AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 2, 2006
REGISTRATION NO. 333-_______
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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INCENTRA SOLUTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
NEVADA 7371 86-0793960
(State or Other Jurisdiction of (Primary Standard (I.R.S. Employer
Incorporation or Organization) Industrial Classification Identification No.)
Code Number)
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
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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 of
1933 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. [_]
CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM PROPOSED
AGGREGATE MAXIMUM
TITLE OF EACH AMOUNT OFFERING AGGREGATE AMOUNT OF
CLASS OF SECURITIES TO BE PRICE PER OFFERING REGISTRATION
TO BE REGISTERED REGISTERED SHARE(1) PRICE(1) FEE(2)
---------------- ---------- ---------------- ---------- ------------
Common Stock, $.001 par value .......... 1,752,690 $1.36 $2,383,658 $255.05
Common Stock, $.001 par value(3) ....... 2,270,093 $1.36 $3,087,326 $330.34
Common Stock, $.001 par value(4) ....... 2,789,635 $1.36 $3,793,904 $405.95
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Total Registration Fee ............... $991.34
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(1) Estimated solely for the purpose of computing the amount of the
registration fee pursuant to Rule 457(c) based on the average of the high
and low prices on the OTC Bulletin Board on May 24, 2006.
(2) This registration fee is being offset pursuant to Rule 457(p) of the
General Rules and Regulations under the Securities Act of 1933, as amended,
by the registration fee in the amount of $991.34 paid in connection with
unsold shares of common stock registered by the registrant under
Registration Statement No. 333-134537, filed on May 26, 2006 and
subsequently withdrawn on June 2, 2006.
(3) The shares of common stock being registered hereunder are being registered
for resale by a selling stockholder named in the prospectus following
conversion of interest on and/or principal of two convertible notes held by
such selling stockholder or our payment of the interest on and/or principal
of such convertible notes with shares of our common stock. In accordance
with Rule 416(a), the Registrant is also registering hereunder an
indeterminate number of shares that may be issued and resold to prevent
dilution resulting from stock splits, stock dividends or similar
transactions.
(4) The shares of common stock being registered hereunder are being registered
for resale by certain selling stockholders named in the prospectus upon
exercise of outstanding warrants and options. In accordance with Rule
416(a), the Registrant is also registering hereunder an indeterminate
number of shares that may be issued and resold to prevent dilution
resulting from stock splits, stock dividends or similar transactions.
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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.
The information in this Prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This Prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED JUNE 2, 2006
PROSPECTUS
6,812,418 SHARES
INCENTRA SOLUTIONS, INC.
COMMON STOCK
This prospectus relates to the resale of up to 6,812,418 shares of our
common stock, of which 2,270,093 are issuable to a certain selling stockholder
identified in this prospectus upon the conversion of two secured convertible
promissory notes and interest thereon; and 1,752,690 shares of our common stock
and 2,789,635 shares of common stock underlying warrants by certain selling
stockholders identified in this prospectus. All of the shares, when sold, will
be sold by the selling stockholders. The selling stockholders may sell their
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 the selling
stockholders.
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 6 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 __________, 2006
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
Prospectus Summary .......................................................... 3
Risk Factors ................................................................ 6
Forward-Looking Statements .................................................. 20
Use of Proceeds ............................................................. 20
Description of Securities ................................................... 21
Principal Stockholders ...................................................... 24
Market Price of Our Common Equity ........................................... 27
Selected Financial Data ..................................................... 28
Financial Statements and Supplementary Financial Information ............. 29
Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................. 31
Quantitative and Qualitative Disclosures About Market Risk .................. 46
The Laurus Transactions ..................................................... 47
Selling Stockholders ........................................................ 49
Plan of Distribution ........................................................ 50
Legal Matters ............................................................... 51
Experts ..................................................................... 52
Where You Can Find More Information ......................................... 52
Incorporation of Certain Information by Reference ........................... 52
Information with Respect to the Registrant .................................. 53
Material Changes ............................................................ 53
Commission Position on Indemnification for Securities Act Liabilities ....... 53
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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.
ii
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
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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"); PWI Technologies
("PWI") and Network System Technologies ("NST"). 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, PWI and NST are leading systems integrators
that provide Information Technology ("IT") products, professional services and
outsourcing solutions to enterprise customers located primarily in the central
and 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,
3
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, PWI and NST (which we acquired in April 2006), 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, education, non-profit and manufacturing sectors. With offices and
sales personnel located primarily throughout the mid-west and western United
States, these entities are a cornerstone to our North American expansion plans.
The established customer base of these entities provides an immediate market for
our complete solutions, such as First Call and Enhanced First Call support
services and our GridWorks remote monitoring and management system.
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,
Lombard, Illinois 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 6,812,418 shares of common
stock, of which 2,270,093 are issuable to a selling stockholder identified in
this prospectus upon the conversion of two secured convertible promissory notes
and interest thereon; and 4,542,325 shares owned by, or issuable upon the
exercise of outstanding options or warrants owned by, certain selling
stockholders identified in this prospectus. All of the shares, when sold, will
be sold by the selling stockholders. The selling stockholders may sell their
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 the
selling stockholders. However, we would receive proceeds upon the exercise of
the warrants or option held by the selling stockholders. See the "Use of
Proceeds"
4
section in this prospectus for a discussion of the amount of proceeds we would
realize from the exercise of such warrants or option 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.......................... 6,812,418 shares
Common Stock Outstanding at May 23, 2006(1) .. 14,261,293 shares
Use of Proceeds............................... We will not receive any of the
proceeds from the sale of the
shares by the selling
stockholders, but would receive
proceeds if certain common stock
purchase warrants or options are
exercised.
OTC Bulletin Board Ticker Symbol.............. ICNS.OB
SUMMARY FINANCIAL DATA
The selected financial information presented below is derived from and
should be read in conjunction with our consolidated financial statements,
including the notes thereto, appearing elsewhere in this prospectus. See
"Financial Statements." 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
fully diluted basis. As a result, MSI was deemed to be the acquirer for
accounting purposes. Accordingly, the information below and the 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.
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(1) Excludes 4,933,942 shares issuable upon the conversion of outstanding shares
of Series A preferred stock. Does not include (i) 3,310,861 shares that are
issuable upon the conversion of outstanding convertible notes, (ii)
2,108,349 shares issuable upon the exercise of outstanding warrants, (iii)
1,071,428 shares issuable upon the exercise of an outstanding option, (iv)
2,238,746 shares issuable upon the exercise of outstanding options granted
under our 2000 Equity Incentive Plan, (v) 216,536 shares issuable upon the
exercise of outstanding options granted under MSI's 2000 Option and Grant
Plan, or (vi) 1,204,611 shares issuable upon the exercise of outstanding
options granted under our 2006 Stock Option Plan.
5
SUMMARY OPERATING INFORMATION
THREE MONTHS ENDED MARCH 31 FISCAL YEAR ENDED DECEMBER 31,
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2006 2005 2005 2004 2003 2002 2001
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unaudited unaudited
Total revenue $12,909,171 $ 6,007,165 $50,831,936 $13,284,670 $ 9,810,741 $ 6,344,768 $15,809,428
Loss from operations (1,622,147) (1,940,617) (12,038,401) (7,711,394) (8,486,177) (12,243,685) (55,124,739)
Net loss applicable to
common shareholders (4,290,853) (3,002,957) (16,843,123) (11,777,613) (12,735,276) (8,621,656) (62,586,139)
Net Loss per common
share--Basic and Diluted (0.32) (0.27) (1.34) (2.31) (6.72) (8.43) (2.75)
Weighted Average Common
Shares Outstanding --
Basic and Diluted 13,326,810 11,090,153 12,541,642 5,102,733 1,894,552 1,022,563 22,733,061
SUMMARY BALANCE SHEET INFORMATION
March 31, March 31, December 31, December 31,
2006(1) 2005(2) 2005(1) 2004
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unaudited unaudited
Working capital (deficit) $(14,330,240) $ (2,322,470) $(13,104,316) $ 96,638
Total assets 36,060,851 46,528,177 37,883,343 28,677,045
Total liabilities 26,630,102 27,013,326 26,482,083 11,699,719
Series A convertible redeemable preferred stock 25,272,725 22,655,158 24,618,333 22,000,767
Shareholders' equity (deficit) (15,841,976) (3,140,307) (13,217,073) (5,023,441)
(1) All long term debt is classified with current liabilities because of a
default with a creditor that is the subject of a legal proceeding. Cross
default provisions in other long-term debt agreements caused all
outstanding long-term debt to be callable. See unaudited and audited
consolidated financial statements and notes thereto included elsewhere in
this prospectus.
(2) Goodwill, total assets, and shareholders' deficit have been adjusted by
$4,573,067 from amounts reported in the financial statements included with
our Form 10-QSB for the quarter ended March 31, 2005 as a result of an
error made in accounting for goodwill in connection with business
acquisitions during the first quarter of 2005. The error was discovered in
connection with preparing the December 31, 2005 consolidated financial
statements and was disclosed as such in the Annual Report on Form 10-KSB.
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), in our Incentra of CA and PWI lines of
business in February 2005 and March 2005, respectively, and in our NST line of
business in April 2006. 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;
6
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;
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 shareholders of $12.7 million
in 2003, $11.8 million in 2004, $16.8 million in 2005 and $4.3 million in the
first three months of fiscal 2006 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, $1.5 million in 2005 and $0.2 million in
the first three months of fiscal 2006. 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 March 31, 2006, we had a shareholders' deficit of $15.8 million. We
may not achieve
7
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 February 6,
2006, we obtained from Laurus Master Fund, Ltd. ("Laurus") a $10 million
revolving, non-convertible credit facility that matures on February 6, 2009 (the
"2006 Revolver Facility"). On February 6, 2006, we received an initial draw
under the 2006 Revolver Facility of $6.48 million, of which approximately $6.0
million was used to extinguish, in full, our indebtedness to Laurus under our
June 30, 2005 secured convertible credit facility (the "June 2005 Facility") and
the balance of the initial draw, less expenses incurred in connection with the
2006 Revolver Facility, are being used for general corporate and working capital
purposes. On April 13, 2006, we borrowed an additional $3.25 million from Laurus
pursuant to a $1.75 million secured term note and a $1.5 million secured,
convertible term note, each due May 31, 2009 ("collectively, the "2006 Term
Facility"). The proceeds of the 2006 Term Facility were used to fund, in part,
our acquisition of NST. On May 19, 2006, we entered into a Note Purchase
Agreement (the "Purchase Agreement") with eleven "accredited investors" (the
"Purchasers") pursuant to which we issued and sold unsecured convertible term
notes (the "Convertible Notes") in the aggregate principal amount of $960,000 in
connection with offering by us of up to $4 million aggregate principal amount of
such Convertible Notes.
Management believes our cash and cash equivalents will provide us with
sufficient capital resources to fund our operations, debt service requirements,
and working capital needs for the next twelve months. In our Annual Report on
Form 10-KSB for the year ended December 31, 2005, the report of our Independent
Registered Public Accounting Firm includes an explanatory paragraph that
describes substantial doubt about our ability to continue as a going concern
because nearly all of our long term debt may be accelerated due to a dispute
with a creditor. 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 2006 REVOLVER 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 2006 Revolver
Facility cannot exceed 90% of our borrowing base, which includes our eligible
accounts receivable and the combined eligible accounts receivable of our
wholly-owned subsidiaries PWI, Incentra of CA and NST. 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. If we are unable to generate
sufficient accounts receivable relative to borrowings outstanding, 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
8
of Series A preferred stock, the holders of which may elect to redeem such
shares on or after August 16, 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.
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.
9
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 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
10
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.
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 is 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.
11
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 $18.8 million at March 31,
2006, representing approximately 52% 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. We recorded an impairment loss to
goodwill in the fourth quarter of 2005 of $4.2 million related to the
acquisition of Incentra of CA made in the first quarter of 2005. 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;
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.
12
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.
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;
13
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 future impairment loss related to intangible assets and goodwill of
acquired companies;
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 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. 123R SHARE-BASED PAYMENTS, which requires the expensing of stock
options. We adopted SFAS No 123R on January 1, 2006. The effect on our results
from implementing this pronouncement was an increase in the charge to income and
net loss for the three months ended March 31, 2006 by approximately $0.3 million
as compared to the three months ended March 31, 2005. This new accounting
pronouncement will result in charges, which could be significant, against our
income in future periods related to unvested options and new option grants.
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 two issued patents relating
to our DIVArchive software product. 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.
14
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.
15
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
16
difficult for a third party to acquire control of our company, even if such
change in control would be 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 $0.51 to $2.80 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 6.9
million of the 14,361,293 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, 6,812,418 shares of common stock
offered under this prospectus have been registered for resale (of which
1,752,690 shares are included in the 14,361,293 shares outstanding as of May 23,
2006). We also have outstanding approximately 7.4 million 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.
17
CONVERSION OR EXERCISE OF OUR OUTSTANDING CONVERTIBLE SECURITIES AND WARRANTS
HELD BY LAURUS COULD SUBSTANTIALLY DILUTE OUR EARNINGS PER SHARE AND THE VOTING
POWER OF EXISTING STOCKHOLDERS.
In connection with the execution of our 2004 Facility and 2006 Term
Facility with Laurus, we issued secured convertible promissory notes to Laurus,
the outstanding aggregate principal amount of which, at May 23, 2006, was
convertible at a fixed conversion price into approximately 960,184 shares and
1,071,428 shares of our common stock, respectively. We also issued to Laurus
stock purchase warrants and a common stock option that, at May 23, 2006, were
exercisable to purchase an aggregate of 2,745,285 shares of our common stock.
All interest payable from time to time on our secured, convertible notes with
Laurus is also 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 HAVE SIGNIFICANT PRINCIPAL AND INTEREST PAYMENTS RELATED TO OUR TERM NOTES
WITH LAURUS AND MAY BE UNABLE TO MAKE THESE WHEN DUE, WHICH COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR LIQUIDITY.
The terms of the convertible notes we issued to Laurus in connection with
the 2004 Facility and the 2006 Term 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 the 2004 Term 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, Laurus agreed to defer payment of the scheduled
principal payments on the 2004 Term Note for the first six months of 2006, a
total of $952, 495, until the 2004 Term Note matures on May 13, 2007. Payments
will resume on July 1, 2006. An unfavorable outcome in our pending legal
proceeding, combined with our already tight cash position, could affect our
ability make scheduled principal and interest payments to Laurus on the 2004
Facility and the 2006 Term Facility and could have a material adverse effect on
our financial condition.
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 May 23, 2006, Laurus had the right to acquire 2,031,612 shares of our
common stock upon the conversion of the aggregate principal amount of two
convertible notes, 1,673,857 shares of our common stock upon the exercise of
five stock purchase warrants and 1,071,428 shares of our common stock upon the
exercise of a common stock option, which shares will be freely tradeable without
restriction and are offered in this prospectus. Although the terms of our credit
facilities with Laurus provide that, 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.
18
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 18 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 waive the penalty or
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 with certain exceptions. 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 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 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 hearing phase of the arbitration proceeding was
19
completed in April 2006, and both parties have submitted their proposed findings
of fact and conclusions of law to the arbitrator. A ruling from the arbitrator
is expected by the end of June 2006. The full outstanding balance of the STAR
Note could be accelerated if the arbitrator were to rule in favor of Mr. Curmi.
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.
As a result of this dispute and current uncertainty as to how the matter will be
resolved, in our Annual Report on Form 10-KSB for the year ended December 31,
2005, the Report of our Independent Registered Public Accounting Firm includes
an explanatory paragraph that describes substantial doubt about our ability to
continue as a going concern as a result of nearly all of our long term debt
being callable. 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 $4,587,669 upon the exercise, if any,
of the warrants or option granted by us to the selling stockholders identified
in this prospectus, which warrants and option are exercisable for an aggregate
2,789,635 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.
The amount of proceeds to us described above assumes the selling
stockholders will not elect to exercise their warrants or option through a
"cashless exercise". Under the terms of such warrant or option, payment of the
exercise price may be made, at the option of the warrant or option holder,
either in cash
20
or by a "cashless exercise". Upon a cashless exercise, in lieu of paying the
exercise price in cash, the warrant or option 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 or option, multiplied by the number of shares so exercised. There would
be no proceeds to us upon a "cashless exercise" of the warrant or option.
We cannot assure you that the selling stockholders will exercise the
warrant described above, or that they will elect to pay the exercise price in
cash in lieu of a "cashless exercise."
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 May 23, 2006, 14,361,293
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, 5,635,059 shares
of common stock were reserved for issuance upon the exercise of outstanding
options and warrants and 3,310,861 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
21
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 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 16, 2008, 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.
22
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 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.
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 our acquisition of NST, we granted registration rights
to a former NST stockholder with respect to the shares of our common stock
issued in the acquisition and we granted registration rights to Transitional
Management Consultants, Inc., a consulting firm controlled by such stockholder
("TMC"), with respect to the shares issuable under the earn-out provision
contained in the purchase agreement. Pursuant to each registration rights
agreement, at any time after April 13, 2008, the holders of such rights shall
have the right to cause us to register under the Securities Act the shares of
our common stock issued on the closing date of the transaction and the shares of
common stock issuable pursuant to the earn-out provision described in the
purchase agreement. The agreements also provide that, after April 13, 2008, the
holders shall have 'piggy-back' registration rights with respect to such shares.
In connection with obtaining each of our 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 or option 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.
In connection with our offer and sale of convertible bridge notes in May
2006, we granted registration rights to the purchasers of such notes in the
offering. The registration rights agreement between our company and such
noteholders provides, among other things, that, upon the request of the holders
of fifty-one percent of the noteholders, we are obligated to file a "resale"
registration statement to register the resale of shares of our common stock
issuable (i) upon conversion of the convertible notes or (ii) upon exercise of
the warrants issued in connection with the convertible notes (with certain
exceptions). If, at any time after May 19, 2007, we decide to register any of
our equity securities or other securities convertible into equity securities, we
must notify each holder of the notes and include any registrable securities as
such noteholder may request, in such registration statement.
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.
23
PRINCIPAL STOCKHOLDERS
The following table sets forth information as of May 23, 2006 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 23.3%(4)
One Liberty Square Series A Preferred Stock 843,170 34.2%
Boston, MA 02109
Tudor Investment Corporation Common Stock 2,684,547 16.4%(5)
1275 King Street Series A Preferred Stock 1,004,405 40.7%
Greenwich, CT 06831
J.P. Morgan Direct Venture Common Stock 2,330,797 15.0%(6)
Capital Institutional Series A Preferred Stock 602,775 24.4%
Investors, LLC
522 Fifth Avenue
New York, NY 10036
Alfred N. Curmi Common Stock 1,135,580 7.9%(7)
910 Seasage Drive
Delray Beach, Florida 33483
Joseph J. Graziano Common Stock 1,129,596 7.8%(8)
2050-80 Finley Road
Lombard, Illinois
DIRECTORS AND NAMED
EXECUTIVE OFFICERS
- --------------------
Thomas P. Sweeney III Common Stock 941,820 6.3%(9)
1140 Pearl Street Series A Preferred Stock 16,588 *
Boulder, CO 80302
James Wolfinger Common Stock 495,866 3.4%(10)
Michael Knaisch Common Stock 209,325 1.4%(11)
Matthew Richman Common Stock 157,269 1.1%(12)
Shawn O'Grady Common Stock 95,113 * (13)
Walter Hinton Common Stock 73,972 * (14)
24
Number of
Shares Percent of
Beneficially Outstanding
Name Title of Class Owned(1) Shares(2)(3)
- --------------------------------------------------------------------------------
Paul McKnight Common Stock 49,378 * (15)
Patrick Whittingham Common Stock 8,333 * (16)
Carmen J. Scarpa -- -- --
Thomas G. Hudson -- -- --
David E. Weiss -- -- --
All directors and executive Common Stock 2,031,077 12.7%
officers as a group (10 persons) Series A
Preferred Stock 16,588 0.7%
- --------------
* 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 May 23, 2006.
(2) All percentages for common stock are calculated based upon a total of
14,361,293 shares outstanding as of May 23, 2006, 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 May
23, 2006.
(3) All percentages for Series A preferred stock are calculated based upon a
total of 2,466,971 shares outstanding as of May 23, 2006.
(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 and 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 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 2,416,151 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), 266,583 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 1,813 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 shareholder of TIC.
25
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 the person named herein with the Securities and Exchange
Commission.
(8) Represents 1,034,483 shares of unregistered common stock issued to Mr.
Graziano upon our acquisition of NST, 71,429 shares issuable upon
conversion of convertible term note issued to Mr. Graziano and 23,684
shares issuable upon exercise of warrant held by Mr. Graziano.
(9) Represents 122,443 shares of common stock owned of record by Equity Pier
LLC, of which Mr. Sweeney is the founder and managing member, 141,837
shares of common stock owned of record by Mr. Sweeney, 71,429 shares
issuable upon conversion of convertible term note issued to Mr. Sweeney,
23,684 shares issuable upon exercise of warrant held by Mr. Sweeney and
549,250 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.
(10) Represents 59,524 shares owned of record by Mr. Wolfinger, 321,429 shares
issuable upon conversion of convertible term note issued to Mr. Wolfinger,
106,579 shares issuable upon exercise of warrant held by Mr. Wolfinger,
and 8,334 shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Wolfinger.
(11) Represents 64,814 shares of common stock owned of record by Mr. Knaisch,
7,143 shares issuable upon conversion of convertible term note issued to
Mr. Knaisch, 2,368 issuable upon exercise of warrant held by Mr. Knaisch
and 135,000 shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Knaisch.
(12) Represents 60,014 shares of common stock owned of record by Mr. Richman,
3,571 shares issuable upon conversion of convertible term note issued to
Mr. Richman, 1,184 shares issuable upon exercise of warrant held by Mr.
Richman and 92,500 shares of common stock issuable upon the exercise of
presently exercisable options held by Mr. Richman.
(13) Represents 71,429 shares issuable to Mr. O'Grady upon conversion of
convertible term note issued to Mr. O'Grady and 23,684 shares issuable
upon exercise of warrant held by Mr. O'Grady.
(14) Represents 11,905 shares of common stock owned of record by Mr. Hinton,
3,571 shares issuable upon conversion of convertible term note issued to
Mr. Hinton, 1,184 shares issuable upon exercise of warrant held by Mr.
Hinton and 57,312 shares issuable upon the exercise of presently
exercisable options held by Mr. Hinton.
(15) Represents 234 shares of common stock owned of record by Mr. McKnight,
3,571 shares issuable upon conversion of convertible term note issued to
Mr. McKnight, 1,184 shares issuable upon exercise of warrant held by Mr.
McKnight and 44,389 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.
(16) Represents shares of common stock issuable upon the exercise of presently
exercisable options held by Mr. Whittingham.
26
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET FOR COMMON STOCK
Our common stock is currently quoted on the OTC Bulletin Board under the
symbol "ICNS". The following table sets forth the high and low bid prices for
our common stock for each fiscal quarter within our last two fiscal years, as
reported by the National Quotation Bureau. The prices set forth below represent
interdealer quotations, without retail markup, markdown or commission and may
not be reflective of actual transactions. Prices for periods prior to June 9,
2005 have been adjusted to reflect a ten-for-one reverse split of our common
stock effective on that date.
HIGH BID LOW BID
YEAR ENDED DECEMBER 31, 2004
First Quarter........................... $ 11.25 $ 1.20
Second Quarter.......................... 8.60 3.20
Third Quarter........................... 3.90 1.60
Fourth Quarter.......................... 3.50 2.00
YEAR ENDED DECEMBER 31, 2005
First Quarter........................... $ 3.10 $ 1.61
Second Quarter.......................... 2.80 0.51
Third Quarter........................... 2.00 0.90
Fourth Quarter.......................... 1.90 0.85
YEAR ENDED DECEMBER 31, 2006
First Quarter........................... $1.40 $0.90
Second Quarter (through May 23)......... $1.65 $1.05
HOLDERS
At May 23, 2006, there were approximately 350 record holders of our common
stock. This number excludes any estimate by us of the number of beneficial
owners of shares held in street name, the accuracy of which cannot be
guaranteed.
DIVIDENDS
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 senior secured convertible promissory note prohibits the declaration
or payment of dividends on our common stock so long as twenty-five percent (25%)
of the principal amount of such note remains outstanding, unless we obtain the
written consent of the noteholder. 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 obtained the affirmative vote or
consent of at least 80% of the voting power of our shares of Series A Preferred
Stock.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
As of May 23, 2006, the following equity compensation plans were in
effect:
27
Number of Number of
securities to be Weighted average securities
issued upon exercise price remaining
exercise of of outstanding available
outstanding options, options, warrants for future
Plan category warrants and rights and rights issuance
================================================================================
Equity compensation
plans approved by
security holders -0- N/A -0-
========= ===== =======
Equity compensation
plans not approved by
security holders
2000 Equity Incentive Plan (a) 2,238,746 $2.92 23,754
MSI 2000 Stock Option Plan (b) 216,536 $0.43 -0-
2006 Stock Option Plan (c) 1,204,611 $1.30 545,389
--------- ----- -------
Total 3,659,893 $2.24 569,143
========= ===== =======
- ----------
(a) Total number of securities remaining available for future issuance
includes 2,262,500 shares reserved for issuance under our 2000 Equity
Incentive Plan, less options outstanding.
(b) Represents options to purchase unregistered shares of our common stock
pursuant to grants under the MSI 2000 Stock Option and Grant Plan. There
will be no additional grants under such plan.
(c) Adopted May 4, 2006. Total number of securities remaining available for
future issuance includes 1,750,000 shares reserved for issuance under the
2006 Stock Option Plan, less options outstanding.
SELECTED FINANCIAL DATA
The selected historical consolidated financial information presented below
is derived from our unaudited consolidated financial statements for the
three-month periods ended March 31, 2006 and 2005 and should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and from our audited consolidated financial
statements and related notes thereto included elsewhere in this Prospectus. 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 information
below and the audited and unaudited consolidated financial statements presented
elsewhere 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.
28
THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31,
---------------------------- ----------------------------------------------------
(in thousands, except per share amounts)
2006 2005 2005 2004 2003 2002 2001
(unaudited) (unaudited)
STATEMENT OF OPERATIONS DATA
Total Revenue $ 12,909 6,007 50,832 13,285 9,811 6,345 15,809
Gross Margin $ 5,118 2,943 16,325 5,984 2,859 (2,060) (9,514)
Loss from Operations $ (1,622) (1,941) (12,038) (7,711) (8,486) (12,244) (55,125)
Net Loss $ (3,636) (2,349) (14,226) (10,438) (10,991) (8,010) (56,211)
Preferred Stock Dividends and
Accretion of Preferred Stock Discount $ (654) (654) (2,617) (1,339) (1,744) (612) (6,375)
Net Loss Applicable to
Common Shareholders $ (4,291) (3,003) (16,843) (11,777) (12,735) (8,622) (62,586)
Weighted Average Common Shares
Outstanding--Basic and Diluted 13,327 11,090 12,542 5,103 1,895 1,023 2,273
Net Loss per Common Share--Basic and Diluted $ (0.32) (0.27) (1.34) (2.31) (6.72) (8.43) (27.53)
BALANCE SHEET DATA (AS OF END OF PERIOD)
Cash and Cash Equivalents $ 457 2,206 1,109 3,068 2,201 80 1,315
Capitalized Software Development Costs, Net $ 2,312 1,453 2,133 1,189 -- -- --
Intangible Assets, Net $ 12,946 16,256 13,685 16,537 1,671 250 --
Goodwill $ 5,858 9,992 5,858 -- 592 -- --
Total Assets $ 36,061 46,528 37,883 28,677 13,564 5,825 18,876
Long-Term Obligations (including
Current Installments) $ 11,197 10,338 11,371 4,005 19,990 6,448 17,847
Mandatorily and Convertible Redeemable
Preferred Stock $ 25,273 22,655 24,618 22,001 13,587 -- --
Shareholders' Deficit $(15,842) (3,140) (13,217) (5,023) (23,035) (15,907) (88,283)
Cash Dividend Declared per Common Share $ -- -- -- -- -- -- --
- -------------------
(A) Goodwill, total assets, and shareholders' deficit have been adjusted by
$4,573 from amounts reported in the March 31, 2005 Form 10-QSB as a result of an
error made in accounting for goodwill in connection with business acquisitions
during the first quarter of 2005. The error was discovered in connection with
preparing the December 31, 2005 consolidated financial statements and was
disclosed as such in the Annual Report on Form 10-KSB.
