================================================================================
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 December 31, 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.
================================================================================
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 - December 31, 2006 (Unaudited) and
March 31, 2006 (Audited) 3
Condensed Consolidated Statements of Operations - Three and nine months ended
December 31, 2006 and December 31, 2005 (restated) 4
Condensed Consolidated Statement of Stockholders' Equity - Nine months ended
December 31, 2006 5
Condensed Consolidated Statements of Cash Flows - Nine months
ended December 31, 2006 and December 31, 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 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4. Controls and Procedures 26
PART II - OTHER INFORMATION
Items 1, 2, 3, 4 and 5. Not Applicable
Item 1A. Risk Factors 28
Item 6. Exhibits 29
SIGNATURES 30
2
PART I - FINANCIAL INFORMATION
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Balance Sheets
December 31, 2006 and March 31, 2006
December 31, 2006 March 31, 2006
----------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 7,747,147 $ 3,929,438
Accounts receivable, net of allowance for doubtful accounts of
$414,000 at December 31, 2006 and $325,000 at March 31, 2006 8,667,806 10,726,762
Unbilled contracts in progress 1,396,277 2,650,453
Deferred contract costs 1,456,873 2,523,065
Prepaid expenses and other current assets 951,565 740,385
Note and interest receivable from officer, net of allowance of $306,000 at
December 31, 2006 256,356 -
Current assets of discontinued operations - 3,640,069
----------------- -----------------
Total current assets 20,476,024 24,210,172
Property and equipment, net 3,495,536 3,833,943
Note and interest receivable from officer - 826,341
Deferred financing costs, net 68,821 86,616
Deferred tax asset 4,175,802 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 $ 35,812,053 $ 42,713,166
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,024,455 $ 4,505,344
Accrued compensation 2,274,235 1,494,432
Accrued job costs 1,113,577 1,368,235
Other accrued liabilities 2,260,958 1,974,713
Deferred revenue and other client credits 11,400,017 15,745,269
Deferred taxes payable 247,272 247,272
Notes payable bank - current 2,250,000 3,000,000
Current liabilities of discontinued operations - 2,464,371
----------------- -----------------
Total current liabilities 22,570,514 30,799,636
Deferred rent 2,560,224 2,613,541
Noncurrent liabilities of discontinued operations - 723,827
----------------- -----------------
Total liabilities 25,130,738 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 7,379,751 shares at December 31, 2006 and 6,831,423 at March
31, 2006, respectively 7,379 6,831
Additional paid-in capital 10,647,208 10,250,003
Retained earnings (accumulated deficit) 26,728 (1,680,672)
----------------- -----------------
Total stockholders' equity 10,681,315 8,576,162
----------------- -----------------
Total liabilities and stockholders' equity $ 35,812,053 $ 42,713,166
================= =================
See accompanying notes.
3
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statements of Operations
Three and Nine Months Ended December 31, 2006 and 2005
(Unaudited)
Three Months Ended December 31, Nine Months Ended December 31,
--------------------------------- ----------------------------------
2006 2005 (restated) 2006 2005 (restated)
--------------- --------------- --------------- ---------------
Sales $ 23,938,534 $ 20,871,399 $ 76,610,354 $ 63,854,138
--------------- --------------- --------------- ---------------
Operating expenses:
Reimbursable program costs and expenses 11,738,782 7,247,409 31,582,537 22,160,170
