UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the period ended June 30, 2006
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______ to _______.
Commission File Number 333-16031
INCENTRA SOLUTIONS, INC.
------------------------
(Exact name of small business issuer as specified in its charter)
Nevada 86-0793960
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(State or other jurisdiction (I.R.S. Employer
of (incorporation or organization) Identification No.)
1140 PEARL STREET
BOULDER, COLORADO 80302
-----------------------
(Address of principal executive offices)
(303) 449-8279
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(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. Yes [_] No [X]
As of August 7, 2006, 13,285,713 shares of the issuer's common stock, $.001 par
value per share, and 2,466,971 shares of the issuer's Series A preferred stock,
$.001 par value per share, were outstanding.
Transitional Small Business Disclosure Format (check one): Yes [_] No [X]
PART I. FINANCIAL INFORMATION
INCENTRA SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
JUNE 30,
2006
----
ASSETS
Current assets:
Cash and cash equivalents $ 967,595
Accounts receivable, net of allowance for
doubtful accounts of $224,496 9,038,079
Other current assets 743,582
Assets held for sale (Note 5) 19,770,920
-------------
Total current assets 30,520,176
Property and equipment, net 2,288,012
Capitalized software development costs, net 909,004
Intangible assets, net 624,000
Goodwill 14,698,106
Restricted cash 38,175
Other assets 510,492
-------------
TOTAL ASSETS $ 49,587,965
=============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current portion of notes payable, capital leases
and other long term obligations $ 19,996,934
Accounts payable 10,269,472
Accrued expenses 3,883,704
Current portion of deferred revenue 775,024
Liabilities associated with assets held for sale (Note 5) 5,252,029
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Total current liabilities 40,177,163
Notes payable, capital leases and other long term
obligations, net of current portion 838,824
Deferred revenue, net of current portion 111,141
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TOTAL LIABILITIES 41,127,128
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Commitments and contingencies
Series A convertible preferred stock, $.001 par value,
$31,500,000 liquidation preference, 2,500,000 shares
authorized, 2,466,971 shares issued and outstanding 25,927,117
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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,
14,421,293 shares outstanding at June 30, 2006 14,421
Additional paid-in capital 122,738,844
Accumulated other comprehensive gain 210,164
Accumulated deficit (140,429,709)
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TOTAL SHAREHOLDERS' DEFICIT (17,466,280)
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TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 49,587,965
=============
See accompanying notes to unaudited condensed consolidated financial statements.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2006 2005 2006 2005
---------------------------- ----------------------------
Revenues:
Products $14,739,546 $ 10,422,023 $ 20,579,015 $ 11,524,000
Services 3,362,707 3,120,682 5,882,577 5,198,340
----------- ------------ ------------ ------------
TOTAL REVENUE 18,102,253 13,542,705 26,461,592 16,722,340
----------- ------------ ------------ ------------
Cost of revenue:
Products 12,433,923 8,923,683 17,089,836 9,694,174
Services 2,262,237 2,005,189 4,204,612 3,400,662
----------- ------------ ------------ ------------
Total cost of revenue 14,696,160 10,928,872 21,294,448 13,094,836
----------- ------------ ------------ ------------
GROSS MARGIN 3,406,093 2,613,833 5,167,144 3,627,504
Selling, general and administrative 5,480,587 3,709,220 9,398,833 6,087,945
Stock-based compensation expense 468,452 60,792 835,332 168,861
Depreciation and amortization 134,774 286,638 268,119 582,573
----------- ------------ ------------ ------------
6,083,813 4,056,650 10,502,284 6,839,379
----------- ------------ ------------ ------------
OPERATING LOSS FROM CONTINUING OPERATIONS (2,677,720) (1,442,817) (5,335,140) (3,211,875)
----------- ------------ ------------ ------------
Other income (expense):
Interest income 205 3,516 339 25,947
Interest expense (1,045,115) (610,000) (1,668,674) (1,171,310)
Loss on early extinguishment of debt - - (1,232,174) -
Other income (expense) 23,828 (34,843) 33,669 319,897
Foreign currency transaction gain 18,239 1,424 17,551 1,397
----------- ------------ ------------ ------------
(1,002,843) (639,903) (2,849,289) (824,069)
----------- ------------ ------------ ------------
LOSS FROM CONTINUING OPERATIONS (3,680,563) (2,082,720) (8,184,429) (4,035,944)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS,
NET OF INCOME TAXES (Note 5) (465,805) (273,406) 399,053 (668,749)
----------- ------------ ------------ ------------
NET LOSS (4,146,368) (2,356,126) (7,785,376) (4,704,693)
Accretion of redeemable preferred stock to redemption amount (654,392) (654,392) (1,308,784) (1,308,784)
----------- ------------ ------------ ------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $(4,800,760) $ (3,010,518) $ (9,094,160) $ (6,013,477)
=========== ============ ============ ============
COMPREHENSIVE NET LOSS
Net loss $(4,146,368) $ (2,356,126) $ (7,785,376) $ (4,704,693)
Foreign currency translation adjustments 305,377 (76,717) 313,399 $ (153,950)
----------- ------------ ------------ ------------
$(3,840,991) $ (2,432,843) $ (7,471,977) $ (4,858,643)
=========== ============ ============ ============
Weighted average number of common shares outstanding -
basic and diluted 14,239,362 12,703,068 13,780,565 11,901,066
=========== ============ ============ ============
Basic and diluted net loss per share applicable to
common shareholders:
Loss from continuing operations $ (0.31) $ (0.22) $ (0.69) $ (0.45)
Income (loss) from discontinued operations (0.03) (0.02) 0.03 (0.06)
----------- ------------ ------------ ------------
Net loss per share--basic and diluted $ (0.34) $ (0.24) $ (0.66) $ (0.51)
=========== ============ ============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
INCENTRA SOLUTIONS AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT AND
COMPREHENSIVE GAIN (LOSS)
SIX MONTHS ENDED JUNE 30, 2006
(UNAUDITED)
ACCUMULATED
COMMON STOCK OTHER
--------------------- ADDITIONAL COMPREHENSIVE ACCUMULATED
SHARES AMOUNT PAID-IN CAPITAL GAIN (LOSS) DEFICIT TOTAL
---------- -------- --------------- ------------- -------------- --------------
BALANCES, JANUARY 1, 2006 13,326,810 $ 13,327 $ 119,517,168 $ (103,235) $ (132,644,333) $ (13,217,073)
Common stock issued in
acquisition of Network
Systems Technologies, Inc.
