UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB/A
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2004
-----------------
[ ] Transition Report pursuant to 13 or 15(d) of the Securities Exchange
Act of 1934
Commission File Number 000-33391
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SYSTEMS EVOLUTION INC.
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(Exact name of Small Business Issuer as specified in its charter)
IDAHO 82-0291029
- ---------------------------------- -----------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
10777 WESTHEIMER ROAD, SUITE 810
HOUSTON, TEXAS 77042
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(Address of principal executive offices)
713-979-1600
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Issuer's telephone number
NONE
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(Former name, former address and former fiscal year, if changed
since last report)
Check whether the issuer (1) has filed all documents and reports required
to be filed by Section 13 or 15(d) of the Securities and 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.
(1) [X] Yes [ ] No
(2) [X] Yes [ ] No
The number of shares of issuer's Common Stock outstanding as of January 18,
2005: 79,490,843 SHARES
SYSTEMS EVOLUTION INC.
INDEX
QUARTERLY REPORT ON FORM 10-QSB/A
FOR QUARTERLY PERIOD ENDED November 30, 2004
PART I. FINANCIAL INFORMATION
ITEM 1 - Unaudited Consolidated Financial Statements
a. Consolidated Balance Sheets as of November 30,
2004 (Unaudited) and May 31, 2004 3
b. Consolidated Statements of Operations
for the Six and Three Months Ended November 30,
2004 and 2003 (Unaudited) 4
C. Consolidated Statements of Cash Flows
for the Six Months Ended November 30,
2004 and 2003 (Unaudited) 5
d. Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis
ITEM 3 - Controls and Procedures
PART II. OTHER INFORMATION
ITEM 6 - Exhibits
SIGNATURES
EXHIBIT 31 - Certification pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
EXHIBIT 32 - Certification pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
PART I. FINANCIAL INFORMATION
ITEM 1 - Unaudited Consolidated Financial Statements
SYSTEMS EVOLUTION INC.
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2004 (UNAUDITED)AND MAY 31, 2004
November 30, May 31,
2004 2004
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ASSETS (Unaudited)
(Restated)
CURRENT ASSETS:
Cash $ 74,681 $ 19,522
Accounts receivable - trade,
net of allowance of $16,551 & $15,000 351,082 107,369
Other current assets 85,021 --
------------ ------------
Total current assets 510,784 126,891
DEFERRED FINANCING COST 4,606,259 --
INTANGIBLES 3,179,530 143,150
FURNITURE AND EQUIPMENT, NET 134,639 55,883
OTHER 3,040 --
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Total assets $ 8,434,252 $ 325,924
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 413,093 $ 48,515
Accrued expenses 107,683 192,369
Current portion, long-term debt -- 5,000
Notes payable 90,000 150,973
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Total current liabilities 610,776 396,857
Convertible note, net 152,083 --
Long-term debt, net of current portion 300,300 11,137
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Total liabilities 1,063,159 407,994
Commitments
STOCKHOLDERS' EQUITY
Common stock, no par value 13,514,857 2,679,765
Accumulated deficit (6,143,764) (2,761,835)
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Total stockholders' equity 7,371,093 (82,070)
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Total liabilities and stockholders' equity 8,434,252 325,924
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SYSTEMS EVOLUTION INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NOVEMBER 30, SIX MONTHS ENDED NOVEMBER 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Restated) (Restated)
REVENUES $733,012 $164,813 $965,641 $350,956
OPERATING EXPENSES:
Payroll and related costs 1,161,312 165,525 1,465,177 425,477
General, administrative and selling 576,043 37,727 2,254,329 125,117
------------ ------------ ------------ ------------
Loss from Operations (1,004,343) (38,439) (2,753,865) (199,638)
------------ ------------ ------------ ------------
Interest Expense 610,622 -- 628,064
------------ ------------ ------------ ------------
Net Loss (1,614,965) (38,439) (3,381,929) (199,638)
============ ============ ============ ============
Basic and Diluted Loss Per Share: ($0.02) $0.00 (.05) $0.00
============ ============ ============ ============
Basic and Diluted Weighted Average Shares
Outstanding 67,239,771 37,500,000 65,888,643 37,500,000
============ ============ ============ ============
SYSTEMS EVOLUTION INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED NOVEMBER 30, 2004 AND 2003
(UNAUDITED)
2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES: (Restated)
Net loss $(3,381,929) $ (199,638)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 823,129 14,000