Outside production and other program expenses 3,623,048 6,143,610 16,817,091 19,614,928
Compensation expense 5,862,322 5,051,374 17,293,252 15,471,529
General and administrative expenses 2,630,222 2,808,481 7,522,007 7,846,019
--------------- --------------- --------------- ---------------
Total operating expenses 23,854,374 21,250,874 73,214,887 65,092,646
--------------- --------------- --------------- ---------------
Operating income (loss) 84,160 (379,475) 3,395,467 (1,238,508)
Interest income (expense), net 20,499 (64,583) (48,368) (191,605)
Other income (expense), net 42,228 - (206,714) -
--------------- --------------- --------------- ---------------
Income (loss) from continuing operations before
provision (benefit) for income taxes 146,887 (444,058) 3,140,385 (1,430,113)
Provision (benefit) for income taxes 58,761 (140,624) 1,256,161 (507,713)
--------------- --------------- --------------- ---------------
Income (loss) from continuing operations 88,126 (303,434) 1,884,224 (922,400)
--------------- --------------- --------------- ---------------
Discontinued operations:
Income (loss) from discontinued
operations, net of tax provision
(benefit) of $0, $73,527, ($32,591) and
$139,682, respectively - 54,077 (49,650) 92,494
Net loss on disposal of discontinued
operations, net of tax provision of
$ 302,004 - - (127,174) -
--------------- --------------- --------------- ---------------
Income (loss) from discontinued operations - 54,077 (176,824) 92,494
--------------- --------------- --------------- ---------------
Net income (loss) $ 88,126 $ (249,357) $ 1,707,400 $ (829,906)
=============== =============== =============== ===============
Basic earnings (loss) per share:
Income (loss) from continuing operations $ .01 $ (.05) $ .28 $ (.14)
Income (loss) from discontinued operations - .01 (.03) .01
--------------- --------------- --------------- ---------------
Net income (loss) per share $ .01 $ (.04) $ .25 $ (.13)
=============== =============== =============== ===============
Diluted earnings (loss) per share:
Income (loss) from continuing operations $ .01 $ (.05) $ .26 $ (.14)
Income (loss) from discontinued operations - .01 (.02) .01
--------------- --------------- --------------- ---------------
Net income (loss) per share $ .01 $ (.04) $ .24 $ (.13)
=============== =============== =============== ===============
Weighted average number of common shares outstanding:
Basic 6,855,575 6,605,303 6,830,127 6,397,479
Dilutive effect of options, warrants
and restricted shares 537,883 - 359,265 -
--------------- --------------- --------------- ---------------
Diluted 7,393,459 6,605,303 7,189,392 6,397,479
=============== =============== =============== ===============
See accompanying notes.
4
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statement of Stockholders' Equity
Nine Months Ended December 31, 2006
(Unaudited)
Common Stock
par value $.001 Retained Earnings Total
--------------------------- Additional (Accumulated Stockholders'
Shares Amount Paid-in Capital Deficit) Equity
------------ ------------ --------------- ----------------- -------------
Balance, March 31, 2006 6,831,423 $ 6,831 $ 10,250,003 $ (1,680,672) $ 8,576,162
Exercise of options 371,380 371 453,285 - 453,656
Issuance of non-vested stock, net of
forfeitures 330,000 330 (330) - -
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 - - 103,980 - 103,980
Compensation cost recognized in connection
with stock options - - 123,264 - 123,264
Net income - - - 1,707,400 1,707,400
------------ ------------ --------------- ----------------- -------------
Balance, December 31, 2006 7,379,751 $ 7,379 $ 10,647,208 $ 26,728 $ 10,681,315
============ ============ =============== ================= =============
See accompanying notes.
5
COACTIVE MARKETING GROUP, INC.