(B) Long-term debt at December 31, 2003 included $19.3 million of redeemable
preferred stock that was exchanged for a new series of preferred stock in August
2004. All of the preferred stock outstanding at December 31, 2003 was exchanged
for our common stock in August 2004.
We have made several acquisitions and had a significant disposition of an
operation during this five-year, three-month period that may affect the
comparability of the selected historical financial information presented above,
and the comparability of such information to future years' financial
information. Certain reclassifications have been made to the consolidated
financial statements for the years ended December 31, 2004, 2003, 2002 and 2001
to conform to the presentation for the year ended December 31, 2005. See Note 1
to the consolidated financial statements.
FINANCIAL STATEMENTS AND
SUPPLEMENTARY FINANCIAL INFORMATION
Our unaudited condensed consolidated financial statements and audited
consolidated financial statements are listed in the Index to Consolidated
Financial Statements appearing on page F-1 of this Prospectus.
The following is a summary of the unaudited quarterly financial
information for the past two full fiscal years. Note that, as result of a
reverse merger recorded in the third quarter of 2004 and large fluctuations
29
in the number of shares outstanding throughout 2004, the quarterly losses per
share will not equal the total loss per share for the year as computed on an
annual basis.
2006 2005 2004
--------- ------------------------------------------- ----------------------------------------
First Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
--------- ------- ------- ------- ------- ------- ------- ------- -------
Total revenues $ 12,909 14,801 12,425 17,599 6,007 4,675 4,348 1,898 2,364
Total cost of revenue $ 7,791 9,933 9,005 12,505 3,064 2,271 2,480 1,337 1,212
-------- ------ ------ ------ ------ ------ ------ ------ ------
Gross profit $ 5,118 4,868 3,420 5,094 2,943 2,404 1,868 561 1,152
Operating expenses 6,740 11,357 5,835 6,287 4,884 4,343 4,496 2,458 2,399
-------- ------ ------ ------ ------ ------ ------ ------ ------
Loss from operations $ (1,622) (6,489) (2,415) (1,193) (1,941) (1,939) (2,628) (1,897) (1,247)
Net loss applicable to
common shareholders $ (4,291) (6,964) (3,865) (3,011) (3,003) (3,718) (3,306) (2,715) (2,039)
Basic and diluted net loss
per share applicable to
common shareholders $ (0.32) (0.53) (0.30) (0.24) (0.27) (0.73) (0.35) (1.39) (1.05)
Weighted-average number of
common shares outstanding--
basic and diluted 13,327 13,322 13,022 12,703 11,090 5,103 9,358 1,953 1,950
Certain reclassifications were made to the unaudited quarterly financial
information to conform to the December 31, 2005 presentation.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
GENERAL
When used in this discussion, the word "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 additional funds to
enable us to successfully pursue our business plan; (2) the uncertainties
related to the effectiveness of our technologies and the development of the 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, vendor
relationships 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.
We are a leading provider of complete solutions for the data protection
needs of an enterprise. 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 Incentra
Solutions of Colorado ("Colorado"), ManagedStorage International ("MSI"),
Incentra Solutions of California ("Incentra of CA"), PWI Technologies ("PWI")
and Network Systems Technologies, Inc. ("NST"). Front Porch provides unique
software and professional services solutions for digital archive management to
broadcasters and media companies.
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
31
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 remote
monitoring/management services, maintenance support services (first call) for
third-party hardware and software maintenance, professional services,
third-party hardware/software procurement and resale and financing solutions.
MSI provides 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 these services
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, PWI and NST (which we acquired in April 2006), 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, education, non-profit and manufacturing sectors. With offices and
sales personnel located primarily throughout the mid-west and western United
States, these entities are a cornerstone to our North American expansion plans.
The established customer base of these entities provides an immediate market for
our complete solutions, such as First Call and Enhanced First Call support
services and our GridWorks remote monitoring and management system.
For the three months ended March 31, 2006, revenues totaled $12.9 million
as compared to $6.0 million for the comparable prior period in 2005. The rate of
increase for the three-month period ended March 31, 2006 was approximately 115%
when compared to the same period for 2005. The increase in revenue from the
prior year quarter is a result of the acquisitions of Incentra of CA and PWI,
increased sales of hardware as part of complete archive solutions, and an
increase in deliveries of broadcast solutions.
We continue to invest in hardware and the development of our software and
digital archiving in the data storage and infrastructure areas. During the three
months ended March 31, 2006, we invested $0.4 million in software development
and $0.6 million for data storage infrastructure.
During the three months ended March 31, 2006, our loss from operations
decreased by approximately $0.3 million to $1.6 million as compared to a loss of
$1.9 million for the comparable prior-year period. This reduction in our loss
was due to the increase in gross margin generated primarily from increased sales
of our
32
broadcast software solutions, which was offset in part by an increase in
selling, general and administrative costs of approximately $2.0 million. The
increase in our selling, general and administrative expenses was due to the
inclusion of the operations of Incentra of CA and PWI for the entire quarter in
2006.
During the three months ended March 31, 2006 and 2005, our results were
breakeven on an adjusted EBITDA(1) basis. Results for the three months ended
March 31, 2006 on an adjusted EBITDA basis included the add back of the $1.2
million loss on the early extinguishment of debt related to the 2005 Facility
and $427,000 of non-cash compensation expense following the adoption of SFAS
123R effective January 1, 2006. Results for the first quarter of 2005 on an
adjusted EBITDA basis included a gain of approximately $341,000 due to the
revaluation of a derivative warrant liability.
- ---------------
(1) EBITDA is defined as earnings before interest, taxes, depreciation and
amortization and cumulative effect of changes in accounting principles. Although
EBITDA is 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 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 provides useful information
to the investor because EBITDA excludes significant non-cash interest and
amortization charges related to our past financings that, when excluded, we
believe produces more meaningful operating information. EBITDA also excludes
depreciation and amortization expenses, which are significant when compared to
such levels prior to the acquisition of MSI. 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 to the most comparable GAAP financial measure net loss before deemed
dividends and accretion on preferred stock is set forth below.
EBITDA Reconciliation
All amounts in (000's)
FOR THE THREE MONTHS ENDING
MARCH 31,
2006 2005
------------ ------------
Net loss before deemed dividends
and accretion on preferred stock $ (3,636) $ (2,348)
Depreciation and amortization 1,261 1,285
Taxes 94 318
Interest (cash portion) 332 77
Interest (non-cash portion) 297 462
------------ ------------
EBITDA (1,652) (206)
Loss on early extinguishment of debt 1,232 --
Non-cash stock based compensation 427 156
Referral fees -- 43
------------ ------------
EBITDA, as adjusted $ 7 $ (7)
============ ============
33
We continue to leverage our unique intellectual property by taking
advantage of our position as a leading provider of archive software solutions.
We continue to expand our product and service offerings in an effort to position
our company as a provider of a wide range of services and products to the
broadcast and media markets and to further solidify our leading market position.
We also continue to increase the number of products we have available for resale
to our customers, both directly and through existing channel partners. We have
increased our expenditures for sales and marketing initiatives to meet an
increasing volume of digital archive implementations worldwide. We introduced
the sales of managed services along with our sales of storage products and
professional services directly to enterprise customers. We also believe we can
increase our sales of managed services by introducing these services to the
customers of our acquired businesses. We believe our professional services
business will be enhanced as we leverage our engineering resources across our
entire customer base.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 3 to the Audited
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,
accounting for obligations and instruments potentially settled in shares of our
common stock, impairment of long-lived assets, and concentrations of risk
related to customers.
REVENUE RECOGNITION
Given our diverse product and sales mix, 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.
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 recognize revenue under the completed contract method of accounting as
prescribed by American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2 in connection with an arrangement to deliver
software or a software system requiring significant production, modification or
customization of software. We recognize revenue when persuasive evidence of an
arrangement exists, delivery and acceptance has occurred, the fee is fixed or
determinable, and collection is reasonably assured.
We allocate revenue to each component of a contract based on objective
evidence of its fair value, as established by management. Because the licensing
of software is generally not dependent on the professional services portion of a
contract, software revenue is generally recognized upon delivery, unless a
contract exists with a customer requiring customer acceptance.
We recognize revenues from storage services 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 whom we have not yet performed certain services.
We sell computer equipment and software purchased from third parties to
customers as part of an integrated solution and on a stand-alone basis. Hardware
sales are recognized when the hardware is received by the customer.
34
We recognize fees for maintenance agreements ratably over the terms of the
agreements. Maintenance is generally billed in advance resulting in deferred
revenues.
We provide hardware and software-related professional services. Services
are generally provided on a time- and materials-basis and revenue is recognized
as the services are provided.
SOFTWARE DEVELOPMENT COSTS
As expenditures for software development are expected to increase, the
capture and measurement, as well as proper capitalization and amortization 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 earnings. 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 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 three years.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards ("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 for periods prior to 2006.
For periods prior to 2006, we 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 was 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 pricing models 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 Financial Accounting Standards Board ("FASB") issued
SFAS No. 123R "Share-Based Payment", which addresses the accounting for
share-based payment transactions. SFAS No. 123R 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. Application of SFAS 123R requires the use of significant
estimates, including expected volatility, expected term, risk-free interest rate
and forfeiture rate. SFAS No. 123R was effective for us for our filing on Form
10-QSB for the first quarter of 2006. The impact on our operating results and
other information related to stock-based compensation upon adopting SFAS 123R
are included in our Quarterly Report on Form 10-QSB for the quarter ended March
31, 2006.
ACCOUNTING FOR OBLIGATIONS AND INSTRUMENTS POTENTIALLY SETTLED IN OUR CAPITAL
STOCK
We account for obligations and instruments potentially to be settled in
our capital stock in accordance with Emerging Issues Task Force ("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.
35
Under EITF No. 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. The classification of a contract 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. As a result of the
acquisitions we consummated in 2004 and 2005, we had approximately $12.9 million
in intangible assets at March 31, 2006. Determination of recoverability was
based on an estimate of undiscounted future cash flows resulting from the use of
the assets and their eventual disposition. Measurement of an impairment loss for
such long-lived assets was based on the fair value of the assets.
Goodwill is not amortized and is subject to write downs charged to results
of operations only when its carrying amounts is determined to be more than its
estimated fair value 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 a result of the 2005 acquisitions, we had approximately $5.9
million in goodwill at March 31, 2006 after recording an impairment loss of $4.2
million in the fourth quarter of 2005 as discussed in Note 4 to the Notes to
Consolidated Financial Statements.
In connection with preparing our consolidated financial statements for
fiscal 2005, we determined that an error was made in accounting for goodwill
recognized in connection with business acquisitions that occurred in the first
quarter of 2005. As a result of the error, goodwill was overstated by
approximately $4.5 million and shareholders' deficit was understated by the same
amount at March 31, June 30, and September 30, 2005. This error had no effect on
our consolidated statements of operations for the year ended December 31, 2005
or for any quarter of 2005. The error was corrected in the fourth quarter of
2005 by decreasing goodwill and increasing shareholders' deficit by $4.5
million.
CONCENTRATION OF RISK--CUSTOMERS AND GEOGRAPHIC
The following is a breakdown of our revenues and long-lived assets by geographic
area* (in thousands):
North America Europe/Asia Total
------------- ----------- -----
Year Ended December 31, 2005
Revenues $37,420 $13,412 $50,832
Long-lived assets, 1,625 605 2,230
Year Ended December 31, 2004
Revenues 8,575 4,710 13,285
Long-lived assets, net 1,779 674 2,453
Year Ended December 31, 2003
Revenues 8,730 1,081 9,811
Long-lived assets, net 2,784 0 2,784
36
*The geographic breakout by country is not practical to obtain. Long-lived
assets include Property, Plant and Equipment.
During 2005, one customer represented 16% of revenues. During 2004,
revenues from two customers, each exceeding 10% of total revenue, aggregated 13%
and 11%, respectively. For the year ended December 31, 2003, revenues from three
customers each exceeding 10% of total revenues aggregated 36%, 19% and 11%,
respectively.
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
disclosures of contingent assets and liabilities. These estimates are based on
historical experience and on various other assumptions that we believe 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
Our Independent Registered Public Accounting Firm's report on our
consolidated financial statements as of December 31, 2005, and for each of the
years in the two-year period then ended, includes a "going concern" explanatory
paragraph, that describes factors that raise substantial doubt about our ability
to continue as a going concern.
THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 2005
Our unaudited condensed consolidated financial statements as of March 31,
2006 and for the quarter then ended have been prepared on a going concern basis,
which contemplates the realization of assets and settlements of liabilities and
commitments in the normal course of business. Our audited consolidated financial
statements for the year ended December 31, 2005 were also prepared on a going
concern basis. In our Annual Report on Form 10-KSB for the year ended December
31, 2005, the report of our Independent Registered Public Accounting Firm
includes an explanatory paragraph that describes substantial doubt about our
ability to continue as a going concern because of the possibility that
substantially all of our long-term debt may be accelerated due to a dispute with
a creditor as discussed in Notes 4(A) and 6(E) to our unaudited condensed
consolidated financial statements.
REVENUE. Total revenue for the three months ended March 31, 2006 increased
$6.9 million, or 115%, to $12.9 million compared to total revenue of $6.0
million for the three months ended March 31, 2005. This increase was
attributable to the additional revenues of $1.7 million resulting from increased
sales in our broadcast division and $5.3 million related to the inclusion of the
operating results of Incentra of CA and PWI in the full period, which increases
were offset in part by a reduction of $0.1 million in managed service revenues.
Revenue from the sale of our products increased to $9.5 million compared to
revenue of approximately $3.2 million for the comparable prior year period.
Revenue from the delivery of our services increased $0.6 million to $3.4 million
compared to $2.8 million for the comparable prior year period. On a pro forma
basis assuming that the acquisitions of Incentra of CA and PWI occurred on
January 1, 2005, revenue for the three months ended March 31, 2006 decreased
$3.5 million, or 22%, to $12.9 million due to lower sales of third-party product
sales for Incentra of CA and PWI of $4.9 million, lower services revenues for
Incentra of CA resulting from the loss of a large customer representing $0.6
million of total revenues for the prior period and slightly lower service
revenues for MSI of $0.1 million. These decreases were offset by increases in
revenues generated by our broadcast division of $1.7 million and higher services
revenues for PWI of $0.3 million.
For the quarter ended March 31, 2006, a significant portion of our
revenues was derived from the European and Asian geographic markets. During that
period, aggregate revenues from customers located in Europe or Asia amounted to
$4.1 million, or 32% of total revenue, while revenues from customers located in
North
37
America totaled $8.8 million, or 68% of total revenue. For the quarter ended
March 31, 2005, revenues from customers located in Europe and Asia amounted to
$3.0 million, or 50% of total revenue, while revenues from customers located in
North America totaled $3.0 million, or 50% of total revenue.
GROSS MARGIN. Total gross margin for the three months ended March 31, 2006
increased $2.2 million to $5.1 million, or 40% of total revenue, as compared to
gross margin of $2.9 million, or 49% of total revenue, for the comparable prior
year period. The decline in gross margin as a percentage of revenue was due to
increased sales of third-party products at lower gross margins, which offset
higher margins on the sales of our software and service solutions. Product gross
margin for the three months ended March 31, 2006 totaled $4.1 million, or 43% of
product revenue. Service gross margin for the three months ended March 31, 2006
totaled $1.0 million, or 30% of service revenue. On a pro forma basis, gross
margin for the three months ended March 31, 2006 increased $0.6 million due to
the mix of higher-margin broadcast product sales.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("SG&A") expenses for the three months ended March 31, 2006
increased by approximately $2.0 million to $6.0 million from $4.0 million for
the comparable prior year period. SG&A expenses included $4.5 million in
salaries and related benefits for employees not directly related to the
production of revenue, $0.5 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 $4.0 million for the comparable prior year
period included $2.6 million in salaries and related benefits for employees not
directly related to the production of revenue, $0.5 million in general office
expenses, $0.2 million in travel related costs, $0.5 million in professional
fees and $0.2 million of facilities costs. The increase for the three months
ended March 31, 2006 was due to an additional $1.5 million of SG&A expenses
relating to Incentra of CA and PWI as a result of the inclusion of these
operations for the entire quarter in 2006, an increase of $0.2 million in
salaries related to the broadcast business and an increase in employee headcount
for managing the new resellers businesses. Also included in the 2006 increase in
SG&A expenses was an increase of $0.4 million related to the adoption of SFAS
123R and the recording of additional non-cash compensation expense. On a pro
forma basis, SG&A expenses for the three months ended March 31, 2006 increased
$0.4 million, primarily due to the increase of non-cash compensation expense
related to the adoption of SFAS 123R.
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 for each of the three months ended March
31, 2006 and 2005, of which approximately $0.5 million and $0.4 million was
included in cost of revenue for the three-month periods ending March 31, 2006
and 2005, respectively.
OPERATING LOSS. During the three months ended March 31, 2006, we incurred
a loss from operations of $1.6 million as compared to a loss from operations of
$1.9 million for the three months ended March 31, 2005. This decrease in
operating loss was primarily the result of the increase in gross margin of
approximately $2.2 million, offset by an increase in SG&A expenses of
approximately $2.0 million.
LOSS ON EARLY EXTINGUISHMENT OF DEBT. Refinancing of the 2005 Facility in
the first quarter of 2006 was accounted for as an early extinguishment of debt.
A loss of $1.2 million was recorded, which included $375,000 for an early
termination fee and $107,500 in costs associated with the refinancing. No
similar refinancing occurred in the first quarter of 2005.
INTEREST EXPENSE. Interest expense was $0.6 million for the three months
ended March 31, 2006 compared to $0.6 million for the three months ended March
31, 2005.
OTHER INCOME AND EXPENSE. Other expense was approximately $60,000 for the
three months ended March 31, 2006 compared to other income of approximately
$367,000 for the three months ended March 31, 2005. Other income of $0.4 million
for 2005 included $0.3 million of income resulting from the reassessment of the
value of contracts recorded under EITF 00-19 for outstanding warrants and $0.1
million of investment income from leased equipment to customers and gains from
sales of fixed assets.
38
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 March 31, 2006 and 2005 were
minimal for each period.
INCOME TAX EXPENSE. We incurred income tax expense for the three months
ended March 31, 2006 of $0.1 million compared to $0.3 million for comparable
period in 2005. This expense was entirely represented by non-cash income tax
expense related to our French subsidiary, Front Porch Digital International,
SAS, and any liability otherwise payable was offset by the utilization of the
subsidiary's deferred tax assets during the period.
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. For the reasons set forth
above, during the three months ended March 31, 2006, we incurred a net loss
applicable to common shareholders of $4.3 million as compared to a net loss
applicable to common shareholders of $3.0 million for the three months ended
March 31, 2005. The increase in net loss for the three months ended March 31,
2006 was primarily due to an increase in interest expense.
YEAR ENDED DECEMBER 31, 2005 COMPARED TO THE YEAR ENDED DECEMBER 31, 2004
REVENUE. Total revenue for the year ended December 31, 2005 increased
$37.5 million, or 283%, to $50.8 million compared to total revenue of $13.3
million for the year ended December 31, 2004. Revenue from the sale of our
products increased to $37.6 million compared to revenue of $5.2 million for the
comparable prior year period. This increase was attributable to: (1) the
additional revenues resulting from the acquisitions of Incentra of CA and PWI,
(2) increased orders for our software and related products, consisting primarily
of sales of our DIVArchive solutions, (3) revenues resulting from the inclusion
of the results of operations of Front Porch for the full year 2005 and (4) sales
of hardware as part of complete archive solutions. Revenue from delivery of our
services increased $5.1 million, or 63%, to $13.2 million compared to $8.1
million for the comparable prior year period. The increase in service revenue
was the result of the additional revenues resulting from the professional
services provided by Incentra of CA and PWI to its customers, as well as the
introduction of first call maintenance services by these businesses. Pro forma
revenue for the year ended December 31, 2005 increased to $61.3 million compared
to $56.5 million in the previous year. The increase was due to the increased
revenue from PWI and the broadcast division, which was offset in part by the
decline in the revenues of Incentra of CA and MSI.
For the year ended December 31, 2005, a significant portion of our
revenues was derived from the European and Asian geographic markets. During that
period, aggregate revenues from customers located in Europe, Asia and the
Pacific Rim amounted to $13.4 million, or 26% of total revenue, while revenues
from customers located in North America totaled $37.4 million, or 74% of total
revenue. For the year ended December 31, 2004, our revenues from customers
located in Europe and 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.
GROSS MARGIN. Total gross margin for the year ended December 31, 2005
increased $10.3 million to $16.3 million, or 32% of total revenue, as compared
to gross margin of $6.0 million, or 45% of total revenue, for the comparable
prior year period. The decrease in margin percentage was due to the introduction
of third-party product sales from the two acquisitions in 2005. Product gross
margin for the year ended December 31, 2005 totaled $12.2 million, or 32% of
product revenue. Service gross margin for the year ended December 31, 2005
totaled $4.2 million, or 32% of service revenue. The decrease in the margin
percentage in product revenue was due to the introduction of third-party
products offered by the new acquisitions compared to the heavier percentage of
the DIVArchive products in the prior year. On a pro forma basis, the gross
margin for the year ended December 31, 2005 was $17.9 million compared to $16.8
million in the comparable prior year period. The increase of $1.1 million was
net of a decrease of $1.2 million in gross margin from Incentra of CA.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses for the year
ended December 31, 2005 increased by approximately $10.2 million to $20.5
million from $10.3
39
million for the comparable prior year period. SG&A expenses for the year ended
December 31, 2005 included $14.5 million in salaries and related benefits for
employees not directly related to the production of revenue, $2.6 million in
general office expenses, $1.6 million in professional fees, $1.1 million for
travel-related costs, $1.1 million in facilities costs, $0.1 million in bad debt
expense and $0.1 million in research and development costs. SG&A expenses of
$10.3 million for the prior year ending December 31, 2004 included $5.9 million
in salaries and related benefits for employees not directly related to the
production of revenue, $1.7 million in general office expenses, $0.9 million in
professional fees, $0.8 million in travel related costs, $0.6 million of
facilities costs and $0.2 million of bad debt expense. The increase in SG&A
expenses during the year ended December 31, 2005 was a direct result of the
inclusion of the SG&A expenses for a full year of Front Porch and the inclusion
of SG&A expenses relating to the Incentra of CA and PWI businesses from the
dates of the acquisitions forward. On a pro forma basis, SG&A expenses were
$21.8 million for the year ending December 31, 2005 compared to $20.4 million
for the comparable prior year period, a slight increase.
MERGER COSTS. Merger costs of $1.3 million in 2004 consisted of costs
incurred in the acquisition of Front Porch. These costs consisted of $0.8
million in compensation expense related to the accelerated vesting of stock
options, $0.4 million in professional fees for legal, banking and accounting
services, and $0.1 million of severance-related costs due to reductions in
staffing as result of the acquisition. There were no significant merger-related
costs in 2005.
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 $5.4 million and $4.0 million for the years ended
December 31, 2005 and 2004, respectively, of which $1.1 million and $2.0 million
respectively was included in cost of revenue. The increase of $1.4 million was
primarily the result of the increase in amortization associated with the Front
Porch intangible assets.
OPERATING LOSS. During the year ended December 31, 2005, we incurred a
loss from operations of $12.0 million as compared to a loss from operations of
$7.7 million for the year ended December 31, 2004. The increase in the loss for
2005 is due to a loss for impairment of the goodwill related to the acquisition
of Incentra of CA of $4.2 million. Operating profits and cash flows for Incentra
of CA were lower than expected in the fourth quarter of 2005. The major
contributors to this negative trend were the loss of a major customer and the
impact of a distributor violation. Therefore, during the fourth quarter of 2005,
we determined that the goodwill associated with the Incentra of CA acquisition
was impaired and accordingly recorded an impairment loss of $4.2 million.
Included in the operating loss for the year ended December 31, 2004 was $1.3
million of costs related to the acquisition of Front Porch. On a pro forma
basis, the net operating loss for the year ended December 31, 2005 was $11.9
million compared to $8.9 million for the comparable prior year period. This
increase was due to the impairment loss being offset in part by improved
performance.
INTEREST EXPENSE. Interest expense was $2.4 million for the year ended
December 31, 2005 compared to $2.4 million for the year ended December 31, 2004.
Interest expense during 2005 included cash interest costs of $0.8 million on
notes payable and capital leases and non-cash interest charges of $1.6 million,
consisting of $0.7 million related to amortization of debt discounts, $0.3
million related to warrants, $0.2 million related to the beneficial conversion
feature of the Laurus note, and $0.4 million related to amortization of
financing costs. 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.
OTHER INCOME AND EXPENSE. Other income of $0.7 million for 2005 included
$0.2 million of income from the sale of New Jersey state net operating losses
from prior years and $0.4 million related to a gain on the adjustment to the
valuation of warrants classified as liabilities. 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.
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, 2005, we
40
reported an accumulated translation loss of $103,235 as a component of
accumulated other comprehensive loss. 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
effect of exchange rate fluctuations in remeasuring foreign currency
transactions for the years ended December 31, 2005 and 2004 was a loss of
$43,209 and $24,756, respectively. In June 2004, we entered into two forward
contracts, one of which expired on December 7, 2004 and the other on April 1,
2005. We recorded a $59,900 realized gain on these contracts as of December 31,
2005 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. We recorded a
realized loss of $144,086 and an unrealized loss of $134,500 on these contracts
as of December 31, 2004.
INCOME TAX EXPENSE. We incurred income tax expense for the years ended
December 31, 2005 and 2004 of $0.5 million and $0.4 million, respectively. This
charge represented non-cash deferred income tax expense related to our French
subsidiary, Front Porch Digital International, S.A.S. The income taxes were
incurred during the period from the date of the MSI acquisition through December
31, 2005 and represented the utilization of the subsidiary's deferred tax assets
(net operating losses) during that period, which was recorded as a deferred tax
asset as part of the allocation of the purchase price of the subsidiary.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS. During the year ended December
31, 2005, we incurred a net loss applicable to common stockholders of $16.8
million as compared to a net loss applicable to common stockholders of $11.8
million for the year ended December 31, 2004. Included in the net loss for the
year ended December 31, 2004 was $1.3 million of costs related to the merger
with Front Porch. The increase in net loss for the year ended December 31, 2005
was primarily due to the $4.2 million impairment loss related to Incentra of CA,
additional amortization of $1.5 million and the net increase of the accretion
and dividends on 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 was 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
41
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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. 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 costs of $1.3 million in 2004 consisted of costs
incurred in the acquisition of Front Porch. The costs consisted 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, and
$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 software 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 was 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
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
42
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 March 31, 2006, we had $0.5 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 pursuant to which we
issued to Laurus Master Fund, Ltd. ("Laurus") a secured convertible term note
due May 13, 2007 in the principal amount of $5.0 million (the "2004 Note"), and
a common stock purchase warrant entitling the noteholder to purchase 443,500
shares of our common stock. Subsequent to that date, the note and other terms
related to the indebtedness were amended on several occasions. On February 6,
2006, we entered into an Amendment and Deferral Agreement (the "Amendment and
Deferral Agreement") with Laurus amending the 2004 Note. Pursuant to the
Amendment and Deferral Agreement, the monthly principal amount payable to Laurus
under the 2004 Note for each of January, February, March, April, May and June
2006, equal to an aggregate of $952,495, is deferred until May 13, 2007.