Beneficial Conversion Feature -- --
Bad debt expense 10,006 --
Stock issued for services 162,050 --
Stock option and warrant expense 1,536,486 --
Gain on sale of fixed assets 1,392 --
Changes in assets and liabilities:
Accounts receivable - trade (12,600) 48,889
Prepaid expenses and other assets (69,501) --
Deposits (3,040) --
Accounts payable 261,661 7,594
Accrued expenses (111,711) (11,885)
----------- -----------
Net cash used in operating activities (784,057) (141,040)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures (29,546)
Purchase of Duration Software (450,000)
Purchase of Next Hire --
Purchase of CMS (10,000)
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Net provided by investing activities (489,546) --
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CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (419,240) (5,051)
Proceeds from stockholder receivable -- 16,422
Proceeds from notes payable and long-term debt 82,527 100,000
Proceeds from convertible note 1,825,000 --
Deferred financing cost (286,616) --
Sale of common Stock 127,091 9,300
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Net provided by financing activities 1,328,762 120,671
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Net Change in cash 55,159 (20,369)
CASH, beginning of year 19,522 29,670
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CASH, end of year $ 74,681 $ 9,301
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SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 3,287 $ --
=========== ===========
Income taxes paid $ 4,465 $ --
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NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued for Acquisition of CMS $ 104,000 $ --
Common stock issued for Acquisition of Duration 2,250,000 --
Common stock issued for Acquisition of Next Hire 40,000 --
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Common stock issued for computer equipment $ 52,070 $ --
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SYSTEMS EVOLUTION INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 2004
(UNAUDITED)
(RESTATED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited interim financial statements of Systems
Evolution Inc. ("SEVI") have been prepared in accordance with accounting
principles generally accepted in the United States of America and the rules of
the Securities and Exchange Commission ("SEC"), and should be read in
conjunction with the audited financial statements and notes thereto contained in
the Company's Annual Report filed with the SEC on Form 10-KSB. In the opinion of
management, all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of financial position and the results of
operations for the interim periods presented have been reflected herein. The
results of operations for the interim periods are not necessarily indicative of
the results to be expected for the full year. Notes to the financial statements
which would substantially duplicate the disclosure contained in the audited
financial statements for 2004 as reported in the 10-KSB have been omitted.
NOTE 2 - STOCK OPTIONS
SEVI accounts for its stock-based compensation plans under Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees. Statement of Financial Accounting Standard ("FAS") No. 148,
Accounting for Stock-Based Compensation-Transition and Disclosure, issued in
December 2002 requires pro forma net loss and pro forma net loss per share to be
disclosed in interim financial statements.
During fiscal 2004, the Company created the 2003 Directors, Officers,
and Consultants Stock Option, Stock Warrant and Stock Award Plan ("2003 Plan").
Under the 2003 Plan, the total number of shares of common stock that may be
granted is 20,000,000. As of November 30, 2004, the Company has granted a total
of 13,693,333 options with exercise prices of $.05 to $.36 per share which vest
over 3 to 48 months. The maximum term of the options is ten years. During the
quarter ended November 30, 2004, the Company recorded compensation expense
totaling $148,936 based on the intrinsic value of the options vested during the
quarter.
The following table illustrates the effect on net income and earnings
per share if SEVI had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation:
Three Months Ended
November 30,
-----------------------------
2004 2003
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Net loss, as reported (1,619,817) (38,439)
Add: Expense recorded 148,936 --
Deduct: Total stock-based employee compensation
expense determined under the fair value based
method for all awards (312,010) --
Pro forma net loss (1,782,891) (38,439)
Loss per share:
Basic and diluted - as reported (.02) .00
Basic and diluted - pro forma (.03) .00
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: dividend yield 0.0%, expected volatility of 200%, risk-free
interest rate of 1.5%, and expected life of six months to two years.
