Exhibit 99.3
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATE
TABLE OF CONTENTS
Page
Independent Auditor's Report F-1
Combined Balance Sheet F-2
Combined Statements of Operations F-3
Combined Statements of Changes in Stockholders' Equity F-4
Combined Statements of Cash Flows F-5
Notes to Combined Financial Statements F-7
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Stockholders
Conversion Services International, Inc. and Affiliate
East Hanover, New Jersey
We have audited the accompanying combined balance sheet of Conversion Services
International, Inc. and affiliate as of December 31, 2003, and the related
combined statements of operations, changes in stockholders' equity and cash
flows for the years ended December 31, 2003 and 2002. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Conversion Services
International, Inc. and affiliate as of December 31, 2003 and the results of its
operations and its cash flows for the years ended December 31, 2003 and 2002, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Ehrenkrantz Sterling & Co. LLC
Livingston, New Jersey
March 30, 2004
F-1
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATE
COMBINED BALANCE SHEET
DECEMBER 31, 2003
ASSETS
CURRENT ASSETS
Cash $ 411,586
Accounts receivable, net of
allowance for doubtful accounts of $92,000 2,052,343
Prepaid expenses 113,803
Deferred tax asset 36,700
--------------
TOTAL CURRENT ASSETS 2,614,432
--------------
PROPERTY AND EQUIPMENT, at cost, net 270,696
--------------
OTHER ASSETS
Due from stockholders, including accrued interest of $21,600 203,623
Goodwill 1,094,206
Deferred loan costs, net of accumulated amortization of $77,484 24,862
Intangible assets, net of accumulated amortization of $89,710 344,290
Deferred tax asset 191,000
Security deposits 16,791
--------------
1,874,772
--------------
$ 4,759,900
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit $ 1,782,699
Current portion of long-term debt 461,981
Accounts payable and accrued expenses 1,025,248
--------------
TOTAL CURRENT LIABILITIES 3,269,928
--------------
LONG-TERM DEBT, net of current portion 233,928
--------------
DEFERRED TAXES 36,900
--------------
COMMITMENTS -
STOCKHOLDERS' EQUITY
Capital Stock 2,000
Additional paid in capital 1,445,250
Accumulated deficit (228,106)
--------------
1,219,144
--------------
$ 4,759,900
==============
See Notes to Combined Financial Statements.
F-2
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATE
COMBINED STATEMENTS OF OPERATIONS
Years ended December 31
------------------------------
2003 2002
------------ ------------
(Restated)
REVENUE $ 14,366,456 $ 16,244,790
COST OF SERVICES 10,265,808 10,677,527
------------ ------------
GROSS PROFIT 4,100,648 5,567,263
------------ ------------
OPERATING EXPENSES
Selling and marketing 1,552,766 1,095,072
General and administrative 2,701,934 3,549,423
Depreciation and amortization 213,158 149,463
------------ ------------
4,467,858 4,793,958
------------ ------------
INCOME (LOSS) FROM OPERATIONS (367,210) 773,305
------------ ------------
OTHER INCOME (EXPENSE)
Interest income 5,400 5,400
Interest expense (135,753) (139,152)
------------ ------------
(130,353) (133,752)
------------ ------------
INCOME (LOSS) BEFORE TAXES (497,563) 639,553
------------ ------------
INCOME TAXES (BENEFIT)
Current -- 101,100
Deferred (190,800) (78,700)
------------ ------------
(190,800) 22,400
------------ ------------
NET INCOME (LOSS) $ (306,763) $ 617,153
============ ============
See Notes to Combined Financial Statements.
