collectively referred to as the "Loan Documents." On March 30, 2005, the Credit
Agreement was amended to make PWI a co-borrower thereunder.
Pursuant to the Credit Agreement, the maximum principal amount of all borrowings
under the line of credit cannot exceed 80% of Incentra of CA's and PWI's
eligible accounts receivable. At certain times during the quarter ended June 30,
2005, we were over advanced on our line of credit due to fluctuations in the
eligible accounts receivable. The bank did not require the over advances to be
repaid. At June 30, 2005, we were not in an over advanced position. The Credit
Agreement further provides that all borrowed amounts shall, at the option of the
bank and without notice, become immediately due and payable upon the occurrence
of an event of default (as defined in the Credit Agreement). Principal amounts
not paid when due bear interest at 4% above the per annum rate of interest of
the LOC Note.
The LOC Note provides that interest on all outstanding principal amounts shall
accrue at a rate per annum equal to the prime rate plus 1.5%. Interest on the
LOC Note is payable monthly on the first day of each month during the term of
the LOC Note, commencing April 1, 2005. Pursuant to the Security Agreements,
borrowings under the line of credit are secured by a first priority lien on all
assets of Incentra of CA and PWI. If an event of default occurs under the
Security Agreements or the LOC Note, the bank has the right to accelerate
payments under the LOC Note and, in addition to any other remedies available to
it, to foreclose upon the assets securing the LOC Note. In addition, the LOC
Note contains certain financial covenants for which compliance is measured
quarterly. During the three and six months ended June 30, 2005, we drew $862,000
and $4,381,452 on the line of credit. We were not in compliance with one of our
covenants for the quarter ended June 30, 2005 and obtained from the bank a
waiver for this covenant through September 30, 2005.
The LOC Note was repaid in full on July 5, 2005 in connection with the New
Laurus Financing, discussed below.
(8) SUBSEQUENT EVENTS
(A) NEW LAURUS FINANCING
On June 30, 2005, we entered into a Security Agreement with Laurus pursuant to
which Laurus provided us with a $9 million revolving, convertible credit
facility (the "Facility"). The term of the Facility is three years. In
connection with the Facility, we executed in favor of Laurus a $9 million
Secured Revolving Note (the "Revolver Note"). Borrowings under the Facility
accrue interest at a rate per annum equal to the "prime rate" (as published in
The Wall Street Journal) plus 1%, which is subject to reduction if the market
price of our common stock exceeds certain designated thresholds. Pursuant to the
Facility, the minimum initial amount available to us, until December 31, 2005,
is $6.0 million. Thereafter, the maximum principal amount of all borrowings
under the Facility cannot exceed 90% of the combined eligible accounts
receivable of PWI and Incentra of CA.
Pursuant to the revolver note issued under the Facility, Laurus has the option
to convert borrowings under the Facility into shares of our common
F-18
stock. The first $3 million of borrowings are convertible into shares of our
common stock registered under the Securities Act of 1933, as amended (the
"Act"), at a fixed conversion price of $2.05 (as adjusted for dilutive
issuances, stock splits, stock dividends and the like, "as adjusted"). The
second $3 million of borrowings are convertible into unregistered shares of our
common stock at a fixed conversion price of $2.56, as adjusted. The last $3
million of borrowings are convertible into unregistered shares of our common
stock at a fixed conversion price of $2.99, as adjusted.
On July 5, 2005, we requested, and Laurus agreed to lend, an initial draw under
the Facility of $6.0 million, of which approximately $4.4 million was used to
extinguish, in full, our indebtedness to Wells Fargo Bank, N.A. and the balance
of the initial draw, less expenses of the Facility, will be used for general
corporate and working capital purposes.
Borrowings under the Facility are collateralized by a security interest in
substantially all of our assets, including a pledge to Laurus of all of the
outstanding capital stock of PWI and Incentra of CA. Repayment of borrowings
under the Facility is guaranteed by PWI and Incentra of CA pursuant to a
Subsidiary Guaranty in favor of Laurus.
In connection with the financing, we issued Laurus a warrant that entitles
Laurus to purchase, at any time through June 30, 2012, up to 400,000 shares of
our common stock at a price of $2.63 per share, as adjusted (the "Warrant").
The first $3 million of borrowings under the Facility is further evidenced by a
Secured Convertible Minimum Borrowing Note (the "$3 Million Minimum Borrowing
Note"), which provides Laurus with certain additional rights, including without
limitation, the right to receive a pre-payment penalty and certain registration
rights (as further described herein). In the event we redeem, or prepay, the
outstanding balance under the $3 Million Minimum Borrowing Note, we are required
to pay Laurus a sum equal to one hundred twenty five percent (125%) of the
principal amount outstanding under such note, together with accrued but unpaid
interest thereon. All other borrowings under the Facility may be prepaid from
time to time without penalty.
Pursuant to a registration rights agreement with Laurus, we are obligated to:
(a) file a registration statement under the Act to register the resale of the
shares of our common stock issuable upon conversion of the $3 Million Minimum
Borrowing Note and exercise of the Warrant (the "Registration Statement") within
55 days of the date of the funding with respect to the $3 Million Minimum
Borrowing Note; (b) use our best efforts to have the Registration Statement
declared effective under the Act as promptly as possible, but in any event prior
to the 115th day following the funding of the $3 Million Minimum Borrowing Note;
and (c) maintain the effectiveness of the Registration Statement until the
earliest date of when (i) all registrable securities have been sold, (ii) all
registrable securities may be sold immediately without registration under the
Act and without volume restrictions pursuant to Rule 144(k) or (iii) all amounts
payable under the $3 Million Minimum Borrowing Note have been paid in full.
Laurus is entitled to certain remedies specified in the registration rights
agreement if we do not timely comply with its registration obligations.
In connection with the Facility, we paid Laurus approximately $359,000,
comprised of a facility fee of $324,000 (representing an annual fee equal to
1.2% of the Facility payable in advance at closing) and reimbursement of $35,000
of Laurus' expenses.
F-19
Concurrently with the closing of the Facility, we amended our existing Secured
Convertible Term Note with Laurus, dated March 13, 2004, to provide that an
event of default by us under the Facility shall also constitute an event of
default under such Term Note.
On August 1, 2005, we entered into an amendment with Laurus to the Laurus Note
pursuant to which the conversion price for $200,000 of principal converted on or
after April 28, 2005 was reduced to an amount equal to eighty seven percent
(87%) of the average of the five (5) lowest closing prices of the common stock
during the twenty-two (22) trading days immediately prior to the date of such
conversion, but not less than $1.52. On August 1, 2005, Laurus converted this
$200,000 into 131,579 shares of our common stock. The conversion was deemed
beneficial, and as a result, additional interest expense of approximately
$40,000 will be recorded during the three months ended September 30, 2005.
As of August 11, 2005, the default on the STAR Note discussed in footnote 2(A)
above and item (B) below, created an event of default of certain provisions of
the Facility and the Term Note discussed in footnote 7(A). On August 12, 2005,
we obtained a waiver from Laurus waiving the default.
(B) STAR Note Default
We elected not to make the August 1, 2005 payment within the grace period
allowed under the STAR Note, which creates an event of default as of August 11,
2005. We have not received any notice of default or acceleration from the STAR
note holder. We elected not to make the scheduled payment as we are in the
process of negotiating post-closing adjustments to the purchase, which could
have a significant impact on the amount and terms of the note. As of the balance
sheet date, we have reclassified approximately $1.3 million of the debt to
current liabilities based on the default. Management does not believe the debt
will be paid in one year from the balance sheet date, however, the
reclassification on the balance sheet was made as the debt is now callable.
F-20
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Incentra Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Incentra
Solutions, Inc. and subsidiaries (the "Company") as of December 31, 2004, and
the related consolidated statements of operations, mandatorily redeemable
preferred stock, shareholders' deficit and comprehensive loss, 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. 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 Incentra Solutions,
Inc. and subsidiaries as of December 31, 2004, and the results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
As discussed in Note 4 to the consolidated financial statements, on August 18,
2004, the Company acquired Managed Storage International, Inc. in a transaction
recorded as a reverse merger.
/s/ GHP Horwath, P.C.
Denver, Colorado
March 4, 2005,
except for Notes 2 item (A) and 17 item (D),
as to which the date
is April 5, 2005, and Note 2 item (B),
as to which the date
is August 31, 2005
F-21
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Incentra Solutions, Inc.:
We have audited the accompanying consolidated statements of operations,
mandatorily redeemable preferred stock, shareholders' deficit and comprehensive
loss, and cash flows of ManagedStorage International, Inc. and subsidiaries for
the year ended December 31, 2003. 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. 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 results of operations and the cash flows
of ManagedStorage International, Inc. for the year ended December 31, 2003, in
conformity with U.S. generally accepted accounting principles.
On August 18, 2004, ManagedStorage International, Inc. was acquired by Front
Porch Digital, Inc., now known as Incentra Solutions, Inc., in a transaction
accounted for as a reverse merger whereby ManagedStorage International, Inc. was
the acquirer for accounting purposes.
/s/ KPMG LLP
Denver, Colorado
October 29, 2004
except for Note 2(a),
as to which the date
is April 5, 2005, and
Note 2(b), as to
which the date
is August 31, 2005
F-22
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2004
ASSETS
Current assets:
Cash and cash equivalents $ 3,068,458
Accounts receivable, net of allowance for doubtful
accounts of $274,879 3,740,554
Other current assets 645,637
-------------
Total current assets 7,454,649
-------------
Property and equipment, net 2,452,817
Capitalized software development costs, net 1,188,885
Intangible assets, net 16,537,060
Other assets 1,043,634
-------------
21,222,396
-------------
TOTAL ASSETS $ 28,677,045
=============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current portion of note payable, capital leases and other
long-term obligations $ 1,738,516
Accounts payable 1,374,953
Accrued expenses 3,058,806
Current portion of deferred revenue 1,185,736
-------------
Total current liabilities 7,358,011
Note payable, capital leases and other long-term obligations,
net of current portion 2,266,970
Derivative warrant liability 1,925,534
Deferred revenue, net of current portion 149,204
-------------
TOTAL LIABILITIES 11,699,719
-------------
Commitments and contingencies
Series A convertible redeemable preferred stock, $.001
par value, $31,500,000 liquidation preference, 2,500,000 shares
authorized, 2,466,971 shares issued and outstanding 22,000,767
-------------
Shareholders' deficit:
Preferred stock, nonvoting, $.001 par value, 2,500,000 shares --
authorized, none issued or outstanding
Common stock, $.001 par value, 200,000,000 shares authorized,
10,649,362 shares issued,
10,505,998 shares outstanding, 143,364 shares in treasury 10,506
Additional paid-in capital 113,365,645
Accumulated other comprehensive income 19,184
Accumulated deficit (118,418,776)
-------------
TOTAL SHAREHOLDERS' DEFICIT (5,023,441)
-------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 28,677,045
=============
See accompanying notes to consolidated financial statements.
F-23
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
2004 2003
------------ ------------
Revenues:
Products $ 5,155,101 $ --
Services 8,129,569 9,810,741
------------ ------------
TOTAL REVENUE 13,284,670 9,810,741
------------ ------------
Cost of revenue:
Products 1,479,580 --
Services 5,820,755 6,951,781
------------ ------------
Total cost of revenue 7,300,335 6,951,781
------------ ------------
GROSS MARGIN 5,984,335 2,858,960
------------ ------------
Selling, general and administrative 10,262,730 9,361,089
Acquisition costs 1,275,189 --
Amortization 1,776,473 928,851
Depreciation 183,057 363,099
Impairment of goodwill 198,280 692,098
------------ ------------
13,695,729 11,345,137
------------ ------------
LOSS FROM OPERATIONS (7,711,394) (8,486,177)
------------ ------------
Other income (expense):
Interest income 22,096 39,167
Interest expense (2,428,643) (2,225,443)
Other income (expense) 382,989 (327,468)
Foreign currency transaction (loss) gain (303,342) 8,550
------------ ------------
(2,326,900) (2,505,194)
------------ ------------
LOSS BEFORE INCOME TAX (10,038,294) (10,991,371)
Income tax expense (400,000) --
------------ ------------
NET LOSS (10,438,294) (10,991,371)
------------ ------------
Deemed dividends on redeemable preferred stock (348,493) (1,647,669)
Accretion of redeemable preferred stock to
redemption amount (990,826) (96,236)
------------ ------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $(11,777,613) $(12,735,276)
============ ============
Weighted average number of common shares
outstanding - basic and diluted 5,102,733 1,894,552
============ ============
Basic and diluted net loss per share applicable
to common shareholders $ (2.31) $ (6.72)
============ ============
See accompanying notes to consolidated financial statements.
F-24
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Mandatorily Redeemable Preferred Stock
Years ended December 31, 2004 and 2003
"NEW" SERIES PREFERRED
-------------------------------------------------------------------------
MSI SERIES A MSI SERIES B MSI SERIES C
REDEEMABLE CONVERTIBLE 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
payable $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
====== ========== ======= ========== ========== ============ ============
(Continued)
F-25
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Mandatorily Redeemable Preferred Stock (continued)
Years ended December 31, 2004 and 2003
-----------------------------------------------------------------------------------
MSI SERIES A REDEEMABLE MSI SERIES B CONVERTIBLE FPDI SERIES A CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
-------------------------- ------------------------ -------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT TOTAL
---------- ------------ --------- ----------- ---------- ------------ -------------
Balance at December
31, 2003 50,000 $ 5,000,000 650,000 $ 8,587,011 -- -- $13,587,011
Exchange of MSI Series A
redeemable preferred stock
for common stock of
FPDI in merger (50,000) (5,000,000) -- -- -- -- (5,000,000)
Deemed dividends on MSI
redeemable preferred stock -- -- -- 348,493 -- -- 348,493
Accretion of MSI mandatorily
redeemable preferred stock
to redemption amount -- -- -- 19,793 -- -- 19,793
Exchange of MSI Series B
convertible preferred stock
for common stock of
FPDI in merger -- -- (650,000) (8,955,297) -- -- (8,955,297)
Issuance of FPDI Series A
convertible preferred stock
due to merger -- -- -- -- 2,466,971 $21,029,734 21,029,734
Accretion of FPDI convertible
preferred stock to
redemption amount -- -- -- -- -- 971,033 971,033
---------- ------------ --------- ----------- ---------- ----------- -----------
Balance at December 31, 2004 -- $ -- -- $ -- 2,466,971 $22,000,767 $22,000,767
========== ============ ========= =========== ========== =========== ===========
See accompanying notes to consolidated financial statements.
