UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
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 000-30271
PARADIGM HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
Wyoming 83-0211506
------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
2600 Tower Oaks Blvd. Suite 500,
Rockville, Maryland 20852
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(Address of principal executive offices, zip code)
Registrants' telephone number, including area code: (301) 468-1200
--------------
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Shares of common stock outstanding on May 1, 2005 were 20,003,368.
Explanatory Note
This Quarterly Report on Form 10-Q/A (this "Amendment") is being filed as
Amendment #2 to our Quarterly Report on Form 10-Q for the quarter ended March
31, 2005.
The purpose of the current form is to amend and restate Item 4. Controls and
Procedures. An evaluation was carried out during December 2005 under the
supervision and with the participation of our management, including our Chief
Executive Officer and new Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act). The Chief Executive Officer and new Chief Financial Officer
concluded that these disclosure controls and procedures were not effective for
the quarter ended March 31, 2005 as a result of a material weakness in internal
controls as of March 31, 2005.
The purpose of our previous amendment was to:
1. break-out certain expenses previously reported as "Indirect Costs" into
Cost of Revenue and Selling, General and Administrative expenses;
2. restate revenue and cost of revenue balances for our federal maintenance
contracts and federal service contracts; and
3. reflect the decrease in revenue, gross margin and net income attributable
to changing the Company's revenue recognition as it relates to software
licenses. In accordance with SOP 97-2, the Company will recognize software
license revenue over the contract term until it establishes VSOE.
We have updated the Management's Discussion and Analysis section, financial
statements and financial notes as appropriate.
In accordance with the rules of the Securities and Exchange Commission, this
Amendment sets forth the complete text of each amended Item of the Quarterly
Report on Form 10-Q, as amended.
2
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION..................................................4
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)..................................4
CONSOLIDATED BALANCE SHEETS.......................................4
CONSOLIDATED STATEMENT OF OPERATIONS..............................6
CONSOLIDATED STATEMENT OF CASH FLOWS..............................7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................14
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......19
ITEM 4: CONTROLS AND PROCEDURES..........................................19
PART II: OTHER INFORMATION....................................................21
ITEM 1: LEGAL PROCEEDINGS................................................21
ITEM 6: EXHIBITS.........................................................21
SIGNATURES....................................................................22
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2
3
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
CONSOLIDATED BALANCE SHEETS
Restated
3/31/05 12/31/04
(Unaudited)
- -------------------------------------- ------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 246,761 $ 179,389
Accounts receivable - contracts 11,451,321 11,478,901
Inventory, net 697,198 616,020
Prepaid expenses 3,041,177 4,239,770
Other current assets 80,257 89,890
------------ ------------
TOTAL CURRENT ASSETS 15,516,714 16,603,970
------------ ------------
PROPERTY AND EQUIPMENT, AT COST
Furniture and fixtures 126,384 124,845
Equipment 1,086,486 1,043,725
Software 302,481 221,965
Leasehold improvements 121,000 121,000
------------ ------------
TOTAL PROPERTY AND EQUIPMENT 1,636,351 1,511,535
------------ ------------
Less: Accumulated depreciation (590,599) (504,348)
------------ ------------
NET PROPERTY AND EQUIPMENT 1,045,752 1,007,187
------------ ------------
OTHER ASSETS
Deposits 77,182 77,182
------------ ------------
TOTAL ASSETS $ 16,639,648 $ 17,688,339
============ ============
The accompanying Notes to Consolidated Financial Statements are an integral part
of these financial statements.
4
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
CONSOLIDATED BALANCE SHEETS
Restated
3/31/05 12/31/04
(Unaudited)
- -------------------------------------------------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 1,046,773 $ 1,046,160
Note payable - line of credit 3,775,354 3,220,072
Capital lease payable 4,671
Accounts payable and accrued expenses 4,259,141 5,476,967
Accrued salaries and related liabilities 2,224,813 1,812,545
Deferred income taxes 563,609 527,000
Deferred revenue 907,789 1,749,410
----------- -----------
TOTAL CURRENT LIABILITIES 12,782,150 13,832,154
----------- -----------
LONG-TERM LIABILITIES
Deferred rent 146,247 144,435
Capital lease payable, net of current portion 13,185
Deferred income taxes, net of current portion 1,184,102 1,356,000
----------- -----------
TOTAL LIABILITIES 14,125,684 15,332,589
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, 50,000,000
shares authorized, 20,003,368 shares
issued and outstanding 200,034 200,034
Retained earnings 2,313,930 2,155,716
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 2,513,964 2,355,750
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $16,639,648 $17,688,339
=========== ===========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these financial statements.
5
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Quarters Ended March 31, 2005 2004
Restated Restated
- ----------------------------------------------------- ------------ ------------
Contract Revenue
Service contracts $ 10,242,608 $ 9,409,130
Repair and maintenance contracts 4,803,579 4,702,041
------------ ------------
Total contract revenue 15,046,187 14,111,171
------------ ------------
Cost of revenue
Service contracts 8,384,402 8,207,261
Repair and maintenance contracts 4,425,842 4,319,767
------------ ------------
Total cost of revenue 12,810,244 12,527,028
------------ ------------
Gross margin 2,235,943 1,584,143
Selling, general and administrative 1,941,579 1,722,710
------------ ------------
Income (loss) from operations 294,364 (138,567)
------------ ------------
Other (expense) income
Interest income 4,272 4,633
Other income 168 80
Interest expense (39,801) (15,831)
------------ ------------
Total other (expense) income (35,361) (11,118)
------------ ------------
Net income (loss) before income taxes $ 259,003 $ (149,685)
------------ ------------
Provision for income taxes 100,788 3,636
------------ ------------
Net income (loss) $ 158,215 $ (153,321)
------------ ------------
Basic and diluted net income (loss) per common share $ 0.01 $ (0.01)
------------ ------------
Basic and diluted weighted average common shares used
to compute net income (loss) per share 20,003,368 17,500,000
------------ ------------
Pro-forma income tax provision (benefit) 100,788 (55,078)
------------ ------------
Pro-forma net income (loss) $ 158,215 $ (94,607)
------------ ------------
Pro-forma basic and diluted net income (loss) per
common share $ 0.01 $ (0.01)
------------ ------------
Pro-forma basic and diluted weighted average common
shares used to compute net income (loss) per share 20,003,368 17,500,000
------------ ------------
The accompanying Notes to Consolidated Financial Statements are an integral part
of these financial statements.