NOTE 3 - RECLASSIFICATIONS
Certain amounts in the August 31, 2004 financial statements have been
reclassified to conform with the November 30, 2004 financial statement
presentation.
NOTE 4 - ACQUISITIONS
Effective July 27, 2004, the Company completed the acquisition of all
the issued and outstanding shares of Southwest CMS Technology Services, LP and
its general partner CMS Associates, LLC ("CMS"), a San Antonio based network
integration firm. Pursuant to the transaction, the Company paid $10,000 cash,
issued a note payable totaling $40,000 and issued an aggregate of 200,000 shares
of the Company's common stock to the owners of CMS. As of the effective date,
CMS became a wholly-owned subsidiary of the Company. The acquisition was
accounted for using the purchase method of accounting. The purchase price
allocation is preliminary awaiting a valuation of the assets acquired.
The following are pro forma condensed statements of income for the
three month period ended August 31, 2004 and 2003, as though the acquisition had
occurred on June 1, 2003. Other historical financial statements will be included
in the Company's report on Form 8-K/A when filed.
Three Months Ended
August 31,
------------------------------
2004 2003
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Revenues 286,468 471,461
Net Income/(Loss) (1,767,800) 4,233
Loss per share - basic and diluted (.03) .00
Effective September 24, 2004, the Company completed the acquisition of
all the issued and outstanding shares of Duration Software, Inc. an Austin based
IT consulting firm. Pursuant to the transaction, the Company paid the selling
stockholders $450,000 in cash, and issued them $300,000 aggregate principal
amount of our non-interest bearing notes due February 1, 2007, and 15,000,000
shares of our common stock. The purchase price allocation is preliminary
awaiting a valuation of the assets acquired.
As of the effective date, Duration Software, Inc. became a wholly-owned
subsidiary of the Company. The acquisition was accounted for using the purchase
method of accounting.
The following are pro forma condensed statements of income for the six
month period ended November 30, 2004 and 2003, as though the acquisition had
occurred on June 1, 2003. Other historical financial statements will be included
in the Company's report on Form 8-K/A when filed.
Six Months Ended
November 30,
------------------------------
2004 2003
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Revenues 2,783,190 1,943,159
Net Income/(Loss) (2,962,948) (79,809)
Loss per share - basic and diluted ($0.04) 0.00
The Company entered into a definitive agreement to acquire Next Hire
("Next Hire") Consultants Inc., a Houston based staffing and permanent placement
firm, on July 12, 2004, and closed the acquisition on September 23, 2004. In
connection with the acquisition of Next Hire from its stockholder, the Company
issued 400,000 shares of our common stock.
NOTE 5 - COMMON STOCK
On September 22, 2004, the Company increased its authorized number of
shares of common stock to 750,000,000.
During the three months ending November 30, 2004, the Company recorded
a liability totaling $9,300 related to un-issued shares as of November 30, 2004.
During the three months ending August 31, 2004, the Company issued
2,250,000 shares of common stock to H.C. Wainwright and 1st SB Partners related
to the exercise of warrants (see Note 6). The warrants were issued and exercised
during the quarter at an exercise price of $.001 per share resulting in
$1,110,000 of compensation expense being recorded based on the fair value of the
warrants.
During the three months ending August 31, 2004, the Company issued
20,000 shares to an employee. The company recorded consulting expense totaling
$137,000 based on the fair market value on the date issued (earned). Fair market
value was determined by using the stock price on the date issued.
During the three months ended August 31, 2004, the Company issued
200,000 shares of common stock as consideration for the acquisition of CMS (See
note 4).
During the three months ended August 31, 2004, the Company acquired
equipment in exchange for 100,000 shares of the Company's common stock valued at
$52,070 using the stock price on the date acquired.