(Note 4) 1,034,483 1,034 1,303,449 1,304,483
Amortization of employee
stock-based
compensation expense 884,665 884,665
Accretion of FPDI mandatorily
redeemable preferred stock to
redemption amount (1,308,784) (1,308,784)
Warrants issued to Laurus
related to 2006 financings
(Notes 7(B) and 7(C)) 1,707,052 1,707,052
Common stock issued to
investment advisor 60,000 60 80,340 80,400
Warrants issued related to
Convertible Notes (Note 7(E)) 554,954 554,954
Components of comprehensive
loss:
Net loss (7,785,376) (7,785,376)
Change in foreign currency
translation adjustments 313,399 313,399
--------------
Total comprehensive loss (7,471,977)
--------------------------------------------------------------------------------------------
BALANCES, JUNE 30, 2006 14,421,293 $ 14,421 $ 122,738,844 $ 210,164 $ (140,429,709) $ (17,466,280)
=========== ======== ============= ========== =============== ==============
See accompanying notes to unaudited consolidated financial statements.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
2006 2005
---- ----
Cash flows from operating activities:
Net loss $ (7,785,376) $ (4,704,693)
Adjustments to reconcile net loss to net cash used in continuing operating activities:
(Income) loss from discontinued operations, net of income taxes (399,053) 668,749
Depreciation 728,067 736,519
Amortization of intangible assets and software development costs 320,270 661,862
Amortization of non-cash loan discount 0 12,735
Stock-based compensation 835,332 168,851
Non-cash interest expense 768,214 959,402
Non-cash loss on early extinguishment of debt 749,674
Bad debt expense 12,204 20,787
Loss on disposal of assets 45,773
Gain on revaluation of of derivative warrant liability (390,280)
Changes in operating assets and liabilities, net of business acquisitions:
Accounts and other receivables 1,086,160 337,574
Other current assets 140,220 90,440
Other assets (40,544) 55,496
Accounts payable (75,945) 40,903
Accrued liabilities 458,152 (396,693)
Deferred revenue 54,913 (102,545)
Other liabilities 182,227 (68,932)
------------ ------------
Net cash used in continuing operations (2,965,485) (1,864,052)
Net cash provided by discontinued operations 977,892 745,451
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Net cash used in operating activities (1,987,593) (1,118,601)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (838,930) (409,929)
Capitalized software development costs (307,419) (309,504)
Proceeds from sale of property and equipment 750
Cash acquired in STAR acquisition 1,597,498
Cash acquired in PWI acquisition 74,297
Cash paid in acquisition of NST (Note 4) (5,192,858)
Net change in restricted cash 42,781 (366)
------------ ------------
Net cash (used in) provided by continuing operations (6,296,426) 952,746
Net cash used in discontinued operations (616,613) (526,314)
------------ ------------
Net cash (used in) provided by investing activities (6,913,039) 426,432
------------ ------------
Cash flows from financing activities:
Proceeds from line of credit, net 3,895,096 131,452
Proceeds form acquisition term notes 3,250,000
Proceeds from convertible notes 2,410,000
Proceeds from lease line of credit, net 56,180 (12,424)
Payments on capital leases, notes payable and other long-term liabilities (186,333) (354,315)
------------ ------------
Net cash provided by (used in) continuing operations 9,424,943 (235,287)
Net cash provided by (used in) discontinued operations
------------ ------------
Net cash provided by (used in) financing activities 9,424,943 (235,287)
Effect of exchange rate changes on cash and cash equivalents (related to discontinued operations) 291,364 (82,417)
Net increase (decrease) in cash and cash equivalents from continuing operations 163,032 (1,146,593)
Net increase in cash and cash equivalents from discontinued operations 652,643 136,720
------------ ------------
Net increase (decrease) in cash and cash equivalents 815,675 (1,009,873)
------------ ------------
Cash and cash equivalents at beginning of period:
Continuing operations 804,563 2,469,881
Discontinued operations 304,079 598,576
------- -------
Total 1,108,642 3,068,457
Cash and cash equivalents at end of period:
Continuing operations 967,595 1,323,288
Discontinued operations 956,722 735,296
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Total $ 1,924,317 $ 2,058,584
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 900,121 $ 185,961
Supplemental disclosures of non-cash investing and financing activities:
Net liabilities acquired in Incentra of CA acquisition, excluding cash 620,178
Net assets acquired in PWI acquisition, excluding cash 269,306
Net liabilities acquired in NST acquisition, excluding cash (Note 4) 958,490
Purchases of property and equipment included in accounts payable 220,414
Conversion of notes payable and accrued interest in exchange for common stock 400,000
Reclassification of derivative liability to equity 1,910,254
See accompanying notes to unaudited condensed consolidated financial statements.
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 four 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 "); on March 30, 2005, we acquired PWI
Technologies, Inc., a privately-held Washington corporation ("PWI"); and on
April 13, 2006, we acquired Network Systems Technologies, Inc, a private-held
Illinois corporation ("NST"). 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.
On July 31, 2006, we completed the sale of the assets of FPDI. The sale
included all of the outstanding capital stock of our wholly-owned subsidiary in
France, Front Porch Digital International, SAS. FPDI provides archive solutions
to broadcasters and media companies. The sales price was approximately $33
million in cash and we have the right to receive up to an additional $5 million
in cash pursuant to the terms of an earn-out based on a percentage of gross
revenues received by Front Porch from certain software sales through December
31, 2008. Management believes the sale of the FPDI business will allow us to
focus on our core business as represented by Incentra of CA, MSI, PWI, and NST.
Proceeds from the sale of FPDI were used to repay most of our long-term debt
(see Note 10(B)) and management plans to use the remainder for investment in our
other businesses, potential future acquisitions, and to generally strengthen our
balance sheet.
We provide complete solutions for an enterprise's data protection
needs. We supply a broad range of storage products and storage management
services to enterprises and information technology service providers worldwide.
We market to service providers and enterprise clients under the trade names MSI,
Incentra of CA, PWI and NST. 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. Our customers are located in North America, Europe,
Asia and the Pacific Rim.
BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements as of June
30, 2006 and for the three and six months ended June 30, 2006 and 2005 include
Incentra Solutions, Inc. and its wholly-owned subsidiaries, MSI, which is based
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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; PWI, which is based in Kirkland, Washington; and NST, which is based
in Lombard, Illinois, from the date of acquisition through June 30, 2006. As a
result of the asset sale (as discussed in Note 5), the operations of FPDI are
presented retroactively for 2005 as discontinued operations. Substantially all
of its operating assets, including certain liabilities associated with these
assets, are presented as held for sale as of June 30, 2006 and are classified as
current since the proceeds were realized in cash in July 2006. ManagedStorage
UK, Inc. and Seabrook Technologies, Inc. did not have any significant operating
activities during the quarter ended June 30, 2006 and the six months then ended.
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. Except as described above, 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 MATTERS AND RESOLUTION
Our unaudited condensed consolidated financial statements as of June
30, 2006 and for the quarter and six months 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 the
former principal stockholder of Incentra of CA.
On July 28, 2006, we entered into a Letter Agreement, as amended on
July 31, 2006, with the former principal stockholder of Incentra of CA, pursuant
to which we settled all claims and disputes with the former principal
stockholder that arose from our claimed adjustment of the purchase price paid in
connection with our acquisition of Incentra of CA in February 2005. Pursuant to
the Letter Agreement, as amended, we agreed to pay the former principal
stockholder $2,380,000, of which $505,000 was paid upon execution of the Letter
Agreement and $1,875,000 was paid on August 2, 2006. As part of the settlement,
the former principal stockholder returned to us all of the 1,135,580 shares of
our common stock issued to him in the acquisition and cancelled the $2.5 million
promissory note issued to him in February 2005. Upon full performance of each
party's obligations, the parties will seek a dismissal of the action filed by
the former principal stockholder.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
In addition, repayments of indebtedness amounting to $14,589,662 owed
to Laurus Master Fund, Ltd. ("Laurus") were made on July 31, 2006. Included in
this payment were all amounts previously in default.
Following the sale in July 2006 of our FPDI operations and finalization
of a negotiated agreement with the creditor as discussed above, sufficient funds
were available to fully pay off all of the callable indebtedness.
(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 June 30, 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.
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.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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". Our
GridWorks software product is used internally for providing services to our
customers and is also marketed separately 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 and six-month periods ended June 30, 2006, capitalized
software development costs, which related primarily to enhancements to our
GridWorks software solution, totaled $146,221 and $307,419, respectively. These
costs are amortized on a straight-line basis over the estimated life of the
enhancements, typically three years. For the three and six-month periods ended
June 30, 2006, $131,704 and $256,717, respectively, of amortization costs were
charged to expense. As of June 30, 2006, the unamortized portion of software
development costs was $909,004.
For the three and six-month periods ended June 30, 2005, capitalized
software development costs totaled $138,218 and $309,504, respectively. For the
three and six-month periods ended June 30, 2005, $130,449 and $248,182,
respectively, of amortization costs were charged to expense.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The balance sheet accounts of our international subsidiary (Front Porch
Digital International, SAS) (included in assets and liabilities held for sale)
were translated using the exchange rate in effect at the balance sheet date, and
the results of these operations (included in gain (loss) on discontinued
operations) were translated at the average exchange rates during the period. At
June 30, 2006, we reported a cumulative translation gain of
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
$210,164 as a component of accumulated other comprehensive gain (loss). We were
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 June 30, 2006 and 2005 were gains
of $18,239 and $1,424, respectively. The effects of exchange rate fluctuations
in remeasuring foreign currency transactions for the six-month periods ended
June 30, 2006 and 2005 were gains of $17,551 and $1,397, respectively.