F-26
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Deficit and Comprehensive Loss
Years ended December 31, 2004 and 2003
SERIES C
CLASS A REDEEMABLE
COMMON STOCK COMMON PREFERRED ADDITIONAL
---------------------- STOCK STOCK DEFERRED PAID-IN ACCUMULATED
SHARES AMOUNT WARRANTS WARRANTS COMPENSATION CAPITAL DEFICIT TOTAL
----------- -------- -------- ----------- ------------ ----------- ------------- ------------
Balance at December 31, 2002 6,317 $ 6 -- -- -- $81,082,601 $ (96,989,111) $(15,906,504)
Accretion of mandatorily
redeemable preferred stock -- -- -- -- -- (96,235) -- (96,235)
Dividends on redeemable
preferred stock -- -- -- -- -- (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 1,668,177 1,668 -- -- -- 4,424,489 -- 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 271,060 271 -- -- -- 877,229 -- 877,500
Class A common stock offering
costs -- -- -- -- -- (156,528) -- (156,528)
Issuance of restricted Class A
common stock for cash 2,895 3 -- -- -- 466 -- 469
Exercise of stock options 1,539 2 -- -- -- 738 -- 740
Repurchase of nonvested
restricted Class A
common stock (161) -- -- -- -- (1) -- (1)
Estimated fair value of
warrants issued to purchase
Series C mandatorily
redeemable preferred stock
in exchange for the
equipment lease facility -- -- -- $ 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 -- -- $65,571 92,725 -- (31,659) -- 126,637
Deferred compensation related
to grants of options to
employees to purchase
common stock -- -- -- -- $(670,558) 670,558 -- --
Amortization of deferred
compensation -- -- -- -- 308,418 -- -- 308,418
Net loss before amounts
allocable to common
shareholders -- -- -- -- -- -- (10,991,371) (10,991,371)
----------- -------- ------- -------- --------- ----------- ------------- ------------
Balance at December 31, 2003 1,949,827 $ 1,950 $65,571 $115,652 $(362,140) $85,123,989 $(107,980,482) $(23,035,460)
=========== ======== ======= ======== ========= =========== ============= ============
(continued)
F-27
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Deficit
and Comprehensive Loss (Continued)
Years ended December 31, 2004 and 2003
SERIES C ACCUMULATED
CLASS A REDEEMABLE OTHER
COMMON STOCK COMMON PREFERRED DEFERRED ADDITIONAL COMPRE-
--------------------- STOCK STOCK COMPEN- PAID-IN HENSIVE ACCUMULATED
SHARES AMOUNT WARRANTS WARRANTS SATION CAPITAL INCOME DEFICIT TOTAL
----------- -------- ------- -------- --------- ------------ ------- ------------- ------------
Balance at
December 31, 2003 1,949,827 $ 1,950 $65,571 $115,652 $(362,140) $ 85,123,989 -- $(107,980,482) $(23,035,460)
Accretion of MSI
mandatorily redeemable
preferred stock to
redemption amount -- -- -- -- -- (19,793) -- -- (19,793)
Accretion of FPDI
mandatorily redeemable
preferred stock to
redemption amount -- -- -- -- -- (971,033) -- -- (971,033)
Deemed dividends on MSI
redeemable preferred
stock -- -- -- -- -- (348,493) -- -- (348,493)
Exercise of MSI stock
options 3,481 4 -- -- -- 1,835 -- -- 1,839
Repurchase of MSI
common stock (7,284) (7) -- -- -- (4,769) -- -- (4,776)
Cancellations of MSI
stock options -- -- -- -- 11,519 (11,519) -- -- --
Transactions related to
reverse acquisition of
FPDI by MSI:
MSI Series A preferred
stock exchanged for
common stock of FPDI 1,000,000 1,000 -- -- -- 4,999,000 -- -- 5,000,000
MSI Series B preferred
stock exchanged for
common stock of FPDI 1,806,285 1,806 -- -- -- 8,953,491 -- -- 8,955,297
Stock-based compensation
incurred in connection
with the merger -- -- -- -- -- 798,598 -- -- 798,598
Acquisition of FPDI by
MSI, based on fair
value of common
stock, warrants and
options 5,723,869 5,724 -- -- -- 16,468,706 -- -- 16,474,430
Series C warrants of
MSI exchanged for
Series A stock
warrants of FPDI -- -- -- (115,652) -- 115,652 -- -- --
Class A common stock
warrants of MSI
exchanged for common
stock warrants of FPDI -- -- (65,571) -- -- 65,571 -- -- --
Reclassification of
deferred compensation
to additional paid-in
capital due to merger -- -- -- -- 238,388 (238,388) -- -- --
Cancellation of MSI
common stock exchanged
for common stock
of FPDI -- -- -- -- -- 6,277 -- -- 6,277
Amortization of deferred
compensation and stock
option expense -- -- -- -- 112,233 280,446 -- -- 392,679
FPDI common stock issued
in lieu of interest
payment 29,365 29 -- -- -- 12,471 -- -- 12,500
Reclassification of
derivative warrant
to liability -- -- -- -- -- (1,836,534) -- -- (1,836,534)
Exercise of FPDI stock
options 455 -- -- -- -- 138 -- -- 138
Acquisition costs -- -- -- -- -- (30,000) -- -- (30,000)
Components of
comprehensive loss:
Net loss -- -- -- -- -- -- -- (10,438,294) (10,438,294)
Change in foreign currency
translation adjustments $19,184 19,184
------------
Total comprehensive loss (10,419,110)
----------- -------- ------- -------- --------- ------------ ------- ------------- ------------
Balance at
December 31, 2004 10,505,998 $ 10,506 -- -- -- $113,365,645 $19,184 $(118,418,776) $ (5,023,441)
=========== ======== ======= ======== ========= ============ ======= ============= ============
See accompanying notes to consolidated financial statements.
F-28
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
2004 2003
----------- ----------
Cash flows from operating activities:
Net loss $(10,438,294) $(10,991,371)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 2,197,213 2,337,524
Amortization of intangible assets 1,776,473 928,851
Amortization of non-cash loan discount -- 1,274
Stock-based compensation 1,191,277 308,418
Interest expense paid with common stock 12,500 877,500
Non-cash interest expense 447,797 14,191
Non-cash interest expense on Series C mandatorily redeemable preferred stock liability 1,703,332 1,262,508
Share of losses of Front Porch Digital, Inc. and related impairment of goodwill 198,280 1,328,283
(Gain) loss on disposal of assets 22,291 (15,868)
Non-cash interest income on note receivable -- (13,666)
Bad debt expense 233,864 266,387
Gain from early extinguishments of debt -- (20,826)
Changes in operating assets and liabilities, net of business acquisition:
Accounts and other receivables (942,174) (967,544)
Other current assets 91,811 (93,226)
Prepaid expenses -- 16,211
Other assets 45,295 15,687
Accounts payable (73,065) (286,417)
Accrued liabilities 739,287 34,523
Deferred revenue (738,456) 831,790
Other liabilities (11,784) (9,518)
------------ ------------
Net cash used in operating activities (3,544,353) (4,175,289)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (1,152,120) (2,103,746)
Captialized software development costs (1,044,325) (320,414)
Acquisition costs (198,597) --
Proceeds from sale of property and equipment 126,084 267,902
Purchase of intangible assets -- (2,349,714)
Net change in restricted cash (638) (648)
Cash and restricted cash acquired in FPDI acquisition (Note 3) 4,005,685 --
Issuance of note receivable from Front Porch Digital -- (250,000)
Purchases of short-term investments -- (5,300,000)
Maturities of short-term investments 3,793,099 1,506,901
------------ ------------
Net cash provided by (used in) investing activities 5,529,188 (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, notes payable and other long term liabilities (1,151,319) (446,372)
Proceeds from exercise of stock options and purchase of restricted stock 1,977 1,208
Repurchase of common stock (31,427) --
------------ ------------
Net cash (used in) provided by financing activities (1,180,769) 14,845,716
------------ ------------
Effect of exchange rate changes on cash and cash equivalents 63,200 --
------------ ------------
Net increase in cash and cash equivalents 867,266 2,120,708
Cash and cash equivalents at beginning of year 2,201,192 80,484
------------ ------------
Cash and cash equivalents at end of year $ 3,068,458 $ 2,201,192
============ ============
(continued)
F-29
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
YEARS ENDED DECEMBER 31,
2004 2003
----------- ----------
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 202,516 $ 72,789
Supplemental disclosures of non-cash investing and financing activities:
Net assets acquired in FPDI acquisition, excluding cash (Note 3) $13,517,778 --
Reclassification of derivative contract to liability 1,836,534 --
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 815,654 654,852
Purchases of property and equipment included in accounts payable 130,471 215,715
See accompanying notes to consolidated financial statements.
F-30
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
(1) ORGANIZATION
Incentra Solutions, Inc. (which is referred to herein together with its
subsidiaries as the "Company"), formerly Front Porch Digital, Inc.
("FPDI"), was organized and incorporated in the state of Nevada. On October
25, 2004, the name of the Company was changed from Front Porch Digital,
Inc. to Incentra Solutions, Inc., and the common stock of the Company now
trades on the Over-the-Counter Bulletin Board under the trading symbol
"ICEN". On August 18, 2004, the Company acquired ManagedStorage
International, Inc., a Delaware corporation incorporated in March 2000
("MSI") (the "Acquisition", Note 4). The Acquisition has been accounted for
as a reverse merger, and therefore, MSI is deemed to be the acquirer for
accounting purposes. Accordingly, the consolidated financial statements
presented herein include the financial statements of MSI for all periods
prior to August 18, 2004 and the financial statements of the consolidated
companies from the date of the Acquisition forward.
The Company markets its complete storage solutions to broadcasters under
the trade name Front Porch Digital and to service providers and enterprise
clients under the trade name ManagedStorage International. Through FPDI,
the Company provides a software and management solution that enables
searching, browsing, editing, storage and on-demand delivery of media-rich
content in nearly any digital format. The software converts audio, video,
images, text and data into digital formats for ease of use and archiving.
Through MSI, the Company delivers comprehensive storage services, including
professional services, hardware/software procurement and resale, financing
solutions and remote monitoring/management services. The Company focuses on
providing data protection solutions and services that ensure that its
customers' data is backed-up and recoverable and meets internal data
retention compliance policies. MSI's remote monitoring and management
services are delivered from its Storage Network Operations Center, which
monitors and manages a multitude of diverse storage infrastructures on a
24x7 basis throughout the United States, United Kingdom, Bermuda and Japan.
MSI delivers these services utilizing its proprietary GridWorks Operations
Support System, which enables automated remote monitoring, and management
of complete storage infrastructures and back-up applications. MSI provides
outsourcing solutions for customer data protection needs under long-term
contracts. Customers pay on a monthly basis for storage services based on
the number of assets managed and/or the volume of storage assets utilized.
The Company's customers are located in North America, Europe, Asia and the
Pacific Rim.
BASIS OF PRESENTATION
At December 31, 2004, the consolidated financial statements include
Incentra Solutions, Inc. and its wholly-owned subsidiaries, Front Porch
Digital International, SAS, which is based in France, MSI, which is based
in Colorado, and MSI's wholly-owned subsidiaries, ManagedStorage UK, Inc.
and Seabrook Technologies, Inc. ManagedStorage UK, Inc. and Seabrook
Technologies, Inc. did not have any operating activities during the year
ended December 31, 2004. All significant intercompany accounts and
transactions have been eliminated in consolidation.
F-31
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
RISKS, UNCERTAINTIES AND MANAGEMENT'S PLANS
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 assurance that the Company
will be successful in addressing such risks.
Since inception, the Company has incurred substantial operating losses and
has a shareholders' deficit at December 31, 2004. Management of the Company
intends to fund these deficiencies by utilizing its existing cash and cash
equivalents, and anticipated 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 impairment charge to operations.
The Company's 2005 operating plan and the execution thereof is focused on
increasing revenue, controlling costs, and conserving cash, however, there
can be no assurance that the Company will be able to meet the operational
and financial requirements of its operating plan. The Company's 2005 plan
also includes growth through business acquisitions (Notes 4 and 17). The
Company cannot predict with certainty the expected revenue, gross profit
margin, net loss, and/or usage of cash and cash equivalents as a result of
these acquisitions. However, the Company's management believes that the
Company's cash and cash equivalents and working capital will provide
sufficient capital resources to fund its operations, debt service
requirements, and working capital needs at least through December 31, 2005.
(2) SHARE AND PER SHARE DATA
(A) In accordance with generally accepted accounting principles, and as a
result of the Acquisition being accounted for as a reverse merger, all
share and per share data prior to the Acquisition have been
retroactively adjusted to reflect the .03089 to 1 exchange of shares
occurring in connection with the merger of the Company and MSI, in a
manner similar to a reverse stock split, with differences in par value
being recorded through an offset to additional paid-in capital.