Scheduled payments will resume on July 1, 2006.
On June 30, 2005, we entered into a Security Agreement with Laurus
pursuant to which Laurus provided us a $9 million revolving, convertible credit
facility. The outstanding principal amount under this facility was paid off on
February 6, 2006 in connection with our execution of a new security agreement
with Laurus pursuant to which Laurus provided us a non-convertible revolving
credit facility of up to $10 million (the "2006 Facility"). The term of the 2006
Facility is three years and borrowings under the 2006 Facility accrue interest
on the unpaid principal and interest at a rate per annum equal to the "prime
rate" published in The Wall Street Journal from time to time, plus 1%, subject
to a floor of seven percent (7%).
In connection with the 2006 Facility, we executed in favor of Laurus a
secured non-convertible revolving note in the principal amount of $10 million
(the "2006 Revolver Note"). Interest on borrowings under the 2006 Revolver Note
is payable
43
monthly on the first day of each month during the term of the 2006 Revolver
Note, commencing on March 1, 2006. All outstanding principal amounts are due and
payable on February 6, 2009. The minimum amount available to us until April 30,
2006 was $6.5 million. Thereafter, the maximum principal amount outstanding
under the 2006 Revolver Note cannot exceed 90% of the combined eligible accounts
receivable of our company and of all of our U.S. subsidiaries.
On March 31, 2006, we consummated a private placement pursuant to which we
issued a secured term note due May 31, 2009 in the principal amount of
$1,750,000 (the "2006 Term Note") and a secured convertible term note due May
31, 2009 in the principal amount of $1,500,000 (the "2006 Convertible Note"). In
connection with the issuance of the 2006 Term Note and 2006 Convertible Note, we
issued a common stock purchase warrant entitling Laurus to purchase 417,857
shares of common stock (the "2006 Warrant") at $0.001 per share. Funding of
$3.25 million under the 2006 Term Note and the 2006 Convertible Note was
completed on April 13, 2006 and was used to fund part of the cash portion of the
purchase price of our acquisition of NST.
On May 19, 2006, we entered into a Note Purchase Agreement (the "Purchase
Agreement") with eleven "accredited investors" (the "Purchasers") pursuant to
which we issued and sold unsecured convertible term notes (the "Convertible
Notes") in the aggregate principal amount of $960,000 in connection with
offering by us of up to $4 million aggregate principal amount of such
Convertible Notes. The Convertible Notes are convertible, at the option of the
Purchasers, into shares of our common stock at a conversion price of $1.40 per
share, subject to customary anti-dilution provisions. We also issued to the
Purchasers warrants to purchase an aggregate of 227,368 shares of our common
stock at $1.40 per share, subject to normal anti-dilution provisions. The
warrants expire on May 19, 2011.
Absent earlier redemption by us or conversion by the Purchasers, the
Convertible Notes mature on May 19, 2007. Interest will accrue on the unpaid
principal and interest at the rate of 12% per annum. Subject to prepayment
penalties payable to the Purchaser ranging from 11% to zero depending on the
month during the term in which such prepayment is made, we may prepay the
Convertible Notes at any time by paying to Purchaser all sums due and payable
under the Convertible Notes. Subject to the payment of a prepayment penalty, we
have the right to convert any amounts due to a Purchaser into fully paid and
nonassessable shares of our common stock at $1.40 per share. Certain waivers
were obtained from Laurus in order to complete this offering of Convertible
Notes.
As of March 31, 2006, we had current assets of $12.0 million. These assets
were primarily derived from our operations in 2006 and from our acquisitions of
Incentra of CA and PWI. Long-term assets of $24.2 million consisted of $12.9
million of intangible assets resulting from the acquisitions of MSI, Incentra of
CA and PWI, $5.9 million of goodwill resulting from the acquisitions of Incentra
of CA and PWI, $2.4 million of property and equipment, $2.3 million of software
development costs and $0.7 million of other assets, which consisted of $0.5
million of deferred financing costs and $0.2 million of deposits, prepaid
expenses and other receivables.
Current liabilities of $26.3 million at March 31, 2006 consisted of $8.5
million of accounts payable; $2.3 million of deferred revenue, which consisted
of billings in excess of revenue recognized, deposits and progress payments
received on engagements currently in progress; $4.5 million of accrued expenses;
and $11.0 of current portion of notes payable, other long term obligations, and
capital leases.
Our working capital deficit was $14.3 million as of March 31, 2006, which
included the outstanding principal balance on the 2006 Facility of $5.3 million,
net of debt discount of $1.2 million, which was classified as a current
liability as a result of the credit facility containing a lockbox arrangement
which requires all receipts to be swept daily to reduce borrowings outstanding
under the credit facility, and a subjective acceleration clause, as described in
Note 6(C) to the unaudited condensed consolidated financial statements. Also
included in the deficit was $1.3 million 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 and $2.4 million (net of discount) on
the Laurus Note due to cross default provisions with other long-term
indebtedness, as described in Notes 6(A) and 6(E) in the notes to unaudited
condensed consolidated financial statements as of March 31, 2006.
We used net cash of $0.2 million in operating activities during the three
months ended March 31, 2006, primarily as a result of the net loss incurred
during the period. We used net cash of $0.9 million in investing activities
during the three months ended March 31, 2006, of which $0.6 million was used
primarily to purchase or develop computer software and equipment. Financing
activities provided net cash of $0.5 million during the three months ended March
31, 2006 primarily from the new Laurus financing. Repayment of capital leases,
long-term obligations and notes payable of $5.3 million was offset by borrowings
of $5.4 million under the 2006 Facility and $0.4 under the lease line of credit.
As described in Note 6(E) to the unaudited condensed consolidated
financial statements, we are currently in default of the STAR Note and in the
event the outcome of our current arbitration proceeding is unfavorable, it is
possible that
44
the full outstanding balance of the STAR Note could be accelerated. We do not
have the cash available to pay such amount and, in such event, we could require
additional financing to meet our obligations. 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.
We are still in the early stages of executing our business strategy, have
completed three 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.
Management believes our cash and cash equivalents and borrowings available
from the 2006 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.
Our actual financial results may differ materially from our stated plan of
operations. Factors that may cause a change from our plan of operations to vary
include, without limitation, decisions of our management and board of directors
not to pursue our stated plan of operations based on their 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 $2.0 million and
capitalized software development costs to be approximately $1.6 million during
the 12-month period ended March 31, 2007. 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.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual cash obligations under long-term
debt and capital lease obligations, operating lease agreements and purchase
commitments and other long-term liabilities as of December 31, 2005. The amounts
include the liability to the former stockholder of Incentra of CA, which amount
is under dispute and currently subject to an arbitration proceeding.
45
PAYMENTS DUE BY PERIOD
-----------------------------------------------------
2006(1)(2) 2007-2008 2009-2010 BEYOND TOTAL
---------- --------- --------- ------ -----------
Long-term debt $ 9,882,493 $ 9,882,493
Capital lease obligations 797,867 $ 33,668 831,535
Operating lease
obligations 706,781 723,074 $553,349 1,983,204
Purchase commitments 386,561 269,984 656,545
Series A convertible
redeemable preferred
stock (3) 31,500,000 31,500,000
----------- ----------- -------- ---- -----------
Total $11,773,702 $32,526,726 $553,349 -- $44,853,777
=========== =========== ======== ==== ===========
(1) Includes $2.4 million due to a creditor that is the subject of an
arbitration proceeding expected to be resolved by July, 2006.
(2) Includes $7.8 million due Laurus at December 31, 2005 which is callable
due to cross-default provisions with other long-term indebtedness. $5.5
million of this amount was refinanced in February 2006 and is no longer in
default.
(3) Assumes redemption of 2.5 million shares at $12.60 per share. Payment may
be higher if the fair market value of our common stock exceeds $6.30 per
share on or after August 16, 2008.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include changes in foreign currency exchange
rates and interest rates. Market risk is the potential loss arising from adverse
changes in market rates and prices, such as foreign currency exchange and
interest rates. In 2004, we entered into forward financial instruments in the
form of forward exchange contracts to manage and reduce the impact of changes in
foreign currency rates. The last of these contracts matured in 2005, and we have
not entered into any new contracts since that time or otherwise hedged our
exposure to adverse changes in foreign exchange rates.
At March 31, 2006, we had approximately $8.2 million of long-term debt
(including current maturities) that was subject to annual, floating interest
rates ranging from the prime interest rate (as published from time-to-time in
the Wall Street Journal) plus 1%-2% with a floor ranging from 5%-9%. A
one-percentage-point increase in the prime interest rate at March 31, 2006
would result in an estimated annual increase in interest expense of $82,000.
Actual interest rates could change significantly more than by one percentage
point.
46
THE LAURUS TRANSACTIONS
Of the 6,812,418 shares of common stock being registered hereunder,
5,015,378 shares are being registered for resale by Laurus upon conversion or
exercise of convertible securities, warrants or options issued to Laurus in
connection with the 2004 Facility, the 2005 Facility, the 2006 Revolver Facility
or the 2006 Term Facility (each as defined below). The following discussion of
each of the 2004 Facility, the 2005 Facility, the 2006 Revolver Facility and the
2006 Term Facility is not a complete description of the terms of such facilities
and each is qualified in its entirety by reference to the disclosures in our
annual and quarterly reports filed pursuant to the Exchange Act, which are
incorporated herein by reference, and to the agreements entered into in
connection with such facilities, which agreements are attached as exhibits to
the registration statement of which this prospectus forms a part.
THE 2004 FACILITY
On May 13, 2004, we completed a private placement to Laurus of a
convertible term note in the principal amount of $5,000,000 (the "2004 Term
Note"), and a warrant to purchase up to 443,500 shares of our common stock
(collectively, the "2004 Facility"). On each of May 4, 2005, May 31, 2005,
August 1, 2005 and August 31, 2005, we amended the 2004 Term Note (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 716,669 shares of our common stock were issued to Laurus under the
2004 Term Note. The principal and unpaid interest on the 2004 Term Note are
convertible into shares of our common stock at a price of $3.00 per share, which
conversion price is subject to antidilution adjustments.
The 2004 Term Note provides for monthly payments of 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. The 2004 Term Note also provides for monthly amortization, which
commenced on September 1, 2004, at the rate of $45,454 per month and 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 then Fixed Conversion
Price. At May 3, 2006, the outstanding principal amount of the 2004 Term Note
was approximately $2.9 million.
The warrant issued in connection with the 2004 Term Note entitles the
holder thereof 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. On February 18, 2005. we issued Laurus a warrant to
purchase up to 362,500 shares of our common stock at $2.60 per share, which
warrant was issued in lieu of certain cash penalties due under the 2004 Facility
and in satisfaction of $375,000 of liquidated damages incurred due to our
failure to maintain the effectiveness of the registration statement covering the
shares issuable under the 2004 Facility. On October 26, 2004 we entered into an
Amendment and Waiver with Laurus that waived certain events of default under
certain loan documents in the 2004 Facility and, 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.
The terms of the 2004 Term Note and the warrants also provide that Laurus
may not convert its convertible securities or exercise its warrants 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.
47
THE 2005 FACILITY
On June 30, 2005, we entered into a three-year, $9.0 million revolving,
convertible credit facility (the "2005 Facility") with Laurus. 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 was repaid in full on February 6, 2006 in
connection with the 2006 Revolver Facility described below. The terms of the
warrant provide that Laurus may not exercise the warrant if such exercise would
result in Laurus beneficially owning more than 4.99% of our outstanding common
stock, without first providing us 75 days' prior notice.
THE 2006 REVOLVER FACILITY
On February 6, 2006, we entered into a new security agreement with Laurus
pursuant to which Laurus provided us a non-convertible revolving credit facility
of up to $10 million (the "2006 Revolver Facility"). At May 3, 2006, the
outstanding principal amount under the 2006 Revolver Facility was approximately
$9.3 million. Interest under the 2006 Revolver Facility is payable monthly at
the prime rate (as published from time to time in the Wall Street Journal) plus
1%. Proceeds from this facility were used to repay borrowings under the 2005
Facility and for a portion of the cash required at closing in the acquisition of
NST.
In connection with the 2006 Revolver Facility, we issued to Laurus a
common stock purchase option (the "Option"), entitling Laurus to purchase up to
1,071,428 shares of our common stock at an exercise price of $.001 per share
(subject to applicable adjustments). The Option expires on February 26, 2026.
The terms of the Option provide that Laurus may not exercise the Option if such
exercise would result in Laurus beneficially owning more than 4.99% of our
outstanding common stock, without first providing us 75 days' prior notice.
THE 2006 TERM FACILITY
On March 31, 2006, we consummated a private placement pursuant to which we
issued to Laurus a secured term note due May 31, 2009 in the principal amount of
$1,750,000 and a secured convertible term note due May 31, 2009 in the principal
amount of $1,500,000 (the "2006 Convertible Note") (collectively, the "2006 Term
Facility"). Proceeds from this facility were used to fund a portion of the
purchase price in the acquisition of NST. The principal and unpaid interest on
the 2006 Convertible Note are convertible into shares of our common stock at a
price of $1.40 per share, which conversion price is subject to antidilution
adjustments. In connection with the issuance of the 2006 Term Facility, we
issued a common stock purchase warrant entitling Laurus to purchase 417,857
shares of common stock (the "2006 Warrant") at $0.001 per share. The terms of
the 2006 Convertible Note and the warrants also provide that Laurus may not
convert the 2006 Convertible Note or exercise the 2006 Warrant 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. At
May 3, 2006, the outstanding principal amount under the 2006 Term Facility was
approximately $3.25 million.
48
SELLING STOCKHOLDERS
The following table sets forth information with respect to the number of
shares of our common stock beneficially owned by the selling stockholders, 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
May 3, 2006. All information contained in the table below is based upon
information provided to us by the selling stockholders and we have not
independently verified this information. The selling stockholders are not making
any representation that any shares covered by this prospectus will be offered
for sale. The selling stockholders 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
BENEFICIALLY NUMBER OF SHARES
OWNED NUMBER OF BENEFICIALLY
PRIOR TO SHARES OWNED AFTER
SELLING STOCKHOLDER OFFERING(1) % OFFERED(3) OFFERING(1) %
------------------- ----------- --- ---------- ---------------- ---
Laurus Master Fund, Ltd(2) 5,184,878 26.5 5,015,378(4) 169,500 0.8
Alfred Curmi 1,177,555 8.2 1,135,580(5) 41,975 0.2
MRA Systems, Inc. 441,934 3.1 441,934(6) -0- -0-
Elaine Bellock 126,176 0.9 126,176(7) -0- -0-
Biscayne Capital 153,350 1.1 93,350(8) 60,000 *
Markets, Inc.
- ----------
* Constitutes less than 1%
(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 May 3, 2006 plus
that number of shares of common stock that the selling stockholders have
the right to acquire within 60 days of May 3, 2006.
(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) 1,021,330 shares of our common stock issuable upon the
conversion of principal and/or interest of the 2004 Term Note issued to
Laurus in connection with the 2004 Facility, (ii) 1,673,857 shares of our
common
49
stock upon the exercise of five stock purchase warrants issued to Laurus
for 443,500, 417,857, 400,000, 362,500 and 50,000 shares, (iii) 1,071,428
shares of our common stock issuable upon the exercise of a common stock
option issued to Laurus, and (iv) 1,248,763 shares of our common stock
issuable upon the conversion of principal and/or interest of the
2006 Convertible Note issued to Laurus in connection with the 2006 Term
Facility. In each case, the number of shares presented in the table
represents the maximum number of shares issuable under that convertible
security.
(5) Represents 1,135,580 shares issued as part of the purchase price in the
acquisition of Incentra of CA in February 2005.
(6) Represents 441,934 shares issued as part of the purchase price in the
acquisition of PWI in March 2005.
(7) Represents 126,176 shares issued as part of the purchase price in the
acquisition of Incentra of CA in February 2005.
(8) Represents 49,000 outstanding shares and 44,350 shares issuable upon the
exercise of outstanding warrants that expire on May 13, 2011 and are
exercisable at a price of $4.80 per share, subject to certain
anti-dilution adjustments.
No affiliate of the selling stockholders has held any position or office
with us or any of our affiliates and the selling stockholders have 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 the
selling stockholders 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.
PLAN OF DISTRIBUTION
The selling stockholders may, from time to time, sell any or all of their
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. The selling stockholders 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 the selling stockholders 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.
The selling stockholders 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 the selling stockholders may arrange for other
broker-dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the selling stockholders (or, if any broker-dealer acts as
agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. The selling stockholders do 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
50
selling expenses, if any, attributable to the sale of shares will be borne by
the selling stockholders. The selling stockholders 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.
The selling stockholders 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.
The selling stockholders 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 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 the selling
stockholders against certain losses, claims, damages and liabilities, including
liabilities under the Securities Act.
The selling stockholders acquired the securities offered hereby in the
ordinary course of business and have advised us that they have not entered into
any agreements, understandings or arrangements with any underwriters or
broker-dealers regarding the sale of their 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 the selling stockholders. If we are notified by any
selling stockholder 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 any selling stockholder uses this prospectus
for any sale of the shares of common stock, they 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 the selling stockholderss. If the selling
stockholders are 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 the selling stockholders. In such case, under Regulation
M, neither the selling stockholders nor their agents may bid for, purchase or
attempt to induce any person to bid for or purchase, shares of our common stock
while such selling stockholders are distributing any shares covered by this
prospectus. In addition, the selling stockholders are not permitted to cover
short sales by purchasing shares while the distribution is taking place. The
selling stockholders 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.
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.
51
EXPERTS
Our consolidated financial statements as of and for the years ended
December 31, 2005 and 2004 included herein have been audited by GHP Horwath,
P.C., independent registered public accounting firm, for the periods and to the
extent set forth in their report (which includes an explanatory paragraph
relating to our ability to continue as a going concern, an explanatory paragraph
relating to our 2005 accounting for goodwill recorded in connection with
business acquisitions that occurred during the first quarter of 2005 and an
explanatory paragraph describing that on August 18, 2004, we acquired
ManagedStorage International, Inc. in a transaction recorded as a reverse
merger) appearing elsewhere herein. Such consolidated financial statements have
been so included in reliance upon the report of such firm given their authority
as experts in auditing and accounting.
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
This prospectus constitutes the prospectus of our company filed as part
of a registration statement on Form S-1, and it does not contain all information
in the registration statement, as certain portions have been omitted in
accordance with the rules and regulations of the SEC.
We are subject to the informational requirements of the Securities
Exchange Act of 1934, which requires us to file reports, proxy statements and
other information with the SEC. Such reports, proxy statements and other
information may be inspected at the public reference room of the SEC at
Judiciary Plaza, 4350 Fifth street N.W., Washington D.C. 20549. Copies of such
material can be obtained from the facility at prescribed rates. Please call the
SEC toll free at 1-800-SEC-0330 for information about is public reference room.
Because we file documents electronically with the sec, you may also obtain this
information by visiting the SEC's Internet website at http://www.sec.gov or our
website at http://www.incentrasolutions.com. Information contained in our
website is not part of this prospectus.
Our statements in this prospectus about the contents of any contract or
other document are not necessarily complete. You should refer to the copy of our
contract or other document we have filed as an exhibit to the registration
statement for complete information.
You should rely only on the information incorporated by reference or
provided in this prospectus or any supplement. We have not authorized anyone
else to provide you with different information. This prospectus is an offer to
sell or buy only the securities described in this document, but only under
circumstances and in jurisdictions in which it is lawful to do so. The
information contained in this prospectus is current and accurate only as of the
date of this prospectus.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The SEC allows us to "incorporate by reference" in this prospectus the
information we file with them, which means that we can disclose important
information to you by referring you to the documents we have filed with the SEC.
The information incorporated by reference is considered to be a part of this
prospectus. We are incorporating by reference in this prospectus the following
documents previously filed by us:
52
1. Our Annual Report on Form 10-KSB for the fiscal year ended
December 31, 2005 filed on April 4, 2006;
2. Our Quarterly Report on Form 10-QSB for the fiscal quarter
ended March 31, 2006 filed on May 15, 2006; and
3. Our Current Report on Form 8-K, dated May 19, 2006, as filed
on May 23, 2006.
We will provide to you, upon written or oral request and without charge, a
copy of the document referred to above that we have incorporated in this
prospectus by reference. You can request copies of such document if you call or
write us at the following address or telephone number: Secretary, Incentra
Solutions, Inc., 1140 Pearl Street, Boulder, Colorado 80302, telephone (303)
440-7930, or you may visit our website at www.incentrasolutions.com.
INFORMATION WITH RESPECT TO THE REGISTRANT
The information required to be disclosed in the registration statement
pertaining to our company is incorporated by reference from the documents listed
as incorporated by reference above. Such documents are being delivered with this
prospectus. See "Prospectus Summary," "Risk Factors," and "Incorporation of
Certain Information by Reference."
MATERIAL CHANGES
There have been no material changes since December 31, 2005 which have not
been described in our Annual Report on Form 10-KSB, this prospectus, a Quarterly
Report on Form 10-QSB or in a Current Report on Form 8-K.
COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
We maintain directors and officers insurance which, subject to certain
exclusions, insures our directors and officers against certain losses that arise
out of any neglect or breach of duty (including, but not limited to, any error,
misstatement, act, or omission) by the directors or officers in the discharge of
their duties, and insures us against amounts which we have paid or may become
obligated to pay as indemnification to our directors and/or officers to cover
such losses.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling our company
pursuant to the foregoing, we have been informed that in the opinion of the SEC
such indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
53
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
PAGE
(A) Interim Unaudited Financial Statements of Incentra Solutions, Inc.
and Subsidiaries
Unaudited Condensed Consolidated Balance Sheet as of
March 31, 2006 ...................................................... F-2
Unaudited Condensed Consolidated Statements of Operations and
Comprehensive Loss for the three months ended March
31, 2006 and 2005 ................................................... F-3
Unaudited Condensed Consolidated Statement of Shareholders' Deficit
and Comprehensive Loss for the three months ended March 31, 2006 .... F-4
Unaudited Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2006 and 2005 .......................... F-5
Notes to Unaudited Condensed Consolidated Financial Statements ...... F-6
(B) Audited Consolidated Financial Statements of Incentra Solutions,
Inc. and Subsidiaries
Report of Independent Registered Public Accounting Firm-GHP Horwath,
P.C. ................................................................ F-25
Report of Independent Registered Public Accounting Firm-KPMG LLP ... F-26
Consolidated Balance Sheets as of December 31, 2005 and 2004 ........ F-27
Consolidated Statements of Operations for the years ended December
31, 2005, 2004 and 2003 ............................................. F-28
Consolidated Statements of Mandatorily and Convertible Redeemable
Preferred Stock for the years ended December 31, 2005, 2004 and
2003 ................................................................ F-29
Consolidated Statements of Shareholders' Deficit and Comprehensive
Loss for the years ended December 31, 2005, 2004 and 2003 ........... F-31
Consolidated Statements of Cash Flows for the years ended December
31, 2005, 2004 and 2003 ............................................. F-34
Notes to Consolidated Financial Statements .......................... F-36
F-1
INCENTRA SOLUTIONS, INC.
Condensed Consolidated Balance Sheet
(unaudited)
MARCH 31
2006
-------------
Assets
Current assets:
Cash and cash equivalents $ 457,183
Accounts receivable, net of allowance for doubtful
accounts of $228,602 10,211,945
Other current assets 1,300,385
-------------
Total current assets 11,969,513
Property and equipment, net 2,417,939
Capitalized software development costs, net 2,312,001
Intangible assets, net 12,946,473
Goodwill 5,857,770
Restricted cash 38,046
Other assets 519,109
-------------
TOTAL ASSETS $ 36,060,851
=============
Liabilities and shareholders' deficit
Current liabilities:
Current portion of notes payable, capital leases and
other long term obligations $ 10,964,731
Accounts payable 8,479,311
Accrued expenses 4,509,564
Current portion of deferred revenue 2,346,147
-------------
Total current liabilities 26,299,753
Notes payable, capital leases and other long term
obligations, net of current portion 232,079
Deferred revenue, net of current portion 98,270
-------------
TOTAL LIABILITIES 26,630,102
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 25,272,725
-------------
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,
13,326,810 outstanding at March 31, 2006 13,327
Additional paid-in capital 120,520,704
Accumulated other comprehensive loss (95,213)
Accumulated deficit (136,280,794)
-------------
TOTAL SHAREHOLDERS' DEFICIT (15,841,976)
-------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 36,060,851
=============
See accompanying notes to unaudited condensed consolidated
financial statements.
F-2
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
and Comprehensive Loss (unaudited)
THREE MONTHS ENDED MARCH 31
------------------------------
2006 2005
------------- -------------
Revenues:
Products $ 9,543,801 $ 3,231,513
Services 3,365,370 2,775,652
------------- -------------
TOTAL REVENUE 12,909,171 6,007,165
------------- -------------
Cost of revenue:
Products 5,443,048 1,276,375
Services 2,348,442 1,787,610
------------- -------------
Total cost of revenue 7,791,490 3,063,985
------------- -------------
GROSS MARGIN 5,117,681 2,943,180
------------- -------------
Selling, general and administrative 5,987,905 4,027,373
Amortization 644,547 785,281
Depreciation 107,376 71,143
------------- -------------
6,739,828 4,883,797
------------- -------------
LOSS FROM OPERATIONS (1,622,147) (1,940,617)
------------- -------------
Other income (expense):
Interest income 239 22,431
Interest expense (628,933) (561,310)
Loss on early extinguishment of debt (1,232,174) --
Other (expense) income (60,397) 366,741
Foreign currency transaction gain 1,290 82,189
------------- -------------
(1,919,975) (89,949)
------------- -------------
LOSS BEFORE INCOME TAX (3,542,122) (2,030,566)
Income tax expense (94,339) (318,000)
------------- -------------
NET LOSS (3,636,461) (2,348,566)
------------- -------------
Accretion of redeemable preferred stock
to redemption amount (654,392) (654,391)
------------- -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $ (4,290,853) $ (3,002,957)
============= =============
COMPREHENSIVE NET LOSS
Net Loss $ (3,636,461) $ (2,348,566)
Foreign currency translation adjustments 8,022 (77,233)
------------- -------------
$ (3,628,439) $ (2,425,799)
============= =============
Weighted average number of common shares
outstanding - basic and diluted 13,326,810 11,090,153
============= =============
Basic and diluted net loss per share
applicable to common shareholders $ (0.32) $ (0.27)
============= =============
See accompanying notes to unaudited condensed consolidated
financial statements.
F-3
INCENTRA SOLUTIONS, INC.
Condensed Consolidated Statement of Shareholders' Deficit and Comprehensive Loss
Three months ended March 31, 2006
(unaudited)
Accumulated
Common stock Other
------------------------ Additional compre-
Paid-In hensive Accumulated
Shares Amount Capital Loss deficit Total
----------- ---------- ------------ ---------- ------------- ------------
Balances, January 1, 2006 13,326,810 $ 13,327 $119,517,168 $ (103,235) $(132,644,333) $(13,217,073)
Amortization of stock based compensation expense 426,857 426,857
Accretion of FPDI mandatorily redeemable
preferred stock to redemption amount (654,392) (654,392)
Warrants issued to Laurus related to 2006
Facility (Note 6C) 1,231,071 1,231,071
Components of comprehensive loss: (3,636,461) (3,636,461)
Net loss
Change in foreign currency translation adjustments 8,022 8,022
------------
Total comprehensive loss (3,628,439)
----------- ---------- ------------ ---------- ------------- ------------
BALANCES, MARCH 31, 2006 13,326,810 $ 13,327 $120,520,704 $ (95,213) $(136,280,794) $(15,841,976)
=========== ========== ============ ========== ============= ============
See accompanying notes to unaudited condensed consolidated
financial statements.