NOTE 6 - WARRANTS
During the three months ended August 31, 2004, warrants were issued to
H.C. Wainwright and 1st SB Partners for consulting services. These warrants were
exercised fully during the three month period ending August 31, 2004 (NOTE 5).
Subsequent to the three month period ending August 31, 2004 and in
conjunction with the Purchase Agreement (See Note 8), the Notes were issued
together with warrants, denominated Series A, B, C and D warrants (each, a
"Warrant"), to purchase in the aggregate 36,500,000 shares of our Common Stock.
Each investor received Warrants to purchase shares of Common Stock equal to the
number of shares of common stock that are issuable upon full conversion of that
investor's Note, each investor receiving an equal number of each of the four
series of Warrants. The Series A Warrants are exercisable at $.06 per share
commencing on the Closing Date and expire 90 days after the registration
statement that we are required to file has been declared effective by the
Securities and Exchange Commission. The Series B Warrants are exercisable at
$.07 per share commencing on the Closing Date and expire 180 days after such
registration statement is declared effective. The Series C Warrants are
exercisable at $.08 per share commencing on the Closing Date and expire 270 days
after such registration statement is declared effective. The Series D Warrants
are exercisable at $.15 per share commencing on the Closing Date and expire five
years from the Closing Date.
In conjunction with the Purchase Agreement (see Note 8), 14,600,000
warrants were issued to H.C. Wainwright to purchase shares of the Company's
common stock with the following exercise prices: 7,300,000 shares at $.05,
1,825,000 shares at $.06, 1,825,000 shares at $.07, 1,825,000 shares at $.08 and
1,825,000 shares at $.15, providing for a cashless exercise, and expiration of
August 31, 2009. Also in conjunction with the Purchase Agreement (See note 7),
7,300,000 warrants were issued to 1st SB Partners to purchase shares of the
Company's common stock with the following exercise prices: 3,650,000 shares at
$.05, 912,500 shares at $.06, 912,500 shares at $.07, 912,500 shares at $.08 and
912,500 shares at $.15, providing for a cashless exercise, and expiration of
August 31, 2009. Previously, these warrants were all issued at a $0.05 exercise
price.
During the quarter ending November 30, 2004, the Company issued
7,809,868 shares of common stock to H.C. Wainwright and 1st SB Partners in
exchange for 11,656,521 warrants. The warrants redeemed represented a portion of
the 14,600,000 warrants issued to H.C. Wainwright and the 7,300,000 warrants
issued to 1st SB Partners in conjunction with the Purchase Agreement (see Note
8). As of November 30, 2004, the Company has outstanding warrants to acquire
46,743,479 shares of common stock.
NOTE 7 - RESTATEMENTS OF PREVIOUSLY REPORTED FINANCIAL STATEMENTS
There were several errors and misstatements in the originally prepared
November 30, 2004 financials discovered in 2004. See the notes below.