F-3
CONVERSION SERVICES INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Retained Total
Capital Paid-in Earnings Stockholders'
Stock Capital (Deficit) Equity
----------- ----------- ----------- -----------
Balance, January 1, 2002, as restated $ 1,900 $ 139,800 $ 190,424 $ 332,124
Net income - - 617,153 617,153
Distributions to stockholders - - (178,340) (178,340)
----------- ----------- ----------- -----------
Balance, December 31, 2002, as restated 1,900 139,800 629,237 770,937
Net loss - - (306,763) (306,763)
Issuance of 100,000 shares of Common
Stock of Conversion Services
International Inc. 100 1,522,338 - 1,522,438
Distributions to stockholders - (216,888) (550,580) (767,468)
----------- ----------- ----------- -----------
Balance, December 31, 2003 $ 2,000 $ 1,445,250 $ (228,106) $ 1,219,144
=========== =========== =========== ===========
See Notes to Combined Financial Statements
F-4
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS
Years ended December 31
----------------------------
2003 2002
------------ ------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (306,763) $ 617,153
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation 95,837 108,890
Amortizaton of intangible assets and deferred loan costs 117,321 40,573
Deferred tax benefit (190,800) (78,700)
Allowance for doubtful accounts 42,000 (75,000)
Conversion of accrued interest to additional paid-in capital 22,438 -
Changes in operating assets and liabilities:
Decrease in accounts receivable (268,325) (180,980)
(Increase) decrease in prepaid expense (50,611) 73,139
(Increase) decrease in security deposits (2,070) 1,250
Decrease in accounts payable and accrued expenses (327) (548,661)
Decrease in deferred revenue - (10,000)
------------ ------------
Net cash used in operating activities (541,300) (52,336)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (93,640) (41,050)
Collection (issuance) of note receivable 2,100 210,000
Acquisition of intangible assets and goodwill (11,951) (82,277)
------------ ------------
Net cash provided by (used in) investing activities (103,491) 86,673
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft (5,661) 5,661
Net advances under line of credit 1,112,863 454,137
Principal payments on long-term debt (777,957) (308,828)
Deferred loan costs in connection with long-term debt - (23,241)
Issuance of convertible debt 1,500,000 -
Due from stockholders (5,400) (5,400)
Distributions to stockholders (767,468) (178,340)
------------ ------------
Net cash provided by (used in) financing activities 1,056,377 (56,011)
------------ ------------
NET INCREASE (DECREASE) IN CASH 411,586 (21,674)
CASH, beginning of year - 21,674
------------ ------------
CASH, end of year $ 411,586 $ -
============ ============
F-5
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS
Years ended December 31
-----------------------
2003 2002
-------- ---------
(Restated)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 89,630 $ 135,066
Cash paid for income taxes 28,258 229,007
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
During 2003 and 2002, the Company entered into various capital lease
arrangements for computer equipment in the amount of $23,556 and $2,928,
respectively.
During 2002, the Company financed the acquisition of certain intangibles
through an obligation due to a third party in the amount of $700,811.
See Notes to Combined Financial Statements.
F-6
CONVERSION SERVICES INTERNATIONAL, INC.
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Conversion Services International, Inc. ("CSI") was incorporated in the State of
Delaware and has been conducting business since 1990. CSI and Doorways, Inc.
(together the "Company") are principally engaged in the information technology
services industry in the following areas: Data Warehousing, Business
Intelligence, Management consulting and professional services, on credit, to its
customers principally located in New Jersey and New York. In November 2002, the
Company acquired the operations of Scosys, Inc. that is engaged in the
information technology services industry. Included in the Company's results of
operations related to scosys were the following:
Years ended December 31
----------------------------
2003 2002
----------- ---------
Revenues $ 3,034,000 $ 456,000
Cost of Services 2,169,000 335,000
----------- ---------
Gross Profit 865,000 121,000
General and Adminstrative 159,000 10,000
The accompanying combined financial statements include the accounts of CSI and
Doorways, Inc. which is owned by the two principal shareholders of CSI. All
intercompany transactions and balances have been eliminated.
REVENUE RECOGNITION
Revenue from consulting and professional services is recognized at the time the
services are performed, evidence of an arrangement exists, the fee is fixed or
determinable and collectibility is reasonably assured.
ACCOUNTS RECEIVABLE
The Company carries its accounts receivable at cost less an allowance for
doubtful accounts. On a periodic basis, the Company evaluates its accounts
receivable and changes the allowance for doubtful accounts, when deemed
necessary, based on its history of past write-offs and collections, contractual
terms and current credit conditions.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and includes equipment held under
capital lease agreements. Depreciation, which includes amortization of leased
equipment, is computed principally by an accelerated method and is based on the
estimated useful lives of the various assets ranging from three to seven years.
When assets are sold or retired, the cost and accumulated depreciation are
removed from the accounts and any gain or loss is included in operations.
Expenditures for maintenance and repairs have been charged to operations. Major
renewals and betterments have been capitalized.