(B) On April 12, 2005, our Board of Directors and the holders of the
required number of the Company's capital stock approved an amendment to
the Company's Articles of Incorporation to effect a one-for-ten reverse
common stock split effective June 9, 2005. All references to common
shares, per-common-share, and options and warrants for common shares in
the accompanying financial statements as of December 31, 2004 and for
each of the years ended December 31, 2004 and 2003 have been adjusted
retroactively to reflect this reverse stock split.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 periods. 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 intangible assets, and the establishment of an allowance
for estimates of uncollectible accounts receivable.
RECLASSIFICATIONS
Certain reclassifications of previously reported amounts have been made to
conform to the current period presentation.
F-32
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
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.
RESTRICTED CASH
The Company has restricted cash of $80,048 at December 31, 2004,
(classified as a non-current asset) which secures a letter of credit issued
in connection with an operating lease (Note 9).
PROPERTY AND EQUIPMENT
Property and equipment, if acquired at the formation date of MSI or through
acquisition, have been recorded at the estimated fair value at the
acquisition date. 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 two to
seven years. Equipment recorded under capital leases and leasehold
improvements are amortized using the straight-line method over the shorter
of the respective lease term or estimated useful life of the asset.
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 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 expected future cash flows 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.
GOODWILL
Prior to the Acquisition, MSI accounted for an investment in common stock
and warrants of FPDI using the equity method of accounting. The excess
estimated fair value of FPDI's common stock and warrants over MSI's share
of FPDI's net assets at the date of the investment purchase (July 31,
2002), was recognized as goodwill, and in accordance with SFAS No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, was not amortized. MSI reviewed such
goodwill for impairment and recognized an impairment loss when there was a
loss in value in the equity method investment, which was other than a
temporary decline. For the years ended December 31, 2004 and 2003, MSI
recorded impairment losses of $198,280 and $692,098, respectively. As of
December 31, 2004 the Company had no recorded goodwill.
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.
REVENUE RECOGNITION
Revenue is recognized when all of the following criteria are met:
persuasive evidence of an agreement exists, delivery has occurred or
F-33
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
services have been rendered, the sales price is fixed or determinable, and
collectibility is reasonably assured.
The Company licenses software under license agreements and provides
professional services including training, installation, consulting and
maintenance. License fee revenues are recognized when a license agreement
has been signed, the software product has been shipped, the fees are fixed
and determinable, collection is reasonably assured, and no significant
vendor obligations remain.
The Company allocates revenue to each component of a contract based on
objective evidence of its fair value, as established by management. Because
licensing of the software is generally not dependent on the professional
services portion of the contract, software revenue is generally recognized
upon delivery, unless a contract exists with the customer requiring
customer acceptance.
Fees for maintenance agreements are recognized ratably over the terms of
the agreements. Maintenance is generally billed in advance, resulting in
deferred revenue.
The Company also provides software related professional services. Services
are generally provided on a time and materials basis and revenue is
recognized as the services are provided.
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.
COST OF REVENUE
Cost of revenue consists primarily of direct labor, cost of hardware,
depreciation ($2,014,156 in 2004 and $1,974,425 in 2003), amortization,
third party royalties and licenses and facilities costs.
ADVERTISING EXPENSES
All advertising and promotion costs are expensed as incurred. Total
advertising expenses incurred were $80,844 and $270,964 for the years ended
December 31, 2004 and 2003, respectively.
SOFTWARE DEVELOPMENT COSTS
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. MSI's Gridworks software product is used internally for
providing services to the Company's customers and is also marketed
separately as a stand-alone product. FPDI's DIVArchive software product is
marketed solely as a stand-alone product. As required by SFAS No. 86, the
Company capitalizes costs in developing software products upon
determination that technological feasibility has been established for the
product, if that product is to be sold, leased or otherwise marketed. Costs
incurred prior to the establishment of technological feasibility are
charged to research and development expense. When the product or
enhancement is available for general release to customers, capitalization
is ceased, and previously capitalized costs are amortized based on current
and future revenue for the product, but with an annual amortization amount
at least equal to the straight-line amortization over an estimated useful
F-34
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
life of three years. For the years ended December 31, 2004 and 2003,
capitalized software development costs, which related primarily to
enhancements to the Company's Gridworks and DIVArchive software solutions
totaled $1,044,325 and $320,414, respectively. These costs are amortized on
a straight-line basis over the estimated life, typically three years. For
the years ended December 31, 2004 and 2003, $384,974 and $272,731,
respectively, was charged to expense. As of December 31, 2004, the
unamortized portion of software development costs was $1,188,885.
DEFERRED LOAN COSTS
Loan costs included in other non-current assets, are amortized over the
3-year term of the related loan using the straight line method.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. For the years
ended December 31, 2004 and 2003, research and development costs were
$134,793 and $0, respectively.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The accounts of the international subsidiary, (Front Porch Digital
International, SAS) are translated using the exchange rate in effect at the
balance sheet date, and the results of operations are translated at the
average exchange rates during the year. At December 31, 2004, the Company
reported a cumulative translation gain of $19,184, as a component of
accumulated other comprehensive income. The Company is also subject to
foreign exchange transaction exposure when its subsidiary transacts
business in a currency other than its own functional currency. The effects
of exchange rate fluctuations in remeasuring foreign currency transactions
for the years ended December 31, 2004 and 2003 were a loss of $24,756 and a
gain of $8,550, respectively.
In June 2004, the Company began managing its foreign currency cash flow
exposure through the use of $/Euro forward contracts, which are considered
derivative instruments and which are recorded as either an asset or
liability, measured at fair value. Changes in fair value are recognized
currently by the Company in the statement of operations. The Company
recorded a realized loss of $144,086 and an unrealized loss of $134,500 on
these contracts as of December 31, 2004, which represented the change in
the fair value of the foreign currency forward contract related to the
difference between changes in the spot and forward rates excluded from the
assessment of hedge effectiveness.
PER SHARE DATA
The Company reports its earnings (loss) per share in accordance with SFAS
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. In
accordance with accounting requirements for reverse mergers, the historical
loss per share of MSI prior to the Acquisition has been retroactively
restated to reflect the Company's capital structure. Due to the Company's
net loss, shares from the assumed conversion of outstanding warrants,
options, convertible preferred stock and convertible debt have been omitted
from the computations of diluted loss per share for the years ended
December 31, 2004 and 2003 because the effect would be antidilutive. Shares
issuable from securities that could potentially dilute earnings per share
in the future that were not included in the computation of loss per share
because their effect was anti-dilutive totaled approximately 10.2 million
at December 31, 2004. Without regard to any reduction for the use of the
treasury stock method, 0.3 million shares of common stock issuable upon the
conversion of outstanding convertible preferred stock, the exercise of
options and warrants, and restricted stock have been omitted from the
computations of basic and diluted loss per share for the year ended
December 31, 2003 because the effect would be antidilutive.
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
Financial Accounting Standards Board ("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.
F-35
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
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. SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
and SFAS 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 years
ended December 31, 2004 and 2003. All amounts except per share amounts in
(000's)
Years ended
December 31,
2004 2003
-------- --------
Net loss before deemed dividends and accretion
on preferred stock, as reported $(10,438) $(10,991)
Add stock-based employee compensation expense
included in reported net loss, net of tax 1,191 308
Deduct total stock-based employee compensation
expense determined under fair value-based
method for all awards, net of tax (1,853) (322)
-------- --------
Pro forma net loss before deemed dividends
and accretion on preferred stock $(11,100) $(11,005)
======== ========
Net loss per weighted average common share
outstanding - basic and diluted - pro forma $ (2.43) $ (6.73)
======== ========
Net loss per weighted average common share
outstanding - basic and diluted - as reported $ (2.31) $ (6.72)
======== ========
In determining the fair value of stock options granted by the Company in
2004, and thus determining pro forma compensation expense under the fair
value method, the Company utilized the Black-Scholes valuation model with
the following weighted average assumptions: dividend yield of 0%, risk free
interest rates ranging from 1.2% to 2.09%, expected volatility of 143%, and
expected lives of three years. The weighted average fair value of these
options granted during 2004 is $2.80.
In determining the fair value of stock options granted by MSI in 2003, the
Company utilized the Black-Scholes valuation model to determine pro forma
compensation expense under the fair value method with the following
weighted average assumptions: dividend yield of 0%, risk free interest rate
of 3.91%, expected volatility of 0.001%, and expected lives of ten years.
The weighted average fair value of options granted during 2003 was $3.00.
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
was included as a reduction of compensation expense in the period of
forfeiture.
FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments held by the Company, which
include cash equivalents, restricted cash, accounts receivable, and
accounts payable, approximate fair value due to their short duration. The
carrying values of the note payable and other non-current obligations
approximate fair values based upon market rates currently available to the
Company.
F-36
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
CONCENTRATIONS OF CREDIT RISK
The Company sells its products and services throughout the United States,
Europe, Asia and the Pacific Rim. The Company performs periodic credit
evaluations of its customers' financial condition and generally does not
require collateral. Accounts receivable are reported at their outstanding
unpaid principal balances reduced by an allowance for doubtful accounts.
The Company estimates doubtful accounts based on historical bad debts,
factors related to specific customers' ability to pay and current economic
trends. The Company writes off accounts receivable against the allowance
when a balance is determined to be uncollectible. Credit losses have been
within management's expectations. For the year ended December 31, 2004,
aggregate revenues from customers located in Europe, Asia and the Pacific
Rim amounted to $4.7 million or 35% of total revenue, while revenues from
customers located in North America totaled $8.6 million or 65% of total
revenue. For the year ended December 31, 2003, aggregate revenues from
customers located in Europe, Asia and the Pacific Rim amounted to $1.1
million or 11% of total revenue, while revenues from customers located in
North America totaled $8.7 million or 89 % of total revenue. For the year
ended December 31, 2004, revenue from two customers individually accounted
for approximately 13% and 11% of total revenues. Accounts receivable from
these customers represented approximately 20% of total trade receivables at
December 31, 2004. For the year ended December 31, 2003, revenues from
three customers each exceeding 10% of total revenues aggregated 36%, 19%
and 11%, respectively.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENT,
which addresses the accounting for share-based compensation transactions.
SFAS No. 123(R) eliminates the ability to account for share-based
compensation transactions using APB 25, and generally requires instead that
such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123(R) will be effective for
public companies that file as small business issuers as of the first
interim or annual reporting period that begins after December 15, 2005. The
Company is evaluating the provisions of this standard. Depending upon the
number and terms of options that may be granted in future periods, the
implementation of this standard could have a material impact on the
Company's financial position and results of operations.
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY, which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
SFAS No. 150 requires that an issuer classify a financial instrument that
is within its scope, which may have previously been reported as equity, as
a liability (or an asset is some circumstances). Mandatorily redeemable
instruments (i.e. instruments issued in the form of shares that
unconditionally obligate the issuer to redeem the shares for cash or by
transferring other assets) are to be reported as liabilities by their
issuers. This statement does not affect the classification or measurement
of convertible bonds, puttable stock, or other outstanding shares that are
conditionally redeemable. The provisions of SFAS No. 150 are generally
effective for those provisions relating to mandatorily redeemable
non-controlling interests, which have been deferred. MSI's previously
outstanding New Series C preferred stock was mandatorily redeemable on
January 9, 2008, (the redemption amount was estimated to be $33,156,000,
representing $1,000 per share plus five years of dividends at $100 per
share per year), and therefore was considered a liability under the
provisions of SFAS No. 150. Accordingly, on July 1, 2003, the carrying
amount of the New Series C, which approximated its fair value, was
reclassified from the "mezzanine" section of the balance sheet to the
F-37
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
liability section. There was no gain or loss recorded upon the adoption of
SFAS No. 150. From July 1, 2003 through December 31, 2003, the Company
recorded non-cash interest expense of $1,262,508, and from January 1, 2004
through August 18, 2004, when the stock was exchanged for Series A
preferred stock, the Company recorded non-cash interest expense of
$1,703,332, reflecting an effective interest rate on this security of
13.477%.
In December 2003, the FASB issued Interpretation No. 46R ("FIN 46R"), a
revision to SFAS Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST
ENTITIES. FIN 46R clarifies some of the provisions of FIN 46 and exempts
certain entities from its requirements. FIN 46R requires a variable
interest entity to be consolidated by a company if that company is subject
to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46R also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has
a significant variable interest. FIN 46R became effective for variable
interest entities created after December 15, 2003 for public companies, and
became effective for all other variable interest entities by the end of the
first annual reporting period ending after December 15, 2004 for companies
that are small business issuers. FIN 46R did not have an impact on the
Company's financial position or results of operations.
(4) ACQUISITIONS
ACQUISITION OF MSI
On August 18, 2004 (the "Acquisition Date"), the Company (formerly Front
Porch Digital, Inc.) acquired all of the outstanding capital stock of MSI,
a Delaware corporation. The Company acquired MSI to increase its ability to
deliver a complete storage infrastructure and management solution to its
customers. The transaction was structured as a reorganization of MSI with
and into Front Porch Merger Corp., a Delaware corporation and newly-formed,
wholly-owned subsidiary of the Company. The Acquisition of MSI by the
Company 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 the Company on a voting and diluted basis. As a result, MSI
is deemed to be the acquirer for accounting purposes. Accordingly, the
consolidated financial statements presented herein include the financial
statements of MSI for all periods prior to the Acquisition Date and the
financial statements of the consolidated companies from the Acquisition
Date forward. Historical share and per share amounts for periods prior to
the Acquisition have been retroactively restated to reflect the exchange
ratio established in the transaction, in a manner similar to a reverse
stock split, with differences in par values being recorded through an
offset to additional paid-in capital. The consolidated accumulated deficit
of the accounting acquirer (MSI) has been carried forward after the
Acquisition. 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 the Company in exchange
for shares of the Company's common stock. After the Acquisition, the former
MSI shareholders owned approximately 64% of the common stock of the
Company, giving effect to the conversion of Series A preferred stock.