A summary of the restatements are as follows:
Increase
Previously Stated (Decrease) Restatement
-------------------- -------- -------------------- -------------------
As of November 30, 2004
Balance Sheet:
Cash $74,681 $74,681
Accounts receivable - trade,
Net of allowance of $16,551 & $15,000 351,082 351,082
Other current assets 85,021 85,021
(1)
Deferred Financing Cost - (2) 4,606,259 4,606,259
Intangibles 3,179,530 3,179,530
Furniture and Equipment, Net 134,639 134,639
Other 3,040 3,040
------------ ------------ ------------
Total assets $3,827,993 4,606,259 $8,434,252
============ ============ ============
Accounts payable $413,093 $413,093
Accrued expenses 107,683 107,683
Current portion, long-term debt 0 -
Notes payable 90,000 90,000
(3)
Convertible note, net 577,106 (4) (425,023) 152,083
Long-term debt, net of current portion 300,300 300,300
(1)
(3)
Common stock 8,251,001 (5) 5,263,856 13,514,857
Accumulated deficit (5,911,190) (232,574) (6,143,764)
------------ ------------ ------------
Total liabilities and stockholders' equity 3,827,993 4,606,259 8,434,252
============ ============ ============
Previously Increase
Stated (Decrease) Restatement
---------------------- ------ --------------------------------------------
For the six months ended November 30, 2004:
Statement of Operations
REVENUES $965,641 $965,641
OPERATING EXPENSES:
Payroll and related costs 1,465,177 1,465,177
General, administrative and selling 2,413,820 (5) (159,991) 2,253,829
------------- -------------- --------------
Loss from Operations (2,913,356) (159,991) (2,753,365)
------------- -------------- --------------
(2)
Interest Expense 235,499 (4) 392,565 628,064
-------------- -------------- --------------
Net Loss (3,148,855) 232,574 (3,381,429)
============== ============== ==============
Basic and Diluted Loss Per Share: ($0.02) ($.02)
============== ============== ==============
Basic and Diluted Weighted Average Shares 67,239,771 67,239,771
Outstanding ============== ==============
Restatement notes:
(1) Deferred Financing Costs had been misclassified as a reduction in
Capital Stock and had not been calculated with regard to the $1,825,000
financing agreement (see Note 8). This resulted in assets being
understated by the amount of the deferral, $5,025,011, and an
understatement of the Capital Stock account by the same amount.
(2) Because Deferred Financing Costs (see (1) above) had been unaccounted
the appropriate Interest Expense had not been recorded as amortization
over three months of the 36 month term of the financing. This resulted
in Interest Expense being understated by $418,752.
(3) A beneficial conversion feature related to the $1,825,000 convertible
debt (See Note 8) was not recorded. The beneficial conversion rate was
$.05 for stock that was currently trading at $.22 per share. This
resulted in the Discount on Investor Financing to be understated by
$398,837 and the Capital Stock to be understated by the same amount.
(4) The corresponding amortization of the Discount on Investor Financing
was understated for the reason identified in (1) above. This resulted
in General and Administrative Expenses being understated by $33,237.
The Interest Expense was calculated for a 3 month period over the 36
month term of the debt. Additionally, the original discount had been
amortized over a 24 month life and interest expense was reduced by
$59,423 to correctly reflect the 36 month life.
(5) Stock Option Expense for the quarter was incorrectly reported as
$308,928. This overstated the Capital Stock Account and Stock Option
Expense by $159,992.
NOTE 8 - PROMISSORY NOTES
On September 9, 2004, we completed the sale of an aggregate of
$1,825,000 principal amount of Notes, initially convertible into an aggregate of
36,500,000 shares of common stock, together with Warrants to purchase an
additional 36,500,000 shares of common stock.
Maturity. The Notes are due August 31, 2007, unless prepayment of the
Notes is required in certain events.
Conversion. The Notes are convertible at five ($.05) cents per share,
subject to proportionate adjustment for stock splits, stock combinations, and
stock dividends and distributions (the "Conversion Price"). In addition, the
Notes provide for adjustments for dividends payable other than in shares of
common stock, for reclassification, exchange or substitution of the common stock
for another security or securities of the Company or pursuant to a
reorganization, merger, consolidation, or sale of assets, where there is a
change in control of the Company.