F-7
AMORTIZATION
The Company amortizes deferred loan costs on a straight-line basis over the term
of the related loan instrument. The Company amortizes acquired customer lists
and contracts over an estimated useful life of 5 years.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the amounts paid in connection with a settlement agreement
with the Elligent Consulting Group to re-acquire the ownership rights to the
Company and in connection with the acquisition of Scosys, Inc. Additionally, as
part of the Company's acquisition of Scosys, Inc., executed in November 2002,
the Company acquired intangible assets. The Company adopted FASB Statement 142
as of January 1, 2002 for all goodwill recognized in the Company's balance sheet
as of December 31, 2001. This statement changed the accounting for goodwill from
an amortization method to an impairment-only approach, and introduced a new
model for determining impairment charges.
Goodwill and intangible assets are reviewed for impairment whenever events or
circumstances indicate impairment might exist or at least annually. The Company
assesses the recoverability of its assets, in accordance with SFAS No. 142
"Goodwill and Other Intangible Assets," comparing projected undiscounted cash
flows associated with those assets against their respective carrying amounts.
Impairment, if any, is based on the excess of the carrying amount over the fair
value of those assets. The Company's goodwill and intangible assets were not
impaired at December 31, 2003.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk are cash and accounts receivable arising from its normal business
activities. The Company routinely assesses the financial strength of its
customers, based upon factors surrounding their credit risk, establishes an
allowance for doubtful accounts, and as a consequence believes that its accounts
receivable credit risk exposure beyond such allowances is limited. At December
31, 2003, one customer approximated 25% of the Company's accounts receivable
balance.
The Company maintains its cash with a high credit quality financial institution.
Each account is secured by the Federal Deposit Insurance Corporation up to
$100,000.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising costs amounted
to approximately $8,000 and $5,700 for the years ended December 31, 2003 and
2002, respectively.
INCOME TAXES
The Company accounts for income taxes under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax consequences, the
Company generally considers all expected future events other than enactments of
changes in the tax laws or rates.
F-8
On January 1, 2001, CSI elected to be an "S" Corporation whereby, the
shareholders account for their share of CSI's earnings, losses, deductions and
credits on their Federal and various state income tax returns. CSI is subject to
New York City and various state income taxes. On September 30, 2003, CSI's "S"
Corporation status was revoked in connection with the conversion of convertible
subordinated debt into common shares. Effective October 1, 2004, as a result of
the revocation, the Company's tax status reverts to a C Corporation and on a
prospective basis, the Company would expect to have an effective income tax rate
of approximately 40%.
DERIVATIVES
In September 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133 " Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"), which requires the recognition of all derivatives as either assets or
liabilities measured at fair value, with changes in value reflected as current
period income (loss) unless specific hedge accounting criteria are met. The
effective date of SFAS No. 133, as amended by SFAS No. 138, is for fiscal years
beginning after September 15, 2000. The Company adopted SFAS No. 133 as of
January 1, 2001, resulting in no material impact upon adoption. SFAS No. 133 did
not have a material impact on the financial results for the years ended December
31, 2003 and 2002.
RECLASSIFICATIONS
Certain amounts in prior periods have been reclassified to conform to the 2003
presentation.
RESTATEMENT OF FINANCIAL STATEMENTS
The following is a brief description of the differences between the Company's
original accounting treatment and the revised accounting treatment that it has
concluded is appropriate and has been reflected in the accompanying financial
statements for the respective periods.
Recognition of interest income on Due from Stockholders - Retained earnings at
January 1, 2002 has been adjusted to reflect interest income on loans receivable
due from stockholders. The Company's original accounting did not include any
adjustments to its financial statements for interest due on these loans. These
loans receivable bear interest at 3% per annum and are due and payable by
December 31, 2005. The revised accounting resulted in an increase to retained
earnings of $10,800 as of January 1, 2002. The Company also recorded an
additional $5,400 as interest income as a result of the correction of this error
for the year ended December 31, 2002.