The MSI stockholders were issued 4,745,499 restricted shares of common
stock and 2,466,971 restricted shares of the newly-designated, voting and
non-dividend bearing Series A Redeemable Preferred Stock (the "Series A
Preferred") of the Company in exchange for their ownership of MSI
securities. The Series A Preferred shares are convertible into shares of
common stock on a two-for-one basis (Note 11). In connection with the
Acquisition, the Company canceled 1,345,238 shares of outstanding Incentra
common stock and warrants to purchase 0.4 million shares of Incentra common
stock that were held by MSI prior to the Acquisition Date. MSI canceled
F-38
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
$0.2 million in receivables owed to it from the Company. The Company also
has outstanding warrants to purchase 20,274 shares of restricted common
stock at a price per share of $.003 and outstanding warrants to purchase
33,029 shares of Series A Preferred at a price per share of $10.35.
Although there is no impact on the purchase price allocation or in the
financial information presented, the determination of the value of the
consideration issued to the former MSI shareholders was as follows:
a) Common shares issued - the valuation of the common was based upon the
average closing price of the Company's common stock as posted on the
OTC Bulletin Board for the three-day period prior to the closing date,
the closing date and the three-day period after the closing date.
b) Series A Preferred - the issuance price of the preferred stock was
fixed at $31.5 million. The preferred stock was recorded at its fair
value at the Acquisition Date, which approximated the value of the
redeemable preferred stock of MSI exchanged in the Acquisition. The
difference between the issue price and the fair value is being
recorded as an accretion on the Series A Preferred stock and charged
to net loss applicable to common shareholders over the term of the
redemption period.
The 4,745,499 common shares issued in the Acquisition was based on the
following: each outstanding share of MSI's Series A Redeemable Preferred
Stock was converted into 20 shares of common stock of the Company, each
outstanding share of MSI's Series B Convertible Preferred Stock was
exchanged for 2.7789 shares of common stock of the Company, and each
outstanding share of MSI common stock was converted into 0.03089 shares of
common stock of the Company. Each outstanding share of MSI's Series C
Redeemable Preferred Stock was exchanged for 111.6042 shares of Series A
Preferred. In addition, each outstanding option to purchase MSI common
stock was converted into an option to purchase unregistered common stock of
the Company, 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 the 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 the
Company's common stock for a period of 18 months (with limited exceptions).
Concurrent with the consummation of the Acquisition, the Company 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 the Company 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.
Since the Acquisition has been accounted for as a reverse merger, a
determination of the purchase price was made based upon the estimated fair
value of Front Porch at the time of the acquisition. Accordingly, the total
purchase price for the Company was determined to be approximately $17.5
million, for which the allocation is below.
Cash and cash equivalents $ 946,732
Other current assets 2,000,773
Property and equipment 193,637
Restricted cash 3,058,953
Deferred tax asset 400,000
Other assets 920,357
Intellectual property-DIVArchive software 6,600,000
Intellectual property-customer base 10,039,785
Current liabilities (3,732,031)
Other liabilities (2,904,743)
------------
$ 17,523,463
============
F-39
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
As of the Acquisition Date, the excess fair value over the net assets
acquired totaled approximately $16.6 million. This excess was allocated to
the Company's intellectual property, including its DIVArchive and Bitscream
proprietary software and its customer base in the broadcast, media and
entertainment industries. The amounts allocated to intellectual property
for the Company's software and customer base are being amortized over 5 and
10-year periods, respectively. The weighted average amortization period is
approximately 8 years.
The following unaudited pro forma results of operations for the years ended
December 31, 2004 and 2003 are presented to reflect the Acquisition as if
it had occurred as of the beginning of the periods presented; all amounts
except per share amounts in (000's):
Years ended December 31,
2004 2003
---------- ----------
Revenues (2) $ 17,740 $ 12,728
Loss from continuing operations (12,631) (12,674)
Loss from discontinued operations (1) -- (3,711)
---------- ----------
Net loss applicable to common shareholders $ (12,631) $ (20,511)
========== ==========
Loss per share - basic and diluted, pro forma $ (2.48) $ (10.82)
========== ==========
(1) During 2003, Front Porch disposed of two business units: the
DIVArchive Medical business unit and the Media Services business unit.
The operating results of the two business units were accounted for as
discontinued operations.
(2) On a pro forma basis, giving effect to the Acquisition as if it had
occurred on January 1, 2004, for the year ended December 31, 2004,
aggregate pro forma revenues from customers located in Europe, Asia or
the Pacific Rim amounted to $9.0 million or approximately 51% of total
pro forma revenue, while revenues from customers located in North
America totaled $8.7 million or approximately 49% of total pro forma
revenues. On a pro forma basis, giving effect to the Acquisition as if
it had occurred on January 1, 2004, one customer exceeded 10% of total
pro forma revenues.
ASSET ACQUISITION
In January 2003, MSI closed on an asset purchase agreement, whereby MSI
purchased certain assets from Sanrise, Inc. ("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 contained an earn-out provision payable in cash and stock,
payable upon meeting certain conditions.
In September 2003, MSI 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
F-40
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
connection with the asset acquisition of its DataVault business and MSI
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.
(5) RECAPITALIZATION AND STOCK PURCHASE AGREEMENTS
In January 2003 and May 2003, MSI 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 1,939,237 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 20,272
shares of Class A common stock. The warrants for the purchase of the New
Series C and the Class A common stock were exercisable for $1,000 and $.03,
respectively, for a period of 5 years from the date of the securities
purchase agreement. The New Series C was converted into shares of Series A
convertible preferred stock of the Company at the Acquisition date. The
Class A common stock was converted into common stock of the Company at the
Acquisition date.
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 was nonvoting, had a
par value of $0.01 per share, accrued a dividend of $100 per share per
annum, had a $1,000 per share liquidation preference, and was 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
non-cash cost of financing were warrants with an estimated value of
$126,637.
The purchase price of the Class A common stock was $3.24 per share. A total
of 1,668,177 shares of the Class A common stock were issued for total
proceeds consisting of $3,214,704 cash and the conversion of a note payable
with a $1,190,000 principal amount and $21,453 of related interest. The
remaining 271,060 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 $3.24 per share.
(6) PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31, 2004:
Computer equipment $ 5,844,721
Software 3,519,284
Office furniture and equipment 1,764,550
Leasehold improvements 65,343
------------
11,193,898
Less accumulated depreciation (8,741,081)
------------
$ 2,452,817
============
F-41
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
Depreciation expense for the years ended December 31, 2004 and 2003 was
$2,197,213 and $2,337,524, respectively.
Included in property and equipment is equipment under capital lease with a
cost of $1,334,427 and accumulated depreciation of $628,176 at December 31,
2004.
(7) INTANGIBLE ASSETS
Intangible assets consist of the following as of December 31, 2004:
Acquired customer base - FPDI (life of 10 years) $ 10,039,785
Intellectual property - DIVArchive (life of 5 years) 6,600,000
Acquired customer base - MSI (life of 3 years) 2,599,714
Patents (life of 7 years) 2,885
------------
19,242,384
Less accumulated amortization (2,705,324)
------------
Intangible assets, net $ 16,537,060
============
Amortization expense for the years ended December 31, 2004 and 2003 was
$1,776,473 and $928,851, respectively. Estimated amortization expense for
each of the five succeeding years is as follows:
Year ending December 31:
2005 $ 3,107,629
2006 2,345,445
2007 2,324,391
2008 2,324,391
2009 1,809,419
Thereafter 4,625,785
------------
$ 16,537,060
============
(8) ACCRUED EXPENSES
Accrued expenses consist of the following as of December 31, 2004:
Wages, benefits and payroll taxes $ 1,202,677
Professional service fees 393,545
Derivative liability 134,500
Accrued intereset and penalties 126,667
Taxes, other than income taxes 662,244
Other liabilities 539,173
------------
$ 3,058,806
============
(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.
F-42
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
The Company leases facilities and equipment under non-cancelable capital
and operating leases. Rental expense relating to operating leases was
$536,192 and $492,901 for the years ended December 31, 2004 and 2003,
respectively. Certain of the operating lease agreements have renewal
provisions, which range from month-to-month to 24-month terms.
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 Broomfield, Colorado facility if the Company were unable to make the
monthly rent payments. At December 31, 2004, the amount of the letter of
credit is $80,048. The letter of credit is secured by restricted cash in
the same amount.
Future minimum lease payments as of December 31, 2004 are as follows:
CAPITAL OPERATING
LEASES LEASES
--------- ----------
Year ending December 31:
2005 $ 549,922 $ 290,574
2006 -- 247,465
2007 -- 160,145
2008 -- 36,190
2009 -- 13,062
--------- ---------
Total minimum lease payments 549,922 $ 747,436
=========
Less amounts representing interest (33,909)
---------
Present value of minimum lease
payments (all current) $ 516,013
=========
(10) NOTE PAYABLE, CAPITAL LEASES, AND OTHER LONG-TERM OBLIGATIONS
The following is a summary of the Company's long-term debt as of December
31, 2004:
Senior secured convertible note (A) $ 3,119,112
Capital leases (B) 516,013
Other obligations (C) 370,361
------------
4,005,486
Less current portion (1,738,516)
------------
Long-term portion $ 2,266,970
============
F-43
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
(A) SENIOR SECURED CONVERTIBLE NOTE
On the Acquisition Date, liabilities assumed in the Acquisition included
the fair value of a convertible note. This convertible note originated on
May 13, 2004, when the Company consummated a private placement pursuant to
which the Company issued a secured convertible term note due May 13, 2007
in the principal amount of $5,000,000 (the "Note"), and the Company issued
a common stock purchase warrant, entitling the holder to purchase 443,500
shares of common stock (the "Warrant") at $4.80 per share. The Note and the
Warrant were sold to Laurus Master Fund, Ltd. ("Laurus"), for a purchase
price of $5,000,000. The principal and unpaid interest on the Note are
convertible into shares of the Company's common stock at a price of $3.00
per share, subject to antidilution adjustments.
In connection with the issuance of the Note to Laurus, the Company recorded
the fair value of the warrant issued as debt discount in the amount of
approximately $1.8 million based upon the Black-Scholes option-pricing
model, resulting in an imputed interest rate of 37%. This discount is being
amortized to earnings as additional interest expense over the term of the
Note. Accordingly, the Company has recorded $209,317 of additional non-cash
interest expense relating to the amortization of the discount during the
year ended December 31, 2004.
In accordance with Emerging Issues Task Force Issue 00-19, ACCOUNTING FOR
DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO, AND POTENTIALLY SETTLED IN, A
COMPANY'S OWN STOCK, the Company initially accounted for the fair value of
the Warrant as equity. As discussed below, in the fourth quarter of 2004,
due to an October 2004 change in Note conversion terms, the Company's
authorized and unissued shares available to settle the Warrant (after
considering all other commitments that may require the issuance of stock
during the maximum period the Warrant could remain outstanding) were
determined to be insufficient (Note 11, item B). As a result, the Company
reassessed and reclassified the value of the Warrant to a liability at the
reassessment date. The fair value of the Warrant is evaluated at each
reporting period with any resulting change in the fair value being
reflected in the Consolidated Statement of Operations. The fair value of
the Warrant from the reassessment and reclassification date through
December 31, 2004, increased by approximately $30,000, which was not
recorded due to the immaterial amount of the change.
The Note provides for monthly payments of interest at the prime rate plus
1%, which is subject to reduction if the market price of the Company's
common stock exceeds certain designated thresholds. However, the rate
cannot be less than 5%. The Note also provides for monthly amortization of
principal, which commenced on September 1, 2004 of $45,455, plus accrued
interest, per month, (increased to approximately $159,000 per month
beginning in March 2005) with the balance payable on the maturity date.
Laurus has the option to receive shares of the Company's common stock in
lieu of debt service payments at the market price of the Company's common
stock at the date of conversion. The Note is collateralized by a security
interest in all of the assets of the Company. The Warrant entitles the
holder to purchase, at any time through May 13, 2011, up to 443,500 shares
of the Company's common stock at a price of $4.80 per share, subject to
antidilution adjustments.
Pursuant to a Securities Purchase Agreement (the "Securities Purchase
Agreement") between the Company and Laurus, for so long as 25% of the
principal amount of the Note is outstanding, the Company may not directly
or indirectly declare or pay any dividends without the prior written
consent of Laurus. The Securities Purchase Agreement also requires the
written consent of Laurus relating to any liquidation, material
reorganization or certain additional indebtedness of the Company.
Pursuant to a Registration Rights Agreement (the "Registration Rights
Agreement") between the Company and Laurus, the Company: (a) filed a
registration statement under the Act to register the resale of the shares
of the Company's common stock issuable upon conversion of the Note and
exercise of the Warrant (the "Registration Statement"), which Registration
Statement became effective on July 29, 2004, and (b) is required to
maintain the effectiveness of the Registration Statement until the earliest
date of when (i) all registrable securities have been sold, (ii) all
registrable securities may be sold immediately without registration under
the Act and without volume restrictions pursuant to Rule 144(k) or (iii)
all amounts payable under the Note have been paid in full. Laurus, or other
holders of the Note and the Warrant, are entitled to certain specified
remedies if the Company does not maintain the effectiveness of the
Registration Statement, subject to certain exceptions.
F-44
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
On October 26, 2004, the Company entered into an Amendment and Waiver, (the
"Amendment and Waiver"), with Laurus. The Amendment and Waiver amends the
Securities Purchase Agreement and certain other documents (the "Loan
Documents") and waived certain events of default under certain of the Loan
documents. Pursuant to the Amendment and Waiver, the parties agreed to
reduce the "Fixed Conversion Price" set forth in the Term Note from $5.00
to $3.00 per share and to amend the Master Security Agreement to provide
for a "Lockbox Deposit Account" to be maintained by the Company and its
subsidiaries under the Master Security Agreement. Lockbox remittances do
not automatically reduce the debt outstanding unless an event of default
has occurred. Laurus further agreed to (i) release to the Company
approximately $3 million, which represented all funds then remaining in a
restricted account (less outstanding accrued interest and fees); (ii)
postpone the monthly principal payments due by the Company under the Note
on November 1, 2004 through February 1, 2005 until the maturity date of the
Note; (iii) waive certain events of default, and all fees and default
interest rates applicable to such events of default; (iv) extend the time
for the Company's subsidiaries to be joined as a party to the Master
Security Agreement; (v) waive all fees and default interest arising from
the Company's failure to pay the liquidated damages set forth in the
Registration Rights Agreement and further waive any liquidated damages due
and payable to Laurus by the Company.