ACCOUNTING FOR OBLIGATIONS AND INSTRUMENTS POTENTIALLY SETTLED IN OUR
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 and six-month periods ended June 30, 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 and six-month periods ended June 30, 2006 and 2005 because
the effect would be antidilutive.
An aggregate of 14.7 million and 10.3 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 computations of basic and diluted loss per share at June 30,
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
2006 and 2005, respectively and for the three and six-month periods then ended,
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 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 in 2006 and
2005 were calculated using the following estimated weighted average assumptions:
2006 2005
---- ----
Stock options granted 1,254,611 175,000
Weighted-average exercise price $ 1.29 $ 0.21
Weighted-average grant date fair value $ 1.10 $ 1.43
Assumptions:
Expected volatility 112% 111%
Expected term (in years) 6 Years 3 Years
Risk-free interest rate 4.79% 3.64%
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.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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 June
30, 2006. This analysis will be re-evaluated periodically 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 six months of 2006 results: net loss before deemed dividends and
accretion on preferred stock increased by $0.8 million and net loss per weighted
average common share outstanding--basic and diluted increased by $.06 per share.
The following table details the effect on net loss before accretion on
preferred stock and net loss per weighted average common share outstanding had
stock-based compensation been recorded for the first three and six-months of
2005, respectively, based on the fair-value method under SFAS 123, "Accounting
for Stock-Based Compensation". The reported and pro forma net loss before
accretion on preferred stock and net loss per weighted average common share for
the second quarter of 2006 and year-to-date for 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 Six Months
Ended June 30, Ended June 30,
2005 2005
---- ----
Loss from continuing operations before
accretion on preferred stock, as reported $ (2,083) $ (4,036)
Add stock-based compensation expense included in
reported net loss 61 169
Deduct total stock-based employee compensation expense
determined under the fair-value based method for all awards (634) (1,091)
--------- ---------
Pro forma loss from continuing operations before
accretion on preferred stock (2,656) (4,958)
Loss from discontinued operations, net of income taxes (273) (669)
--------- ---------
Pro forma net loss, before accretion on preferred stock $ (2,929) $ (5,627)
========= =========
Net loss per weighted average common share outstanding--
Basic and diluted--pro forma $ (0.28) $ (0.58)
========= =========
Net loss per weighted average common share outstanding-
Basic and diluted-as reported $ (0.24) $ (0.51)
========= =========
Summaries of option activity under the plans as of June 30, 2006, changes during
the six months then ended, and status of non-vested options are presented below:
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
------- ----- ----
Balance January 1, 2006 2,217,016 $ 2.92 8.50
Granted 1,254,611 1.29 10.00
Exercised - - -
Forfeited (106,862) 5.09 8.70
---------- ------- -------
Balance at June 30, 2006 3,364,765 $ 2.25 9.05
========== ======= =======
Vested balance at June 30, 2006 901,095 $ 3.27 7.59
========== ======= =======
Weighted
Average
Grant Date
Fair Value
----------
Non-vested options January 1, 2006 1,379,524 $ 2.42 $ 0.52
Granted 1,254,611 1.29 1.10
Vested (79,303) 1.96 1.38
Forfeited (91,162) 2.23 1.16
---------- ------- -------
Non-vested options at June 30, 2006 2,463,670 $ 1.87 $ 0.94
========== ======= =======
As of June 30, 2006, there was $3.0 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 1.92 years. The total fair value of shares
vested during the six-month period ended June 30, 2006 was approximately
$86,000. The intrinsic value of vested options is not material at June 30, 2006.
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
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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 determined to be uncollectible. Credit losses have
been within management's expectations.
For the six-month period ended June 30, 2006, no one customer accounted
for greater than 10% of total revenues from continuing operations nor did any
single customer account for over 10% of accounts receivable at June 30, 2006.
For the six-month period ended June 30, 2005, no one customer accounted for
greater than 10% of revenue from continuing operations.
(4) ACQUISITION OF NST
On April 13, 2006 (the "NST Closing Date"), we acquired all of the
outstanding capital stock of NST, pursuant to a Stock Purchase Agreement, dated
as of the NST Closing Date (the "NST Stock Purchase Agreement").
The consideration paid for NST was approximately $8.2 million, which
consisted of $5.5 million in cash, the issuance of 1,034,483 shares of our
common stock valued at $1,304,483 (based on an average of the closing prices of
our common stock during the seven-day periods before and after the acquisition
date) and the issuance of a two-year 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 NST 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 performance
of consulting services by the former shareholder through TMC to us through March
31, 2008, with certain exceptions as defined in the NST Stock Purchase
Agreement. 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
required for the acquisition was provided by additional borrowings on our
existing line of credit and two newly-issued term notes from Laurus Master Fund,
Ltd. (Note 7(C)).
The NST Note accrues interest at an annual rate of one-half percent
(1/2%). The NST Note has been discounted by $109,300 to reflect a fair value
rate of interest of 8.75%. We are required to make eight equal payments of
principal and interest in the amount of $190,190, the first payment of which was
paid 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.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
Concurrently with the consummation of the acquisition, we granted
certain registration rights to the former owner and TMC with respect to the
shares of our common stock issued in the acquisition and the shares issuable
under the earn-out provision contained in the NST Stock Purchase Agreement.
Pursuant to the registration rights agreements, at any time after April 13,
2008, the holders have a demand registration right to require us to register
under the Securities Act such shares of our common stock issued in the
acquisition. 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.
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, as defined in the NST Stock Purchase
Agreement.
In connection with the consummation of the acquisition, we entered into
a consulting and subcontractor agreement (the "Consulting Agreement") with TMC
under which 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
annual 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
performance 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. Legal fees and other costs of approximately
$100,000 were also paid in connection with the acquisition.
The following represents the preliminary purchase price allocation at
the date of the NST acquisition:
Cash and cash equivalents $ 885,555
Other current assets 3,339,493
Property and equipment 136,036
Goodwill 8,840,336
Current liabilities (4,434,019)
-----------
Total purchase price $ 8,767,401
===========
The purchase price is not considered final as of the date of this
report as we, along with our independent valuation advisors, are still reviewing
all of the underlying assumptions and calculations used in the allocation.
However, we believe the final purchase price allocation will not be materially
different than presented herein.
The following unaudited pro forma financial information presents our
combined results of operations as if the acquisition of NST had occurred as of
the beginning of each of the periods presented below. The unaudited pro forma
financial information is not intended to represent or be indicative of the
consolidated results of operations that would have been reported by us had the
acquisition been completed as of the beginning of the periods presented, and
should not be taken as representative of our future consolidated results of
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
operations or financial condition. Unaudited pro forma results were as follows
for the three and six-month periods ended June 30, 2006 and 2005:
Three Months Ended June 30 Six Months Ended June 30
2006 2005 2006 2005
---- ---- ---- ----
Revenues $ 18,102,253 $ 21,441,705 $ 32,316,592 $ 30,597,340
Loss from continuing operations (1) (3,680,563) (1,811,043) (8,288,236) (3,509,286)
Income (loss) from discontinued operations (1) (465,805) (273,406) 399,054 (668,749)
Net loss applicable to common shareholders (4,800,760) (2,738,841) (9,197,965) (5,486,819)
Net earnings (loss) per share - basic and diluted, pro forma:
From continuing operations $ (0.31) $ (0.27) $ (0.67) $ (0.38)
From discontinued operations (0.03) (0.02) 0.03 (0.06)
------------ ------------ ------------ ------------
Total net loss per share-basic and diluted, pro forma $ (0.34) $ (0.29) $ (0.64) $ (0.44)
============ ============ ============ ============
(1) In July 2006, we sold substantially all of the assets of FPDI, including
certain liabilities associated with those assets as described in Note 5.
