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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-20394
COACTIVE MARKETING GROUP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-1340408
------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
75 Ninth Avenue
New York, New York 10011
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 660-3800
Indicate by check mark whether the registrant: (1) has 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 [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [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 May 4, 2007, 7,466,001 shares of the Registrant's Common Stock, par value
$.001 per share, were outstanding.
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INDEX
COACTIVE MARKETING GROUP, INC. AND SUBSIDIARIES
Page
----
PART I - FINANCIAL INFORMATION
- ------------------------------
Item 1. Consolidated Financial Statements of CoActive Marketing Group, Inc.
and Subsidiaries (Unaudited)
Condensed Consolidated Balance Sheets - September 30, 2006
(Unaudited) and March 31, 2006 (Audited) 3
Condensed Consolidated Statements of Operations -
Three and six months ended September 30, 2006 and
September 30, 2005 (restated) 4
Condensed Consolidated Statement of Stockholders' Equity -
Six months ended September 30, 2006 5
Condensed Consolidated Statements of Cash Flows -
Six months ended September 30, 2006 and
September 30, 2005 (restated) 6
Notes to Unaudited Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Item 4. Controls and Procedures 27
PART II - OTHER INFORMATION
- ---------------------------
Items 1, 2, 3, and 5. Not Applicable
Item 1A. Risk Factors 28
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 6. Exhibits 30
SIGNATURES 31
- ----------
2
PART I - FINANCIAL INFORMATION
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Balance Sheets
September 30, 2006 and March 31, 2006
September 30, March 31,
2006 2006
------------ ------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 2,897,386 $ 3,929,438
Accounts receivable, net of allowance for doubtful accounts of
$455,000 at September 30, 2006 and $325,000 at March 31, 2006 19,242,248 10,726,762
Unbilled contracts in progress 1,400,679 2,650,453
Deferred contract costs 1,530,598 2,523,065
Prepaid expenses and other current assets 321,225 740,385
Note and interest receivable from officer, net of allowance of $306,000 at
September 30, 2006 244,058 --
Current assets of discontinued operations -- 3,640,069
------------ ------------
Total current assets 25,636,194 24,210,172
Property and equipment, net 3,607,568 3,833,943
Note and interest receivable from officer -- 826,341
Deferred financing costs, net 76,518 86,616
Deferred tax asset 4,175,699 5,661,027
Goodwill and intangible asset 7,557,203 7,557,203
Other assets 38,667 49,919
Noncurrent assets of discontinued operations -- 487,945
------------ ------------
Total assets $ 41,091,849 $ 42,713,166
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,571,355 $ 4,505,344
Accrued compensation 1,853,944 1,494,432
Accrued job costs 1,265,996 1,368,235
Other accrued liabilities 1,956,882 1,974,713
Deferred revenue and other client credits 17,617,834 15,745,269
Deferred taxes payable 247,272 247,272
Notes payable bank - current 2,500,000 3,000,000
Current liabilities of discontinued operations -- 2,464,371
------------ ------------
Total current liabilities 28,013,283 30,799,636
Deferred rent 2,577,997 2,613,541
Noncurrent liabilities of discontinued operations -- 723,827
------------ ------------
Total liabilities 30,591,280 34,137,004
------------ ------------
Commitments and contingencies
Stockholders' equity:
Class A convertible preferred stock, par value $.001; authorized 650,000 -- --
shares; none issued and outstanding
Class B convertible preferred stock, par value $.001; authorized 700,000 -- --
shares; none issued and outstanding
Preferred stock, undesignated; authorized 3,650,000 shares; none issued and -- --
outstanding
Common stock, par value $.001; authorized 25,000,000 shares; issued and
outstanding 7,194,751 shares at September 30, 2006 and 6,831,423 at
March 31, 2006, respectively 7,194 6,831
Additional paid-in capital 10,554,773 10,250,003
Accumulated deficit (61,398) (1,680,672)
------------ ------------
Total stockholders' equity 10,500,569 8,576,162
------------ ------------
Total liabilities and stockholders' equity $ 41,091,849 $ 42,713,166
============ ============
See accompanying notes.
3
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statements of Operations
Three and Six Months Ended September 30, 2006 and 2005
(Unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
2005 2005
2006 (restated) 2006 (restated)
------------ ------------ ------------ ------------
Sales $ 25,650,355 $ 24,070,949 $ 52,671,820 $ 42,982,739
------------ ------------ ------------ ------------
Operating expenses:
Reimbursable program costs and expenses 9,130,424 8,340,385 19,843,755 14,912,761
Outside production and other program expenses 5,900,334 7,688,109 13,194,043 13,471,318
Compensation expense 6,135,058 5,289,172 11,430,930 10,420,156
General and administrative expenses 2,709,455 2,739,195 4,891,785 5,037,537
------------ ------------ ------------ ------------
Total operating expenses 23,875,271 24,056,861 49,360,513 43,841,772
------------ ------------ ------------ ------------
Operating income (loss) 1,775,084 14,088 3,311,307 (859,033)
Interest expense, net (30,955) (65,781) (68,867) (127,022)
Other expense, net (305,942) -- (248,942) --
------------ ------------ ------------ ------------
Income (loss) from continuing operations before
provision (benefit) for income taxes 1,438,187 (51,693) 2,993,498 (986,055)
Provision (benefit) for income taxes 575,275 (20,677) 1,197,400 (367,089)
------------ ------------ ------------ ------------
Income (loss) from continuing operations 862,912 (31,016) 1,796,098 (618,966)
------------ ------------ ------------ ------------
Discontinued operations:
Income (loss) from discontinued
operations, net of tax provision
(benefit) of $0, $24,597, ($32,591) and
$66,155, respectively -- 40,350 (49,650) 38,417
Net loss on disposal of discontinued
operations, net of tax provision of $302,004 -- -- (127,174) --
------------ ------------ ------------ ------------
Income (loss) from discontinued operations -- 40,350 (176,824) 38,417
------------ ------------ ------------ ------------
Net income (loss) $ 862,912 $ 9,334 $ 1,619,274 $ (580,549)
============ ============ ============ ============
Basic earnings (loss) per share:
Income (loss) from continuing operations $ .13 $ (.01) $ .26 $ (.10)
Income (loss) from discontinued operations -- .01 (.02) .01
------------ ------------ ------------ ------------
Net income (loss) per share $ .13 $ -- $ .24 $ (.09)
============ ============ ============ ============
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ .12 $ -- $ .25 $ (.10)
Income (loss) from discontinued operations -- -- (.02) .01
------------ ------------ ------------ ------------
Net income (loss) per share $ .12 $ -- $ .23 $ (.09)
============ ============ ============ ============
Weighted average number of common shares
outstanding:
Basic 6,849,751 6,325,443 6,817,403 6,293,567
Dilutive effect of options ,warrants
and restricted shares 312,181 622,536 269,955 --
------------ ------------ ------------ ------------
Diluted 7,161,932 6,947,979 7,087,358 6,293,567
============ ============ ============ ============
See accompanying notes.
4
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statement of Stockholders' Equity
Six Months Ended September 30, 2006
(Unaudited)
Common Stock
par value $.001 Additional Total
---------------------------- Paid-in Accumulated Stockholders'
Shares Amount Capital Deficit Equity
------------ ------------ ------------ ------------ ------------
Balance, March 31, 2006 6,831,423 $ 6,831 $ 10,250,003 $ (1,680,672) $ 8,576,162
Exercise of options 361,380 361 433,295 -- 433,656
Issuance of non-vested stock, net of
forfeitures 155,000 155 (155) -- --
Retirement of common stock in connection
with payment of interest on note
receivable (153,052) (153) (282,994) -- (283,147)
Compensation cost recognized in connection
with non-vested stock -- -- 53,510 -- 53,510
Compensation cost recognized in connection
with stock options -- -- 101,114 -- 101,114
Net income -- -- -- 1,619,274 1,619,274
------------ ------------ ------------ ------------ ------------
Balance, September 30, 2006 7,194,751 $ 7,194 $ 10,554,773 $ (61,398) $ 10,500,569
============ ============ ============ ============ ============
See accompanying notes.
5
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statements of Cash Flows
Six Months Ended September 30, 2006 and 2005
(Unaudited)
2006 2005
(restated)
------------ ------------
Cash flows from operating activities:
Net income (loss) $ 1,619,274 $ (580,549)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 414,002 364,494
Deferred rent amortization (35,544) (28,215)
Provision for bad debt expense 161,030 70,400
Provision for uncollectible note receivable from officer 305,942 --
Interest income on note receivable from officer (24,024) (16,077)
Compensation expense on non-vested stock and stock options 154,624 --
Deferred income taxes 1,183,324 (366,927)
Loss from discontinued operations, net of tax 49,650 --
Loss on disposal of discontinued operations, net of tax 127,174 --
Changes in operating assets and liabilities:
Accounts receivable (8,676,516) (2,799,898)
Unbilled contracts in progress 1,249,774 (1,498,915)
Deferred contract costs 992,466 109,109
Prepaid expenses and other assets 430,412 154,187
Accounts payable (1,933,989) 2,114,324
Deferred revenue and other client credits 1,872,565 415,687
Accrued job costs (102,239) 1,295,501
Accrued compensation 359,512 415,040
Other accrued liabilities (17,830) (42,442)
------------ ------------
Net cash used in operating activities of continuing operations (1,870,393) (394,281)
Operating activities of discontinued operations (35,004) 79,282
------------ ------------
Net cash used in operating activities (1,905,397) (314,999)
------------ ------------
Cash flows from investing activities:
Proceeds from sale of discontinued operations 1,100,000 --
Proceeds from collection on note receivable 17,218 --
Purchases of fixed assets (172,529) (160,451)
------------ ------------
Net cash provided by (used in) investing activities of continuing operations 944,689 (160,451)
Investing activities of discontinued operations -- (117,698)
------------ ------------
Net cash provided by (used in) investing activities 944,689 (278,149)
------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options 433,656 387,847
Borrowings of debt -- 3,800,000
Payments of debt (500,000) (4,884,500)
Financing costs (5,000) (19,380)
------------ ------------
Net cash used in financing activities (71,344) (716,033)
------------ ------------
Net decrease in cash and cash equivalents (1,032,052) (1,309,181)
Cash and cash equivalents at beginning of period 3,929,438 2,171,103
------------ ------------
Cash and cash equivalents at end of period $ 2,897,386 $ 861,922
============ ============
Supplemental disclosures of cash flow information:
Interest paid during the period $ 120,378 $ 121,361
============ ============
Income tax paid during the period $ 14,076 $ 145,555
============ ============
Noncash activities relating to investing and financing activities:
Retirement of common stock in connection with payment of interest on note
receivable $ 283,147 $ --
============ ============
Amortization of projected reimbursements from clients for straight lining of rent $ -- $ 18,380
============ ============
Issuance of non-vested stock, net of forfeitures $ 155 $ --
============ ============
See accompanying notes.
6
CoActive Marketing Group, Inc. and Subsidiaries
Notes to the Unaudited Condensed Consolidated Financial Statements
September 30, 2006 and 2005 (restated)
(1) Basis of Presentation
---------------------
The interim financial statements of CoActive Marketing Group, Inc. (the
"Company") for the three and six months ended September 30, 2006 and
2005 have been prepared without audit. In the opinion of management,
such consolidated financial statements reflect all adjustments,
consisting of normal recurring accruals, necessary to present fairly
the Company's results for the interim periods presented. The results of
operations for the three and six months ended September 30, 2006 are
not necessarily indicative of the results for a full year.