6
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Quarters Ended March 31, 2005 2004
Restated
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 158,215 $ (153,321)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET
CASH (USED)PROVIDED BY OPERATING ACTIVITIES:
Depreciation 86,251 87,418
(INCREASE) DECREASE IN
Accounts receivable - contracts 27,580 4,877,771
Inventory, net (81,178) (139,853)
Prepaid expenses 1,198,593 608,662
Other current assets 9,633 (2,987)
Deposits
(DECREASE) INCREASE IN
Accounts payable and accrued expenses (1,217,826) (1,379,046)
Accrued salaries and related liabilities 412,267 149,030
Deferred income taxes (135,289)
Deferred revenue (841,621) (2,296,973)
Deferred rent 1,812
------------ ------------
NET CASH(USED)PROVIDED BY OPERATING ACTIVITIES (381,563) 1,750,701
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (106,025) (98,369)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (106,025) (98,369)
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft 614
Payments on capital lease (936)
Proceeds from line of credit 11,003,964 9,075,337
Payments on line of credit (10,448,682) (10,077,488)
------------ ------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 554,960 (1,002,151)
------------ ------------
NET INCREASE IN CASH 67,372 650,181
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 179,389 17,891
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 246,761 $ 668,072
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes $ 300 $ 3,636
============ ============
Cash paid for interest $ 39,801 $ 15,831
============ ============
Equipment purchased under capital lease $ 18,791 $
============ ============
The accompanying Notes to Consolidated Financial Statements are an integral part
of these financial statements
7
PARADIGM HOLDINGS, INC.
(FORMERLY PARADIGM SOLUTIONS CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Paradigm Holdings, Inc. ("PDHO"), formerly Cheyenne Resources, Inc., was
incorporated in the state of Wyoming on November 17, 1970. On November 3, 2004,
Paradigm Holdings, Inc. entered into an Agreement and Plan of Reorganization
with Paradigm Solutions Merger Corp. ("Merger Sub"), Paradigm Solutions
Corporation ("PSC"), and the shareholders of PSC. Pursuant to the Agreement and
Plan of Reorganization, the Merger Sub was merged with and into PSC, which was
the surviving corporation, and became a wholly owned subsidiary of PDHO. In
consideration of the merger, the PSC shareholders exchanged 13,699, or 100%, of
their common stock for 17,500,000 shares of common stock of PDHO.
Although PDHO is the legal acquirer in the acquisition, and remains the
registrant with the SEC, under generally accepted accounting principles, the
acquisition was accounted for as a reverse acquisition, whereby PSC is
considered the "acquirer" of PDHO for financial reporting purposes. The
following factors were considered: 1) PSC's shareholders controlled more than
50% of the post acquisition combined entity, 2) management, after the
acquisition, is that of PSC, 3) PDHO had no assets and an immaterial amount of
liabilities as of the acquisition date, and 4) continuing operations of the
business are that of PSC.
Effective November 3, 2004, PDHO conducts business through its wholly owned
subsidiary Paradigm Solutions Corporation. On December 17, 2004, PSC formed a
wholly owned subsidiary, Paradigm Solutions International, Inc. ("PSI"). The
accompanying consolidated financial statements include the accounts of PDHO, PSC
and PSI (collectively, the "Company"). All significant inter-company balances
and transactions have been eliminated in consolidation.
The Company is a full-service information technology (IT) and business solutions
provider offering a wide range of technical support and management services to
improve the operational efficiency of government and industry. The Company
graduated from the Small Business Administration's 8(a) Business Development
program on October 13, 2004. Today, the Company possesses a portfolio of
flexible contract vehicle arrangements to expedite delivery of information
technology services and solutions to clients across the federal government.
The consolidated condensed financial statements included herein have been
prepared by Paradigm Holdings, Inc. (the Company) without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to such rules and
regulations; however, the Company believes that the disclosures are adequate to
make the information presented not misleading. The condensed financial
statements included herein should be read in conjunction with the financial
statements and the notes thereto included in the Company's 2004 Form 10-K.
In the opinion of the registrant, the accompanying financial statements contain
all adjustments (consisting of only normal recurring accruals) necessary to
present fairly the financial position of the Company at March 31, 2005 and
December 31, 2004, its results of operations for the three months ended March
31, 2005 and March 31, 2004, and its cash flows for the three months ended March
31, 2005 and March 31, 2004.
SUBSEQUENT EVENTS
On October 14, 2005, Paradigm Holdings, Inc., a Wyoming corporation ("Paradigm
Holdings"), Paradigm Solutions International, Inc., a Maryland corporation and
wholly-owned subsidiary of Paradigm Holdings ("PSI"), Blair Management Services,
Inc. t/d/b/a Blair Technology Group, a Pennsylvania corporation ("Blair") and
the shareholders of Blair (collectively, the "Shareholders") consummated a
merger transaction pursuant to the terms of that certain Merger Agreement (the
"Merger Agreement"), whereby Blair was merged with and into PSI. PSI is the
surviving corporation and will continue its corporate existence under the laws
of the State of Maryland as a wholly-owned subsidiary of Paradigm Holdings.
Pursuant to the Merger Agreement, the Shareholders exchanged all of the issued
and outstanding capital stock of Blair in exchange for (i) One Million Dollars
(US $1,000,000) and (ii) five hundred thousand shares of common stock, par value
$0.001 per share, of Paradigm Holdings (the "Shares"). Pursuant to the Merger
Agreement and an Escrow Agreement entered into by the parties, sixty thousand
(60,000) of the Shares will be held in escrow for a period of one (1) year from
the date of closing subject to the terms and conditions of the Merger Agreement.
In addition, under the terms of the Merger Agreement, Paradigm Holdings will
issue to the Shareholders up to an additional 350,000 shares of common stock of
Paradigm Holdings pursuant to an earn-out provision.
At the October 14, 2005 share price of $3.00, the transaction has a total
purchase price of $3,550,000 assuming all earn-out provisions are achieved.
Blair Technology Group was founded in 1992. The Company has provided business
continuity and information technology security solutions to over 300 commercial
customers in a variety of industries including finance, healthcare and energy.
8
The acquisition of Blair Technology Group allows Paradigm Holdings to combine
the OpsPlanner software suite with Blair's extensive credentials in the business
continuity arena. Paradigm Holdings can now offer our customers a comprehensive
business continuity solution. The acquisition also allows Paradigm Holdings to
expand its presence in the commercial marketplace. For the year ended December
31, 2004, Blair generated $4.6 million in revenue and $0.4 million in net
income.
At the closing of the merger, PSI entered into employment agreements with
Messrs. Kristofco, Duffy and Fochler.
DESCRIPTION OF CRITICAL ACCOUNTING POLICIES
The preparation of these consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States,
which require our management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting periods. On an ongoing basis,
management evaluates its estimates including those related to contingent
liabilities, revenue recognition, and other intangible assets. Management bases
its estimates on historical experience and on various other factors that are
believed to be reasonable at the time the estimates are made. Actual results may
differ from these estimates under different assumptions or conditions.
Our management routinely makes judgments and estimates about the effects of
matters that are inherently uncertain. As the number of variables and
assumptions affecting the probable future resolution of the uncertainties
increase, these judgments become even more subjective and complex. We have
identified certain accounting policies, described below, that are the most
important to the portrayal of our current financial condition and results of
operations.
USE OF ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue from time and materials contracts is recognized as costs are incurred at
amounts represented by the agreed-upon billing amounts.