(5) ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
As of June 30, 2006, we were in active negotiations related to the sale
of FPDI and we met the criteria defined in SFAS No. 144 requiring the
classification of FPDI as held for sale. Accordingly, the assets and liabilities
of FPDI are segregated from our continuing business and classified as held for
sale as of June 30, 2006. Similarly, FPDI's operations are classified as
discontinued in the related statements of operations and cash flows. On July 31,
2006, we completed the sale of substantially all of the assets of FPDI,
including our wholly-owned subsidiary, Front Porch International, SAS. See note
10(A) to these unaudited condensed consolidated financial statements.
The operating results from discontinued operations were as follows for
the periods presented below:
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
Three Months Ended June 30 Six Months Ended June 30
2006 2005 2006 2005
---- ---- ---- ----
Revenues $ 3,886,017 $ 4,056,527 $ 8,435,848 $ 6,884,056
Cost of revenues 1,705,400 1,576,553 2,900,167 2,474,572
--------- --------- --------- ---------
Gross profit 2,180,617 2,479,974 5,535,681 4,409,484
Operating expenses 2,421,249 2,230,760 4,743,586 4,331,831
--------- --------- --------- ---------
Operating income (loss) (240,632) 249,214 792,095 77,653
Other income (expense) 9,242 36,380 (64,287) 130,598
----- ------ ------- -------
Income (loss) before income taxes (231,390) 285,594 727,808 208,251
Income tax expense (234,415) (559,000) (328,755) (877,000)
-------- -------- -------- --------
Income (loss) $ (465,805) $ (273,406) $ 399,053 $ (668,749)
=========== =========== =========== ===========
The components of assets held for sale and liabilities associated with assets
held for sale are as follows:
June 30,
2006
----
Cash and cash equivalents $ 956,722
Accounts receivable, net of allowance for doubtful accounts
doubtful accounts of $10,967 3,135,723
Unbilled revenue 1,899,377
Other current assets 412,903
Property and equipment, net 378,212
Capitalized software development costs, net 1,495,149
Intangible assets, net 11,464,564
Other noncurrent assets 28,270
--------------
Assets held for sale $ 19,770,920
==============
Accounts payable 1,463,310
Accrued expenses 2,161,582
Deferred revenue 1,627,137
--------------
Liabilities associated with assets held for sale $ 5,252,029
==============
(6) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of June 30, 2006:
Computer equipment $ 5,282,850
Software 1,797,531
Leasehold improvements 116,540
Office furniture and equipment 129,591
------------
7,326,512
Less accumulated depreciation (5,038,500)
------------
$ 2,288,012
============
Depreciation expense from continuing operations for the three and
six-month periods ended June 30, 2006 was $345,825 and $728,067, respectively
and for the three and six-month periods ended June 30, 2005 was $367,681 and
$736,519, respectively.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
Included in property and equipment was equipment under capital leases
with a cost of $2,020,283 and accumulated depreciation of $707,489 at June 30,
2006.
(7) NOTES PAYABLE, CAPITAL LEASES, AND OTHER LONG-TERM OBLIGATIONS
The following is a summary of our long-term debt as of June 30, 2006:
Senior secured convertible note (A) $ 2,480,939
Line of credit (B) 8,811,735
Acquisition term notes (C) 2,818,642
STAR note (D) 2,106,281
Convertible notes (E) 1,947,538
NST note (F) 1,404,365
Capital leases (G) 830,235
Other obligations 436,023
-----------
20,835,758
Less current portion (19,996,934)
----------
Long term portion $ 838,824
===========
(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 through May 13,
2011 up to 443,500 shares of common stock (the "Laurus Warrant") at $4.80 per
share, subject to standard antidilution adjustments. The principal and unpaid
interest on the Laurus Note were convertible into shares of our common stock at
a price of $3.00 per share. All outstanding principal and accrued interest were
paid in full on July 31, 2006 as described in Note 10(B) to these unaudited
condensed consolidated financial statements.
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.
(B) 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").
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
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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 approximately
$600,000 and was recorded as a debt discount.
All borrowings under the 2005 facility were repaid in full on February
6, 2006 on which we incurred a loss on early extinguishment of debt of
approximately $1.2 million. The loss included the write-off of the balance of
the debt discount and the deferred financing costs. In addition, $375,000 was
paid to Laurus as an early termination fee for the 2005 Facility and $107,500
(recorded as expense) was applied towards costs of the 2006 Facility.
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 was 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 plus 1%, subject to a floor of 7%. All outstanding principal
amounts were due and payable on February 6, 2009. On July 31, 2006, all
outstanding principal and accrued interest under the 2006 Facility were repaid,
as more fully described in Note 10(B) to these unaudited condensed consolidated
financial statements.
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 and subject to certain
volume limitations. Based upon the Black-Scholes model, we determined the value
of the option to be approximately $1.2 million and recorded a debt discount of
the same amount which is being amortized over the term of the 2006 Facility.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
(C) 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") to purchase 417,857 shares of common stock at
$0.001 per share, subject to certain standard antidilution adjustments, at any
time after March 31, 2007 and on or prior to March 31, 2026. Based upon the
Black-Scholes model, we determined the value of the 2006 Warrant to be
approximately $476,000 and recorded a debt discount of the same amount to be
amortized over the term of the notes beginning in April 2006. 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 of NST.
All outstanding principal and interest on the 2006 Term Note was repaid
on July 31, 2006 as more fully described in Note 10(B) to these unaudited
condensed consolidated financial statements.
The 2006 Convertible Note provides 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 Convertible Note also provides for monthly amortization of principal,
commencing on August 1, 2006, at the rate of $46,875 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, subject to
certain standard antidilution adjustments. The conversion price exceeded the
market price of our common stock on the date the 2006 Convertible Note was
issued.
All of our indebtedness to Laurus is accompanied by substantially
similar agreements governing registration rights, standard events of default
provisions, typical remedies available to Laurus in the event of default,
restrictions on the payment of dividends and other provisions standard in these
types of arrangements.
(D) STAR NOTE
As part of the acquisition of Incentra of CA in February 2005, we
issued an unsecured convertible promissory note for $2,500,000 to the selling
stockholder of Incentra of CA (the "STAR Note") that was payable in ten
installments and was to mature on August 1, 2007. The STAR Note provided 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. 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. Our failure to make the scheduled payment and
any subsequent payments constituted an event of default. Accordingly, as of June
30, 2006, we classified the entire principal amount to current liabilities based
on the default. We accrued interest at the 12% default rate since August 11,
2005.
The event of default on the STAR Note created an event of default of
certain provisions of the Laurus Note, and as a result, all amounts due under
the Laurus Note, the 2006 Term Note, and the 2006 Convertible Note have also
been classified with current liabilities at June 30, 2006. On July 28, 2006, and
as amended on July 31, 2006, we entered into a settlement agreement with the
holder of the STAR Note, which, among other provisions, included our payment of
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
$2,380,000 to the noteholder as payment in full of all amounts due under the
STAR Note.
(E) CONVERTIBLE NOTES
On May 19, 2006 and May 26, 2006, we entered into a Note Purchase
Agreement (the "Purchase Agreement") with twelve "accredited investors" (the
"Purchasers"), pursuant to which we issued and sold unsecured convertible term
notes (the "Convertible Notes") in the aggregate principal amount of $1,060,000
in connection with the offering by our company of up to $4,000,000 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 (as adjusted for stock splits, stock
dividends and the like, the "Conversion Price"). The Conversion Price exceeded
the market price of our common stock on the date the Convertible Notes were
issued. We also issued to the Purchasers five-year warrants (the "Warrants") to
purchase an aggregate of 251,048 shares of our Common Stock, at an exercise
price $1.40 per share (as adjusted for stock splits, stock dividends and the
like, the "Exercise Price"). Of the $1,060,000 aggregate principal amount
purchased by investors in this offering, $775,000 aggregate principal amount was
purchased by certain officers and directors of our company. The remaining
$285,000 aggregate principal amount of the Convertible Notes was purchased by
certain employees or consultants of our company.