The consolidated financial statements of the Company include the
financial statements of the Company and its wholly owned subsidiaries.
In addition, through May 22, 2006, the consolidated financial
statements included the accounts of a variable interest entity, Garcia
Baldwin, Inc. d/b/a MarketVision ("MarketVision"), an affiliate that
provided ethnically oriented marketing and promotional services. The
Company owned 49% of the common stock of MarketVision. A third party
owned the remaining 51%. The third party owned portion of MarketVision
was accounted for as minority interest in the Company's consolidated
financial statements. As disclosed in Note 2, the Company sold its 49%
interest in MarketVision in May 2006, and all amounts relating to
MarketVision have been reclassified as discontinued operations in the
Company's financial statements for all periods presented. All
significant intercompany balances and transactions have been eliminated
in consolidation.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These
consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K/A for the year ended March 31,
2006.
Restatement
-----------
The consolidated financial statements as of and for the fiscal years
ended March 31, 2006, 2005 and 2004 and the fiscal quarter ended June
30, 2006 were restated as a result of management's determination that
the Company had incorrectly applied revenue recognition policies to a
particular promotional program, resulting in the premature recording of
approximately $1,137,000 of revenues during the year ended March 31,
2006, including $623,000 in the three and six month periods ended
September 30, 2005. This error resulted in an understatement of
revenues by approximately $524,000 and an overstatement of operating
expenses by approximately $398,000 in the three months ended June 30,
2006. In addition, the Company improperly accrued approximately
$252,000 during the quarter ended June 30, 2006 for sales and use taxes
due to State taxing authorities with respect to the years ended March
31, 2006, 2005, and 2004. The restatement for these errors increased
the Company's net income as originally reported for the quarter ended
June 30, 2006 by approximately $704,000 ($.10 per diluted share).
In accounting for the promotional program referred to above, the
Company originally had determined that the design of the promotional
program itself and the acquiring of participating partners entitled the
Company to recognize a portion of the revenue to be generated from the
program. Management subsequently determined that the accounting for
this program, which contained multi-deliverables, is governed by EITF
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables"
("EITF 00-21") and that under EITF 00-21 revenue could only be
recognized as certain field events under the program were executed.
Accordingly, the sales and outside production costs and expenses for
this promotion, previously recorded in the year ended March 31, 2006,
were required to be deferred and could only be recognized upon the
execution of such events. Such execution occurred during the period of
April 2006 through July 2006.
To reflect the financial statement impact of the foregoing adjustments
on its previous filings with the SEC, the Company is filing
contemporaneously with this Form 10-Q, an amendment to its Annual
Report on Form 10-K/A for the year ended March 31, 2006, and an
amendment to its Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 2006, which reflect (i) a reduction in revenues for the year
ended March 31, 2006 and an increase in revenues and decrease in
operating expenses for the quarter ended June 30, 2006 in connection
7
with the promotional program referred to above, and (ii) an increase in
sales and use taxes and related expenses aggregating approximately
$604,000 for the years ended March 31, 2006, 2005, and 2004 and a
decrease in such expenses of $252,000 for the quarter ended June 30,
2006.
As previously noted, these adjustments required a restatement of the
Company's consolidated balance sheets and consolidated statements of
operations, as well as related adjustments to the Company's
consolidated statements of stockholders' equity and consolidated
statements of cash flows, without any effect on the Company's cash or
net cash provided from operations at and for the fiscal quarter ended
June 30, 2006, as well as the fiscal years ended March 31, 2006, 2005
and 2004. After reviewing the circumstances leading up to the
restatement, management believes that the errors were inadvertent and
unintentional. In addition, following the discovery of these errors,
the Company implemented procedures intended to strengthen its internal
control processes and prevent a recurrence of future errors of this
nature.
The effect of the restatements on the Company's consolidated statements
of operations for the three and six months ended September 30, 2005 is
presented below:
Three months ended Sept. 30, 2005
---------------------------------------------------------------------------
Reclass for
As previously discontinued Restatement
reported operations adjustment As restated
---------------------------------------------------------------------------
Sales $ 27,186,383 $ (2,508,222) $ (607,212) $ 24,070,949
---------------------------------------------------------------------------
Reimbursable program costs and
expenses 9,460,427 (1,135,830) 15,788 8,340,385
Outside production and other
program expenses 7,902,492 (233,692) 19,309 7,688,109
Compensation expense 6,115,384 (826,212) -- 5,289,172
General and administrative expenses 2,937,779 (205,575) 6,991 2,739,195
---------------------------------------------------------------------------
Operating income (loss) 770,301 (106,913) (649,300) 14,088
Interest expense, net (61,545) (29) (4,207) (65,781)
---------------------------------------------------------------------------
Income (loss) from continuing
operations before provision
(benefit) for income taxes 708,756 (106,942) (653,507) (51,693)
Provision (benefit) for income
taxes 265,323 (24,597) (261,403) (20,677)
---------------------------------------------------------------------------
Income (loss) from continuing
operations 443,433 (82,345) (392,104) (31,016)
Minority interest (41,995) 41,995 -- --
Income from discontinued operations -- 40,350 -- 40,350
---------------------------------------------------------------------------
Net income (loss) $ 401,438 $ -- $ (392,104) $ 9,334
===========================================================================
Basic earnings (loss) per share:
Income (loss) from continuing
operations N/A $ (.01) $ (.06) $ (.01)
Income from discontinued
operations N/A .01 .00 .01
---------------------------------------------------------------------------
Net income (loss) per share $ .06 $ .00 $ (.06) $ .00
===========================================================================
Diluted earnings per share:
Income (loss) from continuing
operations N/A $ (.01) $ (.06) $ .00
Income from discontinued
operations N/A .01 .00 .00
---------------------------------------------------------------------------
Net income (loss) per share $ .06 $ .00 $ (.06) $ .00
===========================================================================
8
Six months ended Sept. 30, 2005
---------------------------------------------------------------------------
Reclass for
As previously discontinued Restatement
reported operations adjustment As restated
---------------------------------------------------------------------------
Sales $ 48,698,926 $ (5,115,172) $ (601,015) $ 42,982,739
---------------------------------------------------------------------------
Reimbursable program costs and
expenses 17,416,236 (2,525,459) 21,984 14,912,761
Outside production and other
program expenses 13,844,571 (424,441) 51,188 13,471,318
Compensation expense 12,000,067 (1,579,911) -- 10,420,156
General and administrative expenses 5,468,406 (441,043) 10,174 5,037,537
---------------------------------------------------------------------------
Operating loss (30,354) (144,318) (684,361) (859,033)
Interest expense, net (117,865) (238) (8,919) (127,022)
---------------------------------------------------------------------------
Loss from continuing operations
before provision (benefit) for
income taxes (148,219) (144,556) (693,280) (986,055)
Benefit for income taxes (23,622) (66,155) (277,312) (367,089)
---------------------------------------------------------------------------
Loss from continuing operations (124,597) (78,401) (415,968) (618,966)
Minority interest (39,984) 39,984 -- --
Income from discontinued operations -- 38,417 -- 38,417
---------------------------------------------------------------------------
Net loss $ (164,581) $ -- $ (415,968) $ (580,549)
===========================================================================
Basic earnings (loss) per share:
Loss from continuing
operations N/A $ (.01) $ (.07) $ (.10)
Income from discontinued
operations N/A .01 .00 .01
---------------------------------------------------------------------------
Net loss per share $ (.03) $ .00 $ (.07) $ (.09)
===========================================================================
Diluted earnings per share:
Loss from continuing
operations N/A $ (.01) $ (.07) $ (.10)
Income from discontinued
operations N/A .01 .00 .01
---------------------------------------------------------------------------
Net loss per share $ (.03) $ .00 $ (.07) $ (.09)
===========================================================================
(2) Investment in MarketVision
--------------------------
On May 22, 2006, the Company sold its 49% interest in MarketVision back
to MarketVision for $1,100,000. In connection with the sale, the
Company recorded a pre-tax gain of approximately $175,000 and an after
tax loss of $127,000. The after tax loss reflects a tax provision of
approximately $300,000 on the sale and reflects the estimated tax due
as a result of the sale. This tax provision reflects the difference in
the book and tax basis of the Company's holdings in MarketVision and
resulted in a corresponding reduction in the Company's deferred tax
asset on its consolidated balance sheet. The after tax loss of $127,000
is included in the computation of the loss from discontinued operations
on the Company's consolidated statement of operations. The results of
operations for MarketVision for the period April 1, 2006 through May
22, 2006, as well as for the three and six months ended September 30,
2005, have been reclassified to discontinued operations, on a net of
tax basis. Summarized financial information for MarketVision, reflected
as discontinued operations, is as follows:
9
Balance Sheet at March 31, 2006:
Cash $ 1,962,106
Accounts receivable, net 903,154
Unbilled contracts in progress 673,335
Prepaid expenses and other current assets 101,474
Property and equipment, net 229,714
Goodwill 244,379
Other assets 13,852
Accounts payable 1,239,915
Deferred revenue and other client credits 965,566
Accrued job costs 245,390
Accrued compensation 13,500
Minority interest 723,827
Results of Operations for the period April 1, 2006 through May 22, 2006
and the three and six months ended September 30, 2005:
April 1, 2006 Three months Six months
to May 22, ended ended
2006 Sept. 30, 2005 Sept. 30, 2005
--------------- --------------- ---------------
Sales $ 1,197,677 $ 2,508,222 $ 5,115,172
--------------- --------------- ---------------
Operating expenses:
Reimbursable program costs and
expenses 617,663 1,135,830 2,525,459
Outside production and other
program expenses 151,184 233,692 424,441
Compensation expense 397,082 826,212 1,579,911
General and administrative
expenses 163,705 205,575 441,043
--------------- --------------- ---------------
Total operating expenses 1,329,634 2,401,309 4,970,854
--------------- --------------- ---------------
Operating (loss) income (131,957) 106,913 144,318
Interest (expense) income (1,963) 29 238
Benefit (provision) for income
taxes 32,591 (24,597) (66,155)
Minority interest 51,679 (41,995) (39,984)
--------------- --------------- ---------------
Net (loss) income $ (49,650) $ 40,350 $ 38,417
=============== =============== ===============
(3) Summary of Significant Accounting Policies
Reimbursable Program Costs and Expenses
---------------------------------------
Pursuant to contractual arrangements with some of its clients, the
Company is reimbursed for certain program costs and expenses. These
reimbursed costs are recorded both as revenues and as operating
expenses. Such costs may include variable employee program compensation
costs. Not included in reimbursable program costs and expenses are
certain compensation and general and administrative expenses which are
recurring in nature and for which a certain client fee arrangement
provides for payment to the Company of such costs. These costs are
included in compensation and general and administrative expenses in the
Company's income statement.
In July 2000, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") released Issue 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent" ("EITF 99-19").
Additionally, in January 2002, the EITF released Issue 01-14, "Income
Statement Characterization of Reimbursements Received for
"Out-of-Pocket" Expenses Incurred" ("EITF 01-14"). EITF 99-19 and EITF
01-14 provides guidance on when client reimbursements, including out of
pocket expenses, should be characterized as revenue. Pursuant to such
literature, the Company records such client reimbursements as revenue
on a gross basis.