Recognition of Additional Intangibles and Goodwill related to acquisition of
Scosys, Inc. - Retained earnings at December 31, 2002 has been reduced by
approximately $11,000 to reflect additional amortization expense on certain
acquired intangibles and interest expense on an obligation to a third party in
connection with the acquisition of Scosys, Inc. (See Note 5). The Company's
original accounting did not properly include the amount of intangibles acquired
in connection with the Scosys, Inc. acquisition in November 2002. In connection
with this acquisition, the Company recorded an additional $351,723 in intangible
assets and $349,088 in goodwill and a corresponding obligation of $700,811 to a
third party. (See Note 7)
NOTE 2: RECENT PRONOUNCEMENTS
On August 16, 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. Specifically, this standard
requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. The entity is
required to capitalize the cost by increasing the carrying amount of the related
F-9
long-lived asset. The capitalized cost is then depreciated over the useful life
of the related asset and the liability is accreted, with changes to the
operating expense, to the estimated settlement obligation amount. Upon
settlement of the liability, an entity either settles the obligation for its
recorded amount or incurs a gain or loss. The standard is effective for fiscal
years beginning after June 15, 2002. The Company adopted SFAS No. 143 as of as
of January 1, 2003 and this adoption had no material impact on the Company's
combined financial statements for the year ended December 31, 2003.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144 "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144).
SFAS 144 supersedes Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and certain provisions of APB Opinion No. 30 "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS 144 establishes standards for long-lived assets to be
disposed of, and redefines the valuation and presentation of discontinued
operations. SFAS 144 is effective for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years. The adoption of SFAS 144
did not have a material effect on the Company's financial position, results of
operations, and cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing or other exit or disposal activity. Previous accounting
guidance was provided by EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". SFAS No. 146 replaces EITF 94-3. SFAS 146
is to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The Company adopted SFAS No. 146 as of January 1, 2003 and
this adoption had no material impact on the Company's combined financial
statements for the year ended December 31, 2003.
In November 2002, the EITF reached consensus on EITF No. 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables". This consensus requires that
revenue arrangements with multiple deliverables be divided into separate units
of accounting if the deliverables in the arrangement meet specific criteria. In
addition, arrangement consideration must be allocated among the separate units
of accounting based on their relative fair values, with certain limitations. The
Company will be required to adopt the provisions of this consensus for revenue
arrangements entered into after June 30, 2003, and the Company has decided to
apply it on a prospective basis. The Company does not have any revenue
arrangements that would have a material impact on its financial statements with
respect to EITF No. 00-21.
In November 2002, the FASB issued FASB Interpretation, or FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. However, a liability does not have to be recognized for a
parent's guarantee of its subsidiary's debt to a third party or a subsidiary's
guarantee of the debt owed to a third party by either its parent or another
subsidiary of that parent. The initial recognition and measurement provisions of
FIN No. 45 are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002 irrespective of the guarantor's fiscal year
end. The disclosure requirements of FIN No. 45 are effective for financial
statements with annual periods ending after December 15, 2002. The Company does
not have any guarantees that would require disclosure under FIN No. 45.
F-10
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation - Transition and Disclosure - an Amendment to SFAS No. 123". SFAS
No. 148 provides alternative methods of transition for a voluntary change to the
fair value-based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 for
public companies. This statement is effective for fiscal years beginning after
December 15, 2002. The Company adopted the disclosure requirements of SFAS No.
148 as of January 1, 2003 and plans to continue to follow the provisions of APB
Opinion No. 25 for accounting for stock based compensation.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities -- An Interpretation of ARB No. 51", which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46 provides guidance related to identifying
variable interest entities (previously known generally as special purpose
entities, or SPEs) and determining whether such entities should be consolidated.
FIN No. 46 must be applied immediately to variable interest entities created or
interests in variable interest entities obtained, after January 31, 2003. For
those variable interest entities created or interests in variable interest
entities obtained on or before January 31, 2003, the guidance in FIN No. 46 must
be applied in the first fiscal year or interim period beginning after June 15,
2003. The Company adopted FIN No. 46 as of January 1, 2003 and this adoption had
no material impact on the Company's combined financial statements for the year
ended December 31, 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) because that financial instrument embodies the characteristics of
an obligation of the issuer. This standard is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The Company has determined that it did not have any financial instruments
that are impacted by SFAS No. 150.
F-11
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
December 31,
2003
------------
Computer equipment $ 609,968
Furniture and fixtures 103,777
Automobiles 72,833
Leasehold improvements 87,546
---------
874,124
Accumulated depreciation (603,428)
---------
$ 270,696
=========
NOTE 4: RELATED PARTY TRANSACTIONS
Due from stockholders of $203,623 at December 31, 2003 consists of loans
receivable and accrued interest thereon from the majority stockholders /
officers of the Company. These loans bear interest at 3% per annum and are due
and payable by December 31, 2005.