Condensed Consolidated Statements of Cash Flows
Nine Months Ended December 31, 2006 and 2005
(Unaudited)
2006 2005
----------------- -----------------
(restated)
Cash flows from operating activities:
Net income (loss) $ 1,707,400 $ (829,906)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization 596,943 549,698
Deferred rent amortization (53,317) (50,261)
Provision for bad debt expense 122,790 110,477
Provision for uncollectible note receivable from officer 305,942 -
Interest income on note receivable from officer (36,322) (25,981)
Compensation expense on non-vested stock and stock options 227,244 -
Deferred income taxes 1,183,221 (532,596)
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 1,936,166 (7,470,830)
Unbilled contracts in progress 1,254,176 (984,154)
Deferred contract costs 1,066,192 114,178
Prepaid expenses and other assets (199,928) (290,556)
Accounts payable (1,480,889) 319,712
Deferred revenue and other client credits (4,345,252) 8,064,345
Accrued job costs (254,658) 1,701,955
Accrued compensation 779,803 599,830
Other accrued liabilities 286,245 585,444
----------------- -----------------
Net cash provided by operating activities of continuing operation s 3,272,580 1,861,355
Operating activities of discontinued operations (35,004) 68,643
----------------- -----------------
Net cash provided by operating activities 3,237,576 1,929,998
----------------- -----------------
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 (235,741) (178,334)
----------------- -----------------
Net cash provided by (used in) investing activities of continuing operations 881,477 (178,334)
Investing activities of discontinued operations - (161,402)
----------------- -----------------
Net cash provided by (used in) investing activities 881,477 (339,736)
----------------- -----------------
Cash flows from financing activities:
Proceeds from exercise of stock options 453,656 387,847
Borrowings of debt - 3,800,000
Payments of debt (750,000) (5,134,500)
Financing costs (5,000) (19,380)
----------------- -----------------
Net cash used in financing activities (301,344) (966,033)
----------------- -----------------
Net increase in cash and cash equivalents 3,817,709 624,229
Cash and cash equivalents at beginning of period 3,929,438 2,171,103
----------------- -----------------
Cash and cash equivalents at end of period $ 7,747,147 $ 2,795,332
================= =================
Supplemental disclosures of cash flow information:
Interest paid during the period $ 173,830 $ 198,091
----------------- -----------------
Income tax paid during the period $ 72,941 $ 230,844
================= =================
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 $ - $ 27,569
================= =================
Issuance of non-vested stock, net of forfeitures $ 330 $ -
================= =================
See accompanying notes.
6
COACTIVE MARKETING GROUP, INC. AND SUBSIDIARIES
Notes to the Unaudited Condensed Consolidated Financial Statements
December 31, 2006 and 2005 (restated)
(1) Basis of Presentation
The interim financial statements of CoActive Marketing Group, Inc. (the
"Company") for the three and nine months ended December 31, 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 nine months ended December 31, 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 $352,000 and $975,000 in the three and nine month
periods ended December 31, 2005, respectively. 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
7
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
aggregating approximately $604,000 for the years ended March 31, 2006,
2005, and 2004 and a decrease in such expenses of approximately
$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 nine months ended December 31, 2005 is
presented below:
Three months ended Dec. 31, 2005
------------------------------------------------------------------------
Reclass for
As previously discontinued Restatement
reported operations adjustment As restated
--------------- --------------- --------------- ---------------
Sales $ 25,837,066 $ (4,622,663) $ (343,004) $ 20,871,399
--------------- --------------- --------------- ---------------
Reimbursable program costs and
expenses 10,156,832 (2,918,090) 8,667 7,247,409
Outside production and other
program expenses 6,434,094 (305,115) 14,631 6,143,610
Compensation expense 5,957,449 (906,075) - 5,051,374
General and administrative expenses 3,109,296 (311,508) 10,693 2,808,481
--------------- --------------- --------------- ---------------
Operating income (loss) 179,395 (181,875) (376,995) (379,475)
Interest expense, net (59,244) (2,014) (3,325) (64,583)
--------------- --------------- --------------- ---------------
Income (loss) from continuing
operations before provision
(benefit) for income taxes 120,151 (183,889) (380,320) (444,058)
Provision (benefit) for income
taxes 85,031 (73,527) (152,128) (140,624)
--------------- --------------- --------------- ---------------
Income (loss) from continuing
operations 35,120 (110,362) (228,192) (303,434)
Minority interest (56,285) 56,285 - -
Income from discontinued operations - 54,077 - 54,077
--------------- --------------- --------------- ---------------
Net loss $ (21,165) $ - $ (228,192) $ (249,357)
=============== =============== =============== ===============
Basic earnings (loss) per share:
Income (loss) from continuing