On June 26, 2006 and June 30, 2006, we consummated second and third
closings (collectively, the "Additional Closings") under which we issued and
sold to the Purchasers Convertible Notes in the aggregate principal amount of
$1,350,000 and Warrants to purchase 320,421 shares of our common stock also at
an exercise price of $1.40 per share. The Conversion Price exceeded the market
price of our common stock on the date the Convertible Notes were issued. The
sale of the Convertible Notes were made to three institutional investors
pursuant to a Note Purchase Agreement (the "Second Purchase Agreement") dated as
of June 6, 2006. As a result of the Additional Closings, aggregate proceeds
received from the offering to date total $2,410,000. Based upon the Black-Sholes
model, we determined the value of all Warrants issued in connection with the
Purchase Agreement and the Second Purchase Agreement to be $555,000, to be
amortized over the term of the Convertible Notes beginning in May 2006. Both
purchase agreements contain standard events of default provisions.
Absent earlier redemption by our company, or conversion by the
Purchaser, the Convertible Notes issued in May 2006 mature on May 19, 2007 and
the Convertible Notes issued in June 2006 mature on June 6, 2007. Interest
accrues on the unpaid principal and interest on the Convertible Notes at a rate
of 12% per annum (subject to certain adjustments). Any outstanding principal
amount together with any accrued and unpaid interest, along with any amounts due
to Purchasers under the Convertible Notes, is due and payable on the respective
maturity dates.
Subject to a prepayment penalty 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 issued in May 2006 at any time by
paying to the Purchaser all sums due and payable under the Convertible Notes,
the Purchase Agreement and any Related Agreement. Convertible Notes issued
pursuant to the Additional Closings may be prepaid without penalty at any time
prior to the maturity date.
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
Each Purchaser may convert any portion or all of the issued and
outstanding principal amount and/or accrued interest and fees due and payable
under such Convertible Note into fully paid and nonassessable shares of our
Common Stock at the Conversion Price. Subject to the payment of the prepayment
penalty referenced above (if applicable), we also have the right to convert any
amounts due to a Purchaser under the Convertible Notes, Purchase Agreement or
any Related Agreement into fully paid and nonassessable shares of our common
stock at the Conversion Price. The Convertible Notes issued in the Additional
Closings contain a provision that gives us the right to convert all or any
portion of the then unpaid and accrued interest on such Convertible Notes into
shares of our common stock at the then-effective conversion price of such
Convertible Notes, if the average closing price of our common stock on the
applicable market for the five (5) consecutive trading days immediately
preceding the date of conversion is greater than or equal to one hundred
twenty-five percent (125%) of the conversion price; provided there is an
effective registration statement covering the resale of the shares issuable upon
conversion of such Convertible Notes.
Pursuant to the terms of a Registration Rights Agreement between the
Purchasers and our company (the "Registration Rights Agreement") for the
Convertible Notes issued in May 2006, upon the request of fifty-one percent of
the Purchasers, and as soon as practicable, we are obligated to file a "resale"
registration to register the resale of shares of our Common Stock (the
"Registrable Securities") issuable (i) upon conversion of the Convertible Notes
or (ii) upon exercise of the Warrant (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 Purchaser and
include any Registrable Securities as such Purchaser may request, in such
registration statement. Registration rights for the Convertible Notes issued in
the Additional Closings (the "Second Registration Rights Agreement") require us
to register by September 26, 2006 for resale under the Securities Act the shares
of our common stock issuable to them upon conversion of the Convertible Notes or
upon exercise of the Warrants.
The Convertible Notes and Warrants executed in connection with the
Additional Closings include a weighted-average anti-dilution provision and a
limitation on the number shares for which the Convertible Note and Warrant may
be converted or exercised. Pursuant to such limitation, a holder may not convert
its Convertible Note nor exercise its Warrant if, as a result of such conversion
or exercise, the number of shares of our common stock such holder would
beneficially own exceeds the difference between (i) 9.99% of the then-issued and
outstanding shares of our common stock and (ii) the number of shares of our
common stock beneficially owned by such holder and/or such holder's affiliates
(as defined under Rule 144 of the Securities Act of 1933, as amended (the
"SECURITIES ACT")), except upon (i) sixty-one (61) days' prior notice from such
holder to us or (ii) upon the occurrence and continuance of an event of default
under the Purchase Agreement. Unlike the Convertible Notes issued in May 2006,
the Convertible Notes issued in the Additional Closings do not permit us to
redeem the Convertible Notes in cash upon five (5) days notice.
(F) NST Note
Pursuant to the NST Stock Purchase Agreement discussed in Note 4, we
issued an unsecured convertible promissory note for $1,500,000 to the selling
stockholder of NST (the "NST Note") which is payable in eight installments and
matures on March 1, 2008. The NST Note provides that all unpaid principal and
accrued interest shall, at the option of the holder and without notice, become
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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, (i) our
failure to make a payment when due, subject to a five (5) days notice and cure
period or (ii) our failure to observe, keep or comply with any provision or
requirement in contained in the NST Stock Purchase Agreement.
(G) 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.
Subsequent to November 2003, we entered into two amendments to the Lease Line
which has enabled us to draw an additional $1.5 million in total on the line for
purchases through August 31, 2006. The amendments also grant 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
unpaid balance on the Lease Line at June 30, 2006 was $830,235.
(8) 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 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).
(9) 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 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
INCENTRA SOLUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UNAUDITED
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 award agreement, options
generally terminate three months after the termination of employment, except in
the case of termination for cause or upon death or disability. On July 7, 2006,
we filed a registration statement on Form S-8 to register under the Securities
Act of 1933, the resale of the shares of our common stock issuable upon exercise
of the options granted pursuant to the Plan.
(10) SUBSEQUENT EVENTS
(A) SALE OF FRONT PORCH DIGITAL, INC.
On July 31, 2006, we sold substantially all of the assets of our
wholly-owned subsidiary, Front Porch Digital, Inc., a Delaware corporation
("Front Porch"), to FPD Acquisition Corporation, a newly-formed Delaware
corporation ("FPD"), and 1706045 Ontario Limited, an Ontario corporation
("Ontario" and collectively with FPD, the "Buyers"), each owned by Genuity
Capital Management Services, Inc., pursuant to the terms of the Purchase
Agreement (the "Purchase Agreement"), dated as of July 31, 2006, among our
company, MSI and the Buyers. The material assets owned and operated by Front
Porch, all of which were transferred to the Buyers in the sale, included,
without limitation, all of the outstanding capital stock of Front Porch
International SAS, its wholly-owned French subsidiary, its DIVArchive and
Bitscream software and all intellectual property rights associated with that
software and all tangible personal property, contracts, account receivables
relating to Front Porch's business.
The purchase price was $33,000,000 plus an amount by which the net
working capital amount (defined as current assets minus current liabilities) of
Front Porch on the closing date exceeded a targeted amount of $660,000, or less
an amount by which $660,000 exceeded such net working capital amount. Of such
purchase price, $30,500,000 was received in cash at the closing and $2,500,000
was placed in escrow to secure payment of indemnification claims the Buyers may
have against us following the closing. Following the closing, the parties will
reconcile the net working capital amount of Front Porch as of the closing date.
In addition to the purchase price payable at the closing, we may receive up to
$5,000,000 pursuant to an earn-out provision. Under the terms of the earn-out,
we are entitled to receive an amount equal to five percent (5%) of Front Porch's
gross software sales, net of customer discounts, for each of the years ending
December 31, 2006, 2007 and 2008, not to exceed $5,000,000 in the aggregate.
An estimated gain of approximately $17.6 million was realized on the
sale after expenses and fees of approximately $2.4 million and subject to
finalization of post-closing adjustments.