5. INTANGIBLES
Intangibles acquired have been assigned as follows:
December 31,
2003
------------
Customer lists and contracts $ 414,000
Proprietary rights and rights to the name of Scosys Inc. 20,000
---------
434,000
Accumulated amortization (89,710)
---------
$ 344,290
=========
NOTE 6: LINE OF CREDIT
The credit facility provides for a maximum borrowing of $2,250,000, based on
eligible accounts receivable. The interest rate is at the bank's prime rate plus
one (5.0% at December 31, 2003). The line is collateralized by all corporate
assets, guaranteed by the Company's shareholders, and expires on June 30, 2004.
As of December 31, 2003, the Company is in violation of certain financial
covenants in connection with the credit facility and notes payable to a bank.
(See Note 14).
On October 29, 2003, the Company obtained an additional $2,000,000 Unsecured
Convertible Line of Credit Note. The terms of the note provide for interest
accruing at 7% per annum with a maturity date of October 28, 2008, unless
converted into Common Stock at the Company or the Noteholder's option. (See Note
14)
F-12
NOTE 7: LONG-TERM DEBT
Long-term debt consisted of the following:
December 31,
2003
------------
Note payable to a bank requiring monthly installments of
$8,333, plus interest at the bank's prime rate plus 1/4%
(4.25% at December 31, 2003), due November 2005. The note is
collateralized by all corporate assets and is guaranteed by
the Company's shareholders. $ 191,666
Note payable to a bank requiring monthly installments of
$11,667, plus interest at LIBOR plus 200 basis points, due
November 2005. The note is collateralized by all corporate
assets, pledged securities of one of the shareholders, and
is guaranteed by the Company's shareholders. The LIBOR rate
at December 31, 2002 was 1.46%. 268,333
An obligation due to a third party (See Note 1 - Restatement
of Financial Statements) in connection with an acquisition
of Scosys, payable through May 2004. The obligation has been
present valued at the Company's implicit borrowing rate at
the time of the acquisition (5.25%) 213,533
Notes payable under capital lease obligations payable to
various finance companies for equipment at varying rates of
interest and maturity dates through 2006. 22,377
----------
695,909
Less: Current portion of long-term debt, including obligations
under capital leases of $8,448. (461,981)
----------
$ 233,928
==========
Future annual payments of long-term debt is as follows:
Years Ending December 31
------------------------
2004 $ 461,981
2005 227,706
2006 6,222
---------
$ 695,909
=========
As a result of the Replacement Line of Credit described in Note 14, no long-term
portion of the Notes payable to the bank were reclassified to be reported as
currently due as a result of the Company's violation of existing covenants.
F-13
NOTE 8: OBLIGATIONS UNDER CAPITAL LEASES
The Company has entered into various capital leases that are collateralized by
computer equipment with an original cost of approximately $389,000.
The following is a schedule of future minimum payments required under the leases
together with their present value as of December 31, 2003:
Years Ending December 31
------------------------
2004 $ 11,012
2005 9,219
2006 6,593
--------
26,824
Less: Amount representing interest (4,447)
--------
$ 22,377
========
NOTE 9. STOCKHOLDERS' EQUIT
Capital stock consisted of the following:
December 31,
2003
---------
CSI: Common stock, $.001 par value, 1,000,000 shares
authorized, 1,000,000 shares issued and outstanding
in 2003 and 900,000 shares issued and outstanding
in 2002 $ 1,000
Doorways, Inc.: Common stock, no par value, 3,000 shares authorized,
1,000 shares issued and outstanding in 2003 and 2002 1,000
--
---------
$ 2,000
=========
In July 2003, the Company issued $1,500,000 of 7% Convertible Promissory Notes
due January 1, 2006. On September 30, 2003, these notes were converted into
100,000 shares of CSI's common stock.