Fixed price labor hour and level of effort contracts involve defined numbers of
hours or categories of personnel. Revenue on fixed unit price contracts, where
specific units of output under service agreements are delivered, is recognized
as units are delivered based on the specific price per unit. Fixed price
maintenance contracts are recognized as revenue on a pro-rata basis over the
life of the contract.
In certain arrangements, the Corporation enters into contracts that include the
delivery of a combination of two or more of its service offerings. Such
contracts are divided into separate units of accounting and revenue is
recognized separately, and in accordance with, the Corporation's revenue
recognition policy for each element.
Software revenue recognition is in accordance with AICPA Statement of Position
97-2. Since the Company has not established VSOE, recognition of revenue from
the sale of licenses is over the term of the contract.
Revenue from cost-type contracts is recognized as costs are incurred on the
basis of direct costs plus allowable operating costs and expenses and an
allocable portion of the fixed fee.
The Company is subject to audits from federal government agencies. The Company
has reviewed its contracts and determined there is no material risk of financial
adjustments due to government audit. To date, we have not had any adjustments as
a result of a government audit of our contracts.
Revenue recognized on contracts for which billings have not yet been presented
to customers is included in the Accounts Receivable - contracts classification
on the accompanying Balance Sheets.
Deferred revenue relates to contracts for which customers pay in advance for
services to be performed at a future date. The Corporation recognizes deferred
revenue attributable to our maintenance contracts over the related service
periods, which run through 2005. Revenue related to our OpsPlanner offering,
including consulting, software subscriptions and technical support, is deferred
and recognized over the appropriate contract service period. These payments are
nonrefundable.
COST OF REVENUE
Cost of revenue for service contracts consist primarily of labor, consultant,
subcontract, materials, travel expenses and an allocation of indirect costs
attributable to the performance of the contract.
9
Cost of revenue for repair and maintenance contracts consist primarily of labor,
consultant, subcontract, materials, travel expenses and an allocation of
indirect costs attributable to the performance of the contract.
MAJOR CUSTOMERS
During the quarters ended March 31, 2005 and 2004, the Company's revenues
generated from five major customers, totaled 97% and 90% of total revenue,
respectively. The Company's accounts receivable related to these five major
customers were 78% and 80% of total accounts receivable at the end of the
respective quarters. The Company defines major customers by government agency.
INVENTORY
Inventory consists of replacement printer parts and is stated at the lower of
cost or market using the FIFO method.
INCOME TAXES
Prior to November 5, 2004, Paradigm Solutions Corporation was treated as an S
Corporation, and therefore, did not pay Federal and state corporate income taxes
since the tax attributes of the entity were reported on the stockholders' tax
returns. Paradigm Solutions Corporation filed its income tax returns on the cash
basis of accounting, whereby revenue was recognized when received and expenses
were recognized when paid. Effective November 5, 2004, Paradigm Solutions
Corporation revoked its S-Corporation status and therefore is subject to income
taxes at the corporate level.
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax bases of assets and liabilities and their financial
reporting amounts at each year end based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable earnings. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount more likely than not to be realized.
PRO FORMA FINANCIAL DATA:
The unaudited pro forma information for the periods set forth below is based on
the operations of Paradigm Solutions Corporation and is prepared as if the
Corporation had been a C Corporation at the beginning of each period assuming a
tax provision of 38.6%.
March 31, March 31,
2005 2004
STATEMENT OF OPERATION DATA: (Pro forma) (Pro forma)
------------------------
(in thousands, except per share data)
Contract revenue $ 15,046 $ 14,111
Net income (loss) before income taxes 259 (150)
Income tax provision (benefit) 101 (55)
Net income (loss) 158 (95)
Basic and diluted net income (loss) per common share $ 0.01 $ (.01)
Weighted average common shares outstanding 20,003 17,500
2. COMPENSATION AND EMPLOYMENT AGREEMENTS
Effective April 1, 2005, Samar Ghadry and Paradigm Solutions Corporation, a
wholly-owned subsidiary of Paradigm Holdings, entered into a Letter Agreement
pursuant to which Ms. Ghadry and Paradigm Solutions Corporation agreed and
acknowledged that Ms. Ghadry's employment with Paradigm Solutions Corporation
ended effective April 1, 2005. Pursuant to the terms of the Letter Agreement,
Paradigm Solutions Corporation agreed to pay Ms. Ghadry severance pay in an
amount equal to Ms. Ghadry's base pay for nine months in accordance with
Paradigm Solutions Corporation's normal payroll practices. Paradigm Solutions
Corporation agreed to pay Ms. Ghadry a bonus for the first quarter of 2005 equal
to $20,250. In addition, Paradigm Holdings agreed to register 1,575,000 shares
of common stock owned by Ms. Ghadry. Further, Ms. Ghadry agreed that she will
not, except with the prior written approval of Paradigm Holdings, engage in a
disposition with respect to 100% of these shares until the earlier to occur of:
(i) the date of the closing of a financing through the sale of debt or equity
securities in which Paradigm Holdings receives in one or a series of
transactions gross proceeds in an amount equal to at least $3 million or (ii)
September 30, 2005. Ms. Ghadry also agreed that, when she is able to sell her
shares of common stock, that she will not sell more than 2,000 shares in any
single business day; however, in the event the average daily volume of the
shares of Paradigm Holdings' common stock exceeds 10,000 shares for a period of
5 consecutive business days, Ms. Ghadry may sell up to an aggregate of 4,000
shares per day, commencing on the first business day thereafter and continuing
so long as the average 5-day daily volume continues to exceed 10,000 shares. Ms.
Ghadry and Paradigm Holdings agreed that, to the extent allowed by law and with
the express written approval of the President and Chief Operating Officer
10
of Paradigm Holdings, Ms. Ghadry may sell her shares to a bona fide purchaser in
a private placement provided such purchaser agrees to be subject to the terms of
the Letter Agreement.
3. CONTRACT STATUS
The Company has authorized but uncompleted contracts on which work is in
progress at March 31, 2005 approximately, as follows:
Total contract prices of initial contract awards, including
exercised options and approved change orders (modifications) $ 170,035,000
Completed to date (128,044,000)
-------------------------------------------------------------------------------
AUTHORIZED BACKLOG $ 41,991,000
=============
The foregoing contracts contain unfunded and unexercised options not reflected
in the above amounts of approximately $85,542,000.
4. NOTE PAYABLE - LINE OF CREDIT
The Company had a line of credit arrangement with SunTrust Bank which expired on
June 30, 2005. Subsequently, on June 22, 2005 the company received an extension
of the line of credit arrangement through September 30, 2005. Under the terms of
the latest agreement, the Corporation had to maintain: (1) minimum tangible net
worth of $2,650,000 beginning on and as of June 30, 2005; (2) debt coverage
ratio of not more then 5.0 to 1.0 beginning on and as of June 30, 2005; (3)
minimum quarterly net income of $1.00 for the quarters ending June 30 and
September 30, 2005. The Corporation was in compliance with the line of credit
agreement covenants as of June 30, 2005.
The Company terminated its line of credit agreement with SunTrust Bank effective
September 1, 2005.