10
Revenue Recognition
-------------------
The Company's revenues are generated from projects subject to contracts
requiring the Company to provide its services within specified time
periods generally ranging up to twelve months. As a result, on any
given date, the Company has projects in process at various stages of
completion. Depending on the nature of the contract, revenue is
recognized as follows: (i) on time and material service contracts,
revenue is recognized as services are rendered and the costs are
incurred; (ii) on fixed price retainer contracts, revenue is recognized
on a straight-line basis over the term of the contract; (iii) on fixed
price multiple services contracts, revenue is recognized over the term
of the contract for the fair value of segments of the services rendered
which qualify as separate activities or delivered units of service; to
the extent multi-service arrangements are deemed inseparable, revenue
on these contracts is recognized as the contracts are completed; (iv)
on certain fixed price contracts, revenue is recognized on a percentage
of completion basis, whereby the percentage of completion is determined
by relating the actual costs incurred to date to the estimated total
costs for each contract; (v) on other fixed price contracts, revenue is
recognized on the basis of proportional performance as certain key
milestones are delivered. Costs associated with the fulfillment of
projects are accrued and recognized proportionately to the related
revenue in order to ensure a matching of revenue and expenses in the
proper period. Provisions for anticipated losses on uncompleted
projects are made in the period in which such losses are determined.
Effective April 1, 2006, the Company changed its accounting policy
regarding its method of revenue recognition for certain contracts in
one of its subsidiaries from percentage of completion to completed
contract. The Company believes that the completed contract method of
revenue recognition for these contracts is the preferable method of
accounting due to the short-term nature of such contracts. The impact
of the change in accounting policy was not considered to be material as
of and for the year ended March 31, 2006.
Goodwill and Intangible Asset
-----------------------------
Goodwill consists of the cost in excess of the fair value of the
acquired net assets of the Company's subsidiary companies. The
Company's other intangible asset consists of an Internet domain name
and related intellectual property rights which has been determined to
have an indefinite life.
Goodwill and intangible assets deemed to have indefinite lives are no
longer amortized but are subject to annual impairment tests. Goodwill
impairment tests require the comparison of the fair value and carrying
value of reporting units. Measuring fair value of a reporting unit is
generally based on valuation techniques using multiples of earnings.
The Company assesses the potential impairment of goodwill annually and
on an interim basis whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Upon
completion of such annual review, if impairment is found to have
occurred, a corresponding charge will be recorded. The Company has
determined that it has four reporting units representing each of its
subsidiaries.
As a result of the Company's annual test to determine whether goodwill
has been impaired, the Company concluded that at March 31, 2006, the
carrying value of the goodwill associated with one of its reporting
units, Optimum, was greater than its fair value. As a result, the
Company recorded a non-cash pre-tax charge of $626,000 for the year
ended March 31, 2006 (net after tax in the amount of $382,000) to
reflect such impairment and reduce the carrying value of the goodwill
associated with Optimum to zero.
Goodwill and the intangible asset will continue to be tested annually
at the end of each fiscal year to determine whether they have been
impaired. Upon completion of each annual review, there can be no
assurance that a material charge will not be recorded. During the six
months ended September 30, 2006, the Company has not identified any
indication of the impairment of goodwill of its reporting units or
intangible asset.
Net Income (Loss) Per Share
---------------------------
For the quarter ended September 30, 2006, options and warrants, which
expire through March 31, 2016, to purchase approximately 1,393,000
shares of common stock at prices ranging from $2.00 to $10.00 per share
were excluded from the computation of diluted earnings per share. For
the six months ended September 30, 2006, options and warrants, which
expire through March 31, 2016, to purchase approximately 1,429,000
shares of common stock at prices ranging from $1.70 to $10.00 per share
were excluded from the computation of diluted earnings per share. For
the three months ended September 30, 2005, options and warrants,
11
which expire through April 30, 2015, to purchase approximately 527,000
shares of common stock at prices ranging from $3.38 to $10.00 per share
were excluded from the computation of diluted earnings per share. For
the six months ended September 30, 2005, options and warrants, which
expire through April 30, 2015, to purchase approximately 2,200,000
shares of common stock at prices ranging from $1.12 to $10.00 were
excluded from the computation of diluted earnings per share. Options
and warrants excluded from the computation of diluted earnings per
share were excluded as their effect would have been anti-dilutive.
Unbilled Contracts in Progress
------------------------------
Unbilled contracts in progress represent revenue recognized in advance
of billings rendered based on work performed to date on certain
contracts. Accrued job costs are also recorded for such contracts to
properly match costs and revenue.
Deferred Contract Costs
-----------------------
Deferred contract costs represent direct contract costs and expenses
incurred prior to the Company's related revenue recognition on such
contracts. Notwithstanding the Company's accounting policy with regards
to deferred contract costs, labor costs for permanent employees are
expensed as incurred.
Deferred Revenue and Other Client Credits
-----------------------------------------
Deferred revenue and Other Client Credits represents contract amounts
billed and client advances in excess of revenues earned.
(4) Note Receivable from Officer
----------------------------
Note receivable from officer (the "Officer") at March 31, 2006
consisted of an Amended and Restated Promissory Note (the "Amended
Note") from an Officer of the Company dated May 24, 2001 in the
original principal amount of $550,000. The Amended Note provided for
(i) monthly interest payments at a floating rate equal to the highest
rate at which the Company pays interest on its bank borrowings, (ii)
monthly payment of one-half of the interest that accrued over the
preceding month, (iii) payment of accrued interest and principal from
one-half of the after-tax amount, if any, of bonuses paid to the
Officer by the Company, and (iv) payment of the remaining balance of
principal and accrued interest on May 24, 2006. As of March 31, 2006,
the Officer had not made any of the required monthly interest payments
under the Amended Note. The Amended Note was secured by a first lien
and security interest in (i) 163,196 shares of the Company's common
stock owned by the Officer (after giving effect to the surrender of
153,052 shares described below), and (ii) a second mortgage on the
Officer's home. At March 31, 2006, the amount due from the Officer with
respect to the Amended Note of $826,341 included accrued interest in
the amount of $276,000, of which $78,500 was past due and owing on such
date.
On April 26, 2006, the Officer surrendered to the Company for
cancellation 153,052 shares of the Company's common stock as payment in
full of interest in the amount of $283,147 accrued through May 24, 2006
and pledged as collateral options to purchase 225,000 shares of the
Company's common stock. At September 30, 2006, the principal amount of
such note was outstanding and all accrued interest through such date
has been paid to the Company.
Pursuant to an Agreement dated as of March 27, 2007, subsequent to the
balance sheet date, the employment relationship between the Company and
the Officer terminated effective March 31, 2007, the last day of the
term of his employment under the Officer's Employment Agreement with
the Company. Pursuant to the Agreement:
o The Company agreed to pay the Officer (i) a severance payment
of $50,000 by April 15, 2007, and (ii) $12,500 per month for
the three-month period beginning April 1, 2007 and ending June
30, 2007 for consulting services to be provided by the Officer
to the Company during that period.
o The Officer agreed to sell to three directors of the Company
163,196 shares of the Company's common stock for an aggregate
consideration of $258,568. The shares of common stock had been
pledged to the Company by the Officer to secure his
obligations under the Amended Note, as set forth above, and
12
the proceeds of the sale were paid to the Company to reduce
the Officer's obligations to the Company under that note.
o The Company agreed to the cancellation of the Officer's
remaining obligations under the Amended Note in the amount of
approximately $306,000.
Since the Amended Note was cancelled prior to the issuance of the
consolidated financial statements as of and for the six months ended
September 30, 2006, the Company has recorded an allowance for the
uncollectible portion of the note receivable in the amount of $306,000
at September 30, 2006. The provision for the uncollectible portion of
the note receivable is included in other expense, net for the three and
six months ended September 30, 2006.
Since the Amended Note was satisfied in full by the Officer prior to
the issuance of the consolidated financial statements as of and for the
six months ended September 30, 2006, the Company has classified the
full balance of the note receivable as current at September 30, 2006.
In comparison, at March 31, 2006, the Company believed that the
expected repayment date on the Amended Note may extend beyond one year,
and therefore, at March 31, 2006, the Company classified the full
balance of the note receivable as long-term.
(5) Deferred Rent
-------------
Deferred rent consists of (i) the excess of the allocable straight line
rent expense to date as compared to the total amount of rent due and
payable through such period, (ii) prior to January 1, 2006, the
capitalization of rent during any build out period during which the
Company has the right to occupy the space but pays no rent or a reduced
rate of rent, and (iii) funds received from landlords to reimburse the
Company for the cost, or a portion of the cost, of leasehold
improvements. Deferred rent is amortized to rent expense over the term
of the lease. Effective January 1, 2006, in accordance with FASB Staff
Position No. 13-1, "Accounting for Rental Costs Incurred during a
Construction Period" ("FSP 13-1"), rental costs associated with any new
ground or building operating leases that are incurred during a
construction period are recognized as rental expense.
(6) Notes Payable Bank
------------------
In March 2005, the Company entered into an Amended and Restated Credit
Agreement ("Credit Agreement") with Signature Bank (the "Bank"), under
which amounts available for borrowing under its revolving credit line
were increased by $2.4 million to $3 million, and the term loan portion
of the credit facility was increased by $1.1 million to $4 million. As
a condition to providing its consent to the sale of the Company's
interest in MarketVision in May 2006, the Bank required the Company to
deposit the proceeds of such sale, in the amount of approximately $1.1
million, in a cash collateral account as security for its obligations
under the Credit Agreement. As part of a July 12, 2006 amendment to the
Credit Agreement, the Bank released the cash collateral to the Company
and reduced the amount available for borrowing under the revolving
credit line to $2 million.
Borrowings under the Credit Agreement are evidenced by promissory notes
and are secured by all of the Company's assets. The Company pays the
Bank a quarterly fee equal to .25% per annum on the unused portion of
the revolving credit line. Pursuant to the Credit Agreement:
o Principal payments on the term loan are made in equal monthly
installments of $83,333, with the final payment due in March
2009.
o The maturity date of loans made under the revolving credit
line is March 24, 2008.
o Interest charges on the revolving credit line and term loan
accrue at the Bank's prime rate (8.25% at September 30, 2006),
and its prime rate plus .50%, respectively.
The Credit Agreement provides for a number of affirmative and negative
covenants, restrictions, limitations and other conditions including,
among others, (i) limitations regarding the payment of cash dividends,
(ii) restriction on the use of proceeds, (iii) prohibition on incurring
a consolidated net loss, as defined in the Credit Agreement, in two
consecutive fiscal quarters or any fiscal year, (iv) compliance with a
defined senior debt leverage ratio and debt service ratio covenants,
(v) limitation on annual capital expenditures, and (vi) maintenance of
15% of beneficially owned shares of common stock by certain
stockholders. Although the Company was in compliance with these
financial covenants with respect to the period ended September 30,
2006, as a result of the restatement described in Note 1, the Bank's
waiver granted on July 12, 2006 with respect to the Company's failure
to comply with these financial covenants at March 31, 2006 is no longer
effective, and an Event of Default exists under the Credit Agreement as
a result thereof.
13
At September 30, 2006, the Company's term bank borrowings amounted to
$2,500,000 (exclusive of a letter of credit outstanding in the amount
of $500,000) and there were no borrowings outstanding under the
revolving line of credit.