F-4
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)
THREE MONTHS ENDED MARCH 31,
2006 2005
------------ ------------
Cash flows from operating activities:
Net loss $ (3,636,461) $ (2,348,566)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 388,951 394,700
Amortization of intangible assets and software development costs 871,577 890,454
Amortization of non-cash loan discount -- 10,188
Stock-based compensation 426,857 155,515
Non-cash interest expense 296,566 526,447
Non- cash loss on early extinguishment of debt 750,362 --
Non-cash tax expense 94,339 318,000
Bad debt expense 5,860 --
Gain on revaluation derivative warrant liability -- (341,495)
Changes in operating assets and liabilities, net of business acquisitions (2005):
Accounts and other receivables 1,147,043 (965,496)
Other current assets (18,316) (90,777)
Other assets 15,034 (17,462)
Accounts payable 238,112 296,984
Accrued liabilities (399,619) (80,677)
Deferred revenue (311,450) 424,404
Other liabilities (91,713) (66,212)
------------ ------------
Net cash used in operating activities (222,858) (893,993)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (573,664) (155,995)
Capitalized software development costs (405,828) (399,311)
Proceeds from sale of property and equipment -- 750
Cash acquired in STAR acquisition (Note 4A) -- 1,597,498
Cash acquired in PWI acquisition (Note 4B) -- 74,297
Net change in restricted cash 42,910 (175)
------------ ------------
Net cash (used in) provided by investing activities (936,582) 1,117,064
------------ ------------
Cash flows from financing activities:
Proceeds from line of credit 478,639 164,177
Proceeds from lease line of credit 414,514
Payments on capital leases, notes payable and other long term liabilities (394,484) (1,213,386)
------------ ------------
Net cash provided by (used in) financing activities 498,669 (1,049,209)
------------ ------------
Effect of exchange rate changes on cash and cash equivalents 9,312 (36,412)
------------ ------------
Net decrease in cash and cash equivalents (651,459) (862,550)
Cash and cash equivalents at beginning of period 1,108,642 3,068,458
------------ ------------
Cash and cash equivalents at end of period $ 457,183 $ 2,205,908
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 332,368 $ 99,676
Supplemental disclosures of non-cash investing and financing activities:
Net liabilities acquired in Incentra of CA acquisition, excluding cash (Note 4A) -- 620,178
Net assets aquired in PWI acquisition, excluding cash (Note 4B) -- 269,306
Purchases of property and equipment included in accounts payable 302,575 80,279
See accompanying notes to unaudited condensed consolidated
financial statements.
F-5
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
(1) ORGANIZATION
Incentra Solutions, Inc. (which is referred to herein together with its
subsidiaries as "we", "us" or "our"), formerly Front Porch Digital, Inc.
("FPDI"), 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., and our common stock now trades on the Over-the-Counter Bulletin Board
under the trading symbol "ICNS". We have 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, formerly 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 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 market our 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, 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. The
software converts audio, video, images, text and data into digital formats for
ease of use and archiving. Through MSI, we deliver comprehensive storage
services, including professional services, hardware/software procurement and
resale, financing solutions and remote monitoring/management services. We focus
on providing data protection solutions and services that ensure that our
customers' data is backed-up and recoverable and that meet 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, the 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.
Through Incentra of CA and PWI, we deliver complete IT solutions,
including professional services, third-party hardware/software procurement and
resale, financing solutions, maintenance support services (first call) for
third-party hardware and software maintenance and managed storage solutions.
Solutions are sold primarily to enterprise customers in the financial services,
government, hospitality, retail, security, healthcare and manufacturing sectors.
Incentra of CA and PWI primarily service customers in the western United States.
Our customers are located in North and South America, Europe, Asia and the
Pacific Rim.
F-6
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
BASIS OF PRESENTATION
The unaudited condensed 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., Incentra of CA, which is based in San Diego, California, and
PWI, which is based in Kirkland, Washington. ManagedStorage UK, Inc. and
Seabrook Technologies, Inc. did not have any operating activities during the
quarter ended March 31, 2006. All significant intercompany accounts and
transactions have been eliminated in consolidation.
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 footnote 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 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. For further information, refer to the consolidated financial
statements and footnotes included in our Annual Report on Form 10-KSB for the
year ended December 31, 2005 filed with the SEC on April 4, 2006 .
GOING CONCERN AND MANAGEMENT'S PLANS
Our unaudited condensed consolidated financial statements as of March 31,
2006 and for the quarter then ended have been prepared on a going concern basis,
which contemplates the realization of assets and settlements of liabilities and
commitments in the normal course of business. Our audited consolidated financial
statements for the year ended December 31, 2005 were also prepared on a going
concern basis. In our Annual Report on Form 10-KSB for the year ended December
31, 2005, the Report of our Independent Registered Public Accounting Firm
includes an explanatory paragraph that describes substantial doubt about our
ability to continue as a going concern as a result of nearly all of our long
term debt being callable due to a dispute with a creditor as discussed below and
in Notes 4(A) and 6(E) to these unaudited condensed consolidated financial
statements.
We are currently engaged in 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 financial condition. In connection with our
acquisition of Incentra of CA in February of 2005, we issued the former owner of
Incentra of CA a promissory note in the principal amount of $2,500,000 (the
"STAR Note"). On August 1, 2005 we elected to cease making payments on the STAR
Note, which created an event of default. On August 16, 2005, we received a
demand for arbitration from legal counsel of the former owner. In the event the
dispute is not resolved in our favor, the full outstanding balance of the STAR
Note could be accelerated. As a result, the entire balance of the STAR Note,
which totals $2.4 million, is classified as a current liability at March 31,
2006 as it is callable. 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. See Note 6(E).
The event of default on the STAR Note created an event of default under
our Senior Secured Convertible Note outstanding with Laurus Master Fund Ltd.
F-7
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
("Laurus"), our senior secured lender. As a result, the entire balance of this
Note, which totaled $2.9 million at March 31, 2006 prior to discount, has been
classified as a current liability at March 31, 2006 as it is callable. See Note
6(A). 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.
We believe we have a solid relationship with Laurus; however, there is
uncertainty regarding our ability to comply with required debt covenants in the
future, which places the debt in a position to be called due. This raises
substantial doubt about our ability to continue as a going concern. Our ability
to continue as a going concern is dependent on future financial results, the
results of the arbitration proceeding discussed above and, should we continue to
be in breach of the covenants on the debt, our ability to restructure or
otherwise amend the terms of that debt. Our financial statements do not include
any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classifications of liabilities that
might result from the outcome of this uncertainty.
Management's plans in regard to these matters are as follows:
If we continue to be in default of our covenants in the future, we would,
as we have in the past, seek to obtain amendments to the debt or waivers of the
covenants so that we are no longer in violation.
While we believe we will execute our current business plan, which calls
for growth in the business, we will also institute various cost controls to
reduce operating expenses where necessary. This includes the timely monitoring
of labor and selling, general and administrative costs.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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", we review
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. At March 31, 2006, we believe that there are
no indicators that an impairment of any long-lived assets has occurred.
GOODWILL
Goodwill represents the excess of the purchase price over the net of the
fair value of the identifiable tangible and intangible assets acquired and the
fair value of liabilities assumed in acquisitions. SFAS No. 142, "Goodwill and
Other Intangible Assets," (SFAS 142) requires the testing of goodwill and
indefinite-lived intangible assets for impairment at least annually. We test
goodwill for impairment in the fourth quarter of each year or during interim
periods if factors indicating impairment concerns arise.
F-8
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
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 whom 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 amortization over an estimated useful life of three years.
For the three-month periods ended March 31, 2006 and 2005, capitalized
software development costs, which related primarily to enhancements to our
GridWorks and DIVArchive software solutions, totaled $405,828 and $399,311,
respectively. These costs are amortized on a straight-line basis over the
estimated life of the enhancements, typically three years. For the three-month
periods ended March 31, 2006 and 2005, $227,030 and $117,734, respectively, of
amortization costs
F-9
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
were charged to expense. As of March 31, 2006, the unamortized portion of
software development costs was $2,312,001.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The balance sheet accounts of our 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 period. At March 31, 2006 and 2005, we
reported a cumulative translation loss of $95,213 as a component of accumulated
other comprehensive income (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-month periods ended
March 31, 2006 and 2005 were gains of $1,290 and $82,189, respectively.
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 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 No. 00-19") 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 No. 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. The classification of a contract is
reassessed at each balance sheet date.
PER SHARE DATA
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 our financial
statements for the three-month period ended March 31, 2006 and in prior periods,
have been adjusted to reflect the post-reverse split amounts.
We report our earnings (loss) per share in accordance with SFAS No. 128,
"Accounting for Earnings Per Share". 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 and stock splits, the historical loss per share
amounts have been retroactively restated to reflect our capital structure. Due
to our net losses for the periods presented, 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 months ended March 31, 2006 and 2005 because the effect would be
antidilutive.
An aggregate of 13.2 million and 10.1 million shares of common stock
issuable upon the conversion of outstanding convertible preferred stock, the
exercise of outstanding options and warrants, and restricted stock have been
omitted from the
F-10
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
computations of basic and diluted loss per share for the three-month periods
ended March 31, 2006 and 2005, respectively, because the effect would be
antidilutive.
STOCK-BASED COMPENSATION
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued SFAS 123 (revised 2004), "Share-Based Payment" (SFAS 123R). SFAS 123R
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
amends SFAS No. 95, "Statement of Cash Flows". Generally, the approach in SFAS
123R is similar to the approach described in SFAS 123. However, SFAS 123R
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values at the date of grant. Pro forma disclosure is no longer an alternative.
On January 1, 2006 (the first day of our 2006 fiscal year), we adopted
SFAS 123R using the modified prospective method as permitted under SFAS 123R.
Under this transition method, compensation cost recognized in the first quarter
of 2006 includes: (a) compensation cost for all share-based payments granted
prior to but not yet vested as of December 31, 2005, based on the grant-date
fair value estimated in accordance with the provisions of SFAS 123, and (b)
compensation cost for all share-based payments granted subsequent to December
31, 2005, based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123R. In accordance with the modified prospective method of
adoption, our results of operations and financial position for prior periods
have not been restated.
We use the Black-Scholes option pricing model to calculate the grant-date
fair value of an award. The fair value of options granted during the first
quarter of 2006 (there were no options grants during the first quarter of 2005)
was calculated using the following estimated weighted average assumptions:
Stock options granted 50,000
Weighted-average exercise price $ 1.11
Weighted-average grant date fair value $ 0.95
Assumptions:
Expected volatility 113%
Expected term (in years) 6 years
Risk-free interest rate 4.62%
All of our employee options vest over three years, which is considered to
be the requisite service period. We use the graded vesting attribution method to
recognize expense for all options granted prior to the adoption of SFAS 123R.
Upon adoption of SFAS 123R on January 1, 2006, we switched to the straight-line
attribution method to recognize expense for options granted after December 31,
2005. The expense associated with the unvested portion of the pre-adoption
grants will continue to be expensed using the graded vesting attribution method.
The amount of stock-based compensation recognized during a period is based
on the value of the portion of the awards that are ultimately expected to vest.
SFAS 123R requires forfeitures to be estimated at the time of grant and revised,
if necessary, in subsequent periods if actual forfeitures differ from those
estimates. The term "forfeitures" is distinct from "cancellations" or
"expirations" and represents only the unvested portion of the surrendered
option. We currently expect, based on an analysis of historical forfeitures that
approximately 90% of our options will actually vest, and therefore have applied
a forfeiture rate of 3.5% per year to all unvested options as of March 31, 2006.
This analysis will
F-11
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
be re-evaluated quarterly and the forfeiture rate will be adjusted as necessary.
Ultimately, the actual expense recognized over the vesting period will only be
for those shares that vest.
Expected volatilities are based on the historical volatility of the price
of our common stock. The expected term of options is derived based on the sum of
the vesting term plus the original option term, divided by two.
The adoption of SFAS 123R on January 1, 2006 had the following impact on
the first quarter of 2006 results: net loss before deemed dividends and
accretion on preferred stock increased by $.4 million and net loss per weighted
average common share outstanding--basic and diluted increased by $0.03 per
share. The following table details the effect on net loss before deemed
dividends and accretion on preferred stock and net loss per weighted average
common share outstanding had stock-based compensation been recorded for the
first three months of 2005 based on the fair-value method under SFAS 123,
"Accounting for Stock-Based Compensation". The reported and pro forma net loss
before deemed dividends and accretion on preferred stock and net loss per
weighted average common share for the first quarter of 2006 are the same since
stock-based compensation expense was calculated under the provisions of SFAS
123R. All amounts except per share amounts in 000's:
Three Months Ended
March 31, 2005
------------------
Net loss before deemed dividends and accretion
on preferred stock , as reported $(2,349)
Add stock-based compensation expense included in
reported net loss 156
Deduct total stock-based employee compensation expense
determined under the fair-value based method for all awards (510)
-------
Pro forma net loss before deemed dividends and
accretion on preferred stock $(2,703)
=======
Net loss per weighted average common share outstanding--
Basic and diluted--pro forma $ (.30)
=======
Net loss per weighted average common share outstanding-
Basic and diluted-as reported $ (.27)
=======
Summaries of option activity under the plans as of March 31, 2006, changes
during the quarter then ended, and status of non-vested options are presented
below:
F-12
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE CONTRACTUAL
OPTIONS PRICE LIFE (YEARS)
--------- -------- -----------
Balance at January 1, 2006 2,217,016 $ 2.92 8.5
Granted 50,000 1.11 10
Exercised -- -- --
Forfeited (28,267) 5.09 (8.7)
---------- ------ ------
Balance March 31, 2006 2,238,749 $ 2.85 8.3
========== ====== ======
Vested balance at March 31, 2006 878,693 $ 3.58 7.7
========== ====== ======
WEIGHTED
AVERAGE
GRANT DATE
FAIR VALUE
----------
Non-vested options at January 1, 2006 1,379,524 $ 2.42 $ 0.52
Granted 50,000 1.11 0.95
Vested (48,203) 2.3 (1.35)
Forfeited (21,265) 2.16 (0.94)
---------- ------ ------
Non-vested options at March 31, 2006 1,360,056 $ 2.38 $ 0.50
========== ====== ======
As of March 31, 2006, there was $2.2 million of total unrecognized
compensation expense related to the non-vested, share-based compensation
arrangements granted under the plans. That cost is expected to be recognized
over a weighted-average period of 1.42 years. The total fair value of shares
vested during the quarter ended March 31, 2006 was approximately $43,000.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us 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. We have
recorded transactions that include the issuance of options and warrants to
purchase shares of our preferred and common stock. The accounting for such
securities is based upon fair values of our equity securities and other
valuation criteria that were determined by our Board and us. We believe these
estimates of fair value are reasonable. Other significant estimates made by us
include those related to fair values of acquired intangible assets, and the
establishment of an allowance for estimates of uncollectible accounts
receivable.
(3) CONCENTRATIONS OF CREDIT RISK
We sell our products and services throughout the United States, Europe,
Asia and the Pacific Rim. We perform periodic credit evaluations of our
customers' financial condition and generally do not require collateral. Accounts
receivable are reported at their outstanding unpaid principal balances reduced
by an allowance for doubtful accounts. We estimate doubtful accounts based on
historical bad debts, factors related to a specific customer's ability to pay
and current economic trends. We write off accounts receivable against the
allowance when a balance is
F-13
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
determined to be uncollectible. Credit losses have been within management's
expectations.
For the quarter ended March 31, 2006, aggregate revenues from customers
located in Europe, Asia and the Pacific Rim amounted to $4.1 million or 32% of
total revenue, while revenues from customers located in North America totaled
$8.8 million, or 68% of total revenue. For the quarter ended March 31, 2005,
aggregate revenues from customers located in Europe, Asia and the Pacific Rim or
in North America both amounted to $3.0 million or 50% of total revenue in each
case. For the quarter ended March 31, 2006, no one customer accounted exceeded
10% of total revenues nor did any single customer account for over 10% of
accounts receivable at March 31, 2006. For the quarter ended March 31, 2005, no
one customer exceeded 10% of revenue.
(4) ACQUISITIONS
(A) ACQUISITION OF INCENTRA OF CA, FORMERLY 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
financial statements beginning on February 18, 2005.
Pursuant to the STAR Merger Agreement, the purchase price consisted of (i)
a cash payment of $1,500,000 (paid subsequent to the acquisition date with the
proceeds from a line of credit), (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"). We
entered into a consulting agreement with the seller pursuant to which we agreed
to pay consulting fees in the amount of $500,000 which was included as part of
the purchase price. 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%, which has
been discounted by $300,000 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, which commenced 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. As of March 31, 2006, we classified the entire
principal amount of $2.4 million to current liabilities based on the default, as
the debt is now callable. Refer to Note 6(E).
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 March 31, 2006 and pending the results of the arbitration proceedings
described in Note 6(E), the principal balance on 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.
F-14
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
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 purchase price allocation at the date of the
Incentra of CA acquisition:
Cash and cash equivalents $ 1,597,498
Other current assets 824,998
Property and equipment 20,909
Other assets 7,005
Goodwill 6,177,686
Customer relationships (5 year life) 540,000
Current liabilities (1,473,088)
-----------
Total purchase price $ 7,695,008
===========
The purchase price allocation was considered final as of December 31,
2005. As a result of the goodwill impairment test we completed in the fourth
quarter of 2005 in accordance with SFAS 142, the amount allocated to goodwill
was considered impaired and an impairment loss of $4,151,450 was charged to
income in the fourth quarter of 2005.
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 a cash payment of $2,350,000 (paid
subsequent to the acquisition date with the proceeds from a line of credit) 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, during the
year ended December 31, 2005, the former PWI shareholders achieved a partial
earn out of $100,000 which was paid to them in cash. As a result of the earn-out
payment, the purchase price (goodwill) was increased by $100,000. We paid
approximately $250,000 in investment banking fees in connection with the
transaction.
Concurrent 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 have "piggy-back" registration rights with
respect to such shares.
The following represents the purchase price allocation at the date of the
PWI acquisition:
Cash and cash equivalents $ 74,297
Other current assets 7,009,601
Property and equipment 173,610
Other assets 28,010
Goodwill 3,831,534
F-15
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
Customer relationships (5 year life) 310,000
Current liabilities (6,877,351)
Other liabilities (64,564)
-----------
Total purchase price $ 4,485,137
===========
The purchase price allocation was considered final as of December 31,
2005.
C) PROFORMA RESULTS
The following unaudited pro forma financial information presents our
combined results of operations for the first quarter of 2005 as if the
acquisitions of Incentra of CA and PWI had occurred as of January 1, 2005. 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
period presented, and should not be taken as representative of our future
consolidated results of operations or financial condition. Unaudited pro forma
results were as follows for the three-month periods ended March 31, 2006 and
2005:
Three-month periods ended
March 31,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
Revenue $ 12,909,171 $ 16,452,125
Cost of revenue 7,791,490 11,971,102
------------ ------------
Gross margin 5,117,681 4,481,023
Operating expenses 6,739,828 6,377,743
------------ ------------
Loss from operations (1,622,147) (1,896,720)
Other expense, net (1,919,975) (184,604)
Income tax expense (94,339) (319,607)
------------ ------------
Net loss (3,636,461) (2,400,931)
Accretion of redeemable preferred
stock to redemption amount (654,392) (654,391)
------------ ------------
Net loss applicable to common
shareholders $ (4,290,853) $ (3,055,322)
============ ============
Net loss per share applicable to
common shareholders-basic and diluted $ (0.32) $ (0.29)
============ ============
(5) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of March 31, 2006:
F-16
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
Computer equipment $ 5,225,499
Software 1,640,110
Leasehold improvements 63,246
Assets under construction 172,209
Office furniture and equipment 758,345
-------------
7,859,409
Less accumulated depreciation (5,441,470)
-------------
$ 2,417,939
=============
Depreciation expense for the three-month periods ended March 31, 2006 and
2005 was $388,951 and $394,700, respectively.
Included in property and equipment is equipment under capital leases with
a cost of $2,130,065 and accumulated depreciation of $830,437 at March 31, 2006.
(6) NOTES PAYABLE, CAPITAL LEASES, AND OTHER LONG-TERM OBLIGATIONS
The following is a summary of our long-term debt as of March 31, 2006:
Senior Secured Convertible Note (A) $ 2,371,954
Lines of Credit (B) and (C) 5,292,689
Acquisition Term Notes (D) 0
STAR Note (E) 2,106,281
Capital Leases (F) 901,040
Other obligations 524,846
------------
11,196,810
Less current portion (10,964,731)
------------
Long-term portion $ 232,079
============
(A) SENIOR SECURED CONVERTIBLE NOTE
On May 13, 2004, we consummated a private placement pursuant to which we
issued a secured convertible term note due May 13, 2007 (the "Maturity Date") 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 are
convertible into shares of our common stock at a price of $3.00 per share,
subject to adjustments for standard antidilution provisions.
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 $108,986 and $139,545 of additional non-cash interest expense
relating to the amortization of the discount for the three-month periods ended
March 31, 2006 and 2005, respectively.
F-17
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
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. However, as a result of
the one-for-ten reverse stock split effected on June 9, 2005, there were again
sufficient authorized and unissued common shares to settle the Laurus Warrant,
and it was again reclassified and is included in equity through March 31, 2006.
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, at the
rate of $45,455 per month and increased to approximately $159,000 per month
beginning in March 2005, with the balance payable on the Maturity Date. However,
due to an event of default on the STAR Note (see Note 6(E)), all amounts due
under the Laurus Note have been reclassified to current liabilities at March 31,
2006.
Laurus has the option to receive shares of our common stock in lieu of
debt service payments at a fixed price of $3.00 per share. The Laurus Note 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 standard
antidilution adjustments.
On February 6, 2006, we entered into an Amendment and Deferral Agreement
(the "Amendment and Deferral Agreement") with Laurus amending the Laurus Note.
Pursuant to the Amendment and Deferral Agreement, the monthly principal amount
of the Laurus Note payable to Laurus for each of January, February, March,
April, May and June 2006, equal to an aggregate of $952,495, is deferred until
the Maturity Date.
(B) 2005 LINE OF CREDIT
In June 2005, we entered into a Security Agreement with Laurus pursuant to
which Laurus provided us a $9 million revolving, convertible credit facility
(the "2005 Facility"). The term of the 2005 Facility was three years. In
connection with the 2005 Facility, we executed in favor of Laurus a $9 million
Secured Revolving Note (the "Revolver Note").
Borrowings under the 2005 Facility were 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 2005 Facility was guaranteed by PWI and Incentra of CA
pursuant to a Subsidiary Guaranty in favor of Laurus.
In connection with the financing, we issued to 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, subject to adjustment
for standard antidilution provisions (the "2005 Warrant"). The value of the
warrant was determined, using the Black-Scholes model, to be $0.6 million and
was recorded as a debt discount.
F-18
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
All borrowings under the 2005 facility were repaid in full in February
2006 and the balance of the debt discount, $448,533, and the deferred financing
costs, $301,140, were included in the loss on the early extinguishment of debt.
(C) 2006 LINE OF CREDIT
On February 6, 2006, we entered into the New Security Agreement with
Laurus pursuant to which Laurus agreed to provide us with a non-convertible
revolving credit facility of up to $10 million (the "2006 Facility"). The term
of the 2006 Facility is three (3) years and borrowings under the 2006 Facility
accrue interest on the unpaid principal and interest at a rate per annum equal
to the prime rate plus 1%, subject to a floor of 7%. In connection with the 2006
Facility, we executed in favor of Laurus a secured non-convertible revolving
note in the principal amount of $10 million (the "2006 Revolving Note").
Interest on borrowings under the 2006 Revolving Note is payable monthly on the
first day of each month during the term of the 2006 Revolving Note, commencing
on March 1, 2006. All outstanding principal amounts are due and payable on
February 6, 2009.
We entered into the 2006 Facility to pay off the 2005 Facility, of which
approximately $6 million was outstanding as of February 6, 2006. In connection
with the 2006 Facility, we issued to Laurus an option to purchase 1,071,428
shares of common stock at a price of $.001 per share. The Option expires on
February 26, 2026. Pursuant to the 2006 Facility, Laurus may not sell any shares
of our common stock it receives through the exercise of the Option (the "Option
Shares") prior to January 31, 2007. Additionally, Laurus agreed not to sell an
amount of Option Shares that would exceed thirty-five percent (35%) of the
aggregate dollar trading volume of our Common Stock for the twenty-two (22)
trading day period immediately preceding such sale. Using the Black-Scholes
model, we calculated the value of the Option to be $1.2 million and recorded a
debt discount of the same amount to be amortized over 36 months beginning in
February 2006. In conjunction with the payoff of the 2005 Facility, we incurred
a loss on the early extinguishment of that debt of $1.2 million.
The 2006 Facility increased the minimum initial amount of borrowings
available to us and to our subsidiaries from $6 million under the 2005 Facility
to $6.48 million under the 2006 Facility until April 30, 2006. Thereafter, the
maximum principal amount of all borrowings under the 2006 Facility cannot exceed
90% of the eligible accounts receivable of our company and each of our U.S.
subsidiaries, minus any reserves that Laurus may in good faith deem necessary
and appropriate.
On February 6, 2006, we requested and Laurus agreed to lend an initial
draw under the 2006 Facility of $6.38 million, of which (i) approximately $5.9
million was used to satisfy in full our indebtedness to Laurus under the 2005
Facility, (ii) $375,000 was paid to Laurus as an early termination fee for the
2005 Facility, and (iii) $107,500 (recorded as expense) was applied towards
costs of the 2006 Facility. Both of the two latter amounts were included in the
loss on the early extinguishment of debt.
All loans and obligations owed by us to Laurus arising under the 2006
Facility or otherwise are secured by a security interest in substantially all of
the assets of our company and our subsidiaries pursuant to the terms of the
Security Agreement.
In addition, we pledged to Laurus all of the outstanding capital stock of
our subsidiaries pursuant to a Stock Pledge Agreement (the "Stock Pledge
Agreement") executed by us in favor of Laurus, and each of our subsidiaries
executed a Subsidiary Guaranty, dated February 6, 2006 (the "Subsidiary
F-19
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
Guarantee"), in favor of Laurus, guaranteeing all of our present and future
obligations to Laurus.
Under the terms of the 2006 Facility, if an event of default occurs under
any of the agreements with Laurus, Laurus has the right to accelerate payments
in addition to any other remedies available to it and to foreclose upon the
assets securing the borrowings. If an event of default occurs under any of our
agreements with Laurus, within five days after written notice to us, Laurus may
require a payment of 125% of the unpaid principal balance, plus accrued interest
and fees, which will become immediately due and payable. Laurus would also be
entitled to payment of a default interest rate of 1.5% per month on all amounts
due. No events of default exist at March 31, 2006.
The 2006 Facility contains certain negative covenants that require us to
obtain the prior written consent or other actions of Laurus in order for us to
take certain actions at any time when borrowings remain outstanding under the
2006 Facility.
Pursuant to the terms of an Amended and Restated Registration Rights
Agreement between us and Laurus (the "Registration Rights Agreement"), which
amends and restates a Registration Rights Agreement between Laurus and our
company dated May 13, 2004, we are obligated to file a post-effective amendment
to our existing Registration Statement on Form SB-2 originally filed on June 29,
2004 to include the shares of common stock issuable (i) upon exercise of the
Option, (ii) as a result of adjustments made to the exercise price of the
Option, (iii) upon exercise of the warrant issued pursuant to the June 30, 2005
Security Agreement, and (iv) as a result of adjustments made to the exercise
price of such warrant. We anticipate filing a Registration Statement in May
2006.