operations N/A $ (.02) $ (.03) $ (.05)
Income from discontinued
operations N/A .01 .00 .01
--------------- --------------- --------------- ---------------
Net income (loss) per share $ .00 $ .00 $ (.03) $ (.04)
=============== =============== =============== ===============
Diluted earnings per share:
Income (loss) from continuing
operations N/A $ (.02) $ (.03) $ (.05)
Income from discontinued
operations N/A .01 0.00 .01
--------------- --------------- --------------- ---------------
Net income (loss) per share $ .00 $ .00 $ (.03) $ (.04)
=============== =============== =============== ===============
8
Nine months ended Dec. 31, 2005
------------------------------------------------------------------------
Reclass for
As previously discontinued Restatement
reported operations adjustment As restated
--------------- --------------- --------------- ---------------
Sales $ 74,535,992 $ (9,737,835) $ (944,019) $ 63,854,138
--------------- --------------- --------------- ---------------
Reimbursable program costs and
expenses 27,573,068 (5,443,549) 30,651 22,160,170
Outside production and other
program expenses 20,278,666 (729,556) 65,818 19,614,928
Compensation expense 17,957,516 (2,485,987) - 15,471,529
--------------- --------------- --------------- ---------------
General and administrative expenses 8,577,702 (752,551) 20,868 7,846,019
--------------- --------------- --------------- ---------------
Operating income (loss) 149,040 (326,192) (1,061,356) (1,238,508)
Interest expense, net (177,109) (2,252) (12,244) (191,605)
--------------- --------------- --------------- ---------------
Loss from continuing operations
before provision (benefit) for
income taxes (28,069) (328,444) (1,073,600) (1,430,113)
Provision (benefit) for income
taxes 61,409 (139,682) (429,440) (507,713)
--------------- --------------- --------------- ---------------
Loss from continuing operations (89,478) (188,762) (644,160) (922,400)
Minority interest (96,268) 96,268 - -
Income from discontinued operations - 92,494 - 92,494
--------------- --------------- --------------- ---------------
Net loss $ (185,746) $ - $ (644,160) $ (829,906)
=============== =============== =============== ===============
Basic earnings (loss) per share:
Loss from continuing
operations N/A $ (.03) $ (.10) $ (.14)
Income from discontinued
operations N/A .01 .00 .01
--------------- --------------- --------------- ---------------
Net loss per share $ (.03) $ .00 $ (.10) $ (.13)
=============== =============== =============== ===============
Diluted earnings per share:
Loss from continuing
operations N/A $ (.03) $ (.10) $ (.14)
Income from discontinued
operations N/A .01 .00 .01
--------------- --------------- --------------- ---------------
Net loss per share $ (.03) $ .00 $ (.10) $ (.13)
=============== =============== =============== ===============
(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
in 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 nine months ended December 31,
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 nine months ended December 31, 2005:
April 1, 2006 Three months Nine months
to May 22, ended ended
2006 Dec. 31, 2005 Dec. 31, 2005
-------------- --------------- ---------------
Sales $ 1,197,677 $ 4,622,663 $ 9,737,835
-------------- --------------- ---------------
Operating expenses:
Reimbursable program costs
and expenses 617,663 2,918,090 5,443,549
Outside production and other
program expenses 151,184 305,115 729,556
Compensation expense 397,082 906,075 2,485,987
General and administrative
expenses 163,705 311,508 752,551
-------------- --------------- ---------------
Total operating expenses 1,329,634 4,440,788 9,411,643
-------------- --------------- ---------------
Operating (loss) income (131,957) 181,875 326,192
Interest (expense) income (1,963) 2,014 2,252
Benefit (provision) for income
taxes 32,591 (73,527) (139,682)
Minority interest 51,679 (56,285) (96,268)
-------------- --------------- ---------------
Net (loss) income $ (49,650) $ 54,077 $ 92,494
============== =============== ===============
(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 us of such costs. These costs are included in
compensation and general and administrative expenses on our 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 Group, 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 nine
months ended December 31, 2006, the Company has not identified any
indication of the impairment of goodwill of its reporting units or
intangible assets.
Net Income (Loss) Per Share
For the quarter ended December 31, 2006, options and warrants, which
expire through March 31, 2016, to purchase approximately 1,298,000
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 nine months ended December 31, 2006, options and warrants, which
expire through March 31, 2016, to purchase approximately 1,385,000
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 December 31, 2005, options and warrants, which
expire through April 30, 2015, to purchase approximately 1,841,000
shares of common stock at prices ranging from $1.13 to $10.00 per share
were excluded from the computation of diluted earnings per share. For
the nine months ended December 31, 2005, options and warrants, which
expire through April 30, 2015, to purchase approximately 2,080,000
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.