On December 14, 2006, the Company received a letter from the Bank
notifying the Company that its failure to timely deliver to the Bank
its financial statements for the quarter ended September 30, 2006
resulted in the occurrence of an Event of Default under the Credit
Agreement, and that as a result of the Event of Default, (i) the
Company's $2 million revolving credit facility had been terminated,
(ii) the interest rate on the Company's outstanding term loan under the
Credit Agreement had been increased by one-half of one percent per
annum (prime plus one percent), and (iii) effective February 11, 2007
the interest rate on the Company's term loan would be increased by four
percent per annum (exclusive of the one-half of one percent increase
noted above). At the time the Company received the letter, it had no
loans outstanding under its revolving credit facility and $2.25 million
outstanding under the term loan portion of the Credit Agreement.
As a result of the Events of Default noted above, the Company's term
loan is now considered due and payable, and therefore, the Company
classified the full balance of the term loan as notes payable - current
at September 30, 2006 and March 31, 2006.
(7) Accounting for Stock-Based Compensation
---------------------------------------
On April 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (Revised 2004) - "Share-Based Payment" ("SFAS No.
123R"), which requires the Company to measure all employee stock-based
compensation awards using a fair value method and record the related
expense in the financial statements over the period during which an
employee is required to provide service in exchange for the award. SFAS
No. 123R also amends FASB Statement No. 95, "Statement of Cash Flows,"
to require that excess tax benefits, as defined, realized from the
exercise of stock options be reported as a financing cash inflow rather
than as a reduction of taxes paid in cash flow from operations. The
Company elected to use the modified prospective transition method,
which requires that compensation cost be recognized in the financial
statements for all awards granted after the date of adoption as well as
for existing rewards for which the requisite service has not been
rendered as of the date of adoption. The modified prospective
transition method also requires that prior periods not be restated. All
periods presented prior to April 1, 2006 were accounted for in
accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB No. 25"). Accordingly, no
compensation cost was recognized for stock options granted prior to
April 1, 2006 because the exercise price of the stock options equaled
the market value of the Company's common stock at the date of grant,
which was the measurement date.
The adoption of SFAS No. 123R reduced income from continuing operations
before provision for income taxes and net income by $27,200 and
$16,300, respectively, for the three months ended September 30, 2006
and $101,100 and $60,700, respectively, for the six months ended
September 30, 2006. The impact on diluted earnings per share for the
three and six months ended September 30, 2006 was $.00 and $.01 per
share, respectively.
Stock Options
Under the Company's 1992 Stock Option Plan (the "1992 Plan"), employees
of the Company and its affiliates and members of the Board of Directors
were granted options to purchase shares of common stock of the Company.
The 1992 Plan terminated in 2002, although options issued thereunder
remain exercisable until the termination dates provided in such
options. Options granted under the 1992 Plan were either intended to
qualify as incentive stock options under the Internal Revenue Code of
1986, or non-qualified options. Grants under the 1992 Plan were awarded
by a committee of the Board of Directors, and are exercisable over
periods not exceeding ten years from date of grant. The option price
for incentive stock options granted under the 1992 Plan must be at
least 100% of the fair market value of the shares on the date of grant,
while the price for non-qualified options granted to employees and
employee directors is determined by the committee of the Board of
Directors. The 1992 Plan was amended on May 11, 1999 to increase the
maximum number of shares of common stock for which options may be
granted to 1,500,000 shares. At September 30, 2006, there were 158,125
options, expiring from November 2006 through April 2011, issued under
the 1992 Plan that remain outstanding.
14
On May 11, 1999, as approved by the Company's Board of Directors, the
Company established the 1997 Executive Officer Stock Option Plan (the
"1997 Plan"), pursuant to which (i) a maximum of 375,000 non-qualified
stock options may be granted to purchase shares of common stock, (ii)
three officers of the Company were each granted 125,000 non-qualified
stock options to purchase shares of common stock in exchange for the
surrender by each of their incentive stock options to purchase 125,000
shares of common stock issued on May 2, 1997 pursuant to the Company's
1992 Stock Option Plan and (iii) the exercise price and other terms and
conditions of the options granted are identical to those of the options
surrendered. The 375,000 options, all expiring May 2007, issued under
the 1997 Plan remain outstanding at September 30, 2006. Options
outstanding under the 1997 plan that are not exercised by their
expiration date are not available for re-issuance by the Company.
On July 1, 2002, the Company established the 2002 Long-Term Incentive
Plan (the "2002 Plan") providing for the grant of options or other
awards, including stock grants, to employees, officers or directors of,
consultants to, the Company or its subsidiaries to acquire up to an
aggregate of 750,000 shares of Common Stock. In September 2005, the
2002 Plan was amended so as to increase the number of shares of common
stock available under the plan to 1,250,000. Options granted under the
2002 Plan may either be intended to qualify as incentive stock options
under the Internal Revenue Code of 1986, or may be non-qualified
options. Grants under the 2002 Plan are awarded by a committee of the
Board of Directors, and are exercisable over periods not exceeding ten
years from date of grant. The option price for incentive stock options
granted under the 2002 Plan must be at least 100% of the fair market
value of the shares on the date of grant, while the price for
non-qualified options granted is determined by the Committee of the
Board of Directors. At September 30, 2006, there were 872,500 options,
expiring from July 2007 through March 2016, issued under the 2002 Plan
that remain outstanding. Any option under the 2002 Plan that is not
exercised by an option holder prior to its expiration may be available
for re-issuance by the Company. As of September 30, 2006, the Company
had 12,500 options available for grant under the 2002 Plan.
The maximum contractual option period for any of the Company's options
is ten years. The Company uses the Black-Scholes model to estimate the
value of stock options granted under SFAS No. 123R. Because
option-pricing models require the use of subjective assumptions,
changes in these assumptions can materially affect the fair value of
options. The assumptions presented in the table below represent the
weighted-average of the applicable assumptions used to value stock
options at their grant date. The risk-free rate assumed in valuing the
options is based on the U.S. Treasury yield curve in effect at the time
of grant for the expected term of the option. The expected term, which
represents the period of time that options granted are expected to be
outstanding, is estimated based on the historical exercise experience
of the Company's employees. In determining the volatility assumption,
the Company considers the historical volatility of its common stock.
Three Months Ended Sept. 30, Six Months Ended Sept. 30,
2006 (1) 2005 (1) 2006 2005
--------------------------- ---------------------------
Risk-free interest rate N/A N/A 4.92% 4.34%
Expected life - years N/A N/A 5.00 10.00
Expected volatility N/A N/A 42.9% 60.2%
Expected dividend yield N/A N/A 0% 0%
Fair value of option grants N/A N/A $ .77 $ 2.47
(1) The disclosure for the quarters ended September 30, 2006 and 2005
are not applicable ("N/A") as there were no options issued during
those quarters.
A summary of option activity under all plans as of September 30, 2006,
and changes during the period then ended is presented below:
15
Weighted
Weighted average
average Number remaining Aggregate
exercise of contractual intrinsic
price options term value
------------ ------------ ------------ ------------
Balance at March 31, 2006 $ 2.65 1,766,305
Granted (A) $ 1.61 110,000
Exercised $ 1.20 (361,380)
Canceled $ 2.44 (109,300)
------------ ------------
Balance at September 30, 2006 (vested
and expected to vest) $ 2.95 1,405,625 2.00 $ 35,975
============ ============ ============ ============
Exercisable at September 30, 2006 $ 3.01 1,340,625 1.78 $ 23,175
============ ============ ============ ============
(A) Represents options granted to purchase 30,000 shares at an
exercise price of $1.70 and 80,000 shares at an exercise price of
$1.57. Of the options granted, 70,000 became exercisable prior to
September 30, 2006 and 40,000 were to become exercisable upon the
earlier to occur of the Board of Director's selection of a
permanent Chief Executive Officer or June 20, 2007. On October 9,
2006, the Company entered into an employment agreement with a new
Chief Executive Officer; as such the 40,000 options became
exercisable on such date.
The total intrinsic value of options exercised during the three and six
months ended September 30, 2006 was approximately $208,600. Cash
received from the exercise of stock options during the three and six
months ended September 30, 2006 was approximately $433,700.
Total unrecognized compensation cost related to unvested stock option
awards at September 30, 2006 amounts to approximately $30,400 and is
expected to be recognized over a weighted average period of .3 years.
Total compensation cost for the three and six months ended September
30, 2006, amounted to approximately $27,200 and $101,100, respectively,
for these option awards. The related tax benefit for the three and six
months ended September 30, 2006 amounted to $10,900 and $40,400,
respectively.
Warrants
At each of September 30, 2006 and March 31, 2006, there were
outstanding warrants to purchase an aggregate of 81,533 shares of
common stock at a weighted average exercise price per share of $3.68
held by two individuals. These warrants were to expire on April 30,
2007. In April 2007, in consideration of services provided, the
expiration date of one of these warrants, to purchase 40,766 shares of
common stock, was extended to April 30, 2010.
Non-Vested Stock
As of September 30, 2006, pursuant to the authorization of the
Company's Board of Directors and certain Restricted Stock Agreements,
the Company had awarded 345,000 shares of common stock under the
Company's 2002 Plan to certain employees (net of 25,000 shares
forfeited in April 2006 as a result of the termination of employment of
a recipient). Grant date fair value is determined by the market price
of the Company's common stock on the date of grant. The aggregate value
of these shares at their respective grant dates amounted to
approximately $651,600 and will be recognized ratably as compensation
expense over the vesting periods. The shares of common stock granted
pursuant to such agreements vest as follows:
20% on March 31, 2007
30% on March 31, 2008
20% on March 31, 2009
20% on March 31, 2010
10% on March 31, 2011
The shares awarded under the restricted stock agreements vest on the
applicable vesting dates only to the extent the recipient of the shares
is then an employee of the Company or one of its subsidiaries, and each
recipient will forfeit all of the shares that have not vested on the
date his or her employment is terminated (if prior to March 31, 2011).
16
On October 9, 2006, pursuant to a Restricted Stock Agreement and as
approved by the Company's Board of Directors, the Company awarded
200,000 shares of common stock to its newly appointed President and
Chief Executive Officer. The fair value of these shares was determined
by the market price of the Company's common stock on the date of grant.
The value of the shares at the grant date amounted to approximately
$380,000. The shares will vest in one installment on October 9, 2011
provided the recipient is then employed by the Company. In addition, as
set forth in the Restricted Stock Agreement, the shares will be subject
to earlier incremental vesting to the extent the Company's shares of
common stock trade above specified thresholds for a minimum period of
20 consecutive trading days during the term of his employment with the
Company. The accelerated vesting will occur as follows:
Percentage of
Share Price Threshold Shares Vested
--------------------- -------------
$3.00 20%
$4.00 40%
$5.00 60%
$6.00 80%
$7.00 100%
A summary of non-vested stock activity as of September 30, 2006, and
changes during the six month period then ended is presented below:
Weighted Weighted
average average
grant Number remaining Aggregate
date fair of contractual intrinsic
value shares term value
------------ ------------ ------------ ------------
Unvested at March 31, 2006 $ 2.13 190,000
Granted $ 1.67 180,000
Vested -- --
Forfeited $ 2.13 (25,000)
------------ ------------
Unvested at September 30, 2006 $ 1.89 345,000 2.20 $ 40,100
============ ============ ============ ============
Total unrecognized compensation cost related to unvested stock awards
at September 30, 2006 amounts to approximately $598,000 and is expected
to be recognized over a weighted average period of 2.2 years. Total
compensation cost for the three and six months ended September 30,
2006, amounted to approximately $33,700 and $53,500, respectively, for
these stock awards. The related tax benefit for the three and six
months ended September 30, 2006 amounted to approximately $13,500 and
$21,400, respectively.