NOTE 10: INCOME TAXES
The Company provides for federal and state income taxes in accordance with
current rates applied to accounting income before taxes. The provision for
income taxes is as follows:
F-14
Years ended December 31
--------------------------
2003 2002
---------- ---------
Current- Federal $ - $ 63,300
Current - State - 37,800
Deferred - Federal (147,800) (63,500)
Deferred - State (43,000) (15,200)
---------- ---------
$ (190,800) $ 22,400
========== =========
Deferred tax benefit in 2002 consisted of the temporary difference caused by the
conversion of cash-basis tax accounting to accrual-basis tax accounting pursuant
to Internal Revenue Code section 481(a) which allows up to a 4 year spreading of
the income and expenses caused by the change in accounting method that completed
during 2002.
The Company has net operating loss carry-forwards for both Federal and State
purposes totaling approximately $413,000 that expire in 2023.
Deferred tax assets (liabilities) consisted of the following temporary
differences:
December 31,
2003
------------
Net operating losses $ 164,900
Accounts receivable 36,700
Property and equipment 2,200
Goodwill (36,900)
Intangible assets 23,900
---------
$ 190,800
=========
NOTE 11: MAJOR CUSTOMERS
During 2003 and 2002, the Company had sales to two major customers which totaled
approximately $6,126,000 and $9,540,000, respectively. Amounts due from these
customers included in accounts receivable were approximately $366,000 and
$726,000 at December 31, 2003 and 2002, respectively.
NOTE 12: EMPLOYEE BENEFIT PLAN
The Company has a defined contribution profit sharing plan under Section 401(k)
of the Internal Revenue Code that covers substantially all employees. Eligible
employees may contribute on a tax deferred basis a percentage of compensation up
to the maximum allowable amount. Although the plan does not require a matching
contribution by the Company, the Company may make a contribution. The Company's
contributions to the plan for the years ended December 31, 2003 and 2002 was
approximately $24,000 and $20,000, respectively.
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NOTE 13: COMMITMENTS
LEASE COMMITMENTS
The Company's corporate headquarters are located in East Hanover, New Jersey,
where it operates under an amended lease agreement expiring December 31, 2005.
In addition to minimum rentals, the Company is liable for its proportionate
share of real estate taxes and operating expenses, as defined.
Rent expense, including automobile rentals, totaled approximately $313,000 and
$416,000 in 2003 and 2002, respectively.
The Company is committed under several operating leases for automobiles that
expire during 2007.
Future minimum lease payments due under all operating lease agreements as of
December 31, 2003 are as follows:
Years Ending December 31 Office Automobiles Total
------------------------- ---------- ----------- ---------
2004 $ 310,615 $ 33,013 $ 343,628
2005 299,575 30,785 330,360
2006 - 30,785 30,785
2007 - 7,696 7,696
------------- ------------- -------------
$ 610,190 $ 102,279 $ 712,469
============= ============= =============
LETTER OF CREDIT
The Company is committed under an outstanding letter of credit with a bank to
secure the security deposit on the office space in the amount of $83,375 and
$191,356 as of December 31, 2003 and 2002, respectively.
AGREEMENTS
During 2002, the Company executed a twelve month employment agreement with one
of Scosys' senior management. This agreement expired in November 2003 and has
not been renewed.
NOTE 14: SUBSEQUENT EVENTS
Reverse Merger
On August 21, 2003, LCS Group, Inc., LCS Acquisition Corp., a wholly owned
subsidiary of LCS Group, Inc., CSI and CSI's executive officers and principal
stockholders, executed an Agreement and Plan of Reorganization to merge CSI into
LCS Acquisition Corp. This transaction was consummated on January 30, 2004, CSI
became the operating entity, LCS Group changed its name to CSl and the CSI
shareholders control approximately 84% of the shares of the combined company. As
part of this transaction, the Company's affiliate, Doorways, Inc. was merged
into CSI.
In connection with this transaction, LCS Group, Inc. agreed to a.) increase the
number of common shares they were authorized to issue from 50,000,000 to
1,000,000,000; b.) authorized the right to issue up to 20,000,000 shares of
preferred stock; and c.) adopted the 2003 Stock Incentive Plan (the "2003 Stock
Option Plan").
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The 2003 Stock Option Plan authorizes the issuance of up to 100,000,000 shares
of common stock for issuance upon exercise of options. It also authorizes the
issuance of stock appreciation rights. On March 29, 2004, the Company granted
19,200,000 options to purchase its common stock at an exercise price of $0.165.