11
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 December 31, 2006, the amount due from the
Officer of $256,356 included accrued interest in the amount of $12,300,
of which $6,100 was past due and owing on such date.
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 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.
12
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 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 income (expense), net for the
nine months ended December 31, 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
nine months ended December 31, 2006, the Company has classified the
full balance of the note receivable as current at December 31, 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 December 31,
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 December 31, 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.
At December 31, 2006, the Company's term bank borrowings amounted to
$2,250,000 (exclusive of a letter of credit outstanding in the amount
of $450,000) and there were no borrowings outstanding under the
revolving line of credit.
13
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 December 31, 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 $22,200 and
$13,300, respectively, for the three months ended December 31, 2006 and
$123,300 and $74,000, respectively, for the nine months ended December
31, 2006. The impact on diluted earnings per share for the three and
nine months ended December 31, 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 December 31, 2006, there were 34,375
options issued, expiring from May 2007 through April 2011, under the
1992 Plan that remain outstanding.
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 December 31, 2006. Options
outstanding under the 1997 plan that are not exercised by their
expiration date are not available for re-issuance by the Company.
14
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 December 31, 2006, there were 863,750 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 December 31, 2006, the Company
had 46,250 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 Nine Months Ended
December 31, December 31,
------------------- --------------------
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 December 31, 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 December 31, 2006,
and changes during the period then ended is presented below:
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 $ 1.22 (371,380)
Canceled $ 2.45 (231,800)
---------- -----------
Balance at December 31, 2006 (vested
and expected to vest) $ 3.01 1,273,125 1.89 $ 2,744
========== =========== =========== =========
Exercisable at December 31, 2006 $ 3.03 1,248,125 1.75 $ 2,744
========== =========== =========== =========
(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. All of these options are exercisable as of December
31, 2006. Of these options 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; accordingly, the
40,000 options became exercisable on such date.
15
The total intrinsic value of options exercised during the three and
nine months ended December 31, 2006 was approximately $209,500. Cash
received from the exercise of stock options during the three and nine
months ended December 31, 2006 was approximately $20,000 and $453,700,
respectively.
Total unrecognized compensation cost related to unvested stock option
awards at December 31, 2006 amounts to approximately $8,200 and is
expected to be recognized over a weighted average period of .3 years.
Total compensation cost for the three and nine months ended December
31, 2006, amounted to approximately $22,200 and $123,300, respectively,
for these option awards. The related tax benefit for the three and nine
months ended December 31, 2006 amounted to $8,900 and $49,300,
respectively.
Warrants
At each of December 31, 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 December 31, 2006, pursuant to the authorization of the Company's
Board of Directors and certain Restricted Stock Agreements, the Company
had awarded 320,000 shares of common stock under the Company's 2002
Plan to certain employees (net of 25,000 shares forfeited in each of
April and November 2006 as a result of the termination of employment of
two recipients). 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 $602,500 and will be recognized ratably as compensation
expense over the vesting periods. The shares of common stock granted
pursuant to such agreements vest in various tranches over five years
from the date of grant.
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.
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%
In January and February 2007, the Company awarded an additional 246,250
shares of common stock pursuant to the certain Restricted Stock
Agreements.
16
A summary of all non-vested stock activity as of December 31, 2006, and
changes during the nine month period then ended is presented below:
Weighted
Weighted average
average Number remaining Aggregate
grant date of contractual intrinsic
fair value shares term value
---------- ----------- ----------- ---------
Unvested at March 31, 2006 $ 2.13 190,000
Granted $ 1.79 380,000
Vested - -
Forfeited $ 2.05 (50,000)
---------- -----------
Unvested at December 31, 2006 $ 1.89 520,000 3.04 $ 0
========== =========== =========== =========
Total unrecognized compensation cost related to unvested stock awards
at December 31, 2006 amounts to approximately $879,000 and is expected
to be recognized over a weighted average period of 3.0 years. Total
compensation cost for the three and nine months ended December 31,
2006, amounted to approximately $50,500 and $104,000, respectively, for
these stock awards. The related tax benefit for the three and nine
months ended December 31, 2006 amounted to approximately $20,200 and
$41,600, respectively.