(D) ACQUISITION TERM NOTES
On March 31, 2006, we consummated a private placement with Laurus pursuant
to which we issued to Laurus a secured term note due May 31, 2009 in the
principal amount of $1,750,000 (the "2006 Term Note") and a secured convertible
term note due May 31, 2009 in the principal amount of $1,500,000 (the "2006
Convertible Note"). In connection with the issuance of the 2006 Term Note and
the 2006 Convertible Note, we issued to Laurus a common stock purchase warrant
(the "2006 Warrant") entitling the holder to purchase 417,857 shares of common
stock (the "2006 Warrant") at $0.001 per share, subject to certain antidilution
adjustments, at any time after March 31, 2007 and on or prior to March 31, 2013.
The 2006 Term Note, 2006 Convertible Note and the 2006 Warrant were sold to
Laurus for a purchase price of $3,250,000 and were funded on April 13, 2006 in
connection with the acquisition discussed in Note 8(A).
The 2006 Term Note and 2006 Convertible Note provide for monthly payments
of interest at a rate per annum equal to the prime rate plus 2%, subject to a
floor of 9%. The 2006 Term Note and 2006 Convertible Note also provide for
monthly amortization of principal, which commences on August 1, 2006, at the
rate of $101,563 per month. The principal and unpaid interest on the 2006
Convertible Note are convertible into shares of our common stock at a fixed
conversion price of $1.40 per share (which exceeded the market price of our
common stock on March 31, 2006), subject to certain antidilution adjustments.
The 2006 Term Note and 2006 Convertible Note are collateralized by a security
interest in all of our assets.
Pursuant to a Registration Rights Agreement (the "2006 Registration
Rights") with Laurus, we are obligated to: (a) file on or prior to May 15, 2006
a registration statement under the Securities Act ("Registration Statement") to
register the resale of the shares of our common stock issuable
F-20
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
upon conversion of the 2006 Convertible Note and exercise of the 2006 Warrant
(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 July 15, 2006
and (c) maintain the effectiveness of the Registration Statement until the
earliest date of when (i) all Registrable Securities covered by such
Registration Statement have been sold, or (ii) all Registrable Securities
covered by such Registration Statement may be sold immediately without
registration under the Securities Act and without volume restrictions pursuant
to Rule 144(k) under the Securities Act, or (iii) except with respect to the
shares issuable upon the exercise of the 2006 Warrant, all amounts payable under
the 2006 Convertible Note have been paid in full. Laurus, or other holders of
the 2006 Convertible Note and the 2006 Warrant, are entitled to certain
specified remedies if we do not timely comply with our registration obligations.
Pursuant to the 2006 Securities Purchase Agreement (the "Securities
Purchase Agreement") with Laurus, for so long as 25% of the original principal
amount of the 2006 Convertible Note is outstanding or the 2006 Warrant is
outstanding, we may not directly or indirectly declare or pay any dividends
without the prior written consent of Laurus. The 2006 Securities Purchase
Agreement also requires the written consent of Laurus in connection with any
1iquidation, material reorganization, merger or acquisition involving our
company, or the issuance of certain additional indebtedness by our company.
The 2006 Term Note and 2006 Convertible Note contain certain events of
default consistent with those encompassed in our previous financings with
Laurus. Following the occurrence and during the continuance of any such event of
default, we are required to pay additional interest in an amount equal to (1.5%)
per month, and all outstanding obligations, including unpaid interest, shall
continue to accrue interest at such additional interest rate from the date of
such event of default until the date such event of default is cured or waived.
In addition, following the occurrence and during the continuance of any such
event of default, Laurus, at its option, may demand repayment in full of all
obligations and liabilities owing to Laurus and/or may elect, in addition to all
rights and remedies of Laurus, require us to make a default payment equal to
125% of the outstanding principal amount of the Note, plus accrued but unpaid
interest, all other fees then remaining unpaid, and all other amounts payable by
us to Laurus.
(E) STAR NOTE
Pursuant to the STAR Merger Agreement discussed in Note 4(A), we issued an
unsecured convertible promissory note for $2,500,000 to the principal
stockholder of Incentra of CA (the "STAR Note") that is payable in ten
installments and matures on August 1, 2007. 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.
On August 1, 2005, we elected not to make a scheduled payment 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
F-21
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
demand for arbitration from legal counsel of the principal stockholder. As of
March 31, 2006, we have classified the entire principal amount to current
liabilities based on the default. We have been accruing interest at the 12%
default rate since August 11, 2005.
We are engaged in an arbitration proceeding to resolve this dispute, which
if resolved unfavorably, would have a material adverse affect on our liquidity
and financial condition since payment of the full outstanding balance of the
STAR Note could be accelerated. The hearing phase of the arbitration proceeding
was completed in April 2006, and both parties have submitted their proposed
findings of fact and conclusions of law to the arbitrator. A ruling from the
arbitrator is expected by the end of June 2006. As of the balance sheet date,
the entire principal balance of $2.4 million ($2.1 million net of discount) on
the STAR Note is classified as current. 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.
The event of default on the STAR Note created an event of default of
certain provisions of the Laurus Note. Because Laurus has not granted us a
waiver of the default on this indebtedness at March 31, 2006, the entire amount
due under the Laurus Note has also been classified with current liabilities.
Other indebtedness with Laurus discussed in Notes 6(C) and 6(D) was not affected
by the event of default on the STAR Note.
(F) CAPITAL LEASES
In 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. On March
2, 2005, we entered into an amendment to the Lease Line. Under this amendment,
we could draw an additional $500,000 (the "New Credit Facility") for equipment
purchases through June 30, 2005, of which we used $497,667. The amendment also
granted to us a call option to purchase equipment from the lessor. The term of
the agreement is for 15 months with an interest rate of 14.96% per annum.
On September 11, 2005, we entered into Amendment No. 2 to the Lease Line.
Under this amendment, we were able to draw an additional $1,000,000 (the
"Amended Credit Facility") for equipment purchases through December 31, 2005.
The amendment also granted to us a call option to purchase equipment from the
lessor. The terms of the agreement are for lease terms of 12-15 months with
interest rates ranging from 14.964% to 15%. The Amended Credit Facility is to be
repaid in monthly principal and interest installments through September 2006.
During the first quarter of 2006, the period of time in which we were able to
draw under the Amended Credit Facility was informally extended at no cost to us
to March 31, 2006. During the quarter ended March 31, 2006, we drew $583,407 on
the Lease Line. The unpaid balance at March 31, 2006 was $522,873.
(7) SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK
We have designated 2.5 million authorized shares of preferred stock as
Series A Preferred shares and issued 2,466,971 of such shares in connection with
an acquisition in 2004. Warrants are outstanding for the purchase of 26,075
Series A Preferred shares at a purchase price of $10.35 per share and 6,954
Series A Preferred shares at a purchase price of $6.02 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
been expanded to seven members to accommodate these three
F-22
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
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).
(8) SUBSEQUENT EVENTS
(A) ACQUISITION OF NETWORK SYSTEM TECHNOLOGIES, INC.
On April 13, 2006 (the "NST Closing Date"), we acquired all of the
outstanding capital stock (the "NST Stock") of Network System Technologies,
Inc., an Illinois corporation ("NST"), pursuant to a Stock Purchase Agreement,
dated as of the Closing Date (the "NST Stock Purchase Agreement").
The consideration paid for the NST Stock on the NST Closing Date was
approximately $8.2 million, which consisted of $5.5 million in cash, the
issuance of 1,034,483 shares of our common stock and the issuance of an
unsecured promissory note in the amount of $1.5 million (the "NST Note"). In
addition, the NST Stock Purchase Agreement contains an earn-out provision
pursuant to which Transitional Management Consultants, Inc. ("TMC"), a
newly-formed corporation owned by the former NST shareholder, may receive
additional unregistered shares of our common stock based upon certain levels of
EBITDA (as defined in the Stock Purchase Agreement) achieved by NST during the
twenty-four month period ending March 31, 2008. The maximum number of shares
issuable under the earn-out is 1,120,690 shares (subject to customary
adjustments for stock splits, stock dividends and similar transactions) if NST's
EBITDA is $4 million or greater during such period and provided certain other
conditions are met. In addition, TMC's right to receive the earn-out described
above is subject to the continued provision of consulting services by the former
shareholder through TMC to us through March 31, 2008, with certain exceptions.
If the services terminate prior to such date, TMC may under certain
circumstances receive a pro rated portion of the earn-out amount. The cash paid
on the NST Closing Date was provided pursuant to our existing line of credit and
term note from Laurus Master Fund, Ltd., which was amended on the NST Closing
Date to make NST a co-borrower thereunder.
The NST Note accrues interest at an annual rate of one-half percent
(1/2%). We are required to make eight equal payments of principal and interest
in the amount of $190,190.38, the first payment of which is due on July 15,
2006, and the seven remaining payments being due on the first day of September,
December, March and June during the period beginning on September 1, 2006 and
ending on March 1, 2008. The NST Note further provides that all unpaid principal
and accrued interest shall become immediately due and payable upon the
occurrence of an event of default (as defined in the NST Note). Such events of
default include, among others, the occurrence either of the following events:
(i) our failure to make payment when due, subject to a five (5) day notice and
cure period or (ii) our failure to observe, keep or comply with any provision or
requirement contained in the NST Stock Purchase Agreement.
Concurrently with the consummation of the acquisition, we granted
registration rights with respect to the shares of our common stock issued in the
acquisition and we granted registration rights to TMC with respect to the shares
issuable under the earn-out provision contained in the NST Stock Purchase
Agreement. Pursuant to each registration rights agreement executed
F-23
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
UNAUDITED
on the NST Closing Date, at any time after April 13, 2008, the holders of such
rights shall have the right to cause us to register under the Securities Act the
shares of our common stock issued on the NST Closing Date and the shares of
common stock issuable pursuant to the earn-out described above. The agreements
also provide that, after April 13, 2008, the holders shall have 'piggy-back'
registration rights with respect to such shares.
We also entered into a lock-up agreement with the former shareholder dated
as of the NST Closing Date. Under such agreement, the former shareholder agreed
not to sell or transfer the shares he received pursuant to the NST Stock
Purchase Agreement until after April 13, 2008, with certain exceptions.
In connection with the consummation of the acquisition, we entered into a
consulting and subcontractor agreement (the "Consulting Agreement") dated as of
the NST Closing Date with TMC that provides that TMC will provide consulting
services to us relating to the business of NST and will receive a monthly fee of
$24,251. The agreement has a two-year term and provides that TMC may terminate
the agreement for any reason upon thirty (30) days prior written notice and that
we may terminate the agreement, for cause (as defined in the Consulting
Agreement), at any time upon written notice to TMC. In addition, TMC has the
right to earn an annual cash bonus based upon certain levels of EBITDA (as
defined in the Consulting Agreement) achieved by NST during the twelve (12)
months ended March 31, 2007 and 2008. The maximum bonus amount is equal to
$150,000 plus twenty-five percent (25%) of the amount by which EBITDA exceeds $2
million during the relevant annual period. TMC's right to receive the earn-out
described above is subject to the continued provision of consulting services by
TMC to us through end of each such period, with certain exceptions.
In connection with our acquisition of NST, we paid investment banking fees
to a third party of $475,000.
(B) 2006 STOCK OPTION PLAN
On May 4, 2006, our board of directors approved and adopted the Incentra
Solutions, Inc. 2006 Stock Option Plan (the "Plan"), which provides for the
granting of options to key employees, officers and certain individuals to
purchase shares of the our common stock. We currently have reserved 1,750,000
shares of common stock for issuance under the Plan. The Plan has a term of ten
years and provides for the grant of "incentive stock options" within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended and nonstatutory
stock options. Options granted under the 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). Subject to the terms of any agreement, options
generally terminate three months after the termination of employment, except in
the case of termination for cause or upon death or disability. We plan to
register under the Securities Act of 1993, the shares of our common stock
issuable upon exercise of the options granted pursuant to the Plan.
F-24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Incentra Solutions, Inc.
We have audited the accompanying consolidated balance sheets of Incentra
Solutions, Inc. and subsidiaries (the "Company") as of December 31, 2005 and
2004, and the related consolidated statements of operations, mandatorily and
convertible redeemable preferred stock, shareholders' deficit and comprehensive
loss, and cash flows for each of the years in the two-year period ended December
31, 2005. 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 audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the 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, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, as of December 31, 2005, the Company is in
default on a note payable in the amount of $2,374,139. This event of default
created an event of default with regard to other indebtedness of the Company.
The events of default make debt in the amount of $11,231,420 callable. This
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
As discussed in Note 3 to the consolidated financial statements, during the
fourth quarter of 2005, the Company corrected its accounting for goodwill
recorded in connection with business acquisitions that occurred during the first
quarter of 2005.
As discussed in Note 4 to the consolidated financial statements, on August 18,
2004, the Company acquired ManagedStorage International, Inc. in a transaction
recorded as a reverse merger.
/s/ GHP Horwath, P.C.
Denver, Colorado
March 24, 2006, except for Note 18(B)
as to which the date is March 31, 2006
F-25
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-26
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
ASSETS 2005 2004
------------- -------------
Current assets:
Cash and cash equivalents $ 1,108,642 $ 3,068,458
Accounts receivable, net of allowance for doubtful accounts of $219,234 and
$274,879, respectively 10,576,172 3,740,554
Other current assets 1,284,505 645,637
------------- -------------
Total current assets 12,969,319 7,454,649
------------- -------------
Property and equipment, net 2,230,201 2,452,817
Capitalized software development costs, net 2,133,203 1,188,885
Intangible assets, net 13,685,359 16,537,060
Goodwill 5,857,770 --
Restricted cash 80,956 80,048
Other assets 926,535 963,586
------------- -------------
24,914,024 21,222,396
------------- -------------
TOTAL ASSETS $ 37,883,343 $ 28,677,045
============= =============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current portion of notes payable, capital leases and other long-term obligations $ 11,066,921 $ 1,738,516
Accounts payable 7,787,603 1,374,953
Accrued expenses 5,344,475 3,058,806
Current portion of deferred revenue 1,874,636 1,185,736
------------- -------------
Total current liabilities 26,073,635 7,358,011
Notes payable, capital leases and other long-term obligations, net of current portion 303,652 2,266,970
Derivative warrant liability -- 1,925,534
Deferred revenue, net of current portion 104,796 149,204
------------- -------------
TOTAL LIABILITIES 26,482,083 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 at December 31, 2005 and 2004 24,618,333 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
13,326,810 and 10,505,998 shares outstanding at December 31,
2005 and 2004, respectively, 143,364 in treasury at December 31, 2004 13,327 10,506
Additional paid-in capital 119,517,168 113,365,645
Accumulated other comprehensive (loss) income (103,235) 19,184
Accumulated deficit (132,644,333) (118,418,776)
------------- -------------
TOTAL SHAREHOLDERS' DEFICIT (13,217,073) (5,023,441)
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 37,883,343 $ 28,677,045
============= =============
See accompanying notes to consolidated financial statements.
F-27
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
2005 2004 2003
---- ---- ----
Revenues:
Products $ 37,607,872 $ 5,155,101 $ --
Services 13,224,064 8,129,569 9,810,741
------------ ------------ ------------
TOTAL REVENUE 50,831,936 13,284,670 9,810,741
------------ ------------ ------------
Cost of revenue:
Products 25,448,135 1,479,580 --
Services 9,058,835 5,820,755 6,951,781
------------ ------------ ------------
Total cost of revenue 34,506,970 7,300,335 6,951,781
------------ ------------ ------------
GROSS MARGIN 16,324,965 5,984,335 2,858,960
------------ ------------ ------------
Selling, general and administrative 20,516,251 10,262,730 9,361,090
Acquisition costs -- 1,275,189 --
Amortization 3,229,919 1,776,473 928,850
Depreciation 465,747 183,057 363,099
Impairment of goodwill 4,151,450 198,280 692,098
------------ ------------ ------------
28,363,367 13,695,729 11,345,137
------------ ------------ ------------
LOSS FROM OPERATIONS (12,038,401) (7,711,394) (8,486,177)
------------ ------------ ------------
Other income (expense):
Interest income 33,317 22,096 39,167
Interest expense (2,424,218) (2,428,643) (2,225,443)
Other income (loss) 656,088 382,989 (327,468)
Foreign currency transaction gain (loss) 16,691 (303,342) 8,550
------------ ------------ ------------
(1,718,122) (2,326,900) (2,505,194)
------------ ------------ ------------
LOSS BEFORE INCOME TAX (13,756,523) (10,038,294) (10,991,371)
Income tax expense (469,034) (400,000) --
------------ ------------ ------------
NET LOSS (14,225,557) (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 (2,617,566) (990,826) (96,236)
------------ ------------ ------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $(16,843,123) $(11,777,613) $(12,735,276)
============ ============ ============
Weighted average number of common shares
outstanding - basic and diluted 12,541,642 5,102,733 1,894,552
============ ============ ============
Basic and diluted net loss per share applicable to common
shareholders $ (1.34) $ (2.31) $ (6.72)
============ ============ ============
See accompanying Notes to Consolidated Financial Statements
F-28
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Mandatorily and
Convertible Redeemable Preferred Stock
Years Ended December 31, 2005, 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-29
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Mandatorily and Convertible Redeemable
Preferred Stock (Continued)
Years Ended December 31, 2005, 2004 and 2003
------------------------------------------------------
MSI SERIES A REDEEMABLE MSI SERIES B CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK
------------------------ ------------------------
SHARES AMOUNT SHARES AMOUNT
-------- ------------ --------- ----------
Balance at December 31, 2003 50,000 $ 5,000,000 650,000 $ 8,587,011
Exchange of MSI Series A redeemable
preferred stock for common stock of FPDI in merger (50,000) (5,000,000) -- --
Deemed dividends on MSI redeemable preferred stock -- -- -- 348,493
Accretion of MSI mandatorily redeemable
preferred stock to redemption amount -- -- -- 19,793
Exchange of MSI Series B convertible redeemable
preferred stock for common stock of FPDI in merger -- -- (650,000) (8,955,297)
Issuance of FPDI Series A convertible redeemable
Series A preferred stock due to merger
Accretion of FPDI convertible preferred
stock to redemption amount
Balance at December 31, 2004 -- -- -- --
Accretion of FPDI convertible preferred
stock to redemption amount -- -- -- --
------ ------------ ------- -----------
Balance at December 31, 2005 -- $ -- -- $ --
====== ============ ======= ===========
-------------------------
FPDI SERIES A CONVERTIBLE
PREFERRED STOCK
-------------------------
SHARES AMOUNT TOTAL
---------- ----------- ----------
Balance at December 31, 2003 -- -- 13,587,011
Exchange of MSI Series A redeemable
preferred stock for common stock of FPDI in merger -- -- (5,000,000)
Deemed dividends on MSI redeemable preferred stock -- -- 348,493
Accretion of MSI mandatorily redeemable
preferred stock to redemption amount -- -- 19,793
Exchange of MSI Series B convertible redeemable
preferred stock for common stock of FPDI in merger -- -- (8,955,297)
Issuance of FPDI Series A convertible redeemable
Series A 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
Accretion of FPDI convertible preferred
stock to redemption amount -- 2,617,566 2,617,566
--------- --------- ---------
Balance at December 31, 2005 2,466,971 $24,618,333 24,618,333
========= =========== ==========
See accompanying notes to consolidated financial statements.
F-30
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Deficit and Comprehensive Loss
Year Ended December 31, 2005, 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
------ ------ -------- -------- ------------ ------------- -------------
Balance at December 31, 2002 6,317 $ 6 -- -- -- $ 81,082,601 $ (96,989,111)
Accretion of mandatorily redeemable
preferred stock -- -- -- -- -- (96,235) --
Dividends on redeemable
preferred stock -- -- -- -- -- (1,647,669) --
Issuance of Class A common stock
for cash of $3,214,704 and the
conversion of $1,190,000 o f
principal amount and $21,453 of
related interest of notes payable 1,668,177 1,668 -- -- -- 4,424,489 --
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 --
Class A common stock offering costs -- -- -- -- -- (156,528) --
Issuance of restricted Class A
common stock for cash 2,895 3 -- -- -- 466 --
Exercise of stock options 1,539 2 -- -- -- 738 --
Repurchase of nonvested restricted
Class A common stock (161) -- -- -- -- (1) --
Estimated fair value of warrants issued
to purchase Series C mandatorily
redeemable preferred stock in
exchange for the equipment
lease facility -- -- -- $ 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) --
Deferred compensation related to grants
of options to employees to
purchase common stock -- -- -- -- $(670,558) 670,558 --
Amortization of deferred compensation -- -- -- -- 308,418 -- --
Net loss before amounts allocable
to common shareholders -- -- -- -- -- -- (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)
========= ====== ======= ======== ========= ============ =============
TOTAL
------------
Balance at December 31, 2002 $(15,906,504)
Accretion of mandatorily redeemable
preferred stock (96,235)
Dividends on redeemable
preferred stock (1,647,669)
Issuance of Class A common stock
for cash of $3,214,704 and the
conversion of $1,190,000 o f
principal amount and $21,453 of
related interest of notes payable 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 877,500
Class A common stock offering costs (156,528)
Issuance of restricted Class A
common stock for cash 469
Exercise of stock options 740
Repurchase of nonvested restricted
Class A common stock (1)
Estimated fair value of warrants issued
to purchase Series C mandatorily
redeemable preferred stock in
exchange for the equipment
lease facility 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 126,637
Deferred compensation related to grants
of options to employees to
purchase common stock --
Amortization of deferred compensation 308,418
Net loss before amounts allocable
to common shareholders (10,991,371)
------------
Balance at December 31, 2003 $(23,035,460)
============
(Continued)
F-31
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Deficit and
Comprehensive Loss (Continued)
Years Ended December 31, 2005, 2004 and 2003
SERIES C
CLASS A REDEEMABLE
COMMON STOCK COMMON PREFERRED
--------------------------- STOCK STOCK DEFERRED
SHARES AMOUNT WARRANTS WARRANTS COMPENSATION
------------ ----------- ----------- --------- ------------
Balance at December 31, 2003 1,949,827 $ 1,950 65,571 $ 115,652 $(362,140)
Accretion of MSI mandatorily redeemable
preferred stock to redemption amount -- -- -- -- --
Accretion of FPDI mandatorily redeemable
preferred stock to redemption amount -- -- -- -- --
Deemed dividends on MSI redeemable
preferred stock -- -- -- -- --
Exercise of MSI stock options 3,480 4 -- -- --
Repurchase of MSI common stock (7,284) (7) -- -- --
Cancellations of MSI stock options -- -- -- -- 11,519
Transactions related to reverse acquisition of
FPDI by MSI: -- -- -- -- --
Common stock issued in exchange for MSI
Series A preferred stock in merger 1,000,000 1,000 -- -- --
Common stock issued in exchange for MSI
Series B preferred stock in merger 1,806,285 1,806 -- -- --
Stock-based compensation incurred
in connection with merger -- -- -- -- --
Acquisition of FPDI by MSI based on
fair value of common stock; options
and warrants 5,723,870 5,724
Class A common stock warrants of MSI
exchanged for common stock
warrants of FPDI -- -- (65,571) -- --
Series C warrants of MSI exchanged for
Series A stock warrants of FPDI -- -- -- (115,652) --
Reclassification of deferred compensation
to additional paid-in capital due to merger -- -- -- -- 238,388
Cancellation of MSI common stock
exchanged for common stock of FPDI -- -- -- -- --
Amortization of deferred compensation
and stock option expense -- -- -- -- 112,233
FPDI common stock issued in lieu of
interest payment 29,365 29 -- -- --
Reclassification of derivative warrant
to liability
Exercise of FPDI stock options 455 -- -- -- --
Acquisition costs -- -- -- -- --
Components of comprehensive loss:
Net loss -- -- -- -- --
Change in foreign currency translation
adjustments
Total comprehensive loss
------------ ----------- ----------- --------- ---------
Balance at December 31, 2004 10,505,998 $ 10,506 -- -- --
============ =========== =========== ========= =========
ACCUMULATED
ADDITIONAL OTHER
PAID-IN COMPREHENSIVE ACCUMULATED
CAPITAL INCOME (LOSS) DEFICIT TOTAL
------------- ------------- ------------- ------------
Balance at December 31, 2003 $ 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 1,835 -- -- 1,839
Repurchase of MSI common stock (4,769) -- -- (4,776)
Cancellations of MSI stock options (11,519) -- -- --
Transactions related to reverse acquisition of
FPDI by MSI: -- -- -- --
Common stock issued in exchange for MSI
Series A preferred stock in merger 4,999,000 -- -- 5,000,000
Common stock issued in exchange for MSI
Series B preferred stock in merger 8,953,491 -- -- 8,955,297
Stock-based compensation incurred
in connection with merger 798,598 798,598
Acquisition of FPDI by MSI based on
fair value of common stock; options
and warrants 16,468,706 -- -- 16,474,430
Class A common stock warrants of MSI
exchanged for common stock
warrants of FPDI 65,571 -- -- --
Series C warrants of MSI exchanged for
Series A stock warrants of FPDI 115,652 -- -- --
Reclassification of deferred compensation
to additional paid-in capital due to merger (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 280,446 -- -- 392,679
FPDI common stock issued in lieu of
interest payment 12,471 -- -- 12,500
Reclassification of derivative warrant
to liability (1,836,534) (1,836,534)
Exercise of FPDI stock options 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 $ 113,365,645 $ 19,184 $(118,418,776) $ (5,023,441)
============= ======== ============= ============
(Continued)
F-32
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Deficit and
Comprehensive Loss (Continued)
Years Ended December 31, 2005, 2004 and 2003
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------------ PAID-IN COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL INCOME (LOSS) DEFICIT TOTAL
---------- ---------- ------------ ------------- ------------- ------------
Balance at December 31, 2004 10,505,998 $ 10,506 $113,365,645 $ 19,184 $(118,418,776) $ (5,023,441)
Common stock issued in the acquisition
of Incentra of CA (formerly Star
Solutions) (Note 4) 1,261,756 1,262 3,135,102 -- -- 3,136,364
Common stock issued in the acquisition
of PWI Technologies (Note 4) 841,934 842 1,683,026 -- -- 1,683,868
Accretion of FPDI mandatorily redeemable
preferred stock to redemption amount -- -- (2,617,566) -- -- (2,617,566)
Exercise of MSI stock options 453 -- 134 -- -- 134
Amortization of stock based --
compensation expense -- -- 520,641 -- -- 520,641
Reclassification of derivative warrant
to equity 1,910,254 1,910,254
Warrant issued to Laurus related to
line of credit -- -- 538,240 -- -- 538,240
Conversion of notes payable and accured
interest in exchange for common stock 716,669 717 994,114 994,831
Acquisition costs -- -- (12,422) -- -- (12,422)
Components of comprehensive loss:
Net loss -- -- -- -- (14,225,557) (14,225,557)
Change in foreign currency translation
adjustments $(122,419) (122,419)
------------
Total comprehensive loss (14,347,976)
---------- ---------- ------------ --------- ------------- ------------
Balance at December 31, 2005 13,326,810 $ 13,327 $119,517,168 $(103,235) $(132,644,333) $(13,217,073)
========== ========== ============ ========= ============= ============
See accompanying notes to consolidated financial statements.