In consideration of the waivers, the Company issued a seven-year warrant to
Laurus to purchase 50,000 shares of the Company's common stock with an
exercise price of $5.00 per share. The Company further agreed to amend its
Registration Statement, initially filed on the filing date (as defined in
the Registration Rights Agreement), to include the additional warrant and
additional shares of the Company's common stock issuable to Laurus upon
conversion of the Term Note due to the adjustment of the Fixed Conversion
Price. The Company valued the Additional Warrant at $89,000, which
represents the total liquidated damages waived by Laurus as a result of the
Amendment and Waiver. The Company recorded this amount as a liability and
additional interest expense during the quarter ended December 31, 2004.
Subsequent to year end, the Company and Laurus further amended the
Agreement as discussed in Note 17 to the consolidated financial statements.
(B) CAPITAL LEASES
On November 20, 2003, the Company entered into a capital lease line of
credit agreement (the "Lease Line") 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 interest rate on the Lease Line ranges from 10.514% to 10.731%.
As of December 31, 2004, the Company had drawn $1,470,507 on the Lease Line
and $29,493 of the Lease Line expired unused. The Lease Line is to be
repaid in monthly principal and interest installments, with the final
payment due in October 2005. The unpaid balance at December 31, 2004 was
$516,013. Subsequent to year end, the Company amended this Lease Line as
described in Note 17 to the consolidated financial statements.
(C) OTHER OBLIGATIONS
At December 31, 2004, the Company has a $323,318 payable to a single vendor
(net of a $49,000 discount), which was restructured in May 2003, to be
payable over a five-year period, with interest of 5%. Payments are subject
to certain acceleration clauses based upon working capital levels and
capital raised. The obligation is being repaid in monthly installments of
$8,333. In addition, the Company has deferred rent of $47,043, which is
recognized over the life of the Broomfield, Colorado lease.
Aggregate annual maturities of long-term debt are as follows:
Senior
secured
convertible
Capital note, net Other
Leases of discount obligations Total
---------- ----------- ----------- -----------
2005 $ 516,013 $ 1,122,342 $ 100,161 $ 1,738,516
2006 -- 1,346,809 102,926 1,449,735
2007 -- 649,961 99,856 749,817
2008 -- -- 67,418 67,418
---------- ----------- ----------- -----------
$ 516,013 $ 3,119,112 $ 370,361 $ 4,005,486
========== =========== =========== ===========
F-45
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
(11) MANDATORILY REDEEMABLE PREFERRED STOCK AND COMMON STOCK
The Company's authorized capital stock at December 31, 2004 consists of the
following:
(A) PREFERRED STOCK
PREFERRED STOCK
The Company has authorized 2,500,000 shares of preferred stock,
nonvoting, par value $.001. As of the date of this report, none of the
shares are issued or outstanding.
SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK
The Company authorized 2,500,000 shares of Series A Convertible
Redeemable Preferred Stock (the "Series A Preferred") in connection
with the Acquisition. At December 31, 2004, 2,466,971 Series A
Preferred shares are outstanding. Warrants are outstanding to purchase
the remaining 33,029 Series A Preferred shares at a purchase price of
$10.35 per share.
The Series A Preferred has voting rights so long as at least 500,000
originally issued shares of the Series A Preferred (as adjusted
appropriately for stock splits, stock dividends, combinations,
recapitalizations and similar transactions) remain outstanding. The
holders of outstanding shares of Series A Preferred shall, voting
together as a separate class, be entitled to elect three Directors of
the Corporation. Each outstanding share of Series A Preferred shall be
entitled to a number of votes equal to the number of shares of common
stock into which such share of Series A Preferred is then convertible
pursuant to the terms of the agreement.
The Company may (when, and if declared by the Board of Directors)
declare and distribute dividends among the holders of Series A
Preferred and the holders of common stock pro rata based on the number
of shares of common stock held by each, determined on an
as-if-converted basis (assuming full conversion of all such Series A
Preferred) as of the record date with respect to the declaration of
such dividends; provided, that the holders of shares of Series A
Preferred shall be entitled to participate on such a pro rata basis in
any dividends declared with respect to the common stock.
Upon any liquidation, dissolution or winding up of the Company and its
subsidiaries, whether voluntary or involuntary (a "Liquidation
Event"): each holder of outstanding shares of Series A Preferred shall
be entitled to be paid in cash, before any amount shall be paid or
distributed to the holders of the common stock or any other capital
stock ranking on liquidation junior to the Series A Preferred (the
common stock and such other capital stock being referred to
collectively as, "Junior Stock"), an amount in cash per share of
Series A Preferred equal to (A) $12.60 (the "Original Issue Price")
plus (B) an amount equal to all accumulated but unpaid dividends on
such share of Series A Preferred (such amount to be adjusted
appropriately for stock splits, stock dividends, combinations,
recapitalizations and the like) (the "Series A Preference Amount") of
$31.5 million. If the amounts available for distribution by the
Company to holders of Series A Preferred upon a Liquidation Event are
not sufficient to pay the aggregate Series A Preference Amount due to
such holders, such holders of Series A Preferred shall share ratably
in any distribution in connection with such Liquidation Event in
proportion to the full respective preferential amounts to which they
are entitled.
F-46
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
At any time on or after August 16, 2008, the holder(s) may elect to
have all (but not less than all) of the outstanding shares of Series A
Preferred redeemed. In such event, the Corporation shall redeem all
(subject to the terms of the agreement) of the outstanding shares of
Series A Preferred, out of funds legally available therefore, for an
amount equal to the aggregate Series A Redemption Price specified in
the agreement. Any election by a Supermajority Interest pursuant to
the agreement shall be made by written notice to the Company and the
other holders of Series A Preferred at least fifteen (15) days prior
to the elected redemption date (the "Series A Redemption Date"). Upon
such election, all holders of Series A Preferred shall be deemed to
have elected to have their shares of Series A Preferred redeemed
pursuant to the agreement and such election shall bind all holders of
Series A Preferred. Notwithstanding anything to the contrary contained
herein, each holder of shares of Series A Preferred shall have the
right to elect to give effect to the conversion rights contained in
the agreement instead of giving effect to the provisions contained in
the agreement with respect to the shares of Series A Preferred held by
such holder.
The price for each share of Series A Preferred redeemed pursuant to
the agreement shall be an amount (the "Series A Redemption Price")
equal to the greater of (i) the Series A Preference Amount (such
amount to be adjusted appropriately for stock splits, stock dividends,
combinations, recapitalizations and the like), and (ii) the Fair
Market Value (as defined in the agreement) of the Common Stock into
which the Series A Preferred is then convertible. The aggregate Series
A Redemption Price shall be payable in cash in immediately available
funds to the respective holders of the Series A Preferred on the
Series A Redemption Date.
Shares of Series A Preferred Stock shall be converted into shares of
the Company's common stock in accordance with the following:
Voluntary conversion occurs upon the written election of the holder
thereof and without payment of any additional consideration. Each
outstanding share of Series A Preferred held by such holder shall be
converted into such number of fully paid and nonassessable shares of
common stock as is determined by dividing (i) the Series A Preference
Amount, by (ii) the Conversion Price at the time in effect for such
Series A Preferred (such quotient, the "Conversion Rate"). The initial
"Conversion Price" per share for shares of Series A Preferred shall be
$6.30, subject to adjustment as set forth in the agreement. Any
election by a holder of Series A Preferred pursuant to the agreement
shall be made by written notice to the Company, and such notice may be
given at any time and from time to time after August 16, 2004 (the
"Closing Date") and through and including the day which is five (5)
days prior to the Series A Redemption Date or the closing of any
transaction contemplated by the agreement.
Automatic conversion occurs upon the written election of a
Supermajority Interest and without the payment of any additional
consideration. Upon automatic conversion all (but not less than all)
of the outstanding shares of Series A Preferred shall be converted
into fully paid and nonassessable shares of common stock at the
Conversion Rate. Any election by a Supermajority Interest pursuant to
the agreement shall be made by written notice to the Company and the
other holders of Series A Preferred, and such notice may be given at
any time after the Closing Date through and including the date which
is five (5) days prior to the closing of any transaction contemplated
by the agreement. Upon such election, all holders of the Series A
Preferred shall be deemed to have elected to voluntarily convert all
outstanding shares of Series A Preferred into shares of common stock
pursuant to the agreement and such election shall bind all holders of
Series A Preferred.
F-47
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
(B) COMMON STOCK
In October 2004, the Company amended its charter to increase the
number of authorized common shares from 150,000,000 to 200,000,000. At
December 31, 2004, the Company had 10,649,362 shares issued,
10,505,998 shares outstanding and 143,364 shares held in treasury. In
addition, the Company had warrants, options and other convertible
securities outstanding which are exercisable or convertible into
common shares, which, if all were exercised or converted, would cause
the Company's outstanding common shares to exceed its authorized
common shares by approximately 7 million shares at December 31, 2004
on a pre reverse split basis. Under the laws of the State of Nevada,
the Company is prohibited from issuing shares in excess of its number
of authorized shares. The Company may be required to take certain
corporate action to ensure that it has sufficient authorized shares of
its common stock to meet its commitments under such warrants, options
and other convertible securities and to seek the necessary approvals
for such action pursuant to Section 14 of the Securities Exchange Act
of 1934 and the laws of the State of Nevada. Not all of such warrants,
options and other convertible securities are presently exercisable or
convertible by the holders thereof and the Company has sufficient
authorized shares to meet its obligations under those warrants,
options and other convertible securities that are presently
exercisable.
The Company's authorized capital stock at December 31, 2003 consists of the
following:
(C) MANDATORILY REDEEMABLE PREFERRED STOCK
Prior to the Acquisition, the Company had 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 the Acquisition date, New Series A and New Series B were
converted into common stock and New Series C was converted into Series
A Preferred.
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 5. New Series A did not
have voting rights and the holders were 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 have been paid, if approved by the board
of directors. After January 11, 2007, dividends would have accrued
daily in arrears and be compounded annually, whether or not such
dividends were declared by the board of directors or paid. This
cumulative dividend was subordinate to dividends paid on the New
Series B and New Series C.
Series B Mandatorily Redeemable Convertible Preferred Stock
The Company had authorized and issued 650,000 shares of New Series B
as part of the Recapitalization discussed in Note 5. Each share of New
Series B had voting privileges equal to the number of shares of Class
A common stock into which such share of New Series B would have
converted pursuant to the conversion terms of the agreement. The New
Series B accrued 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).
Series C Mandatorily Redeemable Preferred Stock
The Company had authorized 24,500 shares and issued 22,104 shares of
New Series C as discussed in Note 5. The holders of New Series C were
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 would 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.
At December 31, 2003 there were cumulative New Series B dividends of
$1,181,918 and New Series C dividends of $1,047,669.
(12) EMPLOYEE STOCK OPTION AND BONUS PLANS
The Company currently has two employee stock option plans - one plan that
was originally established under MSI, and one that was originally
established under Front Porch Digital, Inc. ("Incentra Option Plan"). As of
F-48
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
the date of the Acquisition, the Company adopted the Incentra Option Plan.
In connection with the Acquisition, no additional grants will be made under
the MSI Plan, however, outstanding stock options issued pursuant to the MSI
Plan may be exercised for unregistered common shares.
EMPLOYEE EQUITY INCENTIVE PLAN
The Incentra Option Plan provides for the granting of options to key
employees, officers and certain individuals to purchase shares of the
Company's common stock. The Company currently has reserved 600,000 shares
of common stock for issuance under the Incentra Option Plan. An increase in
the number of shares reserved from 600,000 to 2,262,500 was approved by the
Board of Directors and shareholders and the effectiveness of the increase
is subject to the Company filing a Schedule 14C Information Statement. The
Incentra Option Plan has a term of ten years. The Incentra Option Plan
provides for the grant of "incentive stock options" within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended, non-statutory
stock options, stock appreciation rights and restricted stock awards. The
Incentra Option Plan is administered by the Company's Board of Directors.
The exercise price of non-statutory stock options may be equal to or more
or less than 100 percent (100%) of the fair market value of shares of
common stock on the date of grant. The exercise price for incentive stock
options may not be less than 100 percent (100%) of the fair market value of
shares of common stock on the date of the grant (110 percent (110%) of fair
market value in the case of incentive stock options granted to employees
who hold more than ten percent (10%) of the voting power of the issued and
outstanding shares of common stock).
Options granted under the Incentra Option Plan may not have a term of more
than a ten-year period (five years in the case of incentive stock options
granted to employees who hold more than ten percent (10%) of the voting
power of the Company's common stock) and generally vest over a three-year
period. Options generally terminate three months after the termination of
employment for any reason other than death, disability or retirement, and
are not transferable by the employee other than by will or the laws of
descent and distribution.
The Company has granted nonqualified stock options to certain employees of
the Company. Such options have been granted with an exercise price below
market at the date of grant. The options vest immediately or contain
accelerated vesting, or vest over three yeas beginning on the first
anniversary of the grant date, and are exercisable for a period of three to
ten yeas. The Company has also granted nonqualified stock options to
certain directors and consultants. These options have been granted with an
exercise price at or below market at the date of the grant, vest
immediately, and are exercisable for a period of not more than ten years.