On July 28, 2005, the Company entered into a two year Loan and Security
Agreement with Chevy Chase Bank that provides for a revolving line of credit
facility of up to $9 million. The agreement became effective August 4, 2005. The
revolving line of credit will be used to borrow revolving loans for working
capital and general corporate purposes.
The revolving loans under the Chevy Chase Bank Loan and Security Agreement are
secured by a first priority lien on substantially all of the assets of the
Company, excluding intellectual property and real estate. Under the agreement,
the line is due on demand and interest is payable monthly depending on the
Corporation's leverage ratio at the LIBOR rate plus the applicable spread which
ranges from 2.25% to 3.00%. Under the terms of the agreement, the Corporation
may borrow up to the lesser of $9,000,000 or 90% of eligible U.S. Government
receivables plus 80% of eligible commercial receivables plus 75% of the
aggregate amount of billable but unbilled accounts to a maximum of $3,000,000.
The Loan and Security Agreement requires that the Company maintain the following
covenants and ratios: (1) minimum tangible net worth of $2,000,000 plus 50% of
Company's net income for each fiscal year beginning with fiscal year ending
December 31, 2005; (2) debt coverage ratio of not less than 1.500 to 1.000; (3)
maximum leverage ratio of 5.50 to 1.00, which will be decreased to 5.25 to 1.00
by December 31, 2005 and 4.00 to 1.00 by December 31, 2006. The Company was in
compliance with all covenant requirements as of September 30, 2005.
The Loan and Security Agreement contains events of default that include among
other things, non-payment of principal, interest or fees, violation of
covenants, inaccuracy of representations and warranties, cross default to
certain other indebtedness, bankruptcy and insolvency events, change of control
and material judgments. Upon occurrence of an event of default, Chevy Chase Bank
is entitled to, among other things, accelerate all obligations of the Company
and sell the Company's assets to satisfy the Company's obligations under the
Loan and Security Agreement.
5. RESTATEMENT
The Company has restated its previously issued financial statements to:
1. Break-out certain expenses previously reported as "Indirect Costs" into Cost
of Revenue and Selling, General and Administrative expenses for the quarters
ended March 31, 2005 and March 31, 2004. There was no impact to total revenue,
net income or earnings-per-share for this adjustment.
2. Restate revenue and cost of revenue balances for our federal maintenance
contracts and federal service contracts.
3. Reflect the decrease in revenue, gross margin and net income attributable to
changing the Company's revenue recognition as it relates to software licenses
for the quarter ended March 31, 2005 and the three months ended March 31, 2005.
In accordance with SOP 97-2, the Company will recognize software license revenue
over the contract term until it establishes VSOE.
11
Three Months Ended
March 31, March 31,
2005 2004
------------ ------------
Total contract revenue, as previously reported $ 15,134,437 $ 14,111,171
Adjustment to Total Contract Revenue due to change
in S/W Revenue Recognition (88,250) --
------------ ------------
Total contract revenue, as restated $ 15,046,187 $ 14,111,171
Gross margin, as previously reported $ 4,177,068 $ 3,456,670
Adjustment to Gross Margin due to
break-out of Indirect Expense (1,852,875) (1,872,527)
Adjustment to Gross Margin due to
change in S/W Revenue Recognition (88,250) --
------------ ------------
Gross margin, as restated $ 2,235,943 $ 1,584,143
Net income (loss) before income taxes, as previously reported $ 347,253 $ (149,685)
Adjustment to Net Income (Loss) before Income Taxes due to
change in S/W Revenue Recognition (88,250) --
------------ ------------
Net income (loss) before income taxes, as restated $ 259,003 $ (149,685)
Net income, as previously reported $ 212,123 $ (153,321)
Adjustment to Net Income due to
change in S/W Revenue Recognition (53,908) --
------------ ------------
Net income, as restated $ 158,215 $ (153,321)
12
Prior Adjustment Restated
3/31/05 Due to S/W 3/31/05
(Unaudited) Recognition (Unaudited)
- -------------------------------------- ------------ ------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 246,761 $ 246,761
Accounts receivable - contracts 11,451,321 11,451,321
Inventory, net 697,198 697,198
Prepaid expenses 3,010,374 30,803 3,041,177
Other current assets 80,257 80,257
------------ ------------ ------------
TOTAL CURRENT ASSETS 15,485,911 30,803 15,516,714
------------ ------------ ------------
PROPERTY AND EQUIPMENT, AT COST
Furniture and fixtures 126,384 126,384
Equipment 1,086,486 1,086,486
Software 302,481 302,481
Leasehold improvements 121,000 121,000
------------ ------------ ------------
TOTAL PROPERTY AND EQUIPMENT 1,636,351 0 1,636,351
------------ ------------ ------------
Less: Accumulated depreciation (590,599) (590,599)
------------ ------------ ------------
NET PROPERTY AND EQUIPMENT 1,045,752 0 1,045,752
------------ ------------ ------------
OTHER ASSETS
Deposits 77,182 77,182
------------ ------------ ------------
TOTAL ASSETS $ 16,608,845 $ 30,803 $ 16,639,648
============ ============ ============
Prior Adjustment Restated
3/31/05 Due to S/W 3/31/05
(Unaudited) Recognition (Unadited)
- --------------------------------------- ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 1,046,773 $ 1,046,773
Note payable - line of credit 3,775,354 3,775,354
Capital lease payable 4,671 4,671
Accounts payable and accrued expenses 4,259,141 4,259,141
Accrued salaries and related liabilities 2,224,813 2,224,813
Deferred income taxes 564,750 (1,141) 563,609
Deferred revenue 819,539 88,250 907,789
------------ ------------ ------------
TOTAL CURRENT LIABILITIES 12,695,041 87,109 12,782,150
------------ ------------ ------------
LONG-TERM LIABILITIES
Deferred rent 146,247 146,247
Capital lease payable, net of current portion 13,185 13,185
Deferred income taxes, net of current portion 1,186,500 (2,398) 1,184,102
------------ ------------ ------------
TOTAL LIABILITIES 14,040,973 84,711 14,125,684
------------ ------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, 50,000,000
shares authorized, 20,003,368 shares
issued and outstanding 200,034 200,034
Retained earnings 2,313,930 (53,908) 2,313,930
------------ ------------ ------------
TOTAL STOCKHOLDERS' EQUITY 2,567,872 (53,908) 2,513,964
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,608,845 $ 30,803 $ 16,639,648
============ ============ ============
13
PARADIGM HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This quarterly report contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases, you
can identify forward-looking statements by terminology such as "may," "will,"
"should," "could," "forecasts," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," "see," "target," "projects," "position,"
or "continue" or the negative of such terms and other comparable terminology.
These statements reflect our current expectations, estimates, and projections.
These statements are not guarantees of future performance and involve risks,
uncertainties, and assumptions that are difficult to predict. Actual events or
results may differ materially from what is expressed or forecasted in these
forward-looking statements. We disclaim any intention or obligation to update
any forward-looking statement.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Paradigm Holdings Inc. is an information technology and business solutions
provider specializing in information technology infrastructure and software
engineering support services, business continuity planning and emergency
management services and software to government and commercial clients. Paradigm
Holdings, Inc. is comprised of two operating subsidiaries, Paradigm Solutions
Corporation and Paradigm Solutions International.