If we issue or sell any shares of additional shares of common stock or
issues options or other convertible securities ("Common Stock Equivalents") at a
price per share less than the Conversion Price then in effect or without
consideration (or, in the case of a Common Stock Equivalent where the aggregate
of the price per share for which additional shares of common stock may be
issuable thereafter pursuant to such Common Stock Equivalent, plus the
consideration received by the Company for issuance of such common stock
equivalent divided by the number of shares of common stock issuable pursuant to
such Common Stock Equivalent is less than the applicable Conversion Price then
in effect), then the Conversion Price upon each such issuance shall be reduced
to a price equal to the consideration per share paid (or deemed to be paid, in
the case of a Common Stock Equivalent) for such additional shares of common
stock. In the case of a Common Stock Equivalent, the adjustment is recalculated
if the particular option or conversion right expires unexercised or the exercise
or conversion price is increased. The above adjustment for additional shares of
common stock or Common Stock Equivalents do not apply to: any transaction
involving (i) the Company's issuance of any securities (other than for cash) in
connection with a merger, acquisition or consolidation of the Company, (ii) the
Company's issuance of securities in connection with strategic license agreements
and other partnering arrangements so long as such issuances are not for the
purpose of raising capital, (iii) the Company's issuance of securities in
connection with bona fide firm underwritten public offerings of its securities,
(iv) the Company's issuance of common stock or the issuance or grants of options
to purchase common stock pursuant to the Company's stock option plans and
employee stock purchase plans as they exist at the date of the Purchase
Agreement, (v) as a result of the exercise of options or warrants or conversion
of convertible notes or preferred stock which are granted or issued as of the
date of the Purchase Agreement, (vi) any Warrants issued to the Holders of the
Notes and any warrants issued to the placement agent for the transactions
contemplated by the Purchase Agreement, or (vii) the payment of any interest on
the Notes.
Limit on Ownership. The Notes provide that, unless waived by the
Holders of the Notes, at no time may a Holder convert all or a portion of its
Note if the number of shares of common stock to be issued pursuant to such
conversion would exceed, when aggregated with all other shares of common stock
owned by the Holder at such time, the number of shares of common stock which
would result in the Holder beneficially owning (as determined in accordance with
Section 13(d) of the Securities Exchange Act of 1934, as amended, and the rules
thereunder) more than 4.9% of all of the common stock outstanding at such time.
Interest. The outstanding principal balance of each Note bears
interest, in arrears, at eight percent (8%) per annum, payable semi-annually at
the option of the Company in cash or in registered shares of the Company's
common stock. The number of shares of common stock to be issued as payment of
accrued and unpaid interest is determined by dividing (a) the total amount of
accrued and unpaid interest to be converted into common stock by (b) the
Conversion Price. Interest is computed on the basis of a 360-day year of twelve
(12) 30-day months and accrues commencing August 31, 2004. As of November 30,
2004, $36,500 of interest has been accrued.
Placement Agent Warrants. In connection with the Note Purchase
Agreement, on August 31, 2004 we issued cashless five-year warrants to two
financial consulting firms to purchase an aggregate of 21,900,000 shares of
common stock (See Note 6), 10,950,000 exercisable at $.05 per share, 2,737,500
exercisable at $.06 per share, 2,737,500 exercisable at $.07 per share,
2,737,500 exercisable at $.08 per share, and 2,737,500 exercisable at $.15 per
share. The warrants were issued as a placement agent fee. The fees are recorded
as a deferred financing cost and will be amortized over the life of the loan
using the effective interest method.
SEVI previously in August, 2004, issued warrants to purchase an
aggregate of 2,250,000 shares of common stock, exercisable at $.001 per share to
these firms. These warrants were fully exercised in August, 2004.
Discount. The $1,825,000 Convertible Promissory Notes were discounted
by the full $1,825,000. $1,426,163 of the discount represents the value placed
on the 36,500,000 warrants issued to investors. The remaining $398,837 in
discount represents the beneficial conversion feature of the Notes. The
$1,825,000 promissory note discount will be amortized over the life of the Notes
or three years using the straight line method.
NOTE 9 - SUBSEQUENT EVENTS
On December 30, 2004, Systems Evolution executed a securities purchase
agreement with certain institutional and accredited investors for the sale of 8%
Callable Secured Promissory Notes and accompanying Warrants. Under this
agreement, on December 30, 2004, we completed the sale of an aggregate of
$500,000 of these Notes, which resulted in net proceeds to the Company of
$408,148, and on January 14, 2005, completed the sale of an additional $500,000
of these Notes, with net proceeds to the Company of $497,500. 3,000,000 warrants
were issued in connection with the two closings.