The Incentra Option Plan also provides for grants of stock appreciation
rights ("SARs"), which entitle a participant to receive a cash payment,
equal to the difference between the fair market value of a share of common
stock on the exercise date and the exercise price of SAR. The exercise
price of any SAR granted under the Incentra Option Plan will be determined
by the Board of Directors at its discretion at the time of the grant. SARs
granted under the Incentra Option Plan may not be exercisable for more than
a ten-year period. SARs generally terminate one month after the termination
of the grantee's employment for any reason other than death, disability or
retirement. Although our Board of Directors has the authority to grant
SARs, they have not granted, and do not have any present plans to grant
SARs.
Restricted stock awards, which are grants of shares of common stock that
are subject to a restricted period during which such shares may not be
sold, assigned, transferred, made subject to a gift, or otherwise disposed
F-49
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
of, or mortgaged, pledged or otherwise encumbered, may also be made under
the Incentra Option Plan. At this time, our Board of Directors has not
granted, and does not have any plans to grant, restricted shares of common
stock.
A summary of all activity in the Incentra Option Plan is as follows:
WEIGHTED
NUMBER AVERAGE
OF OPTIONS EXERCISE PRICE
------------ --------------
Balance, January 1, 2004 262,371 $ 6.20
Granted 1,584,966 2.70
Exercised (10,000) 2.80
Forfeited (8,277) 3.30
------------ ------------
Balance, December 31, 2004 1,829,060 $ 3.20
============ ============
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
----------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
SHARES REMAINING AVERAGE SHARES AVERAGE
EXERCISE UNDER CONTRACTUAL EXERCISE CURRENTLY EXERCISE
PRICE OPTION LIFE PRICE EXERCISABLE PRICE
-------------- ---------- ----------- -------- ----------- --------
$ 1.60 - 13.90 1,800,560 2.40 $ 2.70 496,249 $ 2.60
20.00 - 29.00 11,000 4.40 24.10 11,000 24.10
40.00 17,500 1.60 40.00 17,500 40.00
---------- -----------
1,829,060 2.40 3.20 524,749 4.30
========== ===========
MANAGEDSTORAGE INTERNATIONAL, INC. - 2000 STOCK OPTION AND GRANT PLAN
Prior to the Acquisition, MSI adopted and administered its 2000 Stock
Option and Grant Plan (the "MSI Plan") for its employees, directors,
consultants and other key persons. In connection with the Acquisition, no
additional grants will be made under the MSI Plan, however, outstanding
stock options issued pursuant to the MSI Plan may be exercised for
unregistered common shares. As provided in the Acquisition Agreement, upon
the exercise of any outstanding options issued under the MSI Plan, the
Company will issue 0.03089 shares of common stock for each share of MSI
common stock that would have been issuable upon the exercise of such
options.
The maximum number of shares of unregistered common stock available for
issuance to eligible employees, consultants, and directors of the Company
under the MSI Plan is 219,601 at December 31, 2004. Options to purchase the
Company's unregistered 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 MSI Plan, the exercise prices for incentive stock
F-50
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
options granted shall not be less than 100% of the fair market value of the
unregistered 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
unregistered 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 MSI 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 unregistered 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 2004 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 MSI Plan provisions, the contractual life of all such
options is no greater than ten years.
During 2003, a total of 217,984 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 $199,686 and $290,436 was recognized during 2004 and 2003,
respectively.
During 2002, a total of 2,142 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 $8,860 and $17,982 was recognized through December 31,
2004 and 2003, respectively.
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 436 options and
364 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 $16.20 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 $0.16 and the
estimated fair value of the underlying common stock on December 31, 2003
was $3.237. On December 31, 2003, 266 shares of the replacement-restricted
stock were vested and $818 cumulative compensation expense had been
recognized.
A summary of all activity in the MSI Plan is as follows:
WEIGHTED
NUMBER AVERAGE
OF OPTIONS EXERCISE PRICE
---------- --------------
Balance, December 31, 2002 201 $ 16.20
Granted 249,589 0.30
Exercised (1,539) 0.50
Forfeited (19,045) 0.50
---------- --------------
Balance, December 31, 2003 229,206 0.50
---------- --------------
Granted 22,225 3.20
Exercised (3,947) 3.33
Forfeited (27,883) 2.80
---------- --------------
Balance, December 31, 2004 219,601 $ 0.50
========== ==============
F-51
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
----------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
SHARES REMAINING AVERAGE SHARES AVERAGE
EXERCISE UNDER CONTRACTUAL EXERCISE CURRENTLY EXERCISE
PRICE OPTION LIFE PRICE EXERCISABLE PRICE
------------ ---------- ----------- -------- ----------- --------
$ 0.30 208,304 8.12 $ 0.30 102,978 $ 0.30
3.20 11,229 9.14 3.20 946 3.20
16.20 68 7.31 16.20 68 16.20
---------- -----------
219,601 8.17 0.50 103.992 0.30
========== ===========
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 166,367 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.
EMPLOYEE BONUS PLAN
In connection with the Acquisition, the Company assumed the Front Porch Digital,
Inc. Employee Bonus Plan (the "Bonus Plan"). In March 2001, the Board of
Directors adopted the Bonus Plan to promote the interests of the Company and
shareholders by permitting the Company to award bonuses in cash or in shares of
common stock to key employees in order to reward such employees for their
successful efforts in attaining objectives beneficial to the growth and
profitability of the Company and to retain their services. The Company has
reserved 200,000 shares, subject to adjustment, of common stock for issuance
under the Bonus Plan. As of December 31, 2004, no shares have been issued under
this plan. The Bonus Plan will terminate on March 31, 2006, except that the
Board of Directors may terminate the Bonus Plan (except with respect to any
outstanding bonus awards) at an earlier date.
The Bonus Plan is administered by either the Board of Directors or the
Compensation Committee of the Board. Members of the Compensation Committee are
eligible to receive bonuses only if such bonuses are granted by the Board of
Directors.
The Board of Directors or the Compensation Committee has the authority to
determine which key employees shall be awarded bonuses; the amounts of bonuses
and the number of shares of common stock, if any, to be awarded; and all other
terms and combinations of performance measurement criteria, which may differ as
to various key employees or attainment of certain performance levels. The Board
of Directors or the Compensation Committee decides whether performance criteria
have been met, whether and when to award bonuses, time payment of bonuses, and
whether to pay bonuses in cash or in common stock or any combination thereof.
The determinations of the Board of Directors or the Compensation Committee, as
the case may be, on these matters shall be conclusive. The number of shares of
common stock to be awarded as a bonus is to be equal in value to a fixed cash
amount, with the value of such common stock computed at the higher of (a) the
fair market value of the common stock to be awarded on date of award, or (b) the
par value of the common stock to be awarded.
Any eligible employee whose employment has terminated for any reason other than
death prior to the end of the bonus measurement period may remain eligible for a
full or prorated bonus, or may forfeit his bonus in its entirety, in accordance
with such terms as may be set for such bonus from time to time by the Board of
Directors or the Compensation Committee. Bonuses payable will be paid to the
estate of designee of any eligible employee who has died after termination of
employment but before payment of the bonus award. In the event that any eligible
F-52
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
employee's employment is terminated either (i) for cause, or (ii) without the
consent of the Company, his eligibility for a bonus under the Bonus Plan shall
terminate in whole immediately upon termination of employment. If an eligible
employee dies while he is employed by the Company or any of its subsidiaries,
his estate or designee shall be eligible to receive a prorated bonus. Bonus
rights are not transferable otherwise than by will or the laws of descent and
distribution.
No bonus award of common stock may be made under the Plan unless and until the
shares subject to such award have been listed, registered and qualified upon any
applicable securities exchange or under any applicable state or federal law,
including without limitation, the Securities and Exchange Act of 1933, as
amended, and the consent or approval of any governmental regulatory body,
necessary or desirable as a condition of, or in connection with, the award or
issuance of shares hereunder has been obtained.
(13) WARRANTS
In determining the fair value of warrants granted in 2004, the Company
utilized the Black-Scholes valuation model with the following weighted
average assumptions: dividend yield of 0%, risk free interest rate of
1.16%, expected volatility of 143%, and expected lives of five to seven
years.
At December 31, 2004, the Company had the following warrants outstanding
for the purchase of its common stock:
NUMBER OF EXERCISE
DESCRIPTION EXPIRATION DATE SHARES ISSUABLE PRICE
----------- --------------- --------------- --------
Issued to original Front
Porch Shareholders May 2, 2005 290,000 $ 5.00
February 1, 2005 16,000 $ 5.00
(which has expired)
March 31, 2007 30,000 $ 6.50
Issued in connection with
notes payable December 31, 2005 80,000 $10.00
Issued in connection with
a private placement October 31, 2005 12,950 $24.00
Issued to note holder December 31, 2007 22,500 $ 1.00
Issued to Equity Pier
in exchange for consulting
services (Note 15) February 28, 2006 332,470 $20.00
Issued to noteholder May 1, 2008 10,000 $ 1.00
Issued to noteholder May 1, 2008 50,000 $ 1.00
Issued in connection with
debt issuance May 13, 2011 517,850 $ 4.80
Issued in exchange for
liquidated damages October 25, 2011 50,000 $ 5.00
Issued in exchange for
services in financing
transaction January 10, 2008 20,274 $ 0.003
-----------
1,432,044
Total warrants outstanding ===========
F-53
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
At December 31, 2004, the Company had the following warrants outstanding
for the purchase of its Series A Convertible Preferred Stock:
NUMBER OF EXERCISE
DESCRIPTION EXPIRATION DATE SHARES ISSUABLE PRICE
----------- --------------- --------------- --------
Issued to lease holder
in connection with
equipment lease facility November 20, 2010 6,954 $10.35
Issued in exchange for
services in financing
transaction January 10, 2008 26,075 $10.35
-----------
Total warrants outstanding 33,029
===========
(14) EMPLOYEE CONTRIBUTION PLAN
The Company sponsors a 401(k) Savings Plan (the Plan). The Plan is a
defined contribution plan for all regular domestic employees of the
Company's ManagedStorage International, Inc. subsidiary 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 60% 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.
(15) RELATED-PARTY TRANSACTIONS
The Company's Chairman of the Board and Chief Executive Officer (the
"CEO"), is the founder and managing partner of Equity Pier LLC ("Equity
Pier"). During 2004 and 2003, the Company incurred liabilities to Equity
Pier totaling $100,571 and $153,320, respectively, primarily related to the
reimbursement of airplane usage, travel and business expenses incurred by
the CEO and other executives. In addition, the Company leased office space
from Equity Pier in 2004 and 2003. Total costs incurred under the leasing
arrangement and associated expenses (utilities, supplies and insurance)
amounted to $204,623 and $184,420, respectively. During 2004 and 2003, the
Company paid consulting fees and other reimbursable expenses to
shareholders of Equity Pier, excluding salaries paid to shareholders of
Equity Pier in their capacity as employees of MSI, of $18,613 and $191,884
respectively.
The Company acquired equipment and equipment maintenance services from two
shareholders in the amount of $191,142 for the year ended December 31,
2003.
F-54
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
During 2004, a director of the Company entered into a consulting agreement
with the Company to provide consulting services in the broadcast industry.
The agreement began on June 1, 2004 and expires May 31, 2005. The agreement
requires monthly payments of $2,500 plus expenses. During 2004, the Company
paid the director $18,711 in consulting fees and expenses.
(16) INCOME TAXES
The domestic and foreign components of loss before income taxes for the
years ended December 31, 2004 and 2003 are as follows:
2004 2003
------------- -------------
Domestic $ (11,343,294) $ (10,991,371)
Foreign 1,305,000 --
------------- -------------
$ (10,038,294) $ (10,991,371)
============= =============
The income tax provision of $400,000 for the year ended December 31, 2004,
consisted solely of deferred, foreign income tax expense related to the
Company's French subsidiary. There was no income tax expense (benefit) in
2003.
The reconciliation between the federal statutory tax rate and the Company's
effective tax rate on (loss) for 2004 and 2003 is as follows:
2004 2003
------ ------
Expected tax benefit of federal statutory tax rate (34.0%) (35.0%)
Increase (reduction) resulting from:
State tax - net of federal tax benefit (4.4%) (4.1%)
Effect of permanent differences 10.3% 5.1%
Foreign taxes 4.0% --
Other 0% 2.5%
Change in valuation allowance 28.1% 31.5%
----- -----
Actual income tax expense 4.0% 0%
===== =====
At December 31, 2004, the Company had available for federal and state
income tax purposes, net operating loss carry forwards of approximately
$88,000,000 that expire between 2007 and 2024 and foreign loss carry
forwards of approximately $16,000,000 with no expiration.
F-55
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
The Tax Reform Act of 1986 contains provisions that limit the utilization
of net operating loss carry forwards 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 carry forwards. As a result of a private placement in 2003
and a reverse acquisition in 2004, the Company believes that there are
substantial limitations on the utilization of its net operating loss carry
forwards.
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, 2004:
Deferred tax assets:
Accrued liabilities and other $ 516,583
Property and equipment 630,916
Loss carryforwards 35,037,283
-------------
Deferred tax assets 36,184,782
-------------
Deferred tax liabilities:
Intangible assets - Front Porch Digital Acquisition (5,528,725)
Unremitted earnings of French subsidiary (1,357,960)
-------------
Deferred tax liabilities (6,886,685)
-------------
Net deferred tax assets 29,298,097
Valuation allowance (29,298,097)
-------------
Net deferred tax assets $ --
=============
Management has recorded a valuation allowance against the entire deferred
tax asset, as management does not consider the realization of this asset to
be more likely than not. The decrease in the valuation allowance during the
year ended December 31, 2004 was $942,204.
Undistributed earnings of foreign subsidiaries amounted to $3.4 million at
December 31, 2004. These undistributed earnings are considered to be
indefinitely reinvested, and, accordingly, no provision for U.S. federal or
state income taxes has been provided.