Since the stockholders of CSI own a majority of the issued and outstanding
shares of LCS Group, Inc. (prior to the name change noted above) after the
merger, this transaction will be accounted for as a reverse merger whereby CSI
is deemed to be the accounting acquirer of LCS Group, Inc.. Because LCS Group,
Inc. did not have any assets or liabilities prior to the merger, there is no
goodwill or other intangibles that will arise from the merger. As a result,
historical stockholder's equity of CSI will be retroactively restated to reflect
the recapitalization.
Pro-forma information: For the nine months ended November 30, 2003, LCS Group
Inc. reported an unaudited loss from operations of approximately $561,000. The
loss from operations consisted of $487,000 of selling, general and
administrative expenses and $74,000 of interest expense. As part of the merger
with CSI, a condition precedent to closing the merger transaction, 100% of the
outstanding stock of LCS Golf, Inc. (a wholly-owned subsidiary of LCS Group,
Inc.) was required to be sold to a third-party. As the results noted above are
those of LCS Golf, Inc. which was sold prior to the merger, no pro-forma results
of operations are shown. As a result of the retroactive recapitalization, CSI
would have had 593,000,000 and 592,900,000 shares of common stock outstanding as
of December 31, 2003 and 2002, respectively.
Borrowings under the Unsecured Convertible Line of Credit Note
On October 29, 2003, the Company made arrangements to obtain a $2,000,000
Unsecured Convertible Line of Credit Note. The terms of this new note provide
for interest accruing on advances at 7% per annum with a maturity date of
October 28, 2008, unless converted into Common Stock at the Company's or the
Note holder's option. As of February 28, 2004, the Company has drawn down on the
facility and received advances totaling $2,000,000.
Replacement Line of Credit
On March 30, 2004, the Company executed a $3,000,000 revolving line of credit
secured by substantially all of the corporate assets with a new financial
institution. This credit facility was utilized to replace the existing Line of
Credit facility expiring in June 2004 and both Notes payable to a bank. The
terms of this new note provide for interest accruing on advances at seven
eighths of one percent (7/8%) over the institution's prime rate. This line of
credit contains certain financial covenants including but not limited to a.)
Debt Service Coverage ratios; b.) Minimum Tangible Capital Funds limits; and c.)
Current Ratio limits, as defined. The Company will be measured quarterly on
these covenants beginning June 30, 2004.
DeLeeuw Acquisition
In March 2004, the Company formed a wholly-owned acquisition subsidiary, DeLeeuw
Conversion LLC ("DCL"), for the purpose of consummating a merger with DeLeeuw
Associates, Inc. a privately-held New Jersey corporation ("DAI"). On March 4,
2004, DCL completed the merger with DAI. At the closing of the merger, DAI was
merged with and into DCL, and Mr. DeLeeuw received $2,000,000 and 80,000,000
outstanding shares of common stock of CSI (approximately 11.9% of the
outstanding shares). On March 5, 2004, DCL changed its name to DeLeeuw
Associates, LLC.
Employment Agreements
On March 26, 2004, the Company entered into employment agreement with Scott
Newman , CSI's President and Chief Executive Officer, director and principal
stockholder. The agreement provides for an annual salary of $500,000 and an
annual bonus to be awarded by the Company's to-be-appointed Compensation
Committee. The agreement also provides for health, life and disability
insurance, as well as a monthly car allowance. In the event that Mr. Newman's
employment is terminated other than with good cause, he will receive a payment
of three year's base salary.
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On March 26, 2004, the Company entered into employment agreement with Glenn
Peipert, CSI's Vice President and Chief Operating Officer, director and
principal stockholder. The agreement provides for an annual salary of $375,000
and an annual bonus to be awarded by the Company's to-be-appointed Compensation
Committee. The agreement also provides for health, life and disability
insurance, as well as a monthly car allowance. In the event that Mr. Peipert's
employment is terminated other than with good cause, he will receive a payment
of three year's base salary.
On March 26, 2004, the Company entered into employment agreement with Mitchell
Peipert, CSI's Vice President and Chief Financial Officer. The agreement
provides for an annual salary to of $200,000 and an annual bonus to be awarded
by the Company's to-be-appointed Compensation Committee. The agreement also
provides for health, life and disability insurance, as well as a monthly car
allowance. In the event that Mr. Peipert's employment is terminated other than
with good cause, he will receive a payment of three year's base salary.
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