The following table illustrates the effect on net loss and loss per
share for the three and six months ended September 30, 2005 had the
Company applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," to its stock based incentive
plans for the three and six months ended September 30, 2005:
Three Months Six Months
Ended Ended
Sept. 30, 2005 Sept. 30,2005
(restated) (restated)
-------------- --------------
Net income (loss) as reported $ 9,334 $ (580,549)
Less compensation expense determined under the fair
value method, net of tax (9,550) (19,100)
-------------- --------------
Pro forma net loss $ (216) $ (599,649)
============== ==============
Net income (loss) per share - Basic:
As reported $ 0.00 $ (.09)
Pro forma $ 0.00 $ (.10)
Net income (loss) per share - Diluted:
As reported $ 0.00 $ (.09)
Pro forma $ 0.00 $ (.10)
17
(8) Recent Accounting Standards Affecting the Company
-------------------------------------------------
In June 2006, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes
- an Interpretation of FASB No. 109" ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in the financial
statements in accordance with FASB Statement No. 109, "Accounting for
Income Taxes." FIN 48 prescribes a recognition threshold and
measurement attribute for a tax position taken or expected to be taken
in a tax return. FIN 48 also provides guidance on future changes,
classification, interest and penalties, accounting in interim periods,
disclosures and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company is therefore required to
adopt FIN 48 beginning April 1, 2007. Adoption of this statement
requires that the cumulative effect of adopting this statement be
recorded as an adjustment to retained earnings in the period of
adoption. The Company is currently evaluating the impact of FIN 48 on
its consolidated financial statements and is not yet able to estimate
the effect on its financial statements when adopted.
In September 2006, the SEC staff issued Staff Accounting Bulletin No.
108, "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements" ("SAB
108"). Historically, there have been two widely used methods for
quantifying the effects of financial statement misstatements. These
methods are referred to as the "roll-over" (current year income
statement perspective) and "iron curtain" (year-end balance sheet)
methods. SAB 108 established an approach that requires quantification
of financial statement misstatements based on the effects of the
misstatement on each of the company's financial statements and the
related financial statement disclosures (the "dual approach"). The dual
approach must be adopted for fiscal years ending after November 15,
2006, which is effective for the Company's fiscal year ending March 31,
2007.
SAB 108 allows registrants to initially apply the dual approach either
by (1) retroactively adjusting prior financial statements as if the
dual approach had always been used or by (2) recording the cumulative
effect of initially applying the dual approach as adjustments to the
carrying values of assets and liabilities as of April 1, 2006 with an
offsetting adjustment recorded to the opening balance of retained
earnings.
The adoption of SAB 108 is not expected to have a material effect on
the Company's results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS 157"). SFAS 157 establishes a framework for
measuring fair value and eliminates the diversity in practice due to
the inconsistencies in the guidance provided in previous accounting
pronouncements. SFAS 157 does not require any new fair value
measurements but does require expanded disclosures regarding fair value
measurements.
SFAS No. 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within
those fiscal years, although earlier application is encouraged.
Additionally, prospective application of the provisions of SFAS No. 157
is required as of the beginning of the fiscal year in which it is
initially applied, except when certain circumstances require
retrospective application. The Company is currently evaluating the
impact of SFAS No. 157 on its consolidated financial statements.
(9) Lease Accounting Correction
---------------------------
Until the fourth quarter of Fiscal 2005, the Company recognized certain
lease obligations as they became due and payable. In light of
announcements made by a number of public companies regarding lease
accounting and a Securities and Exchange Commission ("SEC")
clarification on the subject, the Company corrected its lease
accounting in the fourth quarter of Fiscal 2005. As a result, with
regard to one of its office leases, the Company corrected its
computation of rent expense, depreciation of leasehold improvements and
the classification of landlord allowances related to leasehold
improvements. The correction did not affect the Company's historical or
future cash flows or the timing of payments under the related lease.
The effect on the Company's prior years' earnings (loss) per share,
cash flow from operations and stockholders' equity were deemed to be
immaterial requiring no restatement.
18
The Company has historically received reimbursements from certain
clients for expenses, including, but not limited to, rent. Such
reimbursements are made based on current rental payments payable
independent of any straight-lining accounting methodology. Accordingly,
in order to match the effect of the straight line rent adjustment to
projected future reimbursements from clients, the Company recorded a
deferred asset for the estimated portion allocable to these clients.
This asset was expected to be amortized over the period of the clients'
expected reimbursement.
In the fourth quarter ended March 31, 2006, the Company determined that
the amount of projected client reimbursements could not be estimated
with the necessary degree of accuracy and should no longer be carried
as an asset on its balance sheets. The Company's determination resulted
in part from a trend in its customer contract away from direct
reimbursements and towards fixed negotiated fees for services provided.
As a result of the determination, the Company recorded a non-cash
pre-tax reduction in earnings of approximately $218,000, of which
$163,000 was charged to rent expense and $55,000 was charged to
amortization expense, to write off the remaining balance of projected
client rent reimbursements. In addition, in connection with the
adjustment, the Company recorded an increase in property and equipment
- leasehold improvements of $190,000, a decrease in other assets of
$408,000 and a decrease in deferred taxes payable of $85,000.
(10) Commitments and Contingencies
-----------------------------
On June 14, 2006, the Board of Directors accepted the resignation of
John Benfield, the Company's Chief Executive Officer, and appointed
Marc C. Particelli, a member of the Company's Board of Directors, to
serve as Chief Executive Officer and Chairman of the Board on an
interim basis. Both Mr. Benfield's resignation and Mr. Particelli's
appointment were effective as of July 12, 2006.
In connection with his appointment as interim Chief Executive Officer,
the Board and Mr. Particelli entered into an Employment Agreement
pursuant to which Mr. Particelli was to be paid an annual salary of
$250,000 for devoting approximately 50% of his working time to the
Company. In addition, for his agreement to serve as interim Chief
Executive Officer, the Board approved the grant to Mr. Particelli of a
five-year stock option to purchase 80,000 shares of the Company's
common stock at a price of $1.57 per share (the market price of the
common stock on the date the grant was authorized), 40,000 which vested
immediately and the balance to vest upon the earlier of the selection
by the Company of a permanent Chief Executive Officer or June 20, 2007.
Accordingly, in October 2006, upon the appointment of the Company's new
Chief Executive Officer, the remaining 40,000 shares of unvested
options pursuant to this agreement became vested.
In addition, in connection with his resignation, the Company entered
into an agreement with Mr. Benfield pursuant to which Mr. Benfield
will, for the one-year period beginning July 1, 2006, continue to be
compensated at his current rate of $300,000 per annum and receive the
same benefits previously provided to him by the Company. The Company
recorded a pre-tax charge of approximately $330,000 during the quarter
ended September 30, 2006 in connection with its obligations under the
Agreement with Mr. Benfield.
On October 9, 2006, the Company entered into a three year Employment
Agreement with Charles Tarzian under which Mr. Tarzian joined the
Company as its President and Chief Executive Officer, replacing Marc C.
Particelli, who had been serving as Chairman of the Board and Chief
Executive Officer on an interim basis. The Employment Agreement with
Mr. Tarzian is for a three-year term and provides Mr. Tarzian with:
o An annual base salary of $375,000.
o An annual bonus based on the achievement of annual performance
targets approved of by the Company's Board of Directors.
o An award of 200,000 shares of the Company's common stock under
a Restricted Stock Agreement. The shares will vest in one
installment on October 9, 2011 provided Mr. Tarzian is then
employed by the Company. In addition, as set forth in the
Restricted Stock Agreement, the shares will be subject to
earlier incremental vesting to the extent the Company's shares
of common stock trade above specified thresholds for a minimum
period of 20 consecutive trading days during the term of his
employment with the Company.
o Up to an additional 50,000 shares of restricted Common Stock
per year based on the achievement of annual targets approved
by the Company's Board of Directors.
19
In addition, pursuant to the Employment Agreement, in the event that
Mr. Tarzian's employment is terminated by the Company without "Cause"
or by Mr. Tarzian for "Good Reason", Mr. Tarzian will be entitled to
six months severance pay.
In connection with Mr. Tarzian's appointment as President and Chief
Executive Officer, the Company's Board of Directors approved
compensation for Mr. Particelli, as the Company's non-executive
Chairman of the Board following such appointment, in the amount of
$100,000 per annum.
Pursuant to an Agreement dated as of April 30, 2007 between the Company
and Erwin Mevorah, the Company's Chief Financial Officer, the Company
and Mr. Mevorah agreed to Mr. Mevorah's resignation as Chief Financial
Officer and the termination of his employment with the Company
effective on April 30, 2007. In addition, pursuant to the Agreement:
o The Company agreed to pay Mr. Mevorah up to six months' of
severance payments in the amount of $153,000, and in no event
less than four months of severance payments, plus
approximately $11,000 for accrued and unused vacation days.
o The Company agreed to pay Mr. Mevorah a bonus of $65,000 at
the same time bonuses are paid to other management members of
the Company, notwithstanding that Mr. Mevorah will not then be
employed by the Company.
(11) Reclassifications
-----------------
Certain amounts as previously reported have been reclassified to
conform to current year classifications.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, that are based on beliefs of the
Company's management as well as assumptions made by and information currently
available to the Company's management. When used in this report, the words
"estimate," "project," "believe," "anticipate," "intend," "expect," "plan,"
"predict," "may," "should," "will," the negative thereof or other variations
thereon or comparable terminology are intended to identify forward-looking
statements. Such statements reflect the current views of the Company with
respect to future events based on currently available information and are
subject to risks and uncertainties that could cause actual results to differ
materially from those contemplated in those forward-looking statements. Factors
that could cause actual results to differ materially from the Company's
expectations are set forth in the Company's Annual Report on Form 10-K/A for the
fiscal year ended March 31, 2006 under "Risk Factors," including but not limited
to "Outstanding Indebtedness," Security Interest," "Recent Losses," "Dependence
on Key Personnel," "Customers," "Unpredictable Revenue Patterns," "Competition,"
"Risks Associated with Acquisitions," "Expansion Risk," and "Control by
Executive Officers and Directors," in addition to other information set forth
herein and elsewhere in our other public filings with the Securities and
Exchange Commission. The forward-looking statements contained in this report
speak only as of the date hereof. The Company does not undertake any obligation
to release publicly any revisions to these forward-looking statements to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Overview
CoActive Marketing Group, Inc., through its wholly-owned subsidiaries
Inmark Services LLC, Optimum Group LLC, U. S. Concepts LLC and Digital
Intelligence Group LLC, is an integrated sales promotional and marketing
services agency. We develop, manage and execute promotional programs at both
national and local levels. Our programs help our clients effectively promote
their goods and services directly to retailers and consumers and are intended to
assist them in achieving a maximum impact and return on their marketing
investment. Our activities reinforce brand awareness, provide incentives to
retailers to order and display our clients' products, and motivate consumers to
purchase those products.
Our services include experiential marketing, event marketing,
interactive marketing, ethnic marketing, and all elements of consumer and trade
promotion and are marketed directly to our clients by our sales force operating
out of offices located in New York, New York; Cincinnati, Ohio; Chicago,
Illinois and San Francisco, California.
During our fiscal year ended March 31, 2006, and in our first fiscal
quarter of fiscal 2007 until May 22, 2006, we provided marketing services
targeting the Hispanic community through Garcia Baldwin, Inc., doing business as
20
MarketVision, an affiliate of ours of which we owned 49%. On May 22, 2006, we
sold our 49% interest in MarketVision for $1,100,000 in cash. Accordingly, the
results of MarketVision for the period from April 1, 2006 to May 22, 2006 and
the three and six months ended September 30, 2005 have been reclassified to
discontinued operations. Following that sale, we continue to provide services
targeting Hispanic, as well as African American and urban consumers, through our
recently launched Urban Concepts platform.