The following table illustrates the effect on net loss and loss per
share for the three and nine months ended December 31, 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 nine months ended December 31, 2005:
Three Months Nine Months
Ended Ended
Dec. 31, 2005 Dec. 31, 2005
(restated) (restated)
------------- -------------
Net loss as reported $ (249,357) $ (829,906)
Less compensation expense determined under the fair
value method, net of tax (13,970) (77,184)
------------- -------------
Pro forma net loss $ (263,327) $ (907,090)
============= =============
Net loss per share - Basic:
As reported $ (.04) $ (.13)
Pro forma $ (.04) $ (.14)
Net loss per share - Diluted:
As reported $ (.04) $ (.13)
Pro forma $ (.04) $ (.14)
(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 end March 31,
2007.
17
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.
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.
18
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 nine
months ended December 31, 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.
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.
19
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
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 nine months ended December 31, 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 $352,000 and $975,000
in the three and nine month periods ended December 31, 2005, respectively. 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.
20
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, we believe 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 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.
21
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 nine months ended December 31, 2006 and 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------- ------------------------
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 29.7% 45.1% 37.3% 47.0%
Compensation expense 48.1% 37.1% 38.4% 37.1%
General and administrative expense 21.6% 20.6% 16.7% 18.8%
Operating income (loss) 0.7% (2.8)% 7.5% (3.0)%
Interest income (expense), net 0.2% (0.5)% (0.1)% (0.5)%
Other income (expense), net 0.3% 0.0% (0.5)% 0.0%
Income (loss) from continuing operations before provision
(benefit) for income taxes 1.2% (3.3)% 7.0% (3.4)%
Provision (benefit) for income taxes 0.5% (1.0)% 2.8% (1.2)%
Income (loss) from continuing operations 0.7% (2.2)% 4.2% (2.2)%
Income (loss) from discontinued operations 0.0% 0.4% (0.4)% 0.2%
Net income (loss) 0.7% (1.8)% 3.8% (2.0)%
SALES. Sales consist of core business sales as well as sales
resulting from 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 December 31, 2006 were
$23,939,000, compared to $20,871,000 for the quarter ended December 31, 2005, an
increase of $3,068,000, or 15%. Total sales for the nine months ended December
31, 2006 were $76,610,000, compared to $63,854,000 for the nine months ended
December 31, 2005, an increase of $12,756,000, or 20%. The following table
presents a comparative summary of the components of total sales for the three
and nine months ended December 31, 2006 and 2005:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------------------------- -------------------------------------------------
SALES 2006 % 2005 % 2006 % 2005 %
- ---------------------- ------------ -------- ------------ -------- ------------ -------- ------------ --------
(restated) (restated)
Core business $ 12,199,752 51.0 $ 13,623,990 65.3 $ 45,027,817 58.8 $ 41,693,968 65.3
Reimbursable program
costs and expenses 11,738,782 49.0 7,247,409 34.7 31,582,537 41.2 22,160,170 34.7
------------ -------- ------------ -------- ------------ -------- ------------ --------
Total sales $ 23,938,534 100.0 $ 20,871,399 100.0 $ 76,610,354 100.0 $ 63,854,138 100.0
============ ======== ============ ======== ============ ======== ============ ========
Core business sales decreased during the three months ended
December 31, 2006 by 11%, as compared to the three months ended December 31,
2005, and increased during the nine months ended December 31, 2006 by 8%, as
compared to the nine months ended December 31, 2005. The decrease in core
business sales for the quarter ended December 31, 2006 reflects the trend among
certain clients to negotiate contracts under which certain expenses are
classified as reimbursable program costs and expenses. The overall increase in
core business sales for the nine months ended December 31, 2006 reflects
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 several large partner tie-in promotional programs, one
of which was for the first time a significant marketing program that integrated
both experiential and sales promotion elements. This program generated
approximately $6.1 million of core business revenues in the first six months of
the nine month period ended December 31, 2006.