Paradigm Solutions Corporation is the federal subsidiary whose core competencies
are in mission critical systems that focus on key federal agencies such as
Justice, Treasury and Homeland Security. Paradigm Solutions International is the
newly formed commercial subsidiary whose core competencies are developing and
delivering continuity and information technology security/risk management
consulting for both commercial businesses and government agencies. Our
innovations in business continuity development, planning, and information
technology security have positioned us to become a leader in the fragmented
Business Continuity and Continuity of Operations industry.
We derive substantially all of our revenues from delivery of information
technology solutions and services. We generate revenue from contracts with
various payment arrangements, including fixed-price contracts, time and
materials contracts and cost-reimbursable contracts. During the three months
ended March 31, 2005, revenues from these contract types were approximately 61%,
25%, and 14%, respectively of total revenues. During the three months ended
March 31, 2004, revenues from these contract types were approximately 51%, 30%,
and 19%, respectively of total revenues. We typically issue invoices monthly to
manage outstanding accounts receivable balances. We recognize revenues on time
and materials contracts as the services are provided. The Company has two basic
categories of fixed price contract; fixed unit price; fixed price-level of
effort. Revenues on fixed unit price contracts, where specific units of output
under service agreements are delivered, is recognized as units are delivered
based on the specific price per unit. Revenue on fixed price maintenance
contracts is recognized on a pro-rata basis over the length of the service
period. Revenue for the fixed price level of effort contacts is recognized based
upon the number of units of labor actually delivered multiplied by the agreed
rate for each unit of labor. Fixed-price contracts are attractive to clients
and, while subject to increased risks, provide opportunities for increased
margins. We recognize revenues on cost-reimbursable contracts as services are
provided. These revenues are equal to the costs incurred in providing these
services plus a proportionate amount of the fee earned. We have historically
recovered all of our costs on cost-reimbursable contracts, which means we have
lower risk and our margins are lower on these contracts.
Our historical revenue growth is attributable to various factors, including an
increase in the size and number of projects for existing and new clients. During
the three months ended March 31, 2005, contracts with the federal government and
contracts with prime contractors of the federal government accounted for
approximately 99% of our revenues. During that same period, our five largest
clients, all agencies of the federal government, generated approximately 97% of
our revenues. In most of these engagements, we retain full responsibility for
the end-client relationship and direct and manage the activities of our contract
staff.
Paradigm Solutions Corporation utilized the Small Business Administration (SBA)
8(a) Business Development Program to access the federal marketplace starting in
October of 1995 and graduated from the program in October of 2004. The term
"graduate" is used to refer to a Participant's exit from the 8(a) BD Program at
the expiration of the Participant's term, thus the business is no longer
considered 8(a). This program, allowed the business to build a base of business
with various federal civilian agencies. The backlog of federal business under
this program will continue until the contracts end, after which we will pursue
several avenues to maintain the business we believe is important to our strategy
in this marketplace. This includes either migrating this work to other
government contract vehicles, if allowed by the customer, or taking on a
subcontract role when the business comes up for re-compete and teaming with a
SBA business who would be the prime. As of September 30, 2005, SBA 8(a)
contracts which provide 8%, 64% and 28% of our current SBA 8(a) revenues will
come up for renewal in 2005, 2006 and 2007, respectively.
Due to our graduation from the Small Business Administration 8(a) Business
Development Program, we are no longer classified as a small disadvantaged
business by the federal government. Accordingly, we will no longer have access
to contract vehicles set aside for 8(a) businesses. As of October 2004, Paradigm
Solutions Corporation began competing solely in the open marketplace for federal
business. We
14
have a history of winning contracts in "full and open" competitions, including
contracts at the Department of Housing and Urban Development, Department of
Treasury and the Department of Commerce. Paradigm Solutions will continue to
aggressively pursue opportunities in the federal and commercial marketplace. We
believe we can mitigate the impact of transitioning from the 8(a) program
through the acquisition of new contract vehicles and the expansion of work with
current customers.
Our most significant expense is direct costs, which consist primarily of direct
labor, subcontractors, materials, equipment, travel and an allocation of
indirect costs including fringe. The number of subcontract and consulting
employees assigned to a project will vary according to the size, complexity,
duration and demands of the project.
Selling, general and administrative expenses consist primarily of costs
associated with our executive management, finance and administrative groups,
human resources, marketing and business development resources, employee
training, occupancy costs, R&D expenses, depreciation and amortization, travel,
and all other corporate costs.
Other income and expense consists primarily of interest income earned on our
cash, interest payable on our revolving credit facility, cash equivalents and
marketable securities.
Description of Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations discuss our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires management to make estimates and judgments that affect the
reported amount of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period. On an
ongoing basis, management evaluates its estimates including those related to
uncollected accounts receivable, contingent liabilities, revenue recognition,
and other intangible assets. Management bases its estimates on historical
experience and on various other factors that are believed to be reasonable at
the time the estimates are made. Actual results may differ from these estimates
under different assumptions or conditions. Management believes that our critical
accounting policies which require more significant judgments and estimates in
the preparation of our consolidated financial statements are revenue
recognition, costs of revenues, accounts receivables and property and equipment.
Revenue Recognition
Services are performed under contracts that may be categorized into three
primary types: time and materials, cost-plus reimbursement and firm fixed price.
Revenue for time and materials contracts is recognized as labor is incurred at
fixed hourly rates, which are negotiated with the customer, plus the cost of any
allowable material costs and out-of-pocket expenses. Time and materials
contracts are typically more profitable than cost-plus contracts because of our
ability to negotiate rates and manage costs on those contracts. Revenue is
recognized under cost-plus contracts on the basis of direct and operating costs
and expenses incurred plus a negotiated profit calculated as a percentage of
costs or as performance-based award fee. Cost-plus type contracts provide
relatively less risk than other contract types because we are reimbursed for all
direct costs and certain operating costs and expenses, such as overhead and
general and administrative expenses, and are paid a fee for work performed. For
certain cost plus type contracts, which are referred to as cost-plus award fee
type contracts, we recognize the expected fee to be awarded by the customer at
the time such fee can be reasonably estimated, based on factors such as our
prior award experience, communications with the customer regarding our
performance, including any interim performance evaluations rendered by the
customer or our average historical award fee rate for the company. The Company
has two basic categories of fixed price contract: fixed unit price and fixed
price-level of effort. Revenues on fixed unit price contracts, where specific
units of output under service agreements are delivered, are recognized as units
are delivered based on the specific price per unit. Revenue on fixed price
maintenance contracts is recognized on a pro-rata basis over the length of the
service period. Revenue for the fixed price level of effort contacts is
recognized based upon the number of units of labor actually delivered multiplied
by the agreed rate for each unit of labor.