Restatement
The consolidated financial statements as of and for the fiscal years
ended March 31, 2006, 2005 and 2004 and the fiscal quarter ended June 30, 2006
were restated as a result of management's determination that we had incorrectly
applied revenue recognition policies to a particular promotional program,
resulting in the premature recording of approximately $1,137,000 of revenues
during the year ended March 31, 2006, including $623,000 in the three and six
month periods ended September 30, 2005. This error resulted in an understatement
of revenues by approximately $524,000 and an overstatement of operating expenses
by approximately $398,000 in the three months ended June 30, 2006. In addition,
we improperly accrued approximately $252,000 during the quarter ended June 30,
2006 for sales and use taxes due to State taxing authorities with respect to the
years ended March 31, 2006, 2005, and 2004. The restatement for these errors
increased our net income as originally reported for the quarter ended June 30,
2006 by approximately $704,000 ($.10 per diluted share).
In accounting for the promotional program referred to above, we
originally had determined that the design of the promotional program itself and
the acquiring of participating partners entitled us to recognize a portion of
the revenue to be generated from the program. Management subsequently determined
that the accounting for this program, which contained multi-deliverables, is
governed by EITF 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF 00-21") and that under EITF 00-21, revenue could only be
recognized as certain field events of the program were executed on behalf of our
clients. Accordingly, the sales and outside production costs and expenses for
this promotion, previously recorded in the year ended March 31, 2006, were
required to be deferred and could only be recognized upon the execution of such
events. Such execution occurred during the period of April 2006 through July
2006.
To reflect the financial statement impact of the foregoing adjustments
on its previous filings with the SEC, we are filing contemporaneously with this
Form 10-Q, an amendment to our Annual Report on Form 10-K/A for the year ended
March 31, 2006, and an amendment to our Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 2006, which reflect (i) a reduction in revenues for the
year ended March 31, 2006 and an increase in revenues and decrease in operating
expenses for the quarter ended June 30, 2006 in connection with the promotional
program referred to above, and (ii) an increase in sales and use taxes and
related expenses of $604,000 for the years ended March 31, 2006, 2005, and 2004
and a decrease in such expenses of $252,000 for the quarter ended June 30, 2006.
As previously noted, these adjustments (as well as those related to the
presentation for discontinued operations) required a restatement of our
consolidated balance sheets and consolidated statements of operations, as well
as related adjustments to our consolidated statements of stockholders' equity
and consolidated statements of cash flows, without any effect on our cash or net
cash provided from operations at and for the fiscal quarter ended June 30, 2006,
as well as the fiscal years ended March 31, 2006, 2005 and 2004. After reviewing
the circumstances leading up to the restatement, management believes that the
errors were inadvertent and unintentional. In addition, following the discovery
of these errors, we implemented procedures intended to strengthen our internal
control processes and prevent a recurrence of future errors of this nature.
Lease Accounting Correction
Until the fourth quarter of Fiscal 2005, we recognized certain lease
obligations as they became due and payable. In light of recent announcements
made by a number of public companies regarding lease accounting and a SEC
clarification on the subject, we corrected our lease accounting in the fourth
quarter of Fiscal 2005. As a result, with regard to one of our office leases, we
corrected our computation of rent expense, depreciation of leasehold
improvements and the classification of landlord allowances related to leasehold
improvements. The correction did not affect our historical or future cash flows
or the timing of payments under the related lease. The effect on prior years'
earnings (loss) per share, cash flow from operations and stockholders' equity
were deemed to be immaterial requiring no restatement.
We historically have received reimbursements from certain clients for
expenses, including, but not limited to, rent. Such reimbursements are made
based on current rental payments payable independent of any straight-lining
21
accounting methodology. Accordingly, in order to match the effect of the
straight line rent adjustment to projected future reimbursements from clients,
we recorded a deferred asset for the estimated portion allocable to these
clients as of March 31, 2005 to correct this error. This asset was expected to
be amortized over the period of the clients' expected reimbursement.
In the fourth quarter ended March 31, 2006, we determined that the
amount of projected client reimbursements could not be estimated with the
necessary degree of accuracy and should no longer be carried as an asset on our
balance sheets. Our determination resulted in part from a trend in our customer
contracts away from direct reimbursements and towards fixed negotiated fees for
services provided. As a result of the determination, we recorded a non-cash
pre-tax reduction in earnings of approximately $218,000, of which $163,000 was
charged to rent expense and $55,000 was charged to amortization expense, to
write off the remaining balance of projected client rent reimbursements. In
addition, in connection with the adjustment, we recorded an increase in property
and equipment - leasehold improvements of $190,000, a decrease in other assets
of $408,000 and a decrease in deferred taxes payable of $85,000.
The information herein should be read together with the consolidated
financial statements and notes thereto included in our Annual Report on Form
10-K/A for the year ended March 31, 2006.
Results of Operations
The following table presents operating data of the Company expressed as
a percentage of sales, net of reimbursable program costs and expenses, for the
three and six months ended September 30, 2006 and 2005:
Three Months Ended Six Months Ended
September 30, September 30,
------------------------ ------------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(restated) (restated)
Statement of Operations Data:
Sales, net of reimbursable program costs and expenses 100.0% 100.0% 100.0% 100.0%
Outside production and other program expenses 35.7% 48.9% 40.2% 48.0%
Compensation expense 37.1% 33.6% 34.8% 37.1%
General and administrative expense 16.4% 17.4% 14.9% 17.9%
Operating income (loss) 10.7% 0.1% 10.1% (3.1%)
Interest expense, net (0.2%) (0.4%) (0.2%) (0.5%)
Other expense, net (1.9%) 0.0% (0.8%) 0.0%
Income (loss) from continuing operations before provision
(benefit) for income taxes 8.7% (0.3%) 9.1% (3.5%)
Provision (benefit) for income taxes 3.5% (0.1%) 3.6% (1.3%)
Income (loss) from continuing operations 5.2% (0.2%) 5.5% (2.2%)
Income (loss) from discontinued operations 0.0% 0.3% (0.5%) 0.1%
Net income (loss) 5.2% 0.1% 4.9% (2.1%)
Sales. Sales consist of core business sales as well as amounts received
from clients for reimbursable program costs and expenses. We purchase a variety
of items and services on behalf of our clients for which we are reimbursed
pursuant to our client contracts. The amount of reimbursable program costs and
expenses which are included in revenues will vary from period to period, based
on the type and scope of the promotional service being provided.
Total sales for the quarter ended September 30, 2006 were $25,650,000,
compared to $24,071,000 for the quarter ended September 30, 2005, an increase of
$1,579,000, or 7%. Total sales for the six months ended September 30, 2006 were
$52,672,000, compared to $42,983,000 for the six months ended September 30,
2005, an increase of $9,689,000 or 23%. The following table presents a
comparative summary of the components of total sales for the three and six
months ended September 30, 2006 and 2005:
22
Three Months Ended Six Months Ended
September 30, September 30,
----------------------------------------- -----------------------------------------
Sales 2006 % 2005 % 2006 % 2005 %
----------- ----- ----------- ----- ----------- ----- ----------- -----
(restated) (restated)
Core business $16,519,931 64.4 $15,730,564 65.4 $32,828,065 62.3 $28,069,978 65.3
Reimbursable program
costs and expenses 9,130,424 35.6 8,340,385 34.6 19,843,755 37.7 14,912,761 34.7
----------- ----- ----------- ----- ----------- ----- ----------- -----
Total sales $25,650,355 100.0 $24,070,949 100.0 $52,671,820 100.0 $42,982,739 100.0
=========== ===== =========== ===== =========== ===== =========== =====
Core business sales increased during the three and six months ended
September 30, 2006 by 5% and 17%, respectively, as compared to the three and six
months ended September 30, 2005. Core business sales for the three and six
months ended September 30, 2006 reflect continued growth realized from
experiential programs and sales promotion marketing programs. Core business
sales were positively affected by the continued growth of sales to our existing
clients as well as to new ones. In particular, we executed a large partner
tie-in promotional program that integrated both experiential and sales promotion
elements. This program generated approximately $6.1 million of core business
sales in the six months ended September 30, 2006. This consisted of $5.0 million
and $1.1 million of core business sales in the quarters ended June 30, 2006 and
September 30, 2006, respectively.
Operating Revenue. We believe "Operating Revenue" is a key performance
indicator. Operating Revenue is defined as our core business sales less outside
production and other program expenses. Operating Revenue is the net amount
derived from sales to customers which we believe is available to fund our
compensation and general and administrative expenses, debt service and capital
expenditures. For the three and six months ended September 30, 2006, Operating
Revenue amounted to $10,620,000 and $19,634,000, respectively. Operating Revenue
for the three and six months ended September 30, 2006 increased by 32% and 34%,
respectively, from $8,042,000 and $14,599,000, for the three and six months
ended September 30, 2005.
The following table presents a comparative summary of the components of
operating revenue for the three and six months ended September 30, 2006 and
2005:
Three Months Ended Six Months Ended
Sept. 30, Sept. 30,
------------------------- -------------------------
Operating Revenue 2006 2005 2006 2005
----------------- ----------- ----------- ----------- -----------
(restated) (restated)
Core business $16,519,931 $15,730,564 $32,828,065 $28,069,978
Outside production and
other program costs 5,900,334 7,688,109 13,194,043 13,471,318
----------- ----------- ----------- -----------
Operating revenue $10,619,597 $ 8,042,455 $19,634,022 $14,598,660
=========== =========== =========== ===========
Operating Expenses. Total operating expenses of $23,875,000 for the
three months ended September 30, 2006 were approximately 1%, or $182,000, lower
than the amount incurred in the three months ended September 30, 2005. Operating
expenses for the six months ended September 30, 2006 increased by $5,519,000, or
13%, and amounted to $49,361,000, compared to $43,842,000 for the six months
ended September 30, 2005. The changes in operating expenses resulted from the
aggregate of the following:
Reimbursable Program Costs and Expenses. Reimbursable program costs and
expenses for the three months ended September 30, 2006 and 2005 were $9,130,000
and $8,340,000, respectively. Reimbursable program costs and expenses for the
six months ended September 30, 2006 and 2005 were $19,844,000 and $14,913,000,
respectively. The increase in reimbursable costs and expenses is due to an
increase of such costs derived from experiential programs.
Outside Production and Other Program Expenses. Outside production and
other program expenses consist of the costs of purchased materials, media,
services, certain direct labor charged to programs and other expenditures
incurred in connection with and directly related to sales but which are not
classified as reimbursable program costs and expenses. Outside production and
other program expenses for the three months ended September 30, 2006 were
$5,900,000 compared to $7,688,000 for the three months ended September 30, 2005,
a decrease of $1,788,000, or 23%. Outside production and other program expenses
for the six months ended September 30, 2006 were $13,194,000 compared to
$13,471,000 for the six months ended September 30, 2005, a decrease of $277,000,
or 2%. The weighted mix of outside production and other program expenses and the
mark-up related to these components may vary significantly from project to
project based on the type and scope of the service being provided.