ITEM 2 - Management's Discussion and Analysis
FORWARD LOOKING STATEMENTS
This quarterly report contains forward-looking statements that involve
risks and uncertainties. We use words such as anticipate, believe, plan, expect,
future, intend and similar expressions to identify such forward-looking
statements. You should not place too much reliance on these forward-looking
statements. Our actual results are likely to differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks faced by us described in this section.
The Company, previously known as Wallace Resources Inc., was organized
in the State of Idaho on August 26, 1968. Systems Evolution Inc., our Texas
operating company was acquired by the Company on September 9, 2003, and after
the acquisition, the Company's current directors and management took control of
the Company. We generate revenue from professional services performed for our
end-user customers and the end-user customers of our software partners.
Revenue is derived primarily from professional services provided on a
time and materials basis, with the remaining revenue provided from fixed fee
engagements. For time and material contracts, revenue is recognized and billed
by multiplying the number of hours expended by our professionals in the
performance of the contract by the established billing rates. For fixed fee
projects, revenue is generally recognized using the proportionate performance
method. Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such losses
are determined. Billings in excess of costs plus earnings are classified as
deferred revenues. On many projects we are also reimbursed for out-of-pocket
expenses such as airfare, lodging and meals. These reimbursements are included
as a component of revenue.
Our revenue and operating results are subject to substantial variations
based on our customers' expenditures and the frequency with which we are chosen
to perform services for our customers. Revenue from any given customer will vary
from period to period.
Our gross margins are affected by trends in the utilization rate of our
professionals (defined as the percentage of our professionals' time billed to
customers, divided by the total available hours in the respective period), the
salaries we pay our consulting professionals, and the average rate we receive
from our customers. If a project ends earlier than scheduled or we retain
professionals in advance of receiving project assignments, our utilization rate
will decline and adversely affect our gross margins.
RECENT DEVELOPMENTS
The Company entered into a definitive agreement to acquire Southwest
CMS Technology Services LP and its general partner CMS Associates, LLC ("CMS"),
a San Antonio based network integration firm, on June 10, 2004, and closed the
acquisition on July 27, 2004. CMS's primary focus is Microsoft and Novell
network integration. In connection with the acquisition of CMS from its two
stockholders, the Company paid the selling stockholders $10,000 in cash, and
issued them $40,000 aggregate principal amount of our non-interest bearing notes
dependent upon the note holders being retained by the Company, and 200,000
shares of our common stock.
The Company entered into a definitive agreement to acquire Duration
Software, Inc. ("Duration"), an Austin based business and technology consulting
firm, on August 30, 2004, and closed the acquisition on September 24, 2004.
Duration's primary focus is on custom applications and integration solutions for
government, healthcare, and business. Its core service offerings include:
Application Design and Development; Application Integration; Database Design,
Development and Integration; and Project Management. In connection with the
acquisition of Duration from its five stockholders, the Company paid the selling
stockholders $450,000 in cash, and issued them $300,000 aggregate principal
amount of our non-interest bearing notes due February 1, 2007, and 15,000,000
shares of our common stock.
The Company entered into a definitive agreement to acquire Next Hire
("Next Hire") Consultants Inc., a Houston based staffing and permanent placement
firm, on July 12, 2004, and closed the acquisition on September 23, 2004. In
connection with the acquisition of Next Hire from its stockholder, the Company
issued 400,000 shares of our common stock.
RESULTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDING NOVEMBER 30, 2004
Total gross revenue increased from $164,813 for the three month period
ended November 30, 2003 to $733,012 for the three month period ended November
30, 2004, an increase of 345%. The increase in revenue resulted in part from
addition of CMS Technology, Duration Software, and Next Hire Consultants.
Net loss from operations increased from $38,439 for the three month
period ended November 30, 2003 to $1,619,817 for the three month period ended
November 30, 2004.
OPERATING EXPENSES
Payroll and related costs make up the majority of our cost of revenue.
Total payroll and related costs increased from $165,525 for the three month
period ended November 30, 2003 to $1,161,312 for the three month period ended
November 30, 2004, an increase of 602%. This increase is attributed to an
increase in staff, as well as, the acquisitions of CMS Technology, Duration
Software, and Next Hire Consultants.