F-33
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31,
2005 2004 2003
---- ---- ----
Cash flows from operating activities:
Net loss $(14,225,557) $(10,438,294) $(10,991,371)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 1,557,068 2,197,213 2,337,524
Amortization of intangible assets and software development costs 3,867,068 1,776,473 928,851
Amortization of non-cash loan discount 12,735 -- 1,274
Stock-based compensation 520,641 1,191,277 308,418
Interest expense paid with common stock -- 12,500 877,500
Non-cash interest expense 1,610,030 447,797 14,191
Non-cash interest expense on Series C mandatorily redeemable
preferred stock liability -- 1,703,332 1,262,508
Non-cash tax expense 469,034 400,000 --
Share of losses of Front Porch Digital, Inc. and related impairment
of goodwill -- 198,280 1,328,283
(Gain) Loss on disposal of assets 47,809 22,291 (15,868)
Non-cash interest income on note receivable -- -- (13,666)
Impairment of goodwill 4,151,450 -- --
Gain on revaluation of warrant liability (390,280) -- --
Bad debt expense 60,608 233,864 266,387
Gain from early extinguishments of debt -- -- (20,826)
Changes in operating assets and liabilities, net of business acquisitions:
Accounts and other receivables 513,921 (942,174) (967,544)
Other current assets (562,078) 91,811 (77,015)
Other assets 30,771 45,295 15,687
Accounts payable (544,337) (73,065) (286,417)
Accrued liabilities 1,133,631 339,287 34,523
Deferred revenue 787,671 (738,456) 831,790
Other liabilities (513,048) (11,784) (9,518)
------------ ------------ ---------
Net cash used in operating activities (1,472,863) (3,544,353) (4,175,289)
------------ ------------ ---------
Cash flows from investing activities:
Purchases of property and equipment (1,065,172) (1,152,120) (2,103,746)
Capitalized software development costs (1,604,404) (1,044,325) (320,414)
Acquisition costs -- (198,597) --
Proceeds from sale of property and equipment 2,808 126,084 267,902
Purchase of intangible assets -- -- (2,349,714)
Cash and restricted cash acquired in FPDI acquisition (Note 4) -- 4,005,685 --
Cash acquired in STAR acquisition (Note 4) 1,597,498 -- --
Cash acquired in PWI acquisition (Note 4) 74,297 -- --
Earnout payment related to PWI acquisition (Note 4) (100,000) -- --
Net change in restricted cash (908) (638) (648)
Issurance 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 (used in) provided by investing activities (1,095,881) 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 (11,422,289) (1,966,973) (446,372)
Proceeds from exercise of stock options and purchase of restricted stock 136 1,977 1,208
Proceeds on capital lease line and line of credit 12,099,320 815,654 --
Repurchase of common stock -- (31,427) --
------------ ------------ ---------
Net cash (used in) provided by financing activities 677,167 (1,180,769) 14,845,716
------------ ------------ ---------
Effect of exchange rate changes on cash and cash equivalents (68,239) 63,200 --
------------ ------------ ---------
Net (decrease) increase in cash and cash equivalents (1,959,816) 867,266 2,120,708
Cash and cash equivalents at beginning of year 3,068,458 2,201,192 80,484
------------ ------------ ---------
Cash and cash equivalents at end of year $ 1,108,642 $ 3,068,458 2,201,192
============ ============ =========
(Continued)
F-34
INCENTRA SOLUTIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31,
2005 2004 2003
---- ---- ----
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 801,454 $ 202,516 $ 72,789
Supplemental disclosures of non-cash investing and financing activities:
Net liabilities acquired in FPDI acquisition, excluding cash (Note 4) $ -- 3,122,007 $ --
Net liabilities acquired in Incentra of CA acquisition, excluding cash (Note 4) 620,178 -- --
Net assets acquired in PWI acquisition, excluding cash (Note 4) 269,306 -- --
Conversion of notes payable and accrued interest in exchange for common stock 994,831 -- --
Reclassification of derivative contract to liability -- 1,836,534 --
Reclassification of derivative contract to equity 1,910,254 -- --
Deferred compensation for options granted at less than fair value 670,558
Redeemable preferred stoock issued for discount on capital lease obligation 22,927
Redeemable preferred stock warrants and common stock warrants issued for financing costs 158,296
Notes payaable 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 93,766 130,471 215,715
See accompanying Notes to Consolidated Financial Statements
F-35
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004 and 2003
(1) ORGANIZATION
Incentra Solutions, Inc. (which is referred to herein together with its
subsidiaries as "we", "us" or "our"), formerly Front Porch Digital, Inc.
("FPDI"), 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., and our common stock now trades on the Over-the-Counter Bulletin Board
under the trading symbol "ICNS". We have 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, formerly 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 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 market our 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, 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. The
software converts audio, video, images, text and data into digital formats for
ease of use and archiving. Through MSI, we deliver comprehensive storage
services, including professional services, hardware/software procurement and
resale, financing solutions and remote monitoring/management services. We focus
on providing data protection solutions and services that ensure that our
customers' data is backed-up and recoverable and that meet 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.
Through Incentra of CA and PWI, we deliver complete IT solutions,
including professional services, third-party hardware/software procurement and
resale, financing solutions, maintenance support services (first call) for
third-party hardware and software maintenance and managed storage solutions.
Solutions are sold primarily to enterprise customers in the financial services,
government, hospitality, retail, security, healthcare and manufacturing sectors.
Incentra of CA and PWI primarily service customers in the western United States.
Our customers are located in North America, Europe, Asia and the Pacific
Rim.
F-36
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
BASIS OF PRESENTATION
At December 31, 2005, 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., Incentra of CA, which is based in San Diego, California, and
PWI, which is based in Kirkland, Washington. ManagedStorage UK, Inc. and
Seabrook Technologies, Inc. did not have any operating activities during the
year ended December 31, 2005. All significant intercompany accounts and
transactions have been eliminated in consolidation.
GOING CONCERN AND MANAGEMENT'S PLANS
Our consolidated financial statements as of December 31, 2005 and for
the year then ended have been prepared on a going concern basis, which
contemplates the realization of assets and settlements of liabilities and
commitments in the normal course of business.
We are currently engaged in 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 financial condition. In connection
with our acquisition of Incentra of CA in February of 2005, we issued the former
owner of Incentra of CA a promissory note in the principal amount of $2,500,000
(the "STAR Note"). On August 1, 2005 we elected to cease making payments on the
STAR Note, which created an event of default. On August 16, 2005, we received a
demand for arbitration from legal counsel of the former owner. In the event the
dispute is not resolved in our favor, the full outstanding balance of the STAR
Note could be accelerated. As a result, the entire balance of the STAR Note,
which totals $2.4 million, is classified as a current liability at December 31,
2005 as it is callable. 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. See Note 17.
The event of default on the STAR Note created an event of default of
certain provisions of debt outstanding with Laurus Master Fund Ltd. (Laurus),
our senior secured lender. As a result, the entire balance of the amount owed to
Laurus, which totaled $8.8 million at December 31, 2005 has been classified as a
current liability at December 31, 2005 as it is callable. We believe we have a
good relationship with Laurus; however, there is uncertainty regarding our
ability to comply with required debt covenants in the future which places the
debt in a position to be called due. This raises substantial doubt about our
ability to continue as a going concern. Our ability to continue as a going
concern is dependent on future financial results as well as the arbitration
proceeding discussed above and, should we continue to be in breach of the
covenants on the debt, our ability to restructure or otherwise amend the terms
of that debt. The financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts and classifications of liabilities that might result from the
outcome of this uncertainty.
Management's plans in regard to these matters are as follows:
F-37
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
If we continue to be in default of our covenants in the future, we
would, as we have in the past, seek to obtain amendments to the debt or waivers
of the covenants so that we are no longer in violation.
While we believe we will execute our current business plan that calls
for growth in the business, we will also institute various cost controls to
reduce operating expenses where necessary. This includes the timely monitoring
of labor and selling, general and administrative costs.
(2) SHARE AND PER SHARE DATA
(A) In accordance with generally accepted accounting principles, and as a result
of the MSI acquisition being accounted for as a reverse merger, all share and
per share data prior to the MSI acquisition have been retroactively adjusted to
reflect the 0.3089 to one exchange of shares occurring in connection with the
merger with MSI, in a manner similar to a reverse stock split, with the
difference in par value being recorded through an offset to additional
paid-in-capital.
(B) 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 year ended
December 31, 2005 and in prior periods, have been adjusted to reflect the
post-reverse split amounts.
(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 us 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. We have
recorded transactions that include the issuance of options and warrants to
purchase shares of our preferred and common stock. The accounting for such
securities is based upon fair values of our equity securities and other
valuation criteria that were determined by our Board and us. We believe these
estimates of fair value are reasonable. Other significant estimates made by us
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.
CASH AND CASH EQUIVALENTS
We consider all highly-liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
F-38
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
RESTRICTED CASH
We have restricted cash of $80,956 and $80,048 at December 31, 2005 and
2004, respectively, (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 have 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", we
review 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 AND CORRECTION OF ERROR IN ACCOUNTING FOR GOODWILL
Goodwill represents the excess of the purchase price over the net of the
fair value of the identifiable tangible and intangible assets acquired and the
fair value of liabilities assumed in acquisitions. SFAS No. 142, "Goodwill and
Other Intangible Assets," (SFAS 142) requires the testing of goodwill and
indefinite-lived intangible assets for impairment at least annually. We test
goodwill for impairment in the fourth quarter each year.
With the acquisitions of Incentra of CA in February 2005 and PWI in
March 2005, we recorded goodwill of $6,177,686 and $3,831,534, respectively. The
fair value of our reporting units used in determination of the goodwill
impairment is computed using the expected present value of associated future
cash flows. As more fully discussed in Note 17, operating profits and cash flows
were lower than expected in the fourth quarter of 2005 for Incentra of CA. Based
on that trend, the earnings forecast for the next five years was revised.
Therefore, during the fourth quarter of 2005 we determined that the goodwill
associated with the Incentra of CA acquisition was impaired and accordingly
recorded an impairment loss of $4,151,450.
Prior to the MSI 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
F-39
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
recognized as goodwill. In 2004, 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 an impairment loss of $198,280 and
$692,098, respectively.
In connection with preparing the December 31, 2005, consolidated
financial statements, management determined that an error was made in accounting
for goodwill recognized in connection with business acquisitions that occurred
in the first quarter of 2005. As a result of the error, goodwill was overstated
by approximately $4.5 million and shareholders' deficit was understated by the
same amount at March 31, June 30, and September 30, 2005. There was no effect on
the Company's consolidated statements of operations for the year ended December
31, 2005 or for any quarter of 2005 as a result of this error. The error was
corrected in the fourth quarter of 2005 by decreasing goodwill and increasing
shareholders' deficit by $4.5 million.
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 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.
F-40
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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 whom 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.
COST OF REVENUE
Cost of revenue consists primarily of direct labor, cost of hardware,
depreciation ($1,091,321 in 2005, $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 $60,586, $80,844 and $270,964 for the years
ended December 31, 2005, 2004 and 2003, respectively.
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 amortization over an estimated useful life of three years. For the
years ended December 31, 2005, 2004 and 2003, capitalized software development
costs, which related primarily to enhancements to the Company's GridWorks and
DIVArchive software solutions totaled $1,604,404, $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, 2005,
2004 and 2003, $592,259, $384,974 and $272,731, respectively, were charged to
expense. As of December 31, 2005 and 2004, the unamortized portion of software
development costs was $2,133,203 and 1,188,885, respectively.
F-41
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
DEFERRED LOAN COSTS
Deferred loan costs, included in other non-current assets, are amortized
over the three-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, 2005, 2004 and 2003, research and development costs were
$101,760, $134,793 and $0, respectively.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The balance sheet accounts of our 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, 2005 and 2004, we
reported a cumulative translation loss of $103,235 and a cumulative translation
gain of $19,184, as a component of accumulated other comprehensive income
(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 years ended December 31, 2005 and 2004 were losses
of $43,209 and $24,756, respectively. For the year ended December 31, 2003 we
recorded a gain of $8,550.
In June 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. Changes in fair value are recognized in the statement of operations.
We recorded a $59,900 realized gain on these contracts during the year ended
December 31, 2005, 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. We
recorded a realized loss of $144,086 and an unrealized loss of $134,500 on these
contracts during the year ended December 31, 2004. We had no contracts
outstanding at December 31, 2005.
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 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 No. 00-19") 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 No. 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
F-42
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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.
PER SHARE DATA
We report our earnings (loss) per share in accordance with SFAS No. 128,
"Accounting for Earnings Per Share". 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 and stock splits, the historical loss per share
amounts have been retroactively restated to reflect our capital structure. Due
to our net losses for the periods presented, 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, 2005, 2004 and 2003 because the effect would be
antidilutive.
13.2 million and 10.1 million shares of common stock issuable upon the
conversion of outstanding convertible preferred stock, the exercise of options
and warrants, and restricted stock totaling 23.3 million shares have been
omitted from the computations of basic and diluted loss per share for the years
ended December 31, 2005 and 2004, respectively, because the effect would be
antidilutive. 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
We apply the intrinsic value-based method of accounting prescribed by
Accounting Principles Board Opinion No. 25 (APB 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 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. 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 years ended December 31, 2005, 2004 and 2003.
F-43
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
All amounts except per share amounts in (000's):
Years Ended
December 31,
2005 2004 2003
---------- ----------- -----------
Net loss before amounts attributable to common
shareholders, as reported $ (14,226) $ (10,438) $ (10,991)
Add stock-based employee compensation expense
included in reported net loss, net of tax 521 1,191 308
Deduct total stock-based employee compensation
expense determined under fair value-based method
for all awards, net of tax (1,837) (1,853) (322)
---------- ----------- -----------
Pro forma net loss before deemed dividends
and accretion on preferred stock $ (15,542) $ (11,100) $ (11,005)
========== =========== ===========
Net loss per weighted average common share
outstanding - basic and diluted - pro forma $ (1.45) $ (2.44) $ (6.73)
========== =========== ===========
Net loss per weighted average common share
outstanding - basic and diluted - as reported $ (1.34) $ (2.31) $ (6.72)
========== =========== ===========
In determining the fair value of stock options granted by us in 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 rates ranging from
3.64% to 4.36%, expected volatility ranging from 111% to 113%, and expected
lives of three years. The weighted average fair value of these options granted
during 2005 was $1.62.
In determining the fair value of stock options granted by us in 2004,
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 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 was $2.80.
In determining the fair value of stock options granted by MSI in 2003,
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 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 options.
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 us, which include
cash equivalents, restricted cash, accounts receivable, and accounts payable,
F-44
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
approximate fair value due to their short duration. The carrying values of note
payable and other non-current obligations approximate fair values based upon
market rates currently available us. The fair value of a Letter of Credit issued
in conjunction with a lease agreement (Note 8) approximates the fees paid to
obtain it.
CONCENTRATIONS OF CREDIT RISK
We sell our products and services throughout the United States, Europe,
Asia and the Pacific Rim. We perform periodic credit evaluations of our
customers' financial condition and generally do not require collateral. Accounts
receivable are reported at their outstanding unpaid principal balances reduced
by an allowance for doubtful accounts. We estimate doubtful accounts based on
historical bad debts, factors related to specific customers' ability to pay and
current economic trends. We write 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, 2005, aggregate
revenues from customers located in Europe, Asia and the Pacific Rim amounted to
$13.4 million or 26% of total revenue, while revenues from customers located in
North America totaled $37.4 million or 74% of total revenue. 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, 2005, one
customer accounted for 11% of total revenues. One customer accounted for 16% of
accounts receivable at December 31, 2005. For the year ended December 31, 2004,
revenue from two customers individually accounted for approximately 13% and 11%
of total revenues. For the year ended December 31, 2003, revenues from three
customers each exceeding 10% of total revenues aggregated 36%, 19% and 11%,
respectively.
The following is a breakdown of our revenues and long-lived assets by geographic
area (in thousands):
North America Europe/Asia* Total
Year Ended December 31, 2005
Revenues $ 37,420 $13,412 $ 50,832
Long-lived assets, net 1,625 605 2,230
Year Ended December 31, 2004
Revenues 8,575 4,710 13,285
Long-lived assets, net 1,779 674 2,453
Year Ended December 31, 2003
Revenues 8,730 1,081 9,811
Long-lived assets, net 2,784 0 2,784
*The geographic breakout by country is not practical to obtain.
Long-lived assets includes Property, Plant and Equipment
Balances at the beginning and end of the year and changes in the allowance
for doubtful accounts for the years ending December 31, 2005, 2004 and 2003 are
as follows:
Balance at Charged to Balance at
Beginning of Costs and End of
Period Expenses Deductions (a) Period
------------ ---------- -------------- ----------
YEAR ENDED DECEMBER 31, 2005
Allowance for doubtful accounts $ 274,879 60,608 116,253 219,234
YEAR ENDED DECEMBER 31, 2004
Allowance for doubtful accounts $ 199,493 233,864 158,478 274,879
YEAR ENDED DECEMBER 31, 2003
Allowance for doubtful accounts $ 185,000 266,387 251,894 199,493
(a) Bad debt write-offs and charges to the allowance, net of other adjustments,
reclassifications and exchange rate differences.
F-45
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment",
which addresses the accounting for share-based compensation transactions. SFAS
No. 123R 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. 123R will be effective for us during the first quarter of 2006.
We have evaluated the provisions of this standard, and 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
"Accounting Changes" 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 principles. 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.
(4) ACQUISITIONS
(A) ACQUISITION OF INCENTRA OF CA, FORMERLY 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
financial statements beginning on February 18, 2005.
Pursuant to the STAR Merger Agreement, the purchase price consisted of (i)
a cash payment of $1,500,000 (paid subsequent to the acquisition date with the
proceeds from a line of credit), (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"). We
entered into a consulting agreement with the seller pursuant to which we agreed
to pay consulting fees in the amount of $500,000 which was included as part of
the purchase price. We paid approximately $400,000 in investment banking fees
associated with the transaction.
F-46
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Interest on the STAR Note accrues at an annual rate of 0.5%, which has
been discounted by $300,000 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, which commenced 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. As of December 31, 2005, we reclassified $1.3
million of the debt to current liabilities based on the default, as the debt is
now callable. Refer to Note 17.
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 December 31, 2005 and pending the results of the arbitration proceedings
described in Note 16, the principal balance on 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.
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 purchase price allocation at the date of
the Incentra of CA acquisition:
Cash and cash equivalents $ 1,597,498
Other current assets 824,998
Property and equipment 20.909
Other assets 7,005
Goodwill 6,177,686
Customer relationships (5 year life) 540,000
Current liabilities (1,473,088)
-----------
Total purchase price $ 7,695,008
===========
The purchase price allocation was considered final as of December 31,
2005. As a result of the goodwill impairment test we completed in the fourth
quarter of 2005 in accordance with SFAS 142, the amount allocated to goodwill
was considered impaired and a loss of $4,151,450 was charged to income in the
fourth quarter of 2005.
In connection with the acquisition, on February 18, 2005, Incentra of CA
obtained a revolving line of credit from a bank that provided for borrowings
until March 1, 2007, of up to $5,000,000. This line of credit and all the
F-47
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
related accrued interest were paid in full on July 5, 2005 in connection with
the New Laurus Financing Agreement as discussed in Note 9(C).
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 a cash payment of $2,350,000 (paid
subsequent to the acquisition date with the proceeds from a line of credit) 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. During the year ended December 31, 2005, the former PWI
shareholders achieved a partial earn out of $100,000 which was paid to them in
cash. As a result of the earn out payment, the purchase price (goodwill) was
increased by $100,000. 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
$250,000 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 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 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 purchase price allocation at the date of
the PWI acquisition:
Cash and cash equivalents $ 74,297
Other current assets 7,009,601
Property and equipment 173,610
Other assets 28,010
Goodwill 3,831,534
Customer relationships (5 year life) 310,000
Current liabilities (6,877,351)
Other liabilities (64,564)
-----------
Total purchase price $ 4,485,137
===========
F-48
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
The purchase price allocation was considered final as of December 31, 2005.
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
related accrued interest were paid in full on July 5, 2005, in connection with
the New Laurus Financing Agreement, as discussed in Note 9 (C) to these
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 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.
The MSI stockholders were issued 4,745,498 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. In connection with the Acquisition, the Company canceled
13,452,381 shares of outstanding Incentra common stock and warrants to purchase
3.5 million shares of Incentra common stock that were held by MSI prior to the
Acquisition Date. MSI canceled $0.2 million in receivables owed to it from the
Company. The Company also has outstanding warrants to purchase 202,740 shares of
restricted common stock at a price per share of $.0003 and outstanding warrants
to purchase 33,029 shares of Series A Preferred at a price per share of $10.35.
There is no impact on the purchase price allocation or in the financial
information presented, however, the determination of the value of the
consideration issued to the former MSI shareholders was as follows:
F-49
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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 on 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 4,745,498 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, and each
outstanding share of MSI common stock was converted into 0.3089 shares of common
stock of the Company. Each outstanding share of MSI's Series C Redeemable
Preferred Stock was exchanged for 111.6242 shares of Series A Convertible
Redeemable Preferred Stock. 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.
Since the Acquisition was 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
===========
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.
D) 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,
F-50
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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 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.
E) PROFORMA RESULTS
The following unaudited pro forma results of operations for the years
ended December 31, 2005, 2004 and 2003 are presented to reflect the acquisitions
described in (A) and (B) as if these acquisitions had occurred as of the
beginning of 2004 and as if the acquisition described in (C) had occurred as of
the beginning of 2003. 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 future consolidated results of operations or financial
condition. All amounts except per share amounts in (000's):
2005 2004 2003
---- ---- ----
Revenues $ 61,276 $ 56,518 $ 12,728
Loss from continuing operations (11,857) (8,905) (12,674)
Loss from discontinued operations (1) -- -- (3,711)
------------------------------
Net loss applicable to common shareholders $(16,741) $(14,048) $(20,511)
======== ======== ========
Net loss per share - basic and diluted,
pro forma $ (1.33) $ (1.31) $ (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.
F-51
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(5) PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31, 2005
and 2004:
DECEMBER 31,
2005 2004
------------ ------------
Computer equipment $ 4,865,823 $ 5,844,721
Software 1,591,440 3,519,284
Leasehold improvements 63,246 65,343
Assets under construction 114,886 -
Office furniture and equipment 631,135 1,764,550
------------ ------------
7,266,530 11,193,898
Less accumulated depreciation (5,036,329) (8,741,080)
------------ ------------
$ 2,230,201 $ 2,452,817
------------ ------------
Depreciation expense for the years ended December 31, 2005, 2004 and
2003 was $1,557,068, $2,197,213 and 2,337,524, respectively.
Included in property and equipment is equipment under capital lease with
a cost of $1,512,476 and $1,334,427 and accumulated depreciation of $669,278 and
628,176 at December 31, 2005 and 2004, respectively.
(6) INTANGIBLE ASSETS
Intangible assets consist of the following as of December 31, 2005 and
2004:
DECEMBER 31
2005 2004
---- ----
Acquired customer base--FPDI
(life of 10 years) $ 10,039,786 $ 10,039,785
Intellectual property--DIVArchive
(life of 5 years) 6,600,000 6,600,000
Acquired customer base--MSI
(life of 3 years) 2,599,714 2,599,714
Patents (life of 7 years) - 2,885
Acquired customer relationships--
Incentra of CA (life 5 years) 540,000 -
Acquired customer relationships--
PWI (life 5 years) 310,000 -
------------ ------------
20,089,500 19,242,384
Less accumulated amortization (6,404,141) (2,705,324)
------------ ------------
Intangible assets, net $ 13,685,359 $ 16,537,060
============ ============
Amortization expense for the years ended December 31, 2005, 2004 and
2003 was $3,867,068, $1,776,473 and $928,851, respectively. Estimated
amortization expense for each of the five succeeding years is as follows:
Year ending December 31:
2006 $ 2,515,030
2007 2,493,978
2008 2,493,978
2009 1,979,007
2010 1,032,978
Thereafter 3,170,388
-----------
$13,685,359
===========
F-52
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(7) ACCRUED EXPENSES
Accrued expenses consisted of the following as of December 31, 2005 and 2004:
DECEMBER 31,
2005 2004
---- ----
Wages, benefits and payroll taxes $ 2,687,296 $ 1,202,677
Professional fees 420,229 393,545
Customer deposits 263,738 -
Derivative liability - 134,500
Accrued interest and penalties - 126,667
Taxes, other than income taxes 632,074 662,244
Other accrued payables 1,341,138 539,173
------------- ------------
$ 5,344,475 $ 3,058,806
============= ============
(8) COMMITMENTS AND CONTINGENCIES
We have employment agreements with certain executives that provide for
up to one year of salary upon termination with the Company.
We lease facilities and equipment under non-cancelable capital and
operating leases. Rental expense relating to operating leases was $1,176,399,
$536,192 and $492,901 for the years ended December 31, 2005, 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 our limited cash resources 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 we were unable to make the monthly rent payments. At December 31,
2005 and 2004, the amount of the letter of credit was $80,956 and $80,048,
respectively. The letter of credit is secured by restricted cash in the same
amount.
Future minimum lease payments as of December 31, 2005 are as follows:
Capital Operating
Leases Leases
--------- -----------
Year ending December 31:
2006 $ 853,936 $ 706,781
2007 28,035 538,251
2008 7,314 184,823
2009 -- 113,038
2010 and thereafter -- 440,311
--------- -----------
Total minimum lease payments 889,285 $ 1,983,204
========= ===========
Less amounts representing interest (57,750)
---------
Present value of minimum lease payments $ 831,535
=========
F-53
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(9) NOTE PAYABLE, CAPITAL LEASES, AND OTHER LONG-TERM OBLIGATIONS
The following is a summary of our long-term debt as of December 31, 2005
and 2004:
DECEMBER 31,
2005 2004
---- ----
Senior secured convertible note$(A) $ 2,262,968 $ 3,119,112
Capital leases (B) 831,535 516,013
Line of credit (C) 5,513,244 -
STAR Note (D) 2,106,281 -
Other obligations (E) 656,545 370,361
------------ ------------
11,370,573 4,005,486
Less current portion (11,066,921) (1,738,516)
------------ ------------
Long-term portion $ 303,652 $ 2,266,970
============ ============
(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 adjustments for
standard antidilution provisions.
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 $500,096 and $209,317 of additional non-cash interest expense
relating to the amortization of the discount for the years ended December 31,
2005 and 2004, 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
F-54
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
determined to be insufficient. As a result, we reassessed and reclassified the
value of the Laurus Warrant to a liability at the reassessment date. However, 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, and it is again included in equity at December 31, 2005. During the
years ended December 31, 2005 and 2004, we recorded a gain of $390,280 and $0,
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, at the
rate of $45,455 per month and increased to approximately $159,000 per month
beginning in March 2005, with the balance payable on the maturity date. However,
due to an event of default on the STAR Note (see Notes 4(A) and 17), all amounts
due under the Laurus Note have been reclassified to current liabilities at
December 31, 2005. Laurus has the option to receive shares of our common stock
in lieu of debt service payments at a fixed price of $3.00 per share. The Laurus
Note 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
standard 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 and waived certain events of default under
certain of such 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
F-55
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
$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 that 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
intangibles, equipment and inventory of Incentra of CA.
On February 18, 2005, in satisfaction of $375,000 of liquidated damages
to be 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. As a result, we expensed $300,000 for the liquidated damages. 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 year ended December 31, 2005, we agreed to five amendments
with Laurus to the Laurus Note pursuant to which $884,903 of principal was
converted to our common stock on or after April 28, 2005. The conversion price
for each amendment was $1.48, $1.40, $1.52, $1.30 and $1.30, respectively,
following each amendment. During the year ended December 31, 2005, Laurus
converted this $884,903 under the Laurus Note into 716,669 shares of our common
stock. The conversion was deemed beneficial, and, as a result, additional
interest expense of $226,000 was recorded during the year ended December 31,
2005.
See Note 18 for subsequent changes to the senior credit facility with
Laurus effective February 6, 2006.
F-56
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(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 was 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
December 31, 2005 and 2004, we had drawn $1,470,507 on the Lease Line and
$29,493 of the Lease Line expired unused. The original borrowing under the Lease
Line was repaid in full on October 1, 2005.