23
Compensation Expense. Compensation expense, exclusive of program
reimbursable costs, consists of the salaries, payroll taxes and benefit costs
related to indirect labor, overhead personnel and certain direct labor otherwise
not charged to programs. For the quarter ended September 30, 2006, compensation
expense was $6,135,000, compared to $5,289,000 for the quarter ended September
30, 2005, an increase of $846,000 or 16%. For the six months ended September 30,
2006 compensation expense amounted to $11,431,000, an increase of $1,011,000, or
10%, as compared to the same period in the prior year. This increase reflects
the additional costs associated with the growth of experiential marketing
programs, partially offset by lower sales promotion and interactive marketing
compensation costs. The second quarter of fiscal 2007 also included a charge of
approximately $330,000 relating to the resignation of our former chief executive
officer. We continue to focus on aligning our staffing costs to match expected
revenues and investing resources in areas that we believe will generate
increased profitability.
General and Administrative Expenses. General and administrative
expenses consisting of office and equipment rent, depreciation and amortization,
professional fees, other overhead expenses and charges for doubtful accounts,
amounted to $2,709,000 for the three months ended September 30, 2006, compared
to $2,739,000 for the three months ended September 30, 2005, a decrease of
$30,000, or 1%. For the six months ended September 30, 2006 general and
administrative expenses amounted to $4,892,000, a decrease of $146,000, or 3%,
as compared to the same period in the prior year. The decreases realized in
general and administrative costs reflect our continued efforts to reduce fixed
overhead costs and maximize the scalability of such costs. Both for the three
and six months ended September 30, 2005, we have realized lower occupancy costs
resulting from the closing of our Great Neck, New York office in December 2005.
The decreases in occupancy costs were partially offset by higher professional,
bad debt and depreciation charges.
Interest Expense, Net. Net interest expense for the quarter ended
September 30, 2006, consisting of interest expense of $61,000 offset by interest
income of $30,000, amounted to $31,000, a decrease of $35,000, compared to net
interest expense of $66,000 in the quarter ended September 30, 2005. Net
interest expense in the quarter ended September 30, 2005 consisted of interest
expense of $75,000 offset by interest income of $9,000. Net interest expense for
the six months ended September 30, 2006, consisting of interest expense of
$126,000 offset by interest income of $57,000, amounted to $69,000, a decrease
of $58,000, compared to net interest expense of $127,000, consisting of interest
expense of $145,000 offset by interest income of $18,000 for the six months
ended September 30, 2005. Interest expense consists primarily of interest on our
outstanding bank debt and is tied to the bank's prime rate in effect. Interest
income consists primarily of interest on our note receivable from an officer, as
well as interest on our money market and CD accounts. The reduction in interest
expense was a result of reduced bank debt outstanding during the quarter and six
months ended September 30, 2006 and was partially offset by higher interest
expense resulting from increases during the period in the bank's prime rate.
Other Expense, Net. Other expense, net for the three and six months
ended September 30, 2006 amounted to $306,000 and $249,000, respectively,
relating to the charge of approximately $306,000 in connection with the
provision for the uncollectible portion of the note receivable from an officer.
For the six months ended September 30, 2006, such expense was offset by $57,000
in proceeds from the sale of certain Internet domain names which were not being
utilized by the Company.
Income (Loss) from Continuing Operations before Provision (Benefit) for
Income Taxes. Income (loss) from continuing operations before the provision
(benefit) for income taxes for the quarters ended September 30, 2006 and 2005
amounted to $1,438,000 and ($52,000), respectively. Income (loss) from
continuing operations before the provision (benefit) for income taxes for the
six months ended September 30, 2006 and 2005 amounted to $2,993,000 and
($986,000), respectively.
Provision (Benefit) for Income Taxes. The provision (benefit) for
federal, state and local income taxes for the three and six months ended
September 30, 2006 and 2005 were based upon the Company's estimated effective
tax rate for the respective fiscal years.
Income (Loss) from Continuing Operations. As a result of the items
discussed above, income (loss) from continuing operations for the quarters ended
September 30, 2006 and 2005 was $863,000 and ($31,000), respectively, and was
$1,796,000 and ($619,000) for the six months ended September 30, 2006 and 2005,
respectively. Diluted earnings (loss) per share from continuing operations
amounted to $.12 and $.25 for the three and six months ended September 30, 2006,
respectively, compared to $.00 and ($.10) in the three and six months ended
September 30, 2005, respectively.
24
Discontinued Operations. Loss from discontinued operations relating to
the sale of MarketVision in May 2006 as well as the loss incurred on its
disposal amounted to $50,000 and $127,000, respectively, on a net of tax basis
for the six months ended September 30, 2006. The loss on the disposal of
MarketVision includes a tax provision of approximately $300,000 as a result of
this sale with a corresponding reduction of the deferred tax asset on our
balance sheet. Our existing net operating loss carryovers for both federal and
state tax purposes will be used to absorb such liability. Prior year amounts
have been reclassified to reflect results of operations for MarketVision for the
three and six months ended September 30, 2005 as discontinued operations.
Diluted earnings per share from discontinued operations amounted to $.00 for
each of the quarters ended September 30, 2006 and 2005. For the six months ended
September 30, 2006 and 2005, diluted (loss) earnings per share from discontinued
operations amounted to ($.02) and $.01, respectively.
Net Income (Loss). As a result of the items discussed above, net income
for the three and six months ended September 30, 2006 was $863,000 and
$1,619,000, respectively, compared to net income (loss) of $9,000 and
($581,000), for the three and six months ended September 30, 2005. Diluted
earnings (loss) per share amounted to $.12 and $.23 for the three and six months
ended September 30, 2006, respectively, compared to $.00 and ($.09) in the three
and six months ended September 30, 2005, respectively.
Liquidity and Capital Resources
Beginning with our fiscal year ended March 30, 2000, we have
continuously experienced negative working capital. This deficit has generally
resulted from our inability to generate sufficient cash and receivables from our
programs to offset our current liabilities, which consist primarily of
obligations to vendors and other accounts payables, deferred revenues and bank
borrowings required to be paid within 12 months from the date of determination.
We are continuing our efforts to increase revenues from our programs and reduce
our expenses and borrowings, but to date these efforts have not been
sufficiently successful. We have been able to operate during this extended
period with negative working capital due primarily to bank financing made
available to us, advance payments made to us on a regular basis by our largest
customers, and to a lesser degree, equity infusions from private placements of
our securities ($1 million in January 2000, and $1.63 million in January and
February 2003), and stock option and warrant exercises.
In March 2005, we entered into an Amended and Restated Credit Agreement
with Signature Bank, under which amounts available for borrowing under our
revolving credit line were increased by $2.4 million to $3 million, and the term
loan portion of the credit facility was increased by $1.1 million to $4 million.
As a condition to providing its consent to the sale of our interest in
MarketVision in May 2006, our secured lender required us to deposit the proceeds
of such sale, in the amount of approximately $1.1 million, in a cash collateral
account as security for our obligations under the Credit Agreement. As part of a
July 12, 2006 amendment to the Credit Agreement, our lender released the cash
collateral to us and reduced the amount available for borrowing under our
revolving credit line to $2 million.
Borrowings under the Credit Agreement are evidenced by promissory notes
and are secured by all of our assets. We pay Signature Bank a quarterly fee
equal to .25% per annum on the unused portion of the revolving credit line.
Pursuant to the Amended and Restated Credit Agreement:
o Principal payments on the term loan are made in equal monthly
installments of $83,333, with the final payment due in March
2009.
o The maturity date of loans made under the revolving credit
line is March 24, 2008.
o Interest charges on the revolving credit line and term loan
accrues at Signature Bank's prime rate (8.25% at September 30,
2006) and its prime rate plus .50%, respectively.
The Credit Agreement provides for a number of affirmative and negative
covenants, restrictions, limitations and other conditions including, among
others, (i) limitations regarding the payment of cash dividends, (ii)
restriction on the use of proceeds, (iii) prohibition on incurring a
consolidated net loss, as defined in the Credit Agreement, in two consecutive
fiscal quarters or any fiscal year, (iv) compliance with a defined senior debt
leverage ratio and debt service ratio covenants, (v) limitation on annual
capital expenditures, and (vi) maintenance of 15% of beneficially owned shares
of our common stock by certain stockholders. Although we were in compliance with
these financial covenants with respect to the period ended September 30, 2006,
as a result of the restatement of our financial statements for the year ended
March 31, 2006 as described above, Signature Bank's waiver granted on July 12,
2006 with respect to our failure to comply with these financial covenants at
March 31, 2006 is no longer effective and an Event of Default exists under the
Credit Agreement as a result thereof.
25
In addition, on December 14, 2006, we received a letter from Signature
Bank notifying us that our failure to timely deliver financial statements for
the quarter ended September 30, 2006 resulted in the occurrence of an Event of
Default under the Credit Agreement, and that as a result of the Event of
Default, (i) our $2 million revolving credit facility had been terminated, (ii)
the interest rate on the term loan under the Credit Agreement had been increased
by one-half of one percent per annum (prime plus one percent), and (iii)
effective February 11, 2007 the interest rate on the term loan would be
increased by four percent per annum (exclusive of the one-half of one percent
increase noted above). At the time we received the letter, we had no loans
outstanding under the revolving credit facility and $2.25 million outstanding
under the term loan portion of the Credit Agreement. At April 30, 2007, the
outstanding principal amount under the term loan portion of the Credit Agreement
was $1.92 million.
Due to the current existence of Events of Default, Signature Bank is
entitled to demand payment in full of its loan. Even if our lender does not
demand immediate repayment of our loans, we may be required to seek additional
financing in the future to fund our operations if our operations do not produce
the level of revenues required for our operations. There can be no assurance
that funding will be available to us at the time it is needed or in the amount
necessary to satisfy our needs, or, that if funds are made available, that they
will be available on terms that are favorable to us. If we are unable to secure
financing when needed, our businesses may be materially and adversely effected,
and we may be required to cease all or a substantial portion of our operations.
If we issue additional shares of common stock or securities convertible into
common stock in order to secure additional funding, current stockholders may
experience dilution of their ownership. In the event we issue securities or
instruments other than common stock, we may be required to issue such
instruments with greater rights than those currently possessed by holders of
common stock.
At September 30, 2006, we had cash and cash equivalents of $2,897,000,
a working capital deficit of $2,377,000, outstanding bank loans of $2,500,000,
an outstanding bank letter of credit of $500,000, $2,000,000 available for
borrowing under the revolving credit line, and stockholders' equity of
$10,501,000. In comparison, at March 31, 2006, we had cash and cash equivalents
of $3,929,000, a working capital deficit of $6,589,000, outstanding bank loans
of $3,000,000, an outstanding bank letter of credit of $500,000, $3,000,000
available for borrowing under the revolving credit line, and stockholders'
equity of $8,576,000.
Operating Activities. Net cash used in operating activities was
$1,905,000 for the six months ended September 30, 2006. The net cash used in
operating activities was primarily attributable to increases in accounts
receivable and decreases in accounts payable, partially offset by increases in
deferred revenue as well as decreases in unbilled contracts in progress and
deferred contracts costs.
Investing Activities. For the six months ended September 30, 2006, net
cash provided by investing activities amounted to $945,000 as a result of the
$1,100,000 proceeds from the sale of our 49% interest in MarketVision, offset by
the purchase of fixed assets of $173,000. We do not expect to make material
investments in fixed assets during the remainder of Fiscal 2007.
Financing Activities. For the six months ended September 30, 2006, net
cash used by financing activities amounted to $71,000 resulting primarily from
payments made on bank borrowings of $500,000 partially offset by the proceeds
from the exercise of stock options of $434,000.