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 nine months ended December 31, 2006, Operating
Revenue amounted to $8,577,000 and $28,211,000, respectively. Operating Revenue
for the three and nine months ended December 31, 2006 increased by 15% and 28%,
respectively, from $7,480,000 and $22,079,000, for the three and nine months
ended December 31, 2005.
22
The following table presents a comparative summary of the components of
operating revenue for the three and nine months ended December 31, 2006 and
2005:
THREE MONTHS ENDED NINE MONTHS ENDED
DEC. 31, DEC. 31,
--------------------------- ---------------------------
OPERATING REVENUE 2006 2005 2006 2005
---------------------- ------------ ------------ ------------ ------------
(restated) (restated)
Core business $ 12,199,752 $ 13,623,990 $ 45,027,817 $ 41,693,968
Outside production and
other program costs 3,623,048 6,143,610 16,817,091 19,614,928
------------ ------------ ------------ ------------
Operating revenue $ 8,576,704 $ 7,480,380 $ 28,210,726 $ 22,079,040
============ ============ ============ ============
OPERATING EXPENSES. Total operating expenses of $23,854,000
and $73,215,000 for the three and nine months ended December 31, 2006,
respectively, were approximately $2,603,000 or 12% and $8,122,000 or 13% greater
than the comparable period in the prior year. The increases in operating
expenses resulted from the aggregate of the following:
Reimbursable Program Costs and Expenses. Reimbursable costs
and expenses for the three months ended December 31, 2006 and 2005 were
$11,739,000 and $7,247,000, respectively. Reimbursable costs and expenses for
the nine months ended December 31, 2006 and 2005 were $31,583,000 and
$22,160,000, 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 December 31,
2006 were $3,623,000 compared to $6,144,000 for the three months ended December
31, 2005, a decrease of $2,521,000, or 41%. Outside production and other program
expenses for the nine months ended December 31, 2006 were $16,817,000 compared
to $19,615,000 for the nine months ended December 31, 2005, a decrease of
$2,798,000, or 14%. 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.
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 December 31, 2006,
compensation expense was $5,862,000, compared to $5,051,000 for the quarter
ended December 31, 2005, an increase of $811,000 or 16%. For the nine months
ended December 31, 2006 compensation expense amounted to $17,293,000, an
increase of $1,822,000, or 12%, 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 nine months ended December 31,
2006 also includes 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, were $2,630,000 for the three months ended December 31, 2006,
compared to $2,808,000 for the three months ended December 31, 2005, a decrease
of $178,000, or 6%. For the nine months ended December 31, 2006, general and
administrative expenses amounted to $7,522,000, a decrease of $324,000, or 4%,
as compared to the same period in the prior year. The decreases realized in
general and administrative costs reflect our continued efforts to reduced fixed
overhead costs and maximize the scalability of such costs. As a result of the
termination of our lease for our office in Great Neck, NY which resulted in a
$520,000 charge in the quarter ended December 31, 2005, our occupancy costs have
dropped sharply in the three and nine months ended December 31, 2006 as compared
to the same periods in our prior fiscal year. In the three and nine months ended
December 31, 2006, the decreases in occupancy costs were partially offset by
higher professional fees and other administrative costs.
INTEREST INCOME (EXPENSE), NET. Net interest income for the
quarter ended December 31, 2006, consisting of interest income of $77,000 offset
by interest expense of $57,000, amounted to $20,000, a variance of $85,000,
compared to net interest expense of $65,000 in the quarter ended December 31,
2005. Net interest expense in the quarter ended December 31, 2005 consisted of
interest expense of $82,000 offset by interest income of $17,000. Net interest
expense for the nine months ended December 31, 2006, consisting of interest
expense of $182,000 offset by interest income of $134,000, amounted to $48,000,
a decrease of $144,000, compared to net interest expense of $192,000, consisting
of interest expense of $227,000 offset by interest income of $35,000 for the
nine months ended December 31, 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 money market and
CD accounts. The reduction in net interest expense in fiscal 2007 as compared to
fiscal 2006 was primarily a result of both increased interest income earned
resulting from higher bank balances and reduced interest expense on lower bank
debt outstanding.