On March 2, 2005, we entered into an amendment to the Lease Line. Under
this amendment, we could draw an additional $500,000 (the "New Credit Facility")
for equipment purchases through June 30, 2005 of which we used $497,667. 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 paid 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. The New Credit Facility is to be repaid in monthly principal
and interest installments through September 2006. The unpaid balance at December
31, 2005 was $278,207.
On September 11, 2005, we entered into Amendment No. 2 to the Lease
Line. Under this amendment, we may draw an additional $1,000,000 (the "Amended
Credit Facility") for equipment purchases through December 31, 2005. The
amendment also grants us a call option to purchase equipment from the lessor.
The terms of the agreement are for lease terms of 12-15 months with interest
rates ranging from 14.964% to 15%. The Amended Credit Facility is to be repaid
in monthly principal and interest installments through September 2006. During
the year ended December 31, 2005, we have drawn $546,527 on the lease line. The
unpaid balance at December 31, 2005 was $465,564.
On September 11, 2005, we also entered into Amendment No. 1 (the
"Warrant Amendment") to amend 6,954 warrants held by the lessor, that were
issued in connection with the original Lease Line. The Lease Line Warrant
Amendment reduced the exercise price of warrants issued to the lessor with the
original Lease Line from $10.35 per warrant to $6.02 per warrant. The impact of
the re-pricing of the warrants on the consolidated financial statements was not
material.
(C) LINE OF CREDIT
On February 18, 2005, Incentra of CA obtained a revolving line of credit
from Wells Fargo Bank, N.A. that provided for borrowings, from time to time
until March 1, 2007, of up to $5,000,000. The LOC Note was repaid in full on
July 5, 2005 in connection with the financing, discussed below.
On June 30, 2005, we entered into a Security Agreement with Laurus
pursuant to which Laurus provided us a $9 million revolving, convertible credit
facility (the "2005 Facility"). The term of the 2005 Facility was three years.
In connection with the 2005 Facility, we executed in favor of Laurus a $9
million Secured Revolving Note (the "Revolver Note"). Borrowings under the 2005
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 2005 Facility, the minimum initial amount available to us, until
December 31, 2005, was $6.0 million. Thereafter, the
F-57
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
maximum principal amount of all borrowings under the 2005 Facility cannot exceed
90% of the combined eligible accounts receivable of PWI and Incentra of CA. At
December 31, 2005, the outstanding principal balance on the 2005 Facility was
$5.5 million, net of debt discount of $0.5 million.
Pursuant to the Revolver Note, Laurus has the option to convert
borrowings under the 2005 Facility into shares of our common 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. Each conversion is subject to adjustment for standard antidilution
provisions.
On July 5, 2005, we requested, and Laurus agreed to lend, 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 of the 2005 Facility,
was used for general corporate and working capital purposes.
Borrowings under the 2005 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 2005 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, subject to adjustment
for standard antidilution provisions (the "2005 Warrant"). The value of the
warrant was determined, using the Black-Scholes model, to be $0.6 million and is
recorded as a debt discount at September 30, 2005. The discount is being
amortized to earnings as additional interest expense over the term of the 2005
Facility.
In connection with the 2005 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 2005 Facility payable in advance at closing) and
reimbursement of $35,000 of Laurus' expenses, of which $344,000 were recorded as
deferred financing costs. The deferred financing costs will be amortized to
interest expense over the life of the 2005 Facility.
The LOC Note was repaid in full in February 2006 in connection with the
New Laurus LOC financing, discussed in Note 18.
(D) STAR NOTE
Pursuant to the STAR Merger Agreement, we issued an unsecured
convertible promissory note for $2,500,000 as more fully described in Note 4(A)
and in Note 17.
(E) OTHER OBLIGATIONS
F-58
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
At December 31, 2005 and 2004, we have $656,545 and $370,361,
respectively, in other long-term obligations related to contracts with vendors
and certain consulting agreements.
Aggregate annual maturities of long-term debt at December 31, 2005 are as
follows:
Senior Secured
Convertible Note, Capital Line of Star Other
Net of Discount (1) Leases Credit (1) Note (1) Obligations
------------------- ------ ---------- ------- -----------
2006 $2,262,968 $797,867 $5,513,244 $2,106,281 $386,561
2007 26,569 202,567
2008 7,099 67,417
---------- -------- ---------- ---------- --------
$2,262,968 $831,535 $5,513,244 $2,106,281 $656,545
========== ======== ========== ========== ========
(1) As a result of the events of default, these balances have been reported as
current obligations regardless of stated maturity dates.
(10) 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, we 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, we also issued warrants for the purchase
of 270 shares of New Series C and 20,274 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 $.003, respectively, for a period of 5 years from the
date of the securities purchase agreement. The New Series C was converted into
shares of our Series A convertible preferred stock at the date of the MSI
acquisition. The Class A common stock was converted into our common stock at the
date of the MSI acquisition.
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.
F-59
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(11) MANDATORILY AND CONVERTIBLE REDEEMABLE PREFERRED STOCK AND COMMON STOCK
The Company's authorized capital stock at December 31, 2005 and 2004
consists of the following:
(A) PREFERRED STOCK
PREFERRED STOCK
We have 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
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 26,075
Series A Preferred shares at a purchase price of $10.35 per share and 6,954
Series A Preferred shares at a purchase price of $6.02 per share, per the
Amendment described below.
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
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).
(B) COMMON STOCK
At December 31, 2005, we had 13,326,810 shares issued and outstanding.
At December 31, 2004, we had 10,649,362 shares issued, 10,505,998 shares
outstanding and 143,364 shares in treasury.
(C) THE COMPANY'S AUTHORIZED CAPITAL STOCK AT DECEMBER 31, 2003 CONSISTS OF THE
FOLLOWING:
MANDATORILY REDEEMABLE PREFERRED STOCK
Prior to the MSI Acquisition, we 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 MSI Acquisition date, New Series A and
New Series B were converted into common stock and New Series C was converted
into Series A Convertible Redeemable Preferred Stock.
F-60
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
SERIES A MANDATORILY REDEEMABLE PREFERRED STOCK
We authorized and issued 50,000 shares of New Series A as part of the
Recapitalization. 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
We had authorized and issued 650,000 shares of New Series B as part of
the Recapitalization. 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
We had authorized 24,500 shares and issued 22,104 shares of New Series
C. 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 have been 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.
SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", (SFAS 150) was issued in May
2003. This Statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. SFAS 150 was generally effective for financial
instruments entered into or modified after May 31, 2003. Our 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 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 liability
section. There was no gain or loss recorded upon the adoption of SFAS 150. From
July 1, 2003, the Company recorded noncash interest expense of $1,262,508,
reflecting an effective interest rate on this security of 13.477%. The Company
recorded future interest charges related to the New Series C until it was
exchanged for Series A Convertible Reedeemable Preferred Stock.
At December 31, 2003, there were cumulative New Series B dividends of
$1,181,918 and New Series C dividends of $1,047,669.
F-61
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
(12) EMPLOYEE STOCK OPTION PLANS
We currently have 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 the date of the MSI
acquisition, we adopted the Incentra Option Plan. In connection with the MSI
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 PLANS
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. We currently have reserved 2,262,500 shares of common stock for
issuance under the Incentra Option Plan. The Incentra Option Plan has a term of
ten years and provides for the grant of "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code of 1986, as amended,
nonstatutory stock options, stock appreciation rights and restricted stock
awards. The Incentra Option Plan is administered by our 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.
We have granted nonqualified stock options to certain employees 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
years. We have 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.
F-62
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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 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
Granted 456,450 1.62
Exercised --
Forfeited (68,494) 2.25
--------- ------
Balance, December 31, 2005 2,217,016 $ 2.92
========= ======
Outstanding Options Exercisable Options
--------------------------------- ------------------------
Weighted
average
remaining Shares Weighted
shares Weighted average Shares average
Exercise under contractual exercise currently exercise
price option life (years) price exercisable price
----- ------- ------------- -------- ----------- ----------
$ 1.21 - 13.90 2,188,516 8.6 $ 2.52 808,992 $ 2.69
20.00 - 29.00 11,000 3.4 24.06 11,000 24.06
40.00 17,500 0.6 40.00 17,500 40.00
------ ------
2,217,016 8.5 2.92 837,492 3.75
========= =======
ManagedStorage International, Inc.--2000 Stock Option and Grant Plan
Prior to the MSI 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 MSI 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 MSI acquisition agreement, upon the exercise of any
outstanding options issued under the MSI Plan, we will issue 0.3089
F-63
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
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 pursuant to options previously granted is 216,536 at December 31,
2005. Options to purchase our unregistered common stock are exercisable at a
price as determined by the board of directors at the time the options were
granted. Under the terms of the MSI Plan, the exercise prices for incentive
stock options granted shall not be less than 100% of the fair market value of
the unregistered common stock or our common stock 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. Options generally vested 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 $114,523,
$199,686 and $290,436 was recognized during 2005, 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:
F-64
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Number of Weighted Average
Options Exercise Price
-------------------------------
Balance at January 1, 2003 201 $ 16.20
Granted 249,589 0.30
Exercised (1,539) 0.50
Forfeited (19,045) 0.50
-------
Balance at December 31, 2003 229,206 0.50
Granted 22,225 3.20
Exercised (3,947) 3.33
Forfeited (27,883) 2.80
-------
Balance at December 31, 2004 219,601 0.50
Granted -
Exercised (454) 0.30
Forfeited (2,611) 0.26
-------
Balance at December 31, 2005 216,536 $ 0.43
======= ======
Outstanding Options Exercisable Options
-------------------------------------- ---------------------------
Weighted
average Shares Weighted
remaining Weighted average Shares average
Exercise shares under contractual exercise currently exercise
price option life (years) price exercisable price
- -------- ------------ ----------- -------- ------------ --------
$ 0.30 207,146 7.12 $ 0.30 154,865 $ 0.30
3.20 9,359 8.12 3.20 5,382 3.20
16.20 31 6.31 16.20 31 16.20
--------------- ------------
216,536 7.16 0.43 160,278 0.40
=============== ============
(13) WARRANTS
In determining the fair value of warrants granted in 2005 and 2004, we
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, 2005, we had the following warrants outstanding for the purchase
of our common stock:
F-65
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Number of Exercise
Description Expiration Date Shares Issuable Price
----------- --------------- --------------- ---------
Issued to original Front Porch
Shareholders March 31, 2007 30,000 $ 6.50
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 to Laurus 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
Issued to Laurus in exchange for
liquidated damages February 17, 2012 362,500 $ 2.60
Issued to Laurus in connection with
debt issuance June 30, 2012 400,000 $ 2.63
-------------
Total warrants outstanding 1,795,594
=============
At December 31, 2005, we had the following warrants outstanding for the
purchase of our Series A Convertible Preferred Stock:
Number of
Expiration Shares Exercise
Description Date Issuable price
----------- ---------- --------- --------
Issued to lease holder in connection
with equipment lease facility November 20, 2010 6,954 $6.02
Issued in exchange for services in
financing transaction January 10, 2008 26,075 $10.35
---------
Total warrants outstanding 33,029
=========
(14) EMPLOYEE CONTRIBUTION PLAN
We sponsor a 401(k) Savings Plan (the Plan). The Plan is a defined
contribution plan for all of our regular domestic employees 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. We 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.
F-66
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Employee contributions are 100% vested. Contributions made by the
company, 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
Our 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, we incurred liabilities to Equity Pier totaling $6,866 and $153,320,
respectively, primarily related to the reimbursement of travel and business
expenses incurred by the CEO and other executives. In addition, we leased office
space from Equity Pier in 2005, 2004, and 2003. Total costs incurred under the
leasing arrangement and associated expenses (utilities, supplies and insurance)
amounted to $190,178, $84,529, and $180,232, in 2005, 2004 and 2003,
respectively. During 2004 and 2003, we 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 $37,603, respectively.
During 2004, a director of our company entered into a consulting
agreement with our company to provide consulting services in the broadcast
industry. The agreement began on June 1, 2004 and expired on May 31, 2005. The
agreement required monthly payments of $2,500 plus expenses. During 2005 and
2004, we paid the director $13,274 and $18,711, respectively, in consulting fees
and expenses.
(16) INCOME TAXES
The domestic and foreign components of loss before income taxes for the
years ended December 31, 2005, 2004 and 2003 are as follows:
2005 2004 2003
---- ---- ----
Domestic $(15,123,970) $(11,343,294 $(10,991,371)
Foreign 1,367,447 1,305,000 -
------------ ------------ ------------
$(13,756,523) $(10,038,294 $(10,991,371)
============ ============ ============
We account for income taxes in accordance with Statement of Financial
Standard No. 109 "Accounting For Income Taxes" (SFAS 109). Under the provisions
of SFAS 109, a deferred tax liability or asset (net of a valuation allowance) is
provided for in the financial statements by applying the provisions of
applicable laws to measure the deferred tax consequences of temporary
differences that will result in net taxable or deductible amounts in future
years as a result of events recognized in the financial statements in the
current or preceding years.
The income tax provisions of $469,034 and $400,000 for the year ended
December 31, 2005 and December 31, 2004, respectively, consisted solely of
deferred, foreign income tax expense, related to our French subsidiary. During
the first three quarters of 2005, we recorded foreign income tax expense of $1.1
million
F-67
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
based on the earnings of our French subsidiary. In the fourth quarter of 2005,
we executed a license agreement for the sale of DIVArchive products owned by us
and sold to our French subsidiary with an effective date for payment of the
royalty for 2005 as of January 1, 2005. As a result of recording the cross
charge for royalties in the fourth quarter, earnings of the subsidiary
decreased, resulting in a fourth quarter reduction in deferred income tax
expense of $587,216.
The reconciliation between the federal statutory tax rate and our
effective tax rate on loss for 2005, 2004 and 2003 is as follows:
2005 2004 2003
---- ---- ----
Expected tax benefit of federal statutory tax rate (35.0%) (34.0%) (35.0%)
Increase (reduction) resulting from:
State tax--net of federal tax benefit (2.4%) (4.4%) (4.1%)
Effect of permanent differences 17.7% 10.3% 5.1%
Foreign taxes 0.1% 4.0%
Other - - 2.5%
Change in valuation allowance 23.0% 28.1% 31.5%
------ ------ ------
Actual income tax expense 3.4% 4.0% 0.0%
====== ====== ======
At December 31, 2005, approximately $95.9 million of federal and $80.1
million of state net operating loss carryforwards were available to offset
future taxable income through the year 2025. These net operating loss
carryforwards begin to expire in 2011. At December 31, 2005, the Company had
foreign loss carryforwards of approximately $14.8 million with no expiration
date.
The Tax Reform Act of 1986 contains provisions that limit the
utilization of net operating loss and tax credit carry forwards if there has
been a change in ownership as described in Section 382 of the Internal Revenue
Code. As a result of a private placement in 2003 and a reverse acquisition in
2004, we believe that there are substantial limitations on the utilization of
its net operating loss carry forwards. We have not prepared an analysis to
determine if a change of ownership occurred or the effect on the utilization of
the loss and credit carryforwards.
Significant components of our deferred tax assets and liabilities for
federal and state income taxes consist of the following as of December 31, 2005
and 2004:
F-68
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
2005 2004
---- ----
Deferred tax assets:
Accrued liabilities and other $ 1,003,248 $ 516,583
Property and equipment 317,075 630,916
Loss carryforwards 43,369,422 35,037,283
------------ ------------
Deferred tax assets 44,689,745 36,184,782
Deferred tax liabilities:
Intangible assets--Front Porch Digital Acquisition (5,011,325) (5,528,725)
Unremitted earnings of French subsidiary (1,357,960) (1,357,960)
------------ ------------
Deferred tax liabilities (6,369,285) (6,886,685)
Net deferred tax assets 38,320,460 29,298,097
Valuation allowance (38,320,460) (29,298,097)
------------ ------------
Net deferred tax assets $ - $ -
============ ============
Management has recorded a valuation allowance against the entire net
deferred tax asset, as management does not consider the realization of this
asset to be more likely than not.
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. U.S.
income taxes were not provided for on undistributed earnings of non-U.S.
subsidiaries as we intend to reinvest these earnings indefinitely in operations
outside the United States.
(17) INCENTRA OF CA NOTE DEFAULT AND ARBITRATION
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 financial condition.
In connection with our acquisition of Incentra of CA in February 2005,
we issued to the principal stockholder of Incentra of CA 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. 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.
F-69
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
On August 1, 2005, we elected not to make a scheduled payment 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 of the principal stockholder. As of the balance
sheet date, we have reclassified approximately $1.3 million of the debt to
current liabilities based on the default. We have been accruing interest at the
12% default rate since August 11, 2005.
In the event the dispute is not resolved in a mediation and the parties
proceed to arbitration, the full outstanding balance of the STAR Note could be
accelerated if the arbitrator does not rule in our favor in such proceeding. As
of the balance sheet date, the entire principal balance of $2.4 million ($2.1
million net of discount) on the STAR Note is classified as current. 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.
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.
The event of default on the STAR Note created an event of default of
certain provisions of the 2005 Facility and the Term Note with Laurus.
(18) SUBSEQUENT EVENTS
(A) NEW LAURUS LOC
On February 6, 2006, we entered into a New Security Agreement with
Laurus pursuant to which Laurus agreed to provide us with a non-convertible
revolving credit facility of up to $10 million (the "2006 Facility"). The term
of the 2006 Facility is three (3) years and borrowings under the 2006 Facility
shall accrue interest on the unpaid principal and interest at a rate per annum
equal to the "prime rate" published in The Wall Street Journal from time to
time, plus 1%, subject to a floor of 7%. In connection with the 2006 Facility,
we executed in favor of Laurus a secured non-convertible revolving note in the
principal amount of $10 million (the "NOTE"). Interest on borrowings under the
Note is payable monthly on the first day of each month during the term of the
Note, commencing on March 1, 2006. All outstanding principal amounts are due and
payable on February 6, 2009.
We entered into the New Security Agreement to pay off our existing $9
million convertible revolving credit facility with Laurus (the "Existing
Facility"), of which approximately $6 million was outstanding as of February 6,
2006. Prior to such date, the outstanding principal amount under the Existing
Facility was potentially convertible into approximately 3.6 million shares of
our common stock, par value $.01 per share (the "Common Stock"). In connection
with the 2006 facility, we issued to Laurus an option to purchase 1,071,428
shares of common stock. We also entered into an Amendment and
F-70
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Deferral Agreement (the "Amendment and Deferral Agreement") with Laurus amending
the Amended and Restated Secured Convertible Term Note (the "2004 Note") we
issued to Laurus on May 13, 2004 in the aggregate original principal amount of
$5,000,000, that is payable in full on May 13, 2007 (the "Maturity Date").
Pursuant to the Amendment and Deferral Agreement, the monthly principal amount
due Laurus under the 2004 Note for each of January, February, March, April, May
and June 2006, equal to an aggregate of $952,495, is deferred until the Maturity
Date. The Security Agreement increased the minimum initial amount available to
us and our subsidiaries from $6 million under the Existing Facility to $6.48
million under the 2006 Facility until April 30, 2006. Thereafter, the maximum
principal amount of all borrowings under the 2006 Facility cannot exceed 90% of
the eligible accounts receivable of each subsidiary, minus such reserves that
Laurus may in good faith deem necessary and appropriate.
On February 6, 2006, we requested and Laurus agreed to lend an initial
draw under the 2006 Facility of $6.38 million, of which (i) approximately $5.9
million was used to satisfy in full our indebtedness to Laurus under the
Existing Facility, (ii) $375,000 was paid to Laurus as an early termination fee
for the Existing Facility, and (iii) $107,500 was applied towards expenses of
the 2006 Facility.
All loans and obligations owed by us to Laurus arising under the New
Security Agreement, the Securities Purchase Agreement, dated as of May 13, 2004,
between us and Laurus (the "2004 Securities Purchase Agreement"), the Note, the
Option (as defined), the Registration Rights Agreement (as defined), the Stock
Pledge Agreement (as defined), or any other agreements or documents relating to
the relationship between us and Laurus (collectively, the "Ancillary Documents")
or otherwise are secured by a security interest in substantially all of the
assets of our company and the Subsidiaries pursuant to the terms of the Security
Agreement.
In addition, we pledged to Laurus all of the outstanding capital stock
of our subsidiaries pursuant to a Stock Pledge Agreement (the "Stock Pledge
Agreement") executed by us in favor of Laurus, and each of the Subsidiaries
executed a Subsidiary Guaranty, dated February 6, 2006 (the "Subsidiary
Guarantee"), in favor of Laurus, guaranteeing all of our present and future
obligations to Laurus, whether arising under the 2004 Securities Purchase
Agreement and the Related Documents (referred to therein), or under any other
obligations now existing or hereafter arising.
Under the terms of the New Security Agreement, if an event of default
occurs under any of the Ancillary Documents, Laurus has the right to accelerate
payments under the Note and, in addition to any other remedies available to it,
to foreclose upon the assets securing the Note. If an event of default occurs
under any of the Ancillary Documents, within five days after written notice to
us, Laurus may require a payment of 125% of the unpaid principal balance of the
Note, plus accrued interest and fees, which will become immediately due and
payable. Laurus shall also be entitled to payment of a default interest rate of
1.5% per month on all amounts due and such other remedies specified in the
Ancillary Documents and under the Uniform Commercial Code. Such events of
default include, without limitation, the following:
o a failure to make payments of principal and interest under the Note
within three (3) days of when due;
F-71
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
o a material breach by us of any provision contained in any of the
Ancillary Documents (that is not cured within the stated cure
period);
o the filing of any money judgment or similar final process against us
for more than $100,000, which remains unvacated, unstayed or
unbonded for a period of thirty (30) days;
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 thirty
(30) days;
o if our Common Stock is suspended for five (5) consecutive days or
for five (5) days during a ten (10) consecutive day period from a
principal market or pursuant to a stop order issued by the
Securities and exchange Commission (the "SEC") (provided that we
shall not have been able to cure such trading suspension within
thirty (30) days of our receipt of notice thereof or list our Common
Stock on another principal market within sixty (60) days of such
notice);
o and a failure by us to timely deliver shares of our Common Stock to
Laurus when due upon exercise of the Option.
The Security Agreement contains certain negative covenants that require
us to obtain the prior written consent or other actions of Laurus in order for
us to take certain actions at any time when borrowings remain outstanding under
the 2006 Facility. These negative covenants include, without limitation,
restrictions on our ability to: incur or assume indebtedness (exclusive of trade
debt) in excess of $100,000; guarantee or assume any liability in connection
with any obligations of another person or entity (except on behalf of the
Subsidiaries in the ordinary course of business); pay or make any dividend or
distribution on any class of our capital stock or the capital stock of the
Subsidiary or issue any preferred stock; or enter into any merger, consolidation
or reorganization, with limited exceptions.
OPTION. We issued to Laurus a common stock purchase option (the "Option"),
entitling Laurus to purchase up to 1,071,428 shares of our Common Stock at an
exercise price of $.001 per share (subject to applicable adjustments) (the
"Exercise Price"). The Option expires on February 26, 2026. Pursuant to the
Security Agreement, Laurus may not sell any shares of Common Stock it receives
through the exercise of the Option (the "Option Shares") prior to January 31,
2007. Additionally, Laurus agreed not to sell an amount of Option Shares that
would exceed thirty-five percent (35%) of the aggregate dollar trading volume of
our Common Stock for the twenty-two (22) trading day period immediately
preceding such sale.
Laurus may not exercise the Option in connection with a number of shares
of Common Stock which would exceed the difference between (i) 4.99% of the
issued and outstanding shares of Common Stock and (ii) the number of shares of
Common Stock beneficially owned by Laurus except upon (i) seventy-five (75)
days' prior notice from Laurus to us or (ii) upon the occurrence and continuance
of an event of default under the Security Agreement.
F-72
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
REGISTRATION RIGHTS AGREEMENT. Pursuant to the terms of an Amended and Restated
Registration Rights Agreement between us and Laurus (the "Registration Rights
Agreement"), which amends and restates in its entirety that certain Registration
Rights Agreement between Laurus and our company dated May 13, 2004, we are
obligated to file a post-effective amendment to our existing Registration
Statement on Form SB-2 originally filed on June 29, 2004 to include the shares
of Common Stock issuable (i) upon exercise of the Option, (ii) as a result of
adjustments made to the Exercise Price pursuant to the Option, (iii) upon
exercise of the warrant issued pursuant to the June 30, 2005 Security Agreement,
and (iv) as a result of adjustments made to the Exercise Price pursuant to such
warrant.
(B) NEW LAURUS TERM NOTES
On March 31, 2006, we consummated a private placement with Laurus
pursuant to which we issued to Laurus a secured term note due May 31, 2009 in
the principal amount of $1,500,000 (the "2006 Note") and a secured convertible
term note due May 31, 2009 in the principal amount of $1,750,000 (the "2006
Convertible Note") In connection with the issuance of the 2006 Note and the 2006
Convertible Note, we issued to Laurus a common stock purchase warrant (the "2006
Warrant") entitling the holder to purchase 417,857 shares of common stock (the
"2006 Warrant") at $0.001 per share subject to certain antidilution adjustments,
at any time after March 31, 2007 and on or prior to March 31, 2013. The 2006
Note, 2006 Convertible Note and the 2006 Warrant were sold to Laurus for a
purchase price of $3,250,000.
The 2006 Note and 2006 Convertible Note provide for monthly payments of
interest at a rate per annum equal to the "prime rate" published in the Wall
Street Journal from time to time, plus 2%, subject to a floor of 9%. The 2006
Note and 2006 Convertible Note also provide for monthly amortization of
principal, which commences on August 1, 2006, at the rate of $101,563 per month.
The principal and unpaid interest on the 2006 Convertible Note is convertible
into shares of our common stock at a fixed conversion price of $1.40 per share,
subject to certain antidilution adjustments. The 2006 Note and 2006 Convertible
Note are collateralized by a security interest in all of our assets.
The March 31, 2006 financing with Laurus is contingent upon meeting
certain closing conditions that must be satisfied on or before April 21, 2006.
In the event that such conditions are not satisfied on or before that date, the
private placement will terminate and no funding will occur.
Pursuant to a Registration Rights Agreement (the "2006 Registration
Rights") with Laurus, we are obligated to: (a) file a registration statement
under the Act to register the resale of the shares of our ("Registration
Statement") common stock issuable upon conversion of the 2006 Convertible Note
and exercise of the 2006 Warrant on or prior to May 15, 2006. (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 July 15, 2006 and (c) maintain
the effectiveness of the Registration Statement until the earliest date of when
(i) all Registrable Securities covered by such Registration Statement have been
sold, or (ii) all Registrable Securities covered by such Registration Statement
may be sold immediately without registration under the Securities Act and
without volume restrictions pursuant to Rule 144(k) under the Securities Act, or
(iii) except with respect to the shares issuable upon the exercise of the 2006
Warrant, all amounts payable under the 2006
F-73
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(Continued)
December 31, 2005, 2004 and 2003
Convertible Note have been paid in full. Laurus, or other holders of the 2006
Convertible Note and the 2006 Warrant, are entitled to certain specified
remedies if we do not timely comply with our registration obligations.
Pursuant to the 2006 Securities Purchase Agreement (the "Securities
Purchase Agreement") with Laurus, for so long as 25% of the original principal
amount of the 2006 Convertible Note and 2006 Warrant is outstanding, we may not
directly or indirectly declare or pay any dividends without the prior written
consent of Laurus. The 2006 Securities Purchase Agreement also requires the
written consent of Laurus in connection with any 1iquidation, material
reorganization, merger or acquisition involving our company, or the issuance of
certain additional indebtedness by our company.