In addition, any tax benefits recognized in future periods for deferred tax
assets of MSI allowed for at the date of the Acquisition, are to be first
applied to reduce to zero, intangible assets related to the Acquisition.
(17) SUBSEQUENT EVENTS
(A) ACQUISITION OF STAR SOLUTIONS OF DELAWARE, INC.
On February 18, 2005 (the "Closing Date"), the Company acquired all of the
outstanding capital stock of STAR Solutions of Delaware, Inc., a
privately-held Delaware corporation ("Star"). The acquisition was effected
pursuant to an Agreement and Plan of Merger (the "Merger Agreement"). The
results of operations of STAR, will be included in the Company's
consolidated financial statements beginning on Feb. 18, 2005.
F-56
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
Pursuant to the Merger Agreement, the purchase price consisted of (i) a
cash payment of $1,422,000, (ii) the issuance of 1,261,756 unregistered
shares of the Company's common stock and (iii) the issuance of an unsecured
convertible promissory note for $2.5 million (the "Note"). In addition, the
Company paid $78,000 to the sole remaining stockholder of Star in exchange
for all shares of capital stock of Star held by such stockholder. Among
other terms and conditions of the Merger Agreement, as soon as practicable
after the Closing Date the Company is required to take all necessary
actions (including amending the articles of incorporation) to ensure that
the Company will have sufficient authorized but unissued shares of common
stock to permit the conversion of the Note in accordance with its terms.
The Company paid approximately $0.4 million in investment banking fees
associated with the transaction.
Interest on the Note accrues an annual rate of 0.5% which has been
discounted to reflect a fair value rate of interest. Principal is payable
as follows: (i) $125,861 on May 1, 2005, (ii) eight consecutive quarterly
payments of $251,722, commencing on August 1, 2005, and (iii) a single
payment of $377,583 on August 1, 2007 (each of the foregoing dates, a
"Payment Due Date"). All or a portion of the outstanding principal and
interest due under the Note may be converted by the holder into shares of
common stock at any time from the end of each calendar quarter immediately
preceding a Payment Due Date until and including one day prior to such
Payment Due Date. The Note is initially convertible at a conversion price
equal to the greater of (i) $4.00 or (ii) seventy percent (70%) of the
average closing price of the Company's common stock, as reported on the
Over-The-Counter Bulletin Board, for the ten (10) consecutive trading days
ending on and including the last day of the calendar quarter immediately
preceding the applicable Payment Due Date. As of the Closing Date, the Note
was convertible into a maximum of 625,000 shares of common stock. The
Company's obligations under the Note are not secured by any of the
Company's assets.
The Note provides that all unpaid principal and accrued interest shall, at
the option of the holder and without notice, become immediately due and
payable upon the occurrence of an event of default (as defined in the
Note). Such events of default include the occurrence of any of the
following events: (i) failure to pay within ten (10) days after the
applicable due date any amounts payable under the Note, (ii) an assignment
for the benefit of creditors, or (iii) failure to perform any material
covenant under the Merger Agreement, the registration rights agreement of
the consulting agreement described below or any other material agreement
between the seller and the Company. Principal amounts not paid when due
(subject to applicable cure periods) bear interest at twelve percent (12%).
Concurrent with the consummation of the acquisition, the Company entered
into a registration rights agreement with the seller, pursuant to which, at
any time after March 1, 2006, the seller shall have the right to cause the
Company to register under the Securities Act of 1933, as amended, the
shares of common stock issued to him in the acquisition and the shares of
common stock issuable upon conversion of the Note. The agreement also
provides that, after March 1, 2006, the seller shall have `piggy-back'
registration rights.
The following represents the preliminary purchase price allocation at the
date of the Star acquisition:
Cash and cash equivalents $ 1,598,000
Other current assets 687,000
Property and equipment 20,000
Other assets 7,000
Intangible assets 8,704,000
Current liabilities (1,421,000)
Other liabilities (1,900,000)
-----------
Total purchase price $ 7,695,000
===========
F-57
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
The purchase price is not considered final as of the date of this report, as the
Company and its independent valuation advisors are still reviewing all of the
underlying assumptions and calculations used in the allocation. However, the
Company does not believe the final purchase price allocation will be materially
different than that presented herein.
In addition, on February 18, 2005, Star obtained a revolving line of credit from
Wells Fargo Bank, N.A., which provides for borrowings until March 1, 2007, of up
to $5,000,000. See further discussion of this credit facility in item (E) below.
(B) AMENDMENT TO SENIOR SECURED CONVERTIBLE NOTE
On February 17, 2005, the Company entered into an Amendment and Waiver (the
"Laurus Amendment and Waiver") with Laurus. The Laurus Amendment and Waiver
waives certain events of default under the Registration Rights Agreement, (as
amended on October 25, 2004) and the Term Note. Pursuant to the Laurus Amendment
and Waiver, Laurus agreed to waive all fees and default interest arising from
the Company's failure to pay the liquidated damages set forth in the
Registration Rights Agreement and further waive any liquidated damages due and
payable to Laurus in connection with the Company's failure to maintain the
effectiveness of the Registration Statement.
On February 18, 2005, the Company entered into a Waiver and Subordination
Agreement with Laurus (the "Laurus Subordination"). The Laurus Subordination
waives the Company's obligation under the Securities Purchase Agreement, to
cause a new wholly-owned subsidiary STAR Solutions of Delaware, Inc. to become a
party to the Master Security Agreement. Pursuant to the Laurus Subordination,
Laurus also agreed to subordinate to the lender its security interest in the
accounts receivable and other rights to payments, general intangibles, equipment
and inventory of the new entity.
In consideration of the waivers and subordination by Laurus described above, the
Company agreed to issue Laurus an immediately exercisable seven-year warrant to
purchase 362,500 shares of common stock at an exercise price of $2.60 per share,
at any time on or prior to February 17, 2012 (the "Additional Warrant") and
further agreed to amend the Registration Statement to include the shares of
common stock issuable upon exercise of the Additional Warrant, such amendment to
be filed on or before April 10, 2005 and to be made effective by the Securities
and Exchange Commission no later than May 10, 2005. At December 31, 2004, the
Company had accrued $75,000 for the warrant value based on the terms of the Note
agreement relating to liquidated damages for not meeting the deadlines for the
Registration Rights Agreement.
(C) AMENDMENT TO CAPITAL LEASE AGREEMENT
On March 2, 2005, the Company entered into an amendment of its Lease Line. Under
this amendment, the Company may draw an additional $500,000 (the "New Credit
Facility") for equipment purchases through June 30, 2005. The amendment also
grants the Company a call option to purchase equipment from the lessor. If any
part of the New Credit Facility amount is unfunded on June 30, 2005, the Company
is to pay the lessor 5% of such unfunded amount upon demand by the lessor. The
term of the agreement is for term leases for 15 months with an interest rate of
14.96%.
F-58
Incentra Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004
(D) ACQUISITION OF PWI TECHNOLOGIES, INC.
On March 30, 2005, the Company acquired 100% of the outstanding capital stock of
privately-held PWI Technologies, Inc. ("PWI") of Kirkland, WA. PWI is a systems
integrator and solutions provider of Information Technology consulting, storage
solutions, hardware, software and selected managed services to customers in
financial services, communications, government, healthcare and manufacturing.
The results of operations of PWI will be included in the Company's consolidated
financial statements beginning on April 1, 2005.
The purchase price of PWI consisted of $2.3 million in cash and 841,934 shares
of the Company's common stock. In addition, the former PWI shareholders have the
opportunity to earn an additional $200,000 in cash and $1.0 million in common
stock of the Company based upon achieving certain earn out requirements. Should
PWI exceed the earn out requirements, its former shareholders can earn
additional common stock equitable to PWI's EBITDA contribution over the earn out
requirement. The Company paid approximately $0.3 million in investment banking
fees associated with the transaction. Due to the timing of the acquisition, the
Company does not have a preliminary purchase price allocation for the
transaction.
Financing for the cash component of the purchase was provided by Wells Fargo
Bank, N.A. through the existing Line of Credit ("LOC") established as part of
the acquisition of STAR described below. In connection with the financing, the
LOC was amended to make PWI a co-borrower under the agreements and to modify
certain financial covenants to accommodate the addition of PWI to the LOC.
(E) WELLS FARGO REVOLVING LINE OF CREDIT
On February 18, 2004, STAR, obtained a revolving line of credit from Wells Fargo
Bank, N. A. ("Wells Fargo"), which provides for borrowings, from time to time
until March 1, 2007, of up to $5,000,000. In connection with the line of credit,
on February 18, 2005, STAR entered into a credit agreement(the "Credit
Agreement") with Wells Fargo and executed in favor of Wells Fargo a revolving
line of credit note (the "LOC Note"), a continuing security agreement (rights to
payment and inventory) ("Security Agreement #1") and a security agreement
(equipment) ("Security Agreement #2, and collectively with Security Agreement
#1, the "Security Agreements"). The Credit Agreement, the LOC Note and the
Security Agreements are collectively referred to as the "Loan Documents."
Pursuant to the Credit Agreement, the maximum principal amount of all borrowings
under the line of credit cannot exceed 80% of STAR's eligible accounts
receivable. The Credit Agreement further provides that all borrowed amounts
shall, at the option of Wells Fargo and without notice, become immediately due
and payable upon the occurrence of an event of default (as defined in the Credit
Agreement). Principal amounts not paid when due bear interest at 4% above the
per annum rate of interest of the LOC Note.
The LOC Note provides that interest on all outstanding principal amounts shall
accrue at a rate per annum equal to the "Prime Rate" (as reported by Wells
Fargo) plus 1.5% (subject to certain adjustments based on STAR's tangible net
worth (as defined in the Credit Agreement). Interest on the LOC Note is payable
monthly on the first day of each month during the term of the LOC Note,
commencing April 1, 2005. Pursuant to the Security Agreements, borrowings under
the line of credit are secured by a first priority lien on all of STAR's assets.
If an event of default occurs under the Security Agreements or the Note, Wells
Fargo has the right to accelerate payments under the LOC Note and, in addition
to any other remedies available to it, to foreclose upon the assets securing the
LOC Note. In addition, the LOC contains certain financial covenants for which
compliance is measured quarterly.
F-59
- --------------------------------------------------------------------------------
PROSPECTUS
2,428,477
INCENTRA SOLUTIONS, INC.
COMMON STOCK
No person is authorized to give any information or to make any
representation other than those contained in this prospectus, and if made such
information or representation must not be relied upon as having been given or
authorized. This prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the securities offered
by this prospectus or an offer to sell or a solicitation of an offer to buy the
securities in any jurisdiction to any person to whom it is unlawful to make such
offer or solicitation in such jurisdiction.
The delivery of this prospectus shall not, under any circumstances, create
any implication that there has been no changes in the affairs of the company
since the date of this prospectus. However, in the event of a material change,
this prospectus will be amended or supplemented accordingly.
NOVEMBER , 2005
- --------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses expected to be incurred by us
in connection with the issuance and distribution of the common stock registered
hereby, all of which expenses, except for the Securities and Exchange Commission
registration fee, are estimates:
DESCRIPTION AMOUNT
Securities and Exchange Commission registration fee... $472
Accounting fees and expenses.......................... 18,000*
Legal fees and expenses............................... 35,000*
Miscellaneous fees and expenses....................... 3,528*
-------------
Total....................................... $57,000*
=============
- -------------
* Estimated
ITEM 27. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Commission
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Articles of Incorporation dated as of April 10, 1995 (incorporated by
reference to the exhibit of the same number filed with our Registration
Statement on Form SB-2 filed on November 13, 1996).
3.2 Certificate of Amendment to the Articles of Incorporation dated as of
August 22, 1996 (incorporated by reference to the exhibit of the same
number filed with our Registration Statement on Form SB-2 filed on
November 13, 1996).
3.3 Certificate of Amendment to Articles of Incorporation dated as of March
12, 1998 (incorporated by reference to Exhibit 3.1 filed with our
Current Report on Form 8-K filed on March 27, 1998).
3.4 Certificate of Amendment to Articles of Incorporation dated as of April
12, 2000 (incorporated by reference to the exhibit of the same number
filed with our Annual Report on Form 10-KSB for the period ended
December 31, 2000 filed on April 2, 2001).
3.5 Certificate of Amendment to Articles of Incorporation dated as of May
1, 2000 (incorporated by reference to Exhibit 2 filed with our
Quarterly Report on Form 10-QSB for the quarter ended June 30, 2000
filed on August 15, 2000).
3.6 Certificate of Amendment to Articles of Incorporation dated as of May
25, 2004 (incorporated by reference to the Exhibit of the same number
with Amendment Number 1 to our Registration Statement on Form SB-2
filed on July 15, 2004).
II-1
3.7 Certificate of Amendment to Articles of Incorporation dated as of
October 18, 2004 (incorporated by reference to Exhibit A to the
Definitive Schedule 14C Information Statement filed on October 14,
2004).
3.8 Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock of our company (incorporated by reference
to Exhibit 3.2 filed with our Current Report on Form 8-K filed on
August 20, 2004).
3.9 Certificate of Amendment to Articles of Incorporation dated as of May
17, 2005 (incorporated by reference to Exhibit A to the Definitive
Schedule 14C Information Statement filed on May 17, 2005).
3.10 By-Laws of the Company dated as of May 8, 1995 (incorporated by
reference to the Exhibit of the same number filed with our Registration
Statement on Form SB-2 filed on November 13, 1996).
5.1* Opinion of Pryor Cashman Sherman & Flynn LLP.
10.1 2000 Equity Incentive Plan dated as of May 2, 2000 (incorporated by
reference to exhibit 10.9 filed with our Annual Report on Form 10-KSB
for the period ended December 31, 2000 filed on April 2, 2001).