Contract revenue recognition inherently involves estimation. Examples of such
estimates include the level of effort needed to accomplish the tasks under the
contract, the cost of those efforts, and a continual assessment of our progress
toward the completion of the contract. From time to time, circumstances may
arise which require us to revise our estimated total revenue or costs.
Typically, these revisions relate to contractual changes. To the extent that a
revised estimate affects contract revenue or profit previously recognized, we
record the cumulative effect of the revision in the period in which it becomes
known. In addition, the full amount of an anticipated loss on any type of
contract is recognized in the period in which it becomes known. We may be
exposed to variations in profitability if we encounter variances from estimated
fees earned under cost plus-award fee contracts and estimated costs under fixed
price contracts.
Costs Of Revenues
Our costs are categorized as direct or selling, general & administrative
expenses. Direct costs are those that can be identified with and allocated to
specific contracts and tasks. They include labor, subcontractor costs,
consultant fees, travel expenses, materials and an allocation of indirect costs.
Indirect costs consist primarily of fringe benefits (vacation time,
medical/dental, 401K plan matching contribution, tuition assistance,
15
employee welfare, worker's compensation and other benefits), intermediate
management and certain other non-direct costs which are necessary to provide
direct labor. Indirect costs, to the extent that they are allowable, are
allocated to contracts and tasks using appropriate government-approved
methodologies. Costs determined to be unallowable under the Federal Acquisition
Regulations cannot be allocated to projects. Our principal unallowable costs are
interest expense and certain general and administrative expenses. A key element
to be successful in our business is our ability to control indirect and
unallowable costs, enabling us to profitably execute our existing contracts and
successfully bid for new contracts. Costs of revenues are considered to be a
critical accounting policy because of the direct relationship to revenue
recognized.
Property and Equipment
Property and equipment are recorded at the original cost to the corporation and
are depreciated using straight-line methods over established useful lives of
three to seven years. Software is recorded at original cost and depreciated on
the straight-line basis over three years. Leasehold improvements are recorded at
the original cost and are depreciated on the straight-line over the life of the
lease.
Recent Accounting Pronouncements
New accounting pronouncements that have a current or future potential impact on
our financial statements are as follows:
Summary of Statement No. 123 (Revised 2004)
Share-Based Payment
This Statement is a revision of FASB Statement No. 123, Accounting for
Stock-Based Compensation. This Statement supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance.
Scope of this Statement
This Statement establishes standards for the accounting for transactions in
which an entity exchanges its equity instruments for goods or services. It also
addresses transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
This Statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. This
Statement does not change the accounting guidance for share-based payment
transactions with parties other than employees provided in Statement 123 as
originally issued and EITF Issue No. 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services." This Statement does not address the accounting for
employee share ownership plans, which are subject to AICPA Statement of Position
93-6, Employers' Accounting for Employee Stock Ownership Plans. The Company does
not believe that FASB Statement No. 123R will have a material effect on its
financial statements.
Results of Operations
The following discussion and analysis should be read in conjunction with our
Condensed Consolidated Financial Statements and related notes included elsewhere
in this Quarterly Report on Form 10-Q and with our Consolidated Financial
Statements and the information under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations," which are included
in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
The following table sets forth certain items from our consolidated statements of
operations for the periods indicated.
Three Months
Ended March 31, Change
------------------------ ------------------------
(Dollars in thousands) 2005 2004 Dollars Percent
--------- --------- --------- ---------
Revenue 15,046 14,111 935 6.6%
Cost of Revenue 12,810 12,527 283 2.3%
Gross Margin 2,236 1,584 652 41.1%
Selling, general and administrative 1,942 1,723 219 12.7%
Income (loss) from Operations 294 (138) 432 313.0%
Total other (expense) income (35) (11) (24) 218.2%
Income tax (benefit)provision 101 (55)* 156 283.6%
Net Income (loss) 158 (95)* 253 266.3%
* pro forma
16
The table below sets forth, for the periods indicated the service mix in revenue
with related percentages of total revenue.
Three Months
Ended March 31,
-------------------------------------------------
(Dollars in Thousands) 2005 % 2004 %
--------- --------- --------- ---------
Federal Service Contracts $ 10,055 66.8% $ 9,404 66.7%
Federal Repair & Maintenance Contracts 4,804 31.9% 4,702 33.3%
Commercial Service Contracts 187 1.3% 5 0.0%
Total Revenue $ 15,046 100.0% $ 14,111 100.0%
Our revenues and operating results may be subject to significant variation from
quarter to quarter depending on a number of factors, including the progress of
contracts, revenues earned on contracts, the number of billable days in a
quarter, the timing of the pass-through of other direct costs, the commencement
and completion of contracts during any particular quarter, the schedule of the
government agencies for awarding contracts, the term of each contract that we
have been awarded and general economic conditions. Because a significant portion
of our expenses, such as personnel and facilities costs, are fixed in the short
term, successful contract performance and variation in the volume of activity as
well as in the number of contracts commenced or completed during any quarter may
cause significant variations in operating results from quarter to quarter.
The Federal Government's fiscal year ends September 30. If a budget for the next
fiscal year has not been approved by that date, our clients may have to suspend
engagements that we are working on until a budget has been approved. Such
suspensions may cause us to realize lower revenues in the fourth quarter of the
year. Further, a change in presidential administrations and in senior government
officials may negatively affect the rate at which the Federal Government
purchases technology.
As a result of the factors above, period-to-period comparisons of our revenues
and operating results may not be meaningful. You should not rely on these
comparisons as indicators of future performance as no assurances can be given
that quarterly results will not fluctuate, causing a possible material adverse
effect on our operating results and financial condition.
Comparison of the Three Months Ended March 31, 2005 and 2004
Revenue. For the three months ended March 31, 2005, our revenues increased 6.6%
to $15.0 million from $14.1 million for the same period in 2004. This increase
in revenue primarily reflects an increase in organic growth from our Housing and
Urban Development client. In addition, $0.2 million of new revenue can be
associated with sale of the commercial OpsPlanner software and services.
Cost of Revenue. Cost of revenue includes direct labor, materials, subcontracts
and an allocation of indirect costs. Generally, changes in cost of revenue are
correlated to changes in revenue as resources are consumed in the production of
that revenue. For the three months ended March 31, 2005, cost of revenue
increased 2.3% to $12.8 million from $12.5 for the same period in 2004. This
increase was attributable primarily to the increase in revenue. As a percentage
of revenue, cost of revenue was 85.1% for the three months ended March 31, 2005
as compared to 88.8% for the three months ended March 31, 2004. Cost as a
percentage of revenue decreased due to lower operating expenses on our fixed
price federal service contracts and an increase in our commercial software and
services revenue, which has higher gross margins than our federal business.
Gross Margin. For the three months ended March 31, 2005, gross margin increased
41.2% to $2.2 million from $1.6 million for the same period in 2004. Gross
margin as a percentage of revenues increased to 14.9% for the three months ended
March 31, 2005 from 11.2% for the three months ended March 31, 2004. This
overall increase in gross margin was a result of lower operating expenses on our
fixed price federal service contracts and an increase in our commercial software
and services revenue, which has higher gross margins than our federal business.