(B) REPAYMENT OF LONG-TERM DEBT TO LAURUS
On July 31, 2006, we used $14.6 million of the proceeds from the sale
of the assets of Front Porch to repay in full all outstanding principal amounts,
accrued interest and any applicable prepayment penalties related to the Laurus
Note, the 2006 Facility and the 2006 Term Note.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
RECENT DEVELOPMENTS
In July 2006, we sold substantially all of the assets of our Front
Porch division ("Front Porch"), through which we previously provided complete
digital archive solutions to broadcasters and media companies. The sale price
was approximately $33 million and we have the right to receive up to an
additional $5 million pursuant to the terms of an earn-out based on a percentage
of gross revenues received by Front Porch from certain software sales through
December 31, 2008. A portion of the proceeds of the sale were used to repay
approximately $14.5 million of our outstanding secured debt to Laurus Master
Fund, Ltd ("Laurus"). Management believes the sale of the Front Porch business
will allow us to focus on our core business as represented by Incentra of CA,
MSI, PWI, and NST. Proceeds from the sale of FPDI were used to repay most of our
long-term debt, and management plans to use the remainder for investment in our
other businesses, potential future acquisitions, and to generally strengthen our
balance sheet.
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.
Incentra Solutions, Inc. is 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 enterprises and information
technology service providers worldwide. We market our products and services 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 Technology Systems ("NST"). We formerly sold unique software and
professional solutions for digital archive to management and media companies
under the name Front Porch Digital ("Front Porch"). As noted above, Front
Porch's assets were sold in July 2006.
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 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.
Through NST (which we acquired in April 2006), we provide storage,
networking and security solutions, as well as professional services, to over 300
existing customers in the financial services, healthcare, education, non-profit
and manufacturing verticals in the Chicago, Illinois area and central state
region of the U.S. NST's customer base will provide an immediate market for our
other products, such as First Call and Enhanced First Call support services and
our GridWorks remote monitoring and management system in an area of the U.S.
market not previously available to us with our direct sales force.
The following discussion and analysis of financial condition and
results of operations is based upon our historical consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
consolidated financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. These
estimates are based on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
For the three and six month-periods ended June 30, 2006, revenues from
continuing operations totaled $18.1 million and $26.5 million, respectively, as
compared to $13.5 million and $16.7 million, respectively, for the comparable
periods in the prior year. The rate of increase for revenues from continuing
operations for the three-month period ended June 30, 2006 was approximately 34%
and 58% for the six-month period when compared to the same period for 2005. The
increase in revenue from continuing operations from the prior year quarter was a
result of the acquisition of NST in April 2006. The increase in revenues from
continuing operations for the six-month period in 2006 was the result of the
acquisitions of NST in April 2006, the inclusion of the results of Incentra of
CA and PWI for the full six-month period as compared to from the dates of
acquisition for the prior year, and increased sales of hardware as part of
complete archive solutions.
We continue to invest in hardware and the development of our software
and in the data storage and infrastructure areas. During the three and six-month
periods ended June 30, 2006, we invested $0.1 million and $0.3 million,
respectively, in software development and $0.3 million and $0.8 million,
respectively, for data storage infrastructure.
During the three months ended June 30, 2006, our operating loss from
continuing operations increased by approximately $1.3 million to $2.7 million as
compared to a loss of $1.4 million for the comparable prior-year period. This
increase in our loss from continuing operations was due to the adoption of SFAS
123R accounting for additional non-cash compensation expense of $0.5 million,
decreased contribution from PWI, MSI and Incentra of CA and an increase in
sales-related headcount in the various regions..
For the six months ended June 30, 2006, the operating loss from
continuing operations increased by approximately $2.1 million to $5.3 million as
compared to a loss of $3.2 million for the comparable prior-year period. This
increase in our loss from continuing operations was due to the adoption of SFAS
123R accounting for additional non cash compensation expense of $0.8 million,
decreased contribution from PWI, MSI and Incentra of CA and an increase in sales
related headcount in the various regions.
During the three months ended June 30, 2006, our results from
continuing operations on an EBITDA(1) basis include the add back of $468,000 of
non-cash compensation expense following the adoption of SFAS 123R effective
January 1, 2006. For the six month period ended June 30, 2006, EBITDA results
include the add back of the $1.2 million loss on the early extinguishment of
debt related to our 2005 secured credit facility from Laurus and $0.8 million of
non-cash compensation expense as compared to an add back of $0.2 million for
non-cash compensation expense for the comparable period in the prior year.
- -------------
(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)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
2006 2005 2006 2005
---- ---- ---- ----
Loss from continuing operations before
accretion on preferred stock $ (3,681) $(2,083) $(8,184) $(4,036)
Depreciation and amortization 556 669 1,048 1,398
Interest (cash portion) 574 171 901 186
Interest (non-cash portion) 471 439 768 959
-------- ------- ------- -------
EBITDA from continuing operations $ (2,080) $ (804) $(5,467) $(1,493)
-------- ------- ------- -------
Loss on early extinguishment of debt - - 1,232 -
Non-cash stock based compensation 468 108 835 169
Referral fees - 29 - 72
-------- ------- ------- -------
EBITDA from continuing operations, as adjusted $ (1,612) $ (667) $(3,400) $(1,252)
======== ======= ======= =======
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 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 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.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THE THREE
MONTHS ENDED JUNE 30, 2005
Our unaudited condensed consolidated financial statements as of June
30, 2006 and for the three and six-month periods 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 the possibility that substantially all of our long term debt may be
accelerated due to a dispute with a creditor. The nature and subsequent
resolution of the dispute is discussed in Notes 1, 7(D) and 10(B) to our
unaudited condensed consolidated financial statements.
REVENUE. Total revenue from continuing operations for the three months
ended June 30, 2006 increased $4.6 million, or 34%, to $18.1 million as compared
to total revenue of $13.5 million for the three months ended June 30, 2005. This
increase was attributable to additional revenues of $8.7 million resulting from
the inclusion of NST for the period, offset by a reduction in sales from MSI,
Incentra of CA and PWI of 4.1 million. Revenue from the sale of our products
increased to $14.7 million compared to revenue of approximately $10.4 million
for the comparable prior year period. Revenue from the delivery of our services
increased $0.3 million to $3.4 million compared to $3.1 million for the
comparable prior year period. On a pro forma basis, assuming that the
acquisition of NST occurred on January 1, 2005, revenue for the three months
ended June 30, 2006 decreased $3.3 million, or 16%, from $21.4 million to $18.1
million due primarily to lower sales of third-party product sales for Incentra
of CA and PWI of $3.9 million, and slightly lower service revenues for MSI of
$0.3 million.
For the quarter ended June 30, 2006, a portion of our revenues was
derived from the European and Asian geographic markets. During that period,
aggregate revenues from customers located in Europe and Asia amounted to $0.7
million, or 4% of total revenue, while revenues from customers located in North
America totaled $17.4 million, or 96% of total revenue. For the quarter ended
June 30, 2005, revenues from customers located in Europe and Asia amounted to
$0.5 million, or 4% of total revenue, while revenues from customers located in
North America totaled $13.0 million, or 96% of total revenue.
GROSS MARGIN. Total gross margin from continuing operations for the three months
ended June 30, 2006 increased $0.8 million to $3.4 million, or 19% of total
revenue, as compared to gross margin of $2.6 million, or 19% of total revenue,
for the comparable prior year period. The increase in total gross margin is due
to the
inclusion of NST in the 2006 period of $1.7 million offset by the lower margins
from PWI and Incentra of CA and lower contribution from a managed service
customer. Product gross margin for the three months ended June 30, 2006 totaled
$2.3 million, or 16% of product revenue. Service gross margin for the three
months ended June 30, 2006 totaled $1.1 million, or 33% of service revenue. On a
pro forma basis, assuming acquisition of NST had occurred as of April 1, 2006
and 2005, gross margin for the three months ended June 30, 2006 decreased $0.9
million due to the lower sales experienced by PWI and Incentra of CA and lower
contribution from a managed service customer.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("SG&A") expenses from continuing operations for the three months
ended June 30, 2006 increased by approximately $1.8 million to $5.5 million from
$3.7 million for the comparable prior year period. SG&A expenses included $3.9
million in salaries and related benefits for employees not directly related to
the production of revenue, $0.6 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 $3.7 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, $0.4 million in general office
expenses, $0.2 million in travel related costs, $0.3 million in professional
fees and $0.2 million of facilities costs. The increase for the three months
ended June 30, 2006 was due to an additional $1.2 million of SG&A expenses
relating to NST as a result of the inclusion of those operations for the entire
quarter in 2006, and an increase of $0.5 million in salaries related to an
increase in employee headcount. 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 June 30, 2006 increased $0.6
million, primarily due to the increase of non-cash compensation expense related
to the adoption of SFAS 123R and an increase in employee headcount.