General and administrative expenses consist of salaries and benefits
for sales, executive and administrative employees, training, marketing
activities, investor relations, recruiting, non-reimbursable travel costs and
expenses and miscellaneous expenses. General and administrative expenses
increased from $37,727 for three month period ended November 30, 2003 to
$575,400 for the three month period ended November 30, 2004. This increase is
related to hiring a professional management team, including Richard N. Hartmann
and Willie A. Jackson, Jr.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities was ($838,923) for the six month
period ended November 30, 2004 compared to $141,040 used by operating activities
for the six month period ended November 30, 2003.
Net cash provided by financing activities was $324,213 for the six
month period ended November 30, 2004 compared to $-0- for six month period ended
November 30, 2003. This increase was attributed to the acquisition of CMS,
Duration Software, and Next Hire Consultants.
On August 31, 2004, the Company executed a Purchase Agreement with
certain institutional and accredited investors under which the Company agreed to
sell and the purchasers agreed to purchase convertible promissory notes due
August 31, 2007 (the "Notes") in the aggregate principal amount of up to
$2,500,000 bearing interest at the rate of 8% per annum and convertible into
shares of our Common Stock at a conversion price of $0.05 per share. On
September 9, 2004, the Company completed the sale of an aggregate of $1,825,000
in Notes and accompanying Warrants under the Purchase Agreement which resulted
in net proceeds to the Corporation of $1,542,417. The Notes are initially
convertible into 36,500,000 shares of Common Stock, and an additional 36,500,000
shares of Common Stock are reserved for issuance upon exercise of the Warrants
issued to the note holders.
On December 30, 2004, we executed a securities purchase agreement with
certain institutional and accredited investors for the sale of 8% Callable
Secured Promissory Notes and accompanying Warrants. Under this agreement, on
December 30, 2004, we completed the sale of an aggregate of $500,000 of these
Notes, which resulted in net proceeds to the Company of $408,148, and on January
14, 2005, completed the sale of an additional $500,000 of these Notes, with net
proceeds to the Company of $497,500.
The Company estimates that our requirements for additional capital over
the next 15 months will be in the range of $1,000,000. There can be no assurance
we will be able to raise this additional required capital on satisfactory terms,
or at all. In the event we are unable to obtain such additional capital or to
obtain it on acceptable terms or in sufficient amounts, the impact thereof would
have a material adverse effect on our business, operating results, financial
condition and may affect our ability to carry on as a Company.
CRITICAL ACCOUNTING POLICIES
Consulting revenues are comprised of revenue from professional services
fees recognized primarily on a time and materials basis as performed. For fixed
fee engagements, revenue is recognized using the proportionate performance
method (based on the ratio of hours expended to total estimated hours).
Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such losses
are determined. Billings in excess of costs plus earnings are classified as
deferred revenues. Our normal payment terms are net 30 days. We record an
expense for the expected losses on uncollectible accounts receivable each period
based on known facts and circumstances for the respective period.
Deferred Financing Costs
Deferred financing costs relate to the cost incurred in the arrangement
of Systems Evolution Inc.'s debt agreement and are being amortized using the
straight-line method over the terms of the related debt.
ITEM 3 - Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES. The Company's management, with
the participation of the Company's Chief Executive Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of the end of the period covered by
this report. Based on such evaluation, the Company's Chief Executive Officer has
concluded that, as of the end of such period, the Company's disclosure controls
and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any
changes in the Company's internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting
PART II - OTHER INFORMATION
ITEM 6 - Exhibits and Report on Form 8-K
(a) Exhibits.
Ex 31 Certification of Chief Executive Officer and Principal Financial
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Ex 32 Certification of Chief Executive Officer and Principal Financial
Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, as
amended, the Company caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Systems Evolution Inc.
Dated: February 4, 2005
/s/ Robert C. Rhodes
-------------------------
Robert C. Rhodes
Chief Executive Officer
And
Principal Financial Officer