Selling, General & Administrative. For the three months ended March 31, 2005,
indirect expenses increased 12.7% to $1.9 million from $1.7 million for the same
period in 2004. These expenses grew at a rate slightly greater than the growth
rate in revenue mainly due to increases in the costs of fringe benefits,
primarily in the areas of payroll taxes and health insurance.
Net Income. For the three months ended March 31, 2005, net income increased to
$0.2 million from pro forma ($0.1) million for the same period in 2004. This
increase was a due to the increases in gross margin as discussed above, which
was partially off-set by higher selling, general and administrative expenses.
17
Liquidity and Capital Resources
Our primary liquidity needs are the financing of working capital and capital
expenditures. We have historically relied primarily on cash flow from operations
and borrowing under our credit facility to provide for our cash needs.
Net cash used by operations was $0.4 million for the three months ended March
31, 2005 was attributable to a decrease in prepaid expenses offset by decreases
in accounts payable, deferred income taxes and deferred revenue. Net cash
provided by operations of $1.8 million for the three months ended March 31, 2004
was attributable to a decrease in accounts receivable offset by a decreases in
accounts payable and deferred revenue.
Net cash used by investing activities was $0.1 million for the three months
ended March 31, 2005 and for the same period in 2004. This use of cash relates
to the capital equipment in support of operations.
Net cash provided by financing activities was $0.6 million for the three months
ended March 31, 2005 which is related to proceeds for the line of credit to fund
operations. Net cash used by financing activities of $1.0 million for the three
months ended March 31, 2004 is related to the reduction of the line of credit.
The Company had a line of credit arrangement with SunTrust Bank which expired on
June 30, 2005. Subsequently, on June 22, 2005 we received an extension of the
line of credit arrangement through September 30, 2005. Under the terms of the
latest agreement, the Corporation had to maintain: (1) minimum tangible net
worth of $2,650,000 beginning on and as of June 30, 2005; (2) debt coverage
ratio of not more than 5.0 to 1.0 beginning on and as of June 30, 2005; (3)
minimum quarterly net income of $1.00 for the quarters ending June 30 and
September 30, 2005. The Corporation was in compliance with the line of credit
agreement covenants as of June 30, 2005.
The Company terminated its line of credit agreement with SunTrust Bank effective
September 1, 2005.
On July 28, 2005, the Company entered into a two year Loan and Security
Agreement with Chevy Chase Bank that provides for a revolving line of credit
facility of up to $9 million. The agreement became effective August 4, 2005. The
revolving line of credit will be used to borrow funds for working capital and
general corporate purposes.
The revolving loans under the Chevy Chase Bank Loan and Security Agreement are
secured by a first priority lien on substantially all of the assets of the
Company, excluding intellectual property and real estate. Under the agreement,
the line is due on demand and interest is payable monthly depending on the
Corporation's leverage ratio at the LIBOR rate plus the applicable spread which
ranges from 2.25% to 3.00%. Under the terms of the agreement, the Corporation
may borrow up to the lesser of $9,000,000 or 90% of eligible U.S. Government
receivables plus 80% of eligible commercial receivables plus 75% of the
aggregate amount of billable but unbilled accounts to a maximum of $3,000,000.
The Loan and Security Agreement requires that the Company maintain the following
covenants and ratios: (1) minimum tangible net worth of $2,000,000 plus 50% of
Company's net income for each fiscal year beginning with fiscal year ending
December 31, 2005; (2) debt coverage ratio of not less than 1.500 to 1.000; (3)
maximum leverage ratio of 5.50 to 1.00, which will be decreased to 5.25 to 1.00
by December 31, 2005 and 4.00 to 1.00 by December 31, 2006. The Company was in
compliance with all covenant requirements as of September 30, 2005.
The Loan and Security Agreement contains events of default that include among
other things, non-payment of principal, interest or fees, violation of
covenants, inaccuracy of representations and warranties, cross default to
certain other indebtedness, bankruptcy and insolvency events, change of control
and material judgments. Upon occurrence of an event of default, Chevy Chase Bank
is entitled to, among other things, accelerate all obligations of the Company
and sell the Company's assets to satisfy the Company's obligations under the
Loan and Security Agreement.
We intend to, and expect over the next twelve months to be able to, fund our
operating cash, capital expenditure and debt service requirements through cash
flow from operations and borrowings under our revolving credit facility. Over
the longer term, our ability to generate sufficient cash flow from operations to
make scheduled payments on our debt obligations will depend on our future
financial performance, which will be affected by a range of economic,
competitive and business factors, many of which are outside our control.
Subsequent Events
On October 14, 2005, Paradigm Holdings, Inc., a Wyoming corporation ("Paradigm
Holdings"), Paradigm Solutions International, Inc., a Maryland corporation and
wholly-owned subsidiary of Paradigm Holdings ("PSI"), Blair Management Services,
Inc. t/d/b/a Blair Technology Group, a Pennsylvania corporation ("Blair") and
the shareholders of Blair (collectively, the "Shareholders") consummated a
merger transaction pursuant to the terms of that certain Merger Agreement (the
"Merger Agreement"), whereby Blair was merged with and into PSI. PSI is the
surviving corporation and will continue its corporate existence under the laws
of the State of Maryland as a wholly-owned subsidiary of
18
Paradigm Holdings. Pursuant to the Merger Agreement, the Shareholders exchanged
all of the issued and outstanding capital stock of Blair in exchange for (i) One
Million Dollars (US $1,000,000) and (ii) five hundred thousand shares of common
stock, par value $0.001 per share, of Paradigm Holdings (the "Shares"). Pursuant
to the Merger Agreement and an Escrow Agreement entered into by the parties,
sixty thousand (60,000) of the Shares will be held in escrow for a period of one
(1) year from the date of closing subject to the terms and conditions of the
Merger Agreement. In addition, under the terms of the Merger Agreement, Paradigm
Holdings will issue to the Shareholders up to an additional 350,000 shares of
common stock of Paradigm Holdings pursuant to an earn-out provision.
At the October 14, 2005 share price of $3.00, the transaction has a total
purchase price of $3,550,000 assuming all earn-out provisions are achieved.
Blair Technology Group was founded in 1992. The Company has provided business
continuity and information technology security solutions to over 300 commercial
customers in a variety of industries including finance, healthcare and energy.
The acquisition of Blair Technology Group allows Paradigm Holdings to combine
the OpsPlanner software suite with Blair's extensive credentials in the business
continuity arena. Paradigm Holdings can now offer our customers a comprehensive
business continuity solution. The acquisition also allows Paradigm Holdings to
expand its presence in the commercial marketplace. For the year ended December
31, 2004, Blair generated $4.6 million in revenue and $0.4 million in net
income.