Critical Accounting Policies
The preparation of consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America
requires management to use judgment in making estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. Certain of the
estimates and assumptions required to be made relate to matters that are
inherently uncertain as they pertain to future events. While management believes
that the estimates and assumptions used were the most appropriate, actual
results could differ significantly from those estimates under different
assumptions and conditions.
Please refer to the Company's 2006 Annual Report on Form 10-K/A for a
discussion of the Company's critical accounting policies relating to revenue
recognition, goodwill and other intangible assets and accounting for income
taxes. Effective April 1, 2006, the Company changed its accounting policy
regarding its method of revenue recognition for certain contracts in one of its
subsidiaries from percentage of completion to completed contract. The Company
believes that the completed contract method of revenue recognition for these
contracts is the preferable method of accounting due to the short-term nature of
such contracts. The impact of the change in accounting policy was not considered
to be material as of and for the year ended March 31, 2006. During the three and
six months ended September 30, 2006, there were no other material changes to
these policies.
26
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The Company's earnings and cash flows are subject to fluctuations due
to changes in interest rates primarily from its investment of available cash
balances in money market funds and certificates of deposits with portfolios of
investment grade corporate and U.S. government securities and, secondarily, from
its long-term debt arrangements. Under its current policies, the Company does
not use interest rate derivative instruments to manage exposure to interest rate
changes.
Item 4. Controls and Procedures
-----------------------
Evaluation of Disclosure Controls and Procedures
In connection with their review of our financial statements for the
quarter ended September 30, 2006, Grant Thornton LLP, our independent auditor at
the time of such review, communicated to management and our Audit Committee the
existence of internal control deficiencies that constituted material weaknesses
under standards established by the Public Company Accounting Oversight Board. A
material weakness is a significant deficiency or combination of significant
deficiencies, that results in more than a remote likelihood that that a material
misstatement of financial statements will not be prevented or detected. As a
result of our communications with Grant Thornton and further review conducted by
management and our Audit Committee, we believe the following material weaknesses
existed during the period covered by this Quarterly Report:
o Our failure to properly monitor and account for state sales
and use tax liabilities in various jurisdictions.
o Our misapplication of revenue recognition policies.
These material weaknesses resulted in the restatement of our financial
statements for the quarter ended June 30, 2006 and the years ended March 31,
2006, 2005 and 2004 as described elsewhere in this Form 10-Q.
To remedy the weakness related to sales and use taxes, we have retained
third-party consultants with expertise in State and local sales and use taxes to
further assist us in understanding and properly paying these obligations and
recording these obligations on our financial statements.
In addition, with the restatement of our financial statements, we have
corrected our misapplication of EITF 00-21, "Accounting for Revenue Arrangements
with Multiple Deliverables," to a particular promotional program. Prior to the
restatement, our misapplication of EITF 00-21 had resulted in the premature
recording of revenues and related expenses during the fiscal year ended March
31, 2006. This error resulted in the understatement of revenues by approximately
$524,000 and an overstatement of operating expenses by approximately $398,000 in
the quarter ended June 30, 2006. Originally, we had determined that the design
of the promotional program itself and the acquiring of participating partners
entitled us to recognize a portion of the revenues to be generated by this
program. We have now concluded that under EITF 00-21, revenues could only be
recognized as certain field events of the program were executed on behalf of our
clients. Such execution occurred during the period of April 2006 through July
2006. We do not expect future errors of this nature to occur in connection with
our application of EITF 00-21 to revenues we generate from programs we execute
for our clients.
Grant Thornton also advised our Audit Committee that it believed there
existed several other significant deficiencies that in the aggregate constituted
material weaknesses. We believe the following significant deficiencies
identified by Grant Thornton adversely impacted our internal controls during the
period covered by this Quarterly Report:
o Resource constraints faced by the Company's accounting
department.
o Excessive reliance on Excel spreadsheets by the Company in key
areas, including as support for revenue recognition on certain
customer contracts.
o Insufficient controls in monitoring and controlling the
posting of journal entries.
o Ineffective controls over access by information technology
personnel to information technology programs and systems.
Our management and our current independent auditors, Lazar Levine &
Felix LLP, have discussed the material weaknesses described above with our Audit
Committee. By implementing the following remedial measures, management intends
to improve its internal control over financial reporting and to avoid future
material misstatements of our financial statements. Since the end of the period
covered by this Quarterly Report, we have implemented or are implementing the
following measures:
27
o The hiring of additional accounting and financial reporting
staff and restructuring of the accounting and finance
department;
o The engagement of a consultant specializing in accounting and
financial reporting to augment our accounting staff;
o The upgrading of our accounting and financial reporting
software systems;
o Additional monitoring and review of selected journal entries;
and
o The initiation of a comprehensive review of financial controls
and procedures to address the issues identified above and to
bring us into compliance with the requirements of the
Sarbanes-Oxley Act with respect to internal controls and
procedures;
We are monitoring the effectiveness of these measures, and may take
further action as we deem appropriate to strengthen our internal control over
financial reporting. However, we do not expect that our disclosure controls and
procedures or our internal control over financial reporting will prevent all
error and all fraud. A control system, no matter how well designed and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been or
will be detected.
An evaluation was performed, under the supervision of, and with the
participation of, our management, including our Chief Executive Officer and
Principal Accounting Officer, of the effectiveness of the design and operation
of the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-(e) to the Securities and Exchange Act of 1934). Based on that
evaluation, due to the material weaknesses described above, the Company's
management, including our Chief Executive Officer and Principal Accounting
Officer, concluded that the Company's disclosure controls and procedures were
ineffective, as of September 30, 2006, to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934, is recorded, processed, summarized, and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to management, including
our Chief Executive Officer and Principal Accounting Officer, as appropriate, to
allow timely decisions regarding required disclosure. Notwithstanding the
material weaknesses referred to above, management believes that the consolidated
financial statements included in this Quarterly Report on Form 10-Q fairly
present, in all material respects, our financial position, results of operations
and cash flows for the periods presented.
Changes in Internal Controls
There has not been any changes in our internal controls over financial
reporting that occurred during our quarter ended September 30, 2006 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
---------------------------
Items 1, 2, 3, 5. Not Applicable
Item 1A. Risk Factors
Our internal controls may not be sufficient to ensure timely and reliable
financial information.
In November 2006, in connection with their review of our financial
statements for the quarter ended September 30, 2006, Grant Thornton LLP, our
former independent auditors, identified to management and our Audit Committee
material weaknesses in the effectiveness of our internal controls. As a result
of our communications with Grant Thornton and further review conducted by
management and our Audit Committee, we concluded that we needed to correct
28
deficiencies in our internal controls and procedures for financial reporting.
These deficiencies included our failure to properly monitor and account for
state sales and use tax liabilities, inadequate controls and procedures relating
to revenue recognition, insufficient staffing, insufficient controls in
monitoring and controlling the posting of journal entries, and ineffective
controls over access by information technology personnel to information
technology programs and systems.
Working with our Audit Committee, we have identified and implemented,
or are in the process of implementing, corrective actions to improve the design
and effectiveness of our internal controls, including the enhancement of systems
and procedures. However, we will need to continue to improve our operational,
financial and management controls and our reporting systems and procedures. Any
failure to implement required new or improved controls, or difficulties
encountered in the implementation or operation of these controls, could harm our
operating results or cause us to fail to meet our financial reporting
obligations, which could adversely affect our business and harm our stock price.
The effectiveness of our controls and procedures may be limited by a
variety of risks including:
o faulty human judgment and simple errors, omissions or
mistakes;
o collusion of two or more people; and
o inappropriate management override of procedures.
Enhanced controls and procedures may still not be adequate to assure
timely and reliable financial information. A control system, no matter how well
designed and operated, can provide only reasonable assurance that the objectives
of the control system are met. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud will be detected.
We are in default under our Senior Secured Credit Agreement.
As a result of the restatement of our financial statements for the year
ended March 31, 2006, the waiver previously granted by our senior secured lender
with respect to our failure to comply with certain financial covenants at March
31, 2006 is no longer effective, and an Event of Default exists under the Credit
Agreement. In addition, on December 14, 2006, we received a letter from such
lender notifying us that our failure to timely deliver financial statements for
the quarter ended September 30, 2006 resulted in the occurrence of an Event of
Default under the Credit Agreement, and that as a result of the Event of
Default, (i) our $2 million revolving credit facility had been terminated, (ii)
the interest rate on the term loan under the Credit Agreement had been increased
by one-half of one percent per annum (prime plus one percent), and (iii)
effective February 11, 2007 the interest rate on the term loan would be
increased by four percent per annum (exclusive of the one-half of one percent
increase noted above). At the time we received the letter, we had no loans
outstanding under our revolving credit facility and $2.25 million outstanding
under the term loan portion of the Credit Agreement. At April 30, 2007, the
outstanding principal amount under the term loan portion of the Credit Agreement
was $1.92 million.
Although we have since delivered the required financial statements to
our lender, Events of Default continue to exist under the Credit Agreement,
including as a result of the occurrence of a "Change of Control" in our
ownership, as defined in the Credit Agreement. As a result, our lender is
entitled to demand payment in full of its loan at any time. Even if our lender
does not demand immediate repayment of our loans, we may be required to seek
additional financing in the future to fund our operations if our operations do
not produce the level of revenues required for our operations, especially in
light of the termination of our revolving credit facility under the Credit
Agreement.
There can be no assurance that funding will be available to us at the
time it is needed or in the amount necessary to satisfy our needs, or, that if
funds are made available, that they will be available on terms that are
favorable to us. If we are unable to secure financing when needed, our
businesses may be materially and adversely effected, and we may be required to
cease all or a substantial portion of our operations. If we issue additional
shares of common stock or securities convertible into common stock in order to
secure additional funding, current stockholders may experience dilution of their
ownership. In the event we issue securities or instruments other than common
stock, we may be required to issue such instruments with greater rights than
those currently possessed by holders of common stock.
29
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on September 28, 2006 at
10:00 a.m. at our offices located at 75 Ninth Avenue, New York, New York 10011.
A majority of our voting shares were present at the meeting, either in person or
by proxy.
At the meeting, as set forth in the table below, our stockholders
elected James H. Feeney, Herbert M. Gardner, Marc C. Particelli and John A.
Ward, III to the Board of Directors. All of these individuals will serve on the
Board of Directors until the next annual meeting of stockholders and until their
successors are duly elected and qualified. Subsequent to the Annual Meeting, in
connection with his appointment as our President and Chief Executive Officer,
our Board of Directors elected Charles F. Tarzian to serve as a director.
Directors Votes For Votes Withheld
--------- --------- --------------
James H. Feeney 5,254,374 80,998
Herbert M. Gardner 5,118,190 217,182
Marc C. Particelli 5,254,174 81,198
John A. Ward III 5,055,957 279,415
Item 6. Exhibits
--------
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
31.2 Certification of Principal Accounting Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(b) of the Exchange Act
32.2 Certification of Principal Accounting Officer pursuant to Rule
13a-14(b) of the Exchange Act
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COACTIVE MARKETING GROUP, INC.
Dated: May 18, 2007 By: /s/ CHARLES F. TARZIAN
-------------------------------------
Charles F. Tarzian, President and
Chief Executive Officer
(Principal Executive Officer)
Dated: May 18, 2007 By: /s/ JENNIFER R. CALABRESE
-------------------------------------
Jennifer R. Calabrese,
Vice President - Controller
(Principal Accounting Officer)
31