23
OTHER INCOME (EXPENSE), NET. Other income (expense), net for
the three and nine months ended December 31, 2006 amounted to $42,000 and
($207,000). For the three months ended December 31, 2006, other income consisted
of insurance policy proceeds received by the Company. For the nine months ended
December 31, 2006, other expense consisted of a charge of approximately $306,000
taken in connection with the provision for the uncollectible portion of a note
receivable from an officer. 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 as well as $42,000 of insurance policy proceeds.
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 December 31, 2006
and 2005 amounted to $147,000 and ($444,000), respectively. Income (loss) from
continuing operations before the provision (benefit) for income taxes for the
nine months ended December 31, 2006 and 2005 amounted to $3,140,000 and
($1,430,000), respectively.
PROVISION (BENEFIT) FOR INCOME TAXES. The provision (benefit)
for federal, state and local income taxes for the three and nine months ended
December 31, 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 December 31, 2006 and 2005 was $88,000 and ($303,000), respectively, and
was $1,884,000 and ($922,000) for the nine months ended December 31, 2006 and
2005, respectively. Diluted earnings (loss) per share from continuing operations
amounted to $.01 and $.26 for the three and nine months ended December 31, 2006,
respectively, compared to ($.05) and ($.14) in the three and nine months ended
December 31, 2005, respectively.
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 nine months ended December 31, 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 nine months ended December 31, 2005 as discontinued operations.
Diluted earnings per share from discontinued operations amounted to $.00 and
$.01 for the quarters ended December 31, 2006 and 2005, respectively. For the
nine months ended December 31, 2006 and 2005, diluted (loss) earnings per share
from discontinued operations amounted to ($.02) and $.01, respectively.
NET INCOME (LOSS). As a result of the items discussed above,
net income for the three and nine months ended December 31, 2006 was $88,000 and
$1,707,000, respectively, compared to net losses of $249,000 and $830,000, for
the three and nine months ended December 31, 2005. Diluted earnings (loss) per
share amounted to $.01 and $.24 for the three and nine months ended December 31,
2006, respectively, compared to ($.04) and ($.13) in the three and nine months
ended December 31, 2005, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Beginning with our fiscal year ended March 31, 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.
24
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 December 31,
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 December 31, 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.
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 December 31, 2006, we had cash and cash equivalents of
$7,747,000, a working capital deficit of $2,094,000, outstanding bank loans of
$2,250,000, an outstanding bank letter of credit of $450,000, and stockholders'
equity of $10,681,000. 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 provided by operating
activities was $3,238,000 for the nine months ended December 31, 2006. The net
cash provided by operating activities was primarily attributable to our net
income of $1.7 million for the period coupled with decreases in accounts
receivable, unbilled contracts in progress and deferred contracts costs as well
as a partial utilization of our existing deferred tax asset and other changes in
working capital items. These increases were partially offset by decreases in
deferred revenue and accounts payable.
25
INVESTING ACTIVITIES. For the nine months ended December 31,
2006, net cash provided by investing activities amounted to $881,000 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 $236,000. We do not expect to make
material investments in fixed assets during the remainder of Fiscal 2007.
FINANCING ACTIVITIES. For the nine months ended December 31,
2006, net cash used by financing activities amounted to $301,000 resulting
primarily from payments made on bank borrowings of $750,000 partially offset by
the proceeds from the exercise of stock options of $454,000.
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
nine months ended December 31, 2006, there were no other material changes to
these policies.
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.
26
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. Prior to the end of
the period covered by this Quarterly Report, we have implemented or are
implementing the following measures:
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.
27
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 December 31, 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 December 31, 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, 4, AND 5. NOT APPLICABLE
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
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.
28
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.
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
29
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)
30