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 $0.6 million for the three months ended June 30, 2006 and $0.7
million for the same period in 2005, of which approximately $0.4 million and
$0.3 million was included in cost of revenue for the three-month periods ending
June 30, 2006 and 2005, respectively.
OPERATING LOSS FROM CONTINUING OPERATIONS. During the three months ended June
30, 2006, we incurred a loss from continuing operations of $2.7 million as
compared to a loss from operations of $1.4 million for the three months ended
June 30, 2005. This increase in our loss from continuing operations was due to
the adoption of SFAS 123R accounting for additional non-cash compensation
expense of $0.4 million, decreased contribution from PWI, MSI and Incentra of CA
and an increase in sales related headcount in the various regions.
INTEREST EXPENSE. Interest expense was $1.0 million for the three months ended
June 30, 2006 compared to $0.6 million for the three months ended June 30, 2005
due to a significant increase on borrowings primarily related to acquisitions.
OTHER INCOME AND EXPENSE. Other income was approximately $24,000 for the three
months ended June 30, 2006 as compared to other expense of approximately $35,000
for the three months ended June 30, 2005. None of the components of the change
was significant.
FOREIGN CURRENCY GAIN. As discussed above, we conduct business in various
countries outside the United States in which the functional currency of the
country is not the U.S. dollar. We are subject to foreign exchange transaction
exposure because we provide for intercompany funding between the U.S. and
international operations, when we transact business in a currency other than our
own functional currency. The effects of exchange rate fluctuations in
remeasuring foreign currency transactions for the three months ended June 30,
2006 and 2005 were minimal for each period.
LOSS FROM DISCONTINUED OPERATIONS. During the three months ended June 30, 2006
the loss from discontinued operations was $0.5 million as compared to a loss
from discontinued operations for the three months ended June 30, 2005 of
$0.3 million.
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the three months ended June
30 2006, we incurred a net loss applicable to common shareholders of $4.8
million as compared to a net loss applicable to common shareholders of $3.0
million for the three months ended June 30, 2005. The increase in the net loss
for the three months ended June 30, 2006 was primarily due to an increase in
operating expenses explained earlier in addition to increased interest expense.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO THE SIX
MONTHS ENDED JUNE 30, 2005
REVENUE. Total revenue from continuing operations for the six months ended June
30, 2006 increased $9.8 million, or 58%, to $26.5 million as compared to total
revenue of $16.7 million for the six months ended June 30, 2005. This increase
was attributable to the additional revenues of $8.7 million resulting from the
inclusion of NST for the 2006 period and $1.7 million for the inclusion of PWI
(which was acquired on March 31, 2005) for 2006, offset by a reduction in sales
from MSI of $0.3 million. Revenue from the sale of our products increased to
$20.6 million compared to revenue of approximately $11.5 million for the
comparable prior year period. Revenue from the delivery of our services
increased $0.7 million to $5.9 million compared to $5.2 million for the
comparable prior year period. On a pro forma basis assuming that the acquisition
of NST occurred on January 1, 2005, revenue from continuing operations for the
six months ended June 30, 2006 increased $1.7 million, or 6%, to $32.3 million
due to increased sales by PWI and NST of $2.4 million offset by lightly lower
service revenues for MSI and Incentra of CA of $0.7 million.
For the six months ended June 30, 2006, a 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 $1.3
million, or 5% of total revenue, while revenues from customers located in North
America totaled $25.2 million, or 95% of total revenue. For the six months ended
June 30, 2005, revenues from customers located in Europe and Asia amounted to
$1.1 million, or 6% of total revenue, while revenues from customers located in
North America totaled $15.6 million, or 94% of total revenue.
GROSS MARGIN. Total gross margin from continuing operations for the six months
ended June 30, 2006 increased $1.6 million to $5.2 million, or 20% of total
revenue, as compared to gross margin of $3.6 million, or 22% of total revenue,
for the comparable prior year period. The increase in total gross margin is due
to the inclusion of NST in the period for 2006 of $1.7 million and $0.6 million
in additional margin from PWI in 2006 offset by the lower margins from managed
service customers of $0.8 million due to renegotiation of long term contracts.
Product gross margin for the six months ended June 30, 2006 totaled $3.5
million, or 17% of product revenue. Service gross margin for the six months
ended June 30, 2006 totaled
$1.7 million, or 29% of service revenue. On a pro forma basis, assuming
acquisition of NST had occurred as of January 1, 2005, gross margin for the six
months ended June 30, 2006 decreased $0.2 million due to the lost contribution
from a managed service customer, offset by increases in margin from PWI and NST.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses from continuing
operations for the six months ended June 30, 2006 increased by $3.3 million to
$9.4 million from $6.1 million for the comparable prior year period. SG&A
expenses included $6.7 million in salaries and related benefits for employees
not directly related to the production of revenue, $1.0 million in general
office expenses, $0.7 million in professional fees, $0.4 million for
travel-related costs, and $0.5 million in facilities costs. SG&A expenses of
$6.1 million for the comparable prior year period included $3.9 million in
salaries and related benefits for employees not directly related to the
production of revenue, $0.8 million in general office expenses, $0.3 million in
travel related costs, $0.7 million in professional fees and $0.4 million of
facilities costs. The increase for the six months ended June 30, 2006 was
primarily due to an additional $1.2 million of SG&A expenses relating to NST as
a result of the inclusion of those operations for the second quarter in 2006, an
increase of $1.2 million in salaries related to an increase in employee
headcount in other units. On a pro forma basis, SG&A expenses for the six months
ended June 30, 2006 increased $3.0 million, due to the increase of non-cash
compensation expense related to the adoption of SFAS 123R and an increase in
employee headcount.
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 $1.0 million and $1.4 million for each of the six-month periods
ended June 30, 2006 and 2005, respectively, of which approximately $0.7 million
and $0.8 million, respectively was included in cost of revenue for the six-month
periods ending June 30, 2006 and 2005.
OPERATING LOSS FROM CONTINUING OPERATIONS. During the six months ended June 30,
2006, we incurred a loss from continuing operations of $5.3 million as compared
to a loss from operations of $3.2 million for the six months ended June 30,
2005. This increase in our loss from continuing operations was due to the
adoption of SFAS 123R accounting for additional non-cash compensation expense
of $0.7 million, decreased contribution from PWI, MSI and Incentra of CA and an
increase in sales-related headcount in the various regions.
INTEREST EXPENSE. Interest expense was $1.7 million for the six months ended
June 30, 2006 compared to $1.2 million for the six months ended June 30, 2005.
This increase is due to the additional debt incurred since July 2005.
LOSS ON EARLY EXTINGUISHMENT OF DEBT. The refinancing of our 2005 credit
facility with Laurus 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 2005.
OTHER INCOME AND EXPENSE. Other income was approximately $34,000 for the six
months ended June 30, 2006 as compared to other income of approximately $320,000
for the six months ended June 30, 2005. Other income 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.
FOREIGN CURRENCY GAIN. As discussed above, we conduct business in various
countries outside the United States in which the functional currency of the
country is not the U. S. dollar. We are subject to foreign exchange transaction
exposure because we provide for intercompany funding between the U.S. and
international operations, when we transact business in a currency other than our
own functional currency. The effects of exchange rate fluctuations in
remeasuring foreign currency transactions for the six months ended June, 2006
and 2005 were minimal for each period.
INCOME OR LOSS FROM DISCONTINUED OPERATIONS. During the six months ended June
30, 2006 income from discontinued operations was $0.4 million as compared to a
loss from discontinued operations for the six months ended June 30, 2005 of $0.7
million. The difference in earnings was primarily due to increased income tax
expense in 2005 recorded on the income generated by our Front Porch division in
France.