10.2 Employee Bonus Plan dated as of March 20, 2001 (incorporated by
reference to Exhibit 10.10 filed with our Annual Report on Form 10-KSB
for the period ended December 31, 2000 filed on April 2, 2001).
10.3 Registration Rights Agreement dated as of October 10, 2000 between our
company and Equity Pier LLC (incorporated by reference to Exhibit 10.11
filed with our Annual Report Form 10-KSB for the period ended December
31, 2000 filed on April 2, 2001).
10.4 Employment Agreement date as of June 1, 2003 between our company and
Matthew Richman (incorporated by reference to Exhibit 10.2 filed with
our Quarterly Report on Form 10-QSB for the period ended June 30, 2003
filed on September 2, 2003.
10.5 Securities Purchase Agreement, dated as of May 13, 2004, by and between
our company and Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.1 filed with our Quarterly Report on Form 10-QSB for the
period ended March 31, 2004 filed on May 17, 2004).
10.6 Secured Convertible Term Note, dated as of May 13, 2004, made by our
company in favor of Laurus Master Fund, Ltd. (incorporated by reference
to Exhibit 10.2 filed with our Quarterly Report on Form 10-QSB for the
period ended March 31, 2004 filed on May 17, 2004).
10.7 Master Security Agreement, dated May 13, 2004, by and between our
company and Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.3 filed with our Quarterly Report on Form 10-QSB for the
period ended March 31, 2004 filed on May 17, 2004).
10.8 Registration Rights Agreement, dated as of May 13, 2004, by and between
our company and Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.4 filed with our Quarterly Report on Form 10-QSB for the
period ended March 31, 2004 filed on May 17, 2004).
II-2
10.9 Common Stock Purchase Warrant, dated May 13, 2004, issued by our
company in favor of Laurus Master Fund, Ltd. (incorporated by reference
to Exhibit 10.5 filed with our Quarterly Report on Form 10-QSB for the
period ended March 31, 2004 filed on May 17, 2004).
10.10 Registration Rights Agreement dated as of August 18, 2004 by and among
our company and the other signatory parties thereto (incorporated by
reference to Exhibit 10.1 filed with our Current Report on Form 8-K
filed on August 20, 2004).
10.11 Registration Rights Agreement dated as of August 18, 2004 by and among
our company and the other signatory parties thereto (incorporated by
reference to Exhibit 10.2 filed with our Current Report on Form 8-K
filed on August 20, 2004).
10.12 Lock Up and Voting Agreement dated as of August 18, 2004 by and among
our company, Thomas P. Sweeney III, Equity Pier, LLC and the other
signatory parties thereto (incorporated by reference to Exhibit 10.3
filed with our Current Report on Form 8-K filed on August 20, 2004).
10.13 Lock Up and Voting Agreement dated as of August 18, 2004 by and among
our company and the other signatory parties thereto (incorporated by
reference to Exhibit 10.4 filed with our Current Report on Form 8-K
filed on August 20, 2004).
10.14 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and Thomas P. Sweeney III (incorporated by
reference to Exhibit 10.5 filed with our Current Report on Form 8-K
filed on August 20, 2004).
10.15 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and Paul McKnight (incorporated by reference to
Exhibit 10.6 filed with our Current Report on Form 8-K filed on August
20, 2004).
10.16 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and James Wolfinger (incorporated by reference to
Exhibit 10.7 filed with our Current Report on Form 8-K filed on August
20, 2004).
10.17 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and Patrick Whittingham (incorporated by reference
to Exhibit 10.8 filed with our Current Report on Form 8-K filed on
August 20, 2004).
10.18 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and Carmen J. Scarpa (incorporated by reference to
Exhibit 10.9 filed with our Current Report on Form 8-K filed on August
20, 2004).
10.19 Director Indemnification Agreement dated as of August 18, 2004 by and
between our company and Christopher S. Gaffney (incorporated by
reference to Exhibit 10.10 filed with our Current Report on Form 8-K
filed on August 20, 2004).
10.20 Employment Agreement dated as of August 18, 2004 by and between our
company and Thomas P. Sweeney III (incorporated by reference to Exhibit
10.11 filed with our Current Report on Form 8-K filed on August 20,
2004).
10.21 Stock Pledge Agreement dated as of August 18, 2004 by and between our
company and Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.1 filed with our Quarterly Report on Form 10-QSB for the
period ended September 30, 2004 filed on December 10, 2004).
II-3
10.22 Subsidiary Guaranty dated as of August 18, 2004, executed by
ManagedStorage International, Inc. (incorporated by reference to
Exhibit 10.2 filed with our Quarterly Report on Form 10-QSB for the
period ended September 30, 2004 filed on December 10, 2004)
10.23 Joinder in the Master Security Agreement dated as of August 18, 2004,
executed by our company and ManagedStorage International, Inc.
(incorporated by reference to Exhibit 10.3 filed with our Quarterly
Report on Form 10-QSB for the period ended September 30, 2004 filed on
December 10, 2004).
10.24 Employment Agreement dated as of December 21, 2004 by and between our
company and Paul McKnight (incorporated by reference to Exhibit 10.11
filed with our Current Report on Form 8-K filed on December 22, 2004).
10.25 Employment Agreement dated as of December 21, 2004 by and between our
company and Walter Hinton (incorporated by reference to Exhibit 10.11
filed with our Current Report on Form 8-K filed on December 22, 2004).
10.26 Amendment and Waiver, dated as of October 25, 2004, our company and
Laurus Master Fund, Ltd. (incorporated by reference to Exhibit 10.6
filed with our Current Report on Form 8-K filed on October 29, 2004).
10.27 Common Stock Purchase Warrant, dated October 25, 2004, issued by our
company in favor of Laurus Master Fund, Ltd. (incorporated by reference
to Exhibit 10.6 filed with our Current Report on Form 8-K filed on
October 29, 2004).
10.28 Employment Agreement dated as of December 6, 2004 between our company
and Michael Knaisch (incorporated by reference to Exhibit 10.28 filed
with our Annual Report on Form 10-KSB for the period ended December 31,
2004 filed on April 6, 2005).
10.29 Office Lease, dated as of March 15, 2002, by and between W9/MTN Real
Estate Limited Partnership and ManagedStorage International, Inc.
(incorporated by reference to Exhibit 10.29 filed with our Annual
Report on Form 10-KSB for the period ended December 31, 2004 filed on
April 6, 2005).
10.30 First Amendment to Office Lease, dated as of June 30, 2002, by and
between W9/MTN Real Estate Limited Partnership and ManagedStorage
International, Inc. (incorporated by reference to Exhibit 10.30 filed
with our Annual Report on Form 10-KSB for the period ended December 31,
2004 filed on April 6, 2005).
10.31 2000 Stock Option and Grant Plan of ManagedStorage International, Inc.,
as amended (incorporated by reference to Exhibit 10.31 filed with our
Annual Report on Form 10-KSB for the period ended December 31, 2004
filed on April 6, 2005).
10.32 $2,500,000 Convertible Promissory Note, dated as of February 18, 2005,
by our company in favor of Alfred Curmi (incorporated by reference to
Exhibit 10.1 filed with our Current Report on Form 8-K filed on
February 23, 2005).
10.33 Registration Rights Agreement, dated as of February 18, 2005, by and
between our company and Alfred Curmi (incorporated by reference to
Exhibit 10.2 filed with our Current Report on Form 8-K filed on
February 23, 2005).
II-4
10.34 Employment Agreement, dated as of February 18, 2005, by and between
STAR Solutions of Delaware, Inc. and Elaine Bellock (incorporated by
reference to Exhibit 10.3 filed with our Current Report on Form 8-K
filed on February 23, 2005).
10.35 Consulting Agreement, dated as of February 18, 2005, by and between our
company and FGBB, Inc. (incorporated by reference to Exhibit 10.4 filed
with our Current Report on Form 8-K filed on February 23, 2005).
10.36 Amendment and Waiver, dated as of February 17, 2005, by and between our
company and Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.10 filed with our Current Report on Form 8-K filed on
February 23, 2005).
10.37 Common Stock Purchase Warrant, dated as of February 17, 2005, issued by
our company to Laurus Master Fund, Ltd. (incorporated by reference to
Exhibit 10.11 filed with our Current Report on Form 8-K filed on
February 23, 2005).
10.38 Registration Rights Agreement, dated as of March 30, 2005, by and among
our company, Barry R. Andersen and Gary L. Henderson (incorporated by
reference to Exhibit 10.1 filed with our Current Report on Form 8-K
filed on April 4, 2005).
10.39 Employment Agreement, dated as of March 30, 2005, by and between PWI
Technologies, Inc. and Barry R. Andersen (incorporated by reference to
Exhibit 10.2 filed with our Current Report on Form 8-K filed on April
4, 2005).
10.40 Registration Rights Agreement, dated as of March 30, 2005 by and
between our company and MRA Systems, Inc. (d/b/a GE Access)
(incorporated by reference to Exhibit 10.3 filed with our Current
Report on Form 8-K filed on April 4, 2005).
10.41 Waiver and Subordination Agreement, dated as of March 23, 2005, by and
between our company and Laurus Master Fund, Ltd. (incorporated by
reference to Exhibit 10.7 filed with our Current Report on Form 8-K
filed on April 4, 2005).
10.42 Security Agreement, dated as of June 30, 2005, by and among our
company, PWI Technologies, Inc., Star Solutions of Delaware, Inc. and
Laurus Master Fund, Ltd (incorporated by reference to Exhibit 10.1
filed with our Current Report on Form 8-K filed on July 7, 2005).
10.43 Secured Revolving Note, dated as of June 30, 2005, by our company, PWI
Technologies, Inc. and Star Solutions of Delaware, Inc. in favor of
Laurus Master Fund, Ltd (incorporated by reference to Exhibit 10.2
filed with our Current Report on Form 8-K filed on July 7, 2005).
10.44 Secured Convertible Minimum Borrowing Note, dated as of June 30, 2005,
by our company. in favor of Laurus Master Fund, Ltd (incorporated by
reference to Exhibit 10.3 filed with our Current Report on Form 8-K
filed on July 7, 2005).
10.45 Stock Pledge Agreement, dated as of June 30, 2005, by and between our
company and Laurus Master Fund, Ltd (incorporated by reference to
Exhibit 10.4 filed with our Current Report on Form 8-K filed on July 7,
2005).
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10.46 Minimum Borrowing Note Registration Rights Agreement, dated as of June
30, 2005, by and between our company and Laurus Master Fund, Ltd
(incorporated by reference to Exhibit 10.5 filed with our Current
Report on Form 8-K filed on July 7, 2005).
10.47 Common Stock Purchase Warrant, dated as of June 30, 2005, by our
company in favor of Laurus Master Fund, Ltd (incorporated by reference
to Exhibit 10.6 filed with our Current Report on Form 8-K filed on July
7, 2005).
10.48 Subsidiary Guaranty, dated as of June 30, 2005, by and among PWI
Technologies, Inc., Star Solutions of Delaware, Inc. and Laurus Master
Fund, Ltd (incorporated by reference to Exhibit 10.7 filed with our
Current Report on Form 8-K filed on July 7, 2005).
10.49 Amendment and Waiver, dated as of June 30, 2005, by and between our
company and Laurus Master Fund, Ltd (incorporated by reference to
Exhibit 10.8 filed with our Current Report on Form 8-K filed on July
7, 2005).
10.50 Amendment No. 1 to the Front Porch Digital, Inc. 2000 Equity Incentive
Plan dated as of May 17, 2005 (incorporated by reference to Exhibit B
to the Definitive Schedule 14C Information Statement filed on May 17,
2005).
10.51 Employment Agreement, dated as of October 10, 2005, by and between our
company and Shawn O'Grady (incorporated herein by reference to Exhibit
10.1 filed with our Current Report on Form 8-K filed on October 19,
2005).
23.1 Consent of GHP Horwath, P.C., independent registered public accounting
firm.
23.2 Consent of KPMG LLP, independent registered public accounting firm.
23.3* Consent of Pryor Cashman Sherman & Flynn LLP (included in their opinion
filed as Exhibit 5.1).
24.1* Powers of Attorney (included on the signature page of this Registration
Statement).
- ---------------------
* Previously filed.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds, to believe that it met all
the requirements of filing on Form SB-2 and authorized this Amendment No. 1 to
Registration Statement on Form SB-2 to be signed on its behalf by the
undersigned, in Boulder, Colorado on October 31, 2005.
INCENTRA SOLUTIONS, INC.
By: /s/Thomas P. Sweeney III
-----------------------------------
Thomas P. Sweeney III
Chief Executive Officer
By: /s/Paul McKnight
-----------------------------------
Paul McKnight
Chief Financial Officer
In accordance with the requirements of the Securities Act of 1933, this
Amendment No. 1 to Registration Statement was signed by the following persons in
the capacities on October 31, 2005.
SIGNATURE TITLE
/s/Thomas P. Sweeney III* Chairman of the Board and Chief Executive
- ------------------------------ Officer (principal executive officer)
Thomas P. Sweeney III
/s/Paul McKnight* Chief Financial Officer and Director
- ------------------------------ (principal financial and accounting officer)
Paul McKnight
/s/Patrick Whittingham* Director
- ------------------------------
Patrick Whittingham
/s/James Wolfinger* Director
- ------------------------------
James Wolfinger
/s/Carmen J. Scarpa* Director
- ------------------------------
Carmen J. Scarpa
- ----------
* Thomas P. Sweeney III, pursuant to a Power of Attorney executed by each of
the officers and directors noted above and filed with the Securities and
Exchange Commission, by signing his name hereto, does hereby sign and
execute this Amendment No. 1 to Registration Statement on behalf of each of
the persons noted above, in the capacities indicated, and does hereby sign
and execute this Amendment No. 1 to Registration Statement on his own
behalf as Chief Executive Officer.
By: /s/Thomas P. Sweeney III
------------------------------------
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