At the closing of the merger, PSI entered into employment agreements with
Messrs. Kristofco, Duffy and Fochler.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk relates to change in interest rates for borrowing
under our revolving credit facility. These borrowings bear interest at a fixed
rate plus LIBOR, a variable rate. We do not use derivative financial instruments
for speculative or trading purposes. We invest our excess cash in short - term,
investment grade, interest -bearing securities.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the quarter ended March 31, 2005, an evaluation was carried out under the
supervision and with the participation of our management at that time, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
our disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act). The Chief Executive Officer and Chief Financial Officer concluded
that, as of March 31, 2005, these disclosure controls and procedures were
effective.
The board of directors of the Company, including the Chief Executive Officer and
President, identified the need to replace the Chief Financial Officer (CFO)
during May 2005 and began the search for a new CFO. Concurrent with the SEC
review of our pending Registration Statement on Form S-1, an evaluation was
carried out during December 2005 under the supervision and with the
participation of our management, including our Chief Executive Officer and new
Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange Act). The Chief
Executive Officer and new Chief Financial Officer concluded that these
disclosure controls and procedures were not effective for the quarter ended
March 31, 2005 as a result of a material weakness in internal controls as of
March 31, 2005 as discussed below.
Management is responsible for establishing and maintaining adequate internal
control over financial reporting of our company. Internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States of America.
Our company's internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures of our company are
being made only in accordance with authorizations of management and directors of
our company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of our
company's assets that could have a material effect on the financial statements.
As defined by the Public Company Accounting Oversight Board's Auditing Standard
No. 2, a material weakness is defined as a significant deficiency or combination
of significant deficiencies, that results in more than a remote likelihood that
a material misstatement of the annual or interim financial statements will not
be prevented or detected. Management's reassessment in December 2005 concluded
that we did not maintain effective internal control over financial reporting as
of March 31, 2005. As a result of the assessment, we identified the following
material weakness:
o identified insufficient resources of technical accounting and
reporting expertise. This weakness relates to the oversight and
review of financial transactions, which affects our ability to
prepare and properly review financial statements and accompanying
footnote disclosures in accordance with United States generally
accepted accounting principles and the rules and regulations of the
SEC.
19
As a result of the material weakness discussed above, the following occurred:
o restated revenue and cost of revenue balances for our federal
maintenance contracts and federal service contracts for the year
ended December 31, 2004 in our Form S-1, Amendment #6;
o restated our previously filed Form 10-K to conform to the changes
made within our Form S-1 filing. The restatement is further
discussed in "Explanatory Note" in the forepart of the Form 10-K/A,
and in Note 16, "Restatement" in the Notes to the consolidated
financial statements contained in Amendment No.2 to our Annual
Report on Form 10-K for the year ended December 31, 2004;
o restated our previously filed Forms 10-Q for the quarters ended
March 31, 2005 and June 30, 2005,to conform to the changes made in
our Form S-1 filing. The restatement is further discussed in
"Explanatory Note" in the forepart of our Forms 10-Q/A, and in Note
5, "Restatement" in the Notes to the consolidated financial
statements contained in Amendment No.2 to our Quarterly Reports on
Form 10-Q for the quarters ended March 31 , 2005 and June 30, 2005;
and
o restated our Form S-1 Amendment #6 and Forms 10-Q for the quarters
ended March 31, 2005 and June 30, 2005, to reflect the decrease in
revenue, gross margin and net income attributable to changing the
Company's revenue recognition as it relates to software licenses. In
accordance with SOP 97-2, the Company will recognize software
license revenue over the contract term until it establishes VSOE.
Remediation Plan
In addition to controls and procedures consistent with prior practices, we have
developed and are implementing remediation plans. In order to remediate the
aforementioned material weakness, we have:
o Hired a Chief Financial Officer with the requisite experience on
September 19, 2005;
o Hired a corporate controller with the requisite experience and CPA
designation on November 16, 2005;
o Hired an assistant controller with the requisite experience and CPA
designation to assist and work directly with our corporate
controller on October 15, 2005;
o Created an additional position to assist with the financial
reporting process and hired an individual for this position on May
16, 2005;
We believe that, for the reasons described above, we will be able to improve our
disclosure controls and procedures and remedy the identified material weakness.
Management of the Company will continue to evaluate the effectiveness of our
disclosure controls and procedures and anticipates the material weakness
discussed above will be remediated by December 31, 2005. Because of the inherent
limitations in all control systems, controls can provide only reasonable, not
absolute, assurance that all control issues and instances of fraud, if any, will
be or have been detected. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented
by the individual acts of some persons, by collusion of two or more people, or
by management override of the control. The design of any system of controls also
is based in part upon certain assumptions about the likelihood of future
conditions; over time, control may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitation in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
Changes in Internal Controls Over Financial Reporting
During the three months ended March 31, 2005, there were no changes in the
Company's internal control over financial reporting identified in connection
with the evaluation required by paragraph (d) of Securities Exchange Act Rules
13a-15(f) or 15d-15(f) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
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PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Paradigm Solutions Corporation involved in litigation, case number 04-32079,
filed February 24, 2005 in the district of New Jersey, both potential and
actual, arising from a contractual agreement between Paradigm and Norvergence,
Inc. ("Norvergence"). Paradigm entered into an agreement with Norvergence for
the provision of telecommunication equipment and services in June, 2003. Under
the agreement, Norvergence promised to supply all of Paradigm's
telecommunication needs for a period of 60 months for the sum of $2,152 per
month. Soon after executing the agreement with Paradigm, Norvergence sold a
portion of the rights to those payments to a third party, CIT Technology
Financial Services, Inc. ("CIT"). In July, 2004, Norvergence was forced into
bankruptcy by its creditors and, soon thereafter, Paradigm's telecommunication
services provided under the Norvergence agreement were terminated. Paradigm has
taken the position that Norvergence utilized fraud and deception to obtain the
agreement from Paradigm and has ceased paying either Norvergence or CIT.
Paradigm has filed an unsecured claim in the Norvergence bankruptcy in the
amount of $314,573 plus interest and attorney's fees. The claim is based upon
claims under the N.J.S.A. 56:8-1 et. seq. (which provides for treble damages),
common law fraud and breach of contract. Paradigm also has potential exposure to
a lawsuit from CIT. CIT has not yet sued Paradigm, but has threatened to do so.
Paradigm intends to vigorously contest any suit against it by CIT.
On May 27, 2005, the company received a settlement letter from the CIT Group
concerning this matter which is a fully executed release from this liability in
the amount of $3,948. On June 24, 2005, the company finalized this settlement
with CIT in the amount of $3,948.
ITEM 6: EXHIBITS
The exhibits required by this item are set forth on the Index to Exhibits
attached hereto.
EXHIBIT INDEX
Exhibit No. Description
31.1 Certification of CEO pursuant to Rule
13a-14(a)/15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of CFO pursuant to Rule
13a-14(a)/15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
32.2 Certification of CFO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
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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.
PARADIGM HOLDINGS, INC.
(Registrant)
By: /S/ RAYMOND A. HUGER By: /S/ RICHARD SAWCHAK
--------------------------- ---------------------------
Raymond A. Huger Richard Sawchak
Chief Executive Officer Chief Financial Officer
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