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS. During the six months ended June 30,
2006, we incurred a net loss applicable to common shareholders of $9.1 million
as compared to a net loss applicable to common shareholders of $6.0 million for
the six months ended June 30, 2005. The increase in net loss for the six months
ended June 30, 2006 was primarily due to an increase in interest expense, a loss
on early extinguishment of debt, as well as increased operating expenses as
explained above.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2006, we had $1.0 million of cash and cash equivalents.
Issuance of convertible debt and equity securities has 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.
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 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 all our U.S. subsidiaries.
On March 31, 2006, we consummated a private placement pursuant to which
we issued a secured convertible term note due May 31, 2009 in the principal
amount of $1,500,000 (the "2006 Convertible Note") and a secured term note due
May 31, 2009 in the principal amount of $1,750,000 (the "2006 Term 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 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 and May 26, 2006, we entered into a Note Purchase
Agreement (the "Purchase Agreement") with twelve "accredited investors" (the
"Purchasers"), pursuant to which we issued and sold unsecured convertible term
notes (the "Convertible Notes") in the aggregate principal amount of $1,060,000
in connection with the offering by our company of up to $4,000,000 aggregate
principal amount of such Convertible Notes. The Convertible Notes are
convertible, at the option of the Purchasers, into shares our common stock (the
"Common Stock"), par value $0.001 per share at a conversion price of $1.40 per
share (as adjusted for stock splits, stock dividends and the like, the
"Conversion Price").
On June 26, 2006 and June 30, 2006, we consummated a second and third
closing (collectively, the "Additional Closings") under our offering (the
"Offering") of up to $4,000,000 in aggregate principal amount of unsecured,
Convertible Notes. At the Additional Closings, we issued and sold to the
Purchasers Convertible Notes in the aggregate principal amount of $1,350,000 and
Warrants to purchase 320,421 shares of our common stock at an exercise price of
$1.40 per share. The sale of the Convertible Notes were made to three
institutional investors pursuant to a Note Purchase Agreement (the "Second
Purchase Agreement") dated as of June 6, 2006. As a result of the Additional
Closings, aggregate proceeds received from the Offering to date total
$2,410,000.
On July 31, 2006, we completed the sale of substantially all of the
assets of FPDI. Proceeds from the sale amounted to $33 million in cash with a
potential earn out of an additional $5 million. We received $30.5 million in
cash at closing, which is net of an escrow of $2.5 million that will be released
after a year if certain conditions are met. With the proceeds, we immediately
paid off the remaining principal balance ($2.7 million) and accrued interest of
the 2004 Note. In addition, we repaid the principal balance ($1,750,000) of the
2006 Term Note plus accrued interest and the full amount outstanding of the 2006
Facility ($9.2 million) plus accrued interest. The pay off of these notes also
included prepayment penalties amounting to approximately $0.8 million.
On July 27, 2006 we reached an agreement as amended on July 31, 2006,
with the former owner of Incentra of CA to settle the arbitration award,
whereby, we agreed to pay $2,380,000, of which $505,000 was paid on execution of
the agreement and $1,875,000 was paid on August 2, 2006. As part of the
settlement, the former owner returned to us all of the 1,135,580 shares of our
common stock and cancelled the $2.5 million promissory note issued to him in
February 2005.
As of June 30, 2006, we had current assets of $30.5 million. These
assets were primarily derived from our operations in 2006 and from our
acquisition of NST and include assets from discontinued operation of $19.8
million. Long-term assets of $19.1 million consisted of $0.6 million of
intangible assets resulting from the acquisitions of MSI, Incentra of CA and
PWI, $14.7 million of goodwill resulting from the acquisitions of Incentra of
CA, PWI and NST, $2.3 million of property and equipment, $0.9 million of
software development costs and $0.5 million of other assets.
Current liabilities of $40.2 million at June 30, 2006 consisted of
$10.3 million of accounts payable; $5.2 million of liabilities related to assets
held for sale; $0.8 million of deferred revenue, which consisted of billings in
excess of revenue recognized, deposits and progress payments received on
engagements currently in progress; $3.9 million of accrued expenses; and $20.0
million of the current portion of notes payable, other long term obligations,
and capital leases. Of this total, $14.9 million was paid off on July 31, 2006.
Our working capital deficit was $9.7 million as of June 30, 2006 and
includes the effect of including $14.5 million in assets net of liabilities of
discontinued operations. Included in the deficit is the balance on the 2006
Facility of $8.8 million, net of debt discount of $1.1 million. The outstanding
principal amount of the 2006 facility was paid in full on July 31, 2006. Also
included in the deficit was $2.1 million (net of discount) due to the former
owner of Incentra of CA and $2.5 million (net of discount) on the Laurus Note.
Both amounts were in default at June 30, 2006 and therefore classified as
current liabilities. Both amounts were paid off in full in July 2006. See Note
10(B) to the unaudited condensed consolidated financial statements.
We used net cash of $3.0 million in operating activities of our
continuing operations during the six months ended June 30, 2006, primarily as a
result of the net loss incurred during the period. We used net cash of $6.3
million in investing activities in continuing operations during the six months
ended June 30, 2006, of which $1.1 million was used primarily to purchase or
develop computer software and equipment and $5.2 million was used to purchase
NST. Financing activities provided net cash of $9.4 million during the six
months ended June 30, 2006 primarily from new financings with Laurus and from
issuing the Convertible Notes. Discontinued operations generated cash of $0.3
million during the six-month period ending June 30, 2006.
We are still in the early stages of executing our business strategy,
have completed four significant acquisitions and expect to begin numerous new
acquisition engagements during the next 12 months. Although we did complete the
successful sale of our broadcast division which provided a significant amount of
working capital and we are experiencing success in the deployment of our
marketing strategy for the sale and delivery of our 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.
Our management believes our cash and cash equivalents and borrowings
available from the 2006 Facility, proceeds from the issuance of unsecured,
convertible notes to accredited investors and the proceeds from the sale of FPDI
unit 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 its reassessment
of the plan and general economic conditions. Additionally, there can be no
assurance that our business will generate cash flows at or above current levels.
Accordingly, we may choose to defer capital expenditures and extend vendor
payments for additional cash flow flexibility.
We expect capital expenditures to be approximately $2.0 million and
capitalized software development costs to be approximately $1.0 million during
the 12-month period ended June 30, 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.
ITEM 3. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES. Our management, with the participation of
our chief executive officer and chief financial officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) as of the end of the period covered by this
report. Based on such evaluation, our chief executive officer and chief
financial officer have concluded that, as of the end of such period, our
disclosure controls and procedures are effective in recording, processing,
summarizing and reporting, on a timely basis, information required to be
disclosed by us in the reports that it files or submits under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING. Except for the matter discussed
below, there have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the second quarter of 2006 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
During the second quarter of 2006, the Audit Committee of our Board of Directors
directed us to create a formal review process covering acquisition accounting
and to include a Statement of Changes in Shareholders' Deficit and Comprehensive
Gain or Loss for the current year with future filings on Form 10-QSB. These
measures were implemented in April 2006.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
STAR NOTE DEFAULT
As previously reported in our Current Report on Form 8-K, dated July
28, 2006, we settled all claims and disputes with Alfred Curmi relating to our
claimed adjustments of the purchase price paid in connection with our
acquisition of STAR Solutions of Delaware, Inc. (now known as Incentra of CA,
Inc.) in February 2005.
ITEM 6. EXHIBITS.
The exhibits required by this item are listed on the Exhibit Index attached
hereto.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated: August 14, 2006 INCENTRA SOLUTIONS, INC.
By: /s/ Thomas P. Sweeney III
-------------------------
Thomas P. Sweeney III
Chief Executive Officer
(principal executive officer)
By: /s/ Paul McKnight
-------------------------
Paul McKnight
Chief Financial Officer
(principal financial and
accounting officer)
EXHIBIT INDEX
Exhibit
No. Exhibit Description
- ------- -------------------
31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.