The 2006 Note and 2006 Convertible Note contain certain events of
default consistent with those encompassed in our previous financings with
Laurus. Following the occurrence and during the continuance of any such event of
default, we are required to pay additional interest in an amount equal to (1.5%)
per month, and all outstanding obligations, including unpaid interest, shall
continue to accrue interest at such additional interest rate from the date of
such event of default until the date such event of default is cured or waived.
In addition, following the occurrence and during the continuance of any such
event of default, Laurus, at its option, may demand repayment in full of all
obligations and liabilities owing to Laurus and/or may elect, in addition to all
rights and remedies of Laurus, require the us to make a default payment which
shall be equal to 125% of the outstanding principal amount of the Note, plus
accrued but unpaid interest, all other fees then remaining unpaid, and all other
amounts payable by us to Laurus.
F-74
No dealer, salesperson, or other person has been authorized to give any
information or to make any representation not contained in this Prospectus, and,
if given or made, such information and representation should not be relied upon
as having been authorized by us or the selling stockholder. This Prospectus does
not constitute an offer to sell or a solicitation of an offer to buy any of the
securities offered by this Prospectus in any jurisdiction or to any person to
whom it is unlawful to make such offer or solicitation. Neither the delivery of
this Prospectus nor any sale made hereunder shall under any circumstances create
an implication that there has been no change in the facts set forth in this
Prospectus or in our affairs since the date hereof.
6,812,418 SHARES
INCENTRA SOLUTIONS, INC.
COMMON STOCK
------------------------
PROSPECTUS
------------------------
_______________ __, 2006
- --------------------------------------------------------------------------------
- --------------
DIVArchive(R) and BitScream(R) are registered trademarks of Incentra Solutions,
Inc. Gridworks(R) is a registered trademark of ManagedStorage International,
Inc.
PART II--INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. 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..... $ 991
Accounting fees and expenses............................ 25,000*
Legal fees and expenses................................. 35,000*
Miscellaneous fees and expenses......................... 4,009*
--------
Total......................................... $65,000*
========
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* Estimated
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 78.7502 of the Nevada Revised Statutes (the "Nevada Law")
permits a corporation to indemnify any of its directors, officers, employees and
agents against costs and expenses arising from claims, suits and proceedings if
such persons acted in good faith and in a manner reasonably believed to be in or
not opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, had no reasonable cause to believe his conduct
was unlawful. Notwithstanding the foregoing, in an action by or in the right of
the corporation, no indemnification may be made in respect of any claim, issue
or matter, as to which such person is adjudged to be liable to the corporation
unless a court of competent jurisdiction determines that in view of all the
circumstances of the case, indemnification would be appropriate. The
indemnification provisions of the Nevada Law expressly do not exclude any other
rights a person may have to indemnification under any bylaw, among other things.
Article XI of our Articles of Incorporation states that we may indemnify
each of our directors and executive officers with respect to actions taken or
not taken by said directors or executive officers in the course of their duties
for us to the fullest extent permitted by law. The specific terms of any such
indemnification is provided in the our bylaws.
Article VIII of our bylaws provides for the indemnification of any
person made a party to or involved in any civil, criminal or administrative
action, suit or proceeding by reason of the fact that he or his testator or
intestate is or was a director, officer or employee of ours, or of any company
which he, the testator, or intestate served as such at our request, shall be
indemnified by us against expenses reasonably incurred by him or imposed on him
in connection with or resulting from the defense of such action, suit or
proceeding and in connection with or resulting from any appeal thereon, except
with respect to matters as to which it is adjudged in such action, suit or
proceeding that such officer, director, or employee was liable to us, or to such
other corporation, for negligence or misconduct in the performance of his duty.
Article VIII of our bylaws further provides that a judgment of
conviction shall not of itself be deemed an adjudication that such director,
officer or employee is liable to us, or such other company, for negligence or
misconduct in the performance of his duties. Determination of the rights of such
indemnification and the amount thereof may be made at the option of the person
to be indemnified
II-1
pursuant to procedure set forth in the bylaws. Any determination that a payment
by way of indemnity should be made will be binding upon us. Such right of
indemnification shall not be exclusive of any other right which such of our
directors, officers, and employees may have or hereafter acquire, and without
limiting the generality of such statement, they shall be entitled to their
respective rights of indemnification under any bylaw, agreement, vote of
stockholders, provision of law, or otherwise in addition to their rights under
Article VIII. The provisions of Article VIII shall apply to any member of any
committee appointed by our Board of Directors as fully as though each person had
been a director, officer or employee of ours.
Any amendment to or repeal of our Articles of Incorporation or bylaws
shall not adversely affect any right or protection of any of our directors or
officers for or with respect to any acts or omissions of such director or
officer occurring prior to such amendment or repeal.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling persons pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
We maintain directors and officers insurance which, subject to certain
exclusions, insures our directors and officers against certain losses which
arise out of any neglect or breach of duty (including, but not limited to, any
error, misstatement, act, or omission) by the directors or officers in the
discharge of their duties, and insures us against amounts which we have paid or
may become obligated to pay as indemnification to our directors and/or officers
to cover such losses.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
On May 19, 2006, we entered into a note purchase agreement with eleven
investors, pursuant to which we issued and sold unsecured convertible term notes
in the aggregate principal amount of nine hundred sixty thousand dollars
($960,000) in connection with the offering by our company of up to four million
dollars ($4,000,000) aggregate principal amount of such convertible notes. The
notes are convertible, at the option of the purchasers, into shares our common
stock at a conversion price of $1.40 per share (as adjusted for stock splits,
stock dividends and the like). Of the $960,000 aggregate principal amount
purchased by investors in this offering, certain officers and directors of our
company purchased $675,000 aggregate principal amount. We also issued to the
purchasers five-year warrants to purchase an aggregate of 227,368 shares of our
common stock, at an exercise price $1.40 per share (as adjusted for stock
splits, stock dividends and the like). The convertible notes and warrants were
issued in reliance on the exemption from registration provided by Section 4(2)
of the Act, on the basis that their issuance did not involve a public offering,
no underwriting fees or commissions were paid by us in connection with such sale
and that the purchasers represented to us that they were "accredited investors",
as defined in the Act.
In April 2006, in connection with our acquisition of substantially all
of the assets of Network System Technologies, Inc. ("NST"), we issued to the
sole stockholder of NST, or his designees, a promissory note in the aggregate
principal amount of $1.5 million and an aggregate of 1,034,483 shares of our
common stock. Such securities were issued in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act, on the basis that
their issuance did not involve a public offering, no underwriting fees or sales
commissions were paid by us in connection with such sale and the recipient of
the securities represented to us that he was an "accredited investor," as
defined in the Securities Act of 1933, as amended.
In March 2006, in connection with a private placement to Laurus Master
Fund, Ltd. ("Laurus"), we issued a secured term note due May 31, 2009 in the
principal amount of $1,750,000, a secured convertible term note due May 31, 2009
in the principal amount of $1,500,000 and a common stock purchase warrant
entitling Laurus to purchase 417,857 shares of common stock (the "2006 Warrant")
at $0.001 per share. In consideration of the issuance of such securities, Laurus
paid us $3.25 million. The convertible term note is convertible into shares of
our common stock at a fixed conversion price of $1.40 per share. Such notes and
warrant were issued in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, on the basis that their issuance did
not involve a public offering, no underwriting fees or commissions were paid by
us in connection with such sale and Laurus represented to us that it is an
"accredited investor", as defined in the Securities Act of 1933.
In February 2006, in connection with a non-convertible revolving
credit facility from Laurus Master Fund, Ltd. ("Laurus") of up to $10 million
(the "2006 Revolver Facility"), we issued in favor of Laurus a secured
non-convertible revolving note in the principal amount of $10 million (the "2006
Note"). We entered into a security agreement and issued the 2006 Note to pay off
our existing $9 million convertible revolving credit facility with Laurus (the
"Existing Facility"), of which approximately $6 million was outstanding as of
February 6, 2006. Prior to such date, the outstanding principal amount under the
Existing Facility was potentially convertible into approximately 3.6 million
shares of our common stock. In connection with the 2006 Revolver Facility, we
issued to Laurus an option to purchase 1,071,428 shares of our common stock at
an exercise price of $.001 per share (subject to applicable adjustments). The
Option expires on February 26, 2026. The 2006 Note and Option were issued in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, on the basis that their issuance did not involve a
public offering, no underwriting fees or commissions were paid by us in
connection with such sale and Laurus represented to us that it is an "accredited
investor", as defined in the Securities Act of 1933.
II-2
On June 30, 2005, in connection with the credit facility from Laurus
described herein, we issued to Laurus a secured convertible promissory note in
the amount of $9.0 million, of which the first $3.0 million of borrowings are
convertible into shares of our common stock registered under the Securities Act
of 1933, as amended, at a fixed conversion price of $2.05 (as adjusted for
dilutive issuances, stock splits, stock dividends and the like "as adjusted"),
the second $3.0 million of borrowings is convertible into shares of unregistered
common stock at a fixed conversion price of $2.56; and a secured convertible
note in the amount of $3.0 million, which is convertible into shares of
unregistered common stock at a fixed conversion price of $2.99. The funding of
the secured convertible promissory note occurred on July 5, 2005 when we
advanced $6.0 million on this facility. On July 5, 2005, in connection with the
closing of this transaction, we issued to Laurus the notes and warrants
described above. Such issuance was made in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act, on the basis that
their issuance did not involve a public offering, no underwriting fees or sales
commissions were paid by us in connection with such issuance and Laurus
represented to us that it was an "accredited investor," as defined in the
Securities Act of 1933, as amended.
In March 2005, we issued an aggregate of 841,934 shares of unregistered
common stock to the stockholders of PWI Technologies, Inc. ("PWI"), or their
designees, in connection with the acquisition of all of the outstanding shares
of PWI. The transaction, including the type and amount of consideration paid by
us, was previously reported in a Current Report on Form 8-K filed with the
Securities and Exchange Commission (the "Commission") on April 4, 2005. The
shares were issued in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"),
on the basis that their issuance did not involve a public offering, no
underwriting fees or sales commissions were paid by us in connection with such
sale and each former PWI stockholder represented to us that he or she was an
"accredited investor," as defined in the Securities Act.
In February 2005, we issued an aggregate of 1,261,756 shares of
unregistered common stock to the principal stockholder of Incentra of CA
("Incentra of CA"), or his designees, in connection with the acquisition of all
of the outstanding shares of Incentra of CA. The transaction, including the type
and amount of consideration paid by us, was previously reported in a Current
Report on Form 8-K filed with the Commission on February 23, 2005. The shares
were issued in reliance on the exemption from registration provided by Section
4(2) of the Securities Act, on the basis that their issuance did not involve a
public offering, no underwriting fees or sales commissions were paid by us in
connection with such sale and such stockholder represented to us that he was an
"accredited investor," as defined in the Securities Act.
In February 2005, we issued an unsecured convertible promissory note in
the principal amount of $2,500,000 to the principal stockholder of Incentra of
CA, in connection with the acquisition of all of the outstanding shares of
Incentra of CA. The transaction, including the type and amount of consideration
paid by us, was previously reported in a Current Report on Form 8-K filed with
the Commission on February 23, 2005. The unsecured convertible promissory note
was issued in reliance on the exemption from registration provided by Section
4(2) of the Securities Act, on the basis that its issuance did not involve a
public offering, no underwriting fees or sales commissions were paid by us in
connection with such issuance and such stockholder, the acquirer of the Note,
represented to us that he was an "accredited investor," as defined in the
Securities Act.
In February 2005, in consideration of waiving certain events of
default and certain of its rights under loan documents, we issued to Laurus an
immediately exercisable seven-year warrant to purchase, at any time on or prior
to February 17, 2012, 362,500 shares of our common stock at an exercise price of
$2.60 per share. The warrant was issued in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act, on the basis that
its issuance
II-3
did not involve a public offering, no underwriting fees or sales commissions
were paid by us in connection with such issuance and Laurus represented to us
that it was an "accredited investor," as defined in the Securities Act.
In October 2004, we issued 455 shares of common stock to a former
employee pursuant to the exercise of employee stock options. The exercise price
was $0.30 per unregistered share and the aggregate proceeds to us were $138.The
shares were issued in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act, on the basis that such issuance did not
involve a public offering and no underwriter fees or commissions were paid in
connection with such issuance.
In October 2004, in consideration of waiving certain events of defaults
and certain of its rights under loan documents, we agreed to issue to Laurus an
immediately exercisable seven-year warrant to purchase, on or prior to October
25, 2011, 50,000 shares of our common stock at an exercise price of $5.00 per
share. The warrants were issued in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act, on the basis that such issuance
did not involve a public offering, no underwriter fees or commissions were paid
in connection with such issuance and Laurus represented to the Company that it
was an "accredited investor," as defined in Regulation D under the Securities
Act.
In September 2004, we issued 29,365 shares of common stock to a
noteholder in lieu of a cash payment in the amount of $12,500, representing
accrued but unpaid interest pursuant to an 8% unsecured convertible note. The
shares were issued in reliance on the exemption from registration provided by
Regulation D under the Securities Act, and Rule 506 promulgated thereunder on
the basis that such issuance did not involve a public offering, no underwriter
fees or commissions were paid in connection with such issuance and such
noteholder acquired the convertible note and shares in a private placement to a
limited number of "accredited investors," as defined in Regulation D under the
Securities Act.
In August 2004, we issued an aggregate of 4,745,496 shares of common
stock and 2,466,971 shares of Series A Redeemable Convertible Preferred Stock to
certain of the stockholders of ManagedStorage International, Inc. ("MSI") in
connection with our acquisition of all of the outstanding shares of MSI. The
transaction, including the type and amount of consideration paid by us, was
previously reported in a Current Report on Form 8-K filed with the Securities
and Exchange Commission on August 20, 2004. The shares we issued in the
transaction were issued in reliance on the exemption from registration provided
by Section 4(2) of the Securities Act, on the basis that such issuance did not
involve a public offering, no underwriter fees or commissions were paid in
connection with such issuance and such persons represented to the Company that
they were "accredited investors," as defined in Regulation D under the
Securities Act.
In June 2004, we issued an aggregate of 52,400 shares of common stock to
Michael Knaisch, President of our Front Porch Digital division and our former
Chief Executive Officer, and Matthew Richman, our Vice President of Corporate
Development and our former Chief Financial Officer, in satisfaction of Messrs.
Knaisch and Richman's outstanding accrued 2003 bonuses. The shares were issued
in reliance on the exemption from registration provided by Section 4(2) of the
Securities Act on basis that the issuance did not involve a public offering, no
underwriting fees or commissions were paid by us in connection with such
issuance and Messrs. Knaisch and Richman represented to us that they were
"accredited investors," as defined in the Securities Act.
In June 2004, we issued 49,000 shares of unregistered common stock to
Biscayne Capital Markets, Inc. ("Biscayne") in satisfaction of the $245,000
financing commission it earned in connection with the consummation of a $5
million financing with Laurus. The shares were issued in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act, on
the basis that the issuance did not involve a public offering, no underwriting
fees or commissions were paid by us in connection
II-4
with such sale and Biscayne represented to us that it was an "accredited
investor," as defined in the Securities Act.
In June 2004, we issued a warrant to purchase up to 30,000 shares of
unregistered common stock, at a price of $5.00, to LGH Capital, LLC ("LGH") in
satisfaction of financing commissions it earned in connection with the
consummation of a $5 million financing with Laurus. The warrant was issued in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act, on the basis that the issuance did not involve a public
offering, no underwriting fees or commissions were paid by us in connection with
such sale and LGH represented to us that it was an "accredited investor," as
defined in the Securities Act.
In May 2004, we issued a secured convertible term note in the principal
amount of $5,000,000 to Laurus in connection with the consummation of a $5
million financing with Laurus. The convertible term note is convertible into
shares of our common stock at a fixed conversion price of $3.00 per share. We
also issued Laurus a seven-year warrant to purchase up to 443,550 shares of our
common stock, at an exercise price of $3.00 per share. The convertible term note
and the warrant were issued in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act, on the basis that their issuance
did not involve a public offering, no underwriting fees or commissions were paid
by us in connection with such sale and Laurus represented to us that it was an
"accredited investor," as defined in the Securities Act.
In April 2003, we issued $645,000 aggregate principal amount of 8%
unsecured convertible promissory notes to a group of investors primarily
consisting of existing stockholders and management. The notes were sold in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act, on the basis that the issuance did not involve a public
offering, no underwriting fees or commissions were paid by us in connection with
such sale and the purchasers represented to us that they were "accredited
investors," as defined in the Securities Act.
In April 2003, $250,000 aggregate principal amount of outstanding
convertible notes and all accrued interest were converted into 678,572 shares of
our common stock and $250,000 principal amount of the outstanding convertible
notes was exchanged for our 8% unsecured convertible promissory notes by the
holders of such convertible notes. The exchange and conversion of the
convertible notes were made in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act on the basis that neither the
exchange nor the conversion involved a public offering, no underwriting fees or
commissions were paid by us in connection with such exchange or conversion and
the holders represented to us that they were "accredited investors," as defined
in the Securities Act.
ITEM 16. EXHIBITS
EXHIBIT NUMBER DESCRIPTION
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2.1 Stock Purchase Agreement, dated as of March 30, 2005, by and among our
company, Incentra Merger Corp., 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 1, 2005).
2.2 Stock Purchase Agreement, dated as of April 13, 2006, by and between our
company and Network System Technologies, Inc. (incorporated by reference
to Exhibit 2.1 filed with our Current Report on Form 8-K filed on April
17, 2006).
II-5
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
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 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).
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 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).
3.10 Certificate of Amendment to Articles of Incorporation dated as June 9,
2005 (incorporated by reference to Exhibit 3.1 filed with our Current
Report on Form 8-K, filed June 9, 2005.
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 Registration Rights Agreement dated as of October 10, 2000 between us
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).
10.3 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).
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10.4 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).
10.5 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).
10.6 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).
10.7 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).
10.8 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).
10.9 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).
10.10 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).
10.11 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).
10.12 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).
10.13 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).
10.14 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).
10.15 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).
10.16 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).
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10.17 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).
10.18 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).
10.19 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).
10.20 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).
10.21 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).
10.22 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).
10.23 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).
10.24 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).
10.25 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).
10.26 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 year ended December 31,
2004).
10.27 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 year ended December 31, 2004).
10.28 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 year ended December 31,
2004).
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10.29 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 year ended December 31, 2004).
10.30 $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).
10.31 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).
10.32 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).
10.33 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).
10.34 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).
10.35 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).
10.36 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).
10.37 Registration Rights Agreement, dated as of March 30, 2005 by and between
Incentra Solutions, Inc. 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).
10.38 Common Stock Purchase Warrant, dated as of June 30, 2005, by Incentra
Solutions, Inc. 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 June 30, 2005).
10.39 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 June 30, 2005).
10.40 Employment Agreement, effective October 17, 2005, between Incentra
Solutions, Inc. and Shawn O'Grady (incorporated by reference to Exhibit
10.1 filed with our Current Report on Form 8-K filed on October 17,
2005.)
10.41 Security Agreement, dated as of February 6, 2006, by and among our
company, PWI Technologies, Inc., Incentra Solutions of California, Inc.,
ManagedStorage International, Inc., and
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Incentra Solutions International, Inc. and Laurus Master Fund, Ltd.
(incorporated by reference to Exhibit 10.1 filed with our Current Report
on Form 8-K filed on February 6, 2006).
10.42 Secured Non-Convertible Revolving Note, dated as of February 6, 2006,
executed by our company, PWI Technologies, Inc., Incentra Solutions of
California, Inc., ManagedStorage International, Inc., and Incentra
Solutions, International, 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 February 6, 2006).
10.43 Stock Pledge Agreement, dated as of February 6, 2006, executed by our
company and ManagedStorage International, Inc. 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 February 6, 2006).
10.44 Subsidiary Guaranty, dated as of February 6, 2006, executed by PWI
Technologies, Inc., Incentra Solutions of California, Inc.,
ManagedStorage International, Inc., and Incentra Solutions
International, Inc. in favor of Laurus Master Fund, Ltd. (incorporated
by reference to Exhibit 10.4 filed with our Current Report on Form 8-K
filed on February 6, 2006).
10.45 Registration Rights Agreement, dated as of February 6, 2006 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 on
February 6, 2006).
10.46 Common Stock Purchase Option, dated as of February 6, 2006, executed 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 February 6, 2006).
10.47 Grant of Security Interest in Patents and Trademarks, dated as of
February 6, 2006, executed by our company and ManagedStorage
International, Inc. in favor of Laurus Master Fund, Ltd. (incorporated
by reference to Exhibit 10.7 filed with our Current Report on Form 8-K
filed on February 6, 2006).
10.48 Amendment and Deferral Agreement, dated as of February 6, 2006, 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 February 6, 2006).
10.49 Securities Purchase Agreement, dated as of March 31, 2006, by and
between our company and Laurus Master Fund, Ltd. (Incorporated by
reference to Exhibit 10.56 filed with our Annual Report on Form 10-KSB
for the period ended December 31, 2005, filed on April 4, 2006).
10.50 Secured Convertible Term Note, dated as of March 31, 2006, by Incentra
Solutions, Inc. in favor of Laurus Master Fund, Ltd. (Incorporated by
reference to Exhibit 10.57 filed with our Annual Report on Form 10-KSB
for the period ended December 31, 2005, filed on April 4, 2006).
10.51 Non-convertible Secured Term Note, dated as of March 31, 2006, by
Incentra Solutions, Inc. in favor of Laurus Master Fund, Ltd.
(Incorporated by reference to Exhibit 10.58 filed with our Annual Report
on Form 10-KSB for the period ended December 31, 2005, filed on April 4,
2006).
10.52 Common Stock Purchase Warrant, dated as of March 31, 2006, issued by our
company to Laurus Master Fund, Ltd. (Incorporated by reference to
Exhibit 10.59 filed with our Annual Report on Form 10-KSB for the period
ended December 31, 2005, filed on April 4, 2006).
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10.53 Registration Rights Agreement, dated as of March 31, 2006, by and
between our company and Laurus Master Fund, Ltd. (Incorporated by
reference to Exhibit 10.60 filed with our Annual Report on Form 10-KSB
for the period ended December 31, 2005, filed on April 4, 2006).
10.54 Joinder Agreement, dated as of March 31, 2006, executed by PWI
Technologies, Inc., Incentra Solutions of California, Inc. and Incentra
Solutions International, Inc. and delivered to Laurus Master Fund, Ltd.
(Incorporated by reference to Exhibit 10.61 filed with our Annual Report
on Form 10-KSB for the period ended December 31, 2005, filed on April 4,
2006).
10.55 Promissory Note, dated April 13, 2006, by our company in favor of Joseph
J. Graziano (incorporated by reference to Exhibit 10.1 filed with our
Current Report on Form 8-K filed on April 17, 2006).
10.56 Registration Rights Agreement, dated as of April 13, 2006, by and
between our company and Joseph J. Graziano (incorporated by reference to
Exhibit 10.2 filed with our Current Report on Form 8-K filed on April
17, 2006).
10.57 Registration Rights Agreement, dated as of April 13, 2006, by and
between our company and Transitional Management Consultants, Inc.
(incorporated by reference to Exhibit 10.3 filed with our Current Report
on Form 8-K filed on April 17, 2006).
10.58 Consulting and Subcontractor Agreement, dated as of April 13, 2006, by
and between our company, Network System Technologies, Inc. and
Transitional Management Consultants, Inc. (incorporated by reference to
Exhibit 10.4 filed with our Current Report on Form 8-K filed on April
17, 2006).
10.59 Lock-Up Agreement, dated as of April 13, 2006, by and between our
company and Joseph J. Graziano (incorporated by reference to Exhibit
10.5 filed with our Current Report on Form 8-K filed on April 17, 2006).
10.60 Joinder Agreement, dated as of April 13, 2006, by Network System
Technologies, Inc. in favor of Laurus Master Fund Ltd. (incorporated by
reference to Exhibit 10.5 filed with our Current Report on Form 8-K
filed on April 17, 2006).
10.61 2006 Stock Option Plan of Incentra Solutions, Inc, (incorporated by
reference to Exhibit 10.1 filed with our Quarterly Report on Form 10-QSB
for the period ended March 31, 2006).
10.62 Note Purchase Agreement, dated as of May 19, 2006, by and among our
company and the purchasers executing a joinder agreement thereto
(incorporated by reference to Exhibit 10.1 filed with our Current Report
on Form 8-K filed on May 19, 2006).
10.63 Form of Convertible Term Note, May 19, 2006, executed by our company
(incorporated by reference to Exhibit 10.2 filed with our Current Report
on Form 8-K filed on May 19, 2006).
10.64 Form of Common Stock Purchase Warrant to purchase shares of common
stock, dated as of May 19, 2006(incorporated by reference to Exhibit
10.3 filed with our Current Report on Form 8-K filed on May 19, 2006).
10.65 Registration Rights Agreement, dated as of May 19, 2006, between our
company and the purchasers executing a joinder agreement thereto
(incorporated by reference to Exhibit 10.4 filed with our Current Report
on Form 8-K filed on May 19, 2006).
21. Subsidiaries - The significant wholly-owned subsidiaries are as follows:
NAME JURISDICTION OF ORGANIZATION
---- ----------------------------
Managed Storage International, Inc. Delaware
Incentra of CA, Inc. Delaware
PWI Technologies, Inc. Washington
Network System Technologies, Inc. Illinois
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).
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24.1 Powers of Attorney of certain officers and directors of the company
(included on the signature page of this Registration Statement).
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended (the "Securities Act") may be permitted to directors,
officers and controlling persons of the Company, we have been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Company in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, we will,
unless in the opinion of our counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned Company hereby undertakes that:
(1) To file, during any period in which it offers or sells
securities, a post-effective amendment to this Registration
Statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change
in the information set forth in the Registration
Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or
high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in volume and price represent no more than a
20% change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in
the effective Registration Statement;
(iii) Include any additional or changed information on the plan
of distribution.
(2) For determining liability under the Securities Act, the Company
will treat each such post-effective amendment as a new
Registration Statement of the securities offered, and the
offering of such securities at that time to be the initial bona
fide offering.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
(4) For determining any liability under the Securities Act, treat
each post-effective amendment that contains a form of prospectus
as a new Registration Statement for the securities offered in the
Registration Statement, and that offering of the securities at
that time as the initial bona fide offering of those securities.
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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 S-1 and authorized this Registration
Statement on Form S-1 to be signed on its behalf by the undersigned, in Boulder,
Colorado on June 2, 2006.
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
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Thomas P. Sweeney III as true and lawful
attorney-in-fact and agent with full power of substitution and resubstitution
and for him/her and in his/her name, place and stead, in any and all capacities
to sign any and all amendments (including pre-effective and post-effective
amendments) to this Registration Statement, as well as any new registration
statement filed to register additional securities pursuant to Rule 462(b) under
the Securities Act, and to file the same with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitute or substitutes may lawfully do or cause to be done by
virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement was signed by the following persons in the capacities and
on the dates stated.
SIGNATURE TITLE DATE
/s/Thomas P. Sweeney III Chairman of the Board and Chief June 2, 2006
-------------------------- Executive Officer
Thomas P. Sweeney III (principal executive officer)
/s/Paul McKnight Chief Financial Officer and Director June 2, 2006
-------------------------- (principal financial and
Paul McKnight accounting officer)
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/s/Patrick Whittingham Director June 2, 2006
--------------------------
Patrick Whittingham
/s/James Wolfinger Director June 2, 2006
--------------------------
James Wolfinger
/s/Carmen J. Scarpa Director June 2, 2006
--------------------------
Carmen J. Scarpa
/s/Thomas G. Hudson Director June 2, 2006
--------------------------
Thomas G. Hudson
/s/David E. Weiss Director June 2, 2006
--------------------------
David E